ID: 130317827

Over the past two decades, accounting professionals and organisations have been forced to

reconsider their techniques in hindsight of Globalisation in order to strive and compete in the

global market. As a result of globalisation, firms are required to establish highly automated

routines in order to gain strong market positions through boosting their productivity and

reduction in costs. The global complexity has created a reliance upon intellectual systems as

precise cost calculations have become essential, an essentiality the traditional techniques

lack, which has eventually forced the development of Activity Based Costing (ABC). This

essay will aim to assess whether traditional management (costing) accounting techniques in

an organisation, should be replaced by modern management accounting techniques, such as

ABC, demonstrating the failure of traditional techniques interrelating with globalisation and

how the ABC system may improvement profitability for firms outside of a national-state

scale.

With regards to marginal and absorption costing, traditional techniques have been under

scrutiny for their incompatibility with the demands of globalisation. Marginal costing charges

according to cost units, neglecting the accounting standards of fixed costs against the

aggregate contribution. Absorption Costing, meanwhile, reflects the complete product cost,

thus translating into a greater production of goods, in turn, further skewing income statements

and misrepresenting closing inventory calculations. As such, the costing methods precisely

measure the volume-related resources, consumed in proportion to the number of units

produced of each product. This is backed by a double stage procedure, [see Appendix 1].

As markets and businesses evolve, direct labour cost has decreased substantially in its

contribution to total cost, with overhead costs conversely gaining greater importance, due to

the innate diversity within products. The resultant of this diversity causes firms to be misled

by the traditional system. (Kaplan and Cooper, 1991). As such, the traditional techniques are

1
particularly poor, inaccurately reporting product costs, when costs of product-related

activities are unrelated to volume, and are therefore commonly rejected.

ABC costing, on the other hand, does better in recognising these differences in relative input

consumption. Multiple cost drivers assign costs to activities by allocating cost to products

based upon each products use of those activities, thus resembling a cause-and-effect

relationship. As such, a higher profitability measurement is achieved by firms through a

sophisticated allocation of costs, which is imposed through Kaplans (1994) hierarchy of

costs [see Appendix 2]. In distinguishing contributions at these levels, ABC generates a better

understanding of implications of product mix and better erratic apportionments are

formulated.

As such, service companies, burdened by substantial overhead costs, benefit from improved

transparency of the variability of overhead costs. This is directly referred to by Stapleton et al

in stating that, Overhead resources can be located to activities, products, services or

customers, with the objective of reducing or eliminating resource consumption (2004; 595),

thus facilitating firmer strategic decisions.

Unsurprisingly, familiarising and understanding costs orientated around customers helps to

structure effective pricing strategies, which aids firms in gaining market share and increased

profitability. As such, firms can establish a more competitive stance within the market. ABC

is therefore more effective than traditional costing, in providing greater visibility with regards

to overheads, allowing firms to precisely trace costs and subsequently identify areas likely to

yield the greatest profits.

Additionally, utilising more efficient measurements of activity-driven costs guides the

management to advance goods and process value, by producing product design decisions and

cost control. A study conducted by Swenson (1995), revealed that forty-eight percent of

respondents practise ABC to facilitate product design decisions, as shown in Appendix 3.

ABC is greatly beneficial to consumers, since it allows them to investigate and explore the

2
costs of substitute product designs, prior to settling on a final product decision. New costs are

then generated, as activities are adjusted by suppliers to reflect new product characteristics.

Furthermore, unproductive activities and costs with regards to the products will be apparent,

as a result of improved cost control, which provide managers the flexibility to reduce or

increase costs towards products, and the freedom to abolish unproductive activities, in an

attempt to enhance profitability. In Appendix 4, a contrast between ABC and traditional

costing methods indicates the misrepresentations elevated by traditional costing methods,

given the concealed areas within the income statement for losses and profits that may cause

firms to sell unprofitable goods or conversely drop profitable ones. Nevertheless, this issue

only becomes apparent with the guidance of ABC.

However, competitive advantage can be gained through firms repricing output, since cost

control can be established through the openness of these concealed profits and losses. If firms

fail to allocate costs efficiently, the pareto optimal outcome is not achieved, and market

failure occurs, accompanied with the possibility of long-term losses. Evidently, the ABC

system is better for firms, as the system takes account for all overhead costs towards a

specific product, therefore simplifying product design decisions, and due to the vast array of

information provided, information failure is solved, thus further improving cost control.

On the other hand, as many organisations have previously been unsuccessfully under the

ABC system, transitioning to ABC from traditional costing methods is questionable.

