The Concept of Activity-Based Costing Systems


Traditional Activity-Based Costing (ABC) systems have been implemented at organizations since the middle of the 1980s when industrialization reached its peak. Such systems refer to accounting methods, which identify costs and assign them to overhead activities and then link them to product costs. Thus, an ABC system is used for recognizing the connection between such aspects as costs, overhead activities, products produced by a company, and, through this connection, makes the assignment of indirect costs to products less arbitrary compared to other methods of pricing manufactured products.

UPS

United Parcel Service (UPS) is a company that has implemented ABC systems in order to connect operating behaviors to product and consumer segment costs as well as support both new and existing decisions on pricing. It provides package delivery operations with such sectors as freight-based trucking, retail-based packing, shipping centers, and cargo airlines. Founded in 1907, the organization has undergone a chain of developments in price establishment systems. When looking at the history of ABC systems, it is imperative to note that with the decrease of direct labor content of products through the introduction of automation and other advantages of industrial engineering, the fraction of costs for which arbitrary allocations and overhead has increased.

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Also, a large number of companies in the 80s and 90s made a significant shift from the strategies of mass production to those that provided increase options, variety, new features, and additional benefits. For instance, UPS’s customer-oriented strategy made an attempt to attract, retain, and expand businesses by means of offering a range of new services. The company gained the greater capability of both producing and stocking larger varieties of products. Also, it became possible to support both order-entry and order-tracking channels. Specialized technical support, as well as the delivery to end-user locations through expedited options, also became possible.

Implementing ABC

As services subsequently created more value and loyalty among customers; however, this did not come for free for organizations. It meant that companies had to optimize their resources involved in multiple procedures, from engineering to selling, and reduce overhead costs both absolutely and relatively (Stout & Propri, 2011). With the introduction of ABC systems at UPS, it is possible to solve the inaccurate and insufficient allocation of overhead costs from standard costs systems by means of tracing them and assigning the activity costs to products, orders, and customers based on the quantity that each activity within a company consumed. The accuracy that came with the development of ABC can lead to the enhanced knowledge of profitability information and thus better decision-making linked to process improvements, the acceptance, and rejection of orders, pricing, and relationships with customers. The long-term and sustainable process improvements made it possible to increase both customer and product profitability.

Under ABC systems, activities involved in the provision of services to UPS customs are seen as any transactions and events associated with driving costs. Costs drivers, or activity drivers, are used for referring to allocation bases. Their examples include the setting up of machinery, maintenance requests, consumer power, quality inspections, and many others. When properly integrated into the business operations of UPS, they can offer company managers with accurate and specific data on costs that are subsequently used for making informed decisions regarding the improvement of operations, the establishment of reasonable process, and the management of positive relationships with customers.

In general, there are three ways in which ABC systems can improve the costing process at UPS. First, they are expected to expand the range of cost pools that are used for estimating overhead costs. Instead of collecting all possible costs in one company-wide pool, it pools costs by activity. Second, ABC systems develop new ways for assigning overhead costs to items on the basis of activities that generate costs rather than volume measures (for example, direct labor costs or machine hours). Third, the system can change the nature of multiple indirect costs and making them traceable to specific activities. These indirect costs can include power, depreciation, inspection, and others. Also, ABC systems transfer overheard costs from high-volume to low-volume products, thus raising unit costs of low-volume products.

Impact of ABC Models: Competitive Advantage

Previous research on the implementation of ABC models at organizations showed that the success of the system is usually multi-faceted, which means that companies should be careful in addressing the question of what success for an organization considers successfully. Based on the study by Kennedy and Affleck-Graves (2001) that compared the performance of non-ABC companies with those that have implemented the solution, the latter outperform their counterparts three months after introducing ABC. Over the three-year period, ABC companies show an approximate return of 61% compared with 34% of their measured counterparts that have not implemented the solution. Therefore, there is a competitive advantage in terms of financial performance when it comes to implementing the system at UPS.

According to Pokorna (2016), who investigated the impact of the system on financial performance in Czech companies, ABC is the most widespread among industrial companies that focus on mass production, followed by agricultural businesses. However, since UPS is a service company, the researcher also mentioned that consensus was reached regarding the fact that companies that implement the solution are in agreement with its positive outcomes when compared to competitors.

