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НАЛОГИ, УЧЕТ, УПРАВЛЕНИЕ РИСКАМИ
YflK:657 DOI: 10.24411/2071-6435-2018-10061
Methodology of introduction of activity based costing
When esimating the production costs the choice of costing method becomes one of the most important elements that depend on various aspects, such as production type, technological process, production range, expenditure structure. It is appropriate to apply the activity based costing (ABC) method in companies where direct costs have a high relative weight. The main attitude of this method is that expenses are needed for activity that has to be carried out to create products or provide services rather than the production or provision of services themselves. Every activity needs certain costs and production as well as selling of products creates a need for various activities. The recommended ABC method introduction methodology created by the authors is provided in the article; it includes three sets of works: 1) preparatory works (introduction of employees to the ABC; formation of the ABC method introduction team; evaluation of the company's management and organizational structure; evaluation of technological process of production); main works (identification of the company's activities, estimation of costs of every activity; determination of the cost drivers of every activity, calculation of products costs); estimation of efficiency of the ABC method introduction (determination of introduction costs; determination of introduction benefits). This method can be successfully applied in companies of different industries.
Keywords: activity-based costing; stages of introduction of ABC, methodology of introduction of ABC; general attitude of ABC
J. Mackevicius
Introduction
In the modern market economy environment, in order to withstand competition and make as much profit as possible, every company has to decrease their expenses. Yet first of all one has to precisely calculate how much does production or provision of services cost. Production cost is one of the most important indicators defining efficiency of company's activity. Therefore companies can look for possibilities to use resources rationally and decrease expenses only if they know product or services cost. Proper product costing provides the managers with accurate information about product cost formation, trends of variations in the expenses, formation causes and areas. Product costing data helps a company to determine not only the cost of production of certain products or provision of services but also to evaluate production efficiency and ensure operational management of productions processes. Information on the cost of production or provision of services is the most important indicator when determining a price of a product (service).
D. Tamuleviciene
© J. Mackevicius, 2018; © D. Tamuleviciene, 2018
Managers, being aware of the cost of their products (services), can evaluate whether rational price determination principles are applied in the company, i.e. whether products (services) price takes labour-intensive processes, complexity of provision of services and incurred expenses into account.
Various methods of product costing are analysed in economic literature which are usually divided into traditional ones and modern ones. Since 1985 a lot of publications could be found in foreign literature in which traditional methods of product costing (process costing, job order costing, standard costing) are criticized in one way or another. It is underlined that in recent years many companies have underwent important production, commercial, financial or investment activity changes and the business environment has been very complex, dynamic and competitive. Managers want to get the type of information which could be used not only to accurately calculate product cost but also to make optimal decisions on how to make your products competitive, ensure their high quality and decrease costs. Such decisions require information on various areas of the company's activity during which resources are used and new value required by customers is created. Such information is provided by one of the modern product costing methods — activity based costing (ABC). The most important attitude of this method is that every activity needs certain expenses and manufacturing and selling of products creates a need for various activities. The theoretic basis for activity based costing was first laid down by U.S. authors in their publications [4; 5; 13]. Later they and other foreign authors [1; 3; 7; 8; 9; 11; 12; 20; 22; 26; 30; 31] studied the aspects of this method, proposed different names for it (cost management, cost allocation, cost accounting, etc.). It is noteworthy that certain authors analysed the ABC method application possibilities in certain economy areas. Authors like Reyhanoglu (2004), who analysed the application possibilities in electronic industry [23], Duh, et al. (2008) in textile industry [10]; Kumar, Mahto (2013) in the automotive industry [16]; Zinkeviciene, Stravinskaite (2013) for nurseries product costing [32]; Kim T., Kim Y. (2016) in construction [14]; Zizyte, Tamuleviciene (2018) in service undertakings [33], etc. are worth mentioning among them.
Evaluating the fact that activity based costing is not a universal method and is highly dependant on the type and size of company's activity, its production or range of provided services, technical features, it is important to provide the basis for its application taking the company's characteristics into account. But in order to introduce ABC in a particular company, it is important to follow the general provisions of the method, highlight its advantages as well as causes that could disturb its introduction. The aim of the article is to prepare a methodology of introduction of activity based costing on the basis of which it would be easier to introduce and apply it for different companies.