Although costs are controlled significantly under the ABC system, there is little evidence in

support of its perpetual ability to increase profitability (Bromwich and Bhrimani, 1989). A

cause may be the incapability to exploit the vast amount of data delivered by the ABC

system. The usefulness of data concerning activities is doubtful, since the selection of the

drivers of costs are traded off for complexity. Anderson and Kaplan (2007) realised that some

costs occurring from activities were difficult to recognise, thus highlighting ABCs failure to

capture the complexity of operations. This may indicate that ABC does not itself add value,

3
but is merely integrated with variables, such as environmental conditions. Moreover, the

manner in which ABC is implemented could be the defining reason for the systems failure,

as those who do not specialising from an accounting background, such as

sales/marketers/HR, may find using ABC difficult. This then requires a well-balanced team to

acquire input from all involved parties, and eventually attempting to create a revolutionary

way of processing from all the functions within the firm. As such, the system is extremely

infeasible, since this is time consuming and extremely costly. As momentum within the

organisation is lost, employees may display behavioural and cooperation resistance, which is

shown in Appendix 5. There is a reluctance to adopt the ABC system, as employees need to

undergo training and education in regards to ABC which proves extensively expensive and

difficult to withstand (Cobb et all., 1992). As such, it is obvious that the entire suggestion that

the ABC system is significantly beneficial to organisations is incorrect, as the implementation

of the system merely increased the cost pools for organisations rather than increasing their

profitability.

Finally, organisations simply being reliant on ABC cannot be sufficient to solely follow the

system. Despite involving a vast range of costs, the system, however, frequently disregards

costs associated to R&D, advertising and marketing, all of which collectively add value to a

product. This results in an inaccurate picture of product costs as such costs edit consumer

utility (Verma, 1980), impacting consumer expenditure distribution. Arguably more

important is the simultaneous consideration of the strategy implemented, market conditions

and financial goals of the organisations, all of which ABC does not reflect when forming

product selling prices. Businesses require these further factors, as price elasticity of demand

for products is sensitive, therefore the consideration of customer preference and competitor

dynamics is needed (Buzzell and Wiersema, 1981). Furthermore, the continued economic

downturn and doubt has led executives to favour disciplines such as Core Competences and

Strategic Planning over the ABC system (Darrel, 2003). A fall back of ABC is that it does not

4
establish growth directly, but instead focuses on cutting cost, to the detriment of firms during

economic downturns and recessions [see Appendix 6]. Once the economy recovers and

progresses through the business cycle, those implementing a ABC system lack in preparation

as strategic decisions regarding growth methods and management would have not been

established. As such, a globally competitive position cannot be achieved by firms. Therefore,

it is clear that to uphold or maintain market share and competition, the consideration of many

variables is required in order to assist with strategic decisions, and so reliance on the ABC

system to promote profitability is insufficient to compete within the industry.

On the balance of the evidence presented above, it is abundantly clear that one must accept

that despite its perpetual ability to reduce costs, the many doubts remain as to whether the

ABC system can be considered as a reliable profitable tool, and whether traditional

techniques can be replaced by the system. Although there are admittedly some sound

proposed justifications for the system, the nature of ABC is far too uncertain to be applied

consistent with prudence. Although firms have shown great resistance towards its adoption,

the criticism of traditional techniques not being entirely applicable to firms with larger

overheads still stands. ABC provides firms with a sophisticated system to achieve financial

control and identify areas of inefficiency, although the costs of implementing such an

elaborate system outweighs its benefits. Nevertheless, with further improvements to the

system and better guidelines, the system may stand improved. For these reasons, this essay

concludes that the implementation of the ABC system above traditional techniques has to be

reviewed in respect to each firm uniquely, as some may bear the benefits of the system

greater than others.

Word Count: 1,496/1,500

5
Appendix:

Appendix 1: (Bruns and Kaplan, 1987; p.213)

Appendix 2: (Cooper and Kaplan, 1992)

6
Appendix 3: (Swenson, 1995; p.174)

Appendix 4:

S-Curve displaying comparison of costs (Akyol et al, 2007; p.138)

7
Appendix 5: Annual survey of the adoption of management tools, where ABC ranked below

the median, with only a 50 percent adoption rate (Darrel, 2003)

8
Appendix 6: Results from a survey about costs and growth (Darrel, 2003)

9
Bibliography

Akyol, D, Tuncel, G. and Bayhan, G, (2007). A comparative analysis of activity-based

costing and traditional costing. International Journal of Mechanical, Aerospace, Industrial,

Mechatronic and Manufacturing Engineering.

Anderson SR, Kaplan RS, (2004). Time-driven activity-based costing. Harvard Bus Rev

82:131138

Bhimani, A, (1996). "Management Accounting: European Perspectives", Oxford University

Press, Oxford.

Bjrnenak, T, 1997. Diffusion and Accounting: The Case of ABC in Norway, Management

Accounting Research, 8, 3-17.

Bjrnenak, T., & Olson, O, (1999). "Unbundling management accounting innovations".

Management Accounting Research, 10, 325-338.

Bromwich, M. and Bhimani, A, (1989). Management Accounting: Evolution not Revolution.

London, U.K.: Chartered Institute of Management Accountants.