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A general example of a successful ABC system refers to a simple model that integrates several cost drivers and activities instead of integrating complex solutions. Businesses that use ABC in such ways tend to experience more benefits compared to those that implement the system for only the most important and most expensive processes. For UPS, this means determining information about business costs in an adequate way while the integration of the system is not too expensive.

The findings regarding the positive impact of ABC systems compared with non-ABC competitors were also supported by the study by Zaman (2009) that the model can capture the potential of organizations in regard to the strategic allocation and use of resources as well as the increased efficiency and effectiveness. The results of the research, which was focused on the Australian context, showed that company executives had found that ABC implementation helped them allocate the most important costs for each of the products. Therefore, ABC implementation is instrumental in increasing the managerial efficiencies and effectiveness as well as boosting the revenue of firms.

In order to understand the role that ABC systems play at UPS, it is important to mention some limitations that they present to a competitive advantage. Companies that have failed to integrate ABC into their operations are usually challenged by the need to implement both behavioral and organizational changes that come with the introduction of the new solution. However, one of the key challenges is predominantly associated with the complexity of its design, which also calls for the increase in costs (Abusalama, 2008).

Guaranteeing complete accuracy in the assignment of costs is also challenging because they are linked to subjective estimates of times spent on each activity. In addition to the measurement error linked to the best attempts of workers to recall their time allocations when involved in producing specific items, there is also a challenge of bias distorting the responses. As a result, marketing, sales, and operations managers cannot reach the necessary level of accuracy in the estimated model costs and profitability instead of resolving problems linked to inefficient procedures and unprofitable customers and products. In summary, there are several problems associated with implementing conventional ABC systems.

Overall, when integrating ABC systems into the organizational processes of UPS, the company has to account for the mentioned limitations. Despite the complexity of the models and the need for transforming the already established processes, ABC systems represent tremendous benefits when integrated correctly. The effects on performance and the shaping of cost policies are usually expected to be positive, which is why it is important to consider the impact of ABC techniques on company effectiveness.

Impact of Time-Driven ABC

Zaman’s (2009) research suggests that ABC systems can be effective in enhancing the strategic performance of organizations. It is also important to note the updated type of ABC systems – time-driven ABCs that are considered simpler, cheaper, and far more effective (Kaplan & Anderson, 2007). Compared to traditional challenge, the knowledge provided by time-driven ABC systems simplifies the processes and addresses limitations associated with basic ABCs. In the non-time-driven approach, UPS managers will have to collect data about the actual quantities of work; for example, the number of customer inquiries. In time-driven ABCs, it is recommended to estimate times necessary to address the total number of inquiries, thus linking costs to time.

Such ABCs usually simplify the process of cost estimation by reducing the need to survey and interview employees to allocate resource costs to activities. To implement this model, UPS should assign the costs of resources directly to cost objects through the integration of a simple and elegant framework that requires only two estimates, both of which are easy to obtain.

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Conclusion

In contrast to traditional systems of cost measurement that predominantly rely on volume count, such as direct labor hours and machine hours, ABC systems differentiate between the broad activity levels that, to a large degree, are unrelated to the number of units produced. This means that activity-based systems implemented at companies such as UPS have the potential of enhancing the costing process if they are integrated correctly into the business operations. The development of ABC systems over time makes it possible for companies to adapt it to their needs and use the model to its advantage. For example, for UPS, a time-driven ABC system can be easier to implement in multiple because it does not require the company’s managers to spend a lot of time and funds on collecting the necessary information for conducting cost estimations. Overall, when the complexity and costliness of ABC systems are addressed effectively, they can simplify cost establishment at organizations and reduce the complications linked to traditional approaches.

References

Abusalama, F. (2008). Barriers to adopting activity-based costing systems (ABC): An empirical investigation using cluster analysis. Web.

Kaplan, R., & Anderson, S. (2007). Time-driven activity-based costing. Boston, MA: Harvard Business School Publishing Corporation.

Kennedy, T., & Affleck-Graves, J. (2001). The impact of activity-based costing techniques on firm performance. Journal of Management Accounting Research, 13, 19-45.

Pokorna, J. (2016). Impact of activity-based costing on financial performance in the Czech Republic. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 64(76), 643-652.

Stout, D., & Propri, J. (2011). Implementing time-driven activity-based costing at a medium-sized electronics company. Management Accounting Quarterly, 12(3), 1-11.

Zaman, M. (2009). The impact of activity-based costing on firm performance: The Australian experience. International Review of Business Research Papers, 5(4), 200-208.

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