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Traditional Method Of Costing Has The Essence Of Dealing With Overheads By Accounting Essay


In recent old ages the universe of bing systems have shown major developments in bing techniques, specifically a major part of activity-based costing ( ABC ) in fabrication and services organisations. This survey aims to place the grounds why activity-based costing is preferred to traditional costing tools in modern fabrication environment ; why directors are demoing their involvements in the acceptance of ABC to better their fiscal public presentation, managerial and production efficiency ; how ABC helps directors to extinguish production inefficiencies ; how ABC facilitates adaptative and productive acquisition in organisations and the utility of ABC in seller choice, service sector and SME ‘s. Traditional measurement methods of cost accounting proved deficient on these issues, which leads to the innovation of activity-based costing.


Traditional method of costing has the kernel of covering with operating expenses by dividing them into variable operating expenses and fixed operating expenses. If we are utilizing soaking up costing, we will foremost make up one’s mind the suited footing for soaking up ( e.g. machine hours or labour hours ) , so we will absorb all the operating expenses on that footing. The traditional costing methods were designed around 1870-1920. In those yearss industry was labour intensive, there was no mechanization, merchandise assortment was little and overhead costs in organisations were by and large really low as compared to today. However, it changed quickly from 1960 ‘s – peculiarly 1980 ‘s due to the job of increased deficiency of relevancy of traditional cost accounting methods.

Activity – Based Costing ( ABC ) is based on the penetration that activities create costs, while merchandises consume activities. ABC is a costing technique that first identifies the major activities that give rise to overhead costs, so groups activities holding same cost drivers into cost pools and eventually assigns entire operating expense costs to each merchandise or service by ciphering soaking up rate for each cost pool. So we can state that ABC is a costing technique in which multiple operating expense cost pools are created on the footing of one or more non-volume related factors. There is a construct of cost pool and cost driver that distinguishes ABC from traditional costing. Cost driver can be any factor that causes alteration in the cost of an activity. Under ABC operating expense costs are assigned to merchandises on the footing of cause and consequence relationship.

Traditional systems frequently rely on unpredictable allotments of indirect costs ; peculiarly they rely extensively on volume-based allotments. Volume based activities are those which have high correlativity with figure of units produced. Most of the indirect costs are non volume-based. If volume-based allotments are used high volume merchandises are likely to be assigned with greater proportion of indirect costs than they have consumed, whereas low volume merchandises will be assigned lower proportion. It will take to over costing of high volume merchandises and under bing of low volume merchandises, which will further supply misdirecting information. So, traditional systems fail to acknowledge the relationship between costs, activities and merchandises by using volume-related overhead soaking up rates merely.

For Example, a company produced two merchandises – merchandise A and merchandise B. Merchandise A which is a low volume point is produced harmonizing to client specifications that may demand certain activities such as particular technology, extra testing and any machine apparatuss, whereas merchandise B which is a high volume point demands small attending, no particular activities and running continuously. If this company is utilizing traditional costing technique it will apportion all of its operating expenses to merchandises based on figure of machine hours, which will ensue in the allotment of small overhead cost to merchandise A because it did non hold many machine hours but retrieve it demanded tonss of technology, proving and setup activities and costs of these activities have been ignored by traditional system. In contrast, merchandise B will hold tremendous sum of operating expenses due to all those machine hours, but in world it demanded small overhead activity. It will take to misreckoning of each merchandises true entire cost of fabrication. ABC overcomes this job by delegating operating expenses on more than one activity. It recognizes that particular technology, proving and machine apparatuss are besides activities which consume resources of company, so costs of resources used in those activities should besides be calculated and included in entire overhead costs of merely those merchandises that demanded and consumed those activities.

