THE PRACTICABILITY OF ACTIVITY BASED-COSTING IN NIGERIA: A CASE OF GOFCECON LIMITED

BY ISHAQ AHMED MOHAMMED 08069692552 miishaqmashaq@yahoo.com

SCHOOL OF BUSINESS EDUCATION, DEPARTMENT OF ACCOUNTING, FEDERAL COLLEGE OF EDUCATION (TECHNICAL), GOMBE, GOMBE STATE

Electronic copy available at: http://ssrn.com/abstract=1854321

Abstract The costing of products and services has become an important issue in todays business world. This is evident because of the present circumstances characterized by intense competition, galloping quality standard and price wars for customer attraction. Arising from the foregoing, Activity- Based Costing system has developed over the past decades. ABC is an accounting system that measures the use resources by activities. The paper thus, examines the practicability of Activity- Based Costing in GOFCECON LTD. Related literatures were reviewed. The study employs a survey method through the use of unstructured interview to collect data. The population is made up of ten (10) respondents. The method of analysis employed by the study was the use of simple percentage. Findings revealed that the companys management and the finance department are not aware of activity based-costing system and not willing to for now accept and or implement. It is recommended that the management of GOFCECON LTD should accept the concept of ABC and make adequate provisions for management accountants to further their education in order to understand the viability of ABC, extol its virtues and enjoys its practicability. Key words: Activity Based-Costing, Cost- drivers, Practicability, Awareness

Electronic copy available at: http://ssrn.com/abstract=1854321

Introduction The ability of a manufacturing company to compete effectively and favourably in the global market is determined to a large extent by the cost and quality of its products. The cost of a product can be reduced by increasing productivity (the relationship between total output and total input) or by reducing manufacturing costs at the production floor. Increasing recognition of cost competition has forced companies to develop efficient techniques for the control of manufacturing facilities and materials and hence increasing productivity and quality. For the past few years, considerable emphasis has been placed on the cost. Manufacturing cost of a product can be reduced by: minimizing the number of components used in the product, designing components for ease of handling and assembly; and selecting the best material/process combination for economic manufacture of the individual parts (Ong et al., 1993). Activity based costing (ABC) is essentially an accounting system that measures the use of resources by activities. Cost drivers are then used to ascribe the costs of those activities to items generating the activities, e.g. products, customers and companys infrastructure. It therefore allows a more accurate costing of overheads according to their actual usage (Steve, Letza and Gadd, 1994). In a more clear definition as given by Sharma and Gupta, (2008) ABC is an Accounting system that assigns costs to products based on the resources they consumed. The primary success factors for the implementation of activity based costing (ABC) related to capabilities in creating quality products and services, and controlling capital intensity and debt levels. Another important capability is that of being able to create and
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implement an effective policy. ABC is a method of allocating costs to products and services. It is generally used as a tool for planning and control. It was developed as an approach to address problems associated with traditional cost that tend to have inability to accurately determine actual production and services costs, or provide useful information for operating decisions with these deficiencies managers can be exposed to make decisions based on inaccurate data (Kaplan, 1983). ABC is an improved means of identifying high overhead costs per unit and finding ways to reduce the costs (Franklin and Ellen, 2002). Thus, any organizational process that reduces the cash outflows for a smaller or medium enterprise is likely to have positive impact in terms of a reduction of debt, and the consequential savings can be made into profits or into improved market competitiveness through its investment into the differentiating features of the business or into the charging of lower prices. This aim of this paper therefore, is to assess the practicability of the ABC costing system in GOFCECON Ltd. Literature Review Activity based costing (ABC) has attracted the interest of academics and management accountants at a considerable extent in recent years (Bj0rnenak and Mitchell 2002). However, the empirical evidence from a number of surveys shows that the diffusion process of ABC has not been as intense as expected (Lukka and Granlund, 1996; Chenhall and Lang field-Smith, 1998; Innes et al., 2000). The essence of the ABC paradox is that if ABC has demonstrated benefits, why then, is not actually employed by
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a gradually increasing number of firms? (Gosselin, 1997; Innes et al. 2000) A plethora of parameters have been tested in the literature in order to explain this paradox (Gosselin, 1997; Bj0rnenak, 1997; Malmi, 1997, 1999; Brown et al., 2001; Shields, 1995; Foster and Swenson, 1997; McGowan and Klammer, 1997; Fried man and Lyne, 1999; Anderson and Young, 1999: Cobb et al., 1992).

