Category: Activity Based Costing

Activity-Based Costing is a method that has become widespread in European and American enterprises of various profiles. The emergence and development of ABC corresponded to specific changes in the economic structure, namely, a change in views on the methodology of cost accounting and the calculation of the cost of production. In Activity Based Costing, an enterprise is considered as a set of work operations.

This analysis is appropriate since it is vital to create a reliable system at the enterprise that will allow obtaining the necessary information at a reasonable price. I agree with the analysis of the pitfalls of this method in the article, as they may represent obstacles to the more efficient operation of the company. For example, some additional criterion is required for the conditional distribution of costs at the stage of forming a group of expenses such as rent, local tax, depreciation (Kaplan and Anderson). It is unlikely that one cost carrier will explain the behavior or cost dynamics for all storage and accounting objects in the associated cost group.

On the other hand, the number of cost groups and cost carriers cannot be huge; otherwise, the ABC system will be too complex and expensive. Cost carriers will be unsuitable if the resulting costs do not depend on the output (Cidav et al.). For example, it is problematic to quantify the type of activity that may cause the costs of an annual external audit. Nevertheless, the ABC system can become a universally applicable cost calculation method for several reasons despite some disadvantages. The ABC system focuses attention and contributes to a better understanding of the factors that affect the costs of organizing production and managing it (Cidav et al.). In addition, this method is relevant to all overhead expenses, and therefore it takes management accounting to a higher level, beyond the traditional boundaries of the production process.

ABC can be used together with the analysis of profitability by customers to determine the amount of profit received from servicing certain groups of customers with greater accuracy and reliability. Thus, the ABC method has made a significant contribution to management accounting, and its elements have found application in life (Kaplan and Anderson). Its use will make it possible to perform more effective decisions in marketing strategy, the profitability of products, etc. because it allows controlling costs at the stage of their occurrence.

Works Cited

Cidav, Zuleyha, et al. A pragmatic method for costing implementation strategies using time-driven activity-based costing. Implementation Science 15 (2020): 1-15. Web.

Kaplan, Robert, and Steven Anderson. Rethinking Activity-Based Costing. Harvard Business School. Web.

Traditional Costing Approach

Using the traditional costing method, the total cost of each product will be as shown in the schedule below. The total cost column represents a summation of the variable and fixed costs.

Because the relationship between price and output is such that a selling price of 3,000 yields zero sales and a reduction by 100 on this selling price increases the sales units by one; the selling price and the associated profits/(loss) for each unit will be as represented in the schedule below:

Activity Based Costing Approach

Using Activity Based Costing, the fixed cost is assigned to each particular product thus whereas the selling price shall remain as established, the associated profits will change significantly as a result of the apportionment as shown below:

Discussion and Analysis of Details

This model of determining cost is involved with the identification of all necessary activities of the entire production process and allocating the associated cost of each activity to the entire products produced. This allocation is based on the actual uptake or consumption of each activity onto a product.

The main advantage of activity based costing model is that it helps to identify and pinpoint the products, processes or activities which are not operating efficiently. This will be done through comparing their output and consumption. Activity based costing will also be useful in helping to pinpoint the unnecessary costs in the entire production process which the entity can do without.

This model of estimating costs is also key in the allocation of resources in the production process, using the model, more resources can be assigned to the more efficient products, activities or processes while fewer resources can be assigned to the inefficient activities.

The model can also find application in the cost control strategy adopted by the entity because it will provide the necessary information to management on the departments or individual products that are operating below the acceptable (ideal) standards. This method may also be of importance in helping to fix the selling prices of the output. Based on the estimated cost of the product and the level of profits that are expected by the firm, the entity is able to know the price at which sales will be most.

The main limitation of this model however is that it might be extremely difficult to determine and accurately apportion certain costs in the entity to each particular product, for instance the salary of the chief executive officer may be difficult to be accurately assigned to products because the chief executive’s input is not easily and directly traceable on the particular product.

The CEO’s efforts are evenly balanced on the general well being of the firm and are hard to establish a particular criterion that will accurately apportion these efforts. It has also been argued that the ABC model of cost estimation is increasingly expensive and complicated to be used in the management and control of costs (Horngren, Datar & Foster 2006, p. 214).

The traditional costing approach has largely been considered as more convenient and fairly easy to apply. The traditional system is useful to management in providing solutions to among other management problems; make or buy decisions, subcontract or produce internally, proceed or cut down the entire production process.

Within the context of pricing, the organization may adopt a strategy that ensures that its products are not priced extremely high in comparison to the industry average. The prices of its products should be pegged on the prevailing market prices and the prices of goods offered by competitors.

If possible, the firm may adopt a collusion strategy with competitors in order to harmonize the prices of products in the entire market. This will make it impossible for a single firm to undercut the rest of the market players by selling at lower prices (Atrill & McLaney, 2007, p. 124).

Reference List

Atrill, P. & McLaney, E. 2007. Management Accounting for Decision Makers. Financial times management prentice hall. New Jersey.

Horngren, C., Datar, S. & Foster, G. 2006. Cost accounting: a managerial emphasis. Pearson Prentice Hall. NJ.

The Service Company: TripAdvisor, Inc.

TripAdvisor, Inc. is US-based travel Web site company that offers reviews of travel related contents to customers globally, and the company provides interactive travel forums for its community of users (TripAdvisor, Inc., 2016). The company refers to itself as ‘the world’s largest travel site’, which allows travelers to arrange and book seamless trips. Millions of travelers depend on TripAdvisor for advice related to multiple types of travel choices and trip planning. It seamlessly links visitors to numerous booking search tools that assess thousands of Web sites to locate the perfect hotel prices.

