"Product cost estimation is a challenging task, especially during early stages of the design and development phase. This activity is crucial to the financial success of manufacturing firms and is gaining increasing importance in the contemporary competitive environment." (Qian and Ben-Arieh 2008, p. 805)
The traditional cost accounting method determines the cost of a product or a service by assigning the indirect expenses into the direct costs (Narong 2009). Johnson and Kaplan (1987) stated that the traditional cost accounting tends to misinterpret the product costs and is not assuring for decision making (cited in Roztocki et al. 2004, p. 16). Narong (2009) also added that the traditional cost accounting is not productive for excellent practitioners and managers in the advancing complicated business world.
"One innovative costing method designed to deal with the deficiencies of traditional costing systems is activity-basedcosting (ABC). ABC, pioneered by Robin Cooper, Robert Kaplan, and H. Thomas Johnson is a costing methodology used to trace overhead costs directly to cost objects."
(Roztocki et al. 2004, p. 19)
Adams (1996) stated that ABC provides more precise cost evaluation, as well as better approach to the production costs and enhanced information for making strategic business decisions. Cooper and Kaplan (1992) claims that ABC offers manufacturing businesses improved information on their product costs and leads to increase in profit (cited in Raab et al. 2005, p. 13).
Zhuang and Burns, in their 1992 study, are of the same opinion with Cooper and Kaplan that organizations implemented ABC due to its information for strategic decision whereby precise product cost is important (cited in Gunasekaran et al. 1999, p.407). Cooper and Kaplan (1991) also approved of ABC could assists managers emphasize on areas of costs that could help increase the businesses' profits.
"To succeed, companies need a good amount of knowledge about what it costs them to make their product. Activity-based costing is extremely important to us because in our business we have a mixture of long- and shot-run orders," says Salbaing.
(cited in Cross 2003, p. 31)
Many businesses take up ABC as a capable judgment support system which answers the drawbacks of traditional costing (Geri and Ronen 2005), which was in line with the opinion of Gunasekarang (1999) who stated that ABC is obtaining its significance in businesses which are targeting for a main share in the business by advancing the businesses' productivity and quality. Innes and Mitchell, in their studies in 1990 also agreed, where they wrote that businesses adopted ABC due to organizational revolution and environmental issues (cited in Adams 1996, p.513).
Activity Based Budgeting (ABB)
ABB is a development from ABC which helps businesses to put emphasis on specific activities and offers a clear view of the connection between the amount of work and expenses (Shane 2005). Serritzlew (2006) supported this and added on with stronger connections, it diminishes the ambiguity for the agencies.
Shane (2005) also stated that ABB grasps promising solutions to the drawbacks of traditional cost budgeting:
Connolly et al. (1994) stated that the main criticism of traditional budgeting is that it mainly focuses on the rationalization and the inputs of resources apart from accessing the gains of the resources. The authors added that ABB is introduced to help answer to the deficiency of traditional budgeting.
John Antos supports that "ABB means turning traditional budgeting on its head," (cited in Babbini and Christian 1999). Babbini and Christian (1999) in agreement with the idea of John Antos where it makes definitely logic that the gains from ABB are over traditional budgeting because ABB allows managers to deal with costs than budgets. Shane (2005) is also in line with the idea because ABB could help determine the efficiency of the project. Mazzarrone (1998) also agreed that ABB is beneficial where cost can be simply re-cumulated by functional areas, expense activities, and by projects.
However, Durfee (2006) argues that changing from traditional budgeting to ABB would not solve all budgeting problems. Serritzlew (2006) also criticize that even though ABB can be helpful in escalate the correlation between activities and budgets, it is still easier said than done to design the rules because it needs to pay attention not only to ways of measuring the outcome, as well as the current issues with output diversity. Serritzlew (2006) also added on that the reliability of the ABB is constantly a fundamental issue.
Activity Based Management (ABM)
ABC is about collecting and determining cost information whereas ABM provides an idea on way to deal with it (McConville 1993). Armstrong (2002) also added that the expansion of ABC into ABM is to evaluate and examine the workforce function.
Narong (2009) stated that ABM is able to overcome the deficiencies of traditional costing system where the conventional system does not display a clear picture of the costs. The author also added that ABM could also overcome the conventional system where cost are reported in ledgers, thus, decision makers could not determine the specific activities for efficiency, productivity or profitability. Ghicajanu (2008) have the same opinion where ABM is an essential method to cost and performance evaluation when matching up with the conventional method.
When ABM is adopted effectively, there will be potential value added through the growth of the workforce role themselves (Armstrong 2002). Narong (2009) also be in agreement that the purpose and advantage of ABM are introduced as by means for excellent development of opportunities.
According to Evans & Ashworth (1995), "ABM is a way in which an organization can direct, measure and control its aim for enhanced performance. This is achieved by the creation and use of an activity-based performance measurement framework as the primary means of resource management, continuous improvement and decision-making."
