Activity Based Costing

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Table of Contents

Introduction
XU JI Electrical Company Limited
Global Electronics Inc
Conclusion
References

Introduction

Activity-based costing (ABC) is a widely adopted accounting practice where the cost of making various products and services are based on the companies’ activities (Panda1999, p. 5).

The costs are specifically allocated to products and services according to the level of consumption of each category, but comprehensively, it assigns more indirect costs into direct costs (unlike other conventional accounting practices) (Armstrong 2006, p. 363).

The major benefit associated with this accounting technique (ABC) is that a company can be able to specifically know which products and services take up most costs and which are overpriced and less profitable so that a required remedy is developed.

Activity-based costing basically works by allocating the overall resource costs according to the activities commensurate with them to the final products and services that are produced by a given company (Armstrong 2006, p. 363).

In a more general sense, the technique is basically used to understand a company’s profitability in relation to the costs incurred when producing various goods and services. In this regard, it is important to note that activity-based costing has been widely adopted by many organization because it aids in decision-making processes that touch on pricing, outsourcing, identification, and the actual benchmarking of the standards of production of goods and services (Panda1999, p. 5).

However, in as much as the activity-based costing technique has been beneficial to many organizations; many are also finding it very difficult to implement it. This trend has seen a number of organizations in emerging economies face a number of challenges adopting the technique, despite evidence of incredible success of its implementation in other parts of the world existent in many literature excerpts.

Significant challenges have been recorded in areas touching on acceptability, augmentation (with other computer systems in the organization), ensuring the system is of value to the company and its environment (among other challenges) (Liu and Pan 2007).

This study will critically analyze the experiences and challenges of such companies in implementing ABC and how many of them have been able to succeed with this process, while others have openly failed. This will be done through an analysis of two companies (XU JI Electrical Company Limited and Global Electronics Inc) operating in emerging markets.

XU JI Electrical Company Limited

Though activity-based costing has been widely adopted in the Western world, there is still increased skepticism among many companies operating in developing economies of its effectiveness. Such is the situation observed in China (Liu and Pan, 2007). In fact, Hu (2001) explains that the implementation of Activity-based costing in China is still at the theoretical level.

This situation can be evidenced in the case of XU JI Electrical Company Limited which is based in China. The company is basically an electronics company that manufactures electronic goods used in the development of public infrastructures like rail.

Activity based costing technique was introduced in the company in the year 2001 when there was a strong need to devise methods on how to tackle increased competition in the industry and to employ more efficient accounting techniques for better performance. The initial system was particularly based on the labor-hour absorption rate where costs were allocated across production lines.

This system was largely inefficient because it inhibited the company from pursuing competitive pricing strategies. Activity based costing was therefore introduced in the early months of the year 2009 under the First product department where the main objective for implementing the costing technique was to establish accurate product costing information for purposes of cost control (Liu and Pan 2007).

In the implementation of the activity based costing technique, the services of an implementation team was sought, where their primary mandate was to train the existing employees on how to use the system and to build an ABC conceptual model. The latter task was effectively carried out, except for the general administrative and finance expenditures, which contributed an overwhelming expenditure of approximately 77% of the entire cost budget.

Due to the fact that there was an increased organization structure inhibition, the implementation team decided to develop the ABC conceptual model on the number of employees evidenced in each given activity (as a temporary measure) (Liu and Pan 2007).

From this analysis, we can see that the company’s operations in China’s fast-paced business environment posed a challenge in the overall implementation of the ABC model because it was challenging to maintain it on an up-to-date level. In fact, similar research studies point out that many more companies face the same challenges, especially in identifying a good cost driver for the application of ABC because some of these cost drivers become obsolete after a given period of time (Liu and Pan 2007).

Liu and Pan (2007) further explain that the same situation has been evidenced in a number of Western economies where many companies have had to abandon their ABC implementation processes because of the volatility of the economy.

After basing the model on the number of employees, the activity-based costing model had to be computerized where a specific Chinese software was identified for this purpose.

However, during the implementation process, the lack of experience in dealing with such software augmentation led the company into significant conceptual errors that almost grounded the activities of Activity Based Costing implementation process. The company, therefore, had to seek the guidance of the activity based costing implementation team manager to asses the situation and provide possible remedies.

The team manager did so, and after determining the company’s rationale, the project went on smoothly. The company was, therefore, able to produce monthly activity-based costing reports, but there was a significant challenge in augmenting the ABC software with other computer softwares that were in existence before it. From this analysis, we can see that there is a strong need for technical expertise in the product implementation stage of ABC implementation to tackle functionality and compatibility issues.

This fact is also supported by Baker (1998, p. 257), who affirms that the input of technical expertise is vital in the overall successful implementation of ABC. The technical expertise evidenced in the above scenario was characteristic of the team manager’s input in salvaging the situation (ABC implementation).

