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.
