What is Activity Based Costing (ABC)?

Few people will begin a journey with a map that displays neither where they are nor their destination. Yet, organizations seek to contend without knowing the real profit and cost of their products/services, and consumers. To build more value and improve their profitability, companies in service and manufacturing sectors need precise data on costs. Activity Based Costing (ABC) can furnish this. However, organizing an effectual ABC initiative is not easy. ABC is a technique of assigning total costs to consumers or products (Zeuner, 2012). This method was created by Robert Kaplan and Robin Cooper in 1988 to allocate overhead expenses to activities by cost drivers, and subsequently to cost objects like customers, products, machinery, divisions and services. Their goal was to remove the shortcomings of the outmoded volume-based costing techniques and furnish more precise information about a company’s production cost, profitability and managerial decision making by concentrating on the cost of every activity. Many researchers have performed studies and found that the implementation of ABC can offer ample advantages to several users (Kim, 2017).

Overhead expenses within a company are allocated to myriad activities to develop cost “pool.” Activities refer to a grouping of several distinct tasks. Overheads from General Ledger are allocated to cost pools after taking into account ‘resource cost drivers.’ Such cost pools are then assigned to cost objects by way of ‘activity cost drivers,’ which differ with the volume and kind of activities. The key differentiating element between traditional costing and ABC is that the latter relies on a higher number of cost centres and several kinds of second phase cost drivers. Resultantly, as it employs a higher number of cost drivers and cost centres, ABC can be more precise than conventional costing in the context of goods/service costs (Wagener, 2013). The present paper revolves around two studies performed in the gamut of Activity-Based Costing in different firms and industries. The aim is to understand how these two studies explore the subject of ABC and how their findings can be used by management accountants in Australian companies.

Fei, Z., Namazi, M. and Isa, C., 2017. Investigating the Empirical Effect of ABC Stages on the Performance of Companies. Journal of Applied Management Accounting Research, 10(1), pp. 175-205.

From 1925 to 1985, management accounting as a practice transformed very little. Customary management accounting models generated highly aggregated cost data which was assigned to products through arbitrary and simplistic ways, and the allocations were often not connected with demands made by the products (Donaldson, 2001). In the past two decades, however, the speed of change in management accounting practices has started to grow, and some innovations have produced much interest as Activity-Based Costing. Resultantly, many scholars were motivated to perform research to analyze the effect of ABC employment on firm’s economic performance like augmenting shareholders’ value, gaining higher ROI, and manufacturing performance like reduced product costs decreased production processes, and quality improvement (Schoute, 2011).

Most of these research works, nonetheless, present at least 3 shortcomings. Firstly, they provided the indirect effect of ABC. For example, Abusalama’s (2008) research identified no direct relation between ABC application and shareholders’ value among public companies in the UK. Secondly, the research works are underpinned by imperfect performance standards that, at best, identify some economic facet of the company’s performance. In contrast, a careful assessment of the impact of ABC on the company must be underpinned by all elements of the company’s financial and non-financial features (Todorovic, 2016). Lastly, the existing literature in this domain has not analyzed the impact of the different phases of ABC use and the ABC stage evolutions on the company performance. Therefore, the role of distinct phases of the ABC on the company’s performance is completely unexplored (Cao and Yu, 2016).

Benefits of Activity Based Costing (ABC)

Based on these arguments, the main purpose of this study was to address with the abovementioned issues empirically. To be precise, the main objectives of this study were:

1. To identify whether there is a considerable relation between ABC application attributes and company’s performance. This includes the attainment of cost targets, efficiency targets, services goals, quality goals, sales targets and profit goals.
2. To analyze if stages of ABC use will play a mediating role during the process of examining the impact of ABC use success on the company’s

Till date, empirical works regarding the effect of ABC on company performance have majorly been performed on organizations in the Western World. These works have given limited evidence pertaining to the impact of ABC use on company performance. Since China is typified as an Asian culture which is clearly distinct from the ones of the Western firms, it is likely that the stages of ABC use and its impact on the Chinese firms’ performance are very distinct from those of the Western firms. China has a high uncertainty-avoidance culture, whereas Western firms follow the low uncertainty-avoidance culture. Hence Chinese company may be hesitant in adopting ABC in their workplace. Therefore, this study conducted a study on Chinese manufacturing companies. 

