AMA-CW, MAN MING LI

ENU matriculation ID:54088860

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

Table of content

1. Outline of chosen Hong Kong company....P.3

2. Characteristics of an organization contributing to the use of activity based
techniques .P.4-5
3. An appropriate ABM example in chosen
company......................................................................................P.6-8

4. How the ABM information can be used by managers.

....P.9

5. Problem causing an organization to decide not to use or to abandon use

of activity based techniquesP.10-P.11

6. Reference List...
P.12

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

Luen Yick Electrical Mfg Co., Ltd.

Since 1968, the group has been a manufacturer of electrical accessories and
lighting products with a wide range of furniture and bathroom lights, fluorescent,
energy saving and LED lighting products to the international market. From
product design to final assembly, all production processes are done in-house,
which makes customizing products easy for us.
Number of employees: 201-500
Year Established : 1968
Nature of Business : Manufacturing
Major export markets : Hong Kong
Products / Services: electrical accessories and lighting products

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

Activity Based Costing (ABC) is a costing methodology used to trace overhead

costs directly to cost objects, i.e. products, processes, services, or customers.
Costs are assigned to specific activities (e.g. engineering, manufacturing or
purchasing) based on their use of resources and costs are assigned to cost
objects based on their use of activities. ABC recognizes the causal relationship of
cost drivers to activities. ABC techniques enable a business to decide which
products, services, and resources are increasing their profitability, and which are
contributing to losses.
Certain organizations appear to be more successful in implementing ABC than
others. ABC helps the managers in these organizations to make the right
decisions regarding product mix, pricing, process improvements and product
designs. Closer look reveals characteristics of an organization such as structure,
product range or environment contributing to these successes.
Cost Structure
Where overhead costs comprises major portion of product costs as compared to
direct costs such as direct labour and direct materials, correctly attributes
overhead costs to product is highly important. In modern business, service
departments plays a more and more important role than in the past in which
production department is mainly responsible for key manufacturing activities.
Overall product and service costs are more influenced by research, materials
handling, procurement, equipment maintenance, quality control and customer
service requirements than by direct labor or direct materials. Therefore, everincreasing cost of these service departments must be traced to the final product
so that correct pricing and product mix position can be made. ABC is certainly
excels traditional costing method which distribute overhead cost using an
overhead charging rate.
On the other hand, if indirect costs make up a relative small proportion of total
costs in some industries it may not be worthwhile investing in sophisticated
accounting methods to allocate indirect costs. Traditional costing systems may
not result in the reporting of seriously distorted costs in this case.

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

Product Range
One homogeneous overhead rate is no longer an appropriate average for
overhead cost allocation in company which involves huge product variety and
product line complexity. Since overhead resources are used by different products
and product lines at substantially different rates, a change in product mix can
lead to dramatically cost changes that will not be predicted accurately by
traditional cost systems. Arbitrary costs under traditional costing method leads to
incorrect make/buy decisions. Therefore, companies with wide product range are
more prone to accepting ABC techniques for pricing and product mix decision.
Companies with only a few products and markets aren't likely to get as much
benefit from basing costs on activities as companies operating with diverse
products, service lines, channels and customers.
Competitive Environment

Output market competition is associated with greater use of management

controls. More reliable and accurate cost information maybe needed as
competition increases as there is greater chance that a competitor will exploit any
costing errors made. There higher level of competition drives for adoption of ABC
systems.

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

ABM example in chosen company:

Lets have a look how different might be costs allocation using traditional cost
allocation system and ABS system.
Table 1 summarizes costs using traditional cost allocation. Assume that a firm
produces two products (A and B). Product A is high-volume product and product
B is a new low volume product.
Table 1
Costs using traditional cost allocation

Number produced
Sales
Direct labor
Direct material
Overhead
Total costs
Profit
Cost per unit
Profit per unit
Profit % of sales

Product A
100000
$900 000,00
$130 000,00
$200 000,00
$480 000,00
$810 000,00
$90 000,00
$8,10
$0,90
10,00%

Product B
1000
$500 000,00
$25 000,00
$75 000,00
$90 000,00
$190 000,00
$310 000,00
$190,00
$310,00
62,00%

Next table summarizes costs using ABC system. The same products (A and B)
are used.
Table 2
Costs using ABC system approach

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

Number produced
Direct labor
Direct material
Overhead
Setup cost
Inspection cost
Depreciation
Other
Total overhead
Total cost
Cost per unit
Selling price per
unit
Profit per unit
Profit % of sales

Product A
100000
$130 000,00
$200 000,00

Product B
1000
$25 000,00
$75 000,00

$25 000,00
$10 000,00
$50 000,00
$12 000,00
$97 000,00
$427 000,00
$4,27
$9,00

$75 000,00
$85 000,00
$100 000,00
$95 000,00
$355 000,00
$455 000,00
$455,00
$500,00

$4,73
52,56%

$45,00
9,00%

Obviously there is a big difference in costs amount and therefore in profit per
unit. Decisions based on traditional cost allocation system could be wrong,
because of inaccurate costs allocations. You should take into an account that
such a difference often appears when costs are allocated among two products or
services in production, where overhead costs are not volume-based. It means
that when sales increase then costs also proportionally increase. It is also true for
two products when one is high-volume and the second is low-volume.

