Advantages and disadvantages of activity based costing with reference

to economic value addition

Introduction:

The paper has been formulated in order to determine the basic differences that are

present between the activity based costing (ABC) and conventional methods of costing

that are used around the world. A large number of companies have converted to the ABC

system since as far back as 1980 as the system has shown its usability in the appropriate

product mix decision, overheads management etc. (Roztocki 2000) (Reyhanoglu 2004)

The work of many renowned authors have proven to be the crux of the

formulation of this research with sources being as diverse as textbooks and article portals

to renowned journals like the Journal of Accountancy etc. This point is further elucidated

by a scenario study based on the motor vehicle industry which has helped to put things

into numbers and provide a different perspective on the matter. (Reyhanoglu 2004)

Objective:

The objective of this paper is simple to try and uncover whether ABC system is

the best practice in accounting for manufacturing concerns like motor vehicle and parts

industry and whether it is able to cater to problems that are faced by industries employing

conventional costing systems. To achieve this objective, I need to first review the

shortcomings of traditional absorption costing and how ABC can help overcome those

shortcomings, which can be derived from a conceptual and empirical perspective. I

expect to find these concepts through literature review. Some papers and articles with

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case studies would be a good source for the empirical side. And I aim to mathematically

determine the affectivity of the ABC system by conducting a sensitivity analysis on my

system of testing against conventional methods of costing. (Welsh 1981)

To achieve this objective, we need to first review the shortcomings of traditional

absorption costing and how ABC can help overcome those shortcomings, which can be

derived from a conceptual and empirical perspective. We expect to find these concepts

through literature review. Some papers and articles with case studies would be a good

source for the empirical side. We shall come to a conclusion that ABC generally yields a

set of overhead cost numbers that, relative to traditional volume-based methods of

costing, better represent the consumption of shared resources by the firm’s products,

customers and service offerings. Evaluated in light of these new activity-based costs,

particular products may now show up as ‘loss-making’, which appears to be profit-

making when calculated under traditional absorption costing. This information may

enable a firm to change the mix of products produced. The firm may divest the loss-

making product allowing it to focus on making profitable products.

We will perform a walk-through on the company, which aim at comparing and

evaluating the results under the traditional costing method and ABC. In order to make

the introduction successful, other contributing factors, such as management support,

feasibility of introduction, pricing strategy should not be ignored. Discussion will also be

spent in this area, the details of which can be derived from the site visits, management

interviews and study of accounting system and cycle. We aim to obtain some raw data

inputs for applying the concepts we found previously from literature review.

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Background:

In the People’s Republic of China, the demand for motor vehicles and related

products such as tyre has been increasing over the last few years. However, the profit

margin in the Tyre Manufacturing Industry is unimpressive.

Traditionally in the United States or in the United Kingdom, all the expenses were

allocated to the product based on the volume, such as working hours, machine hours, or

number of units produced. ABC was first introduced in the works of John Deere (March

and Kaplan, 1987). In this newly distribution system, costs, products and components

will be allocated by the use of activities, such as set-up time and the number of load

distribution relating to the establishment and material handling. The new system proved

that products cost less in the mass production of small batch processing, compared with

the results in the traditional absorption costing.

In the concepts of ABC, accountants or managers must separate tracking costs

that is required to produce individual units in order to process batch of a product design

or maintenance and maintain a manufacturing facility up and running. Robin Cooper and

Robert Kaplan have presented their views in the ABC system design and implementation.

They also outlined the potential benefits of ABC system in their studies (Cooper and

Kaplan (1988, 1991))

ABC is now commonly adopted by academics and practitioners. However, we

wish to ascertain if it is a good approach for Tyre Manufacturing Industry. For example,

the profitability of Sumitomo Rubber Industry (SRI), a tyre manufacturing company and

one of the famous giants in the industry, has been reducing over the past decade. A recent

case study concluded that apart from the pricing strategy, SRI should focus and adopt a

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more positive accounting approach, such as ABC, in order to maintain sales and

profitability.