The company boasts of the largest travel community globally because of its many branded sites that serve more than 340 million different visitors every month. Additionally, it also gets 350 million reviews and opinions from customers accounting for over 6.5 million hotels, restaurants, and attraction sites. TripAdvisor sites are found across 48 markets globally. It is listed in the NASDAQ as TRIP. The company has other 24 affiliates, which it manages and operates to generate more than $1.5 billion annually. TripAdvisor currently employs over 3,000 people. The company is considered among the early adopters of user-generated content, which is free to users, but the business model is based on the advertisement revenues.

The purpose of this essay is to show how time-driven activity-based costing can be applied at TripAdvisor, Inc. (a service company).

In most instances, firms face critical challenges with regard to cost of product or service determination, specifically in highly competitive business landscapes in which low-cost strategies are applied to drive market leadership. Firms use costing systems to assess costs of products and services they offer. Direct costs associated with labor and materials can be easily determined and can be linked to specific items (Siguenza-Guzman, Van den Abbeele, Vandewalle, Verhaaren, & Cattrysse, 2013).

On the other hand, other indirect costs, such as plant depreciation, marketing, and training among others, cannot be directly linked to cost of product or service. As such, indirect costs are thus attributed to a cost object based on costing systems (Cokins, 2001). The ABC systems were formulated in the 1980s to assist with the accurate product-cost determination (Stout & Propri, 2011).

Kaplan and Anderson (2004) introduced Time-Driven Activity-Based Costing (TDABC) as a cost allocation system to improve allocation of indirect costs to specific cost objects to enhance accuracy and set priorities for product development, pricing, process enhancement, and customer satisfaction. Overall, the main objective of an ABC system is to attribute indirect costs in a manner that they can be captured under cost data more accurately based on resource requirements and usages of a firm’s cost objects, including services, products, and customers.

Time-Driven Activity-Based Costing (TDABC) at TripAdvisor, Inc. and related Benefits

A time-driven activity-based costing system is an updated version of the traditional ABC system that strives to capture cost objects accurately and simply. The TDABC has been designed to assess only two types of indicators. That is, time units spent on activity linked to cost objects and cost for every unit time. It is easier to implement TDABC at the company relative to other traditional ABC systems.

The TDABC is extremely imperative for TripAdvisor, Inc. because it offers time-driven services demanded by millions of people globally. The company can apply the TDABC system to assess unused capacity. As previously observed, TripAdvisor runs and manages other 24 travel Web sites, which offer various services, including advice to visitors on hotels, attractions, and restaurants, as well as, booking tools that locate the better deals and prices for travellers. Hence, the implementation of the TDABC system would greatly assist the company.

TripAdvisor can implement the TDABC to determine utilization of capacity for travel and booking. Employees, for instance, may be available to process such requests while customers are not readily available. In such instances, pricing policies may be implemented to support idle staff, which leads to customer dissatisfaction. On this note, the TDABC would assist the company to determine the exact number of employees required to perform travel and booking processes during both low and high seasons.

TripAdvisor can also implement the TDABC to determine demand for resource capabilities based on time. It can easily evaluate the unit time needed to conduct every activity within a cost center based on visitors’ order requests, priority lists, and even customer behaviors that influence time. Hence, it will know unutilized capacities within a cost center. TripAdvisor can go further to calculate the cost of every time unit (minute) for every employee based on service delivery and employees’ practical performance. Consequently, it would be able to allocate costs based on TDABC by multiplying time consumed by every client with all clients and then dividing by capacity cost rates (Stout & Propri, 2011).

The TDABC would offer TripAdvisor numerous benefits. The company would determine the effectiveness of its online services based on the time taken to deliver customer queries. More important, TripAdvisor would greatly benefit from monitoring and controlling resource capacity, specifically staffing and capacity cost. It would be able to collect valuable data to determine if the cost center is performing below the capacity.

TripAdvisor will also be able to estimate unit time for every process using the TDABC. This approach would eliminate subjective process of making staff account for their time (Stout & Propri, 2011). Thus, the TDABC system would offer reliable estimates of resource and capacity usage for a cost center. Overall, staffing decisions and cost control will be vital outcomes for implementing the TDABC system. Cost cutting could be passed to customers to make the company more competitive in the crowded travel and booking industry. Appropriate staffing would also enhance efficiency and service delivery to customers.

The ABC System for Competitive Advantage at TripAdvisor, Inc. and Impacts on Business Performances

For TripAdvisor, which significantly depends on accurate information for decision-making and providing advice to customers, the TDABC system is extremely useful. It must determine profitability based on information gathered to control costs and ensure effective utilization of resource and capacity. The company can easily determine cost estimates for every activity using the system.

TripAdvisor will use the system to eliminate unused capacity, thereby reducing unnecessary costs. All inefficient and unwarranted activities can be eliminated to enhance profitability.

Activity and cost classification would also assist the company to determine the best pricing strategies for its different services offered through various Web sites. Consequently, it would realize competitive edge based on effective pricing strategies across different Web sites.

Enhanced service delivery and efficiency will ultimately differentiate TripAdvisor from its competitors. The company will continuously add value to customers based on seasons while leveraging available data for effective decision-making.

