Activity Based Costing Method

Question: 1

Activity based costing (ABC) is an accounting method which involves identifying the activities of a firm and assigning overhead cost to the products (activity based costing - ABC, 2015). This method is proven to be more accurate than traditional method which uses direct labor hours, machine hours or other volume based measures to assign indirect cost to products (Mowsen, 202). ABC costing allows companies to identify how much profit products are making and to eliminate unproductive activities. It recognizes the real cost associated with a product and thus makes it easier to fix correct price for a particular product. It helps in allocating resources to the products and services which are more profitable hence increase profitability

Kaplan in the creation of the balance scorecard in 1988. Since then this method is adopted by companies in different industries and governments. Chrysler, one of the biggest American automobile manufacturers adopted ABC costing in 1991. In an article ‘ tapping the potential of ABC costing” on Harvard business review authors Ness and Cucuzza examined Chryslers adoption of ABC costing and it was found it saved cost up to 50 to 100% at some of its sites. Similarly ABC adoption in Chinese electricity company Xu Ji has enabled them to standardize their working practices and processes (activity based costing, 2015). It also facilitates company’s IT development (activity based costing, 2015).

Despite the many advantages of ABC costing, the implementation of ABC remains low in many countries (Abusalama, 2008). The reason is due to its complexity in implementation. According to researches and surveys on adoption and non adoption of ABC costing in different industries and countries, the issues faced by the implementers of activity based costing can be categorized into 3 categories. These are systems, technical and organizational issues (Abusalama, 2008). Out of these, technical issues where more dominant (Abusalama, 2008). The following are the most frequent problems faced by the implementers of

There is difficulty in identifying and selecting suitable activity driver. For example phone calls to the customer may be due to delay in payments by the customer (activity based costing implementation issues, 2015). And the delay in payments may be due to goods supplied to the customer being unsatisfactory. So the root cause may not be known. And the root cause will give the management the most valuable information (activity based costing implementation issues, 2015).

7. Other than technical and system issues organizational culture and availability of resources plays important role in the success of ABC costing implementation. ABC costing implementation and management requires more employees who are trained in the field. And this also requires giving trainings to the existing employees.

8.The top management may be resistant to change as they are afraid to reveal detail information as it might lead to use of those information against them.

9 The employees may be satisfied with the existing traditional system and they may resist any change.

10 Implementation of ABC system brings about a major change to the entire organization. Initial implementation will require lot of work by the employees. And the system requires monitoring of all the activities of the employees. So employees may not be motivated or enthusiastic about the change. The change requires Full cooperation by the employees.

11. Lack of adequate computer software for ABC