Implementation of ABC – Activity Based Costing System in Product Cost

Abstract

The Activity Based Costing or ABC is an advanced way of product costing method. The traditional methods that were used were completely volume-based approaches but the ABC approach helps the managers to seek the excellent strategies which would assist the growth of the organization in the future. The ABC system has been designed to provide realistic product cost information for the purpose of financial reporting. The main implementation of ABC system has been found crucial in the indirect costing method where the traditional methods have been found to unproductive. Another implementation of Activity based costing is required for the understanding, controlling and managing of the overheads. The procedures of cost management and the cost triggering factors are also notified with the assistance of the ABC system. The strategic linkages between different areas of cost in the organization can be understood effectively.

            In this paper a research has been conducted on the implementation of the Activity based costing. As a secondary form of data a literature review has been done to understand the different theories and how the implementation of ABC has benefitted an organization like Woolworths. An interview has been conducted on 50 employees of Woolworths and two managers who have been the primary source of data collection samples. The secondary source of data has been collected from various scholarly articles which have helped in understanding the core factors related to the implementation of the Activity based costing. In this paper the research methodology has been thoroughly discussed to provide a better insight in the implementation of the ABC system in Woolworths. In this paper it has been concluded after conducting the research that the managers are majorly benefited this ABC system as the accounting procedures have been immensely simplified and as a result the management structure has developed.

1.0 Introduction

            Activity-based costing (ABC) is referred to an accounting method where connection between the overhead activities, costs and manufactured products are recognized by the ABC system, after which the indirect costs of the products are assigned in a less arbitrary procedure. This is the new type of method where the indirect method of costing like the office staff salary and the management costs were not possible to be decided through normal accounting methods have become way easier through the ABC system procedure. The main factor that lies here is the implementation of the ABS system in different organizations like Woolworths. Woolworths is a very successful and developing company hence this ABC system implementation is beneficial as well as essential.

            In this paper a literature review will be conducted in regard to the implementation of the ABC system in Woolworths. In this research paper the most prominent questions will be illuminated and based on those problem statements a quantitative and qualitative data analysis will be conducted. A research methodology will also be conducted where research approach, research philosophy, the research design, the limitations of the research and timeframe will be thoroughly analyzed. Implementation of the ABC system in the organization has brought in a huge revolution and that will be analyzed in this paper.

2.0 Literature Review

Background of ABC system

            The activity based costing determines actual cost of the production of product and services in an organization. The basic model is assigned more indirect cost is overhead into direct costs and compared to the conventional costing. ABC is an accounting method that identifies the cost of overhead activity.). The basic theory has been implemented towards the organizational activities to support the delivery and production of services; they are all regarded as product cost in accounting. The basic aspect that lies in the ABC has implemented the producing cost that is generated by activities. The trace of all the product cost can be identify if the organizations can define their activity. The overview of ABC has been done by Namazi, 2016 where he suggested that the ABC has been adopted by most of the big organization by late 1980s and early 1990s. The first introduction of the commercial software in 1990 made it available for commercial use. ABC was advertised and the marketing was done through general media, journals and publications which resulted in showing interested by the large organization implement it in the accounting (Namazi, 2016). In the early 1900s, this had resulted in the rise of implementation of ABC.

ABC concept

There have been several studies that have been conducted on the implementation of ABC concept or system within an organization. (Javid, Hadian, Ghaderi, Ghaffari & Salehi, 2015) referred ABC system as method for giving cost information to the managers who are benefited in the decision-making process where the costs are separately allocated for every product rather than being allocated as a whole. Based on this analysis it can be understood the activities in the organizations need to be in regard to decreasing the cost of the products and increasing the products. Javid et al., 2016 further discusses that the management with the help of the implementation of the ABC system identifies the true costs of the products, processes and services.

Figure 1: ABC process

(Source: Lee et al., 2016)

ABC Implementation

            The research and implementation of ABC has been adopted by the large organization as well as the small manufacturing firms. The estimation of the product cost and identification of accounting in the management. The methods of implementation of ABC are discussed in six points.

