Accounting Based Costing Compared To Traditional Cost Accounting Accounting Essay

A Brief Look at Traditional Cost Accounting ( TCA ) and Accounting-Based Costing ( ABC ) Before the coming of activity-based costing ( ABC ) , bing systems can be classified into the direct costing, the conventional costing in conformity with the difference in administering the operating expense costs. Kwon ( 2002 ) defined “ The direct costing does non see the operating expense costs and the conventional costing distributes the operating expense costs utilizing the estimated production rates based on the direct costs. The ABC, nevertheless, allocates the operating expense costs to activities. ‘

It is believed that the traditional cost accounting ( TCA ) system does non flux with the development in the fabrication environment. It is proved by the fact that TCA today still places same accent on direct labor cost as what it did during its early period of development. True plenty that today ‘s fabrication life in which more mechanization is required, has led direct labor to lose influence and do the TCA to go disused technique. By contrast, ABC has overcome these lacks and in fact ABC has been called one of the most of import direction inventions in the last hundred old ages ( Emblemsvag, 2008 ) .

Despite the tremendous difference in public presentation between ABC and traditional costing, there are three major differences: Traditional methods of cost accounting show some other failings ( Bellis and Develin, 1995 ) . There are, companies do non cognize whether their merchandises or services are profitable and they can non separate profitable from unprofitable clients. In add-on, TCA focal point on the short term at the disbursal of the long term and therefore TCA is going uneffective ( Entrepreneur, 2001 ) .

Consequently, harmonizing to Kaplan ( 1984, cited by Geri and Ronen 2005, p. 34 ) , ‘Yesterday ‘s accounting undermines production, was one of the first among many publications to picture the mistakes of traditional cost accounting, and the clip was mature for the rise of the new methodological analysis – “ activity-based costing ” . ABC allocates costs to merchandises and services. Harmonizing to Hicks ( 1992 ) , the ABC doctrine, defined “ Activity-based costing is a cost accounting construct based on the premiss that merchandises ( and/or services ) require an organisation to execute activities and that those activities require an organisation to incur costs.

In activity-based costing, systems are designed so that any costs that can non be attributed straight to a merchandise, flow into the activities that make them necessary. The cost of each activity so flows to the merchandise ( s ) that make the activity necessary based on their several ingestion of that activity. ” Besides, Cooper and Kaplan ( 1991 ) stated ABC developed into Activity Based Budgeting ( ABB ) and Activity Based Management ( ABM ) to help directors in doing determinations that can take to higher net incomes.

Furthermore, Cooper and Kaplan ( 1992 ) started to depict it as a resource ingestion, instead than resource allotment theoretical account. Resource ingestion looks for fresh capacity and utilizes it to a profitable advantage. Hence, even though some of the TCA ‘s jobs had been overcome with the development of ABC, the companies who use ABC theoretical accounts are ever necessary to be cognizant of these jobs when developing such a theoretical account. The ultimate end of any company is merely to do more money. In order to derive more, there must be greater speed of system in bring forthing the money.

Tom Johnson who had worked closely with one of the developers of ABC, came out with his scathing article on the approach- ” Let ‘s put the Record Straight on ABC. ” His decision is unambiguous: “ To go planetary rivals, American concerns must alter the manner directors think, and no cost system, non even ABC, will make that ” ( TOC Center, 1999 ) . This is supported by Corbett ( 2000 ) who provides illustrations where ABC gives false public presentation consequences. In the first illustration, single cost per merchandise is increased.

Theoretically, this would diminish net income border as the cost position assumes. Unfortunately, in world, costs traced to merchandises may non give accurate net income prognosiss. Therefore, the illustrations show that ABC does non ever show a clear image of profitableness. Furthermore, Eric Noreen, who is the celebrated writer of legion accounting text editions, concluded from this survey and all of his other research: “ ABC systems provide costs that are misdirecting for decision-making intents ” ( TOC Center, 1999 ) .

However, Corbett ( 2000 ) stated that in the yesteryear, it has been accepted that ABC is more good in long-run determination devising. If the company feels that high local efficiencies will take to good overall public presentation, ABC should be the pick. Conversely, Goldratt saw ABC as an obsolete technique which should non be used. He wholly criticised the fiscal community as it does non desire to travel on and continually demands this rotten technique. Again, he repeated here that what matters most is non the merchandise cost but net income generated.