The TDABC in e-Commerce and in Traditional Companies

Relative to e-commerce firms, the TDABC can significantly help in improving time efficiency through effective utilization by relying on data platforms that determine time spent on specific activities. Traditional companies cannot effectively track these processes without automated systems. It is also simple to assess employee performance since the system determines time spent on specific activities. Online activities ensure that accurate information is collected from users, notwithstanding some false data submitted. However, the system eliminates all subjective processes associated with traditional firms and their justification processes. Thus, it is most likely that management will make informed decisions based on available data and information (Zeller, 2000).

Traditional business models are associated with significant amount of time spent on customers. For instance, customers who make travel and booking arrangements physical are most likely to consume more time interacting with staff. Conversely, online processes eliminate more time spent interacting with customers physically. This implies that traditional firms incur more expenses relative to e-commerce companies that have seamless means of delivering services.

TripAdvisor, for instance, can serve millions of customers from various parts of the world every month because of its online platforms. Conversely, a traditional company can simply be overwhelmed and be restricted to specific geographies. The TDABC system ensures effective utilization of capacity and time on activities to deliver value to customers.

For management, effective staff deployment and utilization is an important means of enhancing cost-effectiveness and cost-cutting when unnecessary staff members are not employed. Hence, productive capacity of every employee is important for cost controls (Bogdanoiu, 2009). Improving efficiency and eliminating unused capacities in cost centers are known to reduce wastages.

Overall, the TDABC system would offer numerous advantages, including effective staff utilization, cost-cutting, profit increments, and resource-capacity management. It is also a vital decision-making tool for executives.

References

Bogdanoiu, C. (2009). Activity Based Cost From the Perspective of Competittive Advantage. Journal of Applied Economic Sciences, 4(1/7), 5-12.

Cokins, G. (2001). Activity-Based Cost Management. New York, NY: John Wiley & Sons, Inc.

Kaplan, R. S., & Anderson, S. R. (2004). Time-Driven Activity-Based Costing. Harvard Business Review, 1-9.

Siguenza-Guzman, L., Van den Abbeele, A., Vandewalle, J., Verhaaren, H., & Cattrysse, D. (2013). Recent Evolutions in Costing Systems: A Literature Review of Time-Driven Activity-Based Costing. Review of Business and Economic Literature, 58(01), 34-64.

Stout, D. E., & Propri, J. M. (2011). Implementing Time-Driven Activity-Based Costing at a Medium-Sized Electronics Company. Management Accounting Quarterly, 12(3), 1-11.

TripAdvisor, Inc. (2016). About TripAdvisor.

Zeller, T. L. (2000). Measuring and Managing e-retailing with Activity-Based Costing. Journal of Cost Management, 14(1), 17-30.

Introduction

The global market of the 21st century is characterized by the gradual elimination of trading borders, increased deregulation, a greater diversity of products available, and decreased costs in communication, which lead to a more competitive environment (Forman & Elias, 2016). With the majority of markets already explored and classified as Red, the producers must engage one another not only by increasing the quality of the product but also by decreasing the costs associated with the enterprise (Forman & Elias, 2016). Companies in the domestic market have to face not only local competition but also that presented by multinational corporations located abroad. As a result, there is a dire need for better and sophisticated costing systems.

Costing systems serve as important decision-making tools in an organization, as they help in placing of new products, influence the choices to reduce or even terminate products and services, and define the selling prices by providing reliable information regarding their industrial costs and profitability ratings (Altawati, Kim-Soon, Ahmad, & Elmabrok, 2018). In addition, costing systems can accurately predict and monetize customer satisfaction as an important factor for the viability of companies and their products. As meeting customer expectations for the product is key, there is strong pressure for all organizations to increase productivity while reducing prices. Thus, obtaining a way to more accurately estimate the costs of every operation has become a strategic objective. Activity-Based Costing (ABC) has emerged from the need to do so and serves as a viable alternative to the traditional costing methods implemented today (Altawati et al., 2018). The purpose of the system is to accommodate the new management systems in place, such as Just-in-Time (JIT), Total Quality Management (TQM), and other frameworks that have become increasingly popular in many companies (Altawati et al., 2018).

The company of choice that uses ABC is Illycaffee. It is an Italian-based coffee company that has recently expanded to include wines in its product line, with both lines of products providing a relatively equal profit. The company employs over 1,100 workers and largely focuses on the Italian market, though its products are also exported to the rest of Europe as well as America and East-Asian countries (Illy, 2017). The purpose of this paper is to evaluate the implementation of the ABC system in their manufacturing of coffee and wine.

Illycaffee Profile

Illy coffee is an Italian coffee-roasting brand with a specialization in producing coffee known as espresso (Illy, 2017). In addition to coffee, the company started manufacturing wine after purchasing wineries in Montalcino and Barolo, in order to complement the line of products offered to the HORECA (Hotels, Restaurants, and Cafes) segment of the market (Illy, 2017). The company was founded in 1933 and is still run as a family company, with members of the Illy family presiding over as members of the directorial board (Illy, 2017). The company’s revenues have seen impressive growth in the last 5 years, with the dynamics showing a 5% yearly increase, with a total of 460 million euros as of 2016 (Illy, 2017). As it stands, the company employs over 1,100 workers in both areas of production. The company does not grow its own coffee, instead preferring to import single-origin arabica beans from Brazil, Guatemala, Colombia, Costa Rica, Ethiopia, and India (Illy, 2017). Thus, the manufacturing component of the company revolves around working with coffee beans as well as a growing, seasoning, and bottling wine.

