Term Paper

On
Activity Based Costing – A Literature Review
Course: Management Accounting

Prepared By:
Name & Id:
Emtiaz Ahmed Anik [17211017]
Nahian Al Fattah [17211019]
Fatema Bin Womme Akter [17211029]
Eshfaque Alam Dastagir [17211061]
Faiyana Sharmin [17211069]
Azharul Haque Mazumder [17211075]
Section :A
Batch : BBA (AIS) 2017

Prepared For:
Name : Asia Khatun
Designation: Lecturer
Department: Business Administration in Accounting & Information Systems
Faculty : Business Studies

Date of Submission: May 16, 2020

Abstract
The purpose of this paper is to review current articles and research papers with regard to
influences on and measures of the current situation and usage of Activity Based Costing (ABC).
The paper also examines some findings and some gaps in the existing literature.

The Design/Methodology/Approach: This paper reviews existing literature from some

accounting journals, official accounting associations, and best published papers of all time.

Research Findings: This research recognized some instances of insufficient information and
some gaps in the existing literature. For example, the size of some study samples is not big
enough to draw reasonable conclusions.

Research limitations/Implications: It identifies some gaps in the current literature and calls for
additional research. Further, the paper offers some object lessons, and exposes the reader to
different aspects of Activity Based Costing system.

Introduction
Since the 1990s, practitioners and academics alike have asserted that companies embracing
international standards of excellence need management accounting systems which strengthen the
strategic decision-making process. Recognized as one of the best practices complementing
sophisticated manufacturing techniques, Activity-based Costing (ABC), a world-class
management system, was endorsed by practitioners and academics.

Many scholars studied ABC and its features since it was popular in the 1990s. This study was
conducted to shed light on ABC adoption, its features, success factors, purposes, and challenges.
Several researchers such as Cooper and Kaplan; Kaplan and Anderson, Reyhanoglu, and
Wegmann conducted empirical studies for a more thorough comprehension of the ABC system –
its advantages, the challenges, and the factors which have an impact on its implementation.

Towards the end of the 1990s, interest in ABC waned. Among the reasons given was the
complexity of the system. In 2005, researchers are still mystified by the low adoption rate of
ABC.

The Review Method

The review is supported mainly by accessing some leading accounting journals, and some
research papers done by professors and students at universities around the world. Both sources
are from the period of all time. The search was carried out using the term ―Activity Based
Costing and is based on articles that are published in online databases. The search resulted in
many research papers for review. For our study we have taken 20 papers that are the most
relevant. The given table presents the articles and research papers we used.

Table

No. Study Topic Research Site

01. V.G. Narayanan & Ratna The Impact of Activity Company Background and
G. Sarkar (August 16, Based Costing on Production Economics
1999) Managerial Decisions at
Insteel Industries
02. Robert S. Kaplan and Time-Driven Activity- Estimating a Basic ABC
Steven R. Anderson Based Costing Model
(November 2003)
03. Metin REYHANOGLU Activity Based Costing Implementing of Activity
System “Advantages and Based Costing System
Disadvantages”
04. Dr. Philip G.M.C. Using Activity Based Activity-Based Cost
Vergauwen & Drs. Costing and Theory of Management Model &
Christian C.J.M.C. Constraints to Enhance Theory of Constraints
Kerckhoffs (July 2005) Decision Making at
Duographics B.V
05. Tim Lowder (March The Legacy of Activity The Industrial Revolution
2006) Based Costing:
Addressing the Need for a
Hybrid Methodology
for Costs Allocation
06. Annie McGown, Sarah The Association between Current Healthcare
A. Holmes & Melissa Activity Based Costing Environment
Martin System Adoption and
Hospital Performance
07. Robin Cooper, David Who Wins in a Dynamic Theory of Constraints vs.
Bray & Michael Parzen World: Theory of Activity-Based Costing
Constraints vs. Activity-
Based Costing?
08. Narcyz Roztocki & Evaluating Information Value Chain Analysis,
Heinz Roland Technology Investments: ABC, and Fuzzy Logic
Weistroffer (2005) A Fuzzy Activity-Based
Costing Approach
09. Gregory Wegmann Developments around the The Strategic
Activity-based Costing Management Accounting
Method: A State-of-the approach: A theoretical
Art Literature Review foundation for the ABC
 method
10. Rajiv D. Banker, Indranil The Role of Possibility of Plant
R. Bardhan & Tai-Yuan Manufacturing Practices Performance
Chen (2007) in Mediating the Impact of Improvements due to
Activity-based Costing on Implementation of WCM
Plant Performance Practices
11. Gregory Wegmann The Activity-Based The Activity-Based
(2008) Costing Method: Costing method, a way to
Development and drive strategically the
Applications costs
12. Davood Askarany, Technological Technological Changes in
Malcolm Smith & Hasan Innovations, Activity Manufacturing Practices
Yazdifar (2007) Based Costing And and Diffusion of
Satisfaction Management Accounting
Innovations
13. Davood Askarany & Why ABC is not Widely Relationship between
Hassan Yazdifar Implemented? Attributes of Innovation
and the diffusion of
Activity Based Costing in
Practice
14. Davood Askarany,Supply chain Extent of the Relationship
Hassan Yazdifar & Saeedmanagement, activity- between the Adoption of
Askary (August 12, based costing and ABC and Organizational
2009) organizational factors Factors
15. Abdul ADAMU &The Practicability of Evolution of Activity-
Abdullahi Ismaila
Activity – Based Costing Based Costing
OLOTU System in Hospitality
Industry
16. Juan J. Segovia & Amir The Financial Critical factors for a
H. Khataie Performance Effects of Successful ABC/M
Activity-Based Implementation in
Costing/Management in Telecommunications
the Telecommunications Industry
Industry
17. Narcyz Roztocki (31 Using the Integrated The Essentials of Database
December, 2001) Activity-Based Costing Application for the
and Integrated ABC-and-EVA
Economic Value Added Information System in
Information System for General and Applicable
Project Management Terms
18. Davood Askarany, John The effect of innovation Innovation diffusion
 A. Brierley & Hassan characteristics on theory
Yazdifar (2012) activity-based costing
adoption
19. Rainer Lueg & Margit Customer Accounting Variance Analysis and
Malmmose (2014) with Budgets and Activity Activity-based Costing to
- Based Costing: Understand the Different
A Case Study in Profitability of Customer
Electronic Commerce Groups
20. Dr. Merlita M. Durana Research Review on Design a Performance
Activity-Based Costing Measurement and
System (ABC): ABC’s Management System for
Development, Small and Medium
applications, Challenges, Enterprises.
and Benefits

