IMPLEMENTING AN ACTIVITY-BASED COSTING MODEL by …

[Pages:152]IMPLEMENTING AN ACTIVITY-BASED COSTING MODEL by

HOWARD COHEN Submitted in partial fulfilment of the requirements for the degree of Masters in Cost and Management Accounting at Nelson Mandela Metropolitan University

Date of Submission: December 2004 Promoter: Dr S Krause

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i DECLARATION

This work has not been previously accepted in substance for any degree and is not being concurrently submitted in candidature for any degree.

Signed: Date:

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STATEMENT 1

This dissertation is being submitted in partial fulfilment of the requirements for the degree of Masters in Cost and Management Accounting.

Signed: Date:

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STATEMENT 2

The dissertation is the result of my own independent work/investigation, except where otherwise stated. Other sources are acknowledged by giving explicit references. A bibliography is appended.

Signed: Date:

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ii STATEMENT 3

I hereby give consent for my dissertation, if accepted, to be available for photocopying and for interlibrary loans, and the title and a summary to be made available to outside organisations.

Signed: Date:

__________________________ __________________________

iii ACKNOWLEDGEMENTS Grateful thanks are extended to all those individuals and organisations that contributed to the successful completion of this study. In particular, the assistance of the following are acknowledged:

I would like to direct my sincere gratitude to Dr S Krause, my promoter and mentor, for his valuable and patient assistance, advice and encouragement ? without which this master's thesis would never have seen the light of day.

The staff of the Management Unit at the Port Elizabeth Technikon who were at all times helpful.

The respondents of the study who made the effort to complete the questionnaires as well as those who sacrificed their time in order for me to interview them so as to gain valuable knowledge that assisted with my research.

My wife, Gail, and daughter, Romy, who sacrificed a great deal, thus enabling me to successfully complete my studies. Without their patience and support I would not have been able to achieve this.

Ren?e van der Merwe for her language editing and Sharon van Eeden for editing and formatting the thesis.

iv ABSTRACT

Activity-based costing (ABC) is a forward-looking product costing method. Unlike traditional volume-based approaches, which are historically oriented, ABC concepts guide managers in seeking the best strategies to pursue in the future. This product costing method can be a valuable tool in planning and managing costs not only in the manufacturing area, but also in all aspects of business operations, from product design to distribution. Although its main advantage is its ability to provide more realistic product cost information for financial reporting purposes, use of ABC can lead to a better understanding of the strategic linkages existing between the various cost areas in the organisation. It enables managers to have a holistic view of cost management.

ABC was developed to better understand, manage and control the overheads. The brief fundamental of ABC is: Products consume activities, activities consume resources, and resources consume costs. Based upon this fundamental principle, ABC can trace the cost from resources to activities that are consumed by product manufacturing processes as well as from activities to products. ABC investigates the transactions that trigger cost instead of concentrating solely on measures of physical volume or a certain amount of labour hours. Compared to the traditional costing systems, ABC can not only answer how much product cost is but also tell executives the factors triggering costs and the way to manage costs. ABC helps managers make better decisions about product design, pricing, marketing, and mix and encourages continual improvement.

Unlike the traditional method, instead of using the single pre-determined overhead rate to absorb the indirect cost to products, ABC uses actual incurred cost to

v determine the product cost. By tracing the absorption process of indirect cost, ABC would provide more information to management and help it find better ways to manage costs. However, the cost drivers used in ABC are constants but the cost driver rates are continually changing. ABC still uses predetermined cost drivers so it has the same fundamental problem as the traditional methods for estimating.

vi TABLE OF CONTENTS

Page

DECLARATION STATEMENT 1 STATEMENT 2 STATEMENT 3 ACKNOWLEDGEMENTS ABSTRACT TABLE OF CONTENTS LIST OF TABLES LIST OF FIGURES LIST OF FORMULAS

CHAPTER 1: INTRODUCTION TO THE STUDY

1.1 INTRODUCTION AND BACKGROUND TO THE PROBLEM

1.2 PROBLEM STATEMENT 1.2.1 Sub-problems

1.3 DEFINITION OF KEY CONCEPTS

(i) (i) (i) (ii) (iii) (iv) (vi) (xiv) (xv) (xvi)

1 10 10 10

vii

1.4 ABBREVIATIONS

12

1.5 THE NEED FOR RESEARCH

13

1.6 DELIMITATION OF THE RESEARCH

14

1.6.1 Demarcation of organisations to be researched

14

1.6.2 Geographic demarcation

15

1.7 ASSUMPTIONS

15

1.8 SIGNIFICANCE OF THE RESEARCH

15

1.9 OUTLINE OF THE STUDY

16

CHAPTER 2: UNDERSTANDING ABC

2.1 EVOLUTION OF ACTIVITY- BASED COSTING

17

2.2 TRADITIONAL PRODUCT COSTING

18

2.3 ACTIVITY- BASED COSTING PRINCIPLES

21

2.4 THE MAJOR ADVANTAGES OF ABC

22

2.5 WHY ABC IS NEEDED

28

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