Activity Based Costing

Introduction and brief history of ABC

The use of Activity based Costing (ABC) was very common during the years preceding the 90s. The method was first introduced by Robin Cooper and Robert Kaplan in the 1980s. After the 90s, the concept began losing its evident popularity with the emergence of more viral and better methods of cost estimation such as the economic value added and the Kaplan’s balanced score card analysis.

However, the concept of ABC is still practiced today in diminutive proportions in different companies in different countries all over the globe. This survey is conducted in a bid to understand why some companies are still using the concept and why others abandoned it and more importantly, determine its relevance in the world of accounting today. A few guiding questions are formulated as follows;

1)      How is the concept of ABC applied in companies in the globe today?

2)      How does it compare to other modern concepts in its applicability?

To be able to analyze the concept of ABC effectively, this paper will take a look at the application of the concept in four different countries of the globe. These countries have been chosen following a simple criterion of the diversity in their culture. The culture diversity is important in determining the overall relevance and applicability of the concept. The countries chosen for this study are United States of America, Tunisia, China and Portugal. These countries are located in different continents and hence culture diversity is inherent.

Definition of terms

Before the analysis is conducted, it is important to understand what this concept of ABC is all about.  According to Nehler (2005) quoted in Yousif (p.11, 2011), activity based costing is defined as a costing measure or methodology that produces or designs a particular product that produces activities and then matches activities’ particular costs with resources to actual products and/or services in accordance to the real consumption function by each activity. ABC will identify activities undertaken in a particular organization, then it goes ahead to assign particular costs in relation to particular activities and them matches. The costs are then matched with the resources available to all products and services according to the consumption margin of each activity.

ABC had been introduced to address the problem of the traditional cost accounting which used a single cost driver to give an allocation of the overhead costs and this lead to a distortion of the product costs in the modern manufacturing sectors. Leech (1994) argues that the overhead costs are part of the product costs and they should be treated as one and the same thing. If products costs are estimated incorrectly, this could lead to making of poor decisions (Wang, Du, Lei and Lin, 2010) quoted in Yousif (2011).

Application of ABC concept in different countries

As noted earlier, though the process was phased out, some countries still use them in small proportions. Others have completely abandoned the concept. This part will analyze the usage of the concept in four different countries of the globe namely; America, China, Portugal and Tunisia.

Application of ABC concept in America

Due to an advanced economy early on into the century, the USA had a better chance than any other country in the globe to experiment with this concept of ABC. The availability of numerous accountants and economists enabled the country to be on the forefront in the usage of this concept.

Chea (p.3, 2011) notes that it is in this country where the concept was first introduced and applied in the manufacturing sector in the 1970s to take care of the flaws brought about by the traditional cost accounting model. Yousif (p.54, 2011) attributes the decreased usage and popularity of the ABC concept in major companies in the USA to the lack of resources or organizational personnel for the full implementation of the concept.

Corporate Culture in USA

The USA is a capitalist nation and as such, the corporate culture adopted in many of the organizations and companies in the country has always been inclined to a more liberal and democratic approach. The decisions that companies make are guided mostly by the intrinsic factors in these companies as opposed to outside factors such as politics and governance.  This democracy has enabled these companies to adopt policies and concepts that they think are best suited to their particular organization. From the research carried out on the cost accounting front, the companies that applied the concept of ABC derived some benefits from the usage of the concept. Some of these benefits are outlined below;

The derived benefits of ABC in companies in USA

Taking a retrospective outlook on the kind of uses that the concept was applied to in the USA in the 1980s, a number of sectors have been identified and are discussed below;

Benefits related to products and/or services

ABC is applied extensively in making of decisions relating to products such as in the ordering of raw materials for the production of a particular amount of volume of products and determination of the overall cost of producing these products.

The application of the model provides information on how much resources are used in every step, how many activities are done and how much these activities cost. This concept when well utilized as in the statement described earlier allows the companies to determine the products or services that are valuable to the company and as such also determine the customers that have an impact on the company’s profit model. This is made possible following the assumption that all the work that is present or done in the companies can be directly linked to the activities in this company. The ABC concept then traces costs and assigns them to particular activities in these companies. According to Yousif (2011), the activities that customers are not required to pay for are not value added. Nachtmann & Needy (n.d) concurs with Yousif (2011) in that statement. They argue that it is vital for activities that involve cost in the company to be compensated by the customer. Lack of compensation takes the value addition of these activities.

