The company planned to replace one highly successful product, whose patent was expiring, with new products per year for each of the next five years.
Omitted from the initial analysis, however, was how the new product mix would affect the so-called fixed costs. The ABC analysis showed that batch and product-sustaining operating expenses would soar as the company moved from making one product to making 1, different products.
The company proceeded to expand the product mix, but it immediately initiated programs to reduce resource consumption at the batch and product levels. An additional insight from the ABC hierarchy is that product-related activities do not impact facility-level costs. Only unit, batch, and product-sustaining expenses should be assigned to products. Therefore, in ABC, facility-level expenses are kept at the plant level and not allocated to products. Facility-sustaining expenses become part of another slice, such as a geographic slice, where the company is managing a number of facilities in an area.
They can compare the profits that various customers, product lines, brands, or regions generate. Then they can zero in on the dynamics of the more—or less—profitable ones. And the analysis can be continued beyond the brand level. Expenses such as general research, development, and advertising for all the cereal products should not be allocated to individual brands.
Cereal profitability is determined by subtracting these product-line expenses from the profitability earned in all of the cereal brands. Customer-sustaining expenses are those that are traceable to individual customers but are independent of the volume and mix of purchases. The Kanthal customers generating the greatest losses were among those with the largest sales volume.
Initially, this finding surprised managers, but it soon began to make sense. The large, unprofitable customers demanded lower prices, frequent deliveries of small lots, extensive sales and technical resources, and product changes. The newly revealed economics enabled management to change the way it did business with these customers—through price changes, minimum order sizes, and information technology—transforming the customers into strong profit contributors.
ABC analysis highlights for managers where their action will likely have the greatest impact on profits. Managers should take two types of actions after an ABC analysis. First, they should attempt to reprice products: raise prices for products that make heavy demands on support resources and lower prices to more competitive levels for the high-volume products that had been subsidizing the others.
If the repricing strategy is successful, the company should arrive at a new product mix that either makes fewer demands on its resources or generates more revenues for the same consumption of resources.
Second, and more important, managers should search for ways to reduce resource consumption. This requires either decreasing the number of times activities are performed for the same output—such as by changing product and customer mix—or reducing the resources consumed to produce and serve the existing mix of products and customers. This might mean designing products with fewer and more common parts or customizing products at the last possible production stage. It could also mean implementing continuous-improvement programs to enhance quality, reduce setup times, and improve factory layouts, or adopting information technology to facilitate the processing of batches, products, and customer orders.
Analysis of a large and especially unprofitable customer might show that the customer demands low prices because of its large purchasing volume and also requires extensive technical development and marketing support. The company may decide to attempt the repricing route—maintaining the existing level of customer support but reducing discounts or charging the client for those extraordinary services.
Alternatively, it may decide to provide fewer customer-sustaining services. Engineers might spend less time sharing technical knowledge, marketing people might put on fewer special trade shows for the customer, or salespeople might cut down on routine calls. Steps to reduce resource consumption are, however, just the first round of action. When fewer of their resources are being demanded, managers must either get rid of the freed-up resources or redeploy them for additional output.
The important distinction here is between consumption and spending. Reducing resource consumption gives managers an opportunity to boost profits. Even if the company reduces demands on parts-administration resources, it will experience an increase in profits only when it redeploys parts-administration resources or cuts spending on them. Questions to consider when implementing ABC Do we fully understand the resource implications of implementing, running and managing ABC?
Do we have the resources to implement ABC? Will the costs outweigh the benefits? Can we easily identify all of our activities and costs?
Do we have sufficient stakeholder buy-in? What will it take to achieve this? Will the additional information ABC provides result in action that will increase overall profitability? ABC provides business managers, as well as the finance function, with the information needed to make value-based decisions Use ABC for pricing and product prioritisation decisions ABC should be implemented by management accountants as they are best placed to manage the process and to ensure benefits realisation Do not get caught up in too much attention to detail and control.
It can obscure the bigger picture or make the firm lose sight of strategic objectives in a quest for small savings It is important not to fall into the trap of thinking ABC costs are relevant for all decisions. Related Articles. Chartered Global Management Accountant CGMA is the most widely held management accounting designation in the world with more than , designees.
Get buy-in from the rest of the business. In recognition of this problem, Modigliani and Miller expanded their Irrelevance Proposition theorem to include the impact of corporate income taxes, and the potential impact of distress cost , for purposes of determining the optimal capital structure for a company.
The Return on Equity ROE is a popular fundamental used in measuring the profitability of a business as it compares the profit that a company generates in a fiscal year with the money shareholders have invested. As you can see from the table below, financial leverage can be used to make the performance of a company look dramatically better than what can be achieved by solely relying on the use of equity capital financing.