Quinn, M., Elafi, O. and Mulgrew, M., 2017. Reasons for not changing to activity-based costing: a survey of Irish Firms. Journals of Management Accounting Research, 1(1), pp.63-70.

A lot has been researched and written on the incorporation and adoption of ABC in different countries and settings. Some of these empirical works cite reasons for non-adoption, entailing organizational and technical issues. The implications of quick changes in modern IT and the implications of the recent economic climate have added a new angle to any workplace research, and it is postulated in this research that this may even be applicable to the implementation of more advanced management accounting practices like ABC. There is a huge body of literature in the domain of management accounting explaining IT as a key influence on the discipline. Nonetheless, most of this study precedes the introduction of new technologies like cloud computing – which reduce IT costs and hence potentially augment usage – and the immense leaps in technological advancement in the last one and a half decade.

Likewise, since, 2008, the economic situation of companies has altered because of the recession. For example, Smith, Burt and Gentile (2017) posit how economic change drove the evolution of new management accounting models and more recently, Zhang, Hoque and Isa (2015) cite that the current global recession has impacted all nations. Provided such economic conditions, it is suggested that companies have had to access their goods/services costs and hence may have incorporated more advanced costing methods like ABC. When mixed with the lower costs of IT, it can be expected that the implementation of ABC would rise (Popesko, Záme?ník and Kolkova, 2016). However, this is not always the case. Hence, this paper explored reasons why the implementation of ABC did not rise, based on a survey of Irish companies. Specifically, the main research question of the study was – why companies do not shift from their current costing systems to a more mature costing method, i.e. ABC.

The study draws on the broader research of management accounting in big and medium-sized Irish companies. The emphasis is on particular reasons why companies do not want to shift from their existing costing systems to ABC. The research used The Irish Times Top 1000 database to determine suitable sample companies.

Challenges of implementing Activity Based Costing (ABC)

There are mainly differences in the findings of the two studies, primarily due to the different purposes of the two works. The main objectives of the first research were: 1) to analyze whether ABC adoption can lead to a salient effect on company performance in Chinese manufacturing firms, and 2) to identify whether the phases of ABC application can have a mediating role to play in the relationship between ABC implementation success and company performance. The findings of this study, based on the multiple regression examination in terms of the first objective, support the hypothesis that ABC adoption suggests a direct and significant impact on the company’s performance. To be specific, the findings reflect that ABC adoption significantly and positively impact only the attainment of quality and cost goals. The outcomes are incongruent with previous research results in the Western nations. However, these are congruent with earlier works among manufacturing firms in Singapore and Malaysia.

However, the second study has been performed on a different tangent. Its aim is in stark contrast with the goal of the first study. The second study was aimed at identifying reasons among Irish companies for not switching to more advanced costing systems like ABC. The research instruments and methods used for both the studies were different, and so were their research participants.

However, there is some similarity in the findings of the two studies. In the past two decades, ABC has been endorsed as the core for taking strategic decisions and for enhancing profit performance. Nonetheless, both the studies have an undertone stating that though ABC has gained wide and quick acceptance, there is considerable diversity of perspective, as far as the efficacy of ABC is concerned. Both the studies highlight that the samples selected were not very clear about the contribution of ABC to the betterment of their company’s bottom line.

