Activity Based Costing Project

8/2/2019 Activity Based Costing Project

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Sri Sharda Institute Of Indian Management-Research Foundation7,Institutional Area Phase II Vasant kunj, New Delhi 110070

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Email:[email protected],[email protected]

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The Project On

Activity Based Costing

Cost Accounting

Submitted To: Submitted By:

Dr.Bibhu Sahoo Bhanu Pratap Singh

20110105

Harshit Pathak

20110106

Batch 2011-2013

PGDM- 1st

Year
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ACKNOWLEDGEMENT

The completion of our project depends upon the co-operation, coordination and

combined efforts of several resources of knowledge, inspiration & energy. I

Always knew that in an organization, the work atmosphere yields enormously on

an individuals productivity and quality of work. The competence and expertise of

people around us at Was a factor that motivated us to strive and achieve nothing

short of perfection.

We owe a great many thanks to all those, without whom this project wouldnt

have been as much a learning experience and as successful. To those, who helped

and supported us during the course of this project.

My deepest sense of gratitude for for constant guidance, professional help and

support during the course of the project, for .guiding us and helping us at all

times during the project. He was the key inspirer for us and without his guidance

this project would have been a distant reality.

We thank my colleagues and friends for providing constant encouragement and

help. We are indebted to them for their timely help & the enthusiasm they

expressed in helping us bring this project to the fruitful end.


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DefinitionActivity Based Costing (ABC system) is a costing methodology where costs areallocated to products and services based on the number of transactions or eventsinvolved in the process of providing the product or service.The concept of Activity Based Costing was developed in the manufacturing sector andgiven a broader audience by Robin Cooper and Robert Kaplan. Cooper and Kaplan,proponents of the Balance Scorecard, published a number of articles in HarvardBusiness Reviewbeginning in 1988. Cooper and Kaplan presented Activity BasedCosting as an approach to solve the problems of traditional cost management systems.Traditional cost accounting was limited in its ability to accurately determine the costs ofproduction and related services. As such, managers made decisions based on

inaccurate data. Activity based costing by contrast identifies cause and effectrelationships in order to objectively assign costs. Once activity costs are identified, thecost of each activity is attributed to each product to the extent that the product uses theactivity. Activity based costing enables managers in this way to identify and correctareas of high overhead costs per unit.

Activity based costing can provide detailed cost information to support annual budgets,and determine customer profitability. It also enables management to see howperformance can be maximized and growth strategies realized. For example, acustomer may appear to be profitable based on income. However, in applying activitybased costing, where costs are associated with the services that the customer

demands, it may be discovered that the profitable customer is driving the largestexpenses. In identifying cost drivers, it is important to ensure that the activities aremeasurable and relevant. You must be able to determine that the activity has a direct orindirect relationship to the cost of doing business and you must be able to allocate toeach customer the portion attributable to the activities consumed.


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Introduction & Background of the CaseThe purpose of this descriptive case study is not to elaborate on the

complicated details of EVM, but to elaborate on the fundamentals of activity

based costing (ABC) in the context of project management. The opportunity

is to develop an integrated management system utilizing ABC concepts to

plan, measure, and control costs that allow managers to focus on process

performance and to make informed decisions along the

product/service/project life cycle.

It is assumed that the reader is familiar with common project managementterms. However, Figure 01: Wideman Comparative Glossary in the appendix

contains a web link to Wideman Comparative Glossary of Common Project

Management Terms v3.1 for those readers unfamiliar with project

management terminology.

1.1 Discussion & Analysis of Critical Issues

Organizations are faced with many challenges during this time of economic

recession. The most common organizational reactions are to button down

the hatches, secure the turf, and start chopping staff positions.

Dysfunctional organizations tend to always look in the rearview mirror and

employ managers that make snap decisions without sufficient data, which

often result in organizational demise. Forward looking organizations that

seek out opportunities during a time of economic recession tend to focus on

process improvement initiatives such as, business-process analysis; activity

based costing, life cycle compression metrics, among other things.

This case study assumes the forward looking perspective. The next section

introduces activity based costing, which is followed by a brief discussion of

concepts and methods found during the research of several other

independent case studies. Then an introduction and description of some

basic project management processes. Finally, continued by a simplicity case

and finally the conclusion.


