However, how exactly does activity-based costing match up with a traditional costing system and how does it provide managers with crucial information for decision- making? In order to analyze this point, the similarities and differences between the two systems must be illustrated. Throughout both systems, the practice of including manufacturing costs to products is common. As well, each deals with a cost pool and an allocation method of costs in order to maintain records. The similarities are somewhat trivial and it is the differences between the two systems, which illustrates the added value an activity-based costing system has to offer. With a typical, traditional system, usually one indirect cost pool is created for each department or plant while an ABC system implements a substantially large number of pools. Also, indirect cost application bases, in regards to a traditional system, may be considered as cost drivers, while in an ABC system, cost application bases tend to be cost drivers. Continuing on, indirect cost application bases in traditional systems tend to be financial, such as direct labour or perhaps direct material costs, while on the other hand, ABC indirect cost application bases tend not to depend on variables that do not have a financial implication. Variables used when determining an indirect cost application base in this instance tend to be number of parts in a product or hours of test time. (Hicks, 1999).
Finally, the traditional cost system compared to the ABC system tends to incorporate predetermined rates used based on budget while ABC focuses on capacity (Foster, 1991). Overall, the similarities between the two systems are to be somewhat expected but as indicated above, the differences between the two systems prove to be quite significant. Consequently, it is these differences that will have the greatest impact upon crucial decisions made by management because the assumptions made by an ABC system will illustrate operations, which prove to be beneficial and detrimental to the performance of a company while these factors may pass through a traditional system unnoticed.
The adoption of technology has affected all areas of accounting and extensive applications have also been developed for organizations using an activity based costing system. These applications help simplify and translate into a better ability to control costs, provide more precise information to a widening group of decision-makers, and link the enterprise with its customers, suppliers and partners. Also, Executives are concerned with financial application integration rather than cross-functional applications such as manufacturing, financial and human resources. Having managerial and financial information systems integrated gives businesses a greater ability to analyze the data as well as streamlining accounting practices. With increased automation, production information can be collected in a central database and the data can be applied to cost pools in real time. It is this kind of immediate availability of data that management can use to prepare up-to-date cost statements. Problems arise with these kinds of systems when traditional business practices and recording methods are still used after the adoption of ABC methods. With an activity-based costing system like this journal entries can be automatically generated so that the consumption of costs by specific activities can be measured precisely (Trites, 1999). As a result, managers receive a more granular and accurate view of actual costs, which greatly assists them in improving efficiency and budgeting.
Through a thorough analysis of activity-based costing, it is obvious that there is more information to account for than first expected. It is essential that management be able to understand the concept of ABC beyond the surface in order to grasp the manner in which it behaves. Besides the fact that it is a concept which involves the measurement of manufacturing costs and non-manufacturing costs, ABC has a considerable amount of information to be understood. The manner in which the system is implemented in various companies is essential for management which is contemplating whether or not to use such a system. As well, it is necessary that myths and misconceptions about the subject be clearly understood in order to prevent any ill-fortune to a company. As well, it is evident that ABC has emerged as an important concept in the field of Cost accounting. With many issues at the forefront of Cost accounting, perhaps one of the frontrunners would be the issue of globalization. These current issues provide an interpretation that activity-based costing has emerged as an important aspect of Cost accounting in the sense that it is instrumental for managers when making crucial decisions
The accounting cost methods described here don’t end when optimal pricing has been achieved and variability brought under control. These are only the first two milestones in a continuing process of pricing for maximum profitability. Next, companies must identify products that are no longer profitable and monitor customer churn for signs that prices are higher than the value provided in return.
Any product’s value proposition changes as the market evolves. The number of competitors might swell or shrink; new products or versions of products could be launched; competitors might start or stop giving rebates. Thus, every time market information is collected, it is vital to measure the customer and sales churn of every product – even if prices haven’t changed recently. It may be necessary to change prices as a result.
Since net or final are always moving, a product’s total cost and its impact on profits should also be monitored. Products that don’t meet management’s minimum profit requirements may have to be discontinued. Of course, a product it itself is losing money may be worth keeping for strategic reasons, such as rounding out a comprehensive product line or serving as a mechanism for appealing to big customers.
The analytical rigor and unbiased nature of this approach make considerable organizational demands on the companies that use it. A change in pricing is a major enterprise for any organization; it can’t be achieved overnight. Companies accustomed to anecdotal approaches may resist.
For these reasons, it might be wise to form a specific group to make pricing recommendations and monitor the impact of price changes. With the support of the sales organization and senior management, the group could put forward pricing suggestions even in the face of opposition. By closely monitoring the impact of price changes, the group would be alert to the need for midstream adjustments. To the extent that the organization must evolve over time from a sales-and-technology orientation to a focus on pricing and the bottom line, the pricing group could be the agent of that transformation.
Of course, the leader of the group shouldn’t report to anyone directly affected by its recommendations, even if that person – for example, the vice president of marketing or finance – would otherwise be a logical choice. Moreover, a clear succession plan should be developed to get high-caliber people, especially from sales, to work in a somewhat isolated pricing group. They ought to understand that there will be no negative political repercussions if they want to return to sales or move up the corporate ladder, for by necessity if they want to return to sales or move up the corporate ladder, for by necessity such a group will often irritate the senior people in a company.
Finally, pricing can be a key lever of profitability.
Bibliography
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