ABM is a management technique employed in an organization in order to streamline an organization’s production activities towards meeting the objectives and goals of the organizations.
This technique incorporates activity based costing system, which provides valuable cost information. This information enables managers make sound and informed decisions in the course of managing of the operation of all the functions of an organization.
Introduction
Technological advancements have compelled many companies to update their production methods. The information systems have brought a paradigm shift in the business field. These technological developments have given rise to activity based management.
Indeed, companies are evaluating their manufacturing techniques in order to thrive in the business. There is a need for customization of the commodities produced by various companies in order to diversify the risks of low demand of products.
According to Ansari (2007, 45), the processes and the quality of the products produced are very essential in the success of a company’s performance. The inventory system adopted by accompany ought to be cost effective.
In this regard, stock turn-over should be very high in order to reduce eth stock holding costs. The policies of the work force ought to be employee-friendly and result-oriented.
The determination of accurate information in an organization is important given that this information is used in the evaluation of the productivity of the systems of the firm. This evaluation is used to improve on variances and inefficiencies found.
The aspect of costing is tedious yet it ought to give correct and accurate position of accompany. Most organizations are still applying the obsolete traditional cost accounting techniques.
However, innovation and invention has culminated in the discovery of a new model of cost accounting system, Activity-Based Management (ABM).This system has already been rolled out in the USA and Europe (Baker, 2008, 67).
This system entail the factoring of the entire system of an organization in the manufacturing of a product unlike the traditional method which only takes into consideration the financial aspect of the manufacturing process.
The latter system results in a misleading and inaccurate cost information. ABM uses both financial and non-financial data in the computation of costs of production processes.
The activity based costing (ABC) method takes into consideration the activities involved in the production of commodities whereas the traditional method just allocates costs artificially, to products.
This leaves out hidden costs, which end up not being included in the total cost of production of products.
Furthermore, ABC analyses the work-flow and all the processes of production in order to identify the real activities which incur the costs. ABC phenomenon enables all decision makers to use accurate information concerning the costing of production of products.
Although, this method is not a gateway to making organizations the best competitors, it contributes in the evaluation of performance of the organizations.
Purpose
This paper is aimed at establishing the manner in which the ABC systems can be employed in the decision making process. There is a need for development of a conceptual framework which will enhance the decision making process.
The conceptual framework includes the work force management, product planning, process design, quality management and inventory management.
Activity-based management
ABM is based on the assumption that products consume activities, which in turn consume resources of an entity (Baker, 2008, 53). This system allocates the activity costs based on the resources consumed in the production process.
The costs associated with the activities are assigned to products. This assigning of cost to products is done using specific ratios of their workloads. This system establishes the exact portion of resources consumed by a particular product.
This is aimed at means using the profitability or loss of producing a certain good. In addition, this information helps in the determination of the most value-adding activities. The system also establishes the type of customers who are most valuable to the organization.
This allocation of costs to activities also helps in the improvement of performance of the organization given that non-value adding activities can be eliminated early. In this regard marketing strategies are developed hence improving the sales revenue of various products.
Furthermore, this system has culminated in great advancement in product design and customer satisfaction. Internal processes have been streamlined in order to realize the value of the activity based management. The supplier relationships have been boost by this system.
The ABM employs cost drivers in the allocation of costs to products. A cost driver is an event related to a certain activity, which consumes the organization’s resources. The traditional cost accounting system employs only one cost driver in assigning cost to a product.
This results in the allocation of much cost to a single product while the rest of the products are allocated low cost.The ABM system is a remedy in this scenario because it employs multiple cost drivers in order to realize accuracy and equitable allocation of cost to products.
A cost accountant in ABC system is charged with the responsibility of analyzing the production processes in order to provide valuable information of the activities involved in the whole production process (Brinker, 2008, 71).
The middle managers help the accountant in the identification of activities involved in producing a good. For instance, a portion of the cost of a product or service can be based on the number of purchase orders made for each product.