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2.1 Activity Based Costing (ABC) Introduction

ABC was developed as a continuous improvement initiative of the accounting

information system. Original, ABC was used as a product costing

methodology, but is now being used as a cost management tool in many

different functions of business (Awasthi, 1994, p 8). A couple of differences

between ABC and traditional cost systems are 1) costs are traced to cost

objects by identifying cost drivers and 2) costs are traced on the basis of the

structural or hierarchical level at which costs are incurred. Therefore, ABC

provides more accurate cost estimates of the product or service and the

corresponding activities than traditional costing (Kee, 1995, p 49).

2.2 Activity Based Costing (ABC)

DiscussionIt is important to note that in traditional costing the assumption is that

products consume resources. ABC contrasts traditional costing by assuming

that products consume activities and activities consume resources. Once the

product or service activities are identified, costs are allocated to the product

or service according to the amount incurred by those activities. This method

of allocating costs provides a benefit for making decisions regarding different

types of profitability andproject accounting(Awasthi, 1994, pp 9-10).

There are two sets of costs related to the accuracy of ABC cost information,1) cost of measurement and 2) cost of decision error. As the accuracy of

measurement goes down the cost of decision error goes up. Detail is an

important factor in the success of a ABC system, but the detail must be

value add. It is important to control changes brought on by environmental

factors (competition, volatility, profit margins, etc) while still allowing for

diversity throughout the life cycle of the product or service (Awasthi, 1994, p

11). So how can one ensure accuracy in measurements for better decision

making? The key is to identify and analyze the most optimal cost drivers

that trace the costs of the activities back to the product or service.

2.3 Activity Based Costing (ABC) Activity Identification & Analysis

Cost drivers are linked to business process mapping and activity analysis in

order to obtain rigid data for measurement analysis. Figure 02 depicts a two

stage process that traces expenses through activities to cost objects.
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Figure 02: Basic ABC Flow

The first stage traces expenses from the department or organizational level

budget to activities that are assigned to resources (labor, space, materials,

and suppliers). For example, a labor resource is allocated to an activity at

100% over a duration of time equating to a unit of work converted to an

activity cost. In the second stage, activity costs are traced through the

activity cost drivers to the cost objects, i.e. products and/or services. This

stage is concerned with explaining the causes of work and what things cost.

Managers that focus on process drivers and cost drivers have a more

detailed understanding of activity costs and associated activity

dependencies. Therefore, managers can make better decisions on areas in

need for process improvement instead of shooting from the hip (Brandt,

Levine & Gourdoux, 1999, pp 22-25).

ABC provides a hierarchical structure of detail. The challenge for managers is

to ensure an optimal amount of detail that achieves balance and accuracy.

Next we discuss cost driver optimization.

2.4 Activity Based Costing (ABC) Cost Driver Optimization

Managers chose cost drivers for planning and control purposes. Choosing too

many cost drivers and the system is bogged down creating extra costs and

inefficiency problems. Managers must strive to strike a balance between

accuracy benefits and costs of data management. Babad & Balachandran

indicate in their article, Cost Driver Optimization in Activity-Based Costing,

that an optimal number of cost drivers generally discriminates and captures

most of the incurred costs, and identify a priority order that specifies which


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low-priority and relatively insignificant activities will be combined to save

costs without sacrificing much accuracy (Babad & Balachandran, 1993, p

565).

At this point the concepts of ABC have been introduced and discussed as a

process object for organizations to utilize. The next section expands on the

project management context as it relates to ABC.

3.0 Project Management and ABC Introduction & Background

The project manager is responsible for the scope, schedule, and budget

(triple constraints) at the project level. A project is characterized as a

progressively elaborated temporary endeavor undertaken to create a uniqueproduct, service, or result (PMBOK, 2004, p 5). Projects generally exist as a

sub-set of the organization.

3.1 Project Management and ABC Project Life Cycle

Project managers or organizations parcel projects into phases for better

management control. Phases are typical identified within a life cycle. The

phases of the project life cycle are depicted in Figure 03: Project Life cycle.The project life cycle is not intended to represent the project management

process. The project life cycle typically defines 1) what technical work to do

in each phase; 2) when the deliverables are to be generated in each phase;

3) who is involved in each phase; 4) how to control and approve each phase

(PMBOK, 2004, p 20).


