Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/24067611
CITATIONS READS
4 73
1 author:
Janek Ratnatunga
Institute of Certified Management Accountants (Australia) & Swinburne University
75 PUBLICATIONS 733 CITATIONS
SEE PROFILE
Some of the authors of this publication are also working on these related projects:
Carbonomics of Agricultural and Industrial Outputs: Comparison between Bangladesh and Japan
View project
All content following this page was uploaded by Janek Ratnatunga on 01 February 2017.
• Abstract
A significant portion of the current managerial accounting literature contrasts the benefits and
importance of activity based costing (ABC) systems with the more traditional cost accounting
systems. This paper questions this tendency of making such a stark contrast, by placing ABC
-and
systems within a wider cost accounting framework. Initially, the framework is developed by
providing an overview of the product costing, control and decision making process. Also outlined
are the various costing systems in terms of their objectives, advantages and deficiencies. A schema
for integrating the costing process with decision making and performance evaluation criteria is then
conceptualized. The role of ABC is recognized and integrated within this framework. The link
between 'traditional' and ABC systems is also studied via an analysis of the conventional wisdom
in some of the leading texts in managerial accounting. The analysis demonstrates that there is still
much ambiguity in both the contrasting and the linking of ABC with the more traditional costing
systems.
Introduction
*Address for correspondence: Professor Janek Ratnatunga, Syme Department of Accounting, Monash
University, PO Box 197, Caulfield East, VIC. 3145, Australia.
1
This term is borrowed from Horngren (1989) to reflect the current state of management accounting
research.
2
The meaning and application of the decision making process will be reviewed in a later section of this
paper.
Cost objects
At an operational level, the focus of costing systems are defined according to cost objects.
A cost object is an activity for which a separate measurement of costs is desired. These
measurements can be classified into three main categories : costs for stock valuation, 3 costs
for the purposes of control, and costs for decision making purposes.4 Costs for control
purposes are those costs which are reasonably subject to regulation by the manager who is
responsible for the particular costs (see Figure 1).
Generally, costing systems have a two-step allocation process between the aggregation
(accumulation) of costs into natural accounts e.g., direct material, direct labour, and
manufacturing overhead, and the accumulation of costs by cost object, e.g. products,
customers, channels, etc. Therefore, costing systems first disaggregate the costs in natural
accounts to functional cost centres, such as manufacturing, administration and selling, and
then reaggregates these functional costs to the cost objects.
Costing method
Product costing methods are typically job costing and process costing. Job and process
costing methods accumulate and trace costs to products using either an absorption costing
format or a variable costing format. Job order costing is appropriate when large, unique, or
special-order items are produced (Winicur, 1993), and is normally used when products or
services receive varying attention and effort. All the costs incurred are recorded on a job
order costing sheet. Process costing is more suitable for continuous operations, such as
batch or flow production. These methods are representations of the costs incurred on a
particular job or process and are suitable for stock valuations on external reports.5 Job-
order and process costing can be implemented ex-post via backflush costing, a costing
3
The term ' stock valuation' is used synonymously with ' inventory valuation' in this paper. It refers to the
valuation of inventory for external reporting purposes.
4
This classification framework for cost objectives may seem generic because of the scope for overlap between
the various categories. However, it is useful for formulating the kind of argument presented above. A similar
framework with a more detailed analysis of costs is provided by the Chartered Institute of Management
Accountant' s Official Terminology (CIMA, 1996).
5
In management accounting, costs for decision making would require future costs and opportunity costs. This
information can be provided by a job order costing system when undertaking a 'cost estimation' exercise using
expected future costs.
Costing systems 339
COSTING METHOD
COST TYPE
1
TREATMENT OF OVERHEADS
1
COST ALWCATION BASE
Direct (Cost attachment),
Volume-based,
n4..&efl?:ut-'ff:.~d,
Life cycle-based,
Hybrid
Versions
j Relevant Costing,
Marginal Costing,
Capital Budgeting,
Slrategic Value
Analysis;.
Hybrid ·
DECISION MAKING APPROACH Versions
t
PERFORMANCE EVALUATION CRITERIA
method most suitable within the just-in-time philosophy of waste reduction (Shillinglaw
and McGahran, 1993).
Cost type
The 'costs' accumulated and traced under job and process costing may be measured as
historical costs actually incurred (called actual costing) or may be predetermined costs
(called standard costing) or be a combination of the two: i.e. direct material and direct
labour being 'actual' and the manufacturing overhead being 'predetermined'. Horngren
et a/., (1994) call this hybrid variant normal costing. Standard costing is used when
activities consist of a series of repetitive operations. This is not really a costing system, but
instead a means of assigning predetermined costs to products within a job or process
costing system. Standard costs are target costs set under efficient operating conditions.