The Need for Activity Based Costing

Variable overhead includes such elements as supplies, minor parts, and a portion

of electricity or other power sources. Fixed overhead includes such elements as

supervisory labor, rent, insurance, and a portion of electricity or other power sources.

There is no problem with identifying the variable elements (direct materials, direct labor,

and variable overhead) with the product. In fact, when we produce another unit, we incur

addition variable costs. The problem is in the application of the fixed overhead to the

product. By definition, fixed costs do not increase as we produce an additional unit of

product. However, financial accounting rules require us to include a portion of that fixed

cost in each unit of product. This process is called unitizing fixed costs.

This is a dumb and stupid rule. The unitization of fixed costs treats these costs as

variable even though they are fixed. Thus, when we make decisions concerning products

when fixed costs have been unitized, we are assuming that total fixed costs will change as

the activity level changes and, in fact, those costs do not change. This makes contribution

margin computations invalid - and we have already emphasized the importance of

contribution margin to the decision making process.

Now, let's look at how traditional fixed overhead is added to the product. In the

slide presentation below, the variable costs (direct materials, direct labor, and variable

overhead) have already been assigned to the product. The costs incurred refer only to the

fixed costs that must be allocated to the product. Note the three steps. In the first step, we

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must decide which costs are to be allocated and to which product. This is the definition of

the cost pool. Next the fixed costs are identified and assigned to the cost pool.

Now comes the controversial part. Assume that we have examined the costs and we

decide that direct labor hours (DHL) is to be used for the allocation. Further, assume that

we incurred $120,000 of fixed costs and we estimate we will use 10,000 DHL for the

period. Therefore, we arbitrarily decide to apply (allocate) fixed overhead to the product

at the rate of $12 per DHL. This is the process of unitizing these fixed costs.

In summary, ABC modifies traditional product costing by assigning costs to

activities instead of cost pools. There is a careful analysis of the process to define the

appropriate activities and then a cost driver (allocation method) is selected to allocate

these costs to the product. Now, consider the impact of this change. By defining these

fixed costs within activities, the behavior of the cost has been redefined. Costs that were

previously defined as fixed now are actually treated as variable. In fact, the previous

classification of fixed was inappropriate and the costs are now properly treated as

variable costs. This is the primary (but frequently unrecognized) value of ABC inventory

valuation.

It is important to note that all of the costs previously classified as fixed will be

identified with such an activity. A portion (sometimes a major portion) of costs will

remain in the fixed category and will be treated in the traditional method. The advantage

of ABC is that a portion of costs previously classified as fixed are, in reality, variable and

are now treated as variable.

In this illustration we have the same costs and products as in the traditional

illustration. In step 1, we identify three activities for which costs can be segregated - the

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ordering, cutting, and painting activities. In step 2, we identify that portion of the

previous cost pool costs that are associated with each of these activities. In step 3, we

develop individual cost drivers for each activity and assign the costs based on the activity

incurred by each product. The result is that a significant portion of the costs are now

allocated to the products on the basis of the activities generated by those products.

Advantages of an Activity Based Costing System:

• The first and most important advantage is the accuracy in the process of costing

with regards to the product line, the end-users of the product, the stock-keeping

units employed by the management and the channel and category which

streamline the flow of the product from the producer to the end user.

• This system better assists in the process of understanding the concept of overhead

costs i.e. the allocation of common business resources as they are used by

specific product lines and their relation to specific cost driver.

• The system is easy to understand and interpret is it is accessible, useable and

practically implement able across all norms of business set-ups.

• This process uses unitary cost, or marginal cost as the computation base in

contrast to the traditional cost accounting methods which employ total cost.

• The system works exceptionally well will quality improvement and up gradation

programs e.g. Six Sigma

• This system is particularly helpful in identifying and ear-marking some of the

matters business activities which are a burden or stress on the business i.e.

wasteful or non value adding services.

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 • The system also works exceptionally with performance management systems

which are employed by most human resource departments in contemporary

businesses.