Although the expansion into wine and other related products happened around 2016, the company started adopting advanced methods of accounting, quality control, and supply in 2008, in the wake of the world economic crisis, when dropping sales and increased competition landed a hit on Illy’s profits (Illy, 2017). The adoption of JIT, TQM, and ABC was a complex measure that lasted between 2009 and 2010, when the company underwent a reorganization of its production values, streamlining processes, and investing in corporate training (Illy, 2017). As a result, some positions were cut, others were replaced, and all processes in coffee production were streamlined. The same reorganization of wineries occurred in 2016, after Illy acquired businesses in Montalcino and Barolo, in order to identify the products that had to be kept and ones that could be safely discarded due to low sales.

Definition of ABC

Activity-based costing is a method that involves the assignation of specific components of manufacturing, which includes activities, tasks, acquisitions, services, materials, and products (Altawati et al., 2018). It is based on several parameters, which include the following (Altawati et al., 2018):

• The activities necessary for performing a certain manufacturing process;
• Resources consumed by these activities (raw resources, human resources, instruments, equipment, etc.).

The differences between ABC and traditional cost accounting lie in the precision regarding the need for said allocation (Altawati et al., 2018). Traditional accounting often utilizes arbitrary percentages to cover indirect and overhead costs. As a result, certain processes and activities receive more than they require or are worth, while key processes remain undermanned and underfunded (Altawati et al., 2018). Since both ABC and traditional accounting are meant to estimate the costs of sold goods and the gross margins, the results may differ drastically one from another. This creates major discrepancies, especially in companies where it is necessary to know the exact costs of production in order to determine which products are profitable and which ones are less successful (Altawati et al., 2018).

In the scope of Illy, the need for ABC in comparison to traditional costing is obvious – the company has a myriad of products, ranging from different coffee brands to wines (Illy, 2017). This differentiation of similar offerings to the market requires close supervision of their performance in relation to production costs. Since the company also was planning to move to JIT and TQM at the same time, the provided data could also be used for ABC. For the sake of focusing the paper on the specific line of manufacturing processes, only the coffee-roasting branch of Illy’s production undergo review and analysis. The process of implementation of the system is explained in greater detail in the following chapters.

ABC and its Implementation in Illy

Identification of Processes

Initially, Illy was a company that produced roasted coffee from imported raw material, with a greater focus on coffee capsules, which are either plastic or metallic packages that seal ground or roasted coffee in a vacuum, thus preserving its qualities while protecting it from the outside elements (Gregori, 2018). This sector of activity is comprised of various aspects of labor, including the procurement of industrial equipment, the manufacturing processes, the acquiring of raw materials and subsidiary products, contracted and direct labor, as well as many other subprocesses (Gregori, 2018). In addition, the company produces a variety of alcoholic beverages, which include wines, port wines, champagne, and other varieties (Bendeich & Landini, 2018). The sales volumes for the company are relatively equal in both directions, meaning that no one area has a direct priority over the other. Marketing and distribution are, at the moment, aimed at the Italian peninsula and neighboring countries, while also exploring larger markets, such as those found in China, Russia, and the US (Illy, 2017). Being a premium coffee brand, Illy naturally aims at the upper-middle class of customers as well as the high-end restaurants, clubs, bars, and cafes that can afford to buy coffee in greater volumes.

The company does not exert direct control over its production, as all industrial components are located in facilities separate from its HQ in Trieste, Italy (Illy, 2017). At the same time, the terminal part of the process, which includes the dispatch of merchandise, is a combination process in terms of the use of facilities, employment, and equipment. Thus, the marketing, distribution, and dispatch departments are conjoined. The production of coffee is commercialized via several formats, which follow roughly the same parameters both in the domestic and foreign markets (Illy, 2017). The two channels of distribution include HORECA and modern distribution through retail companies and shops (Illy, 2017). Abroad, Illy completely relies on foreign distributors in order to promote its brand. Although the production of coffee was initially focused on capsules, it is not the only activity developed by the company, as resources are being shared not only between different activities located in the same area but also by different business units. Such conditions vouch for the adoption of ABC, as activities related to the production of any given product have to be evaluated both with the associated costs and the impact they make within the organization.

The ABC framework identifies the list of main and secondary activities that enter the cost evaluation process. Main activities (MA) are critical for the production of the main product of Illy, which is capsules. They have a linear direct relationship with the product, which is verified not only on the cost levels but also affects the quality and the intrinsic constitution of the final product. These activities are as follows (Gregori, 2018):

• Green coffee reception. Conducted at the second coffee warehouse (CW2);
• Green coffee storage. Facilities utilized for this stage are CW1 and CW2;
• Densiometric treatment. Conducted in the densiometric treatment room;
• Blending and roasting. Conducted in the roasting room;
• Grinding. Facilitated in the grinding room;
• Degassing. Conducted in the ground coffee-room;
• Packaging and encapsulation. Organized in the capsules packaging room.
• Semi-finished packaging, placement in cardboard, and final packaging. Also happens in the capsules packaging room.
• Expedition. Conducted in the final product warehouse.

The majority of these activities are contained to a singular industrial building within the company, physically separated into different activity sites. These activities are common to all coffee companies and products, ranging from activities 1 (reception) to 5 (roasting). The roasting stage is what separates most products by allowing the coffee beans to acquire different tasting qualities (Bottazzi, Farina, Milani, & Montorsi, 2012). Illy has 6 groups of products, which constitute complementary activities to the main processes (Gregori, 2018):

• Bulk coffee packaging. Is utilized for HORECA, domestic, and export channels.
• Coffee packaging for HORECA. Utilized in HORECA and vending machines.
• Coffee POD packaging. Domestic and export channels.
• Coffee 250g bag packaging. Domestic and export channels.
• Coffee sachets packaging. HORECA and export channels.
• Coffee capsule packaging. Domestic and export channels.

