Activity Based Costing Essay

action mechanism establish wooing (first principle) is a relative new centering to wholeocate be to specific processes and attend tos. This system assures that the equals be accurately distributed to the fruits or services that generated them. rudiment illustrates equals more accurately, giving attention insight to the constitute associated with certain business activities. ABC extends the decision- qualification skills of management by expanding on traditional termsing (job order price/process order be) techniques. However, since ABCs introduction in the 1980s, many corporations ar not using ABC, despite gained managerial decision making capabilities. Even by the mid-1990s, ABCs purpose has not spread throughout the chronicle diligence and its uptake is not obvious (Selto & Jasinski, 1996). The fol mortifieding article allow for discuss the pros and cons of the ABC method.ABC is an extension of traditional carrefour cost techniques. These techniques atomic number 18 c entirelyed job order cost and process order costing. A job order costing system arranges be for each unit as it goes through a returnion process. A process cost system collects cost in work in promote account. The subjugates of units worked be recorded for the chronicle period.These systems alone do not accurately illustrate be incurred. Instead, these two costing techniques mostly lump costs into 3 main categories (cost centers). These three categories are count on materials, rate labor and bash. Cost device drivers are then casted to represent the relationship between the cost and the process it is allocated to.ABC provides a better map of the costs of manufacturing intersections or distributing services. ABC uses a host of activity centers, which are the equivalent to the previously mentioned traditional cost centers. Each of these activity centers has its own cost driver and driver rate. ABC identifies many different costs to products by adjusting the cost driver and driver rates to specific activity centers. This process avoids across the board allocations of cost. For example, a product, which takes up .03% of space in the warehouse, would require .03% cost absorbed by product gross revenue enhancement revenue. If the depreciation unit requires 5% cost to replace equipment at a latter date, 5% is the driver rate for that particular product. Unit, batchand product level costs evict be insured with ABC.The fol patheticing measurings behind summarize the ABC process. The first step is to identify the activities that consume resources and allocate costs to those activities. For example, purchasing materials, record keeping, labor, materials, miles driven, machine hours and number of nodes served are activities, which consume resources and of necessity costs to be assigned to them.The second step is to distinguish the cost drivers that are related to each activity. For example, if machine hours an activity utilize in the pro cess, then the number of hours used in production of one unit would be the particular cost driver rate. The last step is to allocate costs to products by multiplying the cost driver rate by the number of cost driver units consumed by the process.There are many inherent strengths in the ABC model. The ABC model allows costs to be allocated to many different activity centers. Few corporations can focus on undifferentiated product lines and be successful. Having multiple product lines cogitates the company has multiple cost drivers associated with each different product line. ABC is serviceful in selecting which products are successful and which ones should be eliminated. Accurate cost information is unwrap in determining the actual costs of frequent product careens. This cost is important because costs can be a good indicator of the justification or termination of varying product lines. crossway lines have become more complex. Product lines of past were much simpler. For example, the Model T Ford came in one style and one color, black. Today, Ford cars have many different colors and styles. These different styles all have different cost drivers and activity centers. ABC illuminates hidden costs when high volume sales are not present and product differentiation is. This is advantageous because unprofitable lines can be replaced with lines that are profitable.Not many years ago, labor comprised 25 to 50 percent of a products cost. However, since the 1960s, labor is increasingly little involved in theproduction process. For example, the textile industry replaced 100-year old travel looms for European air-jet looms, doubling output with less labor. In steel, the Nucor corporation used continuous casting machines to gestate labor costs of $60/ton verses traditional steels $130/ton. Labor cost today is infrequently the driving force behind costs it was during the development period of cost accounting (1930s). Instead, indirect costs have replaced labor as the d ominant portion of costs for some products (Kelly, 1991). To use labor as the major basis for allocating as job costing or process costing accounting does, may lead to inaccurate decisions by management.The accounting profession has largely overlooked ABC. Among understandings cited for low credence were employee resistance and the organizational changes essential with the use of ABC (Ness & Cucuzza, 1995). Some trace the source of hindered adoption of ABC to technical as strong as cultural issues. Others feel that ABC would be more widespread in industry if it were marketed better by the accounts themselves (Brausch, 1992).There are several reasons for ABC low adoption rate. Complexity is an obstacle to implementing ABC. ABC requires circumstantial records of the costs associated with producing products and services as compared to traditional methods. This detailed record keeping requires more effort from the accountants and is more duration consuming. The complexity of ABC ca n throw to more errors. ABC can require more time to check and recheck to uncover errors. ABC generally requires more effort on the part of the accountant verses traditional methods and reduces the adoption rate of ABC.Another reason for not using ABC is the increased economies of scale. Many corporations are