By the manner, Waldron did non hold with his positions. Waldron said that alternatively of seeing activity-based costing as a defect, right merchandising monetary value is still of great importance and therefore, ABC will be needed as the merchandise costing system ( Dugdale and Jones, 1996a ) . In a existent universe scene, non in academic footings, “ Activity Based Costing/ Management ( ABC/ABM ) as H. Thomas Johnson, co-author of the seminal work on the topic Relevance Lost: The rise and Fall of Management Accounting, wrote: The belief thata? ABC improves a company ‘s long-run public presentation is a psychotic belief ” ( TOC Center, 1999 ).

It is because no company aims to downsize as its long-run corporate scheme. However, ABC and other cost-based accounting attack focal point on commanding costs, seting disbursal at the Centre of the decision-making and public presentation measuring procedure. Therefore, the terminal consequence is informations that does non fit world. Consequently, any seasoned director ever criticised the defects in the procedure and the demand for extended ‘interpretation ‘ of the Numberss to do sound determinations ( TOC Center, 1999 ) .

The message from the veteran directors was rather clear here, no 1 trusted the system adequate to let it to do the determination on its ain. On the other manus, harmonizing to Noreen ( 1987 ) , J ; A ; K knock the research in direction accounting by stating that all costs, whether sunk, variable or fixed are the consequence of managerial determinations at some point in clip. However, what Noreen disagrees with is that “ all costs should be assigned to merchandise lines by gauging long-term costs. Therefore, these costs are governable to some extent. A good merchandise cost system should demo how all costs vary with determinations.

If we consider all costs as being variable in the long-term they can be traced to the activities that produce the costs. J ; A ; K say that we should abandon the systems that ignore fixed costs or the 1s that allocate them on an arbitrary footing ” . Besides, J ; A ; K province that operating expense costs are allocated by placing “ cost drivers ” for each section and a cost pool is established for each driver. “ To acquire an allotment rate, the entire cost in the pool is divided by the entire figure of minutess that created the costs ” ( Noreen, 1987 ) .

However, Noreen does non believe that it would be worth the cost to put up an allotment system that allocates all overhead costs. “ He is doubting that their “ to the full traced ” costs could supply information to directors that would state them what costs could be avoided. They assume there are no fixed or joint costs between the cost-drivers. Besides, there is an premise that the cost-drivers that are associated with a merchandise line are straight relative to capacity in that merchandise line ” ( Noreen, 1987 ) .

From Emblemsvag ( 2008 ) besides defined, “ resource drivers that keep path of how the subsequent activity degree affects the resource ingestion. In early nomenclature activity drivers were referred to as ‘second phase cost drivers ‘ whereas resource drivers were denoted ‘first phase cost drivers ‘ . However, it is apparent that the word ‘cost driver ‘ is misdirecting in this context because activity and resource drivers do non state what drives costs in the general instance. ” Although there are some lacks in ABC, the usage of cost drivers is expected to increase even more and therefore the solution to these jobs is non to abandon the ABC.

As the consequence, Kaplan and Anderson ( 2004 ) suggest the procedure be simplified through an attack call “ time-driven ABC ” . “ In the revised attack, directors straight estimate the resource demands imposed by each dealing, merchandise, or client instead than delegate resource costs foremost to activities and so to merchandises or clients ” ( Kaplan and Anderson, 2004 ) . Therefore, “ the new attack provides more accurate cost-driver rates by leting unit times to be estimated even for complex, specialised minutess ” ( Kaplan and Anderson, 2004 ) .

The usage of TCA is now being considered by a figure of companies as unrefined and uncomplete because “ the natural information reported does non reflect a clear position of the relationship between the cost and the cost object ” and therefore TCA unable to provide the necessary model for mensurating cost accurately ( Marivic, 2004, p. 7-9 ) . Consequently, at IMA ‘s seventy-fifth Anniversary Annual Conference in New York City, the eminent Prof. John K. Shank of Dartmouth College said, “ Traditional accounting is at best useless and at worst dysfunctional and deceptive ” ( Thomson and Gurowka, 2005 ) .

With the increased accent on commanding costs, ABC was developed as a practical solution and provided an improved cost allotment construction. “ ABC makes cost accounting comprehendible and rational. Users of cost information can associate much better to help in doing favourable impacts on decision-making ” ( Marivic, 2004, p. 7 ) . However, the aim of the company is to increase net incomes, non merely obtain accurate costs! A study from Garg and et Al ( 2003, cited by Linda ) indicates that ABC executions have failed to populate up to the original ballyhoo.

