This coursework is to explain what is Activity-Based Costing (ABC) and Activity-Based Management (ABM) and interpret how they help in working such as decision making, planning and controlling.
Activity-Based-Costing is a type of costing method that assign indirect cost such as overhead cost to production activities. ABC started to be applied during the 1980s as it can identified the production cost accurately (https://www.accaglobal.com, 2013). Besides the ABC, Activity-Based Management (ABM) is also often used for making decision. ABM is a management of eliminating non value-added activities and improving value-added activities. The main purpose of ABM system is to strengthen the efficiency and effectiveness of a company (BusinessDictionary.com, 2019). It is so to speak that ABC provides information, then ABM uses the information to analysis situation for make decision (Turney, 1992). ABM is not only focus on costing but the entire activities and business process.
ABC and ABM in Decision Making
One of the examples of companies who using ABC system is Chrysler. Chrysler is a long-standing automobile company which is found in 1925 and it introduced ABC into its organization in 1991. As Chrysler had met financial crisis in the late 1980s, Chrysler found the disadvantage of the old-accounting system which is the system is not reported costs by process. After understanding about the use and benefits of ABC system, Lutz who is president of Chrysler decided adopting ABC system.
They started collecting data and assigning overhead cost. Meanwhile, training workers by giving them classes in order to let them know operation of ABC system. With the using of ABC, Chrysler will know how much each process or activity costed so that they can make decision based on the information provided by using ABC, they had avoided inefficient cost. As a result, they had saved 50 to 100 times of the implementation costs and get a great profit (Joseph A. and Thomas G., 1995)
As we mentioned before, ABM make decision by using ABC information to satisfy customer needs and improve profitability. A real instance is Pennzoil Production and Exploration Company (PEPCO). Pennzoil company is an American petroleum corporation which is a main producer of crude oil and natural gas. They used ABM not only for identifying cost by processes but also used to support its reengineering work to keep pace with the lower price of the crude and natural gas. In addition, because of the information provided by ABC system, Pennzoil Company understood the what cost is for what activity. After that, they applied ABM to analysis overall situation of the company and then make decision which is changing the cost structure of production efforts such as minimizing the non value-added activities (StudyMoose, 2019).
ABC and ABM in planning. Moreover, ABC and ABM also useful for business manager to plan their business. First, by using ABC system it is helpful to identify the inefficient products, activities or departments across the range of the business practices. Thus, it can help the manager to determine the allocation of resources. Therefore, there will be more resources can be appointed to the profitable products and services. However, the resources will be deducted from the unprofitable products and services. (Rothberg 2011)
Next, manager can find and eliminate the extra cost to increase the efficiencies. ABC system can help to find out the places where the business might be loss money in support of the unprofitable products and services. (Rothberg 2011) Therefore, manager will need to reallocate the funds to the more profitable areas or use the extra funds to produce a new product and increase the efficiency of the business. After determining which activities are cost effective, manager can decide how to increase profits. For those activities who deemed too costly, manager can decide to outsource, cut back or eliminate them and this is call activity-based management.
Besides, for management department to plan and manage their cost and giving performance appraisal to the responsibility centres. (Agarwal n.d.) The cost drivers rates and transactions volume information provided by ABC costing system is very useful. Cost drivers rate bring advantages to design the new products or existing products because they indicate the indirect costs that may be used in product costing. This information will help the company to gain a better understanding of their competitive advantages.
ABC costing system bring benefits to service industry such as banks, insurance companies, government departments and so on. This is because there is no direct cost and majority of the cost are overheads cost. Therefore, by using ABC costing system helps manager to improve their decision making, planning and controlling of their business. For instance, Hewlett Packard (HP) Company who produce printer, may divide the activities such as assembly, packaging and quality control. Through these activities, managers can identify the inefficient activities and managers can plan to reallocate the resources to others profitable products or managers can choose to cut down the activity. (Saylordotorg.github.io, n.d.)
For ABM, it enables the management to identify which activities or processes are spending the most and enable the manager to plan how to save the cost effectively. By identify the activities and processes, managers can plan on how to improve it in an effective way such as outsource, cut back or eliminate them. The improvement projects may require a big amount of capital expenditure, and there will be a need to do a cost benefit analysis to confirm whether is it worth to do so. Therefore, using ABM can provide the more accurate data to the manager to do the planning on improvement projects.
ABM also provide the information about the cost that incurred in the activities. Therefore, it brings more easier to manager to monitor the cost of the activities that have been cut by a particular project. It enables the manager to plan on how to save the cost or reallocate the cost on the other more profitable products or services.
For example, Hewlett Packard (HP) Company who produce printer having difference departments such as assembly, packaging and quality control. By using ABM enable the manager to identify which activities are fully used to the maximum capacity. The manager can plan to decide whether they should outsource or provide more resources to support them.