The Concept of ABC System:

ABC provides management with a valuable new tool to assist in determining and allocating
product costs more realistically. It also provides the means by which to isolate and account for
costs in relation to the activities associated with those costs. It is very critical we understand that
ABC is not a quality improvement program like process reengineering, or statistical process
control. This distinction is important so that we do not classify ABC as a fad or fashion [ CITATION
Abd \l 1033 ].

Estimating a Basic ABC Model:

The standard procedure for estimating a simple ABC model starts with identifying a collection of
resources that perform a variety of activities. For example, consider a customer service
department that performs three activities:

 handle customer orders

 process customer complaints
 Perform customer credit checks.

In building an ABC model for the customer service department, the system designer asks
employees to estimate the percentage of their time spent on the three principal activities they
perform[ CITATION Rob03 \l 1033 ]

ABC in Different Countries:

Although research has examined the adoption rates for ABC in a variety of countries, little
research has compared the adoption rates for ABC between countries in a single study.
Notwithstanding their small sample sizes, Yakhou and Dorweiler (1995) found high ABC
adoption levels in England, France and the USA. Bhimani et al. (2007) report that the adoption
levels of ABC is higher in Canada, France, the UK and the USA than in Germany, Italy and
Japan. They suggest that this is because ABC has received considerable publicity in the late
1980s in Canada, the USA and the UK, and organizations in France had already been using a
method similar to ABC. In addition, there have been replications of research undertaken in the
UK by Drury et al. (1993) and Innes et al. (2000) in New Zealand by Lamminmaki and Drury
(2001) and Cotton et al. (2003) respectively. The results of this research show that the rates of
adoption for ABC are similar between New Zealand and the UK[ CITATION Dav12 \l 1033 ].

Cost Management:
Shukla et al (1997) suggest that cost management strategies can encompass all components of
costs-labor, materials and capital. Ittner (1994) argues that, in a manufacturing setting, traditional
accounting systems create one of the primary reasons why companies overlook opportunities for
productivity gains. These old systems bury the cost of poor quality in poorly understand
overhead accounts, making it difficult to discover inefficacies. Specifically, companies that use
these systems may allocate indirect costs incorrectly, thus causing managers to prioritize projects
for quality improvements that reflect high, but distorted indirect costs[ CITATION Ann \l 1033 ].

Activity-Based Management:
ABC data is typically used for making product line decisions such as discontinuation of
unprofitable products, changing prices, and introduction of new products similar to existing
profitable products. The company conducts simple univariate statistical analysis to test the
hypotheses on product line decisions. They supplement these tests with interviews with Insteel
managers[CITATION VGN99 \l 1033 ].

