Accounting has always been a fundamental part of any business. It seeks

to determine the profitability of a business by ensuring that all
entries are posted at the right place so as to give a clear idea or
picture of the position of the company. Needless to say, there exist
various modes of accounting and assigning costs and expenses. These
modes have continued evolving, with some accounting methods being
relegated to the periphery and some new modes coming up as a reflection
of the growth that the field has been experiencing. Nevertheless, one of
the most popular methods of accounting is Activity Based Costing (ABC).
ABC refers to a methodology of costing that is mainly used to directly
mark overhead costs to costs, thereby assisting managers in making the
appropriate decisions pertaining to the product mix, as well as
competitive strategies to use. The methodology can drastically alter the
way in which managers price their products, determine their product
line’s mix, evaluate new technology or identify sourcing components’
location (Narasimhan & Thampy, 2002, pp. 99). The use of this technique
has been rising steadily as far as enhancing the accuracy of information
pertaining to product cost is concerned (Drury, 2006, pp. 362).
Traditional costing methods are known to allocate overhead costs in an
arbitrary manner, often on the basis of direct labor hours (Yin, 2009,
pp. 48). It is worth noting, however, that direct labor hours are not
usually an adequate representation of the percentage indirect resources
that certain cost objects may have consumed within a certain period.
This, therefore, breeds distortion of product cost. Nevertheless, ABC
technique solves this problem by examining the manufacturing system as
being made up of activities. The technique allocates the activities’
costs to the cost objects via utilization of cost drivers that embody
the use of indirect resources through cost objects, in a more accurate
manner that the arbitrary methods used by traditional costing methods.
This system allocates costs to activities on the basis of their
utilization of those resources and allocates costs to objects on the
basis of their utilization of the activities (Viavio, 2008, pp. 67). The
technique has been depicted as a full-absorption method of costing that
has gained more use than conventional methods, thanks to its incredible
tracing of costs, as well as an accurate assessment of costs (Viavio,
2008, pp. 67). It allows organizations to follow costs that are
associated with activities carried out to deliver services or produce
products. It is not merely a new set of techniques or rules for
allocating overheads to value inventory rather it underlines a way of
looking at operating costs, and offers techniques to divide the
underlying activities that result in the existence of the costs (Turney,
1996, pp. 33).
This technique of accounting has varied benefits. First, the technique
allows for scientific and equitable pricing of products that utilize
less activity resources, as well as increase the cost of products that
use more of the activity resources of a firm (Popesko, 2010, pp 13). In
addition, it assists organizations to offer top-ups or value-added
services to the existing products based on the actual costs incurred.
Third, the technique is known to get rid of unprofitable items from the
line of production, in which case it increases the profitability of an
organization without increasing the prices (Drury, 2006, pp. 362). This
comes as a valuable option especially during times of recession. On the
same note, it allows for the elimination of the cost of running or
maintaining non-remunerative activities, something that increases the
overall profitability of the organization (Cowton et al, 2008). This
technique also allows for the allocation of resources to items that
utilize fewer resources or profitable items. In addition, it safeguards
compatibility with scorecards of performance management through
revealing the contribution of every person to the cost of the products,
and, therefore, the profits accruing to every person (Partanen, 2000, pp
134). The technique has been cited as effective in exposing inefficiency
and waste thereby productivity. In addition, it allows for the
identification, as well as the elimination of non-value adding
activities such as duplicate processes and needless inspections.
According to Stratton et al (2009, pp. 31), the technique, however, has
been giving significantly less than the desired yields. ABC technique
has been abandoned by most companies, which cite the fact that it does
not capture the intricacy of their operations (Partanen, 2000, pp 134).
In addition, it takes significantly long to implement and is costly to
build, as well as maintain (Kulmala, 2002, pp 37). On the same note,
other companies have criticized it as impractical as it mainly involved
the definition of activities and attempting to make a subjective
judgment on the amount of overhead that has been used (Dandago, 2003,
pp. 53). This had to be carried out on a regular basis, in which case
companies relegated it to the periphery and adopted other techniques.
This led to the drop of the technique to the 22nd position from 11th
position in a period of seven years (Stratton et al, 2009. Pp. 31).