Thus, it is possible to see that the process and activities used to create different types of coffee products are similar at stages 1-5, with the first differentiation occurring during the packaging state. They use the same resources at the level of facilities, equipment, and labor. At the same time, there is a set of activities common to several organization processes that influences the production process. These activities include the purchasing and receiving of raw materials, equipment, and facility maintenance, as well as quality control. These actions constitute secondary activities to be included in the ABC process, and are listed below (Gregori, 2018):

• Purchasing of green coffee. The coffee is procured from external suppliers in Brazil, Guatemala, Colombia, Costa Rica, Ethiopia, and India;
• Purchasing of subsidiary products. These include packaging materials, capsules, tools, and miscellaneous items.
• Reception of subsidiary products and coffee. These are delivered to the production facility’s warehouse;
• Equipment maintenance. Is subdivided into two types, one being the routine maintenance provided during specific time periods in exploitation. The other is emergency maintenance, conducted in an event of an accident or breaking;
• Equipment cleaning and sanitation. Conducted in accordance with technical norms and regulations, as well as internal company standards;
• Quality control. In Illy, quality control is done according to the principles of TQM, meaning that there are process owners and intermediary control points at the beginning and the end of each process.

The production of coffee capsules is a complex process that includes a varietyof upstream production subprocesses, which are developed by suppliers. These activities include the creation of plastic capsules using the injection method (Gregori, 2018). The capsules are later being filled with coffee on an industrial scale. Coffee molds used in this activity are designed and provided by the coffee manufacturing company. At the same time, due to the lack of congruent activities related to the production of capsules that could benefit the coffee manufacturing company, it continues to order packages from outside organizations. Therefore, these activities are necessary to be accounted for, with their respective costs entering the ABC system. Due to their reliance on outside suppliers, these activities are called external activities (Gregori, 2018):

• Designing and developing the capsule;
• Protecting property rights for the appearance and functionality of the capsule;
• Producing the capsule for the purposes of coffee packaging.

The Implementation of ABC Methodology in the Company

The implementation of ABC involves two stages, the first one being the allocation of resources and activities, and the second one being the allocation of activities to products based on the definition of industrial costs (Gregori, 2018). As Illy transferred from traditional to ABC methodology, it evaluated all of the main, secondary, and external activities involved in the production of capsulated coffee, as demonstrated above (Illy, 2017). They also highlighted all the tasks performed in each activity. For these tasks, the allocation of industrial facilities, labor, and equipment was performed.

The costs associated with industrial facilities include rental values, electrical payments, maintenance of the facilities, and insurance. Due to the favorable conditions for Illy that allow annual renting, the payments covering these costs were easy to quantify and allocate to the activities pertaining to the building itself as well as in the scope of a more global enterprise (Illy, 2017). The activities behind energy consumption include the lighting, elevators, hoists, and social areas. The energy consumption of the equipment was calculated in accordance with its power on an individual basis and was not included in the building costs (Gregori, 2018). Maintenance costs were largely associated with repairs of the external, internal, and supporting structures. Equipment maintenance was calculated separately, based on the individual piece of equipment.

In regards to insurance, the company has to engage in numerous policies concerning various aspects of coffee production (Gregori, 2018). These include individual employee insurance, business activity, and profits insurance, as well as facilities, stocks, and other related activities. Illy bases its insurance policies on a case-by-case basis, with its allocation reflecting the importance of the insured process or object. The largest expenditures towards object-based insurance are placed on the industrial facilities, as they present the greatest environmental risks, which include gas emissions and waste generation. Civil liabilities are distributed between employees based on the industrial activity they are engaged in. The cost of amenities, such as water, was calculated according to the occupied area since the industrial processes require no water consumption (Gregori, 2018).

The labor costs associated with each task in main and secondary activities were calculated based on the amount of time for each function, as well as taxes, subsidies, social security, and AWT (actual working time) (Gregori, 2018). The working year included 11 months and 20 days, with 10 days allocated for various holidays throughout the year (Illy, 2017). Equipment-related costs were calculated with the expected depreciation of the tools, based on their service expectancy and legal requirements associated with their operation, as well as repair costs and all relevant interventions. Based on these parameters, it was possible to identify the hourly cost for each piece of equipment. The respective costs, thus, would be quantified based on tools and equipment assigned to conduct every activity in the list.

Finally, there are costs associated with external activities, which include the production of capsules. Since they are produced by suppliers, the costs associated directly with Illy include research and development, industrial property patent submission, and maintenance, as well as costs associated with creating molds to be used by the producer (Illy, 2017). All of these costs are fixed and do not absorb the internal resources of the organization, as they are specific to the activity of capsule production. They are also easy to identify and allocate within the ABC framework. Finally, there are costs associated with degassing and expedition of produce, which finish the process of cost identification for processes involving the production of coffee in capsules (Gregori, 2018).

The second phase occurs once all the resources were allocated to the activities involved in the production of coffee capsules. The driver activities involved include the produced roasted coffee, which is measured in kilograms, in relation to the produced coffee capsules that would act as units (Gregori, 2018). Industrial costs are calculated when the product is finalized and the values associated with the bill of materials and products are introduced. The ABC implementation flowchart can be found in Figure 1.

As it is possible to see, all the activities involved in the production of coffee capsules at Illy were successfully identified and attached to resources consumed in these activities. The second phase of the ABC flowchart shows how the activities were attributed through the cost drivers in order to linearly reflect the consumption (Mahal & Hossain, 2015). The total costs of production are calculated by evaluating the prices of materials according to the activities that consume them.

