ABC accounting versus Traditional Accounting - Research Paper Example

ABC Accounting Versus Traditional Accounting al Affiliation Overview of ABC and History Many companies normally require having their purchases tracked to ensure that money allocated to a particular activity is used as per the requirements. Activity-Based Costing often abbreviated ABC refers to a particular costing technique applied by organizations on assigning resources to various costs. Usually, an organization will fund a particular activity, which helps in monitoring the use of other resources, and assess the outcome. Companies that adopt this technique are able to estimate a particular cost-element of the whole batch of products, services and activities. This way, the company finds it easier to make a decision on the identifying products or services, which are less important. Additionally, any service that tends to overpriced is normally reduced to the right pricing. Further, a company can do away with any processing of goods if the process used proves to be unprofitable. In short, the ABC method helps a company in the assigning cost of resources in the activities to help in delivery of products to its clients (Brown & Tower, 2010). As a result, companies are able to decide on the pricing of goods, their identification, outsourcing as well improve non-effective processes. History Whereas George Staubus is the man that ABC is based on, this concept was first initiated in the US in the 70s. In the late 80s, Robert Kaplan and robin Cooper popularized the term when they both compared the traditional method of accounting with the ABC. In their conclusion, they felt that ABC was more effective than the traditional one. Moreover, it was established that ABC is able to locate the exact cost that a company will spend and not just the main expense. That is to say, a company can tell what it will gain or lose even before carrying out a certain activity. For instance, a company may calculate the cost of a certain product without looking into account the extra expenses that could or will occur consequently, the traditional method gave the wrong data concerning the exact cost as opposed to ABC, which normally calculates every expense (Bromwich, & Hong, 1999). However, even before the aforementioned individuals introduced the ABC accounting methods, people long way before used to do accounting. It has been often claimed that accountancy can be traced back to the ancient Egypt. Iran is also mentioned as another place where accounting used to exist many thousands of years ago. This happened during the reign of a certain emperor named Augustus. After, that accounting found its way to Europe mostly in England in 1880 where business people started using it (Huntzinger, 2007). 2. Traditional Accounting Overview (a) Historical practice As explained above, traditional accounting existed way before the introduction and the subsequent development of the ABC method. Firstly, this term is also called conventional in some quarters and it normally allocates indirect expenses to items produced in a factory based on the volumes. Unlike the ABC, this method does not put into consideration other expenses that may arise from the production of a particular product. Instead, the allocation of cost is done as per the output (Huntzinger, 2007). It is for this reason that the proponents of the ABC expressed the weakness of this method. (b) Reasoning It could also be seen that the traditional accounting was focused primarily on the eventual outcome as opposed to exact expense incurred in the production of a product. Carnegie and Napier (2009) noted that in the 21st century, the traditional accounting would not give managers the best results especially because of the consumer behavior. In these times, consumers are having different tastes many of which would require additional expenses being incurred. As a result, it would be pretty hard to estimate the exact cost of producing a particular service using the traditional accounting. The companies that support and implement the ABC technique are often seen that they do not lose bids due to overpricing. In short, there the ABC helps in calculating the cost and if a company is involved in a bidding situation, it becomes easier to bid because the exact cost has been calculated. In contrast, the traditional accounting method may lead to the overpricing of a commodity hence leading to a higher bid. Consequently, the institution conducting the bid will most likely dismiss such an application (Cooper and Maskell, 2008). Even though this technique is often seen as an expensive one, the proponents claim that as the cost of computer technology decreases so are the costs of carrying out an ABC technique. The reasoning behind this notion is that the computer technology would aid the technique by looking for some of these costs elsewhere as opposed to the earlier method of pure speculation (Carnegie & Napier, 2009). However, it is imperative to note that at this point this yet to be the case as the activities involving a particular product vary and also because of the uniqueness of some products. (c) Processes The process used in the traditional accounting involved costing, cost accounting, performance measurements and cultural integration. Firstly, the costing of a product would be estimated followed by accounting for the cost. At this point, there was no consideration of a likelihood of an extra cost. After this step, measuring the performance of a cost would be done where it was measured if the cost was equal to the output. Financial reporting and external reporting would follow the measurement whereby the outcome of a production would be done. Decision would be based on the findings in the previous step and upon analysis, improvement would be made. Finally, gathering of data was done as the last process and it involved collecting data that would help in improving the entire process (Cooper and Maskell, 2008). 