SHORTCOMINGS OF TRADITIONAL COST ACCOUNTING CONVENTIONAL (TRADITIONAL) COSTING SYSTEM MAINLY FOCUS ON ALLOCATING COST OF MATERIALS, LABOUR AND FACTORY OVERHEADS TO PRODUCTS, WITH NO ALLOCATION FOR OTHER OVERHEADS. FACTORY OVERHEADS ARE ALLOCATED TO PRODUCTS ACCORDING TO A TWO-STAGE PROCESS ON A LABOUR OR MACHINE-HOUR BASIS THIS APPROACH WORKED WELL AS COSTS THAN MATERIALS, FACTORY LABOUR AND FACTORY OVERHEADS WERE INSIGNIFICANT IN RELATION TO TOTAL ORGANISATIONAL COST.

RESEARCHERS AND PRACTITIONERS OF MANAGEMENT ACCOUNTING ALL OVER THE WORLD ARE SEEKING IMPROVED METHODS AND PHILOSOPHIES TO MEASURE AND INFLUENCE THE FINANCIAL BEHAVIOR OF ORGANSATIONS ONE OF THESE DEVELOPMENTS, NAMELY ACTIVITY-BASED COSTING AND MANAGEMENT (ABC&M) AND ITS PLACE AMONG THE MANY NEW TECHNIQUES AND METHODS WHICH MANAGEMENT COULD USE TO INFLUENCE ORGANISATIONAL FORTUNES. ACTIVITY-BASED COSTING (ABC) IS DEFINED AS METHODOLOGY THAT MEASURES THE COST AND FERFORMANCE OF ACTIVITIES, RESOURCES, AND COST OBJECTS. ACTIVITY-BASED MANAGEMENT (ABM) IS DEFINED AS A DISCIPLINE THAT FOCUSES ON THE MANAGEMENT OF ACTIVITIES AS THE ROUTE TO IMPROVING THE VALUE RECEIVED BY COSTUMERS AND THE PROFIT RECEIVED BY PROVIDING THIS VALUE (ABC AS ITS MAJOR SOURCE OF DATA)

TABLE 1.1 : INCOME AND EXPENDITURE OF US INDUSTRIES Total industrial income Materials, fuel, supplies, etc Salaries of employees Replacement of plant Interest and rent Salaries of management Taxes Dividends to owners $m %

TABLE 1.1 SHOWS : -THE MANUFACTURING-RELATED COSTS (MATERIALS, SALARIES AND REPLACEMENT OF PLANT OVER 90% OF TOTAL COSTS) - A TRADITIONAL COST SYSTEM FOCUSING ON THESE MAIN COST ELEMENTS, USING LABOUR AS METHOD OF ALLOCATING OVERHEADS, COULD THEREFORE CALCULATE PRODUCT COSTS FAIRLY ACCURATELY.

Table 1.2 : ABRIDGED FINANCIAL STATEMENTS OF A MANUFACTURING CONCERN (CIRCA 1940) Income statement Sales Less : Manufacturing cost Direct materials Direct Labour Factory overheads - Rent - Depreciation - other Gross profit Other expenses (selling, admin, etc) Profit before interest and tax Interest Profit before tax Taxes Distributable profit £ % Comments Table 1.2 continued on next page

Table 1.2 continued Balance sheet Fixed assets Current assets Raw materials and WIP Finished goods Debtors Total assets Liabilities Net assets £ % Comments Comments 1. Major proportion of total cost 2.Substantial material cost 3.Significant labour cost 4.Approximately 10 % of manufacturing cost

5.Low depriciation charge 6.Almost insignificant non-manufacturing overheads 7.Interest rate approximately 5 % 8.Return on owners funds approximately 8.5% (satisfactroy at the time) 9.Relatively low investment in mechanisation; mostly non-mechanised production processes 10.Relativley high investment owing to high proportional material cost, low stock turnover and slow delivery systems 11.Low gearing.

