ABC and the Traditional Costing Methods

ABC AND THE TRADITIONAL COSTING METHODS 5

ABC and the Traditional CostingMethods

ABC and the Traditional CostingMethods

In “Profit Priorities fromActivity-Based Costing”, Robert Cooper and Robert S Kaplan seek toexplore the utility of ABC as an approach for accounting in business.They acknowledge that ABC has become one of the most appropriate anduseful guides for action of the management that can directlytranslate to higher profits. There are varied key aspects of ABC thatmake it useful in business entities. First, ABC would give businessmanagers a clear picture regarding the manner in which regions,facilities, distribution channels, brands facilities and customersconsume resources and generate revenues, in which case they reveallinks between the performance of particular activities and demandspertaining to the same (Cooper &amp Kaplan, 1991). The analysis ofABC would allow mangers to concentrate their energy and attention tothe improvement of activities that have the highest effect on thebottom-line. In addition, the analysis of ABC would give managers thecapacity to slice the business in varied ways such as by group ofsimilar products, client group and distribution channels among othersand provides a close-up view pertaining to the slice underconsideration. it would also illuminate the activities that areassociated with a particular aspect of the business and the manner inwhich those activities are connected to the production of revenuesand resource consumption. Of course, there is the question on why ABCanalysis comes off as a better measure of the relationships betweenresource consumption and activities, as well as profits. Traditionalcost accounting systems make use of bases such as machine hours anddirect labor in allocating the expenses of support and indirectactivities to products. ABC, on the other hand, segregates theexpenses pertaining to support and indirect resources by activities,thereby assigning the activities on the basis of their drivers.

Similarly, ABC can assistmanagers in anticipating the effects of the planned changes. Thiscomes into play particularly considering the additional insight thatthe method provides through its hierarchy, where it demonstrates thatproduct-related activities would not have an impact on facility levelcosts rather only product-sustaining, batch and units expenses shouldbe assigned to products. In essence, facility-level expenses in ABCwould not be allocated to products but kept at plant level (Cooper &ampKaplan, 1991). Further, ABC analysis would assist managers in thereduction of demands for resources through concentrating on theproduct line.

As stated, ABC analysis wouldhighlight the areas where actions would most likely have the highestimpact on the profits. Once this has been done, managers should tryto re-price the products by raising the price of the products thatdemand more support services and reduce the prices of the high volumeproducts that have been subsidizing the others. In addition, managersmust come up with ways for lowering resource consumption (Cooper &ampKaplan, 1991). This may revolve around a reduction of the number oftimes that activities are undertaken for the same output or loweringthe resources that are consumed in the production and service of thecurrent customer or product mix.

In “Whyactivity based costing (ABC) is still tagging behind the traditionalcosting in Malaysia”,Rasiah Devinaga seeks to eliminate the conception that ABC may bebetter than the traditional costing methods in all cases. UsingMalaysia as the base country for his study, Rasiah notes that a largenumber of operations managers believed that their current costssystems were sufficient for decision-making and could even be moreeffective compared to other cost systems. Traditional Cost Accountingexamined the expenses while ABC technique examines what wasaccomplished in terms of activities (Rasiah, 2011). ABC, therefore,becomes more effective in the identification of opportunities thatreduce costs and improve performance. On the same note, ABC wasdetermined to offer much better visibility into the businessdevelopment and cost drivers thereby enabling managers to eliminatecosts pertaining to non-value added activities and develop theefficiencies pertaining to present development (Rasiah, 2011). Italso offered mangers more structured approaches for assessingexpenses pertaining to specific activities used in production. Itsdifferent cost objectives allowed for the analysis of customerprofitability, thereby giving the managers a market-oriented view ofthe manner in which proceeds are earned. Further, it can create adistinction between the costs pertaining to serving varying customersegments.

However, the applicability ofABC on SMEs is contested. Scholars have indicated that ABC are moresophisticated as they are more expensive to operate. As much as ABCcould be a tool for decision-making in pricing and product mixcosting decisions or even more accurate in costing data, it is notonly expensive to use but also comes with an increased frequency oferrors in the measurement of product cost. In addition, it onlyoffered beneficial results within specific conditions (Rasiah, 2011).Essentially, traditional costing systems may not be relevant indynamically changing environments given that traditional costingsystems are founded on the assumptions pertaining to long productionruns for standard products that have static specifications. ACBSwould also be limited given the need for exceptionally too manydetails, requirement of too much time, prospects of insufficient dataand unrealistic expectations for a high level of exactness.

References

Cooper, R &amp Kaplan, R. S(1991). Profit Priorities from Aotivity-Based Costing. HarvardBusiness Review

Rasiah, D (2011). Why activitybased costing (ABC) is still tagging behind the traditional costingin Malaysia?, Journalof Applied Finance &amp Banking,ISSN 1792-6599, Vol. 1, Iss. 1, pp. 83-106