3. ABC overview Perhaps the main area that puts a clear distinction between ABC and Traditional Accounting (TA) is the approach whereby the latter was based on the product-cost while the former on the activities. This section seeks to highlight the concepts sued in the ABC, the processes, impact, as well as the rationale behind it. This is an important part of this paper, as it will help in understanding why this technique has become quite popular especially during this time and why it has sent the TA into oblivion. (a) Rationale behind its changes So far, this paper has stated that there existed a different approach to accounting prior to the invention of ABC. However, as the consumer behavior changed and other cost of production coming up, the TA was found to be deficient in giving the accurate data. Consequently, business people sought to invent another one, which would help in giving the exact calculations. The rationale behind this technique is that in the overhead calculation. The activity tends to consume resources. That is to say, all actions or steps that one takes in producing a product or a service ought to be the ones determining the overhead cost (Armstrong, 2002). They are normally called the Cost Drivers for they are the ones that determine the exact and final figure concerning the actual cost of a product. An additional rationale is that the activities that are taken when a product is being processed are not necessarily classified in the volume. For instance, if a company wants to do marketing for its product, the TA would simply estimate the cost of the term marketing. However, ABC considers the cost of producing an order, handling consumer-complaint and even the cost that may arise in the setting of particular machinery necessary for the order or service production. In short, ABC considers both the indirect and the direct cost unlike the TA, which is more on the direct cost. (b) Impact on accounting No doubt, ABC has revolutionized the world of accounting due to its near-accuracy of products as it helps companies get a clear data. Unlike the TA, ABC helps in estimating costs that could be incurred in the process of delivering a product or service. As a result, ABC has been received well in the accounting world with many expressing satisfaction on the accuracy associated with it. Secondly, it helps business reduce wasteful processes. It was a boost for the accounting whereby the professionals in this arena felt businesses would no longer have to miss the needless expenses Additionally, companies are able to understand and speculate profit margins in the sense that if ABC is applied in estimating the final output companies can start planning. Obviously, this method helps in identifying the exact cost meaning there is not a likelihood of additional costs in the production. The major problem of TA is that it fails to provide the data of the activities leading to the production of a product. Whereas ABC does not give the exact data either, at least it provides a glimpse or an estimation hence ensuring companies plan for such expenses (Cinquini & Mitchell, 2011). . Notwithstanding these benefits and positive impact of the ABC in the accounting field, many have expressed displeasure with the cost of implementing this technique. Whereas it gives companies a chance to speculate on the expected profits, it also requires resources. Moreover, there are concerns that the data this method return is not always accurate thus putting it into further scrutiny leading to some treating it with skepticism. In addition, companies understand that using this technique does not equal profitability as it is just an analysis method yet resources will be spent. In other words, the process takes resources to implement but it does not guarantee that using it will yield positive outcomes. (c) Processes In ABC, the processes followed include activity-analysis which is scrutiny done on the all the activities likely to be encountered or conducted in a particular production of a service. At this point, the company’s relevant individuals assess which are the most likely steps to be taken in the production of a service. For instance, promoting a product on TV would most likely take more than just the actual cost by the media house. The means of taking the advert to the media would obviously cost some resources. The company driver could be sent to deliver the advert meaning some resources would be used. The car may experience some problems along the way yet the cost was not included. All these activities are assessed during this stage of ABC and are necessary. Secondly, cost data gathering comes in as the next step this process takes and this one involves speculation of the cost of certain activities. During this stage, individuals may be required to look for information elsewhere if the service intended to be sold has been sold elsewhere. Secondly, figures could be imagined because some activities are not easy to identify their cost because they may not necessarily occur. A