Utilizing Existing Costing Systems for Activity Based Costing (ABC) Methodologies

It is a well known fact that flawed cost information can cause wrong management decisions to be taken. If management makes a decision on information they believe to be true, but in reality the information is not a true reflection of the facts, it will most certainly lead to losses in the long run. Unreliable cost information is an open invitation to certain disaster. Cost information is used in making a wide range of operational, management and strategic decisions. One of the only ways to be sure that the cost information used as a basis for decisions are accurate, is to do an activity based costing study.

History

The basic elements of the cost systems in general use today were isolated around the turn of the century. During the last decade or so, doubts have been expressed by managers and cost accountants alike, about the suitability of this system of allocating costs in an ever changing industrial and commercial environment.

Incorrect cost information can put any organisation on a crisis course from which it may never recover. This may lead to problems the organisation can ill afford in today's competitive environment. It may focus line management on the wrong priorities and solve the wrong problems.

New Trends

According to Hilton (1994:15) many companies are moving away from a historic cost-accounting perspective towards a proactive cost management perspective. He carries on by identifying that the cost management system places the emphasis on activities. This is a return to the basic idea of cost management ( Hirsch 1994:68). Activity based costing offers an approach which has the potential to overcome many of the problems and limitations which have been associated with the operation of traditional costing systems in modern situations to which they are ill suited (Innes and Mitchell, 1991:62).

A Mining Application Example

The profitability of mining is dependent on the mineral content or grade of the reef, the net earnings obtained for the final product and the cost to produce the product. In order to determine whether a particular area could be mined at a profit, the mining industry in South Africa generally makes use of budgetary and cost controls that are based on standards (Storrar, 1977:135-143).

The accounting system used on most large mines is the Financial Accounting and Management System, described by the acronym FAMIS. This acronym is derived from the first letters of each word of the full name. According to Rothwell (1992:2) the core of FAMIS is the MMS general ledger software package. This system provides a number of capabilities that include the support of the accounts data base, as well as the structure and relationship of accounts. It also supports a comprehensive reporting facility.

The essence of this accounting system is that all transactions will be routed through the books of account via the same route, with only the financial value changing from one transaction to the next. Rothwell carries on by stating that this accounting system sustains the accounts master data base in which each account is distinguished by a unique account number, a description, as well as by type of account. It is said that this accounting system provides a great deal of versatility in the structuring of accounts for accounting, as well as providing management reports.

The FAMIS accounting system is based on the principal that any data required by the management accounting system, should be captured once only and as close to the activity as possible. It receives the input from the source systems, assembles costs by responsibility, equate these to control accounts and provide the financial ledgers. This principal makes the introduction of an activity based costing system a simple matter. Routine reports can easily be generated via the internal report writer on request from the responsible manager. In addition to this accounting package many mines also make use of an area costing system.

Mining costs are allocated to a specific activity with the aid of a fifteen digit cost code. The fifteen digits are divided into six groups of one, two or three digits each. The different groups of digits each describe different element levels of the costing system. The cost code is composed as follows:

The first two digits - the mine code.

The third digit - the profit centre.

The fourth to the sixth digit - the discipline.

The seventh to the ninth digit - the middle manager's section.

The tenth to the twelfth digit - the activity group.

The thirteenth to the fifteenth digit - the activity element.

Conclusion

By using this system it is possible for the management accountant to generate detailed cost reports for a variety of activities in any particular middle manager's section. It is obvious from the description of the system that this system lends itself to the activity based costing system.

© Carl Marx