(cited in Armstrong 2002, p. 110)
"The problem with the ABC/ABM project of recasting indirect costs as direct is not so much that it cannot be completed in practice but that many of the costs which are identified as the direct costs of activities are still infected with indirectness."
(Armstrong 2002, p. 106)
Mitchell and Cobb (1992) commented that the implementation of ABM is costly in context of staff's time (cited in Armstrong 2002, p. 110). However, Armstrong (2002) is also aware that ABM is just an updated and partly programmed structure of cost deduction and managerial. Armstrong (2002) also criticize that it is not even near convincing to use ABM as a tool of increasing profits.
Criticism of Activity Based Costing (ABC)
Cooper et al. (1992) argued that many businesses have adopted the ABC system and reaped benefits from using the system, but there are many other businesses that did not grasp the similar benefits (cited in Drake 1999). Drake et al. (1999) also consent with Cooper regarding the failure in ABC, where managers fright that a transition for the current system for computing profits might cause a reduction in their pay. This was also supported by Ronen and Geri (2005) where they wrote that ABC is basically a modification of absorption costing and it suffers mirrored deficiencies of absorption costing.
Cooper and Kaplan (1991) stated that although ABC provides a clear view of the activity of the business, ABC makes a demand on the businesses' resource, supported by Cobb et al., ABC is tough to be implemented attributable to lack of resources, which includes staff time, internal resources, as well as the computer system (cited in Malmi 1997). Gunasekaran et al. (1999) concurred where he stated that the implementation of ABC requires ample amount of resources from the businesses.
Innes et al. (2000) was also in line with this where ABC's technical complication and the requirements of new systems that generate continuous activity data may lead to the offset of cost of implementation over the benefits that could be reaped. Kaplan and Anderson (2003) also are in agreement where ABC is too costly to implement as well as to maintain. The authors added that ABC regularly fails to detain the complication of actual operations.
Gunasekaran et al. (1999) criticized ABC on the comprehensive detailed information required for strategic decision making. However Ronen and Geri (2005) added on by disapproving the requirements of ABC which involves subjective choice of absorption decisive factor. They also mentioned that ABC is unable to forecast profits when there is a change in production volume, which leads to the inadequacy for strategic decision making. There are also problems regarding the adequacy of assumptions of ABC and the accuracy of the information provided by ABC (Ronen and Geri 2005)
Ronen and Geri (2005) criticized that ABC do not take into account the constraints in the business and does not distinguish a bottleneck from limited resources. The authors also added on that ABC considers the activities in the business are certain but, in reality, businesses do incur discontinued costs. As a result, ABC may bring upon misleading strategic decision making.
"What ABC actually did was to emphasize the need to focus and to cut down the cost of operational complexity. However, once managers internalized these lessons, they no longer required complex cost data to make improvements, and used nonfinancial measurements instead."
(Ronen and Geri 2005, p. 135)
Time-Driven Activity Based Costing (TDABC)
To overcome the deficiency of ABC, an alternative approach would be the TDABC which is easier, cheaper and faster to implement, as well as allocating cost driver rates to be based upon sensible capability of the capital supplied (Kaplan and Anderson 2003)
Kaplan and Anderson (2003) had provided the benefits of TDABC:
(Kaplan and Anderson 2003, p. 1)
Sherratt (2005) appears to be in contrast with Kaplan and Anderson, argued that TDABC can only be applied in particular departments or particular projects, adoption of TDABC in repetitive activities would result in more problematic than benefits. However, Kaplan and Anderson (2005) claim that they had applied TDABC in more than 100 businesses, including well complicated departments and concluded that TDABC does not fall into the same subjective and imprecise traditional ABC.
Sheratt (2005) also argues that TDABC is not ideal for every activities in a business, thus, different department could adopt different methodologies as every methodology has their own strengths and weaknesses. Conversely, Kaplan and Anderson (2005) stated that business does not need to adopt multiple methodologies, as TDABC would be sufficient due to its simplicity and accuracy of information.
Sheratt (2005) also pointed out that internet-based ABC is easier for businesses to regularly obtain and accumulate data, thus, businesses can inform their expenses more regularly despite any methodology used. On the other hand, Kaplan and Anderson (2005) claimed that internet-based ABC only discreetly relieves the trouble faced by the business, yet, the deficiency of traditional costing still remains.
Impact of the Developments of Activity Based System on Companies
Activity Based Costing in Land Transportation Company
The main services provided of the business chosen in this case study comprise of export service from Gaziantep to European countries, as well as import services from European countries to Turkey. The business also provides transit service. The business successfully adopted ABC and it increased the efficiency of the business considerably. In the business, identical activities are gathered to elevate the efficiency and diminish the cost of adopting ABC. In the business, it is significantly hard to determine the cost drivers, yet, the benefits of using ABC in the logistic business are in sight. Managers are able to evaluate the utilization of resources, thus, it provides the ability to improve, replace or eliminate activities that dissipate resources. By comparing the results obtained from traditional costing method and ABC, there is definitely a difference in the information provided by both methods. Therefore, ABC is able to overcome the deficiency of the traditional costing because traditional costing could not allocate overheads to its services whereas ABC is able to. Thus, ABC can be adopted in the logistic businesses.
