Activity-based costing implementation for Carrefour retail operations

Carrefour Supermarket

Company Background

Standard Costing

ABC Costing

Differences in ABC vs. Absorption

The Carrefour Group is one of the world leaders in retail industry and through over fifty years of dedicated efforts, is now the largest retailer in Europe and second largest in world. A literature review was conducted to see how an ABC costing method could potentially benefit this retail giant. It was found that the ABC method would be more accurate than the other costing methods and therefore provide a better representation of the retailer's actual costs. Furthermore, this costing system is also more in line with strategic goals and a focus on quality because it adds value through the managerial accounting perspective. Managers would be able to have better metrics to make key strategy decisions regarding costs as well as quality and could therefore create a better internal retail environment. This analysis will consider the advantages to ABC costing as well as their relevance to Carrefour.

Standard Costing

It currently appears that Carrefour is using a fairly standard costing system for its retail operations. Standard costing is common in a retail environment even when a retail operation deals with perishable items. An accounting department will use standard costing to attempt to estimate the cost of produce as a lump cost segment even though some of it goes to waste. Sometimes calculating the actual cost of each individual good produced in regard to their actual direct labor, direct material, and overhead is either too complex or too time consuming, or both. Using standard costing can help simplify the accounting process by using historical data to generate standard costs. Standardizing the costs based on an average cost can help simplify the accounting procedures in a relatively efficient and effective manner.

Despite the ease of using standardized costing, the estimated costs virtually never actually represent the real costs. Since the standardized costs are based on historical estimates of sales data, then the actual costs are almost always off to some degree of error. Therefore a separate account must be set-up to handle the account difference between the standard cost and the actual cost known as the cost variance. Then the cost variance is reconciled at different points in time depending on the circumstances of the particular operations. Accounting can keep an eye on how closely the standard costs fall in line with the actual costs and adjust the costing rates or estimates if the cost variance is off by a significant rate.

Furthermore, standard costs and the associated cost variance accounts do not always need to be set up for every type of consumer good. For example, some retail products are durable goods and the overhead can be allocated by floor space and the actual size of the products. These products can have costs that involve the labor and shelving space without having to create a standard cost and variance account; however an overhead account could be standardized to account for that portion of the expense. However, items such as perishable goods will have a completely different set of costs. Again the standardization of materials and labor may not be adequate to account for the different production times that the production of each product may take. Many retailers will use a combination of costing models could and should be crafted to fit the unique circumstances that are dependent on the types of products in the retail environment.

There are also many disadvantages inherent in the standard costing system for retailers. One disadvantage is that they variance reports are typically only periodic or seasonal basis. Therefore management might not have accurate costing data that would be relevant for decision making. For example, the retail manager might not have time to notice and significant cost variance until the products were merchandised for weeks or months in some cases. Another issue is that it places the focus on a conception of "standard" that is created. With the focus being on the standard, employees may lose sight of other important factors such as quality or process improvement. This system isn't entirely consistent with a quality approach. For example, employees can also take short cuts so long as their efforts stay in the realm of the standard range that was created.

There are so many negative aspects associated with standard costing that many organizations feel that this form of accounting is inconsistent with their organizational strategies as well as the external environment. For example, in the global business environment, many organizations are integrating tools or strategies such as JIT, ABC, TQM, process reengineering, life cycle assessment and target costing (Sulaiman, Nhmad, & Alwi, 2005). In a total quality management (TQM) organizational environment the focus of the strategy is on continual improvement in all aspects of quality throughout the entire organizations operations. In such a system employees are strongly urged to go beyond the standard, or the standard range, and continually focus on making improvements which is not the same paradigm that the standard accounting was developed from which could counterproductive to the primary organizational goals since it doesn't focus on the same ideas.

ABC Costing

Activity-based costing (ABC) is by contrast one of the newer alterative costing methods that has been developed to work in conjunction with many of the existing accounting systems. ABC is generally not considered a comprehensive system or standalone system. However, ABC accounting can be used alone rather a new way to apply overhead and support costs to individual product or services. The ABC accounting method will look at a business unit or process and designate various cost drivers. The cost drivers can be organized in many different ways and are entirely dependent on the process. For example, if produce requires the usage of different amounts of packaging, handling, or display then these items could possibly be constructed as a cost driver. As opposed to indirect overhead being allocated to all products equally, the products might include overhead calculations depending on the cost driver that is used in the products.

