Activity-based costing adoption and effectiveness in managerial accounting

Product Costing systems (ABC, job costing, put costing, .) advanced topic managerial accounting the thesis statemenit a position body paper show evidence support position. The paper discuss opposite point view discuss position valid.

Product costing systems

Product costing system is a management tool which identifies the actual cost of producing each product. It identifies the profits and loss which can be gained or incurred on each product, hence giving companies the opportunity of identifying and promoting of profitable product while dropping, re-pricing or redesigning of unprofitable products Brierley, 2008.

Product costing is a highly sensitive area for managerial accountants, recently, most of them have changed their focus such that they give their attention to appropriate treatment costs which are directly associated with resources that are committed to support activities, which within the company do not vary proportionally to production once the initial capacities have been set. In such as an event, it is assumed that the cost of the committed resources has to be incurred irrespective of the actual usage and increasing the initial capacities to accommodate unexpected demand involves penalties above the normal costs Brierley, 2011()

According to Turner (1989) model of a decision maker, the accounting of a product cost is normally done in two methods; these are the absorptive and variable costing. Absorptive costing is calculated by taking the unit product cost and adding the unit variable cost to a unitized fixed cost component Turner & Hilton, 1989.

At this stage, the unit fixed cost is determined by dividing total fixed cost by a predetermined quantity that characterizes production capacity. Whereas, the unit variable cost, is determined by; dividing total variable cost at a particular production quantity at that quantity Drudy & M. Tayles, 2005()

In a survey conducted later after the introduction of Activity-based costing in the U.S., it was found that only 20% of the companies had adopted the costing system, but this was the highest among the other systems Park & Simpson, 2008.

Companies are still using other systems because of the scope and nature of information generated by different type of product costing systems. For instance, product costing may vary in their ability to provide information concerning revenue enhancement, performance measurement, and cost-reduction efforts among others. With the internal and external pressures, various companies' faces, one costing system may be suited to serve the needs of a certain business that another costing system Drudy & M. Tayles, 2005.

The prevailing factors such as complexity of the production process, nature of competition or frequency of operation at the company's capacity may determine the type of costing system to be used by the company.

Types of costing systems

There are various types of costing systems in use by different companies all over the U.S., these costing systems include; traditional costing systems, activity-based costing, variable costing, Process costing, Job-order costing, Back-flush costing, Operation costing and Lifecycle costing among others Fisher & Krumwiede, 2012()

Many surveys done to determine which of them is the best in computing the right cost of a product, the result always shows that each and every manager is somehow satisfied with the type costing system they use and they believe their costing system is the most effective compared to the rest. From my assessment, Activity-based costing system is the most effective method among the available costing methods and this research are meant to show why it is more effective in most business scenarios.

Activity-based costing system as the most sought system is an information rich costing system used by companies to perform activities which are value oriented within the company, unlike the case of virtual enterprise where value is added by partners. Activity-based costing is known to portray the actual product cost in complex environments. It is known to identify non-value-added activities and highlights sections where cost can be reduced substantially Park & Simpson, 2008()

Many emerging virtual enterprises are after the idea of seeking a new costing system and approaches which will look into the following; traditional costing system do not provide sufficient non-financial information existing product costing system are inaccurate, the current costing system do not encourage improvements and the overhead costs are predominant Fisher & Krumwiede, 2012()

Since product cost system is used to justify product pricing and capacity planning decisions, many manufacturing companies have over the last thirty years changed their cost profile. This is because production overhead and non-production overhead have increased significantly due to more resources being committed to the company. The cost profile has also led to changes in the management of production and quality, hence, improving on the value adding service they offer to the customer Brierley, 2011.

For instance, the complexity and cost of logistics and shipping have risen rapidly in the newly formed enterprises, especially those engaged in e-commerce. This makes product costing essential since it prevents them from making a poor decision, which might lead to them incurring losses.

Activity-based costing derives its cost decisions from the activities used in the production and delivery of the goods/products manufactured within the company then the various resultant costs are computed together. In comparison to the traditional system, Activity-based costing system provides the most useful information for cost management purpose since, the cost of the activities used in the manufacture of products is therefore assigned to that specific product in a way that approximates a casual relationship. In most companies, the Activity-based costing system in place is developed outside the financial accounting system that was intended to satisfy the management decision making Park & Simpson, 2008.

Therefore, in some companies, the Activity-based costing system' cost analysis has been restricted to direct material, manufacturing overhead costs and labor. Other sectors include marketing and distribution cost, research and development.

Activity-based costing is also the best system because it has been improved from only determining product profitability to finding out the profitability of marketing efforts and individual customers. In as much as Activity-based costing is one of the most adopted costing systems, it has its criticism too, one of its limitation is that many feel that the system is somehow overused by the accounting department who use canned software. It is also being criticized for not being strongly linked to performance evaluation and reward system or to quality and delivery strategies Fisher & Krumwiede, 2012()

Variable costing is also a costing system which entails only variable costs such as certain labor costs and material costs within product costs. In addition, fixed costs are taken as a lump sum that should be covered with the products' contribution margin since there is no need of assigning indirect fixed costs to individual products. Unlike both traditional and Activity-based costing systems, variable costing avoids the problem of cost assignment that is present in the two systems. Recent research show that variable costing system is being used by 12% of the companies for their decision making process. The research continued that, variable cost was mostly used for short-term decisions, unlike for the Activity-based costing which is used for long-term costing projection Brierley, 2011()

Brierley said that, "If the problem is small enough so that contribution margin analysis is relevant, then it can't have a particularly significant impact on a company. And in any chance, the impact in a decision setting is paramount, if it can actually affect a company in a major way, and then it's silly to consider most of the factors to be fixed." Brierley, 2011()

Variable costing has also been supported in areas where the overhead does not vary with units, products, customers or batches. "This occurs in capital intensive environments where a significant part of the overhead structure is machine depreciation, not labor related overhead. Many paper companies also treat direct labor as fixed because the workers remain on site during downtime slack periods of production." Brierley, 2010()

Traditional costing system as one of the costing system majorly focuses on direct materials, manufacturing overheads in their determination of product cost and in direct labor. In traditional costing system, the assumption is that the overhead is assigned to an individual products while putting in consideration the plant-wide overhead rate, although many different companies which have adopted it may decide to compute various department overhead costs.

In addition, there is hardly any casual link between the manner in which overhead is assigned, and the immediate production process, rather, the overhead is assigned in relation to the number of units given out or the that of machine or labor hours consumed in the production process. Criticism over this type of costing system indicates that it is likely to over-costs simple products which are produced in smaller batches. It also over-cost products that majorly deal with high usage of allocation base, which include; labor hours, but low usage on factors such as machine hoursFisher & Krumwiede, 2012.

The mismatch between the way cost are summed up and overhead is assigned is majorly salient especially when the production process is more capital intensive, but the overhead allocation is based on labor hours. Further, critics say that the improperly applied overhead results to inaccurate product costs that lead to inefficient product continuation and pricing decisions Drudy & M. Tayles, 2005.

Therefore, this makes it, not the ideal costing system to be used by most companies.

Conclusion

All in all, variable-cost, traditional cost and Activity-based costing systems all use material cost as product cost. They only differ when it comes to computation of other costs. Activity-based costing is known to be the most sought costing system since it offers information which is mostly useful in cost management, so as to enhance on their profitability; to deal with capacity issues, to become more accurate in assigning the cost linked to the prevailing high levels of operating complexities, and to develop more appropriate pricing schemes.