  • The first point is discussed in the base of establishment objective and requirement of ABC system. The basic requirement of the organizations to adopt a costing system. The costing system can be helpful in controlling the cost and establishment of pricing system. The ABC calculate all the activities require to produce each product and services specification of its cost(Laviana et al., 2016).
  • The second point is discussed regarding the identification of main activity. The activities have been identified but are not limited to order processing, product marketing, product shipping, telephone support and product handling. The organizational management decides the level of accuracy and reliability desired. The assigned cost of supporting activity is defined the individual cost of product and services.
  • The third point includes tracing overhead activities implementing the use of the expense-activity-dependence matrix. The relation of cost to a specific cost object is “Direct”. The overhead cost is defined as the cost which is not associated with a specific cost object. The Expense-Activity-Dependence matrix or EAD matrix can be implemented in association of costs to activities which is systematically determined the overhead use. The implementing of EAD matrix is done to identify the overhead in the ABC method to reduce the costs included in the ABC (Laviana et al., 2016).
  • The fourth point is discussed about tracing overhead to the cost objectives with the use of the matrix for calculating activity-product-dependence. This is a significant step of the ABC as it defines the cost drivers. The object is of particular interest in the field of cost analysis such as product, product line, services, departments, activities, customers, process or even the full organization. The identification of the cost objectives overhead consumption rate is used in the activity-product-dependence matrix. 
  • The fifth point includes the calculation of the product cost of each cost objectives. The product cost is obtained by adding the overhead and the direct cost of each cost object together. The expenses that an organization bears to generate the cost objective are done to estimate and represent the product cost. The basic tracking is done of cost to design a product rather than the price it will be implemented in the market (Linassi, Alberton and Marinho, 2016).
  • The sixth point implements ABC analysis for considering improvements and strategic decision-making. The calculation of the product cost, then organisations management may use the result in acquiring the profitability. The decision of price and identification of cost saving opportunities is done. The identification of the product cost which is derived from the ABC approach does not improve the business performance of an organisation. The efficiency of the business is subject to identification through the ABC system. The service department will be beneficial towards the service delivery to the customer and it will implement informed decision in the ABC analysis (Linassi et al., 2016). The organisation should implement the ABC analysis in regard to the disclosure of profit and specific generation of plan.

Factors affecting the implementation of ABC

According to the study conducted by (Kim, Han, Yi & Chang, 2016) it has been observed that there are various problems occurring at the time of the stages of implementation of the ABC system. The actual problems regarding the implementation has been identified which are absolutely different from the perceived problems. However, there are no such serious problems are associated with the implementation of the ABC system. At the beginning it was observed that ABC was implemented at a smaller scale as a form of experiment in an organization before making ABC a part of the entire organization. The most important factor identified by Kim et al., 2016 was that the acceptance and involvement of the staffs as well as the support from the management is extremely essential for implementation of the ABC system in the whole organization. It has been identified by Mahal and Hossain, 2015 that the top management of the respective organization has a huge role to play in the overall ABC system implementation. It has also been specified that the top management requires prioritization of the project implementation for maximizing its efficiency. Mahal and Hossain, 2015 has also identified that the staffs play a very important role and if proper training is not given to the employees then they resist the smooth implementation of the ABC system.

Limitations of ABC implementation

The analysis and documentation is done to identify limitation in the ABC that may lead to failure.  The cost and time is included in the ABC implementation. The organization need to hire more employees to collection of data and data capturing can lead to increase in cost. The analysis has been done by Lee et al., 2016 that has shown in increase in the plant’s cost. A huge amount of consumption is done by the non-valuable activities.

