Activity based costing Essay

Custom Student Mr. Teacher ENG 1001-04 27 March 2016

Activity based costing

Executive Summary
This report provides an analysis of Activity Based Costing systems and Conventional Costing systems to determine whether the application of Activity Based Costing concepts would be useful at DBS Consulting Services.

A profitability analysis of the two consulting services offered by DBS Consulting Services (e-Commerce Consulting and Information Systems Consulting) was performed using Activity Based Costing and Conventional Costing. Using the conventional costing approach, the overheads of $342,000 were allocated at $129,960 (e-Commerce Consulting) and $212,040 (Information Systems Consulting). Using the Activity Based Costing approach, the overheads of $342,000 were allocated at $107,160 (e-Commerce Consulting) and $234,840 (Information Systems Consulting).

Before implementing an Activity Based Costing system, management needs to assess the problems that the firm is facing so that the Activity Based Costing system can be designed to address those problems. DBS Consulting Services is in a tight local labour market and is having difficulty finding quality staff.

It was found that E-Commerce Consulting Services provided a higher income per billings percentage than that of Information Systems Consulting Services (19% vs. 3%) under the Activity Based Costing approach. E-Commerce Consulting Services provided the higher return per sales dollar. These results would suggest that the professionals at DBS Consulting Services need to spend more time in e-Commerce.

The success of failure of Activity Based Costing approach is determined by the reactions of the people who develop and use the system.

An Activity Based Costing system can be costly and time consuming to implement and maintain, it requires extensive training, expertise and information. However, the benefits of Activity Based Costing systems, being improved cost accuracy and assisting management with decision making, outweigh these costs.

Introduction
It is said that Activity Based Costing can result in improved costing accuracy when compared with Conventional Costing procedures.

Arguments to support this claim are that companies who adopt Activity Based Costing are not limited to a single cost driver when having to allocate costs to their products and activities. Activity Based Costing allows companies to use non-unit cost drivers as well as unit cost drivers to allocate costs. Also, because use differs significantly amongst activities, no single cost driver can accurately assign costs for all activities whereas Activity Based Costing takes advantage of multiple cost drivers, not just a single cost driver.

Arguments against this claim are that service industries often have higher levels of facility costs which mean fewer costs will be included in the Activity Based Costing system. Service industries also have a lot of non-repetitive activities which make it difficult to identify an individual activity to assign a cost driver to.

Both the conventional costing system and the Activity Based Costing system calculate the cost of a product or service in relation to the revenue it generates. However, the conventional costing system assigns manufacturing overheads based on a volume-based cost driver, and Activity Based Costing systems assign the manufacturing and non-manufacturing overheads based on the activities required to produce the item.

Part 3
Case Analysis Report – DBS Consulting Services (cont.)

The Conventional Costing System
Conventional costing approaches assume that manufacturing overhead costs are related to the volume of production which is usually measured by input measures such as direct labour hours or direct machine hours.

The features of a conventional costing system are:
Direct material and direct labour costs are traced to products Manufacturing overheads are assigned to products based on a pre-determined overhead rate The manufacturing overhead rate is calculated using a volume-based cost driver Non-manufacturing costs are not assigned to products

The advantages of using a conventional costing system are:
They are aligned with generally accepted accounting principles (GAAP) They are simpler than Activity Based Costing systems and easier to implement

The disadvantages of a conventional costing system are:
They are not as accurate as Activity Based Costing systems
They can result in under-costing and over-costing of products They can lead to poor management decisions as non-manufacturing costs are excluded

The Activity Based Costing System
Activity Based Costing systems allocate manufacturing and non-manufacturing costs to a product based on the activities required to produce the item. Activity Based Costing systems calculate the cost of individual activities and then assign those costs to cost objects, such as outputs, based on the activities required to produce them.

Activity Based Costing systems can be used to estimate the cost a product and also as a tool for management to monitor and control what is happening in the business by analysing the activity costs, the root causes of activities, the value of to the customer and measures of performance.

The advantages of Activity Based Costing systems are:
They provide a more accurate cost of products
Manufacturing and non-manufacturing costs are included in the calculation They provide a greater understanding of overhead costs

The disadvantages of Activity Based Costing systems are:
Information can be misinterpreted by some users
They can be costly to implement and maintain
They involve major changes in data collection and analysis which can be challenging and also cause resistance amongst employees

Current System at DBS Consulting Services
Currently at DBS Consulting Services our administration costs (overheads) are allocated to both consulting services (e-Commerce and Information Systems) based on billable hours. The following analysis presents the profitability of the firm’s e-Commerce and Information Systems consulting services using Conventional Costing procedures and Activity Based Costing.

