Abstract
The research
study has based on activity based costing with the objectives which are; to find out the implementation
problems of applying activity based costing, to discuss solutions for those
problems and to facilitate activity based costing in Sri Lankan companies. The
literature review has based on an exploratory research of ABC method implementation
in Serbia. According to the guidance of Professor
Kennedy Gunawardana, a mini research works has been conducted by selecting
three manufacturing companies which are using activity based costing. The data
collection method was interviews with relevant managers and accountants of the
company. By conducting those interviews major four issues have been identified
and those have included as a summary in findings. Finally it has concluded with
several suggested solutions for identified issues in order to achieve the vital
objectives of the research.
INTRODUCTION
Background
Costing systems play an important role in overhead costs
allocation on results of production, providing in the same time the management
of one company with important information about: production price of product or
service; the sale price (pricing strategy); information that assists in
business planning and controlling; and information that help managers in
process of alternative decision-making.
Traditional
costing systems allocate production overhead costs to products and services
according to the volume-based cost drivers. In production companies cost
drivers are usually machine-hours, the time that worker spends using a machine
in order to produce one product, or direct-labour hour which is the employee’s
time spent in production of specific product. Those drivers are correlated with
amount of working hours of employees and machines that are directly engaged in
production of products. The greater amount of costs will be allocated to the
products or service that requires more labour or machine hours to be completed.
This is logical and practical solution of a very complex problem, but it cannot
be applied in service providing organizations without sacrificing precision in
cost allocation.
Objectives
·
To find out the implementation problems of
applying activity based costing
·
To discuss solutions for those problems
·
To facilitate activity based costing in
Sri Lankan companies
LITERATURE REVIEW
Robert S. Kaplan introduced in 1988 new costing system (classic
model) as a response to disadvantages and shortcomings of traditional costing
methods.1 Activity based costing system (ABC) quickly found its way to
production companies. The main difference between this method and traditional
costing methods is in the treatment of indirect costs. There is a direct
connection between the results of production and directs costs (such is the
price and quantity of wood used in production of chairs or tables), making its
allocation simple. The problem lies with indirect costs; such is the cost of
electricity used for lighting in production plants, because they have no direct
causal connection with results of production. Total costs could be also
classified to costs of production and period costs. Product cost is a cost
assigned to goods that were either purchased or manufactured for resale, while
period costs consist of costs recognized as expenses during the period in which
they incurred and therefore will be covered with periodical result. Overhead
production costs are not easily traced to the results of production, since
these costs often have no direct relationship with one individual product/service
or activity. In average, production costs, in production companies, measure from
40% to 60% of total costs. However, in service-providing entities, such as
commercial banks, indirect costs make up the largest part of total costs. In
such situations, accurate cost accounting is required, and Activity-based
costing suits this requirements the most.
There are many definitions of the word - activity. Activity is
every repeated action, movement or order of operations, carried out in order to
execute the business function; and it can be described with a verb or noun, for
example starting the machines or unloading of raw materials.
(Rainborn and others, 1996) According to Brimson, activity can be
defined as appropriate combination of people, technology, raw materials,
methods and environment necessary for the production of certain products or
services, which describes what one company does and how it uses its time and
resources in order to achieve its goals. (Brimson, 1991) From these definitions
it can be concluded that activity is a very small part of the business of one
company that employs and spend its resources, and can be divided into smaller
fractions. When implementing activity-based costing system for the first time,
it is very important to develop suitable activity dictionary which is the list
of activities that company perform in its business. While composing activity
dictionary, organizational structure and size of a company can be helpful. When
defining activities, complex business is divided into basic operations and activities
that can be perceived and managed. Different data collection methods and
techniques can be used here, such as conducting interview with key staff, using
diaries or notes of employees and direct observation of activities.
Nevertheless, the basic principles of efficiency and materiality should not be
ignored.
Traditional costing systems have four very complex stages in cost
allocation; Activity-based costing system has only two. In the first phase of
cost allocation, according to Activity-based costing method, total indirect
costs are determined on company or business unit level. The next step is to
define the activities that have to be accomplished in order to provide a
service or to have a product being finalized. Activity-based costing system assumes
that the execution of a certain activities drives the creation of production
costs opposing to the assumption of traditional costing systems that suppose
that results of production (products and services) cause the existence of these
costs. Therefore, indirect costs are allocated on activities or activity cost
pools in the first stage of this method based on pre-defined cost drivers. The
second stage of activity-based costing method distributes total amount of
allocated costs of activity centers to cost objects.
Cost drivers are associated with the nature of activity performed.
