Management Accounting Business Case Study Assignment (Case Study Sample)

MANAGEMENT ACCOUNTING BUSINESS
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20th December 2015
Let us now consider the first question
We shall first understand what we mean by the term ‘Activity Based Costing’ (ABC) before moving into the necessary parts.
By the term ABC, we assign a cost to something, be it a project or a service or a product etc., based on the activities they consume. This method thus differs from the traditional cost accounting, which assigns costs arbitrarily for overheads and has been developed primarily to overcome the perceived weaknesses of the traditional method (Kfknowledgebank.kaplan.co.uk, 2015). A management which uses ABC method for decisions is called as Activity Based Management (ABM). We shall now illustrate with an example how the traditional and the ABC methods vary.
Suppose, let us assume that XYZ Company produces Compact Discs as a part of its expanding business. Then, via traditional and ABC methods, this can be depicted as follows:
Manufacturing Overheads Manufacturing Overheads
Direct labour Cost Setup Assembling
Compact Discs Number of Number of Hours
Batches
Compact Discs
This innovative system depends majorly on the following parameters:
* Cost incurred significance
* Importance of the output produced
* Cost drivers.
Now let us discuss part I of the question.
Basically, the Traditional method of costing product is labour intensified wherein the Indirect Costs will always be lesser than the direct ones. This is basically driven by the principle that, when the production is higher, its overhead costs will also be higher. Thus, in this case the OAR (i.e.) the Overhead Absorption Rate will be either in man or machine hours or in units and is directly proportional to the work done. This was suitable in the past era since there were no heavy rivalries vying for the same group of customers or a heavy competitive market whereas now it is not so. The following point can very well be taken into consideration here:
* Overheads always depend on the costs incurred as they would have constituted only a small portion of the total costs. This was because the traditional way is more labour oriented and hence the direct costs will be way higher than the indirect ones and hence a rough estimate of the overheads was thus far more enough during those periods.
Now in the modern era, as more horizons are being researched and many businesses getting expanded, it becomes impossible for an organization to get struck with this elementary method and thus, in the emergence of 1980’s the actual birth of this ABC method took place albeit its roots are much older. Every method has its shares of positives and negatives and clearly ABC is also a no exception. Here, we primarily try to reduce the head costs by calculating the amount that an activity needs and simply allotting that much money to it. Every output needs a relevant activity to take place and this form ABC’s basic principle. By implementing this, we at every stage identify the unwanted processes and eliminate that and thus improving and speeding the overall process time and according to this, the pricing is also determined based on the relevant cost drivers. Thus both, Time and money, the crucial aspects of any business are saved here. Also, through this method the profitability of a particular area of Business and the profit probabilities of different areas can be adjudged. Thus a fair allocation of overheads happens here and can be effectively applied to the entire business.
But, due to the modern processes getting more machine intensified, this method leads to overheads especially production ones growing more than the direct costs and hence an exact estimate is needed every time. Also, as heavy market competition is happening now-a-days, the diversity of the products has also increased. Then, it is not possible for us to reduce the overhead costs every time, especially in the time when the volume of production is huge. The Next point is in each and every stage it becomes practically not feasible to identify the parameters which influence the costs and hence selection of important cost drivers becomes difficult which thereby leads to difficulty in evaluating costs based on activities, which incidentally is the very basic purpose of implementing ABC, thus small industries like cottage industries thus find it extremely difficult to use this as it heavily leans on skilled labour. Let us consider the case of the XYZ Company depicted above. When, it was a small expanding company, it would have used the Traditional Method, which by then was sufficient for the company’s production as manual labour is more prioritized here than the machine work which was used only at the latter stages of production contributing little to the total costs and hence negligible. The cost allocation base here was only the labourers. Now, let us assume that this company has grown up, established new bases and in order to maximize its production, goes on buying more and more machines, minimizing labourers. Now, for the machines an initial setup is needed, periodical maintenance is needed and assembling is needed. Thus, here the indirect costs at every stage will obviously be far greater than the direct ones and thus the pricing of CD’s also differs. Here, errors can be minimized, a complete finished product is produced and production is quadrupled. Now ABC plays a vital role. It identifies the unnecessary parameters, cuts the head costs and saves monetary loss. Here, implementation of ABC becomes imminent.
Part II
Many theoretical criticisms have been put forth in defiance of ABC, the major ones being,
* ABC can’t be universally adopted (i.e.) those firms which don’t offer diverse products can’t use this method.
* If the implementation is flawed, then the total system just doesn’t work out.
* It can’t provide full relevant information to any firm.
The first one can be attributed to the fact that small industries find it increasingly difficult to adopt this technique. The basis, theoretical criticism of ABC is argued by (Conditions Under Which Activity-Based Cost Systems Provide Relevant Costs, 1991). This is due to the fact that the calculation of full production cost per unit is a tad too inconvenient. Also, Noreen argues that the condition of direct proportionality must be taken as both a necessary and sufficient condition for correct calculation and must not be omitted, which will lead to a huge flaw in the method. Also, according to (Conditions Under Which Activity-Based Cost Systems Provide Relevant Costs, 1991), three if and only if conditions must be considered here:
1 The total cost must be divided into cost pools and for each cost pool; there must be only one cost driver.
2 Those cost pools which have an influence on the activity level must be considered and all other zero intercepts must be excluded.
3 Individual activity costs at each stage must be summed up to form the whole activity costs.
The conditions (2) and (3) are stronger and show the inherent flaw in ABC (i.e.) the inability to identify the unnecessary parameters in all the stages. Also, assuming proportionality as a framework may overstate the relevant overheads. These, theoretical criticisms by Noreen and others led to modifications in the ABC method, which took place in the 1990’s. Kaplan and Cooper redefined the concept of resources and cost hierarchy, thus modifying the original ABC description named as first-wave ABC. New concepts were introduced and were collectively termed as Second-wave ABC. But, still many of the textbooks follow the first original one. The modified one is noted for the fact that for the first time, a cost hierarchy basis was introduced, especially unit and batch level, product and customer based ones were considered. Also, the time frame is taken as an important parameter determining the relevance of ABC in a particular situation. (Kaplan and Atkinson, 1998) argue that avoiding this timeframe concept can have many ramifications in the outcome.
Part III
The main practical problems for not considering ABC in an organization are as follows:
1 Lack of suitability for the business.
2 Lack of internal support from the organization
3 Lack of managerial interest
4 Lack of resources
Also, ABC is treated mainly as one of the decision making tools and not a viable replacement for cost accounting systems. (Troxel, et al, 1990). It should be viewed as a one that should yield a more structured and uniform implementation. Basically, when we consider the business accounting information of a company, the following persons most need it to decide the next course of action. They are the Owners, the Customers, Rivals, its Employees, the Shareholders, the Managers, Trade Analysts, Suppliers, Money lenders and so on. Many companies use standalone ABC packages and specially customized ABC software applications for the above said purposes. Those firms which use ABC are considerably reduced having under its aegis, those who have used and rejected it and those who haven’t thought of it at all. It is mainly used among the users as a parallel costing system in addition to the main one and hasn’t been used as a primary source and this may be attributed to its low success rate and even these users opt for a general package rather than a tailor made one. Hence, more manufacturer...