Introduction

Why there is need for activity-based costing/management? Why it has become vital part for
decision making regarding any financial requirements? These questions arise with the emerging
problem in the traditional accounting system. The traditional accounting system of a company
is often conjunct with its general ledger system, this articulation is grounded in cost allocation.
All those costs that derived from traditional allocation approach undergo from various defects
with end results in distorted costs for decision-making process. For instance, traditional
accounting system allocates the cost of idle capacity to products. Such products are charged for
resources that company didn’t use. To mitigate this problem companies started moving
towards different cost-allocation approach that is called as Activity-based costing and activity-
based management.
Activity-Based Costing
Activity-Based Costing (ABC) was presented in response to the need for a costing tool based on
the factors that give rise to indirect costs as well as one able to show more objectively the
cause and effect relationship between products and costs. The method based on assumption
that production costs are incurred for the implementation of activities. which are performed in
order to produce and sell products. Therefore, ABC correlates costs to activities, then to
products, through a two-stage imputation methodology [ CITATION Joh87 \l 1033 ].
The strength of ABC (Activity-based Costing) is due to its acknowledgement that the
consumption of resources in the production process is accompanied not only to the volume of
production, but largely to activities related to transactions that occur within the
organization[ CITATION Coo88 \l 1033 ].

[ CITATION Joh00 \l 1033 ] told that ABC is a powerful tool for pricing than traditional costing
system. The reason is under ABC, for each unit, batch or product level activity, a cost driver is
identified which determines cost per unit. According to him, when the resource consumption
for an order is typical of total expected company resource, both traditional cost system and
ABC system estimates will be same. They will be different if orders are not typical of total
expected company resource utilization.
Furthermore, ABC was created as a way to address issues and obstacles related with traditional
cost management systems, which in general have the inability to precisely determine actual
production and service costs or give helpful data information for operating decisions. Because
of these insufficiencies managers can be exposed to making decisions based on inaccurate data.
However, ABC helps better to identify the nature of the decisions that management is called
upon to make. It also focuses management on two clear objectives.
1. To ensure that cost effective methods are used to produce current products to current
customers at a price that generates the maximum positive ABM (Activity-based Management)
Product and Customer Contributions.
2. To ensure that the ABM Contributions are used effectively to generate new products and
services to new markets such that the return on the investment in Sustaining costs is greater
than that which would be achieved by shareholders investing elsewhere

Activity-Based Management
In order to manage costs, a manager should concentrate on the activities that offer ascent to
such costs. Accordingly, managers should adopt ABC systems to facilitate cost management.
Utilizing ABC systems to improve financial management is called activity-based management
(ABM). The main objective of ABM is to improve the worth received by customers to improve
profits. The key to ABM success is distinctive amid value-added costs and non-value-
added costs. “A value-added cost is the cost of an activity that cannot be eradicated without
disturbing a product’s value to the customer. In contrast, a non-value-added cost is the cost of
an activity that can be abolished without waning value. Approximately, value-added costs are
always essential, as long as the activity that drives such costs is performed efficiently”.
However, non-value-added costs should always be minimized be-cause they are assumed to be
unnecessary. Examples of non-valued-added activities include storing and handling inventories;
transporting raw materials or partly finished products, such as work-in-process inventory items,
from one part of the plant to another; and redundancies in production-line configurations or
other activities. Oftentimes, such non-value activities can be reduced or eliminated by careful
redesign of the plant layout and the production process [ CITATION Jaf12 \l 1033 ].

Activity Based Management (ABM) allows managers to understand product and customer
profitability, the cost related to business processes, and ways how to improve them. Since
traditional management accounts and standard costing systems do not give this information, it
is perhaps shocking that ABM is not widely used. Unlike many management techniques,
research shows that 80 per cent of companies that have employed activity-based techniques
found them to be successful.
Overhead costs are the black hole in conventional management information systems. ABM
shines light into the hole. Know-how of a business at the level of activities is the fundamental
building block upon which new understanding can be built of where profits are being generated
and where they are being eroded. By making visible what was previously invisible, ABM spread
a spotlight on those areas of a business where action can directly improve business
performance and efficiency. Because it deals with financial numbers’, ABM is often perceived
as the sanctuary of the Finance function. In fact, its real strength lies in providing
genuinely useful information for all functions in an organization.

Relation between ABM and ABC

ABC and ABM are mostly used interchangeably by researchers and practitioners. They referred
to ABC as the actual technique for determining the costs of activities and the outputs that those
activities produce. They referred to ABM as the fundamental management philosophy that
focuses on the planning, execution and measurement of activities as the key to competitive
advantage [ CITATION Rob96 \l 1033 ].
ABC as a means of creating product costs more accurately. He described ABM as a means of
enhancing profitability by focusing on a process view of the business and a deeper
understanding of product, channel and customer profitability [ CITATION Plo01 \l 1033 ].

Rationale Behind ABC and ABM and some real-life Examples.

[ CITATION Che98 \l 1033 ] studied the practices of five manufacturing corporations in Australia
implementing new management accounting systems (including activity-based techniques).
Benefits identified included accurate product costing, timely information, improvements in
profitability and improvements in physical operations and the working environment.
Semi-structured interviews were conducted with nine subjects in a division of a large
manufacturing company with responses indicating user support for ABC. Factors identified
which influenced user perceptions were the expectation of benefits such as improved
information, improvements in communications across functions, greater confidence in decision-
making, more useful, reliable, understandable information, and finally, greater
efficiency[ CITATION Nor93 \l 1033 ].