• This process allows companies to implement costing strategies across another

diagonal of the firm as business processes, supply chains and value addition

channels are ably and optimally analyzed in this process.

• This system mimics the actual business process as the appropriation of common

pool resources takes place in the same way as common resources are used in the

business.

• This system aids in the process of benchmarking which is an integral part of he

quality control system.

Disadvantages of an Activity Based Costing System:

• Data collection process for this system is very time consuming.

• The capital expenditure on the activity based system and its subsequent running

costs can be a road block for firms.

• The system is very transparent which some managers would not approve of as

they would like to keep some things out of the view of the owners of the

company.

Technical Limitations:

The major technical limitation that will be faced is testing the hypothesis in the

real world. Testing the hypothesis whether ABC is a more appropriate accounting

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solution is certainly possible on paper but its desirable effects in the real world cannot be

properly gauged unless it is directly implemented by companies operating in the world

today and the analysis is conducted in a kinetic time mechanism. This is a major

stumbling block for most organizations who are remain transfixed to their current

accounting mechanism and don’t want to change over to this new system, which despite

its obvious benefits, seems to come a great switching or even multi-homing cost.

Advantages of Activity Based Costing: The Case of CommQuest Limited:

CommQuest Limited is a fully incorporated marketing and digital

communications group with leading positions in the mobile and digital segments.

CommQuest provides a wide variety of marketing and communication choices for its

diverse and impressive portfolio of clients such as Telstra, News Limited, NEC, Ford,

Medibank and ANZ. [Google Finance, 2008]

An Activity-based costing system follows two steps. The first step identifies

major activities and appropriates overhead costs to each activity depending on the

proportion of the resources that are employed in that activity. The overhead costs that are

assigned to each activity form an activity cost pool. After the assigning of overhead costs

is complete, identification of cost drivers relevant each cost pool ensues. Then in step

two, division of overhead costs from each cost pool to each product line in proportion to

the cost driver consumed by the product line. [Reyhanoglu, 2004]

Now, as we move onto our own case, we have decided to specifically target the

cost head of consulting fees during the period of 2005 to 2007.

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 Here, we will look at perhaps the most important aspect of activity based costing:

the ascertainment of cost drivers. When we look at the cost head of consulting fees, it is

clear to note that this cost is not restricted to a section of the organization. Suffice to say,

every organization contributes towards the accumulation of this expenditure. Therefore,

the most pertinent cost driver that can be employed in this condition is to trace the

whereabouts of cost with regards to the department or area of their inception in this

organization. So, in principle, the organization is basically being demarcated into smaller

units each of whom provide different services to the customer, and each of whom in

collaboration form CommQuest Limited. From here on, the cost of consulting are

attributed to each section of the organization from where it arises and is duly noted

likewise in the operating statement.

It is not abundantly clear whether the mechanism of costing that is employed by

CommQuest Limited is activity based costing but the structure of their operating

statements certainly seem to make the job of an activity based accountant easy as the

statement is created for the entire organization as well as the operating units of the

company. Therefore, the financial statements take a sort of a grid-like structure whereby

costs associated to a single area head e.g. depreciation, is also displayed in entirety with

regards to the firm’s activities and also broken down in line with the smaller sections that

are doing business as well.

Now, when we look at the segmented version of the operating statement, the

usefulness of the mechanism of activity based costing is made strikingly obvious by the

results that are produced. We can see with clear distinction that which sections of the

organization contribute towards the total expenditure with regards to the consultancy fees

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and which section are not as heavily directed towards consultancy expenses as other. Our

point becomes very clear simply from the results of the 2005 operating statement, where

we see that the 94.5% of the total cost of consultancy is charged by the Smart Ply Limited

sub-entity of CommQuest Limited and out of the eight sub-sections of the company, only

two contribute towards the total consultancy fees that were accumulated in the entirety of

2005 and is subsequently charged to all the sections of the company.

