Critical evaluation of the suitability of an Activity Based Costing system for a UK university | Example Accounting Essay
This paper aims to evaluate the suitability of Activity Based (ABC) Costing implementation in UK universities. The first part will provide a critical analysis of ABC method and the ways of performance assessment by organizations under this methodology. It also discusses the suitability of this method in universities and explains its usefulness. The expected challenges and problems during the implementation of this method in the UK universities have also been discussed in the study. After the analysis it provides a conclusion for its suitability and recommendations.
2. ACTIVITY BASED COSTING
Activity-based costing (ABC) emerged in the late 1980s and has attracted both academicians and businesses at a very high level. ABC method is different from conventional costing because it does not use an arbitrary allocation for all indirect cost. ABC is a costing method that works by assigning the cost of all activities individually based on the consumption by each activity. According to this methodology first all the activities of the organization are identified and then assignment of cost incurred (CIMA, Bjornenak & Falconer, 2002). Therefore, the results for cost of goods sold and gross margin can be different under both methods. Two contradictory results can create problems and confused in decision making (Garrison & Eric, 1999).
3. CRITICAL EVALUATION OF ABC
There has been an increase in the adoption of the ABC method by businesses due to a number of benefits. Some of the advantages have been listed below (Cohen, et al. 2005)
Identification of unprofitable products or activities
The ABC method helps in identifying the unprofitable activities or products in the business. The cost incurring and activities which do not add value are visible which allows the business to work towards their reduction or elimination.
ABC method will provide an accurate idea on the distribution of cost for every products and services individually and this helps in cost reduction for the appropriate activity, product or services.
Accurate allocation of indirect costs
ABC makes direct costs out of various costs that are treated by the traditional method as indirect cost and thus there is much more accurate allocation of the indirect cost.
Improvement of internal processes
With the help of proper cost analysis for every activity and resources the business shall be able to understand the consumption of each process and the activities involved in it. This information can help in improving the internal production and processes when required either by reducing or increasing the cost accordingly.
Accurate information on products and services
The ABC method provides accurate information on product and services individually because it allocates the cost on the basis of consumption by each activity and individual products and services unlike the traditional costing which just provides an average cost for the entire production
Facilitate decision making
ABC method needs details of all the resources and activities involved in overhead unlike traditional costing which only takes into account the total overhead and allocate it evenly. The estimates from traditional costing can create problems for the organization because the management will not know which products or services are profitable and which are at loss. While estimates based on ABC method can help in understanding and differentiating between such products and make right decisions.
Improvement in customer profitability analysis
After obtaining the true cost and details knowledge of each product and services the firm can evaluate which products are more profitable and then focus on the segmentation and target market with more profitability.
Performance management & Modernization systems
ABC method provides the transparency to manage the performances of products and services individually with consistency and improvements. Lastly, it improves and leads to the modernization of accounting systems for the business (Namazi, 2009).
DISADVANTAGES OR CHALLENGES
Despite of all the above benefits the ABC method has some disadvantages and challenges that becomes an impediment in adopting the method frequently. The disadvantages vary from industry to industry; some of them are listed below (Jarvenpaa, 2007).
Cost – The biggest disadvantage of ABC method is the cost involved in it, companies will have to invest a big amount for this method.
Designing and maintaining the model – Most firms think that designing and building a model suitable for the ABC method is a big challenge, moreover, the model has to be maintained and improved continuously which is considered as a problem by many.
Data Management - This method provides excellent results of cost allocation and activities but to get this result the entire process requires a great deal of data management from gathering, integration, loading, maintaining and interpretation
Time - one of the biggest constraints is time and ABC methods requires a lot of time for its implementation and making it work after the implementation. It is a tedious process and requires more time than the conventional costing.
Satisfaction – Most of the firms are satisfied with the existing traditional method, do not feel the requirement of investing time, effort and resources for it.
Support – For an entire transformation support from all departments, management and higher authorities such as parent companies and subsidiaries are required.
4. PERFORMANCE ASSESSEMENT UNDER ABC SYSTEM
Implementation of the ABC method or any method is not beneficial on its own it requires the assessment of the performance under this system. Transformation of the data obtained data from the processes and activities into information needs different tools of analysis. Some of the tools used are as follows: dashboard, balanced scorecard, benchmarking, self-assessment, diagnostic analysis, cost-profit etc.
Dashboard helps in evaluating, controlling and monitoring of the activities by arranging and presenting the indicators (absolute & relative) to visualize the trends. Balanced Scorecard consists of indicators for business strategy, the components helps in pilot performances with the combination of financial and non-financial instruments that provides the managers relevant information. Benchmarking is the process of comparison of the performance with other entities. It helps in the identification of best practices for improvement of performance; it is basically a self improvement tool (Briciu & Capusneanu, 2010).
5. USEFULNESS FOR UNIVERSITY
There is great variation in the use of ABC method in different industries, surveys suggest that manufacturing industry are the highest users of ABC method ranging from 20-50% followed by financial services at 15-25% then public services 12-18% and lastly communications 6-12% . It can be noted that the public services has a very small percentage in the use of ABC method (Schmidt, 2017).
