Aerotech Corporation is a company that deals in the manufacture and distribution of circuit boards that are essential in equipment dealing with communications and radars. It has a 20-year history of operating in Phoenix. Any form of a costing system is important in a company in that it makes it possible for the company to establish its product’s costs in relation to the business’s perceived revenue. According to Cooper (2003), any company can adopt any of the two primary costing systems, which include activity-based costing and traditional costing. However, the change from one system to another ought to be guided by a number of signals. An example of such signals would include the knowledge of the company’s products costs. For a long time, the company has been using a traditional approach to a management whose system was volume-based. Due to its broad involvement in business, along with the need to provide reliable and accurate data, Aerotech opted for a change. The change was from its traditional volume-based management approach to adopting an activity-based costing. This policy is referred to as the ABC system.
There was the need to change the cost management systems at this company in order to adopt a policy that aimed at the provision of reliable data on cost and production than the traditional method systems. One of the primary reasons why there was a need for such a change is that; the traditional volume-based system was misleading. Such was due to the under-costing of the small product line as well as the over-costing of high-volume product lines. In addition, the traditional system of cost management did not serve the purpose. For example, it did not indicate that the overhead costs of low-cost products were taking more of the costs than it was recommendable. For this reason, Aerotech had to adopt a business-friendly cost management system; the ABC systems.
Advantages of Activity-Based Costing
Any company is likely to get a number of benefits from the use of the Activity-Based Costing system of cost management as opposed to a system that focuses only on the volume (Cooper, 2003). For example, a company that uses a cost management system that takes the consideration of activity as opposed to the size gives the company the option of assigning all necessary costs to their products. Improvement in technology has incorporated computers and machines in the work area. As a result, the use of the traditional costing system has lost its superiority. Its insistence on direct labor makes the system outdated as compared to the Activity-based costing. Considering the case of Aerotech Corporation, the ABC system was able to alleviate the problem that the company was having as far as its overhead costs were concerned.
Usually, the ABC system makes it easy for an enterprise to interpret its costs to make the necessary changes in its internal management (Bragg, 2005). It also provides a better overview of overhead costs along with enabling their benchmark. Additionally, the Activity-Based Costing system is advantageous in that; it provides the opportunity to a customer to identify any available cost drivers. Such drivers, ought to have a close relation to the possibility of incurring overhead costs (Cooper, 2003). As such, just as Bragg (2005) points out, a company can determine which costs are coming from which side of the production process. With such, it was possible for Aerotech to price its products accordingly.
Activity-Based Costing System Stages
In order to assign adequately any costs to products, the ABC system incorporates two steps; stages 1 and 2. The first phase involves the establishment of an activity cost pool. The second phase, on the other hand, takes into consideration of the cost drivers that are responsible for the activity cost pool.
Stage 1 – activity cost pool recognized
In this initial phase, the concerned company creates pools for the activity costs. After the identification of the activity pools, what follows is the assigning of overhead costs for the given activity. However, the first stage of the activity cost pooling, is essential in that the concerned organization can manage proportionately its resources. However, considering the case of Aerotech, the costing management system involved batch, facility, and unit levels along with its product sustaining. The service level includes all the general tasks.
Stage 2 – cost driver is recognized to all activity cost pool
The second step involves identifying the cost drivers behind all the cost pools. Just as in stage one, it is necessary to make sure that the assigned costs are proportional to the given cost driver. However, during the design as well as the implementation of an ABC system, is advisable to consider a number of factors.
Non-Value Added Costs
Such are the expenses that a company incurs, and whose elimination does not deteriorate products’ perceived value, performance, or even quality. Such costs can include expenses in finished goods, the uncalled-for movement of raw materials among other similar costs. Aerotech Corporation uses the ABC system to minimize its non-value-added cost. Such is possible by assigning all necessary costs to its cost pool activity.
Maintaining a just-in-time inventory is necessary for Aerotech since it makes it possible for the company to eliminate storage space as well as other costs that do not add value to the products. This approach insists that the company should not buy new materials and products until it has exhausted its current stock.
The arrangement of the factory setting is essential in determining the design, as well as the implementation of an ABC system. As such, any organization ought to ensure that it considers its layout first. For example, considering the case of Aerotech, one finds that its Plant design at Bakersfield just follows that. The features incorporated are advanced making it viable for the ABC system.
Flexible Manufacturing System
The system adopted as far as product manufacturing is concerned ought to be friendly. As such, for the case study, the system should have fewer cells making the process less surplus along with the reduction of downtime.
Outlined below is a rank-ordered list of the top ten factors for the design and implementation of an ABC system.
- Ensuring enough as well as time training
- Determination of the diverse needs in the given organization’s sections
- Logical design and operation timing
- Inclusion of other non-financial sectors in the design and implementation of the ABC system
- Determination of the design team’s eligibility
- Monitoring and supervision of the implementation process
- Full-time operation on the design and implementation of ABC system
- Determination of system design details and non-value-added costs, overhead cost drivers, and activity cost pool.
- Incorporation of system design to a flexible manufacturing system
- Automation of the ABC system along with the application of overhead, and adoption of Backflush costing in the recording of costs of production
From the previously stated, it is evident that any form of costing system is vital to an organization or business. However, of the two costing systems available, activity-based costing is more advantageous when compared to the traditional costing system. As such, any company that wishes to track its costs and eliminate focusing on a volume-based approach should decide on using an activity-based costing system. This method is preferable since it attaches different values to their respective cost activity pools. In the light of Bragg (2005), with ABC, a company can overcome the under-costing of the low product line. In addition, the company can overcome the over-costing of high-volume product lines upon the use of systems whose primary emphasis was on the volume.
Bragg, S. (2005). Controller’s guide to costing. Hoboken, NJ: John Wiley & Sons.
Cooper, R. (2003). Managing a successful ABC project. Wellington, N.Z.: New Zealand Society of Accountants.