As example, in trading company, where one activity can be purchasing of goods
to be sold, the number of suppliers and/or the number of purchase orders could
be recognized as cost drivers. All costs calculated in order to get one
purchase order to be accomplished will be allocated to that activity. In second
phase of Activity-based costing method, allocated costs are being distributed
to cost objects (in this example the good to be sold) according to cost driver
- number of purchase orders accomplished for purchase of that good to be sold.
Therefore, inventory that has been purchased in greater amounts or several
times more than the others groups of inventories will be allocated with higher
amount of indirect overhead costs or the more the activities are performed the
higher will be the overhead cost applied to cost object.
The previous paragraph described classic model of Activity-based
costing method, however in 2004 Kaplan introduced more up to date model:
Time-driven Activity-based costing. This model is even more suited and adapted
for application in service-providing companies, though it can be applied in
manufacturing companies as well. Time-driven Activity-based costing can successfully
implemented in commercial banks. As an example, we can analyse one sector within
the bank – credit department. Activities centers could be defined as: loan
approval, customer complaints processing and other requests. The main
difference between classical and modern model is the inclusion of new
dimension: the capacity utilization. Namely, it is estimated practical capacity
at the level of one sector or company, which represents the approximate number
of working hours provided by employees that will be exploited in certain period
of time. Unused capacity includes the time employees spend on breaks, arrival
and departure from work and time that is not directly linked to the performance
of the operations or activities. Furthermore, allocated indirect costs at the
level of sector can be divided with number of working hours in order to
calculate the amount of costs needed for execution of one unit of time – hours
or minutes. Previous calculation is needed for cost allocation to activities.
By multiplying working hours needed for one activity to be
accomplished with cost per working hour, indirect costs are being allocated to
activities or activity centers. The second stage of Activity-based costing
method distributes allocated indirect costs of activities to cost objects
(single client, or group of clients), by recording all activities conducted for
each group of customers6. Using this calculation, the total indirect costs for
each group of clients could be calculated, by adding all distributed costs for
each client. This information is necessary for pricing strategy. Still, there
is a portion of indirect costs that cannot be allocated, no matter which
costing method company implies, and has to be covered with periodical result. Sometimes
this amount of costs can be sufficient to turn positive periodical result to
negative. Therefore, it is necessary to strive for thorough and complete
indirect costs allocation.
When
discussing real life implementation of activity-based costing, there are
numerous companies that have been used Activity-based costing method in
profitability studies to help them decide which products or clients to cut or
keep. But ABC system helps in decision making in so many other ways. Thousands
of firms have adopted or explored the feasibility of adopting Activity-based
costing, but many have given up, or their programs are stagnating.
The
need to measure more precisely how different services and products use
resources has led companies such as American Express, to refine their costing
systems introducing Activity-based costing system. Other examples of successful
Activity-based costing integration are service providing companies such as The
Cooperative Bank, Nawaloka Hospital,. Also, many retail and wholesale companies
(a retailer and distributor of grocery store products) and Owens and Minor
(medical supplies distributor) have used Activity-based costing method,
alongside with giant Hewlett-Packard. Finally, the initial cost of
Activity-based costing system implementation is either insignificant or less
than 1% of the sales (in most companies) and accordingly the payback period is
less than one year, which concludes that integrating new costing model in
company doesn’t have to be expensive.
FINDINGS
Data collection method – Interviews
Companies:
Finlays
Teas(pvt) Limited
Macbertan (Private)
Limited
By
considering all the ideas and facts which were collected by interviews from
above three companies it could be identified under following four major
headings.
Issues
relating to number of activities.
One
issue examiners frequently confront humorously, more often than not by the
individuals who have grasped the ABC idea most eagerly is the allurement to
assemble an action list that goes down to too fine a level of subtle element.
There are handy issues connected with displaying an excess of exercises
ascertaining the model takes longer, keeping up the action rundown is an
authoritative bad dream, and ordering exercises to distinguish squandered
movement turns into a more burdensome occupation.
In
any case all the more critically including more detail doesn't give better
data. At the point when a model contains a great many exercises, its hard to
home in on germane data you can't see the timberland for the trees. Numerous
exercises will have irrelevant sums apportioned to them. It's best to consider
how you will utilize the movement investigation before you characterize the
exercises, and afterward pick a level of subtle element that is proper.
Case
in point, in case we're setting up a vital examination, its most likely
sufficient to characterize as few as 20 or 30 exercises. In actuality, these
exercises most likely would be at a sufficiently high level to be named
techniques for instance, a progression of related exercises that make the
"client deals request methodology"—instead of the individual
exercises that structure a piece of that process, for example, "take
client arrange by phone." Dividing the procedure cost by a suitable
driver, for example, number of client deals requests, gives a measure that can
be utilized to stand up in comparison the same process in different
organizations, or for exploring conceivable outsourcing choices. What's more,
in the event that you accordingly conclude that you need to grow the
examination to, say, 50 or 75 exercises, its sensibly simple to do as such without
principal changes in the mode.