Results of the ABC Framework

Based on the analysis of activities and associated costs in the general manufacturing of the coffee industry by Illy, it is possible to see the distribution of resources based on their relevance in the cost structure of the final product. The highest share of distribution is associated with activities number 8 and 9, which constitute packaging and semi-finished packaging. Their part in the entire process stands for 23.8% for packaging, and 18.5% for semi-finished packaging. The rest of the activities’ percentages vary between 2% for the lowest (densiometric treatment), and 13% for the highest (expedition) (Gregori, 2018).

Using the ABC framework, Illy was capable of obtaining the industrial costs of their coffee products in different variants (Mahal & Hossain, 2015). Because of the similarities of the majority of the steps involved in the production of different variants of coffee, comparative results were possible to obtain by simply adjusting the differences in the final formula for the cost of the industrial product (Mahal & Hossain, 2015). At the same time, the bull of materials helps individuals distinguish the costs of raw material, capsules, and packaging materials. The largest component costs include the coffee itself (raw, green), the capsule, and the packaging materials. Together, they constitute about 82.6% of total material costs (Gregori, 2018). The information was obtained by comparing each individual position’s weight versus the overall costs as well as the relevance of the costs of the capsules, which constitute at least 50% of the total packaging material costs (Gregori, 2018).

Discussion

The results and the process provided above allows for gaining a perspective on the ABC methodology as it was used by Illy in order to gather information of high importance to the organization (Mahal & Hossain, 2015). The company used the framework in order to verify and conduct changes over the past few years and learn more about the development of their industrial activities. As it is possible to see, the ABC costing system provides valuable info that could be used for the decision-making processes in various domains (Mahal & Hossain, 2015). These include the definitions of costs in relation to sales prices and products, the identification of processes that require additional focus and effort, as well as the realities and needs of restructuring in some areas of the industrial unit. For example, the ABC schematic as well as the percentages of work and costs associated with different processes clearly indicate that packaging constitutes the most resource-intensive component in the business, followed by expedition (Mahal & Hossain, 2015).

Thus, Illy could focus on these actions by diverting human resources, material, and equipment from less occupied areas. In addition, the industrial model developed by Illy was then used to develop a list of specific instructions in regards to the distribution of materials, resources, and finances to accommodate each activity. The higher detail allowed for various venues for optimization of the process, broad analysis of the quality of the product during various stages, and the costs necessary to achieve it. Due to the broad range of products provided by Illy, the existing process of resource allocation was often overly complicated and largely ineffective. The implementation of the ABC costing system helped overcome that challenge by streamlining and simplifying the process of decision-making and information-gathering while improving the relevance and usefulness of the data (Mahal & Hossain, 2015). The ABC system, thus, is considered useful and effective by Illy due to its high adaptability to the needs of the company.

Advantages and Disadvantages of Activity-Based Costing

As illustrated by Illy, which was used as a case study, ABC provides tangible results to companies with long and complex manufacturing process lines. The costs provided to the company as a result of the analysis are both realistic and specific, thus allowing for a more precise pricing strategy for each product line. It also allows evaluating said products based on their cost-efficiency in connection to customer expectations – some products were eliminated from Illy’s line due to being too expensive for the results produced (Mahal & Hossain, 2015). Another strength of the ABC costing system is in the identification of inefficient processes, improvement facilitation, and identification of product margins (Mahal & Hossain, 2015). The elimination of unnecessary processes helps trim and streamline the production, as well as help understand and justify costs when manufacturing overhead. All of these strengths are closely related to the concepts of TQM and JIT, which require significant improvements from the traditional manufacturing that Illy implemented prior to innovations.

Nevertheless, just as any new system utilized in manufacturing, ABC comes with distinctive disadvantages unique to itself. The primary weakness is the time and costs associated with the collection and analysis of information (Altawati et al., 2018). In order to effectively utilize ABC in decision-making, a continuous process of data collection is required. This could only be achieved through automatization and dedication to IT personnel that could help facilitate said data collection. Specialists would also be required to comprise ABC reports, as normal accounting does not necessarily lend the necessary data. In addition, ABC methods are hard to transfer from one company to another, meaning a lack of uniform parameters to be used for external reporting.

One of the significant challenges associated with ABC is management training. Although the framework provides valuable data for decision-making, Illy’s managers and process owners did not have experience with the new systems and had to be retrained or replaced in order to make use of the new system (Altawati et al., 2018). The difference in performance standards, with an aim for improvement, resulted in the company having to adopt a change framework, in order to adapt the systems and people to the principles of JIT, TQM, and ABC (Altawati et al., 2018). It was a difficult task, as utilizing some of these systems without others would have resulted in suboptimal performance. The company had to subscribe to all of them or none. Fortunately, Illy managed to utilize all three, which greatly simplified and reduced the overhead costs for products, which resulted in the impressive 5% revenue growth seen from one year to the other (Illy, 2017).

Conclusions

ABC objectively represents the next step in the evolution of cost accounting, providing a more efficient way of data usage, collection, and cost assignment, based on the resources allocated to each specific process. Unlike traditional accounting, which sometimes allocates resources based on arbitrary views and preferences, ABC helps deliver a closer approximation to what is necessary for a specific process or product line. Illy provides an excellent representation of the utilization of ABC in its product line. The ABC flowchart provided in the paper demonstrates the streamlined allocation of resources based on resource drivers, activities, cost drivers, and industrial costs. The company used ABC for two specific purposes – improving the production processes through prudent resource allocation and removing or improving the products that were not cost-efficient in terms of both sales and production values.