So if you want to command your costs, you have to first command the activities that cause the costs to be incurred. ABC may assist to place value added activities and non-value added activities, which will assist directors to command their costs by extinguishing non-value added activities or at least cut downing figure of cost drivers of non-value added activities. The beauty of ABC is that it reveals fresh capacity and aid directors to extinguish those capacities so that there would be no merchandise cost deformation. There are two stages of activity accounting. First stage is called Activity-Based Accounting ( ABC ) where it tells us how we can better our fight by pull offing our resources more expeditiously. It does non merely supply accurate costs but it is a mechanism for pull offing costs. Second stage is called Activity-Based Management ( ABM ) which is an of import tool for accomplishing uninterrupted betterment. In ABM, we use information obtained from ABC to do strategic betterments in organisations. Directors by and large achieve betterments by pull offing activities in four ways:

Activity decrease – by cut downing the clip required to execute activity.

Activity riddance – by extinguishing the full activity.

Activity choice – by choosing the low-priced activity from set of activity options.

Activity sharing – here directors make such alterations that allow them to portion activities with other merchandises to accomplish economic systems of graduated table.

It depend on director ‘s ability that how he will utilize all these four ways expeditiously and efficaciously to accomplish strategic betterments in organisations. The most accurate costs under ABC allow direction to be after more efficaciously, better quality of cost control and eventually evaluate director ‘s public presentation on meaningful footing. To implement ABC in any organisation is non an easy undertaking, you have to update your activity systems as merchandises and procedures diversify.

This survey aims to show that ABC is preferred to traditional soaking up costing in the modern fabrication environment because now indirect costs constitute greater proportion of entire merchandise costs due to merchandise ‘s complex specifications, widespread usage of computing machine control and mechanization and increased usage of just-in-time ( JIT ) production methods which will finally better the fiscal public presentation of organisations. The usage of ABC with strategic attacks like entire quality direction ( TQM ) , JIT methods etc, can do it more utile. ABC is non merely following by fabricating companies but now many services organisations are demoing their involvement in the importance of costs for determination devising intent. When you implement ABC in your organisation a alteration in the direction construction should happen, directors can accommodate ABM by utilizing the information provided by ABC to accomplish required net incomes. Application of ABC is a squad work and requires a batch of manpower preparation.


Activity-based costing, activity-based direction, modern fabrication environment, athletics organisations, cost accounting, direction accounting.

Literature Review

Cagwin & A ; Bouwman ( 2000 ) reported that there is an association between usage of activity-based costing and betterment in fiscal public presentation of organisation and consequences show that there is so a positive association between ABC and betterment in fiscal public presentation when we use ABC with other strategic enterprises ( P, 04 ) such as entire quality direction ( TQM ) attack, just-in-time ( JIT ) fabrication methods, concern procedure reengineering ( BPR ) and flexible fabrication systems ( FMS ) , these strategic methods will assist to cut down non-value adding activities ( Gunasekaran, Marri, Grieve 1999 ) ; when we use ABC in specific conditions such as in complex and diverse houses, where troughs give importance to costs in determination devising procedure ( P, 13 ) , where there is limited figure of intra company minutess and fresh capacities and where there is immense competition ( P, 14 ) .

Whereas if company is holding sophisticated engineering, informations aggregation, digest and processing cost will be reduced, this will do the usage of ABC more good. It shows that utility of ABC is holding positive relationship with edification of engineering. So ne’er underestimate the cost of informations garnering to implement ABC. If you do non hold plenty technological resources first update your resources otherwise you will hold to bear immense costs ( Gunasekaran, Marri, Yusuf, 1999 ; Sohal & A ; W.C. Chung, 1998 ; Cagwin & A ; Bouwman, 2000 ) .

ABC provides most accurate cost information where non-volume related operating expenses are important and company industries diverse merchandises. It is ABC ‘s beauty that it deals with non-volume related costs and provides true and accurate costs of merchandises ( Sohal & A ; W.C. Chung, 1998 – P, 137 ) .

You can accomplish better consequences by apportioning indirect costs to entire merchandise cost ( Snyder and Davenport, 1997 ) and in this manner direction will hold better control over determination devising procedure.

We can besides unite the benefits of ABC with the benefits of hard currency flow based accounting with the aid of logistics direction accounting construction to back up logistics disposal determinations ( new wave Damme and van der Zon, 1999 ) .