3.0 Research Question

Activity based costing has various aspects and various limitations as well but the main focus in this paper is about the implementation of the Activity based costing which helps organizations like Woolworths to enhance their management and accounting system(Hoozée and Hansen, 2017).These questions have been developed to provide a structure to the whole research. The different prominent questions which has been reflecting in the survey has been highlighted below:

  • What are the steps involved in Activity Based Costing?
  • What are the limitations of Activity Based Costing?
  • What are the benefits of Activity Based Costing as opposed to traditional methods?

4.0 Methodology

4.1 Research outline

Every organization constitutes of different types of accounting procedures but Activity-based costing has been found to be the most accurate form of accounting. In this regard a research has been conducted as to how the implementation of ABC system in the organizations has benefitted the growth of the organization(Tsai et al., 2014). The research data has been collected in both primary and secondary form to form an insight about the implementation of ABC system. The research study can only be conducted successfully with the help of various research approaches and strategies which can be applied to get a successful outcome.

4.2 Research philosophy

Research philosophy is extremely essential to be determined and for this respective research the Positivism research philosophy has been implemented.The realism research philosophy is based on the assumptions but positivism is based on real experiences and encounters(Tsai et al., 2014). Positivism checks the present theories in regard to the literature review and helps in formulating the hypothesis in accordance to the research topic.

4.3 Research approach

In regard to this research paper the deductive approach has been found suitable than the inductive approach as the deductive approach is bend on testing the existing theories, whereas focus of inductive approach remains on the generation new theories. The deductive approach is all relevant to the research philosophy of positivism. This chosen approach has been found effective as it provides assistance in understanding the procedures of implementation of the ABC system.

4.4 Research design

            The descriptive research design has been selected as this design is based on surveys and naturalistic observations (Akhavan, Ward and Bozic, 2016). In this research study a literature review has been conducted and that would help in interconnecting the ABC system implementation with the research study. Through this descriptive research design, the it has been easier for the researcher to study the patterns of ABC system implementation and also the characteristics of the ABC system. The research onion below demonstrates of the research approach, design, philosophy and their interrelations among each other.

Figure 2: Research onion

(Source: Tsai et al., 2014)

4.5 Data type and sampling

            The data that has been collected for the research study are both secondarydata and primary data. The data analysis that has been conducted has been based on both quantitative and qualitative. The quantitative has been conducted with the help of the 50 chosen employees of Woolworths as the sample size. An interview was conducted on these 50 chosen employees based on a questionnaire(Akhavan et al., 2016). This questionnaire has been regarded as the tool for steering both quantitative and qualitative analysis. The qualitative data analysis has been conducted on two managers of Woolworths. The secondary data that has been collected have been used to evaluate implementation procedures and importance of the Activity-based costing.

4.6 Limitations

The researcher has faced a few obstructions while conducting the research. The main challenge that the researcher faced was completing the whole primary data collection i.e. the interview sessions within the constricted timeframe. Moreover, the managers at the Woolworths were found evidentlyindisposed towards providing assistance in regard to this research.

4.7 Ethical considerations

At every step of the research it was encouraged to have an informed consent. The participants who participated in the interview session their anonymity has been invigorated while conducting the research.

4.8 Time-frame

Tasks Week 1-2 Week 3-4 Week  5-6 Week 7-8 Week 9-10 Week 11-12
Approval of the proposal and choosing the topic            
Literature review and secondary data collection            
Research methodology identification            
Data collection            
Data analysis            
Findings            
Conclusion and Recommendation            
Final submission            

Figure 3: Gantt chart

(Source: Self-made)

5.0 Data Analysis

5.1 Quantitative analysis

As formerly stated the sample size had been chosen to be 50. The sample population has been chosen to employees of Woolworths from the finance and resource allocation departments. Furthermore, the qualitative analysis was performed in two steps, namely, from primary and secondary sources. The data analysis has been conducted as follows:

Q1: Would you say direct costs influence the resource allocation of an organisation the most?