At the same time, as demonstrated by the history of ABC’s implementation, the system is not without its inherent costs. In order to successfully implement ABC, Illy had to retrain its managers, hire external experts to teach the personnel the principles and functions of ABC, JIT, and TQM. In addition, the company was forced to undergo the process of change, which resulted in a degree of internal instability and a brief reduction of sales during the transition phase. Nevertheless, ABC is a must-have for companies that process large volumes of overhead production costs and seek to diversify their portfolios of products. Illy falls into this description perfectly, which is why the framework worked so well for the company, resulting in increased sales, reduced costs, better processes, and overall economic efficiency.

References

Altawati, N. O. M. T., Kim-Soon, N., Ahmad, A. R., & Elmabrok, A. A. (2018). A review of traditional cost system versus activity based costing approaches. Advanced Science Letters, 24(6), 4688-4694.

Bendeich, M., & Landini, F. (2018). Beyond coffee: Illy looks to wine and chocolate for stronger aroma.Reuters. Web.

Bottazzi, D., Farina, S., Milani, M., & Montorsi, L. (2012). A numerical approach for the analysis of the coffee roasting process. Journal of Food Engineering, 112(3), 243-252.

Gregori, G. (2018). Illy sustainability business model. Symphonya. Emerging Issues in Management, 1, 104-109.

Illy. (2017). Social value report. Web.

Mahal, I., & Hossain, M. A. (2015). Activity-Based Costing (ABC)–An Effective Tool for Better Management. Research Journal of Finance and Accounting, 6(4), 66-74.

Forman, C., & Elias, J. (2016). Coffee 2016. New Haven, CT: Yale School of Management.

Activity-Based Costing is a method that has become widespread in European and American enterprises of various profiles. The emergence and development of ABC corresponded to specific changes in the economic structure, namely, a change in views on the methodology of cost accounting and the calculation of the cost of production. In Activity Based Costing, an enterprise is considered as a set of work operations.

This analysis is appropriate since it is vital to create a reliable system at the enterprise that will allow obtaining the necessary information at a reasonable price. I agree with the analysis of the pitfalls of this method in the article, as they may represent obstacles to the more efficient operation of the company. For example, some additional criterion is required for the conditional distribution of costs at the stage of forming a group of expenses such as rent, local tax, depreciation (Kaplan and Anderson). It is unlikely that one cost carrier will explain the behavior or cost dynamics for all storage and accounting objects in the associated cost group.

On the other hand, the number of cost groups and cost carriers cannot be huge; otherwise, the ABC system will be too complex and expensive. Cost carriers will be unsuitable if the resulting costs do not depend on the output (Cidav et al.). For example, it is problematic to quantify the type of activity that may cause the costs of an annual external audit. Nevertheless, the ABC system can become a universally applicable cost calculation method for several reasons despite some disadvantages. The ABC system focuses attention and contributes to a better understanding of the factors that affect the costs of organizing production and managing it (Cidav et al.). In addition, this method is relevant to all overhead expenses, and therefore it takes management accounting to a higher level, beyond the traditional boundaries of the production process.

ABC can be used together with the analysis of profitability by customers to determine the amount of profit received from servicing certain groups of customers with greater accuracy and reliability. Thus, the ABC method has made a significant contribution to management accounting, and its elements have found application in life (Kaplan and Anderson). Its use will make it possible to perform more effective decisions in marketing strategy, the profitability of products, etc. because it allows controlling costs at the stage of their occurrence.

Works Cited

Cidav, Zuleyha, et al. “A pragmatic method for costing implementation strategies using time-driven activity-based costing.” Implementation Science 15 (2020): 1-15. Web.

Kaplan, Robert, and Steven Anderson. “Rethinking Activity-Based Costing.” Harvard Business School. Web.

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.

Background

To remain efficient and financially lucrative in the contemporary global economy setting, an organization needs to adopt the accounting system that will align with a firm’s managerial principles and production strategies (Narayanaswamy, 2017). The need to make an accounting system compatible with the framework used for manufacturing is especially important given the fact that the cost-efficient approaches used in manufacturing have a direct effect on the outcomes of decision-making in resource management and the use of corporate assets, especially financial ones. At this point, the notions of the Just-in-Time (JIT) and activity-based costing (ABC) frameworks come into sharp focus as possible options for managing both production- and accounting-related issues (Al-Qudah & Al-Hroot, 2017). Despite the fact that both approaches allow for a significant improvement in the management of costs and the financial strategies used by an organization, they cannot be combined in a single framework due to the difference in values, the discrepancies regarding the interpretation of cost management and corporate efficiency, and a different interpretation of the connection between costs and improvement.

JIT System: Key Characteristics

Ensuring that close attention is paid to the rearrangement of the entire system of a firm’s functioning, JIT requires a radical change in the use of corporate resources. The very concept of JIT implies that the materials required for the completion of a particular process are delivered at the exact time to the exact place where they are needed. As a result, a massive drop in the number of expenses and losses that may be taken in the process is expected (Vogel, 2014). While seemingly simple, the model requires a redesign of a company’s production processes, Supply Chain Management (SCM), information processing and transfer, etc. One must admit, though, that, due to a massive change in the corporate values accepted in a particular company. For instance, the JIT framework also requires significant alterations in the waste management techniques, the Supply Chain Management (SCM) processes, and the manufacturing processes (Christopher, 2016).