There are a number of research papers in the literature that deal with the ABC and its applications (Cooper and Kaplan, 1991; Miller, 1992; Shields and Young, 1989; Johnson and Kaplan, 1987). However there are only a few articles that deal with case experiences with the objective to highlight the appropriateness of ABC and develop a framework for making decisions on the implementation of ABC in a particular company. Even though application of ABC differs from one country to another, for example, (Kidwell et al 2002) identify differences in systems that provide financial and non-financial performance, even if they operate under the same label in different countries. Companies do not have to commit their entire accounting system to ABC; instead they can focus on the areas where value adding activities play a significant role in improving the competitiveness. Decisions about improving pricing, marketing, product design and product-mix can now be made more efficiently with a basic and accurate knowledge of product costs gained by implementing an ABC system as a secondary cost system. First, costs are collected and the activities are identified. Second, various cost drivers are used to trace the costs generated by the relevant activities (Jeans and Morrow, 1989).

Reviews of past relevant work on justification of advanced manufacturing systems find that researchers have mainly focused on the use of revised, traditional economic/analytic approaches along with attempts to incorporate strategic implications into the justification process. Control and evaluation mechanisms are a critical part of an innovative process such as introduction of flexible manufacturing technology into a firm. An early case study by Gerwin (1981) on controlling and evaluating a flexible manufacturing system elaborated on the difficulty of cost accounting procedures in developing completely objective standards. The traditional concept of strategic planning conducted through an executive analysis and decision process and passed down the managerial hierarchy was shown to be inadequate for advanced, computerized technologies.

Borrowing from the concept of the "product champion", a process championing procedure for strategic change was postulated by Meredith (1986). The difficulty of quantifying indirect benefits and inadequacies in costing methods were also enumerated by Suresh and Meredith (1985) followed by a proposed integrated framework addressing both strategic and tactical considerations in justifying multi-machine systems. Meredith and Suresh (1986) discussed the importance of integration effects realized by islands of automation and fully-linked factory information networks.

On the Nigerian scene, most of the manufacturing companies and services organizations alike are not aware of the concept of the ABC let alone plan to implement it. For example, Dabor and Eragbhe (2005), on implementing ABC, studied fifteen private clinics and none of the clinics used activity based costing. On practicability of ABC, in
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an attempt to make over head more realistic there have been various products costing developments in recent years. The most influential is ABC (Adeniji, 2001). Accordingly, Omolehinwa, (2002) opined that ABC is a method of overheads to cut units on the basis of benefits received from the particular indirect activity, for instance ordering, planning, material handling. In other worlds ABC seeks not only to allocate overheads to product costs on more realistic basis than simply production volume, but equally attempts to show the relationship between overhead costs and the activities that cause them. Historical Development of Activity Based Costing Traditionally cost accountants had arbitrarily added a broad percentage of expenses onto the direct costs to allow for the indirect costs. However, as the percentages of indirect or overhead costs had risen, this technique became increasingly inaccurate because the indirect costs were not caused equally by all the products. For example, one product might take more time in one expensive machine than another product, but since the amount of direct labor and materials might be the same, the additional cost for the use of the machine would not be recognised when the same broad 'on-cost percentage is added to all products. Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.

The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s and 1980s. During this time, the Consortium for Advanced Manufacturing-International, now known simply as CAM-1 provided a formative role for studying and formalizing the principles that have become more formally known as ABC. (Consortium for Advanced Manufacturing-International)
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Robin Cooper and Robert S. Kaplan, proponent of the Balanced Scorecard, brought notice to these concepts in a number of articles published in Harvard Business Review beginning in 1988. Cooper and Kaplan described ABC as an approach to solve the problems of traditional cost management systems. These traditional costing systems are often unable to determine accurately the actual costs of production and of the costs of related services. Consequently managers were making decisions based on inaccurate data especially where there are multiple products, instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and affect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.