Table 1: Response to Q1

(Source: Author’s creation)

Response Number of respondents Total number of respondents Response frequency
1. Agree 16 50 32%
2. Strongly agree 18 50 36%
3. May be 6 50 12%
4. Disagree 5 50 10%
5. Strongly disagree 5 50 10%

Figure 4: Statistical representation of Q1

(Source: Author’s creation)

            The influence of direct costs on the resource allocation had been met with mostly positive response from 68% of the sample population. 12% of the respondents remained unsure of their choices, while 20% disagreed. The response frequency points to a mostly positive answer, stating that resource allocation is predominantly affected by direct costs. Woolworths is known to assess and ascertain resource allocation based on the calculation of the direct costs of the organisation.

Q2: Do you think that cost allocation for indirect costs can be influenced through cost-allocation bases?

Table 2: Response to Q2

(Source: Author’s creation)

Response Number of respondents Total number of respondents Response frequency
1. Agree 14 50 28%
2. Strongly agree 16 50 32%
3. May be 10 50 20%
4. Disagree 6 50 12%
5. Strongly disagree 4 50 8%

Figure 5: Statistical representation of Q2

(Source: Author’s creation)

  60% of the participants stated that cost allocation for the indirect costs is affected as a result of the cost-allocation bases. Furthermore, 20% of the participants remained neutral of the response, while another 20% disagreed. Therefore, it may be ascertained from the calculations from the cost-allocation bases, as well as other relevant activities may be responsible for influencing the allocation of indirect costs as well.

Q3: Do you think the identification of the cost drivers for ascertaining the predetermined overhead rate for relevant activities is essential?

Table 3: Response to Q3

(Source: Author’s creation)

Response Number of respondents Total number of respondents Response frequency
1. Agree 15 50 30%
2. Strongly agree 18 50 36%
3. May be 9 50 18%
4. Disagree 4 50 8%
5. Strongly disagree 4 50 8%

Figure 6: Statistical representation of Q3

(Source: Author’s creation)

            The response of the participants illustrate that the determination of the overhead costs can be performed through the identification of the cost drivers. 66% of the respondents had agreed with the statement, while 18% remained unsure of the choices. On the other hand, about 16% of the participants disagreed with the statement. Finding the costing for each of the relevant activities and allocating the overhead cost for each of the activity can be undertaken through the estimation of cost drivers for a firm.

Q4: Would you say that the ABC aids in identifying and eliminating ineffective service or production processes?

Table 4: Response to Q4

(Source: Author’s creation)

Response Number of respondents Total number of respondents Response frequency
1. Agree 14 50 28%
2. Strongly agree 22 50 44%
3. May be 8 50 16%
4. Disagree 4 50 8%
5. Strongly disagree 2 50 4%

Figure 7: Statistical representation of Q4

(Source: Author’s creation)

            72% of the sample size agreed that the elimination and identification of ineffective production as well as service processes could be thoroughly undertaken through the implementation of ABC. On the contrary, 12% of the participants had disagreed, while 16% of the respondents were unaware of the effectiveness of the process. Therefore, it may be mentioned in this regards that this concept gives rise to a process re-engineering objective. Furthermore, ABC has also been considered as a significant tool for evaluating profitability and customer cost based on the performance of the product processes.

Q5: Do you think ABC is more effective than Economic value added and Kaplan’s balanced scorecard?

Table 5: Response to Q5

(Source: Author’s creation)

Response Number of respondents Total number of respondents Response frequency
1. Agree 10 50 20%
2. Strongly agree 8 50 16%
3. May be 21 50 42%
4. Disagree 2 50 4%
5. Strongly disagree 9 50 18%

Figure 8: Statistical representation of Q5

(Source: Author’s creation)

            In the 1990s, it had become prevalent that ABC was deemed inefficient as compared to other similar tools such as Economic value added and Kaplan’s balanced scorecard. This was further demonstrated through an independent report published in 2008, as well as established through the response of the participants. Only 36% of the participants had considered ABC to be an effective tool for calculating overhead, direct, indirect costs. 42% of the participants remained unsure of the efficiencies of the methods, while 22% had disagreed and stated that ABC was efficient enough.