General attitudes of ABC method and advantages of its application
The essence of activity based costing method is to calculate all the indirect costs of certain company's activities first, and then estimate the product cost. The importance of this costing method is explained by the fact that direct labour costs are decreasing whereas indirect costs (e.g. supply of materials, storage, packaging, administration, sale, technological, engineering, etc.) are increasing in current automated and computerized production conditions. As is widely known, indirect costs are not very closely related to
the volume of produced and sold products. Indirect costs depend more on complexity of manufacturing, features of technical and technological processes, product range, quality, etc. Therefore, it is not accurate to distribute indirect costs, whose growth is not influenced by the increasing production volume, in traditional way (e.g.: proportionately to direct labour hours and direct labour costs), it would distort the cost of production. Also, this method is useful in a sense that it helps to understand the essence of indirect costs and factors influencing their change, more clearly. This method of costing is based on the assumption that any activity requires certain costs, which is why in business it is important to determine and understand the factors that influence any important activity. So, the purpose of the activity based costing method is to determine costs of certain activities and the part of those costs that goes to a specific product or service. Thus, the ABC method can be defined as a method which helps to identify the activities carried out by a company, allocate indirect costs to these activities based on their input to development and sale of products and estimate product cost. Thus, the aim of this method is to obtain the most accurate information on costs, evaluate the activity more efficiently and improve cost control, management as well as organization.
ABC method has an important role in the product costing methods system. It has a lot in common with traditional costing methods: process costing, job-order costing, standard costing. ABC method is similar to the process costing in a sense that during the application of the process costing method, production costs are calculated based on the transitional technological process phases of a product, whereas during the application of the ABC method the production costs are estimated based on the activities that need to be done in order to manufacture products. ABC method is similar to the standard costing in a sense that during the application of the standard costing method, an operational analysis of deviations from standards is carried out which ought to allow to determine the reasons and causes of variances. Whereas in the application of the ABC, it is sought to determine the reasons and causes of indirect costs (i.e. cost drivers). So, the aim to determine the reasons and the causes of costs when applying the method is typical to both the standard costing and the activity based costing methods. ABC, joborder costing, process costing and standard costing are characterized by the fact that all manufacturing costs are included in the production costs when applying the methods. All these production costing methods are characterized the fact that they all answer these questions: where the costs were incurred (cost centre), which costs they were (type of resources), when the costs were incurred, who is responsible for the costs (manager of the cost centre). Though, the traditional product costing methods do not answer the question why the costs were incurred. This is not the only question that the ABC method answers — its research area is a lot broader. So the following attitudes of the ABC method can be considered as the most general ones: a) various activities determine certain costs and specific products create a demand for activities; b) the ABC allows to determine the cause of indirect costs and how are they related to products; c) most of long-term manufacturing costs are indirect and the only way to determine what causes the change of indirect costs during a certain period of time, is to apply the ABC method; d) a connection between activities and products appears when operating costs are assigned to
products based on the inputs of activities to a specific product.
Most authors [6; 9; 15; 17; 18; 25; 26; 27; etc.] who analysed the significance, the structure and the possibilities of applying this method in practice, highlight the many advantages it has in comparison with traditional methods. One of the main advantages is that it provides a lot of information on various company's activities that cause certain costs. That is way the main focus should be on the company's internal activities because it is possible to determine, evaluate and control costs only when one has information of the internal activities of the company. This method also helps to identify which activities require the highest costs. Another important advantage and purpose of activity based costing is to prevent the distortion of cost allocation. Traditional costing methods connect all indirect costs and allocate them using bases, common to all company's products. Most often costs are allocated using the allocation base of direct labour hour. This method helps to minimize deviations of costs allocation by identifying main activities where the costs are incurred and by defining cost drivers. A more accurate allocation of costs leads to a better decision making. When employees of a company have the information on accurate costs of activities, they can use the limited resources of a company better. The ABC method helps to determine the most useful activities too. The activities that create a product's value are considered useful. Some authors consider constant improvement of products and production processes as an advantage of this method as well. ABC supports the continuous improvement process by allowing management to gain new insights into activity performance, by focusing attention on the sources of demand for activities and by permitting management to create a behavioral incentive to improve one or more aspects of manufacturing. Others emphasize that this method allows one to analyse the activities inside a company based on whether or not they create a product's value from a client's point of view. The analysing process is continuous, studying the activities that create value and the activities that need to be improved or ought to be renounced. Some management accounting experts argue that the ABC method is valuable since it analyses the profitability of products, services and even customers. As Pauceanu, Hisau (2016) notes, ABC enables companies to alter the combination of products manufactured and clients attended, enabling them to concentrate on the gainful products and productive consumers [21]. Because of this reason the amount of time, funds and efforts is lower for the products that are not as profitable. The listed advantages of the ABC method proves the importance of this method and the possibilities to apply it in companies of various industries.
