Activity Based Costing
Join now to read essay Activity Based Costing
The last several decades have been a turbulent period for management accounting in the United States. Many U.S. businesses failed in the international market, and the management accounting profession recognized that some of the blame rests upon shortcomings in the information provided to managers. A continuous flow of articles dating back to the mid-1980s such as Kaplan (1986) or Chalos and Bader (1986) has criticized contemporary management accounting systems. On the other hand, Reider and Saunders (1988) offered a defense of contemporary management accounting methods asserting that the methods are adequate but have not been used appropriately.
Management accounting plays a crucial role in manufacturing competitiveness by supplying relevant information which guides and facilitates management planning and control, decision making, and performance evaluation (Amenkhienan. and Green, 1990). Until recently, management accounting has been heavily criticized for failing to provide timely and accurate information, and for not keeping pace with the new manufacturing environment and technologies (Johnson and Kaplan, 1988). Other criticisms suggest that management accounting reports are of little help to operating managers and that the system fails to provide accurate product costs.
In response, firms have adopted new costing techniques including the most common, Activity-Based-Costing (ABC). Yet even advocates of ABC have criticized its use (Johnson, 1992). The response to the criticism is that individuals do not understand this accounting method and, therefore, misuse its techniques (Kaplan, 1992). This is similar to the defense of the traditional accounting techniques. Both claim that the techniques are appropriate, but incorrectly used. Maybe all of these authors are correct. Management accounting information does have problems, but where do the problems lie?
In academia, new models have found their way into journals and texts. Caution is necessary however, as it is too easy to criticize the traditional models and move quickly away from them rather than reconcile new ideas with old models. Manufacturing firms are adopting Just-In-Time (JIT) systems, and Total Quality Management (TQM) has become the preferred system. These three currently popular business concepts (ABC, JIT, and TQM) will be discussed.
ACTIVITY-BASED COSTING (ABC)
Among the criticisms of management accounting, a troublesome area has been the inaccurate overhead allocation of costs to products. In the past, the bases used for allocating overhead were either volume driven, such as direct labor hours and machine hours, or financial measures, such as direct labor costs and raw materials costs. These allocation bases are simple and easy to use since the information is readily available either from production or accounting reports, but they often result in mis-measurement of costs.
As firms moved from labor driven manufacturing to automated manufacturing, old allocation bases proved even more inaccurate (Horngren et al., 1999). Products were either under- or over-costed because the bases used did not accurately reflect the activities consumed by the product. Another problem was that the bases did not accurately reflect the overhead triggered by either batches or product lines (Johnson, 1988), nor were all the production costs driven by these bases.
Another source of inaccurate costing has been the mis-measurement or exclusion of relevant costs (Weisman, 1991). Since business firms are subject to a multitude of externally mandated accounting and reporting requirements (e.g., pronouncements of the SEC, FASB, GASB, IRS), management accounting has used these same costs to make business decisions. Though these costs satisfy external reporting purposes, they are incomplete for many internal purposes. For example, R&D, distribution, and advertising costs are not considered as product costs for external reporting purposes and are therefore often erroneously excluded from the calculations of product costs for internal uses (Dyckman, Bierman, and Morse, 1994). ABC has been limited as a successful solution to this problem.
Without the restrictions of Generally Accepted Accounting Principles (GAAP), management accountants realized they could use more appropriate bases for allocating product costs and could create more cost centers to accumulate overhead and production support costs (Cooper and Kaplan, 1999). This does not solve all costing problems, as all costs are not easily identified. Difficulty still remains in quantifying numerous costs, and without objectivity and verification, accounting systems often excluded relevant information.