The cost drivers can be considered any activity that incurs costs. The ABC method attempts to allocate costs based on the activities involved in production. If fresh produce requires that it be continually sprayed with water then this could represent a cost driver that would be associated with these products. By contrast, other systems generally consider the finished product as the only cost driver. Therefore, this approach has been often introduced in Just in Time (JIT) systems, LEAN production systems, Six Sigma, and other newer manufacturing systems. By allocating the costs to the activity, accounting can more closely mirror the production ideologies that are in play in such systems.

Differences in ABC vs. Absorption

The absorption costing method is another popular alternative to standard costing. In the absorption method of costing the fixed overhead costs are divided equally with the number of units. However in activity-based costing the overheads are allocated in the actual proportion of costs incurred by the product unit or cost drivers. Activity based accounting can therefore more precisely allocate various costs with more accuracy than competing methodologies. This results in the fact that the system retains its value in determining product pricing and especially with managerial accounting. In a competitive market, knowing the exact costs that are associated with any product allows for more pricing options.

Figure 3 - Activity-Based Costing (Martin, N.d.)

Activity-based costing has been argued to make up for many of the shortcomings of the traditional cost accounting systems because they are ineffective for managers who focus on quality or continuous improvement (Narong, 2009). Furthermore, since retail organizations are much more complex today than those of previous generations and offer a wide range of durable and perishable goods, many argue that managers require additional levels of information in which to serve as a foundation of decision making. The advantages of activity-based costing have been summarized by the following points (Sohal & Chung, 1998):

Provides more accurate product line costing particularly where non-volume related overheads are significant and a diverse product line is manufactured.

Is flexible enough to analyze costs by cost objectives other than products such as processes, area of managerial responsibility and customers.

Provides a reliable indication of long-run variable product cost which is particularly relevant to managerial decision-making at a strategic level.

Provides meaningful financial (period cost driver rates) and non-financial (period cost driver volumes) measures which are relevant for cost management and performance assessment at an operational level.

Aids identification and understanding of cost behavior and thus has the potential to improve cost estimation.

Provides a more logical, acceptable and comprehensive basis for costing work.

Furthermore it is commonly argued that ABC is superior because even though traditional costing systems are much less expensive to implement and maintain that they can considerably distort product costing (Mishra & Vaysman, 2011).

Despite all of the theoretical advantages and the ability for ABC to provide more accurate costing metrics that are inherent in an activity-based system, many researchers have disputed the fact that these advantages are realized in practice. While under traditional costing methods accounts for overhead and quality metrics are lumped together in a single account which makes them virtually indistinguishable, in activity-based costing these measures can be teased out (Tsai, 1998). However, the ABC system is also more complex and generally more difficult to set-up effectively.

This can be even more of a challenge when organizations are multinational and are used to traditional-based systems. Another potential drawback is that ABC systems are generally far more time consuming to maintain than traditional systems. Some argue that sometimes an ABC provides more detail into costing activities than is actually necessary, or at least cost effective in regard to the expensive of maintaining the system. Furthermore, activity-based costing does not conform to the generally accepted accounting principles (GAAP) and only has a limited application in International Financial Reporting Standards (IFRS) and therefore can only be used for managerial accounting practices while a separate set of books must be kept as well for compliance reporting.

These criticisms of ABC has led to large body of literature that supports ABC costing methods as many experiments that point to the system is overvalued. Despite the debate about the system in general, it is clear that ABC does work in at least certain circumstances. Thus there are many considerations that must be undertaken before an organization should attempt to implement an ABC system. For example, is there sufficient resources available to support the new system or does the organization have enough expertise to design and train the organization for the new system. Although the ABC system can offer an organization a great level of detail into accounting for their operations, the benefits of this system does not always outweigh the cost associated with implementing an ABC costing system.

Conclusion

Carrefour Group is a large multinational retailer; the second largest in the world. Through over fifty years of dedicated efforts, Carrefour is now the largest retailer in Europe and second largest in world. A literature review was conducted to see how an ABC costing method could potentially benefit this retail giant. It was found that the ABC costing method could provide more accurate costing as well as support a strategy to improve quality in the organization. However, many limitations to the system were also identified. One limitation is that the system is complex and often requires a great deal of employee training to administer the system. This could be a major limitation in such a large retailer as Carrefour. Therefore, since the ABC could add significant value to the organization but the implementation of the system has a specific set of risks, it is recommended that the organization experiment with an ABC costing approach in a regional territory and with products that could relevant to such a system. For example, Carrefour could implement an ABC system in Latin America that accounted for fresh produce. If such an implementation was successful, then the organization could implement it in other regions or with other product lines. Therefore it is recommended that Carrefour use a phased rollout approach to implementing an ABC system so that they can carefully monitor their experience as well as build a knowledge base that can serve as an asset to future implementations.