Table 1.3 : Abriged Financial Statements of a Manufacturing Concern (CIRCA 1990) Income statement Sales Less : Manufacturing cost Direct materials Direct Labour Factory overheads - Rent - Depreciation - other Gross profit Marketing, distribution and admin Profit before interest and tax Interest Profit before tax Taxitation Distributable profit £ % Comments Table 1.3 continued on next page

Table 1.3 continued Balance sheet Fixed assets Current assets Raw materials and WIP Finished goods Debtors Total assets Liabilities Interest-bearing debt trade creditors Net assets £ % Comments Considerably reduced since 1940s 2.Engineered down. Effect of quantity and price reduction 3.Replaced by technology cost (depreciation and maintenance) 4.Increased, mainly due to increased machanisation 5.Technology costs higher, shorter economic and technological life spans of equipment Comments

6.Vast increases due to increased advertising, increased spending on information technology, distribution, customer services, etc 7.Increased rates, increased investment requirements, higher gearing 8.Return on equity higher because of inflation, higer gearing and risk 9.Increased investment in technology and mechanisation 10.Considerably reduced because of lower consumption and better methologies (just-in-time practices; material requirements planning) 11.Increased investment due to increased variety, distribution and marketing channels 12.Increase due to competitive forces 13.Increase due to higher accepted gearing 14.Increases due to competitive forces 15.Lower equity due to market acceptability and higer fixed assest cover (by debt).

TRADITIONAL COST SYSTEMS IN THE MODERN ENVIRONMENT 1.PRODUCT COSTING BASED ON MANUFACTURING COSTS ALONE LEAD TO SIGNIFICANT CROSS-SUBSIDISATION OF COSTS AS THE CONSUMPTION OF THE LATTER COSTS IS NOT KNOWN. AN ABC SYSTEM ADDRESSES THE TREATMENT OF ALL OVERHEAD-RELATED COSTS. 2.USING THE LABOUR BASE TO ASSIGN OVERHEADS COULD THUS SEVERELY DISTORT PRODUCT COSTS. 3.THE COST OF TECHNOLOGY IS TREATED IS TREATED AS A PERIOD COST AND CONSEQUENTLY EXPENSED ON A STRIGHT-LINE BASIS, IRRESPECTIVE OF USE. IN THE MODERN ENVIRONMENT, DIRECT LABOUR COST FREQUENTLY IS REPLACED BY AN INDIRECT (MACHINE) COST. 4.SERVICE-RELATED COSTS HAVE INCREASED CONSIDERABLY IN THE LAST FEW DECADES. COSTING FOR THESE SERVICES WAS NON- EXSISTENT.

5.5CUSTOMER-RELATED COST (FINANCE, DISCOUNTS, DISTRIBUTION, SELLING, AFTER-SALES SEVICE, ETC.) ARE NOT RELATED THE PRODUCT COST OBJECT. 6.DIRECT LABOR IS REPLACED TO SOME EXTENT BY INFORMATION TECHNOLOGY. THESE COSTS ARE TREATED TO OVERHEAD. 7.NCREASED COMPETITION WORLD-WIDE HAVE LED TO INCREASED MARKETING COSTS. 8.THE PRODUCTION OF GOODS AND RENDERING OF SERVICES DESIRED BY CUSTOMER/CLIENT.

RELEVANCE LOST JOHNSON AND KAPLAN IN THEIR BOOK RELEVANCE LOST: THE RISE AND FALL OF MANAGEMENT STATES : -MANAGEMENT ACCOUNTING INFORMATION IS PRODUCED TOO LATE, TOO AGGREGATED, AND TO DISTORTED TO BE RELEVANT FOR MANAGERS’ PLANNING AND CONTROL DECISIONS. -MANAGEMENT ACCOUNTING SYSTEMS : # DO NOT PROVIED DETAILED INFORMATION ON PROCESS EFFICIENCIES # FOCUS TOO NARROWLY ON INPUTS, SUCH AS DIRECT LABOUR, THAT ARE RELATIVELY INSIGNIFICANT IN TODAY’ PRODUCTION ENVIRONMENT, AND # FAIL TO PROVIDE ACCURATE PRODUCT COSTS.