Peoples should understand the difference between value-added and non-vale added activities by understanding the grounds why an activity is called as value or non-value added ( Miller 1996 ) . ABM helps troughs to extinguish inefficiencies by airting resources towards value adding activities ( Needles & A ; Crosson 2002 ) .

Horngren ( 1977 ) , Miller & A ; Vollman ( 1985 ) and Johnson & A ; Kaplan ( 1987 ) argued that if you want to increase managerial and production efficiency, you have to cover with some concealed factors really carefully that influence the general industrial and fabrication disbursals. Because of the lack of traditional costing technique in bettering planetary fight, organisations hesitate to utilize it ( Johnson, H. T. , 1990 ) .

Roztocki & A ; LaScola Needy suggests in a survey that we can incorporate ABC system with Economic Value added system ( EVA ) as an technology direction tool that will assist us to pull off our cost and capital successfully and make stockholder ‘s value through cost construction improvement.. ABC is a tool that helps directors to believe about organisations more efficaciously and about how value and worth is produced ( Driver 2001 ; Cokins 1999 ; Cooper et Al. 1992 ; Lebas 1999 ) . In ABC and EVA system, rate of ingestion of resources and capital demand is included in cost of activities. This proposed ABC and EVA system adds capital charges to the activities and will assist directors to understand capital cost associated with the fabrication procedure and protect company leaders from doing short term determinations on net income alone that will destruct economic value over the long-term ( Roztocki and LaScola Needy ) .

Gunasekaran, Marri, Yusuf ( 1999 ) suggests the application of activity-based costing with some instance experiences. They say that the most of import determination to be taken now-a-days is what type of bing technique should be used in a specific organisation. In current fabrication environment because of high degree of engineering and increased competition, function of direct labor is decreasing, whereas support service is increasing. But conventional methods do non take into history this demand of present fabrication atmosphere ; they still allocate overhead costs on decreasing labour bases. This increased competition and engineering has led fabrication companies to follow new fabricating techniques and methods such as TQM, JIT and FMS ( P, 286 ) ( Cagwin & A ; Bouwman 2000 ) . In this survey research worker developed and created a conceptual theoretical account sing realisation and executing of ABC ( with the aid of appropriate instance experiences from Belgium and Dutch companies ) . This theoretical account suggests us that if u want to implement ABC in your organisation, you have to first see conditions and factors that favour and are against the application of ABC ( P, 289 ) . In this manner you can accomplish your net income aims with the aid of ABC and ABM ( P, 292 ) . ABC is a usher that gives direction actions a way towards high net incomes ( Cooper and Kaplan 1991 ) .

Application of ABC requires entire committedness from top to bottom ; direction should clearly understand the benefits offer by ABC by pass oning accomplishable aims to everyone in the organisation. It is direction ‘s responsibility to educate and develop everyone in the organisation about the system which is traveling to be implemented so that everyone understands the complexness of undertaking and its impact on the public presentation of organisation ( Sohal & A ; W.C. Chung, 1998 – P, 144 ) .

ABC facilitates adaptative and productive acquisition ( Driver 2001 ) by back uping uninterrupted betterment at single and organisational degree and direction of bing cognition ( Argyris 1977 ; March 1991 ; Appelbaum and Goransson 1997 ) every bit good as development of a learning civilization to allow organisations go more sceptered and team-oriented ( Cooper et al. 1992 ; Michelman et al. 1999 ) .

Try to maintain execution procedure every bit simple as you can otherwise employees will acquire annoyed. You must hold adequate resources and clip to acquire ABC success. ABC/M success relates with top direction support, preparation of staff, handiness of resources required to implement this system, public presentation rating and compensation systems ( Cinquini and Mitchell, P, 66 ; Shields 1995 ; immature 1989 ) .

Dogan and Sahin ( 2003 ) suggest the usage of ABC in seller choice by taking provider who minimizes entire extra costs that relate to buy determinations. The association between provider and buyer is ever critical. Changing client penchants, environmental concerns, globalisation and governmental ordinances have great impact buying determinations ( de Boer et Al. 2001 ) . Determination of choice standards depends on the demands of the house and degree of success of choice standards to carry through these demands ( Swift Owens 1995 ; Brown 1998 ) .