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Figure 03: Project Life cycle

(PMBOK, 2004, p 68)

3.2 Project Management and ABC Work Breakdown Structure (WBS)

In this process, project deliverables and objectives are subdivided into

smaller more manageable components. A WBS is a deliverable-oriented

hierarchical decomposition of the work. This is the activity analysis concept

mentioned previously in section 2.3 Activity Based Costing (ABC) Activity

Identification & Analysis. Work is planned to the lowest-level WBS

component called a work package. Work packages can be scheduled,

monitored, and controlled.

Figure 04: WBS Example 01 in a generic representation of a WBS. Notice the

phases and deliverables located throughout the WBS. Also notice the work

packages at lowest-levels of the WBS. Figure 05: WBS Example 02 is a

software development representation of a WBS. The activity costs are traced

to the first level and are also the phases of the project. The deliverables are

at level two, where as the resource and activity drivers are at the lowest-

level. As mentioned before, the lowest level is a work packages and can be

scheduled, monitored, and controlled.


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Figure 04: WBS Example 01

(PMBOK, 2004, p 114)

Figure 05: WBS Example 02

(PMBOK, 2004, p 116)

3.3 Project Management and ABC Responsibility Assignment Matrix

(RAM)

To define the cost objects a PM will use a RAM. Max Wideman defines the

RAM as an important tool that correlates the work required by a Contract


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Work Breakdown Structure (CWBS) element to the functional

organization responsible for accomplishing the assigned tasks.

The responsibility assignment matrix is created by intersecting

the CWBS with theprogram Organizational Breakdown Structure (OBS). This

intersection identifies the cost account (Wideman, 2002). Figure 06: RAM

Example 01 and Figure 07: RAM Example 02 are great examples of how cost

objects are realized as cost accounts. All the activity estimates, risks, and

incurred costs related to the cost account are summarized at these

management control points. This gives the PM tremendous insight to the

health of his/her project.

Figure 06: RAM Example 01

(Valuation Opinions, Inc., 2008)
http://www.maxwideman.com/pmglossary/PMG_C14.htm#CWBShttp://www.maxwideman.com/pmglossary/PMG_E01.htm#Elementhttp://www.maxwideman.com/pmglossary/PMG_T00.htm#Taskhttp://www.maxwideman.com/pmglossary/PMG_R04.htm#Responsibilityhttp://www.maxwideman.com/pmglossary/PMG_A05.htm#Assignmenthttp://www.maxwideman.com/pmglossary/PMG_C14.htm#CWBShttp://www.maxwideman.com/pmglossary/PMG_P07.htm#Programhttp://www.maxwideman.com/pmglossary/PMG_O01.htm#Organizational%20Breakdown%20Structurehttp://www.maxwideman.com/pmglossary/PMG_O00.htm#OBShttp://www.maxwideman.com/pmglossary/PMG_C10.htm#Cost%20Accounthttp://www.maxwideman.com/pmglossary/PMG_C10.htm#Cost%20Accounthttp://www.maxwideman.com/pmglossary/PMG_O00.htm#OBShttp://www.maxwideman.com/pmglossary/PMG_O01.htm#Organizational%20Breakdown%20Structurehttp://www.maxwideman.com/pmglossary/PMG_P07.htm#Programhttp://www.maxwideman.com/pmglossary/PMG_C14.htm#CWBShttp://www.maxwideman.com/pmglossary/PMG_A05.htm#Assignmenthttp://www.maxwideman.com/pmglossary/PMG_R04.htm#Responsibilityhttp://www.maxwideman.com/pmglossary/PMG_T00.htm#Taskhttp://www.maxwideman.com/pmglossary/PMG_E01.htm#Elementhttp://www.maxwideman.com/pmglossary/PMG_C14.htm#CWBS


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Figure 07: RAM Example 02

(Performance Management Associates, Inc., 2008)

3.4 Project Management and ABC

Resource Loaded Network (RLN)

A RLN is an integration of schedule and cost and is represented as a network

of time phased resource loaded activities sequentially ordered across the

phases of the project life cycle. A resource loaded activity is also called a

work package. The longest path through the sequential network of activities

is known as the critical path. The PM uses what is known as the critical path

method to focus on those activities along this path to ensure the project

delivers on time and within budget. A PM can exercise a critical path

analyses, what-if drills, and PERT analyses to monitor time and costimpacts. Figure 08: Critical Path represents a network of activities with the

critical path indicated in bold red.

