Barriers of Activity Based Costing Implementation in Sri Lanka

Activity-based Costing

Activity-based costing provides a more accurate view of product cost, but companies typically use it as a supplemental costing system. The allocation bases used in activity-based costing differ from those used in traditional costing. Activity-based costing determines every activity associated with producing an item and allocates a cost to the activity. The cost assigned to the activity is then assigned to products that require the activity for production.

The feature of ABC that is of particular relevance to the use of cost in pricing is its recognition that even though a cost does not vary with volume; it may vary with some other measure of activity.

·         Unit level activities - Some activities must be performed for each unit of a product manufactured. These activities are called unit-level activities.

Ex: product inspection and testing cost in a personal computer manufacturer that inspects and tests all units.

·         Batch level activities – This are performed for each batch of units. The cost of batch activities vary with the number of batches, not the number of units manufactured.

·         Product level activities – the cost must be performed for each product level activities.

Traditional vs. ABC

In traditional approach, there is lack of cause and effect relationship between the cost allocation bases and indirect cost pools because one or a few cost pools for each department or entire plant having little homogeneity are used. In ABC approach, many homogeneous indirect cost pools for various activity areas rather than a department or entire plant are used. There is a cause and effect relationship between the cost allocation bases and the indirect cost pools.

The traditional approach usually uses a few pools of indirect costs, so cost allocations are of intently based on broad averages. The costs of products thus, absorption may be either over-costed or under costed which may lead managers to make wrong pricing decisions resulting in loss of market share by fixing higher selling prices or selling prices for some products may be below the costs incurred to produce them. Activity based costing is a rational way of assigning indirect costs to various activities and pricing decisions taken by managers will be rational.

Impotence of Activity Based Costing

The activity based job costing method or is helpful in ascertaining areas where cost reductions are possible. Activity based costing can lead to improved decision making such as fixing selling price and pinpointing the area where cost reduction is possible because it provides more detailed information about various activities involved in a product or service. With ABC businesses are able to fully identify all the costs that are associated with producing a single unit of their product. Because of this new understanding, they are able to develop pricing strategies and marketing much more efficiently.

Activity based principles can be successfully applied to the art of budgeting. Activity based budgeting is an approach to budgeting that lays emphasis on budgeting the costs of activities necessary to produce and sell products and services. Activity based budgeting is especially useful in case of budgeting of indirect costs.

Barriers of Activity Based Costing

Many managers believe they do not need product costs because the market sets prices. Since one of the main reasons for having product cost information is to set prices, managers in firms whose prices are set by the market often feel the product cost are unnecessary.

ABC method of costs may not be best if the overhead waste is perceived to be relatively low. This is because it can be very costly to implement activity based costing into a business in Sri Lanka. Experts must be brought in for an extended period of time, and other measures may be necessary for the ABC to be effective. Managers often express a concern that ABC systems are too difficult to implement and use. There is certainly a cost associated with designing and implementing a new cost system that has a different architecture and different data requirements than conventional cost accounting systems.  

There is a long time period that is involved in using an activity based costing method in a business. All of the production processes, employee actions, and aspects of the business have to be examined for an extended period of time in order to gain a big view on what the issues truly are.

ABC requires many different departments and individuals to collect and input data. Even the smallest flaw in this information can damage the entire process and the outcome would be tainted. This is one of the biggest risks that are taken on when using this method.