To conclude, we see that employing an activity based costing mechanism has

allowed us to better determine the genesis of all the costs that are incurred in an

organization which allows for better decision making vis-à-vis the determination and

control and subsequent minimization of the costs that are incurred by the organization.

Implementing an Activity Based Costing System:

An Activity-based costing system follows two steps. The first step identifies

major activities and appropriates overhead costs to each activity depending on the

proportion of the resources that are employed in that activity. The overhead costs that are

assigned to each activity form an activity cost pool. After the assigning of overhead costs

is complete, identification of cost drivers relevant each cost pool ensues. Then in step

two, division of overhead costs from each cost pool to each product line in proportion to

the cost driver consumed by the product line. (Diagram 1) (Roztocki, 2000)

To do this, companies can create a new department called ‘activity accountancy’.

This accounting mechanism calculates revenues and costs for each activity. They manage

and control the planned activities of the business. In accordance with the requests of the

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managers of the company, they can organize each activity as a profit centre. The job of an

activity accountant is broken down into three parts mentioned below:

1. Resources determined on activities and then planning.

2. Renewable activities are first determined and then planned.

3. Costs are determined as based on functions.

To do this, companies can create a new department called ‘activity accountancy’.

Diagram 1:

Activity-

Based

Costing

System.

Source:

Hilton 1994: 99.

This accounting mechanism calculates revenues and costs for each activity. They

manage and control the planned activities of the business. In accordance with the requests

of the managers of the company, they can organize each activity as a profit centre. The

job of an activity accountant is broken down into three parts mentioned below:

1. Resources determined on activities and then planning.

2. Renewable activities are first determined and then planned.

3. Costs are determined as based on functions.

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 As a result, the differentiation of above aids allocation of costs to costs places.

General Motors Company practiced this system in their 50 of 193 factories and

succeeded in decreasing overheads especially at high production factories.

Activity based costing has also been extended into activity-based management (ABM) to

include other considerations, such as customer profitability, workforce utilization,

distribution channels, and other management issues. Therefore, activity based costing is

the system that shows the cost and profitability structure of products in a firm, whereas

activity based management explains the actions to improve quality and reduce costs and

production time. (Roztocki, 2000)

To sum up, we can see that activity based costing is not essentially a

groundbreaking accounting concept; it just endeavors to look at the costing mechanisms

from an entirely different perspective. Cost drivers which are determined in accordance

with each organization certainly have their benefits which we have adequately

determined in our paper, but the most important aspect of activity based costing which is

sometimes overlooked is the readily ad-hoc system that comes as part and parcel of

implementing an activity based costing system; the ability to change the entire system at

any step of the way is certainly a benefit which cannot and preferably should not be

ignored whilst one is conducting a cost/benefit analysis of the usage of an activity based

costing system.

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Methodology:

Our analysis will be based on a two pronged approach: primary research which

will help us better understand the notions and impressions that accountants in our

industry of choice i.e. the tyre manufacturing industry have with regards to activity based

costing and its applications. Further, we will move onto a sensitivity analysis of

hypothetical products which will help us determine the greater usability of activity based

costing vis-à-vis proper cost allocations.

Primary Research: Impressions of ABC in the Industry:

The primary research that we have conducted here is basically an attempt to

ascertain the proclivities and the impressions that accounting departments in our country

have with regards to activity based costing. The sample questionnaire is given here:

1. What is the current accounting method that is being used in your organization?

a. Activity based costing

b. Other methods

2. Are you completely satisfied with the performance of your costing mechanism of

choice?

a. Yes

b. No

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3. What is the general level of variance between your forecasted and actual

expenditures?

a. 0-5%

b. 5-10%

c. More than 10%

4. What is your opinion regarding the notion that activity based costing is a costing

best practice?

a. Yes

b. No

c. Unsure

5. Would you switch to activity based costing, if given a costless transition?

a. Yes

b. No

6. Would your transition be affected by the knowledge that your competitors are

using the activity based costing system?

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a. Yes

b. No

c. Unsure

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 Results

Note: The total number of companies used in this experiment was 100 out of which 91

gave answers that were useable in this study.