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

The ABM information can be used by managers:

Activity Based Management (ABM) is a system that allows management to

analyze the efficiency of a company, based on information from ABC system.
ABM is an important tool for achieving continuous improvement. As it is
previously mentioned, ABC system provides an opportunity for decision making.
Once costs are allocated among activities, managers are able to compare them
among different plants within a company or benchmark in order to be sure that
they are not too high. The same applies to the products or services. Managers
are able to decide which product or service is more profitable and make
appropriate decisions, such as increasing production level of highly profitable
products and decreasing or stopping production of low profitable products or
services.
Activity Based Management consists of four major steps:
1. Identify activities of the company;
2. Group costs resources required by these activities;
3. Analyze the efficiency of these activities;
4. Decide how to improve efficiency of these activities.
All of these steps are closely related to the steps of ABC system implementation.
The difference is that ABC measures cost of final products or services through
the activities, however, ABM measures efficiency of companys activities.
According to Stratton et al. (2009), ABC methods are better integrated with
budgeting and planning processes. All this indicates that companies using ABC
feel better equipped to apply their results to management decision support
(activity-based management).

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

Problem causing an organization to decide not to use or to abandon use of

activity based techniques:
Resistance to change
People who are in position of power may fears that ABC will disturb the existing
power structure within the company as ABC expose wrong decision making or
inefficiency in the past, expose the real cost and contribution of some
operations.. So manager who enjoy high prestige status under traditional costing
environment may be reluctant to accept ABC which downgraded their
performance or in extreme case may even fear of loss of job as their division may
turn out to be loss making under ABC method.
Front line staff may also resistant to change to ABC system as life is simple and
easy under traditional costing system. More time and effort are required under
ABC to spend on data collection and processing, identification of cost drivers,
study of cost behaviour etc. They have to learn new skills and adopt new
practices. Without certainty that they will share the benefits from adoption of
ABC, they are reluctant to accept it.
Lack of Top Management Commitment and Under-utilization of Information
Top management commitment is extremely important for successful
implementation of ABC. They are leaders in committing the necessary resources
such as software, training and external consultants as well as incentives to staff
for completion in each milestone in the adoption of ABC. They must have good
implementation plan and communication and consultation process with all staff
involved so as to reduce the resistance to change. They should integrate ABC
with the company strategic objectives as well as existing business processes,
reporting and performance measurement system. Without senior management
commitment, chance of ABC being successfully adopted will substantially be
reduced. Even if ABC could substantially reduce product cost distortions, it is not
likely to help unless senior management can actually utilize better cost
information in its decision making process. So if top management does not fully
capture the benefits from adoption of ABC by acting on the results that the data

AMA-CW, MAN MING LI

ENU matriculation ID:54088860

provide, it will not outweigh the cost of buying, implementing and maintaining
activity based system.
Too complicated implementation
Companies that implement activity-based costing run the risk of spending too
much time, effort, and even money on gathering and going over the data that is
collected. Too many details can prove frustrating for managers involved in ABC.
On the other hand, a lack of detail can lead to insufficient data. Activity definition
may become too detailed and organizations may build a model.

(Words 1595)

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AMA-CW, MAN MING LI

ENU matriculation ID:54088860

References
1. Roztocki, N., Valenzuela, J. F., Porter, J. D., Monk, R. M., and Needy, K.
L., 1999, "A Procedure for Smooth Implementation of Activity Based
Costing in Small Companies", Proceedings from the 1999 ASEM National
Conference, American Society for Engineering Management, pp. 279-88.
2. Dr Pavlatos Odysseas, 2008, Insights into factors affecting the adoption
of ABC systems in the hospitality industry: evidence from Greece,
Department of Economics, University of Crete Panepistimioupoli Gallou,
Rethimno, Greece
3. Roland Bardy and Al Hartgraves , ABC: pitfalls & problems caveats &
remedies. Is there a "transatlantic divide" ? , Goizueta Business School,
Emory University, Atlanta, GA 30322
4. Kengo lighting company

http://www.kengo.com/ [accessed 20.3.2015]

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ENU matriculation ID:54088860

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