impact of activity base costing on the performance of manufacturing firm
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Many traditional cost accounting techniques have been used in manufacturing within the last decades. Traditional cost accounting techniques include standard costing, absorption costing, and marginal costing among others. However, traditional techniques have been severely criticized for not being relevant in today’s business environment. The newer techniques suggested by various advocates of modern techniques include Activity-Based Costing (ABC), Target costing life cycle costing among others. These critics of traditional techniques have inspired to use one of the modern techniques ABC to carry a study on the impact of ABC on the performance of manufacturing firms. To achieve the aim of this study the researcher is guided by the objective; to identify problems associated with implementing ABC and to examine the effect of ABC on the profitability of AZUR S.A Cameroon. Data for this study is collected from secondary sources (cost sheet, statement of comprehensive income and statement of financial position, published articles, websites, and company records) from the accounting and finance department of AZURI SA Cameroun for the period 2010-2014. Both quantitative and descriptive tools were used to analyze the data, descriptive tools include, percentages, frequency, distribution, mean, median, and standard deviation. Quantitatively, the person product-moment correlation coefficient will be used to examine the association between ABC and company performance. Also, the ordinary least square (OLS) has been used. The validity of our result would be confirmed by subjecting our data to the following test; stationarity, spuriousness. To test our hypothesis (Hi) which states that “ABC has a significant effect on the performance of AZUR S.A”. Results proved that ABC has an impact on the performance. From the results, it is concluded that identifying the various activities of a company and assigning a cost to these activities concerning how much of the total percentage each activity consumes is significant in evaluating the performance of the company. Our correlation and regression analysis provides us with a basis for making a conclusion that activity base costing affects the performance of AZUR S.A
The manufacturing industry can trace its roots to the late 18th century and the industrial revolution, (Van de Graaff 2010). During this period the manufacturing of goods developed from a cottage industry into a large-scale, mechanized industry that relied on large factories. In the 20th century, the manufacturing industry flourished in the western world and provided a large portion of job in the industrialized world. In the late 19th century, however, much of the manufacturing industry left western countries in favor of low-wage countries, such as China. Much of the prosperity experienced worldwide after the Second World War can be tied to a booming manufacturing sector first half of the 20th century, the U.S. experienced a trade surplus due largely to its manufacturing sector (Friedman 2006). Decades later the manufacturing sector shrunk, leaving the country with a trade deficit (imports outstripping exports) because the workforce took on more service-industry jobs. This may harm the economy due to the positive ancillary benefits of the manufacturing sector. For example, according to the Manufacturing Journal (2000), a University of Michigan study shows for each job in manufacturing, more than six “spin-off” jobs are created.
Global competition has forced manufacturing services and organizations to become more flexible, integrated, and highly automated to increase their productivity at reduced costs (Cooper and Kaplan 1987). Given that most companies have objectives to maximize profits, it is necessary for production decisions geared towards the attainment of this goal to be made. This involves producing the most profitable products given the constraints of the firm and bearing in mind that it may not be able to produce all that the market demands (Cokins, 1998). The best action is to focus on the most profitable products and use all the existing resources of the company to produce these products. In this way, the company can increase profitability because existing resources will be used to produce the most profitable products.
Cameroon is primarily an agro-based economy with almost 70% of the population engaged in agriculture and allied activities. After 2005, the expansion of the non-oil sector has contributed largely to the economic growth of the country. The fertile land of Cameroon allows the cultivation of cash crops such as cocoa, coffee, tobacco, and cotton. However, in the 1980s, the price of these cash crops declined drastically. This caused a severe impact on the economy resulting in a decade-long recession. In the 1990s, the International Monetary Fund and the World Bank provided financial assistance for the development of the country’s industrial and service sectors. Also, the economy was liberalized for greater private and foreign investment (Economy Watch, 2010). The main industry sectors include oil, mining, manufacturing, and chemical. However, the economy is fueled by other industries such as automotive, engineering, real estate, construction, forestry, and food processing (Business Monitor International, 2010).
The objective of the study is to evaluate the cost accounting techniques that are being used in manufacturing within the last decade. Traditional Cost accounting techniques include Standard Costing, Absorption Costing, and Marginal Costing among others. However, traditional techniques have been severely criticized for not being relevant in today’s business environment. The newer techniques suggested by various advocates of the modern techniques include; Activity Based Costing (ABC), Target Costing, Life Cycle Costing, Just in Time System, Throughput Accounting/costing, Back Flush Costing, and Kaizen costing among others.