As Drury (2008), Hansen, et al. (2001), Primakova (2015); Tamuleviciene, Subaciene (2013), Turney, Stratton (1992), [9; 11; 22; 28; 29] et al. points out, the ABC method can be considered in two views: costs allocation view and process view. Costs allocation view provides information on the resources used, activities carried out and objects of costs estimation. Such assessment of expenses helps to answer the question which activity requires a larger part of expenses as well as to determine the possibilities to reduce the expenses and to focus on more profitable products or services. The second view — process view — allows evaluation of results, provides information on the activities and their connection to cost drivers. When evaluating the activity through this view, these questions
may be answered: which factors determine whether the activity gets carried out as well as how qualitatively the activity was carried out and which factors influence the efficiency of an activity negatively. Therefore, it can be concluded that the ABC method is oriented towards activities as the main objects of expenses and its application is based not only on theeusposes od costs eattmation but also on planning, accounting and control which proves the efficstnca oStht method.
Recommondcd metSoCology of tnSaoductien aOOhx ABC meShod In 1992 C. Drury provided an ABC method application system and distinguished two mainotagee: lOats^nicg o°melirect costs tooetMties, 2) asstooiheof indheci costs to products^ ] treefi^ld-
Many authors ostedeO ihoin own ABC inCro Ceation actems or Hie haios of thtc aoaanple and trhthar feirures of parlionlhu induStriee ^i^d (aoma^o^nyO rcl^tettics thie asconnt. Aeroun-tants of many companies wonder which tasks and how consistently should be carried out whenhrplyine ABC rnclhodole00 There fe no olear enanta^r io iWs quettion usahcounting literaiure. The pceceta of ABC metlso. mtro (hsctioiL satather comptex. Veriouc auth ors mdicateeiOereni scaxh eref staged weSe diffetieot f amrs fcr method inlrodyaУor. Stme authecs dtiamduch4o^ s^otr [8; l9i csss; d 8] while 0^08 c^ir^ti^i^^lt^Ci ayea» O; C4]. However all authors agree on the last stage during which cost should be estimated. One may conclude that different number of stages with different names proposed by different author was the crnlthtuench of dt10ereotonderctxnringof She etshУce if tMr meStod as well ta the ierlures il ttt moroductton in praatice: ontithairs of (bitTereM oompaniot (hffer and bo^^s^^i^^^ end vecy ramoSei aperatKans are aarried aut dsring them. Organizational structures, production cycles, forms of work organisation, etc. differ as well.
Figure 1. Methodologyof applyingActivityBased Costing Source: Drury (1992) [8, p.275]
Taking the discussed general attitudes of application of the ABC method into account one can completely agree with the opinion of C. Drury that the aim of the ABC method is to determine the factors causing the need for certain activities, expenses needed for those
activities and how those activities are related to the products [8, p.275]. Once again it should be underlined that by applying the ABC method, the direct costs are by default allocated to products whereas the indirect costs go through certain stages before being allocated to concrete products. It is important to evaluate and distinguish the stages that could help to introduce the ABC method with lowest costs. Also, it should be introduced consistently and with adequate preparation. An ABC introduction methodology that could be applied to companies of different industries is recommended (see fig. 2).
In the recommended ABC introduction method, special attention is paid to preparatory works. Every company that has decided to introduce the ABC method in its activity and is trying to achieve certain predefined goals through it has to carry out a detailed analysis of the organisational structure, manufacturing processes, work organization, transactions and the riskiest fields of activities. It is also crucial to assess the employees critically: their competences as well as their willingness to learn and work hard and thoroughly when applying this method. An important circumstance should be noted: when only the employees of the accounting department are responsible for applying the method, the goal is often not achieved. Economic, technological and consultancy departments have to actively participate in the process of the introduction of the ABC method as well as ensure coordination of various actions.
Figure 2. Recommendedmethodologyof activity based costing Source: compiled by the authors
It is appropriate todistinguishthese4 most important stages and carry out their honestly before starting main ABC introduction actions:
1) identifyingactivities;
2) assigning coststoactivities;
3) selectingappropriatecost driversand calculatingtheir rates;
4) calculating productscosts.
First stage is identifying the company's activities; the main company's activities should be determined and described in this stage. A company can distinguish up to a hundred or even more such activities. However, the higher the number of activities the more difficult to allocate the costs. The activities chosen should be at a reasonable level of aggregation based on cost versus benefits criteria.
Various classifications of activities are presented in the management accounting literature. The most general classification which is most suitable for most companies is as follows: 1) unit-level activity; 2) batch-level activity; 3) product-sustaining activity 4) facility-sustaining activity.