Since the management of most companies relies heavily on ROE to measure performance, it is vital to understand the components of ROE to better understand what the metric conveys. In its most simplistic form, the DuPont Model establishes a quantitative relationship between net income and equity, where a higher multiple reflects stronger performance. Corporate management tends to measure financial leverage by using short-term liquidity ratios and long-term capitalization, or solvency ratios.
As the name implies, these ratios are used to measure the ability of the company to meet its short-term obligations. Two of the most utilized short-term liquidity ratios are the current ratio and acid-test ratio. Capitalization ratios are also used to measure financial leverage. The use of these ratios is also very important for measuring financial leverage. Moreover, in a market environment where short-term lending rates are low, management may elect to use short-term debt to fund both its short- and long-term capital needs.
Therefore, short-term capitalization metrics also need to be used to conduct a thorough risk analysis. Coverage ratios are also used to measure financial leverage. The funds-from-operations-to-total-debt ratio and the free-operating-cash-flow-to-total-debt ratio are also important risk metrics that are used by corporate management.
First, from the standpoint of sales, a company that exhibits high and relatively stable sales activity is in a better position to utilize financial leverage, as compared to a company that has lower and more volatile sales.
Second, in terms of business risk, a company with less operating leverage tends to be able to take on more financial leverage than a company with a high degree of operating leverage. Third, in terms of growth, faster-growing companies are likely to rely more heavily on the use of financial leverage because these types of companies tend to need more capital at their disposal than their slow growth counterparts. Fourth, from the standpoint of taxes, a company that is in a higher tax bracket tends to utilize more debt to take advantage of the interest tax shield benefits.
Fifth, a less profitable company tends to use more financial leverage, because a less profitable company is typically not in a strong enough position to finance its business operations from internally generated funds. The capital structure decision can also be addressed by looking at a host of internal and external factors. First, from the standpoint of management, companies that are run by aggressive leaders tend to use more financial leverage. In this respect, their purpose for using financial leverage is not only to increase the performance of the company but also to help ensure their control of the company.
Second, when times are good, capital can be raised by issuing either stocks or bonds. The traditional accounting approach often uses a single or departmental base, allocating cost to objects or products, for example through labor hours, machine hours, and production units employed Majid and Sulaiman, and it is therefore not appropriate for firms which have many products or services and these firms require a new costing method in order to allocate costs and monitor cost effectiveness Foong and Teruki, Activity-based costing hereafter ABC is an innovative accounting method to allocate overheads and costs with a higher degree of accuracy and to assign costs to products and services according to the activities and resources consumed Smit et al.
ABC uses cost-drivers to allocate the costs of products and services Banker et al. ABC not only improves the accuracy of product- and service-costing but also helps managers understand how resources are used through financial performance, such as return on investment and bottom line statements Cagwin and Bouwman, In this paper, we focus on ABC implementation success and factors influencing this.
Past research identified two main factors affecting ABC success, namely technical and contextual, and behavioral and organizational variables. However, this paper focusses on contextual, behavioral and organizational variables because these are more strongly associated with ABC success than are technical variables Shields, ABC implementation success refers to the degree to which management uses ABC information for decision making in order to improve financial performance Foster and Swenson, The research used confirmatory factor analysis CFA in order to investigate the six behavioral and organizational constructs on ABC implementation success.
In addition, there are many benefits accruing from ISO registration. These include, for example, giving customers confidence in the quality of the products and services, helping written management systems control effectively the business process life-cycle, ensuring that management can meet the needs of customers and reduce losses in operational quality and maintain cost savings. Thus, if businesses adopt ABC and so make accurate cost analysis, this can help to specify constraints and cut unnecessary costs.
This is in agreement with Sayle , who noted that ABC is a technique that enhances the work process and is in accord with ISO ABC is typically implemented by accounting and finance sections and ISO is usually implemented by the quality group. In addition, sales and marketing is an important function linking data with finance, accounting, and manufacturing systems. Besides, the number of ISO companies is also expected to increase steadily; in Thailand, numbers have increased from 1, in to 2, in This research makes several important contributions.
Second, it focusses only on behavioral and organizational variables which are strongly associated with ABC success. Finally, there is very little prior research on the success of ABC implementation in Thailand.
This study is structured as follows. The relevant literature on all six constructs is reviewed. Next, the research methods used to test the CFA are discussed and lastly come the results, a discussion on the findings and the conclusion.
This model is combined with two academic sources: Shields , who was the first to explore contextual, organizational, and behavioral factors associated with ABC success, and Chongruksut and Brooks , who studied ABC adoption and success in Thailand.
They ranked five factors affecting ABC implementation success, including TMS and commitment, clear and concise objectives, and non-accounting commitment and ownership. This paper investigates the clarity of the objectives of upper-management because, given the nature of Thai society, the effectiveness of these objectives, and the degree to which they are met depends on management Morakul and Wu, and hence, we use the concept of NAO to measure ABC implementation success.