5.2 Qualitative analysis

5.2.1 Qualitative analysis from primary data

            The qualitative analysis has been completed with the help of data from primary as well secondary source. The data from primary sources included the data collected through the interview of 2 managers from Woolworths, one from the finance and accounting, along with another from resource allocation department. The transcripts are provided with the analysis below:

Q1: What do you consider as the limitations of ABC?

Table 6: Response to Q1

(Source: Author’s creation)

Manager 1 (Finance and accounting department) Manager 2 (Resource allocation department)
In case of decision-making, ABC is often and quite easily misinterpreted. The costing data is to be handled with care and it is to be evaluated which of the data are relevant for the decisions to be made. Furthermore, GAAP or generally accepted accounting principles do not accept the solution identified through ABC. Therefore, preparing external and internal cost reports require the implementation of two different methods as a substitute for ABC. It is expensive to maintain ABC once it is implemented. Data is to be collected for multiple activity measures, and entered into the system after checking thoroughly. Therefore, the resources required for the implementation of ABC are extensive. Product margins are numbers produced through ABC; however, the traditional costing systems do not produce such numbers as product margins. Furthermore, managers use these data sets and traditional costing systems for performance evaluation.

            The interview with the managers focuses on one of the important research questions for this paper. The limitations for ABC are identified through this. According to the managers, the acceptance of the outcomes from ABC process cannot conform to the existing GAAP principles. In addition to that, the prevalence of the traditional costs systems being used by the managers account for most of the tools of accounting.

Q2: How would you say ABC benefits the organisation?

Table 7: Response to Q2

(Source: Author’s creation)

Manager 1 (Finance and accounting department) Manager 2 (Resource allocation department)
ABC provides a much better comprehension of overhead costing. Furthermore, the accuracy of costing with regards to the department of customers, distribution channels, services and products. The scope of improvement program remains through integration with Six Sigma and other relevant methods. ABC supports performance management and other relevant activities such as scorecards. Moreover, it is focused on the facilitation of benchmarking, along with the consistent improvement in the costing processes. Furthermore, ABC integrates costing processes for value chains and supply chains.

            Several advantages or benefits of the accounting have also been identified through the information gathered through the interviews. According to the managers, ABC provides an accuracy of calculations regarding the supply chain as well as the value chain. Furthermore, it can continuously be improved through the integration with Six Sigma processes and more. In addition to that, it is to be noted that the managers had considered performance management into the process of ABC. Moreover, ABC is established to provide an accurate and concrete estimate of the overhead costing, which is extensively important and beneficial for a business enterprise.

5.2.2 Qualitative analysis from secondary data

            Several scholars and authors have a varied opinion on Activity-based costing. According to Carroll & Lord (2016), the various accounting methods aid in providing cost estimates for providing output. The hospital sector is considered in this regards for this particular paper. It may be stated that the author emphasizes on the use of effective accounting measures for hospitals. The use of sophisticated cost accounting systems being implemented at hospitals have been a prime scope mentioned in this context. However, the reason identified behind this is the service-level cost information being quite low (Carroll & Lord, 2016). In addition to that, the decisions of the patients affecting the revenue as well as the patient volumes may be estimated through calculations through ABC (Carroll & Lord, 2016).

            Furthermore, Subramaniam & Watson (2016), explains the importance of ABC, at the same time criticizing the role and effectiveness of the process as compared to other tools namely, Economic value added and Kaplan’s balanced scorecard. Furthermore, the development of lean accounting methods as a substitute for ABC and the prevalence of the process are discussed by the scholars. ABC is primarily focused on the calculation of overhead, fixed as well as variable costs (Subramaniam & Watson, 2016). Another article by Al-Sayed & Dugdale (2016), mentions the processes implemented through the evaluation of contingency factors and adoption process procedures in the manufacturing units in UK. A set of interrelated techniques for the innovations based predominantly on the process of ABC have been discussed in the report (Al-Sayed & Dugdale, 2016). Additionally, the paper mentions the innovations related to ABC as one of the prime management accounting practices prevalent in the UK manufacturing sector (Al-Sayed & Dugdale, 2016).