case in point, it is not a must that the car will have mechanical problems, and even if that were to be the case it is not possible to identify the cost of repair. This is because the activity has not happened thus unable to determine its magnitude and subsequent cost. Tracing cost to activities is another vital step in the ABC process, which is mandatory, but one that tends to be tricky as well. Carnegie and Napier (2009) noted that this process seeks to find the connection between the cost and the activities. The implication here is that one has to clearly identify how a particular product is linked to which activity. Tracing is not the easiest, as it requires that one clearly understand the cost of a product then analyze the activities that led to the realization of the same. For instance, the person making the advert can trace the cost by analyzing the resources spent when the advert was being delivered. Here one ought to distribute the cost as per the cost-drivers in order to have a balanced an accurate process Establishing the total output of metrics is a further step that the proponents of ABC back up citing the advantage in the sense that one can now calculate the outcomes. It is the step where individuals try to identify the eventual output of the service production. This is more of a summary of the estimated costs in all the activities in carrying out a task or producing a service. Where one realizes the previously estimated figure may drop, the same adjustment is also done in this section. Cost analysis is an imperative step of ABC and it involves creating a report for the entire process. Again, one has to have a comparison of the results and a strategy; once this is done, the next step is doing the analysis. From the data obtained, the company can plan guided by the newly generated data which gives a clear plan and the subsequent steps to be taken. In the comparison of this data, the person doing the comparison lest there emerges some discrepancies must know the strategy. 4. Similarities Even though the differences exceed the similarities existing between these two methods, some similarities do exist the first one being that both seek to find the cost of a service. Whereas, the data obtained from the two methods widely vary, the intention of both is to determine the cost of a product. Secondly, both can be used in any business in bringing results concerning the company’s expected expenditure. Even though, some companies no longer use the TA, it is applicable in most businesses and the only reason it is not used is the choice of companies. In short, companies avoid using it due to its perceived deficiencies (Klimczaki, 2013). Moreover, both methods are similar in the sense that they include the indirect cost in the estimation. While the ABC approach uses both the direct and indirect costs, TA uses indirect meaning they both use it in the calculations. Lebas (2013) reported that many people these techniques similar in this respect. Others have been quoted as saying these two are similar because the indirect cost tends to be similar even though that is not exactly true. Instead, one ought to distinguish the difference between the usage of the two terms and the exact. Indirect costs can never be the same because of the variance in the data. 5. Differences It has been stated severally that these two approaches are very different albeit with few similarities. At this point, it is imperative to note that some companies still use the TA for their reasons but this section focuses on the differences. The differences analyzed are on the application, practice and action-based in the two techniques. This is because these exist in the said areas as this where the distinction is evident. Many people apply these techniques for various reasons and this why it is important to check the various ways of applying it, using it and the actions that people tend to take while using the two methods. (a) Difference in practice In the practice, the ABC helps in the elimination of non-value adding processes and companies are able to do away with them. Firstly, it is important to note that during the application of ABC, some procedures are judged less important. Companies are then able to remove these from the process of the production. Consequently, resources are saved unlike in the case of TA where it is not possible to find the non-value adding process. In the TA, it is possible to identify the processes that are not working because the method does not give into consideration the activities taken in the production. Instead, its major focus is on the indirect cost thus overlooking all the other activities. (b) Difference in application In the application, the variance is evident especially with the emergence of the new technology. The two vary in because one tends to give more accurate data than the other thus making it more reliable and credible. This reliability is influenced by the application because one has to consider several factors unlike the other, which only focuses on the eventual results. Additionally, the two differ in the sense that the advancement of today’s technology has made the TA approach a rather obsolete (Mishra & Vaysman, 2012). Conversely, the ABC tends to augur well with the technology and this creates a further variance. Again, there are still other differences existing between these two in as far as application is concerned. In addition to the already-mentioned two differences, the focus is different