ISO is a basic principle of quality management systems consisting of five processes: process mapping, documentation, performance, audit, and corrective action Larson and Kerr, A quality system is a set of management activities by which company efficiency is improved through factors such as quality improvement and cost reduction. ISO can help firms establish the agenda required for effective and efficient quality assurance and quality management systems Bhuiyan and Alam, The benefits accruing to ISO qualification for companies may be separated into internal and external.
The internal benefits are that employees gain a better understanding of work processes and responsibilities as well an awareness of quality-improvement culture through teamwork, management support and participation, and better optimization of resources Mcdonald et al. The external benefits are improved market and company reputation, higher perceived quality, cost reduction, and customer service improvement Larson and Kerr, ; Brack, ; Bhuiyan and Alam, ABC ties overhead cost and direct costs to specific products, services or customers by activity, and also highlights the activities of the companies as well as using cost drivers as an important instrument to allocate costs.
Firms with ABC implementation success are more likely to have accurate product and service costs, cost control improvements, and to eliminate waste by providing unnecessary non-added activities. Hence, ABC information can support managers when establishing cost reduction programs and can also help firms manage activities focussed on decreasing costs and increasing quality. Costs can be decreased by reducing unnecessary expenditure, and reducing the time taken to produce products and services.
Quality can also be increased by more efficient planning of production activities and material handling, quicker delivery, and reducing waste.
In addition, prior research shows that the many steps involved in successful ISO registration are also required to implement ABC, including items such as ABC implementation of linking activities to objects, when the results will be used in the process of ISO evaluation Larson and Kerr, In conclusion, successful ABC implementation not only gives information on costs and processes but also assists firms in emphasizing quality.
There has been limited research focussing on ABC success in Thai organizations. However, Chongruksut and Brooks surveyed listed companies in the Bangkok region regarding issues associated with ABC adoption and implementation. They found that 14 Organizations with a larger range of products and with a higher intensity of capital equipment were more likely to adopt ABC. Moreover, the researchers explained that upper-management support and the clarity of the objectives of the ABC implementation among ABC designers and users were the most important factors determining the success of ABC implementation.
Morakul and Wu , who studied the relationship between culture and ABC implementation, found that the key factor determining the failure of ABC was the high-power distance in Thai society, which led to accountants being afraid of losing their power. The above studies focussed on company adoption and implementation but had the limitation of small sample sizes. This study extends the work in these areas, particularly with regard to the success of ISO certified firms in Thailand because ISO supports continuous improvement efforts in quality and productivity so that firms with ISO should apply ABC and this leads to the research having a larger sample size.
Ways of assessing ABC implementation success can be divided into two categories; first, the overall success level and second, the attainment of a particular stage of implementation. The main purpose of measuring overall success is that the meaning of success was problematic and past literature was not clear about this meant.
Foster and Swenson measured the success of the ABC dimensions by using a variety of tools consisting of measurements based on the use of ABCM information in decision making, measurements based on decisions taken with ABCM information, measurements based on the dollar improvements resulting from ABCM and measurements based on management evaluation on the overall success of ABCM.
For example, Baird et al. This was divided into user attitude, technical characteristics, perceived usefulness in improving user job performance, and organizational process. In Thailand, research involving ABC is relatively rare because Thailand is a developing country and the rate of adaptation of modern accounting management techniques is limited. Chongruksut and Brooks found only 14 companies that had implemented the ABC system, and the research of Tupmongkol and Morakul and Wu were limited to case studies.
To ensure the appropriate population group, this research measures the success of the costing system activity by asking participants to rate perceptions of the success of implementation of ABC in their firms, which is similar to Chongruksut and Brooks This refers to the degree of visible support from senior or top managers for ABC Anderson and Young, Prior research mentioned that this is a significant factor affecting the success of ABC implementation Anderson and Young, ; Chongruksut and Brooks, This support is important when using information from ABC systems to communicate with non-accounting staff in order to promote and support ABC Shields, In addition, Majid and Sulaiman stated that a steering committee should oversee ABC implementation and should comprise top-level management in order to ensure that the staff committee was on the right track.
Moreover, senior management should invest in and drive forward ABC projects by providing training and technology. Morakul and Wu indicated that Thai society had a high-power-distance culture so top managers in Thai companies are those who have power to take action and make final decisions in the firm and therefore they play an important role in monitoring ABC project success.
This factor refers to the degree to which firms increase compensation such as bonuses, promotions, and other financial rewards in relation to the quality of the ABC system. Performance measures consist of setting targets and comparing outcomes with goals and these may be simple or complex indicators, such as the economy, efficiency, or effectiveness Amir,
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