ABC System: Key Characteristics

Focusing primarily on the financial aspect of a firm’s functioning, the ABC system provides a simpler way of arranging accounting processes and managing costs. Particularly, it provides the foundation for management decisions based on the costs analysis and essential changes to a company’s financial strategy to avoid excessive expenses. Helping identify a connection between expenses taken by an organization, its performance strategies, and the products or services that it delivers, ABC can be viewed as a means of introducing a more careful resource planning strategy for an organization (Faraji, Maghari, & Mirsepasi, 2015).

JIT and ABC as Incompatible Systems: Reasoning

A well-defined system with each component being in its place and contributing to the enhancement of a company’s productivity with the subsequent reduction of costs and increase in profit margins is crucial. The existence of the frameworks such as JIT and ABC makes it possible for firms to retain their competitiveness and introduce the idea of sustainability and lean management into their design. However, because of their limitations, neither JIT, nor ABC provides a complete protection against all possible risks in the context of the contemporary global economy (Ahmed, 2015; Martin, 1994).

Value of the Elements: Key Disparities

When considering the characteristic of JIT and ABC that do not allow combining them, one must mention the fact that each of the approaches places different values on the elements of a firm’s functioning. For example, the ABC approach will imply introducing the concept of cost tracking as the foundation for implementing any processes within the organizational framework (Martin, 1994). JIT, in turn, will require the rearrangement of all corporate processes, in general. Therefore, the two systems will require assigning different values to the elements of a company’s functioning, which will ultimately lead to the inability to arrange the said processes. Because of the focus on not only financial aspects of a company’s functioning but also on the issues associated with HRM, production, and Supply Chain Management (SCM), JIT provides a much more complex system that will require a massive shift toward valuing long-term improvement over the identification of current financial risks and creating short-term strategies that will help an organization retain its sustainability and competitiveness.

Efficiency vs. Cost Management

The difference between JIT and ABC may also disrupt a range of HRM processes occurring within an organization. For example, the application of the ABC approach may lead to a drop in the levels of cooperation between managers due to the shift of focus toward personal excellence as opposed to teamwork. The adoption of the JIT system, in turn, will require reinforcing the significance of overall performance efficiency, which will demand the active promotion of cooperation and teamwork (Martin, 1994). The issue of personal excellence, in turn, is bound to be overlooked as a result of the specified approach. Therefore, there are few chances for making ABC and JIT coexist in the context of the same organization. It could be argued that the specified strategies will complement each other. However, the necessity to give equal priority to the issues that are barely compatible within the setting of a single workplace does not seem reasonable or profitable.

Costs and Improvement: Difference in Priorities

Similarly, the incorporation of both the ABC principles and the JIT standards is highly likely to introduce confusion into the framework of any organization due to the need to prioritize different aspects of the corporate processes. As a result, a company may choose between efficiency and cost management as opposed to sustaining both in the context of its organizational environment. The idea of a continuous improvement lies at the core of the JIT framework in the form of Total Quality Management (TQM) principles (Martin, 1994).The TQM approach, in its turn, requires substantial and continuous investments in the professional development of staff members. Therefore, the use of the approaches toward cost management suggested by the ABC model, particularly, the concept of reducing costs and minimizing waste, may imply significant restrictions in the choice of a corporate financial strategy for encouraging improvements.

Variability and Inventory Production

It is remarkable that the interpretation of variability is what brings JIT and ABC closer, at the same time pointing to significant differences between the proposed systems Both JIT and ABC allow recognizing the importance of variability, yet the latter focuses primarily on the effects of cost variations on the overall financial performance of an organization while the former deploys ti fully. The specified difference can be regarded as one of the key manifestations of why ABC and JIT cannot be combined within the setting of a single organization. Seeing how different the concept of variability as it is seen through the lens of JIT is from the one in the ABC interpretation, there are few opportunities for marrying the two strategies and creating a vision that will embrace the phenomenon of variability fully. As a result, the understanding of how costs change in a particular market in which an organization operates will be practically impossible to develop (Madan & Ranganath, 2014).

Capacity Management: Incompatibility

In addition to different interpretations of variability, ABC and JIT suggest different ideas of capacity management. While JIT with its model aimed at the continuous improvement leads to the necessity to adopt the system of constrained optimization, ABC opens opportunities for an uninhibited process of optimizing a firm’s cost management process (Wauna & Obwogi, 2015). The fact that the JIT system requires integrating the techniques of managing workflow into the process of capacity enhancement suggests a close focus on HRM issues and the necessity to invest in employees and their development, whereas the ABC framework is linked directly to the assessment of unused capacity expenses as the means of reinforcing the capacity levels and improving the overall financial performance of an organization (Maiga, Nilsson, & Jacobs, 2014). Therefore, combining the two systems does not seem a possibility.

Conclusion

Although the idea of handling both production- and accounting related issues with the same high degree of efficacy seems rather alluring, it can hardly be implemented when making the systems of JIT and ABC collide. The fact that JIT revolves around the concept of an unceasing improvement, whereas ABC requires a reconsideration of an existing cost management model, suggests that the two frameworks are likely to conflict with each other in a setting of an organization. Therefore, even a detailed stipulation of the corporate policy and the usage of all corporate resources cannot contribute to creating a system in which ABC will be compatible with JIT. Consequently, the choice of an appropriate model based on which an organization will structure its management of financial resources will have to be justified by specific properties of a firm. The combination of ABC and JIT, however, is not only unviable but also potentially dangerous to the competitiveness and overall existence of an organization, especially when placed in the competitive setting of the global economy.

References

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