ABC was first clearly defined in 1987 by Robert S. Kaplan and W. Bruns as a chapter in their book Accounting and Management: a Field Study Perspective, (Kaplan, and Bruns, 1987). They initially focused on manufacturing industry where increasing technology and productivity improvements have reduced the relative proportion of the direct costs of labor and materials, but have increased relative proportion of indirect costs. For example, increased automation has reduced labor, which is a direct cost, but has increased depreciation, which is an indirect cost. Like manufacturing industries, financial institutions also have diverse products and customers which can cause cross-product cross-customer subsidies. Since personnel expenses represent the largest single component of non-interest expense in financial
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institutions, these costs must also be attributed more accurately to products and customers. Activity based costing, even though originally developed for manufacturing, may even be a more useful tool for doing this (Crawford and Rebishcke, 1990) then, and the actual costs are traced to those activities in the production process. Therefore, ABC is not only useful for cost calculations but also can play an important role in management decisions; it also provides insights into how a company operates. There are a number of research articles published on the design and implementation of ABC (Johnson and Kaplan, 1987: Zhuang and Burns, 1992; Lyne and Friedman, 1996; Coskins. 1997; Schneewciss, 1998; Sohal and Chung, 1998). However, they have not discussed the suitability of the application of ABC with reference to multiple case companies. Difference between Activity Based Costing and Traditional Costing System
Activity-Based Costing (ABC) Cost pool ABC systems accumulate costs into activity cost pools. These are designed to correspond to the major activities or business Traditional Costing Traditional costing systems

accumulate costs into facility wide or departmental cost pools. The pool are heterogeneous-they are costs of many major processes and generally are not caused by a single factor. Traditional systems allocate costs to products using volume-based allocation bases: units, direct labor input, machine hours,

processes. By design, the costs in each cost pool are largely caused by a single factor-the cost driver. Allocation bases ABC systems allocate costs to products, services and other cost objects from the activity cost pools using allocation bases

corresponding to cost drivers of activity costs. Hierarchy of cost Allows for non-linearity of costs within the organization by

revenue dollars.

Generally estimates all of the cost of an organization as being driven

explicitly recognizing that some costs are not caused by the number of units produced. Cost objectives Focuses on estimating the costs of many cost objects of interest: units, batches, products lines, business processes, customers, and suppliers. Decision support Because of the ability to align allocation bases with cost drivers, provides more accurate

by the volume of product or service delivered.

Focuses on estimating the cost of a single cost object-unit of

product or service.

Because of the inability to align allocation bases with cost drivers leads to over costing and under costing problems.

information to support managerial decisions. Cost control By providing summary costs of organizational activities, ABC

Cost control is viewed as a departmental exercise rather than a cross functional effort.

allows for prioritization of cost management efforts. Cost Relatively expensive to

Inexpensive to implement and maintain.

implement and maintain.

Source: Using Activity-Based Costing to Manage More Effectively (Grant Report, January, 2000)

The Virtues of Activity Based Costing ABC is now an accepted element of the accounting and control systems of industrial and service firms, and it has been employed in both governmental and not for-profit organizations. ABC is a product of the technological era. Conventional managerial information systems can trace their roots to the industrial age, when labor was the dominant factor of production. Within these systems, overhead cost is first allocated from service departments to production departments and then distributed, using an "overhead charging rate," to specific products. This method was developed to measure manufacturing processes in which overhead was either immaterial or was mainly a function of direct labor, which, in turn, was dependent upon production volume.

