APPLYING ACTIVITY-BASED COSTING (ABC) TO A PARAWOOD FURNITURE FACTORY

APPLYING ACTIVITY-BASED COSTING (ABC) TO A PARAWOOD FURNITURE FACTORY

At present Parawood manufacturing industry is growing rapidly in Thailand. There is a high demand for Parawood production in foreign countries and more than 70% of parawood manufacturing is export to foreign countries. Parawood business creates some more profit than other industries but it is not able to identify clear cut percentage relating to Parawood. Two main reasons are the parawood log price is very much high and the recovery rate of sawing and manufacturing process is very much low. The raw material price is very high because of the shortage of parawood log.  This is due to many of parawood plantation owners supply is not to the timber industry but to get rubber latex. Parawood coming to timber industry when they are getting older, because of that lack of technology towards sawing of parawood. Many of parawood damaged when they are sawing. However industry has identified that it is create large cost towards the parawood industry and it is wonderful that in Thailand they do not have proper mechanism to estimate the cost involve with them. Therefore the manufactures does not know how much product that they need to produce to maximize profit. Based on this research it is identified many products are over pricing. On the other way, research giving a fully understand about allocation of sales can mislead product cost with relatively low sale values to those with high sale values.

According to the research it is identified that cost involve with Parawood as following ways,

Indirect Cost – Indirect Material

                        Indirect Labor cost

                        General Overhead cost

Direct Cost -    Direct Material cost

                        Direct Labor cost

They have decided the product cost by using the sum of Indirect Cost and Direct cost.

Additionally, by using ABC, the factory can have recognized non-value-added activities that consume resources without adding value to the products. This will help to management to identify non value added activities and reducing cost of non – value added activities. It will create effective utilization of resources by minimizing the cost.

 There are various barriers to implement ABC Costing in manufacturing environment. Data collection is time consuming and expensive. Also ABC is more complex than traditional cost system due to costs are allocated to different activity pools that are further broken down into several activities. On the other hand, to implement ABC it is required detailed analysis of financial accounting records. Statistical analysis required to allocate costs is much more complex for the ABC system.

The major advantage of the ABC method lies in a more accurate cost computation, especially in situations in which product diversity is important and in which the indirect cost represent an important proportion of total cost. Although the indirect cost, which has the most impact on the ABC approach, accounts for only 11.24% in a parawood furniture factory, its trend will be steadily increasing. This is because parawood furniture factories have been constantly changing from labor orientation to high technology manufacturing environments.

The company Background

The research was conducted at the “Wijethunga Furniture” factory located at Galle, Southern Province Sri Lanka. There are around 50 workers permanently work there and others are casual employers. They are producing different kind of furniture products which essential for home and different sizes and different quantities. Each product may need different kind of materials and machineries. Also they have specialized skill labors for each products. Also they are possessing very good distribution channel island wide for their products.

Traditional Cost system of Furniture Industry

Total cost divided into two parts as direct cost and Indirect cost. Direct cost includes direct labour, direct material cost. Other costs indirect material, indirect labor, indirect other cost are identified as indirect cost. They have calculated cost as following way.

Cost per unit of product          = Direct cost consumed by the product+ Total indirect cost

                                                                                                                  Total Sales

 Product cost using Traditional method                                                                  (Rs.)

Product	Almairah	Table	Bed	Dressing Table	Chair
Amount (No.of units)	4000	5000	4500	6000	10000
Sales	160Mn	100Mn	67.5Mn	30.0Mn	10.0Mn
Direct Material	5000	2000	3000	1500	500
Direct labor	1200	800	800	700	300
Total direct cost per unit	6200	2800	3800	2200	800
Indirect labor	2000	1500	1500	1300	1200
Indirect material	1500	2500	1300	900	800
Overhead	1200	1300	1200	800	500
Total Indirect	4700	5300	4000	3000	2500
Unit cost	10900	8100	8800	5200	3300

Implementation Procedure for Activity-Based Costing for the Furniture Factory

There are several steps involving with implementation of ABC in furniture industry.

(1)   Identifying product for analysis

Selection is based on the volume of the product sales, products with high profit margin and product with high cost. In this scenario it is identified 05 products as follows. Almairahs, Tables , Dressing Tables, Beds and chairs.

(2). Reviewing the Company’s Financial Information

Many of financial information can be obtained from the company’s income statement, balance sheet, production reports and other materials. On the other hand, some information could be obtained by direct observations such as production operations, machine setup activities, and transportation.

(3)    Identifying and Classifying of Activities (Activities Analysis)

All activities related to products are identified, and classified them as direct and indirect activities. Direct activities identified as “cost which can directly identified with products”. The other cost “which cannot identified with product directly” are identified as indirect cost. To maximize the efficient and effective decision making direct cost again classified as Direct labor cost and Direct material cost.