Moreover, the cost of production can also be determined by the number of machine set ups per product manufactured.
Therefore, all the activities, which affect the production of a commodity, are cost drivers. The numbers of cost drivers in the production process are usually many, but the most significant are selected to help in decision making.
The development of the ABM system
The development process involves the identification of resources for the tasks. Then the resource drivers are also identified by the middle manager and the cost accountant. These drivers are used to allocate resources to the activities.
The activities, to which the resources are attributed to, are identified. The activity drivers are also identified in order to know the appropriate costs which ought to be assigned to the products. Finally, the objects of work are identified.
Manufacturing changes that led to ABM system
Manufacturing has experienced major transformations over the last two decades. New methods have been adopted in the process of seeking efficiency in the manufacturing process.
The invention and innovation of this period has resulted in decline in the inefficiencies though profits have not increased. In this regard, competition of manufactured products has increased.
Currently manufacturing is based on the kaizen principles, minimal inventory and high inventory turn-over. Forrest (2006, 23) posits that total quality management should be factored in the manufacturing process.
ABC system can reveal the progress of a company with regard to international performance standards. This makes the multi-product company product costs accurate due to the use of correct absorption of overhead costs.
Good performance in any industry is based on the true product costs and cost drivers. The setting of performance measures will assist in the evaluation of a company’s performance over time. ABM system lays more emphasis on the cost of activities than the cost of products.
This implies that the activities can be reduced by the changing of the mix of products which are produced. The activities can also be increased or reduced by the change of the product design. This adjustment can help in the reduction of costs associated with inventory storage and ordering costs.
The ABM system is focused on the macro picture of the production process hence creating improvement in the entire industry.
ABC and ABM systems
Activity based costing is the use of cost drivers in assigning cost to products in order to have a reliable cost of production. A cost accountant uses this system to analyze the pricing and product sourcing.
Business re-engineering processes have also improved the business performance given that this process enhances the elimination of non-value adding processes.
The shift from activity based costing ( ABC) to activity based management (ABM) is based on the shift from resources, activities and cost objects to cost drivers, activities and performance drivers.
This implies that the activity based costing is based on a cost assignment assumption while the activity based management is purely based on a management point of view.
The activity based management utilizes the information generated from activity based costing, in the performance evaluation process. This results in continuous improvement of the productivity.
This owes to the fact that the production processes are reengineered resulting in efficiency and effectiveness in manufacturing processes. In this regard, ABM qualifies as an internal process for performance improvement.
Many companies have successfully employed this system especially the Tektronic and Zytec Corporation (Kehoe, 2005, 34). This system has improved their business performances by a great magnitude.
ABM provides strategic value for the managers to use in decision making given that the system supplies sufficient financial data for decision making. Moreover, this system helps in the analysis of processes and activities in order to identify value-adding and non-value adding activities.
The ABM system was invented in 1980 and it was assumed to be a mere upgrading of the general ledger system (Kehoe, 2005, 56).
ABM comprises of accounting of the production processes and examination of the effectiveness of the organization structure in place. This shows that this system incorporates all aspects of a firm.
ABM systems and its impact on operations function
Operation management comprises of product planning, product design, quality control, process design, process improvement, employee management and inventory management. These processes are contained in the operation hexagonal model aforementioned and illustrated above.
Leitner (2007, 47) asserts that the operation function is strengthened by the interlinking of all the processes. This allows sound decision making with regard to the efficiency of the system. Activity based management co-ordinates and controls all these processes.
Product planning and design
ABM helps in the designing and innovation of products. It is easy to allocate cost in an industry, which produces one product than in accompany which produces a wide array of products. This owes to the fact that production of multiple products incurs high manufacturing overhead cost.
These costs include the supervisory, maintenance of machinery and equipment, inspection cost and production control costs. The traditional cost accounting system employs only two related variables in overhead cost assignment.
