Activity Based Costing Analysis

Question: Discuss about theActivity Based Costing Analysis. Answer: Introduction Activity based costing is a technique which makes costing of products and services more accurate. It guides the management of the organization about understanding and evaluating about allocation of resources in an organization value chain process. It was introduced in early 1980s, according to Corrigan in 1996, approximately 41% of the organizations were currently using this technique at that time and 33% of the corporations were believed in adopting such practices in near future. This system is usually used in organization where previous system is either not evaluating cost accurately or the organizations which are highly conscious about cost. Traditionally this method was only presumed for manufacturing companies, but now it has been used in each type or organization. However this analysis is not preferred for small manufacturing companies, because it is very difficult for them to identify and evaluate the whole activity cost. Apart from this, it requires more monitoring control at each level. The benefit of this is, it has provided more techniques to trace errors. By this, it has enabled the organization to make more accurate decisions based on costing (Chandra Pramanik, 2012). The assignment gives an overview of activity based costing. The assignment considers this analysis by considering Chysler Corporation. Following are the organizations which gave advanced implementations from ABC analysis like Caterpillar, Marmon keystone, Charles schwab company, Northeastern utilities and Chrysler Corporation (Innes, Mitchell Sinclair, 2000). Uses of Activity Based Costing by Organizations ABC analysis has many uses in an organization. The method of cost structure is a considerable process that is used to understand by a customer to know about the ability of company to compete in the market. It is highly preferred method of costing in organization because, it helps to identify the true and full cost of the processes involves in making the output. It ensures transparency in managing process of organization. Apart from that it helps to identify the non value adding processes, any wastage. According to cooper in 1991, the increasing cost and diversification of costs is the main reason for adopting and implementing activity based costing (Fei Isa, 2010). The main objective of adopting activity based costing is to come over the loop holes of traditional based costing. In traditional method of accounting the business overheads such as lighting, marketing and heating expenses were charged under direct cost of that particular process. Activity based costing indicates proper cost of the product or service. Besides this it also give a better presentation of the organizations financial statements (Fadzil Rababah, 2012). The use of ABC techniques has reduced the cost of the products and services, at the same time it has enabled the company managers to focus on maximization on shareholders wealth. By tracing non valued added inventories, it has enabled the company to spend its resources and energy on those inventories which can lead to positive return. It has to be ensured by the corporation before introducing activity based costing in their organization, the consent of all the managers must be taken, as they are the only one who will make the laborers understands about the technique. Experiences of the Organizations that have used Activity Based Costing Experiences can be identified by the differences in the organizations who have implemented the activity based costing. The difference can be noticed in their financial performances. It was identified the improvement in the behavior and organizational factors of that particular organization. These factors can be termed as improvement in support from top management, adequate training and development courses. According to Anderson in 1995, factors that may influence activity based costing are context specific. That is there are many other factors that can influence the implementation of activity based costing such as stages of implementation of ABC, technical factors and environmental factors of specific organizations. These are the factors that influence the success of activity based costing implementation. Besides this, the respective method requires a lot of data to be collected, hence it is faced by many big corporations like in china, and they took a longer time period for collecti ng the data. It has also been observed in china, that companies which are indulged in intangibles, it seems very difficult to gauge the overhead costing and taking measures to reduce the cost (Rbabah, 2013). Chrysler Corporation which is an American car manufacturer, have adopted ABC analysis in their costing method. The experience they have observed is that the implementation of ABC analysis has enabled the company in saving million of dollars. The corporation has introduced this system in early 1991s. The analysis helped the company in calculating the correct cost of parts used. It was the only first company who make implement activity based costing technique to meet the resistance made by its managers. Hence the company firstly made ready the managers for implementing this technique and after that to make understand to laborers various seminars have been organized by the company. Activity costing method requires more resources as compare to the traditional accounting method, as there are three levels of inventories. It need be continuously observed the particular inventories level. That is if one inventory is not utilizing in an effective manner, than it need to be shifted to another inventory level (Mahal Hossain, 2015). Chrysler required conducting training and