By utilizing ABC for seller choice procedure, buying company will be able to foretell and see internal production costs caused by the seller, can plan different state of affairss by cut downing different costs drivers, this system will assist sellers to reexamine their scheme by the indicant of client ‘s satisfaction and offers betterment in seller buyer relationship ( Roodhooft and Konings 1996 ) .

Because of the utility of ABC/M, it is non even following by fabricating companies to acquire competitory advantage but many services organisations ( Innes & A ; Mitchell 1995 ; Innes et. Al 2000 ; Drury & A ; Tayles 2000 ) and SME ‘s are taking advantage from these direction accounting systems.

Gunasekaran, Marri, Grieve ( 1999 ) suggests the usage of ABC in SME ‘s. The execution of ABC in SME ‘s can assist them in bettering their fiscal and non-financial public presentation. It will assist to cut down direct labor constituents, uninterrupted accomplishment development, reengineering ( P, 390 ) and developing positive attitude of workers that contributes toward successful execution of operations ( Sage and Fox 1989 ) . Chan, Keung and Chung ( 2000 ) conducted a survey to raise an empirical attack with the aid of which we can plan an ABC templet to utilize it as a tool for easy integrating in an SME environment.

No uncertainty ABC was foremost designed to carry through the cost direction demands of fabrication and industrial organisations but researches shortly realized that they can besides use this system in services sector. Kaplan ( 1994 ) paperss that since 1980 ‘s many houses working in services sector e.g. Bankss, infirmaries and logistic companies had already developed their costing system similar to ABC. It means there was besides a demand for ABC like system in services organisation which tells true and accurate costs. By implementing activity-based costing technique in English infirmaries and British National Health system ( King et. Al, 1994 ) , to rational and concern activities of university scene ( Granof, E. Platt, Vaysman, 2000 ) , libraries ( Snyder and Davenport, 1997 ; Ellis-Newman 2003 ) , sport organisations ( Dimitropoulos, 2007 ) and for planning and commanding twenty-four hours surgery unit activities of infirmaries ( Antikainen, Roivainen, Hyvarinen, Toivonen, Karr, 2005 ) , houses can easy accomplish strategic aims.

ABC is likely to be adopted by larger houses than smaller 1s because of holding diverse mix merchandises or services ( Roztocki and M. Schultz, ) . If organisations with diverse merchandises and services use individual cost driver to absorb high operating expenses, may falsify its cost estimations ( Cooper and Kaplan, 1988 ) .

Initially ABC was used merely by fabricating companies and industries and many research workers discusses it ‘s usefulness in selling determinations. Stevenson et al. , ( 1993 ) introduces ABC as a powerful toll for concern selling determination shapers with accents on the consequence of ABC on productiveness steps.

John C. Lere ( 2000 ) states the importance of fabrication costs in sing monetary value dialogues The information provided by ABC captures the differences among client ‘s orders and helps industrial selling determination shapers to understand the influence of possible alterations in client ‘s specification on fabrication cost.

Feature of ABC is its acknowledgment that cost does non merely vary with volume but it can besides change with some other activities i.e. unit-level activities, Batch-level activities and Product-level activities ( Cooper, 1990 ) .

Steve R. Letza and Ken Gadd ( 1994 ) examines the usage of ABM with TQM in entire quality organisations to place their common characteristics and compatibility as direction tools. They stated that by utilizing the accounting information generated by ABC, TQM can measure costs efficaciously.

Charles Praker ( 2000 ) remarks on the usage of ABC and balanced scorecard as the more modern attacks to public presentation measuring as it helps a batch in doing judgements and determinations. We use ABC informations every bit input to mensurate public presentations.


This survey is based on documental analysis and based on secondary degree. Extensive literature has been reviewed to get at the decision with respect to the significance and application of ABC in different organisational scenes. Work of different researches helped us to garner information sing utility of activity-based costing in fabrication and services organisations. For that purpose a figure of 36 research articles written by assorted writers and published in assorted research channels in different states were studied. These writers belong to assorted states. The common findings are generalized henceforth. Finally a decision was drawn.