This often leads to overestimation of company profits and a based analysis of buy or make decisions. In addition, the decision of outsourcing products and employees is subjective given the inaccuracy of information used for decision making.
The activity based costing provides vital information regarding the decision making process. For instance, the system offers valuable information with regard to the size of orders, which is cost effective.
The orders which are produced in small quantities are the most valuable hence any company should endeavor to produce such commodities instead of producing large quantities of products which are not profitable.
The traditional costing system distorted the profitability of organizations because of the inaccurate costs used in the computation of product costs.
Product design
This refers to the process through which a product is customized in order to meet the needs of different customers. ABM system helps in harmonizing the different positions of these three functions with regard to product design.
The machine set up problem can be solved when machine set up cost driver is deemed unnecessary. The employment of ABM enhances horizontal communication between the three functions of an organization especially on issues bordering product design.
Quality management and control
It is a common goal for all organizations to uphold quality delivery at all times. This entails maintenance of high levels of quality and service delivery. Therefore, the bottom line is the improvement of quality in all aspects of the business hence the business will automatically advance.
ABM helps organizations in the cost justification in projects. The system takes into account non-financial factors hence it will help in the selection of an appropriate project. This system also helps in the surmounting the quality costs.
This includes the prevention, appraisal and internal failure costs. The prevention costs are the costs which are incurred in order to prevent the occurrence of errors. The appraisal costs refer to the clerical tasks which confirm whether the products conform to the required standards.
The internal failure costs are the costs incurred in order to ensure that any error committed within the organization does not reach the customers. On the other hand, the external costs refer to the cost incurred in hand of customer complaints and customer dissatisfaction.
ABM system helps in the detection and correction of costs not captured by the traditional costing method.
Process design and improvement
ABM system gives guidance in the decision making pertaining to the equipment and business processes. The system analyses all the determinants of the activities involved in the production process.
In this regard, the system reveals substantial information to the people who design the products. This owes to the fact that the information helps the product designers to select the best design which will meet the market demands.
Most companies resort to random design of their products in a bid to meet market demands. These companies also make complex products, which are expensive to produce.
However, the market and the general prices surpass the cost incurred in product designs and manufacturing of complex products. ABM, system identifies the overestimated product costs through the analysis of the production processes and activities.
This system can also be applicable in pure cellular manufacturing. Cellur manufacturing refers to the mini-assemblies which manufacture similar products. In this regard, there is no distinction between the indirect cost and the direct costs because the system unifies the costs.
Western Zirconium Company benefited from the ABM system IN 1988.this system enabled the company to reorganize its manufacturing floor in order to arrange the work. This improved the production because movements were minimized in the production zone.
The company had initiated a regulatory system which gauged the company’s performance on the absorption of overhead and labor efficiency. However, this culminated in the increase of inventory levels which led to the loss in the competitive edge of the company.
ABM system enabled the firm use the cost drivers and activities in the cost ascertainment process. This led to a significant reduction in the inventory levels and the product acceptance for the company’s products increased by a great margin.
The production time also reduced leading to prompt response to the customer requests.
Inventory and procurement management
Just-in –time strategy helps in the reduction of losses incurred in the inventory storage. This owes to the fact that JIT system emphasizes on zero inventory levels hence reducing the stock-holding costs. However, ABM system establishes the reason for increase of inventory within an organization.
For instance, the incentive system may lead to the large stocks. When the suppliers offer discounts, the purchase department is enabled buy in bulk. This qualifies them to be awarded incentives because of the low cost purchases.
In addition, if the produced goods undergo throughput, then the goods will be produced in bulky. The goods, which do not go through in this process are pushed to the next process of processing. The rest of the goods are taken to the warehouse.
ABM system advocates for minimal inventory levels. Rupp Company also benefited from ABM system through the use of a number of moves as cost drivers in the determination of the cost of production (Kehoe, 2005, 72).