Industry has gone back to that old loyalist, standard costing. Besides, one of the demands of ABC needs to place and quantify the cost drivers. However, in pattern, we can non presume all cause and consequence links a precise because there may be many things that “ thrust ” a cost. Cost allotment has become arbitrary and variable for several grounds and its pertinence is now undependable because presents more companies have common procedure for a scope of merchandises. Hence, it is non easy to mensurate the activity which drives a cost ( CIMA, 2008, p. ) .

Additionally, harmonizing to Corbett ( 2000 ) , ‘ABC focuses on placing cost drivers and bettering “ all ” links. In world, bettering one nexus without sing the others may finally damage another nexus and destruct the full concatenation. ABC may better several parts separately without bettering the overall system ‘ . Consequently, some of the company will experience that ABC is dearly-won to implement and difficultly to keep in pattern.

Harmonizing to Lamond ( 1993, cited by Zaman 1997, p. 5 ) , “ the consequence of ABC execution in a few Australian companies, such as Park Davis, ICI Film Products and Comalco, have shown better investing decision-making and better resource use has been achieved as a consequence of more accurate merchandise costs and more consciousness among the directors and staff of the non-value added construct. ” Furthermore, “ many companies in the USA like Hewlett-Packard, Procter and Gamble, Boeing, Caterpillar and IBM have late implemented ABC and have revealed new information about the merchandise costs ” ( Zaman, 1997, p. 4 ) .

Although many old ages have passed since big companies began implementing ABC, perchance because ABC is more favorable in larger houses that have a diverse mix of merchandises or services, there are few studies about the execution and usage of ABC in little fabrication companies ( Needy and Bidanda, 1995 ) . Because many little companies still do non understand that by configuring these bing systems to run into their ain demands, they can derive better apprehension of their operation ‘s true cost construction ( Benjamin and et al. , 1994 ) .

Therefore, a few instance surveies are written on the usage of ABC will assist little companies to larn more about the benefits and procedure of implementing ABC ( Narcyz, 2003 ) . In order to stay competitory, little makers need more accurate and dependable bing information than their current traditional costing systems. Further, the benefit of the ABC mentality is that it opens up for a much wider array of steps when it comes to bettering productiveness. For illustration, DHL Worldwide Express which is implementing ABC in services industries with success ( Holton and Innes, 1998 ) .

Furthermore, a UK study by Drury and Tayles ( 2000 ) suggests that service organisations are more likely to implement ABC systems. They reported that 51 % of the fiscal and service organisations surveyed compared with 15 % of fabrication organisations which had implemented ABC. Kaplan and Cooper ( 1998, cited by Drury 2005 ) besides “ exemplify how ABC was applied in The Co-operative Bank, a medium sized UK bank. ABC was used for merchandise and client profitableness analysis ” . Hence, the survey reveals that ABC is suited for service organisations while TCA is irrelevant for them.

However, on the other manus, Marivic ( 2004 ) is conducted “ the survey reveals that ABC System is non yet to the full appreciated by most of the companies here in the Philippines. In malice of the built-in strengths in the ABC theoretical account, really few companies have opted to follow it in their concern operations ” . The grounds for ABC ‘s low acceptance in the Philippines were: “ ( 1 ) employees lack of basic cognition of ABC techniques ; ( 2 ) employee opposition ; ( 3 ) organisational alterations indispensable with the usage of ABC ” ( Marivic, 2004, p. 12 ) .

Hence, this research aimed to supply farther grounds that why many companies have non to follow ABC, non merely in the Philippines but besides in other states. There are many companies are sing jobs with implementing ABC. Presents, the usage of ABC increases because of the companies realise some possible danger that the conventional costing attacks might bring forth inaccurate information and therefore cause the directors make incorrect determinations. However, given the cardinal function of direction accounting in all concern maps, is the impact on the concern of switching to ABC truly great?

ABC has caused the displacement in accounting practicians ‘ mentality, but non all. Let ‘s research some instance surveies as illustrations of the needed displacement. Though the lacks of TCA led many companies turn to ABC. However, in pattern, most of the companies still prefer TCA even though TCA involves arbitrary allotment of operating expense costs ( Garg and et Al, 2003 ) . It is because “ the usage of TCA is that it is the compulsory by and large accepted accounting rule for external fiscal coverage, and incorporating fiscal and managerial accounting systems ensures better bing control ” ( Geri and Ronen, 2005, p. 34 ) .

