The design and implementation of Activity-

Based Costing: A case study of a Taiwanese

textile company

Authors:-
Rong-Ruey Duh, affiliated with the Department of Accounting at National Taiwan
University; Thomas W. Lin from the Leventhal School of Accounting at the University of
Southern California; Wen-Ying Wang, associated with the Department of Accounting at
National Chengchi University; and Chao-Hsin Huang, part of the Department of Accounting
at National Taiwan University.

Abstract:-
The research paper describes how an activity-based costing (ABC) system was implemented
for a Taiwanese textile firm. The 39-month study included comprehensive field research
employing techniques such as collecting and analyzing data, file and archive inspection,
visual observation, conversations, and statistical assessments. Despite attempts to include a
production-complexity indicator, the old cost system, which used a volume-based cost driver,
showed product cost distortions. Furthermore, the system ignored the influence of rework
operations on product costs. The addition of cost factors linked to complexity improved the
explanation of overhead cost volatility. The newly built ABC system combines volume-based
and non-volume drivers, considering the impact of rework on product costs. The current
method overestimates costs for large-volume goods while underestimating costs for items
with high manufacturing complexity. Despite these results, the organization failed in the
implementation of the ABC system, perhaps owing to strategy modifications, a lack of
incentive linkage, insufficient MIS assistance, and poor inventory management.
Research Methodology and the Case study company:-
Because of its geographical position and the scarcity of Asian context studies, the authors
chose a textile industry in Taiwan. XYZ Textile Company, founded in 1980, is a mid-level
player in the textile sector, with a twisting & knitting plant as well as a printing and dyeing
facility. The concentration is on completed cloth sales, which account for 69.29% of total
revenues, primarily from the printing and dyeing plant. Plain cloth (dyeing) and calico cloth
(dyeing and printing) are the final products, with further processing for "high-functional"
fabric depending on distinct qualities. The firm processes more than two hundred printing and
dyeing goods and 1,000 monthly client orders, resulting in a varied range of orders with
various features and manufacturing complexity.

In Taiwan, where manufacturing costs are growing and competition is fierce, XYZ competes
by cutting prices and improving competitive capabilities via cost management. Ensuring the
quality of raw materials is essential, despite limited negotiating power with few qualified
suppliers, since raw materials account for 70% of overall product costs. Manufacturing
overhead accounts for approximately 19 percent of the selling price and a major chunk of the
product's profit margin. Effective cost management requires accurate overhead allocation as
well as accurate information on activity costs.

The CEO feels that the current cost accounting method produces erroneous product costs,
which impedes decision-making. Recognizing the significance of the link between product
diversity, cost precision, and decision-making efficacy, the organization made the choice to
examine the cost of product behavior and fix present system shortcomings. Two co-authors
tracked the 39-month design and implementation of the ABC system, using 3 models of
regression for the cost-driver analysis. They created a company-specific ABC, compared
costs between ABC and the previous system, and analyzed implementation performance.

Existing Costing System:-

The production manager sends dyeing orders following client orders and completed fabric
classifications, segregating them with processing methods for efficient production and sales
monitoring. The cost of finished fabric is calculated by adding dyeing orders and paying
direct raw material and conversion expenses (direct labor and manufacturing overhead
charges).
Greige (raw and unbleached fabric) constitutes the direct raw material for finished cloth, with
costs calculated by the unit cost using the monthly average weight technique and the amount
(yardage) supplied in each dyeing order. Conversion costs include attributing the overall
dyeing and print manufacturing expenses to particular dyeing orders.

The following issues with the existing cost accounting system affect how much a product
costs:

Personalized Finished Fabric:

Resource utilization varies each order due to different dyeing procedures and a wide range of
client needs. The system hides real cost variations across orders by using a single base and an
average allocation mechanism.

Clustering Error in Manufacturing:

Distinct resources are used by several processes for every type of fabric. An aggregation
mistake results from the present method's pooling of expenses into a single pool and
assigning them according to an equivalent factor.

Limitations of the Equivalent Factor:

The R&D technicians' old equivalent factor is unreliable. The equivalent factor is not a
suitable way to quantify all processing costs, which leads to specification errors and possible
cost distortion problems.

Cost Distortion in Rework:

Delays in reworking cause major losses when there are quality problems. 48.27% of dyeing
items need rework, and although while rework data is saved, the system does not calculate
the costs of rework for individual orders, which causes cost distortion. Precise assessment of
rework expenses may increase the accuracy of product costs and function as a standard for
activity enhancement.
ABC Design and Implementation:-
The company acknowledged deficiencies, in its existing cost accounting system prompting
the adoption of ABC (Activity Based Costing) to enhance the accuracy of cost estimations.
They formed a team to provide on the job training for employees, seek guidance from
consultants and disseminate information. A group called the "Core Team, for ABC and
Management Planning" was formed, consisting of representatives from departments and
external consultants.