In spite of the negative reports pertaining to the utility of ABC, there
are numerous case studies and reports of companies and organizations
that incorporate ABC techniques and even reported satisfaction. These
include DB Schenker AB (Austria), AstraZeneca AB (London) NCC
Construction AB (Nordic Region), and Indian companies.
DB Schenker
DB Schenker is a leading passengers and Logistics organization based in
Vienna Austria. It offers its customers with solutions for logistic
services in air, rail and road transport, as well as storage and
consulting services ( HYPERLINK
“http://www.schenker.at/english/company/history.html”
http://www.schenker.at/english/company/history.html ). In a 2007
interview with its chief accountant named Jan Saarsoo, it was revealed
that the working method of the company mainly revolves around delivering
items from one point to another, operations that would not be considered
complex. Schenker mainly involves direct costs, which make up the
largest part of the company’s total cost as the company rents
equipment that is used in carrying out the duties from lumpers. The
company makes use of standard cost so as to estimate the amount of
expenses that should be incurred in carrying out a certain service
(Majid & Sulaiman 2008, pp. 47). Mr. Saarso states that the company’s
expenditure mainly results from resource consumption. As much as the
traditional methods of cost allocation were serving the company in a
satisfactory manner, they were unreliable in decision making decisions.
The company applied ABC in the form of a project so as to evaluate the
amount of expenses that went in carrying out a certain order. This was
done in 2006 as a project rather than a full implementation of the
model. The company observed that the model was effective in the
provision of information pertaining to the consumption of resources, as
well as the expenses that go to the production of an output. In
addition, the ABC model has come in handy as a communication tool where
the company communicates with employees in clarifying the amount of any
service activity would cost to carry out. The company also noted that
the ABC model was an effective tool for communicating when negotiating
with customers as it gives a clear view of the amount of material, money
and time consumed by an activity. On the same note, the company realized
that it had been carrying out some activities for free, whereas it was
paying for the same activities (Majid & Sulaiman 2008, pp. 47). However,
the model presented a number of challenges for the company. For example,
the company could not update the model, thanks to its resource and time
commitment, as well as its complexity. The company considered the
numerical data as challenging to align in the appropriate manner.
AstraZeneca AB (Sweden)
AstraZeneca Company was established through the amalgamation of two
large companies that dealt with pharmaceuticals, which were British
Zeneca Group and Swedish Astra. The two companies are known for their
developments and innovations in the pharmaceutical industry, as well as
their science-based cultures and vision ( HYPERLINK
“http://www.astrazeneca.com/About-Us”
http://www.astrazeneca.com/About-Us ). The company produces different
products extending from syringe to pastille, the manufacture of which
demands machines of varied types. It is worth noting that there are
variations in the products of the company from one country to another,
which makes the process complex. According to Eva Markstrom, the
company’s process manager, direct costs make up the largest percentage
or component of the total cost of the company and are only incorporated
in the process of manufacture. Other costs considered direct include
marketing and energy (Cowton et al, 2008, pp. 27). The company sets the
products` prices in line with the manufacturing costs, thereby making it
independent of the prices in the market. ABC makes up the key cost
system in Astra Zeneca. The production of a single process involves
about 9-10 activities. The fundamental reason for using the ABC model is
that it allows every product to bear its own expenses. In essence, the
model is mainly used in making decisions pertaining to products
including product outsourcing and setting prices of products. In some
instances, for example, it is less costly to purchase components of a
certain product than to manufacture it, in which case the model supports
these decisions thereby assisting the top management in making these
decisions (Cowton et al, 2008, pp. 27). Apart from product related
decisions, ABC is used in the making of strategic decisions since it
offers the management with all-inclusive reports pertaining to the cost
of manufacturing medicine of certain types. The company, however, does
not use this model to make customer-related decisions such as customer
segmentation. Nevertheless, the company uses the model in inventory
valuation and comparison of prices between the years.
However, Eva notes that the model is challenging especially considering
that it takes a considerable amount of time, and it must be controlled.
In some cases, the data must be entered manually in cases where the
right data is not obtained. Eva also rues the complexity of calculating
the cost of products from the raw materials to finished products, which
may take a long time. Nevertheless, the company does not see the model
as expensive to maintain.