On the other manus, ABC brings elaborate information from the procedures up to measure costs and manage capacity on many degrees whereas TCA methods merely allocate costs, or capacity to be right, down onto the cost objects without sing any ’cause and consequence ‘ dealingss ( Emblemsvag, 2008 ) . Hence, harmonizing to ’cause and consequence ‘ , ABC costs are assigned between activities ( the existent procedure ) and cost objects, which is captured utilizing drivers. The drivers are hence non allotment bases in the traditional sense ( Emblemsvag, 2008 ) .

By contrast, Linda argues that “ while ABC proposes to apportion costs more representatively to the merchandises or services, ABC is still an allotment. Additionally while costs change often, the allotment theoretical account ( ABC or some other fluctuation ) is typically non updated for these varying costs. ” Furthermore, Kwon ( 2002 ) agued “ we study production planning theoretical accounts based on assorted bing systems which are direct, conventional and ABC bing for an automobile portion fabrication industry.

However, we find out that production program from the theoretical account based on direct costing and conventional costing can non command the operating expense costs suitably, but ABC besides has its defects which can non bring forth programs in practical computational times due to the nature of the assorted whole number scheduling ( MIP ) . ” Furthermore, “ Fresh capacity of “ fixed ” distinct resources made available to execute an activity can and should be identified, but companies implementing ABC failed to place fresh capacity ” ( Lawrence, 2005, p. 13 ) .

Harmonizing to Paul Sharman ( 2003, cited by Lawrence 2005, p. 3 ) , the truth is that many companies have non adopter ABC and many companies that have tried ABC but in conclusion besides have abandoned it. He cited one survey coverage that 80 % of reacting companies in the United States are still utilizing traditional cost allotment systems. He besides cited a survey demoing that of the 60 % of U. S. companies that have tried ABC, every bit many as two-thirds have abandoned it. As the consequence we can see that ABC has lost some of its usefulness since it requires more attempt but without supplying better consequences. Thus, some of the companies today remain to their traditional costing systems.

However, the most of import is how the companies seek and implement or even do the best usage of both attacks because there are still many possibilities that both attacks can be combined to accomplish the companies ‘ overall objectivenesss. Sharman ( 2003 ) defined “ Planning and budgeting has been a reasonably specialised field within the finance map of most organisations. It is frequently combined with analysis of concern instances for new merchandises, or acquisition of capital equipment. ” Hence, allow ‘s research some instance surveies to compare budgeting methods and see the impact of the developments have been in pattern.

Harmonizing to Steven ( 2007 ) , Conventional budgeting is an incremental attack which uses a company ‘s bing operations and current cost construction to find budget costs. It “ will supply accurate budget figures for variable costs such as direct stuffs, direct labor and gross revenues committee, because these have a clear volume-based nexus with production/sales. But this attack is improbable to bring forth accurate figures for support sections, whose costs are mostly fixed and semi-fixed and driven by other factors such as gross revenues orders and purchase orders.

In add-on, no consideration is given to the cost of supplying bing activities, since the focal point is on incremental alteration. Inappropriate concern patterns may besides be perpetuated, because no rating of current activities is made. ” Fortunately, the coming of Activity-Based bing Budgeting ( ABB ) which recognises that it is activities which generate cost in a concern and the desire is to command these cost drivers. “ For each identifiable activity, the cost of a unit is measured, the demand is measured, a budgeted cost is set for each unit of activity, and the budget is designed around activity footings ( e. g. Laptop Z3200 Product Build ) instead than the traditional functional countries ( e. g. Fabrication ) ” ( Fintray Consulting Services Limited, 2004 ) .

Therefore, “ the activity-based attack to budgeting is a more sophisticated version of traditional soaking up costing ” ( Steven, 2007, p. 50 ) . Besides, “ ABB means that costs can be assigned to activity and merchandise degree, instead than averaged out across a figure of merchandises or services. This means that existent cost behavior and cost drivers can be analysed, taking to better cost focal point and more targeted client pricing ” ( Fintray Consulting Services Limited, 2004 ) .

