Full-costing concept and critical evaluation of activity based costing as an alternative.

The main criticisms about full-costing is the fact that it omits opportunity costs analysis and refers to past costs which are irrelevant for future decisions at first and secondly the way we allocate costs is arbitrary and changing method may drive wrong decisions. It becomes even more problematic when we have to deal with different product lines (Glautier and Underdown, 2000) as this could then become the case by developing a new range of sails as assigning indirect costs to specific products will drive the selling price of this product.

The concept of direct and indirect costs is key here as the first ones “can be traced to a specific cost unit and can be measured with respect to it” while the latter “are incurred in pursuance of the activity being costed but which cannot be related to or measured in respect of it” these are also known as overheads (McLaney and Atrill, 1995)

The other main component to take into consideration in the full-cost model is the level of profit (McLaney and Atrill, 2009) as it should then reflect the target business’ profit the company wants to achieve.

In 1998 Cooper and Kaplan of the Harvard Business School argued that this costing method was like “peanut butter spread” and that it could lead to distorted costs allocation in the company (Goektuerk, 2007).

To remediate to this situation, Activity Based Costing (ABC) can be implemented as an alternative to the full-costing concept. To address this issue, ABC will trace all the costs by activity and report them back per product or service. In order to efficiently allocate these costs, there are steps to undertake i.e. identify all the actual activities and then the cost activities and their drivers. Once the drivers are identified and under control, we can then allocate the costs and control them by controlling the drivers. This method helps then increasing the accuracy of costs allocation, having a better grip on cost controls by working on the drivers and also outlining changes that may have to be brought in the organisation to optimise production.

According to Venkataraman and Pinto (2008), the other side of the coin for ABC is that there is less involvement from top management as it is more a bottom-up approach and this may lead to tension between strategic and operational levels of the organisation. Heisinger (2009) brings another view about the costs of implementing ABC in an organisation as it means that people on top of their activities will have to identify, monitor, track and operate the process.

As a conclusion, it is thus important to use it as and when necessary i.e. multiple products and variations in the production, or else the benefits may not outweigh the costs of implementation and embedding ABC in the organisation.

References and bibliography:

ARMSTRONG, M., 2002. A Handbook of Management Techniques: The Best Selling Guide to Modern Management Method, 3rd ed. London, UK: Kogan Page

BAKER, J., 2010. Implementing Value Pricing: A Radical Business Model for Professional Firms. Oxford, UK: Wiley

GEORGES, W. and McGEE, R., 1987. Analytical Contribution Accounting: The Interface of Cost Accounting and Pricing Policy. Westport CT, USA: Quorum Books

GLAUTIER, M. and UNDERDOWN, B., 2000. Accounting theory and practice, 7th ed. London, UK: Financial Times Management

GOEKTUERK, H., 2007. Activity-Based Costing (ABC) – advantages and disadvantages. Munich, Germany: GRIN Verlag

HEISINGER, K., 2009. Essentials of Managerial Accounting. Boston, USA: South-Western College Publishing

HOPPER, T., NORTHCOTT, D. and SCAPENS, R., 2007. Issues in Management Accounting, 3rd ed. New Jersey, USA: Prentice Hall

McLANEY, E. and ATRILL, P., 1995. Management Accounting: An Active Learning Approach (BABS), 1st ed. Oxford, UK: Wiley

McLANEY, E. and ATRILL, P., 2009. Accounting: AND My Accounting Lab: An Introduction, 4th ed. Harlow, UK: FT Prentice Hall

THE ROBERT GORDON UNIVERSITY, 2009. Full costing and activity based costing (MBA_slides_-_session_3_PT.DL.ppt). UK: The Robert Gordon University

VENKATARAMAN, R. and PINTO, K., 2008. Cost and Value Management. Oxford, UK: Wiley

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1 reply »

  1. ABC implementations –they offer unique, and often controversial, ways of looking at a business – are anything but easy. As a practitioner with some twenty years experience implementing ABC systems, tools and models, I would like to offer some additional thoughts.

    Despite Venkataraman and Pinto’s comments, a key business challenge is that every ABC implementation requires sr. management involvement, or it is doomed to fail. And yet, too often leaders are really not certain what it is they want from ABC. Are we focusing on product profitability? Which customers increase our revenues? Where can we focus our CPI efforts for the greatest results? If you’re uncertain of the business needs, any answer will only confuse you. It is the implementation team and its leader who must set the groundwork for any implementation. If you don’t understand the results and implications of what a properly-implemented ABC system will provide, you are unlikely to make any sound business decisions, whether operational, tactical or strategic, on the results. Education goes a long way toward understanding ABC; and small, baby steps should be taken before implementing any full-blown, detailed ABC systems. Try a small ABC proto-type that will showcase the potential of ABC before proceeding toward full implementation This will not only help others understand the power found in ABC but also help direct and focus energies on defining what kind of implementation to attempt and the issues you’re trying to address.

    I once had a Vice President whose standard response to any implementation, and the biggest hurdle to overcome, was a simple phrase, “It’s the culture, stupid.” His point was that change management, especially with cultural hurdles, was where the most work and energy needed to be placed if you wanted a successful implementation. The culture can often derail any of the best-laid plans and schedules. In my experience, you have to tailor any implementation to the willingness of the culture to accept ABC and its results. No, it’s not OK to push ABC out to every manager’s desktop if that’s not the best way to ensure success. Unless sr. management stands behind ABC 100% and is willing to require its use, ABC will never be accepted. Even then, there may be a lingering resentment toward it being forced on staff. If management is skeptical, start small and build a ground swell of support. If there have been prior implementations of ABC that have failed, make it a point to study those failures in detail and build a program and/or model that addresses each issue. At one location, we actually used a “stealth” model that was viewed only by sr. management. Staff had complained about a prior ABC attempt because they viewed it as time-consuming, requiring too much effort – they despised the time reporting requirements as distracting from their day-to-day work. We worked around any staff requirements and/or inputs, and the model was used exclusively by sr. management to influence their resource allocations and business decisions because it was focused on their needs and circumvented the need for direct staff involvement.

    ABC can actually take many shapes and forms. It might reside on the manager’s desktop and be used in day-to-day operations, or it might solve a one-time, one-off outsourcing issue. It could influence sr. management’s decision-making, or it can confirm a business strategy and never be used again. The approach and implementation is as varied and unique, as simple or complex, as the business problems you’re trying to solve.

    Thanks for the opportunity to share my views for a successful ABC implementation. I may be reached at William.c.clark@hotmail.com should you wish to discuss further.

    Like

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