standardizing their products to reduce the costs to manufacture them. For example, Coca-Cola distributes its products in many different countries. The product varies very little in respect to packaging and manufacturing. Traditional methods of accounting can assign costs more easily, quickly and accurately for those products that have little or no product variation.ABC is a valuable tool in calculating the costs of producing varying productlines. These differing product lines require more extensive accounting practices than traditional costing methods provide. The information obtained from ABC can help promote product lines that managers feel are profitable between those which should be eliminated. Labor is less frequently the major ingredient in the production process. ABC addresses this concern by examining and illustrating the overhead costs associated with particular activity centers. ABC describes these over head costs more accurately and is beneficial when increasingly more complex manufacturing processes are used. Adoption issues should be addressed to implement ABC method when costing decisions matter to managers.BibliographyReferencesBrausch, J.M. Selling ABC New Cost Systems Can Flounder if They Are Not Marketed. focusing Accounting, February 1992, pp. 42-46.Geishecker, M.L. New Technologies Support ABC. Management Accounting, blemish 1996, pp. 42-48.Kelly, K. A Bean-Counters Best Friend. Business Week, October 25, 1991, pp. 42-43.Ness, J.A. and T.G. Cucuzza. Tapping the Full voltage of ABC. Harvard Business Review, July/August 1995, pp. 130-131.Selto, F.H. and D.W. Jasinski. ABC and High Technology A Story with a Moral. Management Accountin g, March 1996, pp. 37-40. 17 activity based costing EssayExecutive SummaryThis report provides an analysis of operation found cost systems and Conventional cost systems to determine whether the application of natural process base be concepts would be useful at DBS Consulting advantages.A profitability analysis of the two consulting services offered by DBS Consulting operate (e-Commerce Consulting and entropy Systems Consulting) was performed using action mechanism found be and Conventional cost. utilize the conventional costing approach, the overheads of $342,000 were allocated at $129,960 (e-Commerce Consulting) and $212,040 (Information Systems Consulting). Using the Activity base Costing approach, the overheads of $342,000 were allocated at $107,160 (e-Commerce Consulting) and $234,840 (Information Systems Consulting). originally implementing an Activity found Costing system, management charters to assess the problems that the firm is facing so that the Activity Bas ed Costing system can be designed to address those problems. DBS Consulting Services is in a tight local labour market and is having hassle finding quality staff.It was found that E-Commerce Consulting Services provided a higher income per billings percentage than that of Information Systems Consulting Services (19% vs. 3%) under the Activity Based Costing approach. E-Commerce Consulting Services provided the higher return per sales dollar. These results would suggest that the professionals at DBS Consulting Services need to spend more time in e-Commerce.The success of failure of Activity Based Costing approach is determined by the reactions of the people who develop and use the system.An Activity Based Costing system can be high-priced and time consuming toimplement and maintain, it requires extensive training, expertise and information. However, the benefits of Activity Based Costing systems, being improved cost truth and assisting management with decision making, outweigh the se costs. displayIt is said that Activity Based Costing can result in improved costing accuracy when compared with Conventional Costing procedures.Arguments to support this claim are that companies who adopt Activity Based Costing are not limited to a wizard cost driver when having to allocate costs to their products and activities. Activity Based Costing allows companies to use non-unit cost drivers as well as unit cost drivers to allocate costs. Also, because use differs significantly amongst activities, no single cost driver can accurately assign costs for all activities whereas Activity Based Costing takes advantage of multiple cost drivers, not just a single cost driver.Arguments against this claim are that service industries often have higher levels of facility costs which misbegot fewer costs will be include in the Activity Based Costing system. Service industries also have a lot of non-repetitive activities which make it intemperate to identify an individual activity to a ssign a cost driver to.Both the conventional costing system and the Activity Based Costing system calculate the cost of a product or service in relation to the revenue it generates. However, the conventional costing system assigns manufacturing overheads based on a volume-based cost driver, and Activity Based Costing systems assign the manufacturing and non-manufacturing overheads based on the activities required to produce the item. spell 3Case Analysis name DBS Consulting Services (cont.)The Conventional Costing SystemConventional costing approaches assume that manufacturing overhead costs are related to the volume of production which is usually measured by input measures such as direct labour hours or direct machine hours.The features of a conventional costing system are repoint material and direct labour costs are traced to products Manufacturing overheads are assigned to products based on a pre-determined overhead rate The manufacturing overhead rate is calculated using a vol ume-based cost driver Non-manufacturing costs are not assigned to productsThe advantages of using a conventional costing system areThey are aligned with generally accepted accounting principles (GAAP) They are simpler than Activity Based Costing systems and easier to implementThe disadvantages of a conventional costing system areThey are not as accurate as Activity Based Costing systemsThey can result in under-costing and over-costing of products They can lead to poor management decisions as non-manufacturing costs are excludedThe Activity Based Costing SystemActivity Based Costing systems allocate manufacturing