Part 3
Case Analysis Report – DBS Consulting Services (cont.)

Conventional Costing Procedures:

Part 3
Case Analysis Report – DBS Consulting Services (cont.)

Activity Based Costing Procedures:

Analysis:
Activity-based costing procedures result in a significant increase in the overhead costs allocated to Information Systems Consulting and a significant decrease in the overhead costs allocated to e-Commerce Consulting.

The conventional costing procedures allocate overheads based on billable hours which results in 38% of overhead costs being allocated to e-Commerce Consulting (=1900 billable hours for e-Commerce / 5000 total billable hours), and 62% to Information Systems Consulting (=3100 billable hours for Information Systems / 5000 total billable hours).

However Activity Based Costing shows that the overhead percentage allocations vary for each activity as summarised below.

Part 3
Case Analysis Report – DBS Consulting Services (cont.)

The e-Commerce Consulting services are allocated less overhead costs using Activity Based Costing when compared to the conventional costing approach. Using the conventional costing approach, $342,000 is allocated at $129,960 (e-Commerce Consulting) and $212,040 (Information Systems Consulting). Using the Activity Based Costing approach, $342,000 is allocated at $107,160 (e-Commerce Consulting) and $234,840 (Information Systems Consulting).

E-Commerce Consulting Services provides a higher income per billings percentage than that of Information Systems Consulting Services (19% vs. 3%) under the Activity Based Costing approach. This shows that although both services are charged out at the same rate, and the labour rate for both services are the same, e-Commerce Consulting Services provides the higher return per sales dollar.

By adopting the Activity Based Costing approach we can determine a more accurate method of allocating overhead costs to our services which in turn will provide more accurate profit analysis of each service. This will help to increase customer and shareholder value.

Summary
Given the very tight local labour market and the fact that it is difficult to find quality staff it would not be desirable for an aggressive expansion of either consulting service regardless of the fact that both generate a profit. If we opt to expand either service this would mean having to hire more qualified staff, which as mentioned above, is difficult in today’s competitive market.

Before implementing an Activity Based Costing system, the following factors need to be considered:

Management needs to show conviction that the benefits of the system will outweigh the costs Management and staff need to understand what Activity Based Costing is and how it can help the firm The requirement of resources to implement Activity Based Costing need to be considered Concerns about the resistance to change factors need to be addressed

The success of failure of Activity Based Costing approach is determined by the reactions of the people who develop and use the system. Resistance to change can impede implementation, therefore in order to succeed, there must be a plan in place that is carefully thought out to take into account the factors above as well as determining the extent of change required and the different personalities involved.

Employees should be encouraged to play a major role in developing and using the Activity Based Costing system to give them a sense of ownership and help them to view the system as a tool to help them manage their work.

In conclusion, an Activity Based Costing system can be costly and time consuming to implement and maintain, it requires extensive training, expertise and information. However, the benefits of Activity Based Costing on improved cost accuracy and assisting management with decision making outweigh these costs.

Part 3
Case Analysis Report – DBS Consulting Services (cont.)

References

Langfield-Smith, K., Thorne, H., & Hilton, R. (2012). Management accounting: Information for creating and managing value (6th edition). North Ryde, NSW, Australia: McGraw-Hill.

Heisinger, K., & Hoyle, J. (2013.). Managerial Accounting,v.1.0. Retrieved April 10, 2014 from http:/catalog.flatworldknowledge.com

Johnson, R. (n.d.). Traditional Costing Vs. Activity-Based Costing. Retrieved April 1, 2014 from http:/smallbuiness.chron.com

Wilkinson, J. (July 23, 2013). Activity-based Costing (ABC) vs Traditional Costing. Retrieved April 1, 2014 from http:/strategiccfo.com

Marx, C. (n.d.). Activity Based Costing (ABC) And Traditional Costing Systems. Retrieved April 4, 2014 from http:/financialsupport.weebly.com

Keshav. (n.d). Advantages And Disadvantages of Activity-Based Costing (ABC). Retrieved April 1, 2014 from http:/accountlearning.blogspot.co.nz

Delaware Technical Community College. (n.d.). Retrieved April 1, 2014 from https://www.dtcc.edu

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