Factors to Consider For a Successful Implementation of Activity Based Costing
Instructions:
State and explain key cost and management accounting principles and concepts. Make reasoned recommendations to providers and users of management accounting information or their advisers.
Recommendations As now for the essay I’m writing the report for my manager William, recommendations that is being created would be for actions you think your manager himself should take at this point. Your recommendations may also be for something you think Sierra should do at this point, which your manager may then recommend to Sierra as an action point (or he may choose not to, but that is not your problem when writing the report). Or you can have a mix of the two – recommendations for both your manager and for Sierra.
I would like to recommend the company to use ABC. Please read all the sources from the reading list especially the case study of Sierra. Please follow the given requirement from the instruction pdf and the marking criteria.
“Content
Your report should, as a minimum, consider the following areas from both a theoretical and practical perspective:
• Your assessment of current costing and pricing practices of Sierra Ltd;
• Your assessment of whether activity based costing is suitable for Sierra Ltd;
• Your assessment of the factors that the management team at Sierra should consider to ensure
successful implementation of activity based costing, should they decide to go ahead with Baljit’s proposal.
General guidance on what will earn high marks (and what will not) High marks will be earned when
• The report focuses on Sierra Ltd
• The report is well structured
• The report is comprehensive
• The report is well argued
• The arguments are based on credible sources
• The report is professionally presented
• The report cites credible sources in a way that allows readers to check those sources for themselves”
Please use the appendix 1 from the case study it’d be great to include the given numbers of their declined sales so that it shows that I have managed to use the given table well.
Harvard in-text reference and Harvard bibliography are required. Please do it in details including inserting names and years.
Solution.
Activity Based Costing Help.
The management accounting principles aims at serving cores needs of the internal management which helps in improving business objectives, processes, customer value and utilization of the capacity required to achieving corporate goals. As one of the management principles, this report aims at encouraging the manager to instil the use of activity based-based costing system in the Sierra Ltd. The ABC is a costing methodology identifying with the activities of an organization that assigns costs of all the activities to the products and services. There are various issues in the sierra ltd that leads the company to compromise to the activity based costing systems. These issues include the present costing and the pricing practices and the factors that the management should put into consideration to ensure successful implementation of this system of costing.
Current costing and pricing
Markedly, the business is partnered by the founding Sierra family together with the private equity company with 40% and 60% contribution respectively. Although, the company has long-term loans following the refinancing that was done previously in 2012 (Lucas, 2000), the funds were used in upgrading the factory. Pricing is the total amount that a customer pays for either products or services. The difference between cost and price is that the price is all that is paid while cost all the amount incurred in any business platform. In essence, this section briefly explains the current costing and pricing practices and situation of Sierra Ltd. Following the recent meeting it is noted that the markets has fragmented since the small companies uses technologies like the 3D which creates fast6 and agile product hence the business faces competition. For this reason, there is a reason to react to the market forces on pricing. Thus, it is wise to lower the business prices to avoid further fall on the market shares and revenues especially in the market for engine components which seems faring really bad amongst them all.
Baljit, one of the company management makes some observation on pricing and pricing basing from the traditional point of view. From the observation made by him and other associates of the management depicts that different component of the product have got either few or many products. Markedly, the current costing system used by this company generates sales prices hence serving the business well. It is important adding a margin of about 30% to the manufacturing costs of all the products to attain the sales price. Hopefully, this would cover up the non-production costs and eventually make profit; however, recently the company’s market has been making much margin. Notably, the costing system that is currently used has worked well in the past ten years. The business has greatly invested in training the management accounting members in using software that supports the costing systems since critical changes would be expensive. Consequently, the markets in transmission systems and the clutch components are very stable. Therefore, it is important to reduce the cost of production of the engine component since it has previously contributed to about half of the company’s sales revenue which means it had great impart on the business.