Recently, universities have been facing a lot of challenges including fiscal crisis. The competition and consumer demand is increasing but there has been reduction in resources and cost. State and regulatory bodies have increased the pressure of accountability which has become the same as other industries. The UK has been debating the cuts on public spending including education; therefore, universities have to work towards cost cutting. To achieve this objective it is necessary to have an accounting technique that explains costs better. Number of UK universities have introduced ABC method and have succeeded in financial management & resource allocation (Broad & Crowther, 2001).
6. ANALYSIS FOR ABC SYSTEM SUITABILITY FOR UNIVERSITY
This method can be useful for the universities in many ways such as
Cost Information: It provides the true picture of costs of different departments or courses to the university and legislators. Cost Control: It helps in controlling cost by identifying the activities with the cost, then increasing the value added activities and reduction or elimination of non value adding activities. Identification of Resources: Allocation under the traditional method or volume gives a distorted need of resources for different departments and courses. The ABC method can help in identification of correct resources to correct areas. Scarce Resources: The scarce resources can be distributed better rather than an equal distribution of the resources which is not appropriate. Better Course & Program Mix: Information on true costs can help in better management of course mix or elimination of obsolete courses. Public Relations: This method can work as a tool to report the resource utilization and the mission achievement by the university (Cardos & Pete, 2010; Broad & Crowther, 2001).
It is clear that the universities need the ABC method and undoubtedly has a lot of benefits but there are certain problems associated with it that has made the ABC adoption bit tougher. Some of the problems in adoption of ABC method are listed below: not just an allocation method.
Huge Cost: The biggest problem in ABC adoption is that the method involves huge cost in the instalment of tracking and monitoring mechanisms for measurement of each activity’s cost. The cost involved in this measurement and cost incurred due to inaccurate data needs to studies properly (Mitchell, 1996). Labour Intensive - It is labour intensive so the benefits of accuracy will have to surpass the cost and effort involved. Time – Too much time is required to get into the details of each activity cost, a university will not have enough man hours to complete this task. Lack of support – there is usually lack of support from top management or higher bodies. Cost drivers – choice or selection of cost drivers is not an easy task in real business world. Many of the activities can be inter-dependent so identifying or segregation is daunting (Krishnan, 2006).
LIMITATIONS IN IMPLEMENTATION
There are a number of limitations in the implementations of the ABC method in UK universities. ABC method is like a tool which needs proper implementation to produce proper results. The university has to consider a number of things before the implementation:
Availability of resources: the university needs to check if they have the required resources for this transformation. Accountability of Net results – the university needs to thoroughly examine that will the results outweigh the costs and benefits involved because it is a public body and utilises the tax of the citizens so has a great accountability to legislators and the government. Culture: the culture within the university can be a big limitation like decentralisation stage or the amount of delegation can have a huge impact on the implementation of the costing method. Public & Social welfare: University is not a profit gaining institution so there is a requirement of public and social welfare characteristic above cost cutting. It deals with students and cannot work entirely by elimination of courses based on cost (Mitchell, 1996). Complicated decision making: It is not a product based organization so ascertaining cost drivers or activities in terms of courses is not very easy task. Stakeholders: University has a lot of stakeholders which includes the government and the public directly so they all have to agree to it. Bigger picture: The education industry works for a bigger picture and cannot be quantified by small units therefore, direct cost cutting for small gains might not be beneficial (Krishnan, 2006 & Tatikonda, 2001).
It can be concluded by this study that ABC is a very useful method in costing for UK universities because of the huge benefits of appropriate cost allocation and tight financial management. Although, lot of UK universities have been reaping the benefits of successful implementation but the adoption has not been very high as expected. The reasons for low adoption are it involves high cost, labour and time; it also depends on the relevance of the benefits in the long run. There cannot be a one thumb rule for all industries the method can be implemented in the right way and right proportion according to the demands of the business. It should be treated tool that requires proper analysis of results after implementation to get benefits from just implementing ABC is not work done to achieve the objectives (Schmidt, 2017).
Example Accounting Essay UK
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Briciu, S & Capusneanu, S.(2010) “Effective Cost Analysis Tools of The Activity-Based Costing (ABC) Method” Annales Universitatis Apulensis Series Oeconomica, Volume 12 Issue (1)
Broad, M. & Crowther, D (2001) "Activity based costing in universities ‐ An inappropriate technique?", Journal of Applied Accounting Research, Vol. 6 Issue: 2, pp.55-89,
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Mitchell, M. (1996) “Public Money and Management” Routledge Publications, on behalf of Chartered Institute of Public Finance and Accountancy Volume 16 Issue 1
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Schmidt, M. (2017) “Business Encyclopaedia” Solution Matrix Ltd
Tatikonda, L & Tatikonda, R. (2001) “Activity Based Accounting for Higher Educational Institutions” Management Accounting Quarterly Winter 2001 pp. 19-27