Figure 08: Critical Path

(Construction-planning-and-control.com, 2008)

3.5 Project Management and ABC Descriptive Case


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Project staff utilize ABC concepts throughout the project life cycle and may

not even know it. One of the first jobs for the project manager (PM) and

team to conduct is a delineation of the deliverables and objectives defined in

the statement of work (SOW) using ABC concepts. A simple example of this

is when a project sponsor initiates the transfer of scope (deliverables and

objectives) to be performed within a stated timeline and within a specific

budget to the PM via the project charter. Before establishing the activity

costs, the scope must be decomposed into a work breakdown structure

(WBS). The PM aligns the WBS with the organizational breakdown structure

(OBS) to determine control accounts and assign control account managers

(CAM). CAMs develop the scope description in the WBS dictionary, which is

comprised of inputs, outputs, assumptions, constraints, risks, deliverable

milestones dates, among other things. The resources are assigned toactivities and time phased within a resource loaded network (RLN) or more

commonly known as the schedule. It is the basis of estimate (BOE) artifact

that explains the rationale behind the costs related to the time-phasing of

activities and substantiates the activity cost estimates. All of the appropriate

technical, schedule, and cost artifacts are captured into one project

management plan (PMP).The technical baseline, schedule baseline, and the

cost baseline are integrated into a performance measurement baseline

(PMB), which establishes the foundation for performance tracking andestimate to complete forecasting.

4.0 Conclusions & Recommendations

ABC is absolutely applicable in the context of project management.

Organizational managers and project managers alike need a method to

manage vast amounts of activities. Tracing cost to the

product/service/project element gives managers an advantage to make

informed decision for process improvement. ABC is one method of many and

project management is the discipline of tactical processes to implement

business strategy. Organizations that focus on opportunities and process

improvement initiatives may just come out on top as winners in this most

uncertain time of economic despair.
http://pmstudent.com/pmp-guide/http://pmstudent.com/pmp-guide/http://pmstudent.com/pmp-guide/


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Case Studies On

Activity Base Costing

1. Introduction

Researchers in management accounting have traditionally been, above all,

interested in the accounting systems of large manufacturing companies. Most

accounting researchers interested in service production have conducted their

research in non-profit seeking, public-sector organizations (Pellinen 2003, p. 217).

Outside the non-profit sector, the number of studies on the management

accounting practices of service organizations (profit seeking) have remained very

limited (Brignall et al., 1991; Sharma, 2002). More unfortunately, non-traditional

lodging, (i.e. the B&B industry), is totally lacking in management accounting

research, in contrast with the traditional lodging industry, which is quite well-

researched.

The aim of this paper is to illustrate how activity-based costing (ABC) can be

applied to a hot spring country inn in order to obtain information on activities and

products for decision making purposes. ABC is a cost-accounting method that

allocates resource costs to products using a two stage procedure on the basis of

activity consumption by drivers. Its a method which can overcome many of the

limitations of traditional cost systems which can distort product cost because they

allocate the overhead costs to products mainly by direct labor hours (or volume-related measures). This is particularly prone to result in distortions in cases where

there is a large overhead ratio or a high degree of product diversity.


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The country inn style of non-traditional lodging, especially suitable for ABC

application, has various products such as lodging, hot spring use and dining which

belong to different market segments. The indirect costs of this inn constitute an

important proportion of the total costs (53.46%). In such a typical situation, the

valuing of products of this inn may be distorted by a traditional accounting

system. This article portrays an attempt to apply the ABC model to a hot spring

country inn where the managers normally use a traditional accounting method to

acquire product cost information. Our case study is presented in the hope of

contributing to management accounting research in the non-traditional

accommodations area.

In addition to the introduction, there are four main sections in this paper.

The subsequent section reviews previous research in management accounting for

the lodging industry. The third section presents the ABC model. The fourth section

illustrates the implementation of ABC in a specific case. The fifth section

compares results of the ABC method and the traditional method. Some

conclusions are presented in section six.

