Question

Companies usually, in pursuit of refining their costing system, adopt Activity-Based Costing systems with an aim to arrive at accurate cost figures. Describe, in your own words, the prominent factors/reasons (any four) that contribute to these companies’ taking such initiatives. That is, what are the main factors that are causing these companies to consider refining their costing systems?

Answer 1

1. In the present competitive scenario, where innovation is the rule of the day, product life cycles have shortened and the competition has increased amongst companies at an unprecedented level. Such a scenario requires companies to produce in small batches as per customer requirements (implying higher raw material costs due to smaller purchases than before), deliver quickly and efficiently (higher incidence of cost on the customer support and distribution functions of the value chain) and most importantly be prepared for product obsolescence. Hence traditional costing may not be appropriate today. The above mentioned issues in the changed industrial environment have resulted in new concepts of cost management in companies e.g total quality management, just in time, activity based costing, target costing, back flush costing etc.

2. Total quality management: Customer expectations are very high now a days. Hence an integrated and comprehensive system of planning and controlling all business functions is required. TQM serves the purpose. Applying TQM, we can produce the products or services which meet or exceed customer expectations.

3. Activity based costing: Factors prompting the development of ABC system include,

a. Growing overhead costs because of increasingly automated production.

b. Increasing market competition which necessitated more accurate product costs.

c. Increasing product diversity to secure economies of scope and market share.

d. Need of assigning the resources and overhead costs more accurately to products and services. To do the same, production process to be segregated as different activities.