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Moreover, in a conventional industrial setting, production departments were mainly responsible for the key manufacturing activities and were clearly distinguishable from service departments, which provided only ancillary support. Merits of Activity Based Costing Consolidating the above points, Dandago and Tijjani (2005) have discussed extensively on the merits of ABC as follows; (a) Activity based costing gives a meaningful analysis of costs which should provide a better basis for pricing decisions, product mix decision, designs, decisions and production decisions. (b) Activity based costing focuses on the consumption of resources rather than merely

allocating costs to product or services. This raises a question about why resources are being consumed in the way that they are. (c) Cost control may be improved (under ABC) because the increases in costs can be

more readily identified (poor usage of storage space for example) and means of reducing costs can be investigated (extra shelving, perhaps, or automated packing procedures). (d) Service businesses have characteristics very similar to those required for the

successful application of activity based analysis in modern manufacturing industry. (i) (ii) (iii) (iv) A highly competitive market Diversity of products, processes and customers Significant overhead costs not easily assigned to individual products. Demand on overhead resources placed by individual products and customers, not proportional to volume.

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(e)

The complexity of many businesses has increased, with wider product ranges,

shorter products life circles, the greater importance of quality and more complex production process. Activity based analysis recognizes this complexity with its multiple cost drivers, many of them are transaction- based rather than volume-based. Criticism of Activity Based Costing Much as we appreciate the virtues as well as the merits of ABC, yet the ABC systems have been criticized. It has been suggested by critics according to Dandago and Tijjani (2005) that activity based costing has some serious flaws. (a) The cost of obtaining and interpreting the new information may be considerable.

Activity based costing should not be introduced unless it can provide additional information for management to use in planning or control decisions. (b) Many overhead relate neither to volume nor to complexity and diversity. The

ability of a single cost driver to fully explain the cost behaviour of all items in its associated pool is questionable. (c) Some critics have questioned the fundamental assumptions that activity based

causes cost, suggesting that it could be argued that decisions cause cost or the passage of time causes cost or that there may no one clear cause of cost Limitation of Activity Based-Costing Regardless of the numerous benefits of ABC that are widespread in the literature there are companies that strongly oppose to the possibility of ABC adoption. According to the findings of relevant researches, the main reasons for rejecting the adoption of ABC could be summarized to the following reasons: (a) Satisfaction with the existing costing system.
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(b) ABC implementation being associated with high costs. (c) Lack of time to undertake an assessment of ABC implementation. (d) ABC's perceived inadequacy to provide more accurate cost information. (e) Lack of management support or interest and (f) Finally, requirement to follow parent company's directives, including the selection of cost accounting system. Methodology The study as mentioned earlier is to examine the practicability of Activity Based Costing system in GOFCECON LTD. The study employs the use of unstructured interview method to collect data this is to enable respondents express themselves freely on the subject matter. The population of the study consists of ten (10) respondents out of which four (4) are management staff, three (3) are senior management accountant and finally, three (3) are senior accountant. The method of analysis employed by the study was the simple percentage. Result and Discussion This section presents the data collected and used in determining whether the concept of Activity Based Costing system is practicable in GOFCECON LTD.

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Table 4.1 No. of Respondents and their Categories

S/N 1 2 3 4

Category of Respondents Management Staff Management Accountant Senior Accountant

Total

No of Respondents
4 3 3 10

Percentage (%)
40 30 30 100

Source: Field Survey, 2010 The table 4.1 represents the people interviewed their categories or type, the no. constituting each category or type and the relevant percent. As can be seen, 4 respondents represent management cadre, 3 respondents represent management accountant and finally 3 respondents represent senior accountants Table 4.2 Awareness of Activity-based Costing
S/N 1 2 3 Responses Aware Group Un aware Group Total No of Respondents 0 10 10 Percentage (%) 0 100 100

Source: Field Survey, 2010 Based on table 4.2 it is interesting to note that, all of the respondents belong to the ABC unawares' group which include the executives in the top hierarchy of management and the financial departments which include management accountants and the senior accountants representing 100%. An analysis of the time that these managers obtained the specific professional status revealed that they held the specific position for more than four years. These findings may be indicative both their age and of the period they studied cost accounting. The majority of ABC unawares uses absorption costing while the rest
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use standard costing. For GOFCECON LTD cost accounting information is usually used for rather than traditional purposes, such as stock valuation, price .setting, cost control and preparation of financial statements. Also, they reported that they company did not face significant problems regarding the application of the currently used cost accounting system. Table 4.3 Satisfaction with the Current method
S/N 1 2 3 Responses Satisfied Not satisfied Total No of Respondents 10 0 10 Percentage (%) 100 0 100