However, some lacks in ABB must be considered. “ ABB requires a big attempt to mensurate and analyze activities, and assumes a causal, additive relationship between activity and operating expenses. This may be erroneous, as multiple factors may drive the costs, including the sharing of costs over activities, and the method of apportioning fixed and variable costs ” ( Fintray Consulting Services Limited, 2004 ) . Hence, some of the industry such as cordial reception companies which are seeking ways to better their ability to foretell future operations and related resource demands.

They chose to utilize other budgeting theoretical account such as the more information Zero-based budgeting ( ZBB ) method which is easier for hotelkeepers to utilize the more enlightening ZBB method and it is clip to alter the traditional methods used of incremental, fixed and flexible budgeting procedure. In traditional incremental budgeting, it is used as a starting point for the new budget and justifies merely increases over the old twelvemonth budget. By contrast, ZBB requires the budget starting from the zero-base. Besides, ZBB drives directors to happen cost effectual ways to better operations.

This tends to coerce cost centres to place their mission and their relationship to overall ends. In rule, ZBB leads to the most efficient allotment of resources, as they have to be justified and eliminated uneconomical and disused operations and deployed to the most of import undertakings on a cost/benefit footing and identified chances for outsourcing ( Acosta, 2006 ) . Therefore, ZBB will guarantee that inappropriate activities are non undertaken. However, since ZBB requires assemblage, rating and analysis of big sum of informations thereby the failing of the ZBB is that it is time-consuming.

Consequently, ZBB is used by really few companies ( Steven, 2007, p. 50 ) . As the consequence, it is non easy to alter from one method to another. It would take clip to acquire used to and to gain its benefits. Not all companies are flexible and can easy accommodate with its altering environment. Another ground why many companies do non accommodate ABC/ABB to the full is because it is impractical to utilize the said system in the sort of concern they have. It is of import to observe that ABC/ABB system is non appropriate or unsuitable for all companies and concern operations.

ABC/ABB can be a really utile determination doing tool because it brings visibleness of clearly understanding to the costs in the accounting system, which can non be provided by TCA ( Marivic, 2004, p. 13 ) . There are assorted techniques and theoretical accounts in the existent universe which are adopted by each company to accommodate their ain industry specific demands. Cost control is of import but the most of import that directors use cost accounting to assist do schemes determination to cut down the company ‘s costs and in order to accomplish the company gross revenues and net incomes growing. `

ABC has become highly popular in recent old ages. In fact, it is hard to happen an academic or practitioner diary that does non include at least one article on activity-based costing, Activity-Based Management ( ABM ) , or activity-based budgeting. A powerful tool for mensurating public presentation, Activity-Based Costing is used to place, depict, assign costs to, and study on bureau operations. Companies that adapted ABC believe that it is a more accurate cost direction system than traditional cost accounting.

They say that ABC identifies chances to better concern procedure effectivity and efficiency by finding the “ true ” cost of a merchandise or a service ” ( Marivic, 2004, p. 10 ) . Therefore, ABC provides improved penetration into costs of merchandise or service thereby supplying easier entree to relevant costs. The developments of ABC have overcome the original unfavorable judgment of TCA and budgeting. Although ABC has highlighted that clearly apprehension of what it costs to supply products/services is at the same clip a tool for better direction. However, this may non be accurate adequate to do concern determination.

Therefore, companies have felt the demand for a more antiphonal, more holistic system. The theoretical account available to them merely did non state the whole narrative. In order to carry through that, they sought to rectify the attacks such as ABC, traditional costing are needed. Still the hunt goes on. In the hereafter, altering accounting theoretical accounts requires people to understand and follow a new mentality, with new accounting systems, and ways of doing decisions-no little undertaking for an person, much less an organisation ( TOC Center, 1999 ) .

Last but non least, from a theoretical point of view, it is clear ABC contributes original methodological analysiss to the merchandise mix determination and ABC is an of import development in modern accounting. Thomson and Gurowka ( 2005 ) indicated that “ We believe that ABC and other strategic bing attacks do n’t neglect because of the implicit in methodological analysis entirely but frequently because of hapless execution rules. ‘

Therefore, even though the successful execution of ABC systems has overcome the original unfavorable judgment of traditional cost accounting and budgeting on a figure of companies, one cost system is non plenty for the companies to do accurate strategic determinations. Since the coming of new attacks, companies can hold a better pick among all of these cost accounting theoretical accounts, seek to rectify the cognition spread between the theory and pattern to assist do determinations to cut down the costs and the most of import thing is to better the company ‘s profitableness.