The ABC model is centered around reclassifying cost categories based on how resources are
utilized. There was an emphasis on tracing resources to dyeing orders, which involved
separating costs like dyeing auxiliaries. The manufacturing processes were divided into three
categories; pre-processing, on site facility activities and after-processing. Each category was
measured either by unit or batch level. Pre-processing activities, such as color prescription
and printing plate preparation were considered crucial, for measuring costs.

Rework operations were essential for cost precision and dyeing orders were designed to
distinguish between normal and rework processing. Cost distortion was kept to a minimum
by the ABC model, which directly assigned greige and dyeing chemicals to dyeing orders
that were linked. Additional cost categories were assigned for every dyeing order using the
proper cost drivers, such as volume- and complexity-based considerations, after being
divided up based on associated activities. Rework expenses were divided up for accurate
calculation.

Cost category in existing Contents Cost category in ABC

costing system system
Direct Materials Greige Greige
Indirect Materials Supplies Supplies
Indirect Materials Dyeing auxiliaries Dyeing auxiliaries
Equipment Costs Depreciation, repair, and Equipment Costs
insurance expenses
Labor Costs Salary, pension cost, bonus, Labor Costs
meal and insurance expense
Utility Costs Steam, power and water Utility Costs
expenses
Miscellaneous Costs Travel, stationery, printing Miscellaneous Costs
 Activity Cost drivers Activity Hierarchies in ABC
Pre-dyeing:
Coloring Frequency of coloring Unit level
Pre-printing:
Test-coloring Frequency of coloring Unit Level
Plate-making (materials) Direct attribution Unit Level
Plate-making (others) Number of Plates Batch Level
Drawing (labors) Drawing hours Unit Level
Drawing (others) Number of plates Batch Level
Production:
Various processes Conversion time Unit Level
After-processing:
Administrative support Number of dyeing orders Facility-sustaining
Box packaging Number of counts Batch Level
Plastic film packaging Number of counts Batch Level
Half piece cloth inspection Number of counts Batch Level
Full piece cloth inspection Length in no. of yards Unit Level
Shade matching Length in no. of yards Unit Level

Comparison of costing information under ABC versus the

existing cost system:-

Situation ABC system Existing costing system

Production Volume (yards):
High Lower product cost Higher product cost
Low Higher product cost Lower product cost
Manufacturing Process (hours):
Complex (more hours) Higher product cost Lower product cost
Simple (less hours) Lower product cost Higher product cost
Rework cost:
Less Less product cost High product cost
More High product cost Less product cost
Dyeing auxiliary cost:
Less Less product cost High product cost
More High product cost Less product cost

Because raw materials (greige) are influenced by the conditions of storage, greige generated
in various batches using the same procedure and dyeing auxiliaries may create distinct final
products, necessitating varying rework needs. As a result, under the current pricing approach,
with its emphasis on only conventional processing time (rather than real processing time) and
disregard for rework charges, the costs of dyeing orders with greater actual processing time
or a greater quantity of rework will be underestimated (negative difference between existing
cost system and ABC). Furthermore, if the dyeing auxiliary cost of a single dyeing order can
be recognized, the costs of dyeing jobs with greater dyeing auxiliary costs will be under-
estimated using the current costing approach.

Conclusion:-
The company uses the current traditional volume-based cost system, which takes into account
the level of complexity and cost relationships while allocating manufacturing overhead costs.
However, it is hard to accurately allocate these costs because of flaws in the system's design
and application, which leads to product cost distortion.

Complexity-based drivers like product categories, rework rates, production methods, and
resource utilization, combined with volume-based drivers like equivalent production and
finished goods, can provide a more realistic explanation for variations in manufacturing
overhead costs. The current method for keeping track of costs doesn't take into account how
rework changes the price of the product or how different dyeing orders have different needs,
which causes cost distortions.

Since it incorporates both volume-based and non-volume-based (complexity-based) drivers,

the ABC method is better at estimating how much a product will cost. The current volume-
based cost accounting method overestimates (positive difference between existing cost
system and ABC) the costs of products that are sold in large quantities and underestimates the
costs of products that are more complicated.

Overall, even though XYZ knew ABC was essential, received active support from senior
management, had the right software, and provided educational training, it did not succeed
because of shifts in their competitive strategy, insufficient supervision in managerial controls
(like production and inventory management), insufficient links to performance reviews and
incentives, and problems with the organization's infrastructure (like human resources).

Most earlier research has focused on success examples, but this study gives a failure scenario
that practitioners may use to avoid the same mistakes. This company had poor production
management and inventory controls and changed its business plan when external conditions
changed, which was not observed in the previous ABC study.
References:-
1. Duh, R., Lin, T. W., Wang, W., & Huang, C. (2009). The design and implementation

of activity‐based costing. International Journal of Accounting and Information

Management, 17(1), 27–52.

https://www.researchgate.net/publication/46545235_The_design_and_implementation

_of_activity_based_costing_A_case_study_of_a_Taiwanese_textile_company