Current Accounting Method

Activity Based
Costing
14%

Other methods
86%

Activity Based Costing Other methods

We were able to determine in this part of my research that activity based costing is

not a popular choice largely due to the fact that people are not receptive to changing a

system which has been in place for a large period of time.

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 Level of Satisfaction

Yes
29%

No
71%

Yes No

This part of my questionnaire helped me determine that current accounting

practitioners are not increasingly happy with the current methods that are implemented in

their respective organizations; as shown by the statistics.

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 Variance of forecasted and actual incurred costs

More than 10%

14%

5-10% 0-5%
29% 57%

0-5% 5-10% More than 10%

Most of the companies in this part of the questionnaire replied with the 0-5

percent variance levels, which depicts the stable and consistent nature of current methods

of costing. However, with a 43% majority stating that the variance levels are higher than

5%, certainly means that there is a considerable room for improvement.

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 ABC as a best practice

Yes
14%
No
14%

Unsure
72%

Yes No Unsure

A large majority of the audience of this research responded to this question by

saying that they were unaware of the inner workings of ABC systems, which shows the

inertia towards change that is faced in these organizations.

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 Conversion to Activity Based Costing

Yes
29%

No
71%

Yes No

A majority of the answers were negative in this part of the question which

corroborated the previously held notions that most organizations are content with their

current costing systems, an impression which has been felt throughout the research

process.

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 Change based on rival’s practices

Unsure Yes
14% 0%

No
86%

Yes No Unsure

In the final section of my research process, the results that have been ascertained

in the earlier parts of my research were further amplified by the notion that a was

majority of the respondents were unwilling to change their current costing mechanisms

based on the knowledge that their competitors were using a specific costing method

whereas not even a single respondent answered in a yes, clearly showing that accounting

practices as a value addition proposition is merely that at this point in time: a proposition.

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Secondary Research: Sensitivity Analysis

Company A

Company A is a hybrid tyre manufacturing company in the People’s Republic of

China (a real company as avoided to prevent copyright infringement issues). This

company is owned by three people who also manage the company. Company A employs

more than 100 people; however, a large part of the manufacturing process is automated.

The firm is in the area of manufacturing tyres for all manners of publicly used vehicles.

Company A sells its products mainly in the domestic market, however, some

consignments are shipped abroad to some loyal and permanent customers.

Most customers are manufacturers or electrical companies looking to replace their

old equipment. A portion of the company’s output is sold directly to customers via retail

outlets, while the remainder is sold with the help of independent distributors and

wholesalers. At the time, Company A was using a traditional cost system and overhead

allocation was on the basis of direct labor hours. This retrieved information was

subsequently used for cost management and profit generation activities.

Now, the management of Company A is interested in uncovering methods to get

reliable cost information with regards to their major product lines: Motors and Motor

Parts, Breakers, Control Products, and Miscellaneous Parts. All three costing systems

(Traditional Cost Accounting, Activity Based Costing and Integrated Activity Based

Costing-and-Economic Value Added System) are used to obtain information regarding

the costs of Company A with the basic objective of these calculations being to obtain and

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compare cost information from all three systems. The results are presented in the

following sections.

Integrated Activity Based Costing-and-Economic Value Added System

All the financial information that is needed for our analysis is obtained from

Company A’s income statement and balance sheet. Table 2 and Table 3 present Company

A’s income statement and balance sheet respectively.