development programs, changing in management structure, to making the management understand about the activity based accounting. Chrysler also conducted various seminars to make the employees communicate and understand the concept and uses of activity based costing. It was being observed by Chrysler that after implementing activity based costing in their organization it has made improvements in better effective product costing, better cost control management, effective allocation of overheads, more accurate cost information, tracing of non value added materials, and non effective materials. If activity based costing s treated as the independent variable then, return on assets, return on equity, gross profit margin, net profit margin are considered as dependent variables (Chea, 2011). Chrysler Corporation after implementing activity based costing technique had higher overhead cost as some percentage of its total product cost. Apart from this the production processes made difficult for the companies who have implemented ABC techniques. Impact on Organization that have Implementing ABC Analysis The impact on Chrysler by implementing the activity based costing is that the true cost estimated in the activity based costing was as 30 times as compare to the traditional costing method. Hence the impact of this new costing method had on Chrysler Company was that it has started outsourcing that particular products or services. Because of the threats and challenges consist in ABC analysis is that, 70% failure rate was experienced in the U.S. based companies. The impact on Chryslers financial management was that they need to establish a process in which changes in the assumptions and operations were required. Besides this it has enabled for Chrysler to easily allocate the indirect cost in accounting. Apart from that the most important thing is it does not follow the compliances of GAAP (generally accepted accounting principle). Hence the company implementing the activity based costing analysis is required to maintain two costing methods that is one is for the internal use of the corporation as ABC analysis, and another costing method is used for the compliance of GAAP. Apart from that more resources are required in ABC analysis as compare to traditional costing method. That is in ABC analysis it need to be analyzed continuously that class A inventory are utilized as per the standards set or not. And if these are not used as per the standards then these inventories need to be shifted to other class inventory (Hroot, Mssadeh, Amireh, 2015). Bob Lutz, who is the president at Chrysler, he acted as a spokesperson during the seminar conducted. He created an environment in which ABC implementers presented their respective views regarding the productivity. After all this learning seminars, a considerable amount of success was observed in the performance of the company. This had make mangers more relaxed after the success observed in the operations. Every region has different accounting system and costing variables hence, it cannot be adopted universally same, due to this it was very difficult for the company to set pricing standards. Conclusion It is concluded that to make implementation successful of activity based accounting change in management structure, increased in communication, improved training and development for the managers and laborers need to be required. The dependent variables (operations and financial structure) got affected due to the implementation of independent variables (activity based costing). Apart from this implementation of this method caused an impact on product and services costing, that is as some of the products costs are taken at below cost, while some of the products were taken at above cost. Hence this has resulted into the company in outsourcing the particular product which was taken at above cost. It was the views of the managers that after the implementation of activity based costing it leads to improvement in the organizational performances as compare to the traditionally used costing method. Hence it can be concluded that apart from the benefits of activity based costing there are some major disadvantages also, which has make difficult for the small companies to adopt this practice. References Chandra, N Pramanik,A,K. (2012). Application of activity based costing in manufacturing companies in Bangladesh: A survey based study. The USV annals of economics and public administration. Vol 12. Issue 1(15) Chea,A,C.(2011). Activity-based costing system in the service sector: A strategic approach for enhancing managerial decision making and competitiveness. International journal of business and management, Vol 6th, No. 11th Fadzil,F,H,B Rababah,A. (2012). Management accounting change: ABC adoption and implementation. Journal of accounting and auditing: research practice Fei,Z,Y Isa,C,R. (2010). Factors influencing activity-based costing success: A research framework. International journal of trade, economics and finance, Vol.1st, No.2nd Hroot,Y,A,K. Mssadeh,A,A,D. Amireh,M,S,L. (2015). The effect of activity- based costing on companies financial performance: A study among Jordanian industrial shareholding companies. European journal of business and management. Vol 7th, No. 35th. Innes,J. Mitchell,F Sinclair,D.(2000). Activity-based costing in the U.K.s largest companies: a comparison of 1994 and 1999 survey results. Management accounting research Mahal,I Hossain,M,A. (2015). Activity- based costing (ABC)- an effective tool for better management. Research journal of finance and accounting, Vol 6th, No. 4th Rbabah,A.(2013). The influence of company characteristics factors to activity based costing system implementation. Journal of education and vocational research. Vol 4th, No 2nd