NCC Construction AB (China)
NCC Construction has distinguished itself as a leading company in
property development and construction in the Asia , with emphasis on
China. It is mainly involved in the building of commercial and
residential properties, public buildings, industrial facilities, civil
engineering structures, roads and other categories of infrastructure
(Lana & Fei 2007, pp 249). Its operations are considered complex as
concerning the volume, number of articles and technical equipment.
Different materials are used for different projects, with the company
renting certain machines depending on the project. Renting the machines
is considered indirect cost, while direct cost is made up of material
cost, which makes up about 70%-80% of the entire cost depending on the
manner in which the company undertakes the project (Lana & Fei 2007, pp
249). The company has been using ABC system for more than two decades.
According to its IT-operator, the model satisfies the company’s need
for the accurateness in the process of calculating costs via assigning
costs of activities to the cost objects. This helps the company to set
its prices appropriately, as well as budget and plan well. However, the
company does not depend on ABC entirely for budgeting as there may be
changes in the working process. The model is also used in the making of
strategic decision as it allows for the estimation of the amount to be
charged for every project. This calculation forms the project’s
foundation irrespective of any changes in the magnitude of the project.
The awareness of the cost and the amount to be spent on a certain
project gives the company competitive advantage in the construction
industry (Lana & Fei 2007, pp 249). As much as the company finds the
model as time consuming, requiring regular maintenance, as well as
resources, it does not face problems in maintaining it as the model has
been integrated in the data system of the company for a long time.
Indian companies
In a study carried out in 2011 on Indian companies, it was revealed that
there existed a high inclination towards implementing ABC model among
the respondents. This was especially for companies in the trading and
manufacturing organizations. The companies undertook behavioral
classification of their costs by categorizing them into variable and
fixed costs, with marginal recognition or acknowledgement of
semi-variable costs. All the companies had clearly defined direct and
indirect costs with overheads being allocated on the basis of
predetermined rates. The shift to activity-based costing from the volume
based costing was triggered by the over or under allocation of costs
(Sharma, & Gupta, 2012, pp. 61). The researchers, in this study,
underline the need for a cost management system that would give the true
cost of services and products. In addition, the researchers noted that
conventional costing methods and ABC models were inefficient in locating
constraints, in the manufacturing process that may reduce the
throughput. Both systems incorporated inherent limitations that may lead
to systemic problems in decision-making pertaining to throughput. As
much as ABC comes with a number of constraints, the researchers noted
that it assists companies to price their products appropriately. It
comes in handy in providing information pertaining to product
profitability, thereby enhancing sound decision-making by top management
(Sharma, & Gupta, 2012, pp. 61). On the same note, it assists
enterprises to enhance their efficiency, as well as reduce costs without
compromising on the value for consumers.
In conclusion, ABC has been extremely popular as a method of costing in
many companies. However, its popularity has been reducing thanks to some
limitations especially pertaining to complexity, time consumption, and
the need for regular maintenance (Karolefski, 2004, pp 18). However, as
the research on companies from different companies shows, it is still
extremely relevant in making decisions among the top management,
especially thanks to its provision of product profitability and customer
profitability (Rajaramn, 2000, pp. 575). In addition, the technique
allows for scientific and equitable pricing of products that utilize
less activity resources, as well as increase the cost of products that
use more of the activity resources of a firm. In addition, it assists
organizations to offer top-ups or value-added services to the existing
products based on the actual costs incurred (Geri & Ronen, 2005, pp.
139). Moreover, the technique is known to get rid of unprofitable items
from the line of production, in which case it increases the
profitability of an organization without increasing the prices (Thyssen,
2005, pp 252). This comes as a valuable option especially during times
of recession. On the same note, it allows for the elimination of the
cost of running or maintaining non-remunerative activities, something
that increases the overall profitability of the organization (Ozbayrak
et al, 2004, 57).
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DB Schenker AB webpage, 20th December 2012 from HYPERLINK
“http://www.schenker.at/english/company/history.html”
http://www.schenker.at/english/company/history.html
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http://www.astrazeneca.com/About-Us
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