2. Literature review

Poorani and Smith (1995, p. 58, 63) observe: The hotel and the B&B

industry have very different financial aspects arising from contrasting ownership

motives. In the hotel industry the emphasis is on maximizing profitability

whereas the B&B industry has been traditionally characterized by innkeepers who

embarked on inn-keeping as a second career to satisfy lifestyle goals. But thecurrent economic environment has blurred that distinction. Hoteliers are trying to

be more sensitive to customers needs and create an environment for

personalized service. Meanwhile, many entrepreneurs are entering the B&B

segment with strictly financial motives. Their investigations attribute financial

characteristics to the B&B industry and find that innkeepers in USA with midsize


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and larger operations not only were highly successful in reaching their career

goals but also achieved their economic objectives as measured by return on

investment and equity. However, notwithstanding the importance of financial

aspects, the studies in cost structure of the B&B industry anywhere in the world

were rare. One reason is the inns private-ownership arrangements; others are

the fragmented industry structure and the lack of systematic cost and revenue

data.

Unlike the situation in the B&B industry, there have been a large number of

studies in the hotel industry. In the management accounting side of the tourism

industry, research has been conducted both in tourism management research and

in accounting research. Studies have been carried out in passenger transportation

(Dent, 1991; Rouse et al., 2002), restaurants (Ahrens and Chapman, 2002), and

hotels (Downie, 1997; Edgar, 1998; Noone and Griffin, 1999; Mia and Patiar,

2001; Pellinen, 2003). Downie (1997, p310) emphases the importance of

considering how accounting information can be analyzed to support marketing

decisions more effectively. Noone and Griffin (1999, p111-128) designed a

customer profitability analysis (CPA) integrating activity-based costing (ABC) and

customer segments in order to find profit yield in a hotel. Mia and Patiar, (2001,p111) interviewed only 35 managers and indicated that general managers and

department managers took equal account of the management accounting system,

but general managers were more content with the accounting system and valued

financial information more than department managers. Pellinen (2003, p217)

studied the pricing decisions in six tourism enterprises (including a hotel) and

suggested the enterprises observed all took their prices from the leading

company. Thus, the importance of cost accounting is limited with reference to

pricing decisions from the managerial viewpoint. Obviously, most of the studieshave focused on hotels. As Harris and Brown (1998, p161) pointed out, hotels,

which typically comprise food, beverage and lodging, can be used to illustrate that

the context of the hospitality product can provide a complete range of

characteristics in a single arena. Actually, the B&B industry also has all those

characteristics. But this segment, specifically nontraditional lodging (including


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B&B inns, country inns, small hotels, condominiums, and vacation homes), has

remained an enigma to industry analysts and researchers. Lanier et al. (2000, p91)

think this is in part because the analysts and researchers willfully overlook it in

favor of the traditional lodging industry, pleading lack of data (Statistics dealing

with properties of fewer than 20 rooms are usually estimated or based on small

samples. Since most country inns do not reach the 20-room threshold, statistics

for these properties have not been collected regularly, unlike other industry

segments). This is so prevalent in studying management accounting in the

accommodation industry and that there is a huge lag for researchers to make up

for.

Summarizing the above, previous studies on accounting and product costing,

pricing of hotels propose that : (1) the knowledge in accounting is essential in

hotel management, (2) the connection between accounting information and

marketing is important, and (3) activity-based costing, cost-volume-profit analysis,

yield management, and segment profit analysis were among the most relevant

management accounting methods, (4) the lack of management accounting

research in non-traditional lodging industry needs to be made up.

3. Activity-based costing

Cooper and Kaplan (1988) have developed what they believe is a better

alternative to the traditional cost calculation model. They argue that as products

differ in the complex process of manufacture, they consume activities in different

proportions. The activity-based costing method (ABC) promoted by Cooper and

Kaplan provides a more accurate measure of cost because it traces indirect costs

more closely with regard to the different types of activities consumed. Armed

with knowledge of what activities are consumed by each product and the

resource cost of each activity, one can budget costs for a diversity of products.


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However, the traditional accounting method usually assigns overhead costs of

products by using volume-related allocation bases such as labor hours, direct

labor costs, direct material costs, machine hours, etc. This will not critically distort

the product costs as the overheads are just a small portion of the production

process. But in situation where there is a large diversity of products, or where

there is a high level of automation, as Brimson (1991, p. 179) pointed out, the

overheads distortion will be significant. In our case, for example, high-volume

products (hot spring use) may consume more direct labor hours than low-volume

products (meal serving), but do not necessarily consume more purchasing activity

costs.