(Baykasoglu and Kaplanoglu 2008)
Activity Based Costing in the Life Insurance Industry
In this case, ABC is introduced in the financial service sector, specifically life insurance sector. Most of the life insurance organizations are normally complicated businesses which compete in a highly aggressive market. These businesses often incur lofty support overheads that are tough to be allocated into specific cost drivers. Traditional costing only attributes overhead costs into cost drivers on an arbitrage basis whereby ABC allocates the overhead costs into specific cost drivers that causes them. Therefore, the specific costs information helps to provide more precise information for strategic planning. Moreover, by linking this to ABM, managers are able to perform better by setting priorities and serve customers better. As a result, ABC can be adopted in the life insurance sector where they play a significant part in elevating the performance and quality of the business. (Adams 1996)
Time-Driven Activity Based Costing in Outpatient Clinic Environment
Healthcare managers are trying to provide better services to the customers at a lower cost. To comply with this, healthcare businesses have to adopt an efficient costing method, TDABC. The TDABC will be adopted in five departments in the clinic and present evidence of the benefits gained. The TDABC can assist healthcare managers to evaluate and examine the overhead costs generated by specific activities. The TDABC also assist managers to emphasize on areas required to be improved. The ADABC also helped improve the relationship between departments and improve operations by introducing a healthy competition. Moreover, TDABC is able to elevate the understandings of diversified processes. Therefore, managers can make strategic decision to improve the quality and efficiency of the business, thus, TDABC has a positive impact on the Outpatient Clinic Environment. (Demeere 2009)
Time-Driven Activity Based Costing in Logistics
This case shows how TDABC can be adopted in the logistic industry to provide accurate information. It specifies on a single Belgian wholesaler which abandoned ABC and adopted TDABC for almost 2 years since then and considered helpful in managing profitability. The business had complicated logistic services and TDABC is able to cater for it. Furthermore, TDABC is able to provide more accurate cost information compare to ABC as well as reduction in cost for data gathering. Moreover, TDABC provides managers benefits for strategic decision making. As for this case, TDABC has a positive impact on the logistic industry. (Everaert et al. 2008)
This paper illustrates how Traditional Costing (TC) had developed into Time-Driven Activity Based Costing (TDABC). There were many problems occurred when TC was utilized. The information provided by TC was not accurate and not suitable for strategic decision making because TC assigns indirect costs into the direct costs. Therefore, it is not productive for any business.
However, Activity Based Costing (ABC) was developed to overcome the deficiencies of TC. ABC provides more precise cost information and it enhances the quality of strategic decision making. There are 2 additional applications for ABC which are Activity Based Budgeting (ABB) and Activity Based Management (ABM)
ABB is a development from ABC which assists business to emphasize on specific activities and have a clear view on the correlation between activities and the costs. ABB was also a development to overcome the defects of conventional budgeting, where the main criticism of conventional budgeting was, it mainly focuses on rationalizing and accessing the gains of resources. However, there are still problems with ABB where ABB could not solve all of the budgeting problems.
ABM is also an expansion of ABC where ABM provides an idea on how to deal with the cost information. When ABM is adopted successfully, there will be potential value added through the growth of the labors. ABM also assists in resource management, continuous improvements and decision making. Nevertheless, there are still flaws in ABM. The implementation of ABM is time consuming and it is not convincing to say that ABM is a tool for increasing profits.
On the other hand, even though ABC had overcome the criticism of TC, ABC had also received many criticisms. Not all businesses benefits from the implementation of ABC. The implementation and maintenance of ABC is very costly. Moreover, an ample amount of resources is required for ABC. There are also limitations to the assumptions of ABC, which may lead to inadequacy and misleading information. Therefore, the cost of implementing ABC may offset the benefits gained from it.
With the deficiencies in TC and the scarcity of ABC, a new cost system has to be developed to overcome the drawbacks of its predecessors. Hence, TDABC was introduced and it does provide the solutions to the original criticism. TDABC can be estimated and quickly installed without any hassle. It is also easier to reflect to changes in cost and the data can be fed from other systems, such as ERP and CRM. TDABC can also process millions of transaction without any lag or waiting intervals. Moreover, TDABC can integrate resource's capacity and stress out wastage of resources. Furthermore, TDABC can forecast demands by looking at the changes in orders and trends of customers without complicated the system. Therefore, TDABC had overcome its original criticism on the original ABC.
There were several case studies on the development of ABC and its impact on businesses. However, it points out that it is essential for businesses to have a good costs system because every business needs to have a precise and clear view on their costs information to make strategic decisions. Evidently, a business with good costs system will definitely be able to succeed in its business.