Cost of unit-level activity is proportionate to the number of sold or produced products. Expenses in this category include direct labour, direct material, energy, depreciation, repair, machine processing and other costs. Batch-level activity is the activity needed to produce a batch of products. Expenses related to this type of activity do not depend on the amount of production and are fixed rather than variable. Quality control, equipment set up, materials movement, materials order and other expenses can be allocated to this type of expenses. Product-sustaining activity is the type of activity whose main goal is to develop conditions of production and sales of products. Expenses incurred in this activity do not depend on the production amount because expenses are often fixed. Product design, equipment maintenance, product support and advertising, market research, process controls, preparation of product specifications and other expenses can be allocated to this activity. Facility-sustaining activity is the type of activity that does not depend at all on the volume of production and other production factors. These expenses are allocated to production using different bases, for instance, the volume of product sales. Buildings maintenance, company's security, managers salaries and other expenses are allocated to this type of expenses.
Expenses of unit-level activity are instantly assigned to a product. Expenses of batch-level activity cannot be directly assigned to a product because they depend not on the amount of production but on the number of batches of products. Whether the number of products is 10 or 1000, it does not influence these expenses. When the costs of all batches are estimated, they are divided by the number of batches and thus expenses per batch are estimated. The expenses per product are estimated by dividing the expenses per batch by the number of products. Expenses of product-sustaining activity depend on individual types of products. For example, the number of employees maintaining equipment depends on complexity of the product. Therefore the expenses are first of all allocated on the basis of the product type and then are divided by the number of units. Facility-sustaining expenses are first of all allocated on the basis of the product type and then divided by the number of batches and finally by the number of units. General expenses can also be allocated to products by using direct labour or machine hours.
Second stage is the calculation of the costs of every activity. When certain resources are used in only one activity, their costs can be easily assigned to the activity. However, when certain resources are needed for several different activities, they should be assigned on the basis of how many resources are needed in a certain activity. When estimating the costs of every activity, it is proposed to pay the most attention to the largest resources;
resources whose need differs based on the product; resources whose usage is not related to direct labour time or other basis which is used when allocating indirect costs.
The third stage is selection of the appropriate cost drivers of every activity as well as their rates. Cost drivers determine expenses of certain activity. They are usually identified based on the feature describing their activity most typically. The aim is to relate the expenses to their cause as closely as possible. It is noteworthy that cost drivers can be very different and be expressed by various units of measurement. It is difficult to determine the cost drivers since there are no concrete rules how it should be done as well as no universal list of cost drivers. When forming an individual list of cost drivers of every company, it is important to select those cost drivers that meet two main requirements: 1) The cost drivers should provide enough information on the expenses of activities; the cost drivers should be easy to measure, the information should be easily to obtain, they have to be identifiable with the product. After the cost drivers of every activity are determined, the rates of cost drivers have to be estimated. Rates of cost drivers are estimated by dividing all the expenses needed for a certain activity by the number of the cost drivers.
Fourth stage is estimation of products costs. During this stage the share of the expenses per a relevant product is determined. Therefore, one has to know what activities were used for a product or a service, what are the expenses of the activity and what is the rate of cost drivers for every activity.
Before introducing the ABC method and after its introduction, it is necessary to evaluate its efficiency, i.e. evaluate not only its advantages but also its issues which arise after the decision to introduce the method and later when applying it in practice. The company willing to introduce the method has to take into account the need for additional funds that arises during introduction and application of this method. It is important to determine precisely whether the company is going to benefit from the application of the method or the need for financial and time resources will increase. As practice shows, distinguishing of cost drivers and collecting of data on cost drivers require a lot of monetary expenses. The company's management and organizational structure and even the technological process of production have to be changed sometimes too. The main reasons why the ABC method is barely applied in Lithuanian companies are as follows: a lack of necessary coordination among technical, economic and accounting departments; inadequate preparation of technical and technological production process, incorrect assessment of management and organizational structure and, of course, a lack of interest from the company's managers. Many managers tend to assess the controlling, analytical and informational features of the ABC method inaccurately.
Conclusions
1. Traditional methods for calculating production costs makes it possible to accurately determine direct costs whereas the indirect ones only approximately. Therefore the companies incurring significant indirect costs are recommended to apply the ABC method. When allocating indirect costs using this method, fields of activities causing costs are determined and the number of allocation bases is higher resulting in more accurate information on the costs of the production (services).
2. The ABC method not only helps to determine the costs but also to evaluate their causes, identify activities causing the highest expenses, determine the possibilities to reduce expenses and thus concentrate on the most profitable production.
3. The recommended ABC method introduction methodology includes three sets of works: 1) preparatory works (introduction of employees to the ABC; formation of the ABC method introduction team; evaluation of the company's management and organizational structure; evaluation of technological process of production); main works (identification of the company's activities, estimation of expenses of every activity; determination of the cost drivers of every activity, calculation of products costs); estimation of efficiency of the ABC method introduction (determination of introduction expenses; determination of introduction benefits). This method can be successfully applied in companies of different industries.
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