Activity- Based Costing
There are several advantages in implementing activity-based costing over the traditional accounting methods. With activity-based costing, overheads are not arbitrary assigned to the goods or services. There is an aim to trace those costs to the different products. This results in correct costing analysis. Traditional methods lead to over-costing and under-costing and the management is unable to make a strategic decision wisely on which product to increase or cease production (Asada, Bailes & Suzuki, 2000).
The management is able to get clarity on which products increase the profit and which are a drain on the company resources. With accurate overhead cost allocation, the management is able to control these costs and put in place strategies to monitor these costs. There is special focus on the relevant products of the organization.
In activity-based costing, all the activities of the organization are analysed in terms of how they contribute to the strategic goals of the company. What are the costs of these activities to the company? Activity-based costing assists the management to identify value adding and non-value adding activities that the employees are involved in (Wild & Shaw, 2011). The goal should be to reduce or eliminate the non-value adding activities. The staffs in these departments can be reduced or deployed to other departments which play a critical role in the organization.
There are however challenges in implementing activity-based accounting. First of all, it is a time-consuming activity that requires the effort of all the staffs in the organization. Training is required to enable the staffs understand the aim of the exercise. They have to spend time recording details of the activities they are involved during the day. It is also an expensive system to implement initially. In the long run however, there are great advantages to be gained.
Costing Systems and Pricing
The costing system of a company has a huge impact on its pricing decisions. There are three influences on the price of a product. These are the buyers, the competitors and the costs of production. Costs are important as they influence the supply of products in the market. The company is faced with decisions on fixing the short-term and long-term prices. Short-term pricing refers to the prices of products for a period of one year. It also includes the pricing of one-time special orders. Long-term pricing refers to product prices.
A company may either apply a full costing or variable costing system in a company. Costs are divided into variable and fixed costs. Fixed costs are sunk costs and many accountants consider only the variable or marginal costs when it comes to setting the prices of the company’s products (Damitio, Hayes & Kintzele, 2000). In the short-run, the variable or marginal costs are the ones that are considered in setting prices. In the long-term pricing decisions, both variable and fixed costs are important as the company desires to get a return on their capital investment.
The advantage of using full costs in setting prices is that the company gets to recover all the costs of the product. It also ensures price stability and it is a simple method to implement. Companies put a mark-up on either the variable or the full costs in order to earn a profit. Companies that implement activity-based costing are able to make better pricing decisions since the products have accurate cost allocation of the manufacturing and selling overheads. The products that are more costly to produce are priced higher than the rest in order for the company to get a profit.
Cost Control in Managerial Accounting
Managerial accounting contributes greatly to cost control. It is a highly competitive world and the manager is faced with the task of controlling costs in order to increase the revenue of the organization. Management accounting provides information that is relevant and correct in a timely manner to assist with decision making. It assists the manager to understand the cost drivers in the organization. What are the costs of the different processes, jobs and activities in the organization? (Hartgraves & Morse, 2009). Once the cost drivers have been determined, the company determines which the value-adding activities are and which are not.
The management gets to determine which products the company should specialize in. There is also an in-depth focus in these cost drivers and the management comes up with a budget of the expected costs in a certain period. Variances are investigated to ensure that the company is efficient in its processes. The variances may either be favourable or unfavourable. Is the labour efficient in terms of productivity? Is there idle time? The management is also interested in the efficiency of machine operations? How often are there machine breakdowns or machine idle time?
The overheads in manufacturing and selling processes are also analysed in order to ensure that all the activities are contributing to the company’s strategic goals. The favourable variances are also investigated so that the company understands what it is doing right. In cost control, the company aims to gain cost leadership. This refers to cost minimization compared to the competitors (Porter, 1980). The company is therefore able to sell its products at the market price yet its costs of production are lower.
Asada, T., Bailes,J. & Suzuki, K.(2000). Implementing ABM with Hoshin Management
Management Accounting Quarterly, 1-6.
Damitio, J.,Hayes, G. & Kintzele, P.(2000). Integrating ABC and ABM at Dow
Chemical. Management Accounting Quarterly, 22-26.
Hartgraves, A. & Morse, W. (2009). Managerial Accounting. Westmont: Cambridge
Business Publishers.
Porter, M. (1980). Competitive Strategy. New York: Free Press.
Wild, S. & Shaw, K. (2011). Managerial Accounting. McGraw-Hill Irwin.
