Activity Based Costing (ABC) is an accounting method that assigns costs to activities according to their use of resources, rather than products or services. This enables resources and other related costs to be more accurately attributed to the products and the services which they use. It does not change or eliminate any costs, in the other way; it provides detailed information on how costs are consumed. The main benefits of Activity Based Costing are providing understanding into the fastest growing and least visible element of cost-overhead. We can also improve profitability by monitoring total life-cycle cost and performance so that we can improve the effectiveness of budgeting by identifying the cost of different service levels. In addition, ABC costing does encourage continuous improvement and total quality control because control and planning are directed at the process level and it links the corporate strategy to operational decision making. By using ABC costing, we can also eliminate waste by providing visibility of non-value added activities. Besides that, ABC costing help to improve make or buy, estimating, and pricing decisions which based on product cost that reflects the manufacturing process.
It is widely known that activity based costing has been used by most of the large corporation such as manufacturers. In fact, activity based costing has been widely implemented by small business and service industries such as banks, airlines, hotels, hospitals, insurance companies, financial services firms, accounting firm, railroads and etcetera. However, activity based costing has seemed to be more successful when implemented in large corporation rather than using in small business. Companies with not so much products and markets are not seemed to get as much advantages from basing costs on activities as companies operating with diverse products, service lines, channels and customers.
Actually the primary objective of activity based costing in small industry is no different with manufacturing company. The objective is to figure out the key activities that generate costs and to record how many of those activities are performed for each service provided. Then, managers are able to generate data to provide better budget and concurrently the expenses of a company are known better. The prevalent approach to identify activities, activity cost pools, and cost drivers is the same for manufacturing company and service companies. In addition, the classifying of activities as value-added and non-value added, and the effort to decrease or eliminate non-value added activities are used in service industries too. Since service industries and manufacturer companies are using the same objective of activity based costing, then why sometimes it is difficult in adopting activity-based costing in service industries? The difficulty of implementing activity-based costing in service companies is that a larger proportion of overhead costs are company-wide costs that cannot be directly traced to specific services provided by the company.
Besides that, many of the expenses in service industries are caused by product (services) such as savings account and home mortgage. However, many expenses for service functions are caused by demands by individual customers rather than service demands. Thus, customer behavior which is the feature distinguishing these systems from activity based costing as used in manufacturing companies has to be taken into account when implementing ABC system in services industries. Service companies offer differentiate services in order to satisfy customer needs. Each service, with its characteristics, makes different demands on the organization’s resources. Thus, service companies have to improve their service quality and the variety in service line. Concurrently, service companies have to focus on customer economics far more than manufacturing companies. The cost of marketing, selling, delivery and serving of the products might be customer specific in manufacturing companies. In contrast, for service companies, even the basic operating costs of standard service are determined by customer behavior. Therefore, a fine ABC system for Service Company will provide the information for the measurement of costs and profitability at the customer segment level and market level.
Since small business and large companies are using the same objective of activity based costing, then why does small business get less benefit from using activity based costing compare with large corporation? In fact, lack of knowledge and technical people in adopting the activity based costing system in small business may lead to unsuccessful of using this system in small business. Moreover, activity based costing software is expensive. Most ABC practitioners find that special-purpose ABC software is required to make the task manageable and software can add significantly to outlays for this type of accounting technique. So, small business considers using ABC is wasting of money due to not so much profits and products differentiation for their products. Thus, they omit using ABC.