Criticism Of Traditional Costing System Accounting Essay

The traditional costing can be divided into absorption costing and marginal costing. The primary differences between both of these costing methods will be the treatment of fixed cost. Normally, the absorption costing allocates the preset cost to the units produced predicated on labour hour or machine hour whereas the marginal charging treated the fixed cost as periodical costs. That's means the fixed cost will not be assigned to the systems produced. The truth is, the absorption costing is more popular than marginal costing (Geri N & Ronen B. , 2005).

Criticism of Traditional Costing System

The absorption costing also has few critical areas that probably have an impact on the management's judgement. The administrative and marketing expenditures are overlooked in the original costing system so this will negatively have an impact on the decision making. The original costing may not reflect the true cost of the merchandise since the resolved development cost are allocated by on one or two cost motorists. The the different parts of the fixed creation overhead are not analysed in traditional costing so the management does not know the crucial areas in the set over head (Tardivo. G & Montezemolo. G, 2009). For example, the management may well not know the reason of sharply increase in fixed over head because the costing system will not analyse the preset overhead. Cooper. R (1990) is apparently in agreement with Tardivo. G & Montezemolo. G in that the original costing cannot represent the true cost and even argue that the company management cannot understand the profitable orders if the costing system cannot provide correct product cost. Matching to Geri N & Ronen B. (2005), the allocation of overhead in absorption costing is subjective therefore the result might not exactly reliable.

Definition of Activity Structured Costing (ABC)

Since the original costing system has many deficiencies and criticized by many experts and academics. The new costing system was released to overcome the problems that happen from the traditional costing system. This new system called Activity Centered Priced at (ABC) and it was mainly develop by Cooper and Kaplan. The ABC is defined:

An interesting system that identities the activities performed, that can determine related costs which subsequently decides activity costs connected to products and services through various cost motorists. Cost drivers indicate the use of resources through product and service related activities (Tardivo. G & Montezemolo. G, 2009, p. 68)

In simple phrase, the ABC is a costing system that helps the organization to identify the activities subsequently uses the price driver to assign the activity cost to products. The activities include set-up, machines, receiving, packing and executive. The cost drivers can contain number of creation orders, number of deliveries, volume of receipts and volume of machine hours.

How ABC Overcome The Deficiencies of Traditional Costing

According to Geri N & Ronen B. (2005), the ABC can provide more correct and reliable data to management so it is ideal for decision making. Tardivo. G & Montezemolo. G (2009) is apparently in arrangement with Geri N & Ronen B. for the reason that ABC can offer more appropriate data and even claim that the info from ABC can help cost lowering and process improvement (Tardivo. G & Montezemolo. G, 2009). This argument is recognized by Drake. A et al (1999) and says that most of the business that adopts ABC has achieved the price reduction and continuous improvement. Cooper. R (1990) also support Drake. A and say that the details information from product cost is very important when the company in an extremely competitive market.

The Criticism of ABC

Even although ABC may bring benefits to the business and it can conquer the deficiencies from traditional costing whereas it still criticized by some experts. Corresponding to Johnson & Kaplan's Relevance Lost (1991), support special study is one of the key functions for a new cost system therefore the historical and disaggregate data have to be collected and retained (p. 228). It is because the management does not know what kind of data necessary for special study (p. 228). However this will cause the company to spend lots of time and bills to collect date. According to Cross. L (2003), the price tag on collecting information is the key reason to avoid the printing company take up ABC. This is backed by Roztocki. N et al (2004), the ABC is seldom used by small manufacturing firm as a result of limited financial resources and insufficient computerization. Geri N & Ronen B (2005) also claim that, another reason that triggers the tiny company to depart ABC is basically because ABC system too much emphasizes the price allocation which cause the info over-precision eventually improves the maintenance costs.

A survey that conducted by BetterManagement (2005) appears to be in agreement with the Roztocki. N, the effect show that 71% of large organization implement ABC and only 42% of smaller businesses take up ABC (BetterManagement, 2005).

