Embedding an activity driven operational accounting framework in a fertiliser company
Abstract
Activity–based Costing is a management tool which both covers the shortcomings of traditional costing methods and provides better cost information. There is a lot of competition in the economic environment where only the “fittest will survive”. The overall picture of ABC will bring operational processes to financial figures more visibly and accurately. Operational processes have changed dramatically over the past centuries, therefore we need to change our old way of doing things. Processes get more automated, thus there are higher percentages of variable and indirect costs. When costs are visible, ACME Fertilizer can compete with confidence because they will know when a transaction is not financially beneficial any more. The actual cost of the final product or output is of critical importance. Activities which are not adding value to the process must be identified and eliminated or else costs will be inflated unnecessarily. Competitors will get a higher market share and sales because they might be able to enter the market at a lower price. The end user is extremely price–sensitive, and will accept the lower monetary value offer if the quality is equivalent. It is of critical importance that companies understand and be aware of the true costs of their products. ABC has the ability to assist companies to strive for cost–competitive excellence. In this mini–dissertation, a comparison between ABC and the traditional costing method in a fertilizer company attempts to investigate the distortion of cost. The same scenario is used for the two different costing methodologies: ABC versus the traditional method. The results are discussed and a conclusion with recommendations is made. By analysing the results, the non–value adding processes can be eliminated and management can shift their focus to the relevant activities. This will assist ACME Fertilizer’s management towards better decision–making and better competitiveness. ACME manufactures and blends different mixes of fertilizer. The manufacturing of a product consists of various processes and activities from where the raw material enters the factory premises to the manufacturing, bagging and distribution of the final product. The cost of the raw material can be affected by fluctuating commodity prices, exchange rates and other unforeseen circumstances, for example the recent instances of Somali Piracy and so forth. Overheads and indirect costs get allocated based on the activities required to manufacture the final product. Products will not absorb costs which do not have a direct impact on the manufacturing of the final product or intermediates. The first step of the implementation of an ABC system is to identify the output or the product of which costing needs to be done. The
process and activities must be identified as well as the costs applicable to these activities. Costs then get allocated to the cost pools based on the activity driver per cost pool. The final cost can be calculated and assigned, per cost driver, to the final product or output. The main objective of this study was to determine the feasibility of implementing an ABC system within ACME Fertilizer. The results proved that with the traditional costing method, all the costs are not visible and may be distorted. Thus, the cost of a product will be understated – in other words all the actual costs occurred were higher than the budgeted costs and will not be recovered through the cost of sales. Instead it will take a bite out of the annual profit! On the other hand, should the cost of a final product be overstated, more costs are to be recovered and this becomes a snowball effect. Companies have to either contribute its margin to remain competitive or increase the price of the product and the risk of lost sales and market share increases. ABC is a useful tool to use to control and have visibility of the costs, improved decision–making abilities and the possibility of closely shaven profits to ensure that the necessary volumes get manufactured. The right product, at the right quantity, at the right price!