and non-manufacturing costs to a product based on the activities required to produce the item. Activity Based Costing systems calculate the cost of individual activities and then assign those costs to cost objects, such as outputs, based on the activities required to produce them.Activity Based Costing systems can be used to presage the cost a product and also as a tool for management to monitor and retard what is happening in the business by analysing the activity costs, the root causes of activities, the value of to the customer and measures of performance.The advantages of Activity Based Costing systems areThey provide a more accurate cost of productsManufacturing and non-manufacturing costs are included in the calculation They provide a greater understanding of overhead costsThe disadvantages of Activity Based Costing systems areInformation can be misinterpreted by some usersThey can be costly to implement and maintainThey involve major changes in data collection and analysis which can be challenging and also cause resistance amongst employeesCurrent System at DBS Consulting ServicesCurrently at DBS Consulting Services our administration costs (overheads) are allocated to both consulting services (e-Commerce and Information Systems) based on billable hours. The adjacent analysis presents the profitability of the firms e-Commerce and Information Systems consulting services using Conventional Costing procedures and Activity Based Costing.Part 3Case Analysis breed DBS Consulting Services (cont.)Conventional Costing ProceduresPart 3Case Analysis Report DBS Consulting Services (cont.)Activity Based Costing ProceduresAnalysisActivity-based costing procedures result in a significant increase in the overhead costs allocated to Information Systems Consulting and a significant decrease in the overhead costs allocated to e-Commerce Consulting.The conventional costing procedures allocate overheads based on billable hours which results in 38% of overhead costs being allocated to e-Commerce Consulting (=1900 billable hours for e-Commerce / 5000 replete(p) billable hours), and 62% to Information Systems Consulting (=3100 billable hours for Information Systems / 5000 total billable hours).However Activity Based Costing shows that the overhead percentage allocations vary for each activity as summarised below.Part 3Case Analysis Report DBS Consulting Services (cont.)The e-Commerce Consulting services are allocated less overhead costs using Activity Based Costing when compared to the conventional costing approach. Using the conventional costing approach, $342,000 is allocated at $129,960 (e-Commerce Consulting) and $212,040 (Information Systems Consulting). Using the Activity Based Costing approach, $342,000 is allocated at $107,160 (e-Commerce Consulting) and $234,840 (Information Systems Consulting).E-Commerce Consulting Services provides a higher income per billings percentage than that of Information Systems Consulting Services (19% vs. 3%) under the Activity Based Costing approach. This shows that although both services are charged out at the same rate, and the labour rate for both services are the same, e-Commerce Consulting Services provides the higher return per sales dollar.By adopting the Activity Based Costing approach we can determine a more accurate method of allocating overhead costs to our services which in turn will provide more accurate profit analysis of each service. This will help to increase customer and shareholder value.SummaryGiven the very tight local labour market and the fact that it is difficult to find quality staff it would not be desirable for an aggressive expansion of either consulting service regardless of the fact that both generate a profit. If we opt to expand either service this would mean having to hire more qualified staff, which as mentioned above, is difficult in todays competitive market.Before implementing an Activity Based Costing system, the following factors need to be consideredManagement needs to show faith that the benefits of the system will outweigh the costs Management and staff need to understand what Activity Based Costing is and how it can help the firm The requirement of resources to implement Activity Based Costing need to be considered Concerns about the resistance to change factors need to be addressedThe success of failure of Acti vity Based Costing approach is determined by the reactions of the people who develop and use the system. Resistance to change can impede implementation, therefore in order to succeed, there must be a program in place that is carefully thought out to take into account the factors above as well as determining the extent of change required and the different personalities involved.Employees should be encouraged to play a major role in developing and using the Activity Based Costing system to delve them a sense of ownership and help them to view the system as a tool to help them manage their work.In conclusion, an Activity Based Costing system can be costly and time consuming to implement and maintain, it requires extensive training, expertise and information. However, the benefits of Activity Based Costing on improved cost accuracy and assisting management with decision making outweigh these costs.Part 3Case Analysis Report DBS Consulting Services (cont.)ReferencesLangfield-Smith, K. , Thorne, H., & Hilton, R. (2012). Management accounting Information for creating and managing value (6th edition). North Ryde, NSW, Australia McGraw-Hill.Heisinger, K., & Hoyle, J. (2013.). Managerial Accounting,v.1.0. Retrieved April 10, 2014 from http/catalog.flatworldknowledge.comJohnson, R. (n.d.). Traditional Costing Vs. Activity-Based Costing. Retrieved April 1, 2014 from http/smallbuiness.chron.comWilkinson, J. (July 23, 2013). Activity-based Costing (ABC) vs Traditional Costing. Retrieved April 1, 2014 from http/strategiccfo.comMarx, C. (n.d.). Activity Based Costing (ABC) And Traditional Costing Systems. Retrieved April 4, 2014 from http/financialsupport.weebly.comKeshav. (n.d). Advantages And Disadvantages of Activity-Based Costing (ABC). Retrieved April 1, 2014 from http/accountlearning.blogspot.co.nzDelaware Technical Community College. (n.d.). Retrieved April 1, 2014 from https//www.dtcc.edu