BUS 2011A Financial Management and Control

Activity Based Costing and Management Accounting Technique Report Word Count 2234

Joe Farrington

1. Introduction 2. Activity Based Costing 3. Management Accounting Techniques Report 4. Bibliography

Introduction
Management Accounting is used to provide accurate financial information to companies to enable them to make informed business decisions. Costing systems are methods that are widely used within companies; they are information systems that provide the financial information to help managers make key decisions.

Within this paper we will critically analyse and compare two different types of management accounting techniques, significantly activity based costing (ABC) which is a recent cost management method only introduced in the late 1980s and traditional Costing, which has been established over a long period of time, both are used within business today and give companies very diverse but essential information.

Included will be different issues including cultural, global, and technological concepts and the cost effectiveness of changing to a new accounting method for small and large companies. We will take an in-depth view into ABC costing to look at its strengths and weaknesses and to evaluate what improvements ABC costing has introduced over Traditional based costing management.

Traditional costing and Activity based costing

Traditional based costing was a management concept that was introduced in the 1920s; the methodology is that products consume cost and every unit that is produced will relate to a cost (Marx 2009:1-3). Traditional costing uses a volume based driver usually for e.g. machine hours or direct labour to assign costs which concludes with cost of goods sold based on absorption costing to reach a cost factor.

Management styles in the 1920s were more basic and industry was much more labour intensive so overhead costs were smaller; there was also a less significant range of products being produced. Indirect costs were only a small fraction compared to the current amount that is being spent in the current business world today and by the early 1980s, industry was starting to believe that traditional costing was outdated and was giving meaningless results.

Activity based costing emerged in the late 1980s, this concept is thought to be a more sophisticated management cost system than the traditional and both systems use a two stage allocation process. In the first stage a traditional system (see Diagram A1) allocates overheads to production and service departments and then relocates department costs to the production department(Drury 2009: p188-200).

ABC will also assign overheads to an activity base and not to a department normally known as a cost centre. There can be many activities that could include purchase materials, customer orders and product assembly, there would also be a higher amount of cost centres within ABC than the traditional method of departments, but both can have similar names within the first stage of the process.

The second stage of the allocation process will allocate costs from the department or cost centre to the cost product (see Diagram A1), within the normal traditional structure there are a small number of allocation bases called overhead allocation which would include direct costs and labour.

Activity based costing systems would have many more cost drivers including non volume based drivers and the number of production runs. The use of more cost drivers and cost centres will provide a more accurate financial picture in relation to costs of a product, as this can include the support costs that traditional costing fail to be able to allocate like production scheduling and purchasing.

Traditional Costing System

Activity Based Costing Systems

DiagramA1

Activity based costing is starting to take a global effect; surveys of UK companies indicate 15% have already introduced ABC. Service and financial industry companies who are ideal for the ABC concept have according to a UK survey by Drury and Tayles (2005) already seen 51% change from traditional based costing to ABC(Drury 2009: p188-200). The study also indicates that company size had a significant impact on ABC with the larger companies (sales in excess of 300 million) having a much higher adoption rate than smaller companies.

Companies that are changing to activity-based costing (ABC) will require additional planning in accounting practices, cultural customs of both the country and the company, and capabilities of local staff which will need to be analysed for ABC to succeed.

Having competent employees is important in ABC implementation it is particularly important within global implementation. The employees within local companies are often the product of cultural standards. Their understanding is unique to country-specific accounting requirements. This view can be important within local culture but must be fully expanded to utilise ABC costing and to help monitor business within their cultural area (Brewer 1998: p241-260).

Accounting applications differ widely around the world. Concepts including costing can be different and some of these differences are due to government regulations, such as in Greece where the chart of accounts is specified by regulation. This also happens within the US where the Federal Energy Regulatory Commission's (FERC) have prescribed accounts in the utility industry. Germany is known for having far more detailed cost accounting than the United States and in Japan, cost management is embedded in monitoring operational performance measures and using cost tables to accurately analysis its financial data.

In many cases, the underlying architecture of hardware and software systems varies widely. Even where the systems are the same, different sites run on different releases or versions. This is due to the length of time necessary to globally convert technology and the varying degrees of software support around the world.

While implementation teams cannot change these factors, it helps to plan for how they will be considered. In many cases, an ABC migration plan is used to match up with the systems information systems plan.

ABC- Advantages
Individual activities costs are resourced based Activities are accurately checked within the company Able to identify expensive and inexpensive costs when there acquired Products and services can be analysed before new launch/changes to current business Process development and expansion improvements

ABC- Disadvantages
Can be expensive compared to traditional cost methods Activities all require costing can be a lengthy process (time) Barrier to change-organisational and employee rejection

ABC costing is not always beneficial to businesses, companies with limited competition and a standard product may not benefit from changing from traditional costing to a more expensive ABC system. Companies that have intense competition and a diverse range of products with consuming resources would normally gain the most benefit from ABC especially in the long term period.

Conclusion

Technology has made it possible for companies to change form traditional based costing methods to a new more expensive activity based costing method and this transformation if achieved, will help a company to allocate its overheads correctly and also highlight the importance of allocating indirect costs. ABC is not an easy task to implement all of the companys activities are analyzed and reduced into their smallest components. The easy approach is to use ABC software in conjunction with a companys existing accounting system. The traditional system continues

to be used as before, with the ABC structure as an extra to be called upon when specific cost information is required to help make a particular decision. Large firms should consider a pilot scheme before implementing the system throughout their business as cost to implement can outweigh the potential savings but the longer term benefit will normally be worth the initial investment. ABC costing system is a requirement for improving business processes it requires management to investigate costs closely and helps to identify inefficiencies and is now a recognized cost system that has many satisfied customers all over the world.