First of all, ABC can assist business managers to better control the organization’s costs. What makes this costing methodology efficiency is it can offer a logical cost’s tracing in its ability. As we mentioned in planning, ABC help manager to find out each expense and assign it to become part of a specific activity and thus managers will know which parts of business are losing money. And they can control the team’s costs based on that. (Myabcm.com, 2017) For instance: a midsize waste-recycling company — Safety-Kleen adopted ABC costing method in 1991 and has used it to rationalize operations, prune product lines and extend into new markets. This helps them to reaped cost avoidance and cost-saving on more than $12.7 million. (Joseph A. and Thomas G., 1995)
Moreover, ABC can also help managers to control the resources used. As ABC can help managers to determine the inefficient parts of business, managers will assign more resources to the profitable parts. (Rothberg, 2011) Dependent example including Chrysler, Dave Meador, a financial and performance measure’s manager of Chrysler and other financial staffs spent plenty of time for developed their skills and put in so much efforts to ensured that the ABC system will implement successfully in their corporation. (Dave, n.d.) ABC helps the company to eliminate inefficient, superfluous or unproductive activities and simplify the design of products and thus control the company’s resources, and It brought benefits at hundreds of millions of dollars. (Joseph A. and Thomas G., 1995)
As we mentioned above, once ABC assigns the expense to or divides the product’s production into some specific activities, managers will easy to catch the problems of the company. In order to make the company work better, managers need to control these activities.
ABM method allows a corporation to control properly in its activities. This method’s first step is to identify activities required by product completion, then determine these activities to see whether are valued-added or not，and finally eliminate or minimize the non-valued-added activities and continuously ameliorate the value-added activities. All the activities can be identified and appraised by following these steps and thereby control it. (Saylordotorg.github.io, n.d.)
Back to 1996, a company called TransEuro that put to use ABM method when they were confronted with a need for development capitals and profit problems which demanded abundant budget cuts. The company’s activities included in each process has been determined and recorded after they identified the inputs for each process and outputs produced. Finally, they came out with some improvement ideas and solutions. (Bpir.com, n.d.)
ABM usually put to use after used ABC to assigns costs to several activities. ABC makes company clear about how much each activity cost and then use ABM to make decisions. Since ABC can identify the profitable portions, managers can easily find out unprofitable activities of business and its help to plan how to do next step. After that, these two methods are used by managers to control certain elements. It helps the company to save the number of costs and resources which make better management in activity bases. These two methods were adopted by many companies although the implement cos of these two is so expensive and may have risks. But both methods are really help them to achieved better management and brought about a greater amount of profit.
Decision making, planning and controlling are significant actions for every company. Decision making as the first step for any events or activities, its importance is more than we deemed. If a company makes a wrong decision, it will bring negative effects such as face a loss, or it will even bring down the company.
Planning is also important as it draft a strategy to achieve all the task for making a profit and avoiding unnecessary expenses. It is, so to speak, without planning, a product or activity is difficult to produce and carry out. As we known, controlling is an action which ensure all the activities will be completed on time. The company can discover problem immediately if something wrong thus make up the mistake.
Without any doubt, both ABC and ABM can assist the company to make profit and survive. Nevertheless, I think ABC will be more effective if it is in conjunction with ABM. It is because ABM can analyses all the situation based on the information which provided by using ABC and then make a good decision that will lead the company to succeed. The realistic example that we stated is affirming that my viewpoint is true.
Throughout this coursework, I had learnt about how ABC and ABM work in decision making, planning and controlling. I feel that group working is helping me so that I do not need to do everything and just focus on my part. Group working is also encouraging us to discuss about this coursework. For instance, deciding who responsible for which part, when to turn in and so on.
Finally, I appreciate to my members to provide information at first therefore we can complete all the works. I am also feeling grateful for my lecturer to help us when we got a problem. Under this assignment, our group members need to explain how ABC and ABM this two costing system methods can help business managers to achieve improvement in decision making, planning and controlling. I did the parts of describing how ABC and ABM, these two methods that help business managers used in controlling and provided several examples of it, and the conclusion part.
Honestly, this is my second time to have a study group, but it still makes me learn something. The first one, which is the main information of this project, ABC and ABM — two costing system methods. After reading up information based on my research and the parts my group members finished, I knew the implement steps and some real examples of these two systems. It makes me understood better how this two are working and helping a company to achieve improvement and therefore make them earned a greater amount of profit.
Moreover, we have some issues among members and assignment when doing this work. For example, we will discuss the deadline in a group chat before members start to do their parts. But it’s not always possible that everyone can meet the timeline. Therefore, some doubts may be generated. For the assignment, it’s a little bit hard to find related information and examples at the beginning, and sometimes we have doubts when doing work. But these all be solved now. It makes me know that conversations between members, clear message are vital among the group, and this project may not be finished that well without each member’s help.
This project lets me have a new experience of doing group work. It makes me feel that each member is important and I appreciate the efforts that they made. Also, I thank our lecturer for solving doubts when we have.