Treatment of overheads
For the purposes of the first measurement category, i.e. stock evaluation, the two most
commonly used 'costing systems' employing the above two-step definition are: absorption
costing and variable costing. In addition to the direct material and direct labour costs, full
absorption costing allocates all of the manufacturing overhead (both fixed and variable) to
the cost objects. This costing approach is used for the valuation of inventories in external
financial reports, as it is consistent with the Generally Accepted Accounting Principle
(GAAP) of conservatism and does not understate the value of such inventories. The
alternative format is variable costing, which treats the fixed manufacturing overheads as
period costs and, therefore, only allocates variable manufacturing overheads to products.
This system is not used for inventory valuation, and is generally only used for short-run
internal decision making. 6
6
There is considerable debate in the literature regarding the suitability of variable costing over full absorption
costing for decision making and inventory valuation. Fremgren (1964) provides a summary of the arguments. In
an absorption costing system profit figures are affected by both production and sales volumes, while in a
variable costing system these figures are affeced only by volume changes. This distorts the profit figures when
there are high fluctuations in sales and production volumes. Consetjuently, variable costing is a more relevant
measure of profit for short-run decision making purposes as it is unaffected by changes in production
volume.
Costing systems 341
The second measurement category for the classification of costs is for the purposes of cost
control. Cost control can be achieved by comparing expectations with actual outcomes,
and taking corrective action in areas where outcomes fall far below expectations. This
process is called 'budgetary control' in which we deal with expected future costs, or
standards for cost estimation. The subsequent corrective action process involves a
comparison of such estimates with the actual costs incurred for the purposes of pinpointing
responsibility. Traditional variants of budgetary control have been cost control approaches
such as zero based budgeting (ZBB) and planning programming budgeting systems
(PPBS).
Within the 'control framework' standard costing has two major limitations. First, control
in this system depends heavily upon the standards which are used for comparison with
actual figures. If standards of appraisal are weak, then the results from a comparison are
unsatisfactory. Therefore, standards should be revised to reflect changes in the environ-
ment if such changes are unanticipated (Demski, 1977). Second, the standard costing
system fails to link the operational control techniques clearly with a product's strategy.
This limitation is overcome with target costing (Morgan, 1993).
The third measurement category for the classification of costs is for the purpose of decision
making. In order to make such decisions various performance evaluation criteria such as
contribution margin, profit, return on investment, residual income (EVA), NPV, etc., will
be used. Both absorption and variable costing can be used for decision making with the
incorporation of future expected costs (i.e., cost estimations and budgets). This need for
decision-oriented information has also resulted in the development of two other costing
systems: relevant costing and marginal costing. 9 A relevant costing system places an
emphasis on correct decision making, with regard to the choice among alternatives. This
involves a two-step process in which only future costs and revenues which differ between
7
The conservative principle requires costs to be based on verifiable data. Verifiable data is normally historical,
whereas managers require future costs for decision making. This principle also distorts life cycle costs as it
encourages the expensing of many costs when these costs should be capitalized.
8
Staubus (1988, p. 139) argues that the emphasis on products as objects of costing in the early cost accounting
literature might have arisen out of a misrepresentation of Clark's (1923) statement on using 'different costs for
different purposes. ' Clark recognized ' that the terminology of costs was in a state of confusion.' The generic
nature of Clark's statement might have shifted the emphasis from the products themselves to the activities that
result in the costing.
9
Marginal.costing is sometimes called direct costing. This view is not taken in this paper (see definition later
in the paper).
342 Sharma and Ratnatunga
10
Sorter and Horngren (1962) have extended this approach to inventory valuation. Under relevant costing, only
those costs which represented 'service potential' in the form of an increase in future revenue or a decrease in
future cost were recognised in the cost of inventory. No distinction was made between the behaviour of costs
as fixed and variable.
Costing systems 343
unequivocal support to the notion that ABC constitutes the means for achievinog F
competitive excellence. Johnson (1992) goes further when he notes,
The widely touted cost driver systems defined under the heading of ABC is no c
more than an accounting solution to an accounting problem-distorted overhead
allocation. Improving how companies trace overhead costs may be important for c
some things, but in the guise of cost driver ABC it doesn't necessary stimulate
I-
continuous improvement nor does it mark a pathway to competitive excellence.
(Johnson, 1992, p. 265) I-
Summary I-
I-
This paper suggests a framework for categorizing costing systems by outlining the various I-
systems in terms of their objectives, advantages and deficiencies. A schema for integrating
the costing process within decision making and performance evaluation criteria is then I-
conceptualized. The role of ABC is recognised and integrated within this framework.
It is observed that a significant portion of the current managerial accounting literature I-
contrasts ABC systems over the more traditional cost accounting systems. This paper
J
questions this tendency of making such a stark contrast by placing ABC systems within a
wider cost accounting framework. J
J
References
Atkinson, A.A., Banker, R.D., Kaplan, R.S . and Young, S.M. (1995) Management Accounting, New
Jersey: Prentice Hall.
