Activity Based Costing & Activity Based Management in Chinese Company

Activity Based Costing and Activity Based Management in Chinese Companies
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Activity based costing system
The activity-based costing (ABC) system is a method of assigning indirect costs, to the products and services, and is mostly used for the including nonmanufacturing overhead costs. The products consume activities while the activities consume resources (Weygandt, Kieso & Kimmel, 2017). When using ABC there is an assumption that the overhead costs are linked to certain activities and they vary depending on the cost drivers of these activities (Mahal& Hossain, 2015). The allocation of overhead costs in ABC to multiple activity cost pool requires assigning the activity cost pools to products and services when the cost drivers are identified. An activity incurs costs when producing a product or service and in the activity cost pool, the overhead costs are attributed specific types of activities.
This costing approach is based on grouping cost centers that make up a sequence of value of the products and services of the company's productive activity. The ABC activities and processes are separated and costs are first assigned to activities and then to products or services depending on how the products or services use the activities (Weygandt, Kieso & Kimmel, 2017). When costs are classified grouped into cost pools it is possible to explain the variation in the cost driver. Then the cost per unit (rate) of each pool is assigned to the products, and assigning costs to the product depends on cost rate and the volume of units consumed for the different cost drivers.
Traditional costing system VS Activity based costing
* Traditional costing system uses measures related to volume, such as labor, as to allocate costs to products, while the ABC system uses activities as a basis for assigning costs and also uses cost drivers that are not related to the volume of products.
* In traditional costing system the units produced are used calculate the rates of indirect costs , but the ABC approach uses different bases depending on the activities related to the indirect costs.
* For the traditional costing system, the allocation of indirect costs is carried out in two stages: first they are assigned to an organizational unit or some department and secondly to the products. This differs from the ABC approach where assignment to the activities is first carried out and then to the products. The costs are pooled by the activity centers and then activity center cost pools are allocated to the cost objects.
* The traditional costing method uses general bases as units produced or machine hours without considering the cause and effect relationship when allocating the indirect costs. ABC uses the allocation criteria based on units (volume) and the activity-based cost drivers in the assignment of overhead and indirect costs. There is better cost tracing in ABC since the cause-and-effect relationships are considered when assigning indirect costs to the activity centers (Weygandt, Kieso & Kimmel, 2017).
Implementing ABC in selected type of companies
In a study by Liu & Pan (2007) the researchers focused on the implementation of an ABC system at Xu Ji Electric Co Ltd (Xu Ji), which helped to determine the direct costs and variable overheads more accurately when compared to the traditional costing approach. Xu Ji is a state-owned enterprise (SOE) in the manufacturing industry, and ABC was implemented from 2001-2005 and there was focus on understanding how the system worked in the manufacturing department (Liu & Pan, 2007). One of the major benefits for the company is that there was access to more information on control of the costs and volume. This helped in improving cost control and understanding what processes affected productivity.
Xu Ji used both the traditional costing system and ABC allowing the management to rely on both systems to improve cost allocation. While there was more focus on cost management, the ABC system was associated with standardizing processes and workplace practices. Implementing ABC resulted in the company automating book keeping, where the company previously relied on an inaccurate manual method. Thus, ABC facilitated better record keeping improving costing and made it easier for the Xu Ji managers to decide on appropriate pricing strategies (Liu & Pan, 2007). The direct labor costs to trace costs to the products, while the contract numbers and activities helped in allocating the manufacturing overhead costs.
Focus on improving access to more accurate cost information and data was one of the reasons why the top management sought to implement the cost management system. Xu Ji relied on a Chinese state-enterprise accounting system that was inaccurate where there was external pressure to achieve the desired the results. The problem with the system is that it was inaccurate and the management neglected to improve accuracy when reporting the costs (Liu & Pan, 2007). Manufacturing companies are more likely to integrate the ABC system in China that companies in other industries since ABC can show allocation of indirect costs based on activities.
Benefits of ABC
Accurate cost of the product
The main reason why companies increasingly prefer ABC over the traditional costing method is that the cost system provides more accurate reports on the actual cost of running a business. Additionally, the cost system is not only beneficial in evaluating cost allocation but also determination of various cost objects that generate value (Zecchini et al., 2014). The costs incurred are linked to the activities and the costing method is more accurate to determine realistic product costs, unlike the traditional method that is at times arbitrary when allocating costs.
Cost allocation to different products
Managers of companies with multiple products have a better understanding of cost allocation including products with lower sales volume and higher sales volume. The ABC method considers product complexity since the costs depend on the activities and production circumstances in manufacturing companies. ABC helps to improve competitiveness since companies are better placed to trace costs and control different categories of costs when there is improved accuracy in cost calculation (Kocakulah, Stott & Manyoky (2017).
Costs are...