Activity based costing is suitable for sierra ltd
The activity-based costing is a process of assigning the indirect costs to both products and services provided provide d by as company, and for this case, Sierra Ltd. It entails finding out the cost of each activity that is involved in the process and eventually assigning basing from it consumption (CIMA, 2008). It is a more refined approach to the process of costing as compared to the tradition costing method. Therefore, in order to improve its standards Sierra Ltd there is a need to involve the activity based costing system. It is suitable to use the aforementioned process considering that the company manufactures a variety of products including the engine, transmissions and the clutch components. In addition the manufacturing plant is fully automated and situated in the Eastbourne in the southern coasts parts of England. Therefore, all together, the company manufactures close to ten various major products although they the models are specific to the car models.
Unlike the traditional method systems that entirely depend on volume counts like machines hours, labour or the overhead costs, the ABC system classifies five major levels of activities that are sometime not related to the number of units produced. The said broad levels include the batch, unit, customer, organization and eventually the product level activities.
Cost hierarchy
The activity-based costing involves various steps which includes identifying activities and classifying them hierarchically. It is the order in which the process of activity-based costing system happens, thus, the cost hierarchy is a framework classifying activities basing at the ease which they are traceable to the product. There are four levels of the hierarchy cost which involves unit, batch, product, and the facility levels. The unit level is those activities that are done on each product’s unit (Duh et al, 2009). The batch level involves those activities that are done when the batch of the products is produced. Thirdly, there is the product level where at this level, the activities are carried out separately for every product. Finally, there is the facility level where the activities are performed during the plant level. Notably, the unit level activities are usually easy to trace to products but the facility activities are harder to trace or rather least traceable.
ABC improves the process of costing
The ABC enhances the process of costing in various ways. First, it increases the number of cost pools that are used in assembling overhead costs. Instead of accommodating all costs in the company, it pools cost by every activity. Secondly, it creates new bases for assigning overhead costs to various items such that the cost is allocated basing from the kind of activity that is regenerating costs instead volume measure. The ABC, also changes the nature of various indirect costs hence making costs which is considered indirect such as inspection or depreciation.
Implementation of activity based costing in Sierra Ltd
Managers use the cost allocation procedure for various reasons. To begin with, cost allocation provides a methodology that aids in assigning overhead costs of various activities, products and service involved allowing management access. Cost allocation is also used to reduce wasteful spending hence promoting efficient use of resources through evaluation of needs and uses for the year o come as part of the planning process. Managers can then be evaluated basing on their planning, communication, and how they share the resources efficiently. Therefore, this section will in depth deal with the factors that ensures successful implementation of activity based costing (liu and pan, 2007). Having dealt with the ABC in a brief notion, the knowledge will help us link the key points and come up with concrete point that the management should put into consideration while implementing the ABC systems in the Sierra Ltd.
In order to implement the ABC system in the Sierra Ltd Company, it is important for the management team to tackle certain specific problems that it might be facing. From this point of view, the management should come up with a number of key issues hence that certain factors had become vital to the success of the whole project. Various ABC projects aims at searching out the costing information though this can be a big area meaning different things at varying management levels. It is thus vital to establish the important factors that should be considered in establishing a successful activity based costing systems. First, one needs to be sure whether or not the outcome will take place at a certain level.
Before the advent of the computers and the new technology, the traditional methods of allocating overhead costs were based on the cost driver. Unfortunately, the costing allocated overhead may lack a cause and effects relation of the amount located. The ABC assigns cost depending on the basing on the multiple cost pools of different products where each got its own cost drivers. With that done, it can lead o an accurate costing and a well improved control over the overhead costs. The ABC is effective when a company has diverse products and services just like the Sierra Ltd (Naidoo, 2002). Markedly, it is efficient when the overhead cost account for the all the cost and in the situations where the manufacturing process is intense. Therefore, it is important for the client to identify the cost pools and their appropriate cost drivers through calculation of the overhead costs to be assigned to the production.
