Research Paper on "Activity-Based Costing"

Research Paper 3 pages (1091 words) Sources: 5

[EXCERPT] . . . .

Activity-Based Costing

In today's global market place manufacturing firms are facing ever increasing competition. Furthermore, due to the fluidity of the environment businesses must react quickly to change while manufacturing high-quality, low cost products in order to remain competitive. Traditional costing systems that utilize a volume-based allocation of overhead have lost relevance in a manufacturing environment that has seen a sharp increase in overhead and a subsequent decline in direct labor. These traditional costing systems tend to distort product costs and lead to poor strategic decision making. To make proper decisions, senior managers must have accurate and up to-date costing information (Roztocki, Porter, Thomas, and Needy, 2004).

One innovative costing method designed to deal with the deficiencies of traditional costing systems is activity-based costing (ABC).

Background

The United States dominated the world's economy from the end of World War II until the 1980s. During the period from the 1950s to the 1970s American companies needed only to concentrate on output in order to achieve growth and profitability. Little attention was paid to quality or cost control. In the 1980s the Japanese began to produce low cost high quality goods. The United States companies needed a way to reduce costs and increase quality in order compete. Managers began to employ activity-based costing, which helped identify cost-reduction opportunities. By 1992, activity-based costing had gained worldwide recognition and was being used in America, Europe, Asia, and Australia.

Activity-based costing was first introduced as an improved way to calculate cost by H. Thomas Johnson and Robert S. Kaplan in their 1987 book Relevance Lost: The Rise and Fall of Management Accounting (Naughton-Travers, 2001). ABC was presented as a way to solve the problems of traditional costing systems, which were unable to determine the actual costs of production accurately. The original focus was concentrated on the manufacturing industry where new technology and improvements had reduced the proportion of direct labor and material costs but increased the proportion of indirect costs.

Alexander Hamilton Church originally suggested what would become activity-based costing methods in 1901. Church began writing on the subject of overhead. According to church overhead was the cost of several factors of production and each should be traced individually to the products. He felt that information about a product's cost should reflect all the resources used to make the product (Boyns, 2003).

ABC Proccess

Henry Yennie (1999) describes six key steps in the ABC process. The first step is to identify activities by interviewing those involved in doing the work. Yennie suggests focusing on key and significant activities, and advises avoiding having management staff identify activities as often managements perception of what is happening on the line is out of alignment with the events on the line. Once activities have been identified, the second step is to determine how resources are related to activities. Resources are used (consumed) as activities are performed, the relationship between resource costs and activities is called a "resource driver." Yennie suggests analyzing the general ledger to determine how costs are currently reported. When the relationships have been defined cost and utilization data is be collected to apply to the model. Financial data can be garnered from the general ledger and income statements, while some utilization data may have to be acquired if are not routinely… READ MORE

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