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mn30469 in-class test: suggested answer: ABC essay
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Many claims have been made regarding the merits of activity based costing but in practiceits adoption has been variable and its introduction and impact has not always been as
expected.
Discuss this statement with reference to your reading of the literature and draw
conclusions as to your view of the overall merits of ABC.
ESSAY:
Intro: Why change?
In the modern business environment which is driven by technology and the intensive global
competition, companies produce a wide range of products, leading to a variety of costs.
From the irrelevance of the absorption costing, the activity-based costing approach (ABC)
was advanced by Cooper and Kaplan, it first assigns indirect costs to activities then assigns
the costs to products based on the products’ usage of the activities. It aims to rectify the
problem of inaccurate cost information due to selection of wrong bases of overhead
apportionment. Many claims have been made regarding the merits of ABC but in practice its
adoption has been variable and its introduction and impact have not always been as
expected.
Various adoptions:
ABC had been applied to product costing, and its advocates have argued that ABC can be
usefully implemented in all types of organisations (Major, 2007). Firstly, the use of ABC has
potentially significant commercial implications because pricing can be based on more
realistic costs data and decision making can be improved as ABC offers the highest sales
margins. Pigott (1992) stated that ABC enhanced product cost accuracy and a study by Peter
and Alan (1992) proved that ABC helps to reduce costs and improve the quality of
information. Secondly, more realistic product costs may enable staff to target potential
customers and also to stop targeting customers or market segments that are shown to
offer low or negative sales margins. Lee (1990) studied the effectiveness of the application
of ABC at a company in the services industry and found that the production efficiency,
decision-making process efficiency and competitiveness level of the company increased as a
result of the provision of accurate product costs. Cooper and Kaplan (1989) stated that ABC
provided more relevant information for managerial decision making. Thirdly, managers may
enhance efficiency and improve organisational performance because cost driver analysis
provides useful information about activity performance. Miller and Mitchell (1993) found
that ABC may reveal that it is not production volume that triggers costs, but complexity
expressed by transaction volume. ABC helps companies to understand the relationship
between programs of the improvement process and increase profit (Kaplan, 1992). Better
comprehension of cost drivers should also facilitate planning and budgeting (Innes &
Mitchell, 1993).
Introduction and impacts not as expected:
However, the introduction and impacts of implementing ABC have not always been as
expected. Firstly, users are reported to struggle to allocate joint costs, discretionary costs
such as advertising costs. It is impossible to allocate all overhead costs to specific activities,
companies still need arbitrary cost allocations. In addition, it is costly to accumulate and
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