The findings of both the studies show that despite the benefits ABC provides over the more customary approach to addressing overhead costs, the adoption of ABC is low in some places. The studies reveal that active support of the management is key in the effective adoption and application of ABC. Besides, giving all the means and resources of implementation, the senior management must also demonstrate active support to an accounting staff for implementing ABC. A major reason why companies are not shifting from traditional systems to ABC is that of management’s rigidity to move from the long-standing systems. The studies also make it evident that in the situations where accountants retained ownership of the system and were reluctant to share it with other people, i.e. non-accountants, the adoption of ABC cannot be fruitful. Both the studies put forward some barriers that inhibit the successful implementation of ABC. Synthesizing these barriers, two different sets of variables were obtained that impact ABC adoption and its effective implementation. The one set of variables is dependent on the situations that companies face, and the other set is typical barriers. The contingent factors render ABC suitable for use by specific firms. Hence, for example, companies having a high amount of overheads are more likely to see ABC as suitable for their specific information requirements as compared to companies with lower overheads. Nonetheless, for ABC to be implemented by a company the second set of factors, i.e. “Barriers” should be overcome.

Two Studies in the Gamut of Activity Based Costing

1.

The results of the first research showing that the information given by the application of the ABC method will directly help managers in determining tough problems like zero-value added reworks and activities. The findings of the first study show that the phases of ABC implementation will mediate the impact of the relationship between company performance and ABC application success. To be specific, profits, costs, market shares and services, as elements of a company’s performance, were mediated by the ABC phases. Unexpectedly, the fact that initial adopters of ABC perceived the company performance as an outcome of the effective application of the ABC is superior to that of mature adopters of ABC (Fei, Namazi and Isa, 2017). Such findings were found to be consistent with previous non-Western studies. Nonetheless, they are not congruent with Western nations’ findings like the results of Anti? and Sekuli?, (2017) who identified that higher phases of ABC implementation could lead to greater level of supposed performance of the companies. The reasons behind the findings of the study in question may be because of the presence of an uneven number of mature and initial adopters of the ABC. The results could also be attributed to matured companies’ awareness about weaknesses and hindrances encompassed in applying ABC.

• Firstly, it expanded the gamut of the existing ABC literature to analyzing the impact of ABC adoption on the company’s performance in an Asian context.
• Secondly, by furnishing empirical evidence, the research specifically uncovered that, as opposed to the Western findings, the impact of ABC implementation on the company’s performance among Chinese companies is direct, at least for the attainment of quality and cost goals. This shows that management accountants and senior management cadre must focus on the aspects of quality and cost while restructuring cost management models, especially, for the intentions of performance analysis (Fei, Namazi and Isa, 2017).
• Thirdly, the research in question extends the prevailing theories and literature on ABC by taking into account varied stages of its adoption as an influential factor impacting the company performance. It clearly shows that considering the stages of ABC, as a mediating factor, will not just enhance the theory of the system in the area of performance assessment, but will also lead to fostering the relationship between the performance of the company and ABC application (Fei, Namazi and Isa, 2017).
• Lastly, the research explicitly shows that the mediating impact of the ABC phases on exploring the impact of the ABC application on the company’s performance is significant. These results are mainly noticeable for the initial users of ABC when the issues of market shares, costs, profits and service are involved in their performance evaluation process.

This brief research determined that ABC application rates among the Irish companies are low, especially in comparison to the findings of the earlier studies of a similar context and nature. This is in spite of the fact that respondents, on the whole, did not note knowledge or technical issues as reasons for not adopting ABC. It appears from the findings that the majority of the respondent companies were content with more conventional techniques and have been for several years now. These techniques will seem to be resistant to transition, even in the case of economic shocks and/or growing availability of Information Technology (Quinn, Elafi and Mulgrew, 2017). The findings show that the degree of information technology in the companies is not the main factor for not adopting ABC. Rather, the key reason for non-adoption is centred on stable, ongoing costing systems, which companies expressed content with.