5.3 Summary

The quantitative and qualitative data analysis provides an insight into the concepts of Activity-based costing. The interviews with the managers have been taken into consideration for the qualitative analysis of the primary data, while scholarly articles have been reviewed as secondary sources of information for the qualitative analysis. In addition to that, the survey conducted with 50 employees of Woolworths has been regarded as the primary source of data for the quantitative analysis. The limitations and benefits of ABC have been identified and a comparative study with other tools has been taken into account as well.

6.0 Conclusion

            The Activity based costing has turned out to be the most efficient way of accounting. It has helped various organizations like Woolworths to conduct a successful organizational management. Activity based costing helps Woolworths to answer the market needs efficiently while gaining the competitive edge effectively. The ABC system implementation has contributed to the efficient decision-making of the management. The ABC system confirmed the cost reduction techniques as well as the acquired savings are also confirmed.

The research that has been conducted in this paper was based on the literature review which helped in analysis the data that has been accumulated over the years. The literature review gave a conclusive result towards the secondary data collection method. The research that was conducted used the positivism philosophy and deductive approach. The data analysis was conducted on two managers and 50 employees of Woolworth. As a further scope for the research that was conducted there is a further chance of evaluating the ABC research results and resource optimization.

Bibliography

Akhavan, S., Ward, L., & Bozic, K. J. (2016). Time-driven activity-based costing more accurately reflects costs in arthroplasty surgery. Clinical Orthopaedics and Related Research®, 474(1), 8-15.

Al-Sayed, M., & Dugdale, D. (2016). Activity-based innovations in the UK manufacturing sector: Extent, adoption process patterns and contingency factors. The British Accounting Review, 48(1), 38-58.

Carroll, N., & Lord, J. C. (2016). The growing importance of cost accounting for hospitals. Journal of Health Care Finance, 43(2).

Hoozée, S., & Hansen, S. C. (2017). A comparison of activity-based costing and time-driven activity-based costing. Journal of Management Accounting Research, 30(1), 143-167.

Javid, M., Hadian, M., Ghaderi, H., Ghaffari, S., & Salehi, M. (2015). Application of the activity-based costing method for unit-cost calculation in a hospital. Global journal of health science, 8(1), 165.

Kim, Y. W., Han, S. H., Yi, J. S., & Chang, S. (2016). Supply chain cost model for prefabricated building material based on time-driven activity-based costing. Canadian Journal of Civil Engineering, 43(4), 287-293.

Lee, V. S., Kawamoto, K., Hess, R., Park, C., Young, J., Hunter, C., … & Graves, K. K. (2016). Implementation of a value-driven outcomes program to identify high variability in clinical costs and outcomes and association with reduced cost and improved quality. Jama, 316(10), 1061-1072.

Linassi, R., Alberton, A., & Marinho, S. V. (2016). Menu engineering and activity-based costing: an improved method of menu planning. International Journal of Contemporary Hospitality Management, 28(7), 1417-1440.

Mahal, I., & Hossain, A. (2015). Activity-Based Costing (ABC)–An Effective Tool for Better Management. Research Journal of Finance and Accounting, 6(4), 66-74.

Namazi, M. (2016). Time Driven Activity Based Costing: Theory, Applications and Limitations. Iranian Journal of Management Studies, 9(3), 457-482.

Subramaniam, C., & Watson, M. W. (2016). Additional evidence on the sticky behavior of costs. In Advances in Management Accounting (pp. 275-305). Emerald Group Publishing Limited.

Tsai, W. H., Tsaur, T. S., Chou, Y. W., Liu, J. Y., Hsu, J. L., & Hsieh, C. L. (2014). Integrating the activity-based costing system and life-cycle assessment into green decision-making. International Journal of Production Research, 53(2), 451-465.

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