Barfield, J.T. , Raibom, C.A. and Kinney, M.R. (1994) Cost Accounting: Traditions and Innovations.
St Paul, Minnesota: West Publishing Company. s
Brimson, J.A. (1991) Activity Approach: An Activity Based Costing Approach. New York: John
Wiley and Sons. s
Burch, J.G. (1994) Cost and Management Accounting: A Modern Approach, St Paul, Minnesota:
West Publishing Company. s
CTMA (1996) Management Accounting: The Official Terminology. London: Chartered Institute of s
Management Accountants, CIMA Publishing.
Clark, J.M. (1923) Studies in the Economics of Overhead Costs. Chicago: The University of \
Chicago Press.
Cooper, R. (1989) You need a new costing system when, Harvard Business Review. 67(1)
77-86.
'
Cooper, R. (1990) Five steps to ABC system design, Accountancy 106(1167), 78-81.
Cooper, R. and Kaplan, R.S. (1988) Measure costs right: make the right decisions, Harvard Business
Review 66(5), 96-103.
Cooper, R. and Kaplan, R.S. (1991) The Design of Cost Management Systems: Text, Cases and
Readings. New Jersey: Prentice Hall.
Demski, J.S. (1977) Analysing the effectiveness of the traditional standard cost variance analysis
model. In G.J. Benston (ed) Contemporary Cost Accounting and Control. (2nd edn). Encino,
California: Dickenson Publishing.
Dillon, R.D. and Nash, J.F. (1978) The true relevance of relevant costs, The Accounting Review
53(1), 11-18.
Drury, C. (1996) Management and Cost Accounting, 4th edn. London: ITBP.
Emmanuel, C.R., Otley, D.T. and Merchant, K. (1991) Accounting for Management Control, 2nd
edn. London: Chapman and Hall.
View publication stats
Fremgren, J.M. (1964) The direct costing controversy- an identification of issues, The Accounting
Review, 31(1), 43-51.
Garrison, R.H. and Noreen, E.W. (1994) Managerial Accounting Concepts for Planning Control and
Decision Making, 7th edn. Illinois: Irwin.
Green, F.B., Amenkhienan, F. and Johnson, G. (1991) Performance measures and JIT, Management
Accounting (IMA) 72(8), 50-3.
Hansen, D.R. and Mowen, M.M. (1995) Cost Management: Accounting and Control. Cincinnati:
South-Western College Publishing.
Hendricks, J.A. (1988) Applying cost accounting to factory automation, Management Accounting
(IMA) 70(6), 24-30.
Hilton, R.W. (1994) Management Accounting, 2nd Edn. New York: McGraw-Hill.
Hopwood, A. (1976) Accounting and Human Behaviour, Chapter l. New Jersey: Prentice Hall.
Hopwood, A. and Bromwich, M. (1986) Research and Current Issues in Management Accounting.
London: Pitman Publishing Limited.
Homgren, C.T. (1989) Cost and management accounting: yesterday and today, Journal of
Management Accounting Research 1(1) 21-32.
Homgren, C.T., Foster, G. and Datar, S. (1994) Cost Accounting: A Managerial Emphasis, 8th edn.
New Jersey: Prentice-Hall International.
Jeans, M. and Morrow, M. (1989) The practicalities of using activity based costing, Management
Accounting (CIMA) 67 (10), 42-4.
Johnson, H.T. (1992) Relevance Regained: From Top Down Control to Bottom Up Empowerment.
New York: The Free Press.
Johnson, H.T. and Kaplan, R.S. (1987) Relevance Lost: The Rise and Fall of Management
Accounting. Boston: Harvard Business School Press.
Maher, M.W. and Deakin, E.B. (1994) Cost Accounting, 9th edn. Ilinois: Irwin.
Morgan, M.J. (1993) A case study in target costing: accounting for strategy, Management
Accounting (CIMA) 71(5), 20-2.
Shillinglaw, G. and McGahran, K.T. (1993) Accounting: A Management Approach, 9th edn. Illinois:
Irwin.
Sorter, G. and Horngren, C.T. (1962) Asset recognition and economic attributes - the relevant
costing approach, Accounting Review 37(3) 391-99.
Staubus, G.J. (1988) Activity Costing for Decisions. New York: Garland Publishing.
Steedle, L.F. (1988) Has production measurement outgrown infancy? Management Accounting
(IMA) 70(2)15.
Vatter, W.J. (1945) Limitations of overhead allocation, The Accounting Review 20(2), 163-76.
Wilson, R.M.S. and Chua, W.F. (1993) Management Accounting: Method and Meaning, 2nd edn.
London: Chapman & Hall.
Winicur, B. (1993) Job order costing, National Public Accountant 38(5), 7-8.