As regards functionality and compatibility issues, it should be understood that the incompatibility of the ABC system and other computer systems was likely to pose a problem for other staff members in the organization (like in the warehouse division or the finance department) because there normally are instances of increased workloads where the officers have to double-check data added by the front-line managers into the ABC system.

In making the employees and staff receptive to the new ABC system, XU JI Electrical Company Limited decided to adopt the formal feedback session technique (Liu and Pan 2007). This technique was successfully used to show employees the benefits of the system; a process that ultimately led to a lot of satisfaction among the company staff.

However, some sense of resentment was observed from the front-line managers who pointed out the demanding nature of inputting data into the system as their biggest cause of concern regarding the system. Nonetheless, after subsequent meetings, there was a growing level of understanding among the managers.

A link between ABC implementation and performance measures was identified to be the biggest cause for concern when analyzed in terms of future implementation considerations of the project, which was considered to be a future agenda for discussion.

From this analysis, we can see that the inclusion of the bottom-level and top-level employees in the implementation process was critical to the acceptance of the costing technique.

Though there were significant objections coming from front-line managers, there were subsequent discussions aimed at seeking employee buy-in that brought the managers onboard. This analysis shows that constant communication between all stakeholders in the organization is likely to improve the probability that changes will be accommodated in the organization.

Global Electronics Inc

Global electronics Inc is a company specialized in making power semiconductors for signal processing and power control applications and many of its products are also used in braking antilock systems, airbag systems, computer keyboards, modems and the likes.

During the end of the year 1999, the company had experienced a significant dip in sales that caused a lot of tension within the company (as regards the long-term prospects of the company’s sustainability) (Juras 2003, p. 1). To remedy this situation, the company decided to employ the activity based costing system to uphold the company’s efficiency.

In a general sense, the company experienced significant success in implementing the ABC system because its new manager, Chris Richards, had a good background in ABC. This was the first step that could be learnt from the company’s experience in implementing ABC because the company’s new manager brought a lot of technical expertise that could be used in implementing the ABC model.

In a more general sense, this analysis shows that importing beneficial technical expertise is a positive move towards ensuring smooth implementation of ABC.

It is also important to note that having someone with a significant experience about the implementation of ABC, spearheading the process, is also a good move for the company. It was also observed that the education about the new model (ABC) and the task of wrapping management’s thoughts around the new model was still attributed to him (Chris Richards, the new manager). Basically, management’s buy-in could be attributed to his influence.

This analysis is essential to organizations that experience problems getting management to adopt to new changes in the organization. More essentially, it is important to note that having someone with considerable experience regarding ABC, in the managerial team is a plus towards getting the overall managerial team to accept changes in the organization.

Another reason for the smooth implementation of the model was attributed to the company’s operating capacity. The company’s director of manufacturing (cited in Juras 2003, p. 2) affirmed that:

“The number one thing we had going for us was an “urgency factor.” I truly believe people would not have given us the time of day with respect to ABC if we were making 10 percent return on sales. Having operating losses of $100 million causes people to listen”.

Moreover, in successfully implementing the ABC model, a steering committee that encompassed most members of all the company’s departments was quickly formed.

The members came from finance committees, product engineering, operations management, and other functional teams of the organization, but extra assistance was also sought from external organizations to enable the company effectively implement the ABC model (Juras 2003, p. 2). The move to include members from various departments of the organization ensured that the steering committee was holistic, in terms of member contribution because all the departmental members represented most functional areas of the organization.

It is also important to note the input of the steering committee in the implementation of the ABC model because it played a vital role in the entire process. The steering committee basically went ahead to define the tasks of each company plant department, assign the resource costs to the specific activities, and determine the activity drivers, among other technical areas of the ABC implementation model (it is important to note that all functional managers of the organization gave support to the steering committee) (Juras 2003, p. 1).

From this analysis, we can see that having a steering committee was quite vital to the successful implementation of the ABC model, considering the above tasks are key in the design stage of implementing the ABC model (Salvendy 2001, p. 2319). It is therefore vital for organizations that have a problem going past the design stage of the ABC model to have a steering committee that specializes on moderating the tasks to be covered at this stage.

It was also confirmed by Global Electronics’ manager that setting short-term goals during the implementation of the ABC model was essential in ensuring the process implementation process was smooth (Juras 2003, p. 3). The short-term goals set for the implementation of the ABC model was meant to improve the product cost accuracy and optimize the company’s product mix. A long-term objective was also established, and it was meant to transit the company into a long-term activity-based costing management criterion.

This is also another pointer that can be borrowed by organizations that have a problem implementing the ABC model because quite a number fail to understand the short-term and long-term goals of implementing ABC in the first place. Having clearly set short-term and long-term goals is therefore vital to the overall implementation of the ABC model because it steers the organization into the right direction during implementation.