A study was conducted to examine the relationship between adoption of Activity Based Costing
(ABC) and the Decision Making. The population of the research study was factories located in
Gaza Strip. A questionnaire survey method was considered an appropriate method for this
study. The sample was selected from the Ministry of Industry. 43 questionnaires were returned
back and generating an 86% response rate. The outcomes prompt that the most important
decisions in Gaza Strip factories are taken for Product Quality, Product Cost, Cost of Add/delete
Product Lines and Product Costing concluding that costing system is a vibrant part for the
decision makers in helping for rational decision making. Another result indicates that Gaza
factories were not implementing ABC which affect negatively the decision-making
process[ CITATION Ska06 \l 1033 ].

A large Chinese manufacturing company, Xu Ji is a state-owned enterprise (SOE), turned public

limited company (PLC) when they implemented Activity-based costing. “The company executed
ABC implementation in one of its main production divisions in December 2001. Xu Ji started
from a very elementary level, building financial accounting systems and office computerization
before executing the ABC system which apprehended direct costs and variable manufacturing
overheads before processing. The foremost accomplishments of Xu Ji’s ten years ABC efforts
are that ABC drastically altered the SOE, curved PLC’s traditional costing systems and
encouraged standardization in their working practices and processes. ABC likewise acts as a
compound to Xu Ji’s IT developments – first accounting and office computerization and later the
ERP implementation” [CITATION Jun11 \l 1033 ].

Since Safety-Kleen, a midsize waste-recycling company, introduced ABC into its organization,
also in 1991, it has reaped more than $12.7 million in cost savings, cost avoidance, and
increased revenues—more than 14 times its investment in the program. The company, based in
Elgin, Illinois, has implemented ABC to prune product lines, rationalize operations, and expand
into new markets. Even more important, ABC has helped Safety-Kleen transform itself from an
organization whose individual operations made decisions based on what each one—rightly or
wrongly—thought best for itself into an organization whose operations now make day-in, day-
out decisions that are best for the whole company.
Chrysler Automobile company projected that, meanwhile it began instigating ABC in 1991, the
system has generated hundreds of millions of dollars in advantages by helping simplify product
designs and eliminate unproductive, inefficient, or redundant activities. The profits have been
10 to 20 times greater than the company’s investment in the program. At some sites, the
savings have been 50 to 100 times the implementation cost [ CITATION Nes95 \l 1033 ].

In recent years, the development of hospitality industry has increased incredibly due to the
development of technology, especially internet, which allows price transparency and makes
customer easier in choosing the best hotel for them. However, the competitiveness in the
hospitality market become intense. Thus, firms in hospitality industry have to make realistic and
competitive pricing decision to survive in the market.
A research study was conducted to examine whether the application of ABC in hospitality
industry will improve the pricing decision. In achieving the aim, a review of prior literature on
activity-based costing from management, accounting, and hospitality industry was conducted.
The results indicate that many hotels found that the application of ABC leads to a more
accurate and reliable cost information. They also found that the implementation of ABC
allowed them to conduct customer profitability analysis and get better and proper results about
the profitability of customers. However, the managers also found some challenges of ABC such
as expensive, time-consuming, and complex. Despite the challenges, the managers claimed that
the more accurate and proper cost information and CPA result produced by ABC to lead to
improved pricing decision[ CITATION Eff \l 1033 ].

Steel demand in India is expected to remain high in the coming years on the basis of strong
fundamental economic factors and small per capita consumption of steel, according to a
presentation given to the Ministry of Mines by Tata Steel in 2014. However, traditional costing
methods (practiced by most of the steel plants in India) are not only incapable to provide the
necessary framework for measuring cost accurately,
“An activity-based costing (ABC) model is anticipated for a raw material handling section of an
Indian steel plant. The consequences attained from ABC model application in the said
department facilitates quantification of the unit cost of corresponding process, analysis of
numerous activities in order to recognize inefficiency, setting-up of better budget allocation,
initiation of cost minimization method and formation of an efficient resource prerequisite plan.
Furthermore, the cost information resulting from ABC model is related with that extracted from
the traditional costing system to reveal that ABC model can meaningfully minimize the product
cost distortion resultant from unsystematic allocation of overhead costs” [ CITATION Dwi16 \l
1033 ].

Conclusion
Hence, ABC and ABM are the most discussed and popular accounting innovations in last two
decades because they are largely linked to the notion that information provided is more
accurate and explanatory than that given by traditional costing systems. Moreover, these new
managerial accounting techniques have been used to help businesses decision and taking
control in a widely sophisticated way and by using this they enhance the business image of
managerial accounting.
Operations managers tasked with streamlining processes and removing waste recognize that
ABC data is useful for comparable benchmarking and quantifying the magnitude of non-value-
added costs and of profit-reducing costs of quality.
Lastly, Decision making processes have different information needs, which depend from the
organizational and hierarchical level involved and from the decision time horizon. The different
organizational units need, therefore, cost information structured using different combinations
of fixed and variable costs in order to better support decisions. The ABC model, where the
activities costs are structured maintaining the distinction between fixed costs in the short and
long, and variable costs, is flexible to different information needs as it allows to build ad hoc
cost configurations based on relevant costs and the optimization of decisions taken at any
organizational level. This structure of the model thus allows managers to act in a timely manner
especially in the management of costs, because it provides the information necessary to
intervene at the process production capacity and structure level. It also permits interventions in
terms of production methods, with the great advantage of not have to conduct special studies
to support the various possible decisions.
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