Implementing activity based costing
The steps that should be involved in implementing the activity based costing in sierra ltd
- First clarify the reasons for the allocation process through defining the need to allocate the existing costs and putting down the benefits of doing the same.
- Identifying the operation department cost pools and the support.
- Selecting him allocation base for every department cost pool basing on the cause and effect relationship between the production department and support.
- Choosing and applying a method for allocating support department cost. There are three major widely used methods including direct, step-down and the reciprocal method.
- One the allocation process is complete, the cost drivers are chosen from the newly formed cost pools
Factors to consider ensuring successful implementation of ABC
Technical variables
The adoption and implementation of the ABC highly revolves around the technical factors like identifying main activities, selection of core drivers, and the problems in association with accumulating data cost. Conversely, technical factors alone are not adequate in explaining those factors that influence success ABC implementation.
Behavioural, contextual and organizational variables
To enhance more success in implementation of the ABC, the management team should focus from technical factors to other variables like the behavioural, culture, contextual and also organization and its structure. For a successful implementation of ABC should incorporate the aforementioned factors in four stages. The stages of implementation of ABC include initiation, adoption, adaptation and acceptance.
Cost Drivers and Cost Pools:
The ABC assumption is that, firm’s activities exist to support the production and delivery of goods and services. Therefore, should be considered as product costs. And since nearly all factory and company support costs are distinguishable, they can be divided apart and traced to entity products (Porteus, 2001). Basing from this assumption, ABC costs can be controlled effectively through focusing directly on the management the forcing the activities to the cost drivers instead of than costs.
The reporting of the expense used by the activities of industry and their cost drivers provides the basis for understanding what causes transparency costs and direct attention to where stepladder can be taken to advance profitability. Knowing the high costs of material movements or the cost of producing, various components or maintaining diverse machines, highlighting the need to do these activities effectively (Drury, 2015). Thus, ABC provides improved, precise information, and decision making on prices of product mix and for the manager of manufacturing procedure.
Conclusion
The ABC method aims at to overcoming
the negative aspects through cutting transversely predictable departmental
boundaries. Costs are categorized into ‘pools’ depending on the activities which
drive them. In this, all the expense in association with the procurement
(ordering, inspection, storing etc.) is included in the cost pool hence making the
cost driver identified. Markedly, it is important to go ahead with Baljit’s proposal
in concerning implementing and improving the use of ABC system in Sierra Ltd.
It is because the ABC lays importance on difference costs for various purposes
and then identifies it for just those costs which are applicable to various decisions.
List of References
CIMA, 2008. CIMA Topic Gateway Series Number 1: Activity Based Costing. [Online] Available at: HYPERLINK “http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.pdf” http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.pdf [Accessed 7 January 2017].
Drury, C., 2015. Management and Cost Accounting. New York: Cengage Learning EMEA.
Duh, R.-R., Lin, T.W., Wang, W.-Y. & Huang, C.H., n.d. The design and implementation of activity-based costing: A case study of a Taiwanese textile company. International Journal of Accounting and Information Management, 17(1), pp.27-52.
Liu, L.Y. & Pan, F., 2007. The implementation of Activity-Based Costing in China: An innovation action research approach. The British Accounting Review, 39(3), pp.249-64.
Lucas, M., 2000. Practice defies theory: The reality of product costing. Management Accounting-London, 78(2), pp.28-31.
M, M. & T, H., 2005. Managers divided: Implementing ABC in a Portuguese telecommunications company. Management Accounting Research, 16, pp.205–29.
Naidoo, S., 2002. “Voyage of Discovery. In Financial Management. pp.32-33.
Porteus, J., n.d. As easy as ABC. In Financial Management. pp.40-41.
Shields, M.D., 1995. An Empirical Analysis of Firms’ Implementation Experiences with Activity-Based Costing. Journal of Management Accounting Research, 7, pp.148-66.