addressing the factors. ABC has to consider all the activities leading to a production of a product, which then determines the overhead cost, but the same cannot be said of TA whose primary focus lies in the finished product’s cost. Therefore, companies using the ABC have to put into consideration some factors unlike the others of TA. In essence, one can be applied faster than the other because only a short list of factors has to be considered. (c) Actions Having explained the differences arising from the application and practice, the subsequent actions are not hard to explain one of them being withdrawal of some processes. In the practice, one action noticed was that companies normally withdraw any process that is found to be of less value. This would mean that unlike the TA whereby it is not possible to identify any non-working process, ABC enables a company to eliminate these processes. The most likely outcome of this action is that one company- the one suing ABC- could save some resources but the other using TA may not. 6. Demographics The companies using the ABC technique have increased in this era with this being in the firms that tend to produce goods requiring various steps in production. According to Innes and Mitchell (1995), many big companies in the UK were found to be fond of the ABC approach. Elsewhere, at least 57% of the US companies reported to have adopted the technique as well in the 2009 survey. In addition, in Europe, the technique has been popularized mostly because of giving the data that a company could use in the utilization of resources. Carnegie and Napier (2009) reported that many felt the technique helps companies in projecting the expected revenues. Judging from these figures and statements, it is apparent the technique has become quite popular and has been embraced. A stated earlier, the reason for the embracing of this technique is mainly driven by the seemingly accurate outcomes. Regarding the demographics of the companies using the traditional method, many of them are ones without overhead cost. For instance, companies like Nokia would have used the tradition method because the trend followed is the same. According to Malmi (2011), whenever a company uses a similar process without further modification of a process in the production of a service, the TA method could be utilized. Nonetheless, this method is being shunned by many corporations for the aforementioned reasons though in some countries using it is compelled due to the policies. In these countries, some of the policies would make it somewhat impossible to entirely shun the method though using the ABC is not prohibited either. 7. Summary Despite the advancement of accounting to where it is today, it is important to understand that it has evolved with time just like all other things. Notwithstanding the popularity of the ABC, one ought to understand that its inception was in the 70s but its development stagnated until late 80s. It mainly focuses on the end-product cost. Concisely, is viewed by many as easier to conduct, as it does not involve many resources. It is still used in some businesses especially ones whose production is not diverse. Its main disadvantages are that it is not accurate in giving the data thus making it somewhat unreliable in making a decision. Secondly, it is becoming rather outdated for it tends to be somehow tedious contrary to the expectations of many corporations. ABC on the other hand has become popular because of increasing the chances of accuracy in calculating the cost of a product. When engaged in abiding competition, this technique would a firm because it considers all costs meaning there would no likelihood of overpricing or underpricing. The critics of this method cite the cost as its main shortcoming not to mention the fact the data it gives does not necessarily mean it is accurate. Whereas it increases the chances of accuracy, it does not comprehensively process accurate data. The emergence and the subsequent development of the ABC method have affected the accounting world in various ways. Firstly, the accountants no longer needed to give unreliable information, as was the case before. Even though the TA method was still used, it was not giving firms the exact cost to be incurred. As a result, companies would end up spending extra money on top of the budget. In addition, accounting world can now speculate the likely expenses in a given production of a particular good. While it may not be entirely possible to speculate everything, it gives them an idea of the factors to consider when planning for a production. References Armstrong, P., (2002). The costs of activity based management, Accounting, Organizations and Society, 27 (2) pp. 99-120 Bromwich, M., & Hong, C., (1999) Activity-based costing systems and incremental costs, Management Accounting Research, 10 (1999), pp. 3960 Brown, A., & Tower, G. (2010). Traditional and Western Accounting Disclosure Models for Pacific Island Countries Entities. Pacific Accounting Review, 44(3), 43-66. Carnegie, G., & Napier, C. (2009). Traditional accountants and business professionals: Portraying the accounting profession after Enron. Accounting, Organizations and Society, 34(3), 360-376. Cooper, R. and Maskell, B.H. (2008), How to manage through worse before better, MIT Sloan Management Review, Vol. 49 No. 4, pp. 5865. Cinquini, L., & Mitchell, F. (2011). 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Journal of Accounting Research, 45(2), 619-31. Read More