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In contrast to traditional cost system which is not suited to new manufacturing environment situation, ABC has taken the place of tradition system and been widely used in some countries, such as the United States, Western Europe and Japan. And the type of most enterprise is competitive, low labor costs and high-technology. This essay will analyze the unsuitable situation of traditional costing system and discuss the advantages of activity based costing and explain why it is better than a traditional cost system. It will compare the benefits brought by ABC in different sizes of companies.
Traditional costing system is not suitable for the new economics environment any more. In facing the impact of the new manufacturing environment, if a company insists on using traditional cost system, it will cause at least two major consequences (Nevous, 2011, p. 1). The first problem is that the calculation of a product is not accurate (Nevous, 2011, p. 1). Under the new manufacturing environment, manual work has been replaced by machines and computer-aided production system in some places and the percentage of labour cost has decreased.
However, manufacturing expenses diversified at the same time, so reporting accurately how much a company cost on various products becomes a hard work. Another problem is that cost control may perhaps cause some negative influence (Nevous, 2011, p2). Traditional cost system will combine budget with actual result to get a report showing the different value between the standard cost and actual cost. But ABC may create a negative influence of behaviour. For instance, so as to achieve a higher efficiency, some enterprises may one-side pursuit of mass production, therefore, the number of inventory grows. Nevous, 2011, pp. 1-3) In short, ABC is a development which makes contribution to assigning work more accurately. The rising global competition has caused some changes in the commerce and industry areas. This technique can provide huge benefits for strategic planners and managers. ABC demonstrates that it can implement a system to achieve the manager’s goal. Compared with a traditional cost system, ABC tells companies not only how to evaluate a new kind of manufacturing technology, but also how to use computer-integrated manufacturing more effectively (Brimson, 1997).
In a setting with no informational asymmetries, it is a better choice to use ABC system. The production process of a firm is self-governing of the costing system. Each system uses its own method to measure product costs and these different systems affect the information which is reported to the headquarters and to the manager. However, these methods cannot affect production except through management decisions. This informational construction proves a fact that completion of ABC allows the manager to get information of specific product and then the manager can know whether his decision is good for the company (Mishra & Vaysman 2001, pp. 19–641). By exposing the relationships between performing particular activities and resource consumption, ABC points straightly to profit opportunities. Cooper and Kaplan (1991 p. 130) state that, ‘ABC can provide managers a clear picture of how products, brands, customers, facilities, regions, or distribution channels both generate revenues and consume resources. The profitability picture that emerges from the ABC analysis helps managers focus their attention and energy on improving activities that will have the biggest impact on the bottom line. By using ABC, managers can evaluate different aspects of their company’s operations. They can contrast the profits which are brought by a variety of customers, products, brands or regions. Afterward, they can choose the most profitable ones (Cooper and Kaplan, 1991 p. 130-135). Innes and Mitchell (1995) explored the adoption rate of ABC and how well does this system work in some large companies of UK. Innes and Mitchell (1995) undertook a survey of ABC practice in 1000 of the largest companies in the U. K. which are listed in The Times 1000 which was published in 1994.
Nevertheless, the results showed that ABC system’s impact is often limited and it has also been refused by a high percentage. The survey also considered both the company sector and size. Most of the companies have to make decisions on its use. There is still possibility for considerable increasing in its adoption. ABC is an on-going development, it gives considerable chances for researches who are interested in changing to pursue work different kinds of management accounting’ area. (Innes and Mitchell, 1995) This survey proves that ABC has been adopted by some U. K. companies and these companies are trying to use ABC to make big progress.
On the other hand, the results also show that, at a practical level, opinions on ABC are differed among the U. K. ‘s large companies. In contrast to the survey of largest companies in the U. K. , Douglas (1999) investigated how to make ABC work in the small and mid-sized companies. For the small and medium sized companies, ABC does not need to cost large amounts of dollars in software and expert fees. ABC provides a good way for deciding product costs and giving information for most small or medium sized companies to help them make their own analysis, pricing and costing decisions and even evaluate profit strategies.
This kind of information has conventionally been lacking for the small to medium sized company. What is more, the financial advisor can also find it useful for helping them make decisions for improving the business. (Douglas 1999) ABC has its limitation, too. ABC system doesn’t have a regular framework or a united mode and different companies has different objectives and costing systems, so managers should use it by considering their reality in various industries. Overall, ABC is a personalization costing system which required considering practical condition, (Bradford, 2008)
To sum up, traditional costing system is no longer suited for the companies in the new manufacturing environment because of its inaccurate and negative influence. And ABC has been accepted by many companies. It is more accurate and brings more profits. Even though ABC is not a perfect system for all the companies, this technique has made great profits for most managers and won a wide range of application in recent years. ABC has no fixed frame and a unified model, so the managers should use it by combining with the actual enterprise development.
References: Brimson,J. A. (1992) Activity accounting: An Activity-Based Costing approach. 1stedition. New York: Wiley. Bradford, T. (2008) Activity-Based Costing (ABC): Types of Accounting Costing Systems. Availablefrom:http://www. suite101. com/content/activitybased-costing-abc-a52148 Cooper,B. ,R. S. (1991)Profit Priorities from Activity-Based Costing. HARVARD BUSINESS REVIEW. Available from:http:host. uniroma3. it/facolta/economia/db/materiali/insegnamenti/588_3931. pdf . 130-135 Douglas,H. T. 1999) Activity-based costing: Making it work for small and mid-sized companies. 2nd edition. New York: John Wiley & Sons Innes,J. . F. (1995)A survey of Activity-Based Costing in the U. K. ‘s largest companies. Management Accounting Research. 6(2), 137-153 Mishra, B. & Vaysman, I. (2001) Cost-System Choice and Incentives—Traditional vs. ABC. Journal of Accounting Research. 39(3), 619–641 Nevous (2011) Activity-Based Costing. Baidubaike. Available from:http://baike. baidu. com/view/754109. htm (19)1-3