On a break even scenario, the application of this concept when viewed from the production perspective means that the ABC concept shows the resources that are consumed in a given company and argues that the cost of these resources should at least be corresponding to the cost of the resources (Gurses, 1999). If this is done, it provides the companies with the necessary information in regard to the quantity of resources that a particular volume of product requires.

Benefits related to the consumer

Though this isn’t the primary reason for the application of the model, ABC is instrumental in identifying the important and non-important customers of a particular company. Pete & Cardos (2011) stipulate that companies should break down the activities that go into the production of the products on sale to these customers and then explain to the customers that they have to pay for these activities because the activities incur costs.

Most customers will be happy to oblige and pay when the activities that go into the production of the products they consume are outlined to them and the costs associated with these activities also made known to them. This is synonymous to transfer pricing where the customer is the one who feels the blunt of the costs involved in the production of the product (Kaplan, Weiss & Desheh, 1997)

Benefits related to the Company

Stratton et al (2009), quoted in Yousif (p. 58, 2011), states that as an accounting tool, ABC is capable of giving crucial information regarding products and customers to the company and this information could be useful in the strategic decision making processes.

Application of ABC concept in China

China is a communist country. Though some extensions of capitalism are slowly creeping into the country, China has predominantly been a communist nation (Oi, 1989). The state is among the most populous in the world. It is located in the Asian continent.

The Chinese culture

The culture in China is a little rigid and conservative compared to other cultures of the world. This could be alluded to the communist policy in the country. The industries in the nation operate within the set policies of the government.

ABC use in China

Liu & Pan (2007) denote that the concept of ABC has brought about a successful induction of the application of standardization processes and practices in the corporate industries in china. Standardization was not a very notion in the culture of Chinese and was not widely used or applied. With the introduction of the ABC concept, this process and practice became widespread over time.

Before the ABC system was introduced and adopted by companies in China, these companies operated using the traditional Chinese state- enterprise accounting system that was very cumbersome in that manual book keeping was involved. The ABC replaced this traditional Chinese system and improved the accuracy of product costs since it was not affected by external financial reporting purposes

Application of ABC concept in Portugal

The republic of Portugal is located in the south western part of Europe. With a democratic system of government, the organizations’ culture in the country is much liberalized.

ABC use in Portugal

Portugal has not fully adopted the concept of ABC into its systems since the inception of the accounting system.  Tomas, Major & Pinto (p. 34, 2008) argue that companies in the country have been slow in adopting this concept into the system despite the popularization of the benefits of the concept. Only about 22% of companies have adopted the system even though more than 27% others are lined up to follow suit (Tomas, Major & Pinto, p. 34, 2008).

The utilization of the concept in this country is very minimal, with many companies opting to adopt the modern cost accounting methods in preference to the activity based costing concept.

Application of ABC concept in Tunisia

Tunisia is a small nation located at the horn of Africa (North Africa). Tunisia adopted the government policy of capitalism after it was assimilated by the colonial masters, the French. The corporate culture of the country is hence very liberal.

ABC use in Portugal

The introduction of the activity based accounting concept in Tunisia could be alluded to the influence of the foreign companies that were established in the colony. These companies adopted the systems of accounting that the parent companies back at home used. To be able to understand clearly about the ABC use in Tunisia, a reflection could be carried out ton know what system was used by the parent companies.

However, according to Salem & Bahia (2012), it would be safe to deduce that the concept was applied to selected industries in the same ratio as where they had originated from. Since the majority of these companies had a European origin where the concept had taken root, then they must have transferred its use to the subsidiary companies in the colony.

Conclusion

From the preceding discussion, it is observed that the use of the activity based concept in the accounting analysis in companies has declined very much over the recent years. The initial anxiety with which the concept had been introduced and spread to various companies has been phased out with time and with the inception of more modern and simpler concepts.

However, it shouldn’t escape notice that some companies in different parts of the world are still using this concept in a very competitive structure despite its lack of popularity. This shows that the relevance of the concept has not been windswept with the course of time and the concept can still be applicable today to solve issues relating to production of products in major companies.

To this regard, the research wishes to conclude this paper by stating that I concur with the statement that ABC is still relevant for companies in all geographical locations.

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