(4)    Determining Operating Cost for Each Activity

After proper identification of operating costs for each and every activity, the cost treated as resource consumption by each activity.

(5)    Selecting the Cost Drivers

Cost drivers are used to trace the cost of each activity to a product based on its consumption rate. As the indirect activities for operating the factory are identified , they are linked to each product based on the activities undertaken to produce each of the specific products. For an example, determining the cost of machine maintenance using the value of sales in an appropriate method. A more accurate calculation can be obtained by using the actual number of machine hours in operation. This is because the more one uses a machine, the more maintenance, rental and replacement one would require. In addition direct labor hours are appropriate for applying costs of administration, professional fees, recruitment, and employee training, because these activities are associated with direct labor.

(6)    Calculating Product Costs

At last, all activities are traced to the products using different cost drivers in order to obtain the final costs.

Table 01                                                                                                               (Rs.)

Costing item	Cost Driver	Almairah	Table	Bed	Dressing Table	Chair
Direct material	Amount of usage (ft3)	5000	2000	3000	1500	500
Direct labor	Labor time (hr)	1200	800	800	700	300
Set up	No.of set up	1	1	1	1	1
Depreciation	Machine hour (hr)	3	1	1	1	1
Transportation	No. of Trip	3	3	3	3	3
Storage	Space (ft2)	1500	1800	1500	1000	500
Maintenance	Machine time (hr)	1	1	1	1	1
Accounting	Level of sale value%	1000	800	900	700	400
Marketing	Level of sale value%	1000	800	900	700	400
HR	Labor time (hr)	800	400	400	250	200
Miscellaneous	Labor time (hr)	200	100	150	100	75
Unit cost		10708	5914	6864	4263	2084

 Cost for the above products can be classified as direct material, direct labor, depreciation, set up, transportation, storage, maintenance, accounting, marketing, HR and miscellaneous. Various cost drivers can be chosen by applying indirect activities to the product under ABC as long as cause –effect relationship is evident. Traditional costing on the other hand, uses values of sales related allocation based on amount of sales per month in its cost application.

A Comparison between Activity-Based Costing and Traditional Costing System for the Furniture Factory

                                                                                                                        (Rs.)

Product	Traditional cost	ABC	Difference
Almairah	10900	10708	192
Table	8100	5914	2186
Bed	8800	6864	1936
Dressing Table	5200	4263	937
Chair	3300	2084	1216

Cost calculated through ABC system is lower than the traditional cost system for all 05 products. For example, current cost average of Rs.8100/- for table is different from the cost computed using the ABC system and it is Rs. 5914/-. It is a decrease of 26% when compared with volume based method. All other products except “Almairah” shown big difference of cost when compared with traditional based costing. When compared with present market price and their cost, they are actually gain higher profit than they think.

Barriers to implement Activity Based Costing

Company identified some barriers which is not possible to implement ABC Costing in Furniture industry. They are as follows. Difficulty in selecting cost drivers and difficulty in defining activities were both ranked as the most common difficulties followed by high costs of ABC implementation, uncertainty of ABC benefits, difficulty in assigning resources to activities and data collection difficulties respectively.

The below mentioned the least important reasons, such as internal resistance, higher priority of other changes/projects, lack of top management support and inadequate computer software by Difficulty in selecting cost drivers

- Difficulty in defining activities

- High costs of ABC implementation

- Uncertainty of ABC benefits

- Difficulty in assigning resources to activities

- Data collection difficulties

- Difficulty in assigning activity’s costs to cost objects

- internal resistance

- A higher priority of other changes/projects

- Lack of top management support

- Inadequate computer software

- Other reasons

The manufacturing sector constituted the largest percentage of respondents, followed by Business Services and Financial Services Number of employees and annual turnover have been used and examined in the survey as variables for analyzing the firm sizes.

Quality and Price appear as the dominant and the most important factors in their marketing strategy. The mode values for all other factors (customer service, range of products, product/service innovation and marketing activities) are all the lower half of the scale.

 CONCLUSION

As mentioned in this research paper, the ABC system provides more accurate overhead costing information than volume based costing system. It creates proper cost structure to the company and it recognized costly, unproductive and unprofitable products of the company. Then the company can remove or do precautionary actions to avoid and minimize additional and unwanted cost of the organization. It assists organization to maximize profit of the organization effectively and efficiently.

Anyhow ABC system is time consuming and labor intensive process. Success of the ABC system depends on the participation of every unit of the organization.

 Finally, it is clear that ABC system is a useful tool for better management of an organization and it creates proper management decisions to improve cost system of the organization, improve proper pricing strategy to the organization and minimize unnecessary cost of the organization. Therefore, ABC costing plays a vital role for the success of the organization.