Management Accounting

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Recommended: Activity based costing strengths and weaknesses

Abstract

The initial aim of this report is to layout the main differences of

the client's current basis of overhead absorption, compared to

activity - based costing (ABC). By showing the divergence of both

systems, it appears that information generated from traditional

overhead absorption does not properly equip client's management with

suitable information for decision making. An additional aim of this

paper focuses on the potential benefits of activity - based costing.

It illustrates the chances of ABC as a decision making tool to provide

management benefits regarding the accuracy of cost and the achievement

of goals and strategies. Lastly, this report highlights all

information required for the implementation of ABC into the client's

organisation. It also reveals the necessity to collect and process the

information needed in the correct format at a reasonable cost.

Introduction

Today, manufacturing firms are confronted with an increasing

competition in the global marketplace. The demand to increase

profitability and the need to control costs demand an optimisation of

entrepreneurial ability in managing them. Cost management can provide

the tools, techniques, and mechanisms needed by companies to help

achieve goals and strategies (Andersen, 1999). The augmentation of

automation and rationalisation in manufacture, as well as the steady

increase of complexity in production and distribution, has led to a

serious adjustment of the companies cost structure (Freidank, 1997).

Roztocki (1999) states that in order to be successful in this new

business environment companies have to be flexible and react quickly

in manufacture. Furthermore, the author emphasises the need to have

accurate and up-to date costing information to make decision-making

effective and proper. Scarlett (2002) and Roztocki (1999) argue that

traditional costing systems based on volume-allocation of overhead

(direct labour hours or machine hours) no longer provideany accurate

information for product calculation, due to the serious increase in

overhead and the subsequent decline in direct labour. They even

contribute to poor strategic decision making, owing to the tendency of

traditional costing systems to distort product costs (Johnson and

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