Management Accounting Techniques Report

1.0 Introduction
Business managers in general understand and appreciate how important management accounting is within their corporation. Managerial accounting is not required to be part of the generally accepted accounting principles (GAAP) but Managers create reports using management account systems to help them make important decisions on investment funding and future planning. It will also give there company a possible edge within the business market.

This report as been based on basic management costing data from two very different companies one a small equine riding centre and also a medium sized repair centre, both took part in an interview and filled in a questionnaire which included questions on a variety of cost management technique systems.

2.0

Strategic Cost Management Systems/Techniques

Life Cycle Cost Management Target Costing Activity Based Management Business Process Re-engineering Cost of Quality Cost Management and the Value Chain Benchmarking Environmental Cost Management Just In Time Time Quality Management Long Range Forecasting Product Profitability Analysis Financial Measures Budgeting for Planning Budgeting for Controlling Costs Balanced Scorecard

2.0.1 Northfield Riding Centre- Bold-St Helens

How Important
NI MI IM

Management Accounting Technique

S1

How Often Used

S2 S3 S4 S5

X X X X X X X X X X X X X X X X

Life Cycle Cost Management Target Costing Activity Based Management Business Process Re-engineering Cost Of Quality Cost Management and the Value Chain Benchmarking Environmental Cost Management Just In Time Total Quality Management Long Range Forecasting Product Profitability Analysis Financial Measures Budgeting for Planning Budgeting for Controlling Costs Balanced Scorecard

X X X X X X X X X X X X X X X X

NI- Not Important MI-Moderately Important IM- Important

S1- Never S2- Rarely S3 Sometimes S4- Often S5Very Often

Small Enterprise Northfield Riding Centre-St Helens- Approx. 70,000 Net Profit
100- Acreage Four American Barns-80 Horses 8 Full Time Staff/3 Part Time Staff

2.0.2

GTECH Repair Centre

Management Accounting Technique

How Important
NI MI IM

How Often Used

S1 S2 S3 S4 S5

X X X X X X X X X X X X X X X X

Life Cycle Cost Management Target Costing Activity Based Management Business Process Re-engineering Cost Of Quality Cost Management and the Value Chain Benchmarking Environmental Cost Management Just In Time Total Quality Management Long Range Forecasting Product Profitability Analysis Financial Measures Budgeting for Planning Budgeting for Controlling Costs Balanced Scorecard

X X X X X X X X X X X X X X X X

NI- Not Important MI-Moderately Important IM- Important

S1- Never S2- Rarely S3- Sometimes S4- Often S5-Very Often

Medium Enterprise GTECH Field Service Repair Centre- Approx. 1.3 million Net Profit. Repair Capacity 1000 Lottery Terminals/Week Head Office-Watford and Repair Centre Aintree Approx. 120 Full Time Staff

2.1

Report Recommendations

The aim of this study has been to investigate two different size companies and their management accounting practices. The results of this report cover budgeting, performance evaluation, costing, decision-making.

2.1.1 Small Enterprise

The small enterprise Northfield Riding Centre has limited use for management techniques. Absorption costing and marginal costing are two techniques that are important to the business, absorption is used for cost control purposes and marginal costing is used for management control (Weetman, 2006: P.141-165). Just in time, budgeting and financial measures are concepts that are understood and in current use in some small form but ABC, TQM and Balanced scorecard were not concepts that featured or seem to be thought about for future use. Recommendation for this company is a balanced scorecard which is a simple concept that could be introduced with minimal cost and encompasses Financial, learning and growth, customer focus and internal business processes will provide a framework that provides performance measurements and possible cost savings including increased profits.

2.1.2 Medium Enterprise The medium enterprise GTECH is a much more sophisticated company in terms of management account techniques currently budgeting, benchmarking and financial measures are concepts that are deemed important to the company. Standard costing is mainly in use within GTECH as the nature of their business is mostly a standard same product. Profit has been increasing year on year and forecast and budgets show expected increases in the future financial term. Recommendation for this company is activity based costing and management this concept will enable GTECH to break down its costs to specific products and activities, this can give a more accurate picture in relation to future expansion and new development. ABC can be expensive to implement in the short term but the long term benefits will give GTECH greater control of their business with increased efficiency and improved profits.

2.2

Conclusion

Both companies in my opinion will benefit from improved management accounting techniques, improved control and greater efficiency are key to all small and medium sized businesses and with the development of improved management concepts, it would be a perilous decision to ignore the latest management systems when long term business future is difficult to forecast without it.

Bibliography Atrill, P. (2003) Financial Management. 3rd ed. Essex: Pearson Education Limited Brewer,PC.(1998) National culture and ABC costing system: A Note Management Accounting Research,9:241-260. Drury, C. (2009) Management Accounting for Business. 4th ed. Singapore: Cengage Learning. Gunasekaren,A.(1999) A Framework for the design and audit of an activity based costing system Managerial Auditing Journal, 14(3):118-126. Johnson,T.(1987) Relevance Lost the rise and fall of management accounting,1-18. Marx,C.(2009) Business Consulting Services.ABC And Traditional costing:1-3. Weetman, P. (2006) Management Accounting. Harlow: Prentice Hall. Accounts Standards Board. (2011)Business Accounts. http://www.frc.org.uk/ [05 Oct 2011] CIMA Global.(2011) Activity Based Management an overview.http://www.cimaglobal.com/Documents/ImportedDocuments/ABM_techrpt_ 0401.pdf CIMA Global. (2011) Budgeting and Planning. http://www.cimaglobal.com/engb/Thought-leadership/Research-topics/Budgeting-and-planning/Budgeting-practiceand-organisational-structure/.[03Oct 2011] Patton R. (2011) Easy as ABC.http://www2.accaglobal.com/students/dipfm/finance_matters/archive/2005/65/2 495894