The ABC model applied to the case of this hot spring country inn is depicted

in figure 1. The ABC systems focus on the accurate cost assignment of overheads

to products. In the cost assignment view, the assignment of costs through ABC

occurs in two stages: cost objects (i.e., products or services) consume activities,

activities consume resource costs. In practice, this means that resource costs are

assigned to various activity centers by using resource drivers in the first stage. An

activity center is composed of a group of related activities, usually defined by

function or process. The group of resource drivers is the factor chosen to estimatethe consumption of resources by the activities in the activity centers. Every type

of resource assigned to an activity center becomes a cost element in an activity

cost pool. And, in the second stage, each activity cost is distributed to cost objects

by using


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Cost ObjectsCost Objects

Cost of Resources

Cleaning

First Stage

Cost of Lodging Cost of Hot Spring

Use

Cost of Meal Serving

Activity Center

Customer

Reception

Cooking

Management Center

Second Stage

Activit Drivers

Figure 1

ABC Model in a Hot Spring Country Inn

a suitable activity driver to measure the consumption of activities by products or

services (Turney, 1992). Then, the total cost can be calculated by adding the

various activities costs to a specific product or service. And the total cost divided

by the quantity of the product can acquire the unit cost of product. In our case,the inn provides three products, lodging, hot spring use and meal serving. We

define five activity centers, namely the cleaning center, the customer service

center, the reception center, the cooking and foodservice center and the

management center. Each activity center is composed of related activities,

clustered by their function.


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As Harris and Brown (1998, p161-162) indicated, a hotel operation can be used

as an example of hospitality products, in the same way the elements of a hot

spring country inn of the B&B industry also can be used to illustrate non

traditional accommodation products. For instance, the provision of rooms

constitutes a nearly pure service product incorporating a large proportion of

service elements. It can be defined as the rental of a certain amount of space for a

specified period of time and is thus an intangible good containing a high level of

service provision. The provision of hot spring use also represents a service

product: it includes hot spring rental and service activities. Furthermore, the meal

serving provision, comprised of purchasing, distribution and conversion of food

into meals, again constitutes a service product.

The main advantage of ABC lies in that it provides a more accurate and real

cost computation, especially in situations in which product diversity is important

and in which the indirect costs, not directly traceable to the products, represent

an important proportion of the total costs. In addition, ABC also allows a deeper

level analysis of product costs by explaining the relationship between products

and activities. The improved accuracy of perception of the cost structure of

products and the continuous process improvements in the various departmentsof an enterprise provide the substance of activity-based management (i.e. using

ABC to improve a business). Studies of the implementation of ABC exist in various

fields, e.g. of universities (Cropper and Cook, 2000), a hotel (Noone and Griffin,

1999), library service (Ellis-Newman and Robinson, 1998), distribution logistics

(Pirttil and Hautaniemi, 1995; Themido et al. 2000), (all of which belong to the

service sector); of a manufacturing company (Spedding and Sun, 1999), an

assembly line (Gunasekaran and Singh, 1999), (which belong to the manufacturing

sector); of a wholesale fish market (Lee and Kao, 2001), (agricultural sector); andof a radiotherapy unit (Lievens et al., 2003), (medical sector). All of them agree

that ABC is a useful accounting model and able to obtain more accurate

information about the cost structure as long as implementing managers choose

the right drivers and define activities well. However, it is generally accepted that

there is no universally appropriate accounting system suitable to all organizations


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in all circumstances (Emmanuel et al., 1990). But as Harris and Brown (1998,

p162) point out, management accounting needs to be carried out in the context

of the hospitality product in order to supply the necessary information for

decision-makers if researchers expect to make a significant contribution to the

industry.

4. A Case Study of a Hot Spring Country Inn

The Professional Association of Innkeepers International defines that a country

inn is a business offering overnight lodging and meals where the owner is activelyinvolved in daily operations, often living on site. The hot spring country inn in our

study is located on the Yang-Ming-Shan in the north of Taipei where it faces a

very competitive hot spring tour market environment. It includes 6 twin rooms, 9

quad rooms, a hot spring pool for men (7109.2 square feet), another hot spring

pool for women (3554.6 square feet) and 9 private hot springs bathrooms,

covering a total area of 1 acre and 31076.45 square feet. This inn hires 25 full time