• Firstly, the management accountants in Australia should understand that management accounting systems are prone to be more stable over time and might also be institutionalized. Hence, to ease the change from traditional, long-standing costing systems to ABC, it is important to bring a change in the mindset of the management (Quinn, Elafi and Mulgrew, 2017).
• Secondly, the research suggests that “Contingent Variables” are at play when deciding the application of ABC in the firm. These Contingent Variables render it useful or suitable for the organization to implement ABC, and the management’s readiness or ability to tackle the barriers related to ABC adoption. Management accountants should understand that there is a strong relationship between the adoption of ABC and contingent variables. Hence, from this finding, they can understand that the suitability of any costing system depends on the factors facing a company (Quinn, Elafi and Mulgrew, 2017).
• Thirdly, the study has categorized implementation difficulties into 3 key types. These are “Systems”, “Behavioral”, and “Technical.” Such classification will allow the management accountants to understand which issue is specific to their company. For example, individually determined problems like issues in recognizing activity centres, issues in determining cost drivers and so on can be put under “Technical Issues.” Similarly, problems like shortage of appropriate accounting staff, lack of support from senior management and etc. can be placed under “Behavioral Issues.” “Systems Issues” can include problems with software, or data collection etc. (Quinn, Elafi and Mulgrew, 2017). Such a clear grouping of the barriers pertaining to ABC adoption will help the management accountants target the exact problem and derive a relevant
• Lastly, management accountants and senior management both must understand that training is a crucial factor because it helps the workers to comprehend how ABC varies from traditional cost accounting. Management accountants must be trained the processes, goals and advantages of ABC application. This will enhance their confidence and invigorate a positive approach toward its implementation.

Conclusion

To sum, the report puts in perspective two different studies performed on the subject of Activity Based Costing. These studies have been performed in different context, using different research methods, and on different sample populations. Hence, evidently, their findings will reflect differences. Nonetheless, despite so many differences, the undertone of both the studies bear some similarities, especially when it comes to the perception of ABC and factors restricting its successful adoption and application.

References

Abusalama, F., (2008). Barriers to Adopting Activity-based Costing Systems (ABC): an Empirical Investigation Using Cluster Analysis. Dublin Institute of Technology.

Anti?, L. & Sekuli?, V., (2017). ACTIVITY-BASED COSTING IN HEALTH CARE ORGANIZATIONS. Facta Universitatis, Series: Economics and Organization, pp.351-364.

Cao, X. & Yu, Z., (2016). Applied research of activity-based costing under ERP environment. In Service Systems and Service Management (ICSSSM), 2016 13th International Conference on (pp. 1-5). IEEE.

Donaldson, L., (2001). The Contingency Theory of Organizations. SAGE.

Fei, Z., Namazi, M. & Isa, C., (2017). Investigating the Empirical Effect of ABC Stages on the Performance of Companies. Journal of Applied Management Accounting Research, 10(1), pp. 175-205.

Kim, Y., (2017). Activity Based Costing for Construction Companies. John Wiley & Sons.

Popesko, B., Záme?ník, R. & Kolkova, A., (2016). Profitability analysis of urban mass transport lines using activity-based costing method: An evidence from the Czech Republic. Journal of Applied Engineering Science, 14(3), pp.335-344.

Quinn, M., Elafi, O. & Mulgrew, M., (2017).  Reasons for not changing to activity-based costing: a survey of Irish Firms. Journals of Management Accounting Research, 1(1), pp.63-70.

Schoute, M., (2011). The relationship between product diversity, usage of advanced manufacturing technologies and activity-based costing adoption. The British Accounting Review, 43, pp. 120-134.

Smith, J., Burt, I. & Gentile, M., (2017). Activity Based Costing in Intercollegiate Athletic Departments: Is There Value in Using It?.

Todorovic, M., (2016). TIME-DRIVEN ACTIVITY-BASED COSTING AS A TOOL OF BUILDING AN INTEGRATED MANAGEMENT SYSTEM. Facta Universitatis, Series: Economics and Organization, pp.45-57.

Wagener, D., (2013).  Activity-Based Costing and Its Later Development Into Activity Based Budgeting and Management. GRIN Verlag.

Zeuner, P., (2012).  Activity-Based Costing. GRIN Verlag.         

Zhang, Y. F., Hoque, Z., & Isa, C. (2015). The effect of organizational culture and structure on the success of activity-based costing implementation. Advances in Management Accounting?25, pp.229- 257.