This was carried out in the three stages of production: the purchased parts, work-in-progress and finished goods. This was aimed at the creation of cost pools. This was followed by the assignment of the cost to each product.
In this regard, ABM enhanced the reduction of cost in material handling, supervision and equipment maintenance. This system also enables organizations to carry out manufacturing resource planning in order to ensure utilization of resources.
This also helps the organization to know the various requirements in the production department in order to avoid production stalling. In this manufacturing resource planning process, the purchasing department receives orders, it does an inspection and stores all the items.
On the other hand, the traditional cost accounting system ensured that the purchasing department followed 15 steps in the material requisition process. This implies that ABM system has streamlined the manufacturing system.
Work force management
ABM system positively impacts the employees of an organization. This owes to the fact that the system influences the roles and responsibilities, the performance measures, the employee empowerment and accountability, and Capacity and investment management.
Empowerment and accountability
ABM system converts financial information into activities, which enables the workforce to understand the objectives of the firm. In this regard, employees relate easily with the firm’s agendas.
This boosts both the performance of the work force and continuous improvement of quality. Furthermore, this relates to the application of theory Y whereby the employees have self-drive at their work place (Frost, 2005, 24). The employees can make decisions on the handling of materials.
This empowers the employees hence increasing their overall performance in the organization. The purchasing department does the work of receiving the various orders, inspects them and stores the stock in the warehouse and stores.
The ABM system involves only the three stages in the acquisition of goods from suppliers. On the other hand, the traditional system involves 15 steps in the purchasing of items from the suppliers.
This implies that the ABM system reduces the period of requisition of items from 9 week to one week. This contributes in the efficiency of this system. The system also breaks down the organizational policy framework to a form, which is understood by the shareholders.
This makes it easy for employees to understand the broader picture of the financial implication of their performance. In addition, this helps the employees to have insight into the financial aspect of the organization.
Moreover, this translation enables the employee to improve in his task performance in order to contribute to the overall financial performance of the firm. In fact, the employees are made to be less reckless in their tasks hence reducing the spoilt, sub-standard and faulty items.
In this regard, the application of theory y is manifest given that the employees are self-driven in their tasks. This results in the savings because the work of supervisors and clerical officers is eliminated.
Roles and responsibilities
ABM enable employees to take part in the decision making process. This makes them more responsible and accountable of all their actions pertaining to the overall productivity of the firm. The work of the middle level managers is significantly reduced.
This lot does the facilitating of the performance of the employees instead of supervising them. In this regard, the managers enable employees to exploit their potential in performance.
Capacity and investment management
Many organizations are not aware of the capacity not utilized. This leads to the incurrence of high costs throughout the financial year. ABM is a remedy in this situation given that it gives insight on the defense between reduction of unutilized capacity and increase of shareholder’s wealth.
The ABM system analyses this scenario in three categories: the productive, the non-productive and the idle capacities. The idle capacity is the capacity which is available for use but has not been exploited by the organization.
The non-productive capacity is the capacity which is not useful to the company. Therefore, this non-productive bit has been ignored by the organization. The productive capacity is the capacity which has been fully utilized.
In this regard, the ABM system enables a continuous improvement process through the focusing on the unused capacity of the firm. In addition, the system allows organizations make informed decisions with regard to the going concern of an organization.
Therefore, it is possible for firms to compare alternative courses of actions with regard to the resource management. The make or buy decision help the firms curb the bottlenecks associated with obsolete equipment and machinery.
This decision is informed by the activity based cost accounting data. The ABM system is vital in the business realm given that it evaluates in detail a new technology before the technology can be applied.
In this regard, the cost and the coordination of different production activities can be established in advance. In addition, the system transforms the company objectives into production activities. This helps in the achievement of the goals easily because the workforce easily identifies with the goals.
The decomposition of the company objectives into economic activities results in a sound analysis of investment ventures and scrutiny of the results of these investments. This will boost the competitive edge of an organization.