employees and 13 part time employees, and the owner who also lives there

Table 1

Monthly Costs of Resources

Resource life

time

Replacement

value

Capital

costs

Cost per

month

Rent-a-land 30 700

,000

Owners 30 150,000,000 13,324,092 1,11


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lands 0,341

Buildings 30 16,050,000 1,425,672 118

,806

Personnel Numb

er

Total

Costs

Cost per month

Full time

staffs

23 9,060,000 755,000

Part-time

staffs

13 2,448,000 204,000

Managers 2 1,320,000 110,000

is the general manager. Meanwhile, the inn faces very serious seasonal customer

fluctuations. The average volume of customers for hot spring use can come to a

maximum of 58,048 persons monthly in the winter season and a reaches

minimum of 18,311 persons in the summer season. In addition, this hot spring

country inn bears a heavy space and land costs due to the high cost of buildings

and land in Taipei. The monthly costs of rent, lands, buildings and labor are

showed in table 1.

This inn doesnt use any activity-based costing method in its accounting

system except for the traditional one. Since activity-based costing can be very

complex and time consuming, and even less in tourism industry, it is not widely

applied in the manufacturing industries in Taiwan (Chen, 2001, p. 52). It is

recognized that partial activity-based costing can be used to enhance rather than

totally replace the accounting system when the company finds it too difficult to


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(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

implement full-scale ABC-based accounting. Some companies also complain that

the cost of ABCs administrative and technical complexity, and of continuously

generating activity data, exceeds any benefits subsequently derived from it, so

that they reject proposals to implement ABC to their companies. Nevertheless,

many firms still find they have success in cost reduction, product pricing,

customer profitability analysis and output decisions when they adopt ABC

(Chenhall and Langfield-Smith, 1998; Clarke et al., 1999; Innes and Sinclair, 2000;

Cotton et al., 2003).

Our traditional accounting cost information was gathered from 1

November, 2003 to 30 December, 2003. The figures for customers volume were

acquired from the mean of the number of customers in these two months. In

order to obtain a more accurate picture of

Table 2

Activities Analysis and Assigning Activity to Product Using Activity Drivers

Resourc

Labor Mate

Tot

Quantities of Tot

Unit cost Product costActivit & Cos

Lod in

S rin

Dinin uantit

activit Lod in Hot-

DininCleanin

99 57

20 15

119 7

2 651.

3 749 410.2 6810.6 17.58 hr 46 611 65 904 7 2110.57%

3.67% 0.32%Chan in

1 455 607 2 062 960 0 0 960 2.15 hr 2 062 0 sheets 0.47% 0% 0%Washin

32 22

22 19

54 42

830 1 832 188.6 2 851 19.09 hr 15 849 34 972 3 603.59% 1.95% 0.16%

Clear u 91 47

21 62

113 0

0 0 10 710 10 710 10.56 nu

0 0 113 090% 0% 5.06%

Check 5 454 2 276 7 730 450 0 0 450 17.17 nu

7 730 0

1.75% 0% 0%Orderin

54,45

1 994 56,44

0 0 11 203 11 203 5.04/num

0 0 56 440% 0% 2.52%

Carr in 75 22

2 754 77 97

0 0 103 75

103 75

0.75 num

0 0 77 97(0%) (0%) (3.49%

Re-

4 320 2 437 6 757 20 436 4 460 14.69 hr 294 6 404 50.07% 0.35% 0.00%

Cookin 297 9

58 94

356 9

0 0 2 010 2 010 177.57 hr 0 0 356 91


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(0%) (0%) (15.96%Purchas

73,88

605 74,49

18.5 24 198 240.5 309.73/hr 5,730 7,434 61,321.30% 0.41% 2.74%

Check in 263 8

90 64

354 4

232.4

1 891

692.5 2 816.

125.84 hr 29 255 238 051 87 14out 6.64% 13.26%

3.90%

Admini- 36 60

1 049 37 65

210 779.2 102 1 091.34.51 s a

7 247 26 890 3 52

strative 1.64% 1.50% 0.16%Marketi

6 160 176 6 336 1 440 56 75

33 240 91 430 0.07 ers

100 3 933 2 300.02% 0.22% 0.10%

Account

26 40

756 27 15

1 440 56 75

33 240 91 430 0.297 er

428 16 855 9 870.10% 0.94% 0.44%

Rentin 700 0

251.9

1 385

461.94 2 099.

333.38 s

83 999 461 999 154 00(19.05%

(25.73%

6.89%De reciation 1,229,

251.9

1,385

461.94 2,099.