Cagwin & A ; Bouwman ( 2000 ) reported that there is a positive association between activity-based costing and betterment in fiscal public presentation when we use ABC with new fabricating techniques and methods such as entire quality direction ( TQM ) attack, just-in-time ( JIT ) fabrication methods, flexible fabrication systems ( FMS ) etc. Gunasekaran, Marri, Grieve ( 1999 ) besides supported this fact.

Gunasekaran, Marri, Grieve ( 1999 ) presented the fact that there is a positive relationship between utility of ABC and edification of engineering, if u do non upgrade your technological resources you have to bear immense costs of informations aggregation and processing. Sohal & A ; W.C. Chung ( 1998 ) and Cagwin & A ; Bouwman ( 2000 ) supported this fact.

Horngren ( 1977 ) argued that there are some concealed factors that influence the industrial and fabrication disbursals, if u want to increase managerial and production efficiency you have to cover with those factors really carefully. Traditional costing technique has failed in covering with those factors. Activity-Based costing is a technique which helps us in happening the manner to uncover those factors. Miller & A ; Vollman ( 1985 ) , Johnson & A ; Kaplan ( 1987 ) and Johnson, H. T. ( 1990 ) supported this statement.

Driver ( 2001 ) reported that ABC facilitates adaptative and productive acquisition by continuously bettering bing cognition of single employees and troughs in organisations and developing learning civilization within organisations. Argyris ( 1977 ) , March ( 1991 ) , Appelbaum and Goransson ( 1997 ) , Cooper et Al. ( 1992 ) , and Michelman et Al. ( 1999 ) supported this fact.

Now troughs are taking involvement in the usage of ABC in seller choice procedure. By carefully taking provider with the aid of ABC can minimise entire extra costs which relate to buy determinations. Dogan and Sahin ( 2003 ) , de Boer et Al. ( 2001 ) , Swift Owens ( 1995 ) and Brown ( 1998 ) support this fact.

Because of the utility of activity-based costing, many services organisations such as infirmaries, universities, libraries, athletics organisations, Bankss, logistic companies etc. and SME ‘s are following this new costing technique to better their fiscal and non-financial public presentation by cut downing direct labor constituents, uninterrupted accomplishment development and reengineering. Kaplan ( 1994 ) , King et. Al ( 1994 ) , Antikainen, Roivainen, Hyvarinen, Toivonen, Karr ( 2005 ) , Granof, E. Platt, Vaysman ( 2000 ) , Snyder and Davenport ( 1997 ) , Ellis-Newman ( 2003 ) , Gunasekaran, Marri, Grieve ( 1999 ) and Sage and Fox ( 1989 ) support this fact.

Utility of ABC in selling determinations, importance of fabrication costs information provided by ABC in sing monetary value dialogues, usage of ABC and balanced scorecard as the more modern attacks to public presentation measuring, usage of ABM with TQM in entire quality organisations as direction tool and utility of ABC in houses holding diverse merchandises, services and processes Lashkar-e-Taiba directors think that activity-based costing is the most appropriate costing technique in modern fabrication and services environment than traditional bing techniques. Stevenson et Al. ( 1993 ) , John C. Lere ( 2000 ) , Charles Praker ( 2000 ) , Steve R. Letza and Ken Gadd ( 1994 ) and Cooper and Kaplan ( 1988 ) support this fact.

So all the writers irrespective of civilization are of one position that activity-based costing is from hurting to joy.


From all of the above treatment and findings, it is concluded that there are many issues which can non be dealt comprehensively and meaningfully with the aid of conventional accounting techniques. Traditional accounting has failed to turn to these issues in deepness and in conformity with modern fabricating which lead to the innovation of a more improved and progressive accounting attack i.e. ACTIVITY-BASED COSTING. Many fabrication and services organisations are progressively following this new technique to better their fiscal and non-financial public presentation, pricing determinations, selling determinations and purchase determinations because of the turning importance of costs in determination devising intent.

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