The advantages and disadvantages to using an ABC system
Why an organization might not experience financial improvement after implementing an ABC system with hopes of process improvement and cost reductions
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1. The advantages and disadvantages to using an ABC system. 1. Advantages
The biggest advantage is the accuracy in the data and the analysis of overhead costs. When activity based costing (ABC) is used, costs can be allocated to help managers evaluate the company’s performance. The analysis can lead management to make decisions on profitable and non-profitable products being produced. One of the main goals of ABC is to provide cost data that can help management make better business decisions. Is ideal for larger companies and for companies that produce multiple products. ABC is especially useful on business activities that can make the company more or less profitable. The data can be used for budget and resource planning. ABC analysis is based on actual data which enables companies to better use the costing system. Updating the ABC model can be done easily to reflect any recent changes in business operations. The model can be adjusted to show the time required to complete the new activity or process and the previous cost rate can be used for the new activity.
Activity based costing (ABC) is not useful or efficient for all companies. Companies have to determine if the cost associated with implementing ABC is worth the cost. This option is not viable for companies that do not produce multiple products either. ABC does not comply with GAAP so companies would have produce reports internally and externally. To comply with GAAP only direct materials, direct labor, and overhead can be used in the allocation costs. Internally, payroll processing, shipping costs, legal costs and sales can be used in the cost allocation. ABC is costly to implement and maintain in service departments. Companies would waste a lot of time on tasks related to interviewing and surveying processes. It is also costly when a company decides to add new activities which requires re-estimates of the time and efforts.
2. Why an organization might not experience financial improvement after implementing an ABC system with hopes of process improvement and cost reductions.
There are many disadvantages to implementing ABC for a company or organization. One of the biggest disadvantages is the system not being efficient. A failed implementation could be because it lacked a clear business purpose. A new system implementation must be measurable and attainable. In order to do that, management also has to be honest about the system and its capabilities. The project should also have all parties involved from senior management to the individuals who will be doing the day to the day work that is being measured. It is rare that major decisions don’t involve senior management but it is common that senior level management removes themselves from projects. Senior management place a lot of trust in middle management to complete projects of this magnitude but should remain in constant communication with the team. Employees often feel intimidated with the fear of losing their job security. Most people know that change is inevitable and there is always room to improve. Resistance to change is never good and can detrimental to a business’s bottom line. The resistance is not just with employees but management as well. Management can be fearful of the results which could lead to employment dismissals. Outsourcing is often used as a way to reduce operational costs and allow outside agencies to handle projects or business processes. The advantage to outsourcing a project of this nature is you have dedicated individuals and time to invest in the project. The disadvantage is the third party doesn’t have the familiarity to the business or the business processes.
• The advantages and disadvantages to using an ABC system
Some advantages of using an ABC system include having more accurate data about which products or services are utilizing the overhead costs and being able to make better-informed decisions about how to best allocate these resources for maximum profitability. By linking products or services with the most appropriate cost driver, it is easier to see the cost flows, and products which may previously have seemed profitable could have actually been subsidized by others all along. Additionally, by identifying high resource consumption specific to certain activities, managers can begin to recognize where to focus their process improvements for maximum impact. For example, if ordering materials for a particular product seems to be using a significant amount of time, perhaps those materials could be ordered in bulk and cut ordering time in half (i.e. place a larger order twice a month instead of a smaller one weekly).
An ABC system could be seen as disadvantageous if all of the products and services are relatively proportional and use the same cost driver. In those situations, it may not be seen as worth the investment of software or personnel costs to maintain the system.
• Why an organization might not experience financial improvement after implementing an ABC system with hopes of process improvement and cost reductions
There are a few reasons why a company might not see desired financial improvements after implementation of an ABC system. First, there might not be buy-in from the decision-makers. If an accountant implemented the system, they may be able to generate important data, but they may lack the decision-making power to implement changes in the process or reduce the costs. Additionally, if the system is poorly designed, it may not be providing data that is truly accurate or helpful to the organization. There also needs to be a clear business purpose for the system; the costs need to be considered someone’s responsibility to be fixed, if changes are expected to be made as a result. In general, most people can be resistant to changes and threatened by what they may not understand, which may lead to general defensiveness. “Identifying efficiencies” especially can feel like a bit of a euphemism for lay-offs on the horizon. The best way to address these challenges and concerns head-on is to begin to get buy-in from stakeholders early on in the process, forming a cross-functional project team or task force in the early stages to discuss the benefits of such a system and what managers can expect to learn. By planning ahead and selling stakeholders on what the system can do for the health of the company, the implementation is more likely to be a success.
Time-driven activity-based costing (TDABC) is a cost system that uses two parameters to estimate and assign indirect costs. The first parameter used is the cost rate for each type of indirect resource. The second parameter estimates how much each resource’s capacity is used by the activities performed to produce products, services, and customers. However, there are some advantages and disadvantages of the TDABC system.
Some advantages of using the time-driven activity-based costing system include being more accurate, measuring the cost of unused resources, being easily modified, and allowing managers to forecast resource demands. This system is more accurate because it is based on actual quantities of resources used in production and service processes rather than allocations. This allows for better budgeting and resource capacity planning. Another advantage is being able to modify the data easily to reflect changes in the company’s operation. For example, the cost rate can be adjusted if new machines are added to the process. Although managers can forecast resource demands, this system is unsuitable for short-term feedback on processes, departmental efficiencies, and improvement.
The original ABC system faced many issues when implemented. Some disadvantages of using the original ABC system include that the process is time-consuming and costly, biases affect the accuracy of cost driver rates, and difficult to add new activities. The original ABC system was time-consuming and costly to obtain employees’ time allocations. At large companies, it was a hassle to have employees complete monthly surveys, and many had to have full-time people to collect, process, and report the data. Biases also had a significant impact because managers doubted the system’s accuracy since it was based on an individual’s subjective estimates of how they spent their time. Others also were worried about how the data would be used and may have distorted their responses. For example, few individuals reported that a significant amount of their time was idle or unused, which led to cost driver rates reflecting that the resources were working at full capacity. Lastly, adding new activities or details to an existing activity was difficult. Many of the original ABC systems exceeded the capacity of their spreadsheets and software packages. This led to the system taking longer to process, and often times the system took days to process just one month of data.
Sometimes, an organization might not experience financial improvement after implementing an ABC system. Although an organization may have had hopes of process improvement and cost reductions, others must be open to change. Resistance from individuals or the organization can block its effective use. Several factors play a role in the success of the system. First, there needs to be an accurate and clear business purpose. Second, there needs to be a commitment from senior management. Third, there needs to be constant communication with consultants. These factors influence whether or not an organization may experience financial improvement after implementing this system.
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