Thus, the ABC system makes a number of assumptions including; That products consume activities That it is the activities as opposed to products that consume resources That these activities are the cost drivers That these activities are not always based on production volumes Thus, as opposed to traditional costing methods that allocate cost to cost centers such as finance, manufacturing, etc, ABC system allocates costs to such activities as attending to customers, setting up a machine, etc. When an ABC is approach most advantageous/appropriate? As indicated above, a major assumption of the ABC system is that activities consume resources and hence are the cost drivers rather than volume.
As such, the ABC system would be most appropriately applied in companies that have significant amounts of overheads that relate to diverse activities in their provision of goods or services to customers of varying levels of demand. In other words, the system would not be appropriate for firms with little overhead costs that relate to almost identical products that call for similar attention. Based on this, therefore, the ABC system will be appropriately applied in Mary White Dialysis clinic. The perceived benefits and costs of the ABC system The proposed ABC system has a number of benefits including; It leads to improved business processes.
As costs are allocated to activities, there emerges a clear picture of the business processes or activities that perform well and the ones that need improvement. As such, ABC would be useful in identifying nonvalue added activities hence helping to better allocate resources to more efficient and hence profitable activities. In essence, employing ABC will add value to the business’ continuous improvement. Identification of wasteful products – application of ABC enables one to understand better where overhead costs are going.
As such, it is possible to identify wasteful products as well as unnecessary costs leading to the more productive application of resources. The process would also help the organization in fixing product or service prices that are excessive and hence incorrect. All in all, ABC leads to improvement in overall product or service quality since it reveals cost and production issues in need of adjustments. However, the system may have some undesired costs which may include; The system may be expensive to implement and also time-consuming.
The entire process of breaking down business activities uses valuable resources in collecting, measuring, and entering data into the new system. This is also time-consuming The system does not conform to accounting standards and hence not useful for external reporting. As such, interpretation of ABC data together with regular accounting information may be misleading leading to bad decision making. As such, ABC is only useful for managerial purposes. The problems associated with the costing system currently used by the clinic and how an ABC system overcomes these problems: The system currently being used by the clinic has a number of problems which including the arbitrary allocation of costs to the two services being offered by the clinic.
This has resulted in some services being allocated costs that they do not consume while others are allocated more costs than they should be allocated. For instance, the current system in determining the cost of PD services still allocates machine operators costs to it despite the fact that patients being given this service do not use the dialysis machine and hence no such cost should be allocated to this service.
The problem with this is that one activity may be overcoated and hence overpriced while the other may be undercoated and hence underpriced. This affects resource allocation as well as decision making which may lead to the quality of service being compromised. To overcome this, the proposed ABC system will allocate costs on the basis of activities that consume resources. This will ensure that each of the two services is allocated a fair share of its related costs hence ensuring the services are properly costed and hence priced.
This will ensure the correct reimbursements are sought and that service quality is improved.
ReferencesJohansen, M2012, Management accounting and managerial decision making, London, Rutledge.