Bruns, W. and Kaplan, R, (1987). Accounting & management. 1st ed. Boston, Massachusetts:

Harvard Business School.

Clarke, P. J., Hill, N. T, and Stevens, K, (1999). Activity-Based Costing in Ireland: Barriers

to, and Opportunities for Change, Critical Perspectives on Accounting, 10, 443-468.

Cobb, I, Innes, J. and Mitchell, F, (1992). Activity-Based CostingProblems in Practice,

London, U.K: Chartered Institute of Management Accountants.

Cokins, G, (1997) Activity-based cost management making it works, McGraw-Hill. Inc.

Cooper, R. and R. S. Kaplan, (1992). Activity-based systems: Measuring the costs of

resource usage. Accounting Horizons (September): pp. 1-13.

10
Cooper R, Kaplan RS, (1988). Measure costs right: make the right decisions. Harvard Bus

Rev 66:96103

Cooper, and Kaplan, RS, (1988) How cost accounting distorts product costs, Management

Accounting, vol. 69, pp. 2027.

Cooper, R., & Kaplan, R. S, (1991). "Profit Priorities from Activity Based Costing". Harvard

Business Review, 69(3), 130-135.

Darrel, R, (2003). Management Tools. Boston: Bain & Company.

Drury, C, (1995). Management and cost accounting. 1st ed. London: Chapman & Hall.

Gosselin, M, (1997). "The Effect of Strategy and Organizational Structure on the adoption

and implementation of Activity Based Costing". Accounting, Organizations and Society,

22(2), 105-122.

Graner, S. P, (1954). "Evolution of Cost Accounting to 1925". Tuscaloosa: University of

Albama Press

Grasso L, (2005). Are ABC and RCA accounting systems compatible with lean management?

Manage Account Q 7(1):1227

Kaplan, R.S., and Anderson, S.R. (2007). Time-driven Activity-based Costing: A Simpler

and More Powerful Path to Higher Profits. Harvard Business School Press.

Kaplan, R.S (1994). Management accounting (1984-1994); development of new practice and

theory. Vol. 5. Academic Press. pp. 248-249.

Kennedy A (1996), ABC basics (activity-based costing). J Manage Account (Br)

Kilger W, Pampel J, Vikas K, (2004) Introduction: marginal costing as a management tool.

Manage Account Q 728

11
Kker, U, (2003) Activity-based costing: Implementation in a sanitary ware company,

M.Sc. Thesis, Department of Industrial Engineering, University of Dokuz Eyll.

Malmi, T, (1999). Activity-Based Costing Diffusion Across Organizations: An Exploratory

Empirical Analysis of Finnish Firms, Accounting, Organizations and Society, 24, 649-672.

Ray, H. G. (1982), "Managerial Accounting: Concepts for Planning, Control, Decision

Making". Plano, Tex.: Business Publications. Information Services.

Rogers, E. M, (1995). Diffusion of Innovations (4th edition), New York, NY, Free Press.

R. D. Buzzell and F. D. Wiersema, (1981). Successful share-building strategies. Harvard

Business Review. 1, pp. 135-144

Shank, J.K, (1996), Allied stationary, Cases in Cost Management, South Western College

Publishing, Boston, MA, pp. 9-17.

Stapleton, D., Pati, S., Beach, E. and Julmanichoti, P, (2004). Activity based costing for

logistics and marketing. Business Process Management Journal, 10(5), pp.584-597.

Swenson, D, (1995). The Benefits of Activity-Based Cost Management to the Manufacturing

Industry. Journal of Management Accounting Research, 7.

Tupmongkol, T, (2008).An empirical study of the factors of the activity-based costing (ABC)

implementation in Thailand : four case studies in Thai state enterprises (TSEs).Unpublished

Doctoral, Northumbria University. Verma, V. (1980). A Price Theoretic Approach to the

Specification and Estimation of the Sales-Advertising Function. The Journal of Business,

53(S3), p.S115.

Vieira, R., & Hoskin, K, (2005).Power, discourses and accounting change: the

implementation of activity based costing in a Portuguese bank. Paper presented at the IX

International Congress of costs Walker, S. P., & Shackleton, K. (1995). Corporatism and

12
structural change in the British accountancy profession,19301957.Accounting,

Organizations and Society, 20(6), 467-503

Wallace, R.S.O, (1990), "Accounting in developing countries", Research in Third World

Accounting, Vol. 1, pp. 3-54.

Wallace, RS.O, (1993) "Development of Accounting~ Standards for developing and Newly

Industrialized Countries" Wallace, R.S.O., Sameuls J.M. and Briston RJ.(ed.), Research in

Third World Accountancy, Vol 2, London: Jai Press Ltd. 42. Wallace, R.S.O & BRlSTON,

R.I, (1993). "Improving the Accounting Infrastructure in Developing Countries"

Wallace, RS.O., Samuels J.M. and Briston, (1993). Research in Third World Accountancy,

Vol 2, London: Jai Press Ltd.

13