For
strategic displaying, you have to work at a more itemized level. This is an
absolute necessity when examining squandered expenses, in light of the fact
that it gets to be important to examine exercises identified with slip
amendment, duplication, and holding up. More detail is additionally required
for item, client, and channel costing, so we can allocate diverse exercises to
distinctive mixes of exercises utilizing distinctive expense drivers. A regular
strategic model may investigate somewhere around 200 and 300 exercises and
maybe 10 or 20 drivers. Business process change obliges exercises to be
dissected at a low level—maybe down to assignment or, more probable, a mix of
undertaking and movement level.
In
the event that the entire business is to be inspected, business process change
some of the time brings about more than a thousand exercises. Displaying at
such a level could turn out to be a perplexing and protracted methodology, and
the requirement for such an itemized methodology would significantly rely on
the association's circumstances and its requirement for such data.
One
beginning stage is to add to a generally straightforward key ABC model, which
focuses administration toward ranges that need consideration. More itemized
displaying activities can then be run, concentrating on those ranges of
concern. On the other hand, in case you're keen on expense adequacy, eventually
you have to model at the strategic (action based) level—else, you can't
separate between those exercises that include esteem and those that do
Issues
in Selecting cost drivers
A standout amongst the most troublesome parts of ABC execution is
recognizing and selecting suitable drivers. One reason is on the grounds that
its not generally instantly obvious what drives a specific movement. For
instance, the driver for the action "pursue clients on phone" could
be the quantity of past due receipts, the estimation of late receipts, the
quantity of calls, or some other measure. Moreover, despite the fact that the
conspicuous driver to this action may be the quantity of late receipts, the
underlying driver may be that flawed products cause clients to postpone
installment. As a general rule, the main driver for the most part gives
administration the most helpful data. Particularly in the early period of ABC
usage, it may not be clear which driver is generally critical. It regularly
doesn't get to be clear until after the action expense has been computed,
however in the event that our product arrangement is sufficiently adaptable,
its a sufficiently basic employment to switch a movement starting with one
driver then onto the next. This needn't be an issue, yet we have to be
interested in the thought that we may—and likely will—need to change your
suspicions about driver assignments. Pick an answer that permits us to change
suspicions effectively.
An alternate potential entanglement is that actually when a driver
is unmistakably critical, the driver information may not be effectively
accessible. Potentially the information isn't recorded anyplace or assets
aren't accessible to concentrate the driver from the IT frameworks so you must
be arranged to bargain and maybe utilize distinctive drivers, regardless of the
possibility that just briefly until the suitable information can be separated or
begin to be gathered. To ease this to some degree, its a smart thought to begin
driver gathering early. Experience demonstrates that getting hold of the driver
information is frequently a bottleneck in ABC ventures. Beginning early
minimizes the danger of a bottleneck as well as permits the business to begin
gathering information that it doesn't right now track.
Expand the profit of your work by receiving a couple of
straightforward standards regarding the matter of picking movement drivers.
Initially, attempt to point of confinement the quantity of drivers. You can
likely pick 10 or 20 drivers that fit most exercises, and those identified with
the most unreasonable exercises. For a couple of minimal effort exercises, the
profit of investing a great deal of time and exertion on getting information
for a couple of obscure drivers likely won't be justified regardless of the
inconvenience. For those few minimal effort exercises, appoint the best-fit
driver from the remaining rundown or acknowledge that the action has no
association with clients or items, and regard it as unallocated. On a
comparative tack, when gathering information, organize your time so we can
focus on the most expensive drivers.
In the event that we have to, its very substantial to gauge the
most essential drivers. At the point when a driver is in the main 10 however
information isn't quickly accessible, utilize our administration group and
staff's experience to gauge the volumes, or if proper, example the information
for a brief time to give an evaluation of the yearly driver volume. Albeit by
definition gauges and tests are under 100% precise, its ideal to have data that
is helpful and almost right instead of no data by any means. The length of
administrators and staff who are near to the methodology are included, the
appraisals will end up being astoundingly precise and absolutely adequate to
create a sensible distribution of expense to clients.
