Contributions of Activity-Based Costing (ABC) to the Modern Business Environment
In the increasingly competitive business environment, the enterprises who intend to maintain and enhance competitive advantages must build an efficient costing system to control, plan and decide how to improve the profitability and efficiency of the operation. Activity-based costing system (ABC) is such an advanced costing system that satisfies the needs of companies in modern business environment. This essay gives a whole picture about the ABC from five parts: background introduction, definition of ABC, comparison with traditional costing system, evaluation of ABC and conditions of acceptability.
The reason for the development of activity-based costing
Business enterprises exist in and are surrounded by the environment that includes a set of conditions-political, economic, social and technological (PEST) (Vadim Kotelnikov,2011) that uncontrollable in nature and affect the operating of companies. Such kind of environment is commonly known as business environment, and is divided into two components: internal environment and external environment (What is business environment?, n.d.). In modern society, as economic globalization is developed widely and quickly, business environment becomes more competitive and complicated with the introduction of better technology and more automation. The external environment has powerful impact to the corporations. Under this condition, corporations have a far more multifaceted producing process, and provide an increasingly various range of products for sophisticated consumers (David Russell et al., 2002). Labour resources have been replaced by automatic machinery, and some large corporations even do not set up their own workshops because of production outsourcing. Consequently, the cost structure of such companies has changed, with indirect costs having a larger proportion of total cost than before. The production processes in modern business environment tend to contain costs for a variety of support activities, such as inventory handling and setups for products alteration. Such costs vary with the content and complexity of the product or service operated, more than increasing the volume of activity or output. Based on these changes, organisations are looking for a costing system that would be more realistic and efficient in recording and analyzing the consumption of resources that raise costs. Activity-based costing is just an advanced manufacturing technology (AMT) that is developed in an effort to adapt the advanced business s planning and manufacturing, and then the activities are combined with diverse products or services. In this way, ABC provides cost information that helps the companies to plan, to control, and to decide profitable products or services. There are four steps for activity-based costing system (Pauline Weetman, 2006): 1. Identify overhead costs and the major activities that drive costs 2. Determine the most appropriate cost driver(the factors which most closely influence the cost of an activity) for each major activity 3. Group identical cost drivers into cost pools(groups of associated costs that all relate to a specific product or service in some manner) 4. Allocate costs to products according to the product’s use of each activity Here is an example of activity-based costing for cleaning overhead illustrating how the activity-based costing uses according to the four steps above. There are two departments in a corporation. Department A has already got 15 transactions with an average value of ￡10,000 each, while Department B has got 5 transactions with an average value of ￡50,000 each. The total amount of the overhead costs for the period is ￡100,000. To calculate the overhead costs absorbed for each department using activity-based costing, it is necessary to decide the cost driver, which is the value of transactions in each department at this question. Total...
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