585.39/sp

147 495 811 236 270 41(33.45%

(45.18%

(12.09%Total 1 069

226 2

3,224,36

*

Total activit 346 800 1 673 6

1 203

(78.65%

(93.21%

(53.83%* All activities in column

(3) added

Direct material 61 137 116 843 1 03213.87%

6.51% 46.17%Outsource 33 000

7.48%Hot-s rin 5 049

0.28%Total roduct 440 937 1 795 5

2 236Total 1 440 56 750 33 24Unit roduct 306.21 31.64 67.2

allocated resource costs, working sampling (Tsai, 1996) is used to estimate the

percentage of time spent on each of various activities for each staff member and

manager. In this way an adjusted percentage of personnel time spent on each

activity can be obtained. In the first stage, resources in this country inn are

assigned to all activities in five activities centers by resource drivers.

In the second stage, all activities costs in the five activities centers are

assigned to the three country inns products. Table 2 shows activities analysis andthe assignment of activities to products by activity drivers. Labor, material and

utility costs traced to activities are shown in columns (1)-(3) of table 2. Columns

(4)-(11) present detail about how activities are allotted to each product by

drivers. For example, the driver of the cleaning activity is the true cleaning time

which is total 6810.6 hours. Using the driver to trace the cleaning activity to the


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three products separately, and assigning 2651.4 hours, 3749 hours and 410.2

hours respectively, of cleaning time, the driver can allocate NT$ 46,611 to lodging,

NT$65,904 to hot spring use, and NT$7,212 to dining. Finally, adding all the

allocation activities costs in each product we can get the total activity costs. The

total product cost is the combination of the total activities costs, direct material

costs, and outsource costs (laundry, hot spring water) in each product. Unit

product cost is defined as the total product cost divided by the total number of

customers. The unit product costs of lodging, hot spring use and dining are NT$

306.21, NT$31.64 and NT$ 67.28 per customer respectively in the busy winter

seasons. The lodging, hot spring use and dining products of this country inn

represent three market segments. After applying ABC to the country inn case, the

unit costs of each of the country inns products in three market segments are

clear. The cost information acquired from ABC in this case is extremely useful to

the inns owners (managers) for marketing, decision making and cost-volume-

profit analysis.

5. Comparing ABC with traditional accounting

Table 3 shows a comparison between ABC and the traditional accounting

method. The traditional accounting system here uses direct labor hours to

allocate overheads to the three inn products. Cost for a high-volume product

should not necessarily be traced based on a correspondingly high level of labor

hours, since, in reality, such a product may not consume a proportionally high

amount of overhead. As shown in table 3, the unit cost of the three productsderived from the traditional accounting method are NT$155.4 for lodging,

NT$15.85 for hot spring use, and NT$100.76 for dining, per customer. If we

compare the results between ABC and traditional accounting, the unit cost of

lodging and of hot spring use are underestimated, but the unit cost of dining is


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overestimated under the traditional accounting method. This is because the

traditional accounting method distorts the overheads

Table 3

Comparing ABC with Traditional Accounting

N.T. Dollars

Product

Cost Lodging Hot-Spring Dining

Traditional accounting

allocation:

Overhead 99,640 597,842 1,693,885

(Assigning by direct labor

hours)(240hr) (1440hr) (4080hr)

Direct Labor 30,000 180,000 623,000

Direct Materials 61,137 116,843 1,032,498

Outside laundry 33,000

Hot-spring water 5,049

Total cost on traditional

accounting basis223,777 899,734 3,349,383

Mean number of

customers1,440 56,750 33,240

Unit cost per customer 155.4 15.85 100.76

Unit cost per customer in ABC 306.21 31.64 67.28


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cost allocation in the three products, while the ABC system avoids this distortion

by valuing the activity and driver assigning processes.

6. Conclusion

After deriving the cost of each product by providing accurate and relevant

information, we find that real estate costs consume the greatest proportion of

the hot spring use and of lodging costs (over 50%). This is the result of the high

cost of real estate in Taipei. In this case, through ABC implementation we can

obtain clear and reliable information about the proportions of activities costs in

every single product. Managers also can use the information derived from

implementing ABC for decisions on pricing, product mix (Tsai, 1994), product

design, profitability analysis, and so on. Our comparison of ABC with the

traditional costing method shows that ABC method is practical and appropriatefor application to the hot spring country inn and yields more accurate information

for cost management and pricing decisions.

Activity Based Costing Project

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