Issues
in designing the activity dictionary
The
action lexicon is more than only a rundown of exercises it additionally goes
about as a format for gathering the time spent by staff on exercises. So and in
addition giving an info to the model building, it turns into an important asset
amid the information gathering stage. This area talks about the different
standards that oversee the development of a helpful movement word reference. An
outline workshop ought to be held where key administrators meet to examine and
concede to an arrangement of methodologies and exercises that are to be
demonstrated. The workshop is greatly essential, not just in light of the fact
that it permits the venture to profit from the business information and
experience of your administrators, additionally on the grounds that it teaches
them in the strategy and permits them to admire the purposes behind the
undertaking hence empowering their full investment and participation with the
finishes of the investigation.
Amid
the workshop, recollect what we examined in the past area about the quantity of
exercises. Limit the level of point of interest to what is obliged and to what
will give the essential results toward the end of the examination. More detail
than should be expected results in an unwieldy model—one that is difficult to
keep up and from which determinations are difficult to make. Likewise,
recollect the remarkable focuses about distinguishing the exercises that are
identified with procedure disappointment. On the off chance that we need to
make process upgrades as an aftereffect of the ABC examination, its critical that
our action lexicon records waste exercises, for example, slip revision,
duplication, holding up, checking, and transportation.
A
regular impediment to effective ABC demonstrating is the powerlessness to get
great quality movement driver information. Your outline workshop ought to at
first designate drivers to exercises, and after that endeavor to decrease the
quantity of drivers to a greatest of, say, 20. Get all supervisors included to
survey the first decision of drivers, so they concur on what it is truly the
reason for the action.
Some
of the time you won't have the capacity to get hold of the right data for your
first-decision driver, so be arranged to bargain. In situations where exercises
are known to be brought about by a driver for which information won't be
accessible, and no option best fit is accessible, we can part the movement by
client/item gather in the word reference and ask directors to gauge the
part when finishing the process.
Issues
in choice of modeling tool —spreadsheet or ABC software
There are, essentially, no making tracks in an opposite direction
from the way that a product arrangement is important. The main inquiry is
whether we ought to put resources into a committed ABC device, or on the off
chance that its conceivable to escape with building your own particular
spreadsheet-based arrangement.
For an abnormal state, key model, its just about conceivable to
escape with a homegrown spreadsheet arrangement. For a prototyping, evidence
of-idea activity went for making the approach and putting forth the defense for
ABC—committed application programming may not be vital.
Notwithstanding, once the venture pushes ahead to more definite
levels, or when clients oblige specially appointed questions, or when you have
to keep up the model, a spreadsheet arrangement looks more hazardous. Case in
point, take the issue of information volumes. A commonplace key model may have
20 divisions, 30 records, 50 exercises, 50 client/item gatherings, and 10
drivers. Despite the fact that this isn't a tremendously definite model, it can
bring about 1.5 million estimation substances. Any spreadsheet takes quite a
while to recalculate after even a straightforward information change.
Furthermore, spreadsheets do not have the ability to follow back expenses in
basic report structure to focus source.
A greater danger is that the spreadsheet arrangement gets to be
greatly intricate and hard to keep up actually for the individual or persons
who manufactured it. On the off chance that the spreadsheet maker ought to
leave, experience proposes that the model must be modified or it falls into
neglect on the grounds that nobody has the learning or certainty to disentangle
the complex interrelationships contained inside the spreadsheet.
Therefore alone, dependence on spreadsheet models is not suggested
for the medium or long haul advancement of ABC. Various ABC programming
apparatuses are accessible that make the procedure of model building,
information catch, and examination of the outcomes much simpler, both in the
introductory building stage and amid the continuous existence of the venture.
A typical misinterpretation is that receiving an ABC framework
infers the need to reject the current costing framework and contribute a lot of
capital and exertion in another framework. Actually, the best ABC usages are
ones in which associations as of now utilize frameworks that give solid
information and a decent costing teach in the association. In such
associations, ABC is more inclined to incorporate into the current framework
instead of supplant on traditional costing methods.
CONCLUSION
The mini research study has been conducted with the objectives
which are; to find out the implementation problems of applying
activity based costing, to discuss solutions for those problems and to
facilitate activity based costing in Sri Lankan companies. The research has
based on activity based costing and literature review has based on an
exploratory research of ABC method implementation in Serbia. According to the guidance of Professor Kennedy Gunawardana,
a mini research works has been conducted by selecting three manufacturing
companies which are using activity based costing. The data collection method
was interviews with relevant managers and accountants of the company. By
conducting those interviews major four issues have been identified and those are
issues relating to number of activities, issues in Selecting cost
drivers ,issues in designing the activity dictionary and finally, issues
in choice of modeling tool —spreadsheet or ABC software.
It can
be suggested following solutions for eliminate above issues,
ü Make
accounting people aware in ABC method and its benefits.
ü Seek
expert’s advice in selecting activity drivers and designing activity dictionary
ü Use ABC
software in managing cost