Other criticism of ABC include the ABC cannot help the management to identify the bottleneck therefore the management cannot decide the most profitable product combine (Geri N & Ronen B. , 2005). That's means the ABC cannot realize the profitability of each product so the management cannot make a decision the perfect product combine. ABC assumes the actions and costs have positive relationship whereas this is unrealistic in short term (Geri N & Ronen B. , 2005). For example, the freight cost and materials cost. According to Cooper and Kaplan (1992), the expense of supplied might not exactly be change in the short-term. Besides that, the price allocation in ABC will also involve subjectively arbitrary even although ABC has more cost drivers compare to traditional costing (Geri N & Ronen B. , 2005). The implementation of ABC also required to interview with the staffs to accumulate the info about enough time necessary for their work. Hence, most of the staff will not honestly record the idle time and they'll only report that they have fully utilized the time. Hence, this will cause the cost driver rate to be computed based on full capacity and the cast driver rate will be overstated (Kaplan & Anderson, 2004).

Activity-Based Management (ABM)

ABM means the management use the info that provided by ABC to improve the business process and help the business to be more competitive (Tardivo. G & Montezemolo. G, 2009). Regarding to McConville. D (1993), the ABC identify the all activities that start from customer order before product sent and the ABM give attention to how to reduce the non-value added activities in so doing shorten the complete process. Tardivo. G & Montezemolo. G (2009) appears to be in contract with McConville in that ABM can shorten the procedure and even argue that persisting eliminate inefficiency activities can help the business to continuously enhance their activities and customer satisfactory. ABC focus on cost lowering and ABM concentrate on process improvement so the activity-based system can help the company to improve in qualitative and quantitative basic.

Activity-Based Budgeting (ABB)

ABB use the information that provided by ABC to create the budget for every single activity (Grahame. S, 2007). Relating to Shane. J (2005), the management can starting on ABB to make decision related to moving or hiring employees and make a decision the best practice. There have another 2 type of budgeting method apart from ABB, these are zero-based budgeting (ZBB) and standard budgeting. The traditional budgeting can offer exact budgeted cost if the budget cost is variable and it has clear relationship with the development or sales such as direct labour. However, the traditional budgeting cannot provide exact results if the budget cost is fixed or semi-fixed and it offers powered by purchase order or sales order. The ABB will not face this problem because ABB use different kind of cost driver to do budgeting. Hence, ABB can produce accurate budget figures in any type of activities. Besides that, the traditional budgeting and ABB will not evaluate the current activities whereas ZBB will evaluate current activities. Therefore a good ABB need to constantly evaluate the current activities to guarantee the data is current. The estimated inflation rate will be contained in these three budgeting method. The ZBB is not implemented by many companies because it is frustrating (Grahame. S, 2007).

Time-Driven ABC

Time-driven ABC is the simplified procedure of ABC. In this approach, the resource demands from each activity are projected by management. The price per time unit of capacity and device times of activities must calculate the standard rates. Hence, the management can starting on this standard rate to allocate over head. Precise is not needed in this new system and small problem in estimation is not importance. Time-driven ABC helps the management to save lots of time if the company expands its capacity or add new activities. It is because the management can simply estimate the typical rates of new activities no need to collect the depth data from new activities (Kaplan & Anderson, 2004). This time-driven ABC solve the problem that facing by many companies. Under this new system, the cost and time of collecting data can be reduced significantly because the management may use estimation rather than collecting correct data. Time-driven ABC is simple and inexpensive to implement and it also provide useful information to management better value compare to ABC (Kaplan & Anderson, 2004). In the case of Banta Food, the company could identify the profitability with their product after applying the time-driven ABC. Hence they learn to promote the profitable product, reduced the reduced profitable inventory and pricing their product in line with the final result of time-driven ABC. As a result, the company earnings increase by 35% and the earnings can also increase 43% (Kaplan & Anderson, 2004).

The Impact in the Improvements on Companies

Implementing the ABC will have different impact to the business and the impact maybe positive or negative. In the next report, the research study regarding the impact of putting into action ABC and ABB will be presented. A lot of the insurance companies offer variety of product looked after incur high over head. Hence, the implementation of ABC can help them to acquire exact cost information and the cost of each activity. Besides that, the high over head in insurance firms also very hard to classify therefore the clearer cost information can help the insurance firms to attribute their cost effectively. As a result, the management may easily control and decrease the overhead. The information produced by ABC can help the ABM to raised gauge the performance of the activity subsequently helps the insurance firms to be more competitive (Adams. M, 1996). The aspect analysis into the overhead is very useful for the management to make decision. However the company also needs to spend additional time to prepare and assess data to be able to get the depth information whereas this might not well suited for some company.