Table 2: Company A’s Income Statement in Millions of Dollars

Description $(in million)
Net sales 5,452
Cost of goods sold (2,986)
SG&A expenses (2,214)
Earnings before interest and taxes 252
Interest expenses (87)
Income before tax 165
Income tax (42% of income before tax) (69)
Net Income 96
Arbitrary Figures

Table 3. Company Z’s Balance Sheet in Millions of Dollars

Assets $(in million) Liabilities $(in million)

Current Assets Current Liabilities

Cash 30 Accounts Payable 814
Receivables 833 Accrued Expenses 38
Inventory 1014 Short-term Debt 404
Other Current Assets 0 Total Current Liabilities 1256
Total Current Assets 1877
Long Term liabilities
Fixed Assets Long term Debt 968
Property 0 Total Long-term liabilities 968

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Equipment 1704
Other Fixed Assets 100 Owner's Equity
Total Fixed Assets 1804 Common Stock 300
Retained Earnings 1157
Total Owner's Equity 1457

TOTAL ASSETS 3681 TOTAL LIABILITIES 3681

Arbitrary Figures

Company A’s operating expenses include selling expenses, administrative costs,

and general expenses such as transport, rental fees, utilities, and maintenance charges.

The largest component of operating expenses was included in the SG&A expense

category on the income statement and a part of the operating expenses was also included

in the cost category of the income statement: cost of goods sold ($120,000,000). The

Company’s capital consists of all money invested in the firm. Company A’s capital was

estimated by subtracting all non-interest bearing liabilities (Accounts payable and

Accrued expenses) from total assets. The complete calculation is shown below:

Table 4. Company Z’s Capital in Millions of Dollars

Description $(in million)
Total Assets 3681
Accounts Payable (814)
Accrued Expenses (38)
Capital 2829
Arbitrary Figures

Company A’s implementation of the Integrated Activity Based Costing-and-

Economic Value Added system is initiated with the identification of its major business

activities. Use of overhead resources determined the operating costs for each activity.

These operating expenses are then traced back to products using cost drivers. After

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operating cost drivers were selected, driver volume information (such as material cost

and number of inspections) was collected. Using the previously selected operating cost

drivers and driver volume data, Company A’s overhead was traced to its four product

lines.

The calculation for the Capital Charges for Company Z’s product lines begins

with the estimation of its CCR. Now, a bank interest rate for debt was 11 percent at the

time, therefore, CCRDebt was chosen to be 11 percent. As the expected return on equity for

the managers was 14 percent, the CCREquity was chosen to be 14 percent in accordance.

The company’s applicable tax rate t was obtained from its income statement and the

balance sheet provided the (long and short-term) debt and the value of the owners’ equity.

Using this information and the equation derived earlier, the CCR for Company A

is:

CCR = CCRDebt* (Debt/(Debt + Equity)) + CCREquity * (Equity /(Debt + Equity))

(1-t)

= 11% * (1372/(1372+1457) + 14% * (1457/(1372+1457))

(1-0.42)

= 5.33% + 7.21%
0.58

= 5.33% 12.43%

= 17.77%
Source: Roztocki, 2000

Therefore, a CCR of 18 percent was chosen for all of Company A’s accounting

categories and product lines. The total capital cost can then be generated once the CCR

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and Capital were determined. This calculation returns total capital charges to be $

510,000,000. Using our earlier equation, CT-ratio can be calculated as follows:

CT- Ratio = Capital Cost

Total Cost

= 510000000
5596000000

= 0.091
Source: Roztocki, 2000

We can see that Company A has a high CT-ratio (>0.05) which suggests that

implementing the Integrated Activity Based Costing-and-Economic Value Added system

has potential to increase the reliability of Company A’s cost information. Next, the

Product-Capital-Dependence (PCD) Analysis is used to trace capital charges to product

lines. The relatively high cost of capital for Tyre and Tyre parts as well as Breakers is

explained by the high capital investments in inventory and manufacturing equipment.

Finally, Integrated Activity Based Costing-and-Economic Value Added cost information

was obtained by adding the operating and capital costs to the direct cost. Table 5 shows

these results.