Theory of Constraints vs. Activity-Based Costing:

Value chain analysis serves as a powerful tool for economic planning by (1) categorizing the
value-adding activities of an organizational system and (2) illuminating areas most likely to
increase profitable outcomes. Specifically, value chain analysis identifies the value and cost
drivers for each activity performed by an organization. Such analysis then strives to maximize
aggregate value creation and minimize costs internal to an organization[ CITATION Rob \l 1033 ].

Activity-Based Cost Management Model & Theory of Constraints:

Goldratt (1992) introduces three operational measures - throughput, operating expense, and
inventory - to provide feedback to operations management as they seek to make operating
decisions that will enhance profits, cash flow, return on sales and residual income. Throughput
can be defined as the revenue minus the cost of the raw materials based on the number of units
sold. The Goldratt (1992) definition of operating expense comprises the expenses that are
incurred to convert raw materials to throughput. Thus, he regards all expenses other than raw
materials as operating expenses. Inventory represents the cost of all the raw materials that have
not yet been sold plus the cost of the more traditional assets that are used in the
business[ CITATION DrP05 \l 1033 ].

The Strategic Management Accounting Approach:

The conventional approach to management accounting reveals a conflict among the processes of
strategic management, management control and operational control. Johnson and Kaplan (1987)
explain that coordination between these processes is difficult to achieve. The strategic
management accounting theory is a concept and a set of practices devised to overcome this
difficulty. There has been a growing interest in strategic management accounting since the early
1980s. In a firm, a strategic management accounting instrument connects strategic and marketing
decisions with operational ones and brings a multi-dimensional approach of
performance[ CITATION Gre08 \l 1033 ].

Factors Affecting the Diffusion of Costs:

There are some major factors that affect the cost of diffusion [ CITATION Dav \l 1033 ] . And they
are:

 Lack of suitable software programs

 Cost of system setup and implementation
 Cost of maintain and collecting cost information
 Lack of information on available costing techniques
 Management policies and priorities
 Lack of appropriate cost accounting skills

The ABC developments:

Many scholars and practitioners admit that ABC has several pitfalls. We can make a list of the
major criticisms as follow[ CITATION Gre \l 1033 ]:

 A lot of practitioners explain that ABC systems are expensive to implement, time
consuming and hard to adjust.
 To diversify the costs objects (products, services, processes, customers, markets.
 To widen the analysis perimeter.
 And to determine the relevant level of details to analyze the costs.

Implementing of Activity Based Costing System:

Activity based costing system follows two stage procedures. The first stage identifies the
significant activities and assigns overhead costs to each activity depending on the organization’s
resources it uses. The overhead costs assigned to each activity compose an activity cost pool.
After assigning overhead costs to activity cost pool in stage one, cost drivers are identified that
are appropriate for each cost pool. Then in stage two, overhead costs are allocated from each
activity cost pool to each product line in proportion to the amount of cost driver consumed by the
product line[ CITATION Met \l 1033 ].

Impact of Activity-based Costing on World-class Manufacturing:

Implementation of WCM practices can enable plants to react quickly to changes in customer
demand, and thereby carry lower levels of inventory, improve cost efficiencies, increase the
flexibility of production facilities through use of planning and scheduling software, and improve
overall plant productivity. Investments in JIT and flexible manufacturing practices help to reduce
setup times that permit shorter production runs, thereby allowing for more efficient inventory
control, as well as lower product defect rates[ CITATION Raj07 \l 1033 ].

A Legacy to Build Upon:

Management must understand that ABC is a useful tool that has added tremendous value to the
many organizations that successfully implemented its processes into their operations [ CITATION
Tim06 \l 1033 ]. To build a legacy on ABC

 Management accountants must focus on taking advantage of the positive aspects of both
ABC and GPK.
 Decision makers must acknowledge and understand that current ABC and GPK models
are not total quality management (TQM) programs.
 The hybrid accounting system must incorporate the basic modeling of the ABC system
where both variable and fixed costs are allocated pre-designated costs pools.

Discussion and Future Recommendations:

Contributing to the management accounting literature, this study examines the level of
association between the application of technological changes in manufacturing practices and the
diffusion of ABC as one accounting innovation. It also investigates the level of satisfaction of
users of current implemented accounting techniques in order to specify whether (or not) there is
any issue in relation to such techniques which may need further studies [ CITATION Dav07 \l 1033 ].
In today’s intense global competition, supply chain management (SCM) is as a vital tool for
helping managers to improve productivity, profitability and the performance of their
organizations. In doing so, SCM requires more accurate cost data regarding all activities and
processes within the organizations. Activity-based costing (ABC) can significantly contribute to
global supply chain management as it is suggested to fulfill the requirements by providing more
accurate, detailed and up-to-date information on all activities and processes in
organizations[ CITATION Dav09 \l 1033 ]. ABC/M is a more harmonized and comprehensive cost
management technique as compared to the traditional cost accounting (TCA). Its advantages are
more notorious in a business environment with a high degree of product customization, such as
telecommunications business. The number of companies using ABC/M in the telecommunications
industry has increased over the recent years [ CITATION Jua \l 1033 ]. The paper illustrates that
variance analysis and Activity-based Costing help managers to better understand the different
profitability of customer groups in their portfolios. The study allow for an adjustment to the level
of knowledge of the students. They also serve the purpose to raise students’ awareness for the
limits of customer accounting. Students will need to reflect on how a mechanical application of
customer profitability analysis can lead to dysfunctional decisions that run counter to a
company’s business model[ CITATION Rai14 \l 1033 ]. The framework represents a valuable
contribution to the existing body of knowledge, as it presents an IT evaluation method which can
appreciably complement the currently used approaches, specifically in emerging economies. The
concepts that form the basis for the framework, value chain, ABC, and fuzzy logic, have been
validated in other contexts. Though, for the purpose of simplicity, the illustration of the
framework is based on theoretical perspective, the work presented here is based on wide-ranging
experience in studying the companies in emerging economies[ CITATION Nar05 \l 1033 ].

Looking toward the future of the Integrated ABC-and-EVA Information System, there are many
opportunities for further research related to the preliminary explorations in this paper. One
possibility would be to implement the system in a company engaged with multiple technology
projects, monitoring its performance over a longer period of time. This would provide
researchers with the opportunity to gain practical findings about long-term use of the
system[ CITATION Nar01 \l 1033 ]. Future researchers may focus on applying the three tracks for
ABC implementation in SMEs involving SME characteristics, challenges posed by ABC, and the
ABC implementation process[ CITATION DrM \l 1033 ].

Conclusion:
This paper provides a thorough review of influences and Implementation of activity based
costing. It also identifies some gaps in the literature and provides suggestions for future research.
This paper has practical significance and value for enlightening managers, investors, and other
users about the different aspects of activity based coting. The understanding of the importance of
activity based coting, and having the knowledge about what the influences are, is needed due to
complex and competitive business environments. Reaching a phase where the significance of
activity based coting can be measured precisely will assist in investigating other global issues
related to costing methods in capital markets around the world.
 References
Anderson, R. S. ( November 2003). Time-Driven Activity-Based Costing.

Annie McGown, S. A. (n.d.). The Association between Activity Based Costing System Adoption and
Hospital Performance.

Davood Askarany, H. Y. (August 12, 2009). Supply chain management, activity-based costing and
organizational factors. Int. J. Production Economics.

Davood Askarany, J. A. (2012). The effect of innovation characteristics on. Int. J. Managerial and
Financial Accounting, 291.

Davood Askarany, M. S. (2007). Technological Innovations, Activity Based Costing And.

Durana, D. M. (n.d.). Research Review on Activity-Based Costing System (ABC): ABC’s Development,
applications, Challenges, and Benefits.

Kerckhoffs, D. P. (July 2005 ). Using Activity Based Costing and Theory of Constraints to Enhance Decision
Making at Duographics B.V.

Khataie, J. J. (n.d.). The Financial Performance Effects of Activity-Based Costing/Management in the

Telecommunications Industry.

Lowder, T. (March 2006). The Legacy of Activity Based Costing: Addressing the Need for a Hybrid
Methodology.

Malmmose, R. L. (2014). Customer Accounting with Budgets and Activity - Based Costing: A Case Study in
Electronic Commerce.

OLOTU, A. A. (n.d.). The Practicability of Activity – Based Costing System in Hospitality Industry.

Rajiv D. Banker, I. R.-Y. (2007). The Role of Manufacturing Practices in Mediating the Impact of Activity-
based Costing on Plant Performance.

REYHANOGLU, M. (n.d.). Activity Based Costing System “Advantages and Disadvantages”.

Robin Cooper, D. B. (n.d.). Who Wins in a Dynamic World: Theory of Constraints vs. Activity-Based
Costing?

Roztocki, N. (31 December, 2001). Using the Integrated Activity-Based Costing and Economic Value
Added Information System for Project Management.

Sarkar, V. N. (August 16, 1999). The Impact of Activity Based Costing on Managerial Decisions at Insteel
Industries.
Wegmann, G. (2008). The Activity-Based Costing Method: Development and Applications.

Wegmann, G. (n.d.). Developments around the Activity-based Costing Method: A State-of-the Art
Literature Review.

Weistroffer, N. R. (2005). Evaluating Information Technology Investments: A Fuzzy Activity-Based

Costing. Journal of Information Science and Technology.

Yazdifar, D. A. (n.d.). Why ABC is not Widely Implemented?