In this case, the financial service business decides to forego ABC after using it for seven years. Initially, the company use the info made by ABC to price their service and enhance the costly activities. Nevertheless the process of collecting source data was time-consuming and the companies also have to use 2 days and nights to calculate the price of several hundred activities. Besides that, the time-consuming in updating data also cause the business to upgrade their ABC system double a year. Hence, this cause some of the data was obsolete and irrelevant to decision making. The mature management also makes decision based on their intuition. Eventually, the business decides to depart ABC although ABC provides useful and accurate information (Geri N & Ronen B. , 2005).

Although the ABC can help the insurance provider to be more competitive whereas it does not ensure the other company can obtain the same result similar to the insurance company. In the case of Queensferry Telecommunications Division (QTD), the ABC cannot provide useful information to the merchandise engineers. The management of QTD in the beginning intends to work with ABC to provide exact cost information to product engineers so they could design the merchandise with smaller cost. However the ABC cannot provide accurate product cost when the major agreement was postponed. This is because the trouble made by unused capacity was added to the product costs eventually increase product cost. Hence, the product engineers cannot depend on the ABC anymore (Cooper & Kaplan, 1992).

The ABB is ideal for implement in police force division because the ABB is more clear. Hence, the general public can understand how the police office spends their money. ABB can help the supervisor of police department to see the efficiency of the office. For instance, the procedure of arresting criminal accounted for 37% of total activity so the supervisor of each division can bottom part on this information to determine the way to improve this technique such as use new technology to reduce the actions (Shane. J, 2005).

Conclusion

The absorption costing always is the first choice of the company prior to the introduction of ABC. The ABC was developed after assimilate the deficiencies of the absorption costing and the ABC certainly overcome almost all of the deficiencies in traditional costing. The traditional costing only use a couple of cost individuals to allocate their over head so the productivity of the traditional costing maybe inaccurate. For instance, there have many cost drivers can be utilized in creation area but the direct labour hours and machine hours are the most common cost driver employed by traditional costing. However, the ABC can commendably get over this problem by using more cost drivers such as number of set up, quantity of order and number of inspection. Hence, the ABC provides more correct data than traditional costing. Besides that, the ABC also provides more detail information from product cost so the management can identify the most cost-effective job. This benefit is inaccessibility in traditional costing because the original costing only uses few cost motorists to allocate their over head. Hence, the result from traditional costing always inaccurate. In traditional costing, the administrative cost is dismissed and its own only give attention to the cost occurs in developing process. Nevertheless, the ABC allocates the overhead to each activity that develops before, during and after the processing process. Therefore the ABC provides more info to management for cost decrease and process improvement whereas the original costing cannot provide such information to management. However, the ABC still cannot overcome the condition of arbitrary allocation of overhead. The ABC even required more subjective allocation in their over head because the ABC has more cost individuals. Besides that, the implementation of ABC also necessary to interview with the staff so the staff can provide dishonest answer. Therefore, this will result the cost driver rate can't be calculate accurately. ABB is a budgeting method that derives from ABC and it also help to defeat the shortcoming of normal budgeting. The conventional budgeting cannot provide correct budgeted statistics to management if the budget factor is set or semi set cost. However, the ABB can help the management to get over this issue by using different kind of cost drivers. Notwithstanding the ABC can beat many shortcomings in traditional costing whereas some of the business still makes a decision to abandon it. One of the reasons is the time-consuming in collecting the suggestions data and the high maintenance cost. However this problem can be solved by using time-driven ABC. The main advantage of time-driven ABC is using estimation to calculate the typical rates of every activity. Hence, the management doesn't need to waste a lot of time to collecting and keeping data. The insurance company can benefit from ABC because ABC provides exact and extensive data to them. Hence the insurance provider can accurately allocate the over head to their variety of product. The ABB also help the government department to prepare their budget more clear and ABB also help the federal government department to operate better. The mixture of ABC, ABM and ABB can provide numerous benefits to the business but it still have some shortcoming that need to improve. Despite the fact that the time-driven ABC help get over some criticism of ABC however, many basic problem still cannot be resolved such as arbitrary allocation.

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