Integrating the new ABC model with other existent systems was also a tricky affair for the company, but it successfully managed to undertake the ABC model in an offline manner where the system was managed separately from the previously existing labor-based standard costing system.

In the same manner, the new model was also managed separately from the financial reporting system. However, it was quite tricky for the company to maintain the offline system because there were issues of employee behavior, and other issues arising from previous negative experiences learnt from the PUC process that the company engaged in. Part of this problem was summarized by Juras (2003) that:

“The problem with a non-integrated approach, even though it is certainly a lot simpler and less risky, is how do you affect behavior?… For example, you can’t run the marketing organization based upon achieving some desired gross margin when they are relying upon bogus costs to push the stuff that you don’t want them to be pushing… But, how do you motivate these people to go after the right set of products if you’ve got a bunch of accountants sitting over here who have knowledge derived from some offline system that nobody else is aware of?” (p. 3).

This experience showed that despite the fact that the company had a remedy to solve the problem of implementing the ABC model; it still experienced significant challenges in sustaining the strategy for long.

The biggest cause for this problem can be attributed to the fact that the organization failed to include the behavioral aspect of implementing this strategy. From this analysis, therefore, we can observe that the failure to include the behavioral considerations of implementing the ABC model in the organization can eventually render the whole strategy useless.

Comprehensively, the ABC implementation process went on as planned and fell within a nine-month schedule, but this smooth transition could be attributed to including activities within the cost model that bore a strong influence to strategic product pricing and mix decisions (Juras 2003, p. 3).

The inclusion of a centralized project team also contributed a lot to the coordination of activities that were done in the implementation process. This team was quite crucial in ensuring a sense of consistency was observed within all plants. It is also identified that the top-bottom approach of implementing the ABC model was deemed appropriate because such a model was basically aimed at making lower-level employees understand the benefits of the ABC model.

Moreover, it was identified that the ABC model was essentially hatched at the company’s headquarters and it was the duty of management to push the idea down to lower-level managers and employees (regardless of their personal decisions) (Juras 2003, p. 3). Interestingly, the move by the company’s project team to educate the plant manager was criticized by the company’s manager as ineffective because of the assertion that:

“When we went to the plants to do training, it was like a whirlwind tour; we just showed them some charts and said, now sit down and we are going to ask you some questions… I don’t think we put ourselves in our internal customers’ shoes. We paid very little attention to their constructive concerns or their need to truly understand ABC”.

Conclusion

This study points out the challenges and successes of implementing ABC by two companies operating in emerging markets. Comprehensively, we see that firms in emerging markets have a significant problem in accepting ABC because it is not a previously implemented model.

Having a steering committee and seeking the services of an external agency (with a significant experience in ABC implementation) is a good strategy to making existing managerial teams accept changes. We have also seen that there is a significant challenge experienced by the companies in augmenting ABC with previously existing computer applications, and comprehensively, we see that seeking technical expertise in doing so is a good move towards ensuring there is a smooth transition into ABC, without causing any operational hitches.

Also, we see that having clearly set goals is an important tool to steer the implementation of the ABC model in the right direction. This observation is critical, in the sense that, many organizations have been identified to abandon ABC implementation because they do not have a clear understanding of the importance of implementing the ABC model in the first place.

In a general sense, we can see that adopting a top-bottom implementation strategy is also important in ensuring the ABC mode is implemented effectively. Burke (2006) affirms this fact and implies that the top-bottom implementation strategy is important because the decision to implement an ABC model is normally undertaken at the company’s headquarters and many organizations expect managers to ensure employee buy-in, to make the transition a success.

Conclusively, we can say that organizations operating in emerging markets experience challenges of transitioning from old accounting models to ABC and therefore, tactical strategies need to be adopted to ensure there is a smooth transition from old accounting models into new models.

References

Armstrong, M. (2006) A Handbook Of Management Techniques: A Comprehensive Guide To Achieving Managerial Excellence And Improved Decision Making. London, Kogan Page Publishers.

Baker, J. (1998) Activity-Based Costing and Activity-Based Management for Health Care. London, Jones & Bartlett Learning.

Burke, L. (2006) CIMA Learning System 2007 Management Accounting Decision Management. London, Butterworth-Heinemann.

Hu, Y. M. (2001) The spontaneous formation and development of ABC, ABM in Chinese Organization. Accounting Research (China), 3, 33–38.

Juras, E. (2003) Global Electronics, Inc.: ABC Implementation and the Change Management Process. (Online) Web.

Liu, L. Y. J. and Pan, F. (2007) The implementation of Activity – Based Costing in China: An innovation action research approach. The British Accounting Review, 39, 249 – 264.

Panda, N. (1999) Activity Based Costing For Indian Industries. New Delhi, Mittal Publications.

Salvendy, G. (2001) Handbook of Industrial Engineering: Technology and Operations Management. London, Wiley-IEEE.

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