Source: Field survey, 2010 From table 4.3 10 respondents representing 100% of the respondents revealed that they seem quite satisfied with their cost accounting system. Probably the increased level of satisfaction along with the absence of significant problems regarding the application of the currently used cost accounting system and the profile of the financial department's executives have not forced them to search for another more sophisticated cost accounting system, like ABC. They equally seems to be very conservative i.e. not willing to change from old system.

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Table 4.4 The Practicability of ABC in GOFCECON LTD

S/N 1 2 3 Responses Practicable Not Practicable Total No of Respondents 6 4 10 Percentage (%) 60 40 100

Source: Field Survey, 2010 From table 4.4, 6 respondents representing 60% were of the view that ABC is practicable. This was informed by the proper explanations of the concept of ABC by the researcher. These categories of the respondents were the management accountants and the senior accountants. They believe that ABC would no doubt help the company to reduce waste, improve the profit level and increase efficiency among its workers. While 4 respondents representing 40% which mostly represent the Executives and or the management staff were of view that ABC being a new concept to them will not be practicable in the company. They argued that the concept of ABC is too technical and that understanding the methods and procedures will take time. Conclusion This paper has described the practicability of activity based costing in GOFCECON Ltd. It is clear from the literature reviewed and study presented previously that ABC offers substantial benefits over conventional accounting systems; however, it has a relatively low up-take amongst companies and organizations for instance a survey of fifteen private clinics in Benin City by Dabor and Eragbhe, (2005) shows that all the clinics are not aware of the concept of ABC. Ado, (2006) found large number of the accountants operating in the Nigerian manufacturing companies do not have the necessary knowledge
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and skills about the new method of (ABC). In the same vein but viewing it from international perspective, Cobb, Innes, and Mitchell, (1993) opined that ABC poses several more practical difficulties that have hinder its adoption in most organizations. A survey research by Innes and Mitchell, (1995) shows that a decision to adopt ABC is rarely one which is taken lightly. Yet the concept offered greater returns than the traditional method. Based on the data collected, analyzed and interpreted the researcher comes up with the following findings: (a) the companys executives/management as well as the finance department

including cost and management accountants are not aware of the ABC concept let alone implement or better still put it into practice. (b) The executives/management of GOFCECON LTD are not for now willing to accept or to implement the concept of ABC because of its technicality as argued by them. (c) The practicability of ABC in GCFCECON LTD is possible because of the interest shown by those whom responsibility relates to cost i.e. the cost and the management accountants. They believe that the concept of ABC is a tool that helps management to get an accurate picture of costs cause by different activity, which can be extended to managements decision making framework for different purposes.

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Recommendations Arising from the foregoing the paper wishes to offer the following recommendations: Since the concept of ABC has been introduced to management of GOFCECON LTD, they should give it a try by accepting, implementing and rift the benefits from the advantages offered by ABC. Management should not be conservative on the use of the traditional method. They should adopt current issues not only on ABC, but equally current issues like Just-In-Time (JIT), Activity-Based Management (ABM). Administrative bottle-neck should not come between ABC and the management. The ABC system is not as complex as envisaged by the management, the company must get involved in setting realistic and achievable objectives for it self. The objectives must be clear and simple so that everyone in the company can understand them. Objectives that will bring about reducing waste and maximizing profits, one means of achieving this is through ABC. Based on the interest shown by those staffs whom responsibilities are cost related, GOFCECON Ltd should encourage them. The staff concern must be co-operative and share similar values and attitudes. They should be ready for further training to acquire vast knowledge on ABC in order to achieve overall success of the company. They vast knowledge of traditional cost system they have will help in clearly defining time frames, actions and their responsibilities in implementing ABC. The head of the accounts should continuously monitor the progress of the company and makes the necessary changes so that targets are being achieved.

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