Due to a number of changes taking place in the business environment due to globalization and technology innovation, it has become necessary for the businesses to make some innovations in the use of financial and non financial information in the organizations. The demand of the new environment is up to date information about the costs of the processes, products, services and customers of the organization. Many leading companies are using their cost systems for the following purposes (CARDOS & PETE, N.D.):
- Designing of such products and services that satisfies not only the requirements of customers but also are delivered at profit
- That signifies wherever improvements in quality, efficiency and speed are required
- Help the workers/employees in improving and learning continuously
- Also guide in determining product mix and investment decisions also.
As said by (Kaplan and Cooper, 1998), managers these days need such costing systems which at least satisfy three primary functions:
- For financial reporting purposes, a accurate valuation of inventory and costs of goods sold is required as required by the users of financial statements such as creditors, investors etc. i.e. for external purposes
- For the use of internal managers for estimating the costs of activities, products and services produced by the organization.
- Accurate and timely cost information is also required by managers and operators about the process efficiency; this information assist in making strategic as well as operational improvements (CARDOS & PETE, N.D).
Activity Based Costing System
Activity Based costing System is a more accurate method for cost allocation to products. It identifies the activities as the fundamental cost objects. The ABC costing system assumes that activities cause the costs. Thus the indirect costs are allocated to the products on the basis of the activities required for their production. The costing approach relates the cost to the activity. An activity-based costing (ABC) system first traces costs to activities and then to products. Under the system cost are not assigned to the products directly but are assigned to the activities and charged to the products on the basis of the activities utilized by them.
Activity Cost Pool are the cost of each activity identified. Overheads are identified to the cost pool based on the cost driver. Cost Driver is the activity that proves cause and effect the relationship with the overhead cost and the cost pool. The cost pools are assigned to the products on the basis of the cost driver.
ABC costing can provide overall benefit to every organization. ABC costing aims at assigning the cost to the products in dollar amount that would reflect the reasonable cost of the resources consumed by the product (Lindahl W., 1997). Some cost of resources which are easy to account for the product as they can be directly associated with the production of the product like ink in the pen, paper in the Book, however the challenge lies in accounting for the cost of the resources where the connection between the resource and the product manufactured is indirect and not precise, like repair and maintenance to the machinery used for the production of multiple products. ABC helps in associating this indirect cost to the products based upon the quantum of services utilized by the product irrespective of the volume of its production. Besides allocation of cost to the product accurately ABC also helps in managing cost by providing detailed information about the cost and its behaviour (Thorne, H. and G. Gurd., 1999). Thus ABC will help an organization to identify the cost of its product more specifically and accurately and then control the cost. The use of ABC helps the management in making decisions regarding the production of the products and quantity produced. Thus ABC helps in developing the detailed and successful Decision support system (DSS), we can say that ABC costing will be suitable for both manufacturing as well as service organizations. (Cho, Charles H, Boulianne, Emilio, 2005).
At the same time, we can also say that ABC in service sector is applied only in typical service industries such as banking sector, health care and logistics and that too in a modified version which is Time Driven Activity Based Costing, TDABC which unlike ABC which usually collects the proportion of time, TDABC is more interested in actually time spend for particular activities. Second and the most importantly, TDABC uses simpler procedure to estimate cost. As mentioned previously, TDABC avoids the costly, time consuming and subjective activity surveying tasks. It is possible because TDABC assigns resource costs directly to the cost objects (such as transactions, orders, products, services and customers) by using only two set of parameters through a simple framework. Thus we can say that in a service organization the basis ABC method is not appropriate but a modified form of TDABC is applicable (Kachitvichyanukul V, 2012)
1. Thorne, H. and G. Gurd., 1999, “Activity-based costing: Improved product costing or activity management?”, Published in Advances in Management Accounting (8): 173 – 194, summary from http://maaw.info/ArticleSummaries/ArtSumThorneGurd99.htm
2. Cardos and Pete, N.D. “ABC and ABM-Is this the solution for organizations to gain profitability?” retrieved from: http://www.revecon.ro/articles/2011-1/2011-1-9.pdf
3. Cho, Charles H, Boulianne, Emilio, 2005, “Development of a Decision Support System Based on ABC for Costing and Pricing Decisions and its Conversion to a Web-based DSS”, Published in Journal of Applied Management Accounting Research, on July 1, 2005, http://www.allbusiness.com/electronics/computer-equipment-computer/13478454-1.html
4. Lindahl, W., 1997, “Activity-based costing implementation and adaptation”, Published in Human Resource Planning on June 1, 1997 http://www.allbusiness.com/public-administration/administration-human/632602-1.html
5. Kachitvichyanukul V, 2012, “Application of Time Driven Activity Based Costing to and Industrial service Provider, retrieved from: http://www.apiems.net/conf2012/T5D3.pdf