The ABM system reveals the value of the unused capacity at a glance hence giving the management an opportunity to weigh their options regarding investment projects.
Moreover, the system enables the management to concentrate on the most crucial variables in the firm in order to have continuous improvement in productivity. ABM also gives the managers insight with regard to making of the buy or make decisions.
It helps in the determination of the going concern of an organization through in-depth evaluation and analysis of an organization’s system of operation. In addition, this system enhances the product re-engineering process which boosts the competitive edge of the firm.
It also helps in the determination of viable projects for the firm. The bottle-necks common with the normal operation of business, are eliminated owing to the fact that obsolete machinery and equipment are eliminated promptly.
These initiatives are based on the activity based cost accounting system data. The traditional system can provide inaccurate information regarding the buy or make decisions because of the use of single cost drivers.
Player and Arthur (2009, 65) asserts that the hi-tech strategies employed in the ABM system result in the delivery of informed decisions regarding the replacement of assets. This is because all the implications are simulated given the use of sophisticated software.
This boosts the business because good opportunities are seen at a glance while the bad opportunities are avoided in advance. The firm’s strategy is supposed to be incorporated into the investment decision making.
This enables the evaluation of the technology in the aspects of cost and performance of the business. ABM system also breaks down the goals of the organization into the production activities.
This enables employees to understand the significance of their performance at work to the overall productivity and achievement of the organizational goals. The activity based approach, unlike the product-based approach, provides consistency in the investment and performance appraisals.
Performance measures
The performance appraisals are carried out on managers and employees. However, this is controversial and counterproductive.This is because a high supervisors’ performance will lead to low productivity because employees need independency of thought in performing their duties.
However, ABM system is a remedy in this instance because it provides the bench-marking process which evaluates the overall performance of all employees against the employee performance of similar firms in the same industry.
The benchmarking is also done based on other factors like service levels, time management and quality management.
Conclusion
The traditional costing method is unsatisfactory because it employs only one cost driver in the assignment of overhead costs to products. However, ABM provides a solution by employing multiple cost drivers in the allocation of overhead costs to products.
Moreover, the ABM system is based on the activities of producing a good hence it gives accurate data on the manufactured products. The new system also employs benchmarking process in the performance appraisal of the overall performance of the organization.
In addition, the system employs the re-engineering of products which is a competitive strategy in the market. This boosts the competitive edge of the firm in the industry.
Activity based costing provides valuable information in the management decision making with regard to the cost justification and effectiveness. This enables the determination of the effects of the production activities the cost of production.
The cost accountant bears the responsibility of identifying the value of production activities customers. This helps in the determination of value adding activities.
This results in the employment of management by exception principle whereby value-adding activities are increased while the non-value adding activities are abandoned.
Recommendations
There is a need for ABM system to be customized so that it can accommodate a wide array of situations and organizations. For instance, the system should accommodate organizations undergoing re-engineering and restructuring processes.
In addition, the system should be fully synchronized with the activity based costing system in order to monitor absorption of overhead costs.
References
Ansari, S. L. (2007). Activity-based management (ABM). United States: Irwin.
Baker, J. J. (2008). Activity-based costing and activity-based management for health care. Gaithersburg, Md: Aspen.
Brinker, B. J. (2008). Activity-based management: Emerging practices in cost management. Boston: Warren, Gorham & Lamont.
Forrest, E. (2006). Activity-based management: A comprehensive implementation guide. New York: McGraw-Hill.
Kehoe, J. (2005). Activity-based management in government. Arlington, Va: Coopers and Lybrand.
Leitner, A. (2007). Activity Based Costing. München: GRIN Verlag GmbH.
Frost, W. (2005). ABCs of Activity Based Management: Crushing competition through performance improvement. New York: Universe, Inc.
Player, S., Keys, D. E., & Arthur Andersen & Co. (Firm). (2009). Activity-based management: Arthur Andersen’s lessons from the ABM battlefield. New York: J. Wiley.