Table 5: ABC-and-EVA Product Cost Information for Company Z in Millions of Dollars

Operating

Product Line Direct Cost Cost Capital Charges ABC and EVA

Tyro and Tyre parts 1255 1093 180 2528

Breakers 677 647 113 1437
Control Parts 318 236 36 590
Miscellaneous Parts 616 358 67 1041

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Total 2866 2334 396 5596
Arbitrary Figures

Results

The product cost information for the four product lines shows notable differences

between the three costing systems. Integrated Activity Based Costing-and-Economic

Value Added System was the only system which to capital cost into account. Table 6 and

Table 7 summarize the product cost information and profitability figures respectively. [14]

Table 6 : Comparison of Product Cost Information for Company Z in Millions of

Dollars
Product Line TCA ABC ABC and EVA

Tyre and Tyre parts 1839 2348 2528

Breakers 1261 1324 1437
Control Parts 655 554 590
Miscellaneous Parts 1445 974 1041

Total 5200 5200 5596

Arbitrary Figures

Table 7 : Comparison of Profitability and Value Creation for Company Z in Millions of

Dollars
Product Line TCA ABC ABC and EVA

Tyre and Tyre parts 661 152 (28)

Breakers 310 247 134
Control Parts (154) (53) (89)
Miscellaneous Parts (565) (94) (161)

Total 252 252 (144)

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 Arbitrary Figures

Now, given the results shown by the Integrated Activity Based Costing-and-

Economic Value Added system, Company A’s management should show a tendency to

change its prevalent decision making processes.

This system is able to uncover facts that other were not able to as we see in the

product line Tyre and Tyre Parts, which were earlier believed to be highly profitable

under the traditional cost accounting calculations does not to create economic value in the

Integrated Activity Based Costing-and-Economic Value Added system. However, as the

Economic Value Added in this product line was only slightly negative, it is not difficult to

assume that marginal increase in price would make Tyre and Tyre Parts a value creator.

This price increase would only be feasible if Company A had an especially strong market

position with regards to that particular product line. This mechanism is also very different

from the activity based costing profitability which showed a positive profit which

encouraged managers of the firms to reduce prices in hope of increasing sales.

Atlas Electronics, Inc.'s Costs ($)

Costs According to Costs According to Under-Over

ABC Direct Labour Allocated and
Hours Priced
Product Product Product Product Product Product
A B A B A B
Direct Materials 400.0 200.0 400.0 200.0 0.0 0.0

Direct Labour 50.0 50.0 50.0 50.0 0.0 0.0

Overheads 950.0 137.5 300.0 300.0 (650.0) 162.5

Total per unit cost 1400.0 387.5 750.0 550.0 (650.0) 162.5

Target Price (20% 1680.0 465.0 900.0 660.0 (780.0) 195.0

of cost)

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 Atlas Electronics, Inc.'s Activity Areas

Activities Loadable Number of Application Total Total

Costs Activities Rate
Total A B A B

[a] [b] [c] [d] [a/b=e] [e*c] [e*d]

Material 10000000 5000 3000 2000 2000 60000 400000

handling 00 0
Start Station 10000000 10000 6000 4000 1000 60000 400000
00 0
Machine 25000000 20000 12000 8000 1250 15000 100000
Installs 000 00
Manual 20000000 20000 15000 5000 1000 15000 500000
Installs 000 0
Quality 5000000 10000 6000 4000 500 30000 200000
Testing 00 0
Packaging 5000000 10000 5000 5000 500 25000 250000
00 0
Total 75000000 47500 275000
Overheads 000 00
Total 50000 200000
Production
Overhead 950 137.5
per unit

Conclusion:

Activity based costing is the need of the future. Traditional costing method,

despite being simplistic and easy to handle are continuously becoming too archaic for

them to be of any use to the firms. However, we have seen that even a simple activity

based costing mechanism is inadequate in measuring the trails and tribulations of

contemporary business activities. Therefore, it is imperative the firms wake up to the

notion of activity based costing and even that of the activity based costing mechanism in

addition to the economic value added system in order to better ascertain their costs as we

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have seen in the pilot study of Company A: a tyre manufacturing company in the People’s

Republic of China, so they can increase their profitability and maintain their competitive

advantage in their market of operations.

Bibliography:

Andrea, C, Filho, P, Espozel, M, Maia, A & Quassim, Y 1999, ‘Activity-based costing for

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