According to CIMA terminology, standard costing ‘is a control technique that reports variances by comparing actual costs to preset standards so facilitating action through management by exception’. It refers to the technique which uses standards for costs and revenues for control through variance analysis. Standards are established for each cost element on a scientific basis for an immediate future period, and actual are compared against the standard. Variances from standards are analyzed, reasons established and corrective action taken to stop recurrence of inefficient operation. According to (Küçüksavaş, 2000) standard costing aims to provide the cost information relating to controlling costs, providing convenience and quickness to compute production costs, preparing business budgets, pricing products, and measuring the performance of division
Absorption costing is also known as the full costing method is a costing system that treats all costs of production as a product cost regardless of whether they are variable or fixed costs. Absorption costing principles must be used when preparing financial statements for an external purpose (Hoarend, 2002). Absorption costing is suitable for determining the price of the product as it ensures that all costs are covered, it shows correct profit calculation, conforms with matching and accrual concepts of accounting, and hence, is recognized to prepare external reports and for stock valuation. However, CIMA states that “traditional absorption costing is probably of limited value in a manufacturing environment where the production process is highly automated, and production overhead
costs is a much more significant element of the cost than direct labour”.
Marginal costing is also known as variable costing and direct costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision- making. It is a principal costing technique used in decision-making because it allows management attention to be focused on the changes which result from the decision under consideration. It is a useful technique for short-term decisions such as Make or Buys, Accepting or Rejecting a Special Order, Deleting a line of business or segment, and outsourcing among others.
The activity-Based Costing (ABC) method was conceived in the mid-80 by Robin Cooper (a professor of Management in the area of designing and practicing costing systems) and Robert Kaplan (a professor of Management Accounting at Harvard University). It was developed mainly to correct misleading overhead allocations. At first, it was a response to the inaccurate standard costing American methods. The ABC method was designed in the United-States during the ’80s. It is a refined cost system that enables classifying more costs as direct, expend the number of indirect-cost pools, and identifying cost drivers. ABC favours better
cost allocation using smaller cost pools called activities. Using cost drivers, the costs of these activities are the basis for assigning costs to other cost objects such as products or services. According to CIMA, Activity-based costing is an approach to the costing of final output by monitoring the activities and tracing consumption of resources to the activities. Resources are assigned to activities, and activities to cost objects based on consumption estimates.
Every company is concerned with using its available resources and make the highest profit or maximise its organisational goals (Daly, 2001). However, it is impossible to sustain competitiveness without an accurate cost calculation mechanism. Having a product mix that maximizes a firm’s objectives is of utmost importance. Accurate information about the optimal output mix, their costs of production, and the constraints of the firm will help management make more informed decisions (Ruskin, 2003). Deciding on what to produce, how much to produce and for whom to produce will lead a company towards its goal maximisation. This strategy involves the management of existing successful products, the elimination of obsolete or non-profit making ones, and the development and introduction of new products i.e. product mix decisions are based on three options – modify existing products, delete existing products or add new products. According to a study conducted by the Cost Management Group of the Institute of Management Accountants (IMA), the results reveal that 71% of companies that adopted ABC had the above-average potential for cost distortions, 65% had above-average usefulness of cost information, and 7% report major system software initiative occurring (Krumwiede, 1998).
The modern industry faces many problems and challenges. The most important problems facing industries include labor productivity, energy supply, and government regulation. Besides, industrial societies face such challenges as environmental pollution and unemployment. The problems of traditional manufacturing units include a remote location with less developed infrastructural facilities, lack of managerial talent, poor quality, traditional technology, and inadequate availability of finance (Indian blogger, 2010).
However, it is severely flawed because it usually does not reflect reality. For example, today it is common to see a company value land on their balance sheet at 1 million even though it is worth 50 million or more. Similarly, depreciation and amortization standards often do not reflect reality as well. The answer to this, many experts believe, is Activity Based Costing. This research is therefore structured to answer the following main research question.
- What is the impact of activity-based costing on the performance of a manufacturing company?
It also seeks to provide answers to the following specific questions:
- What are the problems associated with implementing activity-based costing in AZUR S.A Cameroon?
- To what extend does activity-based costing affect the profitability of AZUR S.A Cameroon?
The main objective of this study is to assess the effect of Activity Based Costing (ABC) on performance. This is broken down into specific objectives which include;
- Identify problems associated with implementing Activity Based Costing.
- Examine the effect of Activity Based Costing on the profitability of AZUR S.A Cameroon.
To provide greater insight into the research problem and provide a focus for the entire study, a hypothesis is formulated comprising the null hypothesis (Ho) and the alternative hypothesis (Hi).
The null hypothesis states an opinion in a negative form while the alternative testing hypothesis states an opinion in a positive form (Izedonmi, 2005). The hypothesis testing of this study is therefore stated as follows