- Conventional Cost Accounting and the Differences in the Industries
- Activity-based Costing Model
“Cost accounting measures and reports financial and nonfinancial information related to the organization’s acquisition or consumption of its resources” (Pavlatos & Paggios, 2009, p. 513). The reports include the financial accounting as well as the managerial ones. Traditionally, managerial accounting is regarded as the principal method of costing both in internal and external environments of organizations. The financial accounts system serves as the measure of wealth, prosperity, and value of the business. The conventional approach in managerial accounting helps to generalize the organizational expenses, such as labor and materials. However, the activities and processes are mainly excluded from the system. Thus, companies fail to evaluate the effectiveness and efficiency of functioning as well as the quality of the products or services, and the overall profitability. Nowadays, many researchers and managers suggest the alternative accounting and costing systems that would be more appropriately used in the service industry. For example, the activity-based costing approach allows the managers to summarize the expenses of activities that are associated with products, services, and customers (Narong, 2009, p. 11). When activities are considered in managerial accounting procedures, a more flexible and effective approach to costing and pricing becomes available and, in the service industry, it is of significant importance.
Conventional Cost Accounting and the Differences in the Industries
“The design and effectiveness of cost accounting information and systems are conditional on industry characteristics” (Park & Jang, 2014, p. 760). In the service industry, i.e. tourism and hospitality services, the cost structure differs from the manufacturing industries, and the approach to costing and accounting thus must be different. Usually, in the manufacturing organizations, such systems of the assigning costs to products are used as job costing. Job costing is applied for the diverse products, and it includes the reports of materials, labor, and overheads per produced item. In manufacturing, the main elements of the individual product cost are direct labor and direct materials, and the indirect costs constitute only a small part of total costs. The companies in the service industry supply most of their resources in advance as well and the implementation of the activity resources usually doesn’t affect the spending in a short-term period (Pavlatos & Paggios, 2009, p. 514). Therefore, the term of the fixed costs is relevant to both manufacturing and service industries. And such costing systems do not usually influence the managerial decision-making.
When the costs are fixed, the analysis of profitability doesn’t lead to success and the managers often cannot find the reasonable ground for their decisions. “With the conventional means to cost accounting and cost of quality, it is very difficult to identify if such product or service is profitable and produced via quality processes or with less wastes” (Narong, 2009, p. 11). Therefore, many researchers suggest managers application of the activity-based model that is grounded in the detection of the connections between costs and effects.
In the service industries, such as hotels, cost accounting is concerned with accumulation, evaluation, and implementation of the previous costs. Although the cost accounting data is required to be reported the same way as in the manufacturing industry organizations, the activities of the hotel and the hospitality service business are distinct. The wide range of activities include “fixed capacity, perish ability, demand patents, product range, real-time activities, production and conception, location and size, labour and capital intensity, and cost structure” (Pavlatos & Paggios, 2009, p. 513). Therefore, the traditional accounting can be regarded as inappropriate in the service industries.
Activity-based Costing Model
“Cost management not only involves determining costs, but also requires making decisions about the whole process, cost allocation, pricing and resource management” (Onat & Anitsal, 2014, p. 149). The choice of the right costing tool depends on the industry’s characteristics to a large extent. Activity-based costing system can be thus regarded as the appropriate tool for costing in the service industry because it is based on the efficient cost drivers rather than on volume of production and labor.
The idea of the activity-based costing system was introduced in the manufacturing sector as well and was implied as the attempt to resolve the issues provoked by the traditional cost and accounting management systems and help the managers to make more efficient decisions (Narong, 2009, p. 11). The model focuses on the value and operations, an effective classification of activities and processes. According to the main concept of the activity-based system, “activities create costs, while products use activities to gain value added” (Onat, Anitsal, & Anitsal, 2014, p. 150). The major steps included in the activity-based management are 1) identification of the main activities that create overhead costs, 2) detection and unification of the groups of activities with the same value and the same cost drivers, and 3) assignment of the overhead costs for the services and products through calculation of the absorption rates.
Overall, the activity-based model is comprised of such elements as resources, activities, and costs, and the element of resources is regarded as fundamental. “Resources represent assets used to perform production activities,” and activities are regarded as the first and the last stages of the costing process (Onat, Anitsal, & Anitsal, 2014, p. 151). The given method is more suitable for the service industries because it provides the non-financial information, generates more accurate cost information, helps to allocate the overhead costs effectively and to identify the directions for the further improvements. The managerial ability to make more efficient decisions positively influences not only pricing strategy but also branding and promotion strategies. According to the recent research, adaptation of the model increases the competitiveness of the company in the market by the increase of control over the information (Onat, Anitsal, & Anitsal, 2014, p. 154).
The service industry’s profitability largely depends on the quality of services provided to the customers. The high-quality services and products increase the clients’ level of satisfaction, frequency of attendance, and customer loyalty which, in their turn, positively affect the revenues and financial turnover. The concepts involved in the conventional costing models fail to provide the sufficient information for the managers to assess the effects of the services on the customers and adjust the prices and cost-reduction regulations according to the received data efficiently. Therefore, it is suggested to apply such management methods as the activity-based costing model in the customer-oriented industries and markets. The concepts of the value and activity interrelated with the value help to evaluate the organizational performance and elaborate the strategies aimed at the improvement of the costing and pricing policies. Overall, the activity-based model offers a more effective method of managing costs rather than the traditional models. By considering activities involved in the service and goods production, the management becomes capable of developing the competitive pricing, gaining more profit, and eliminating the undesired financial constraints.
Narong, D., (2009). Activity-based costing and management solutions to traditional shortcomings of cost accounting. Cost Engineering, 51(8), 11-22.
Onat, O. K., Anitsal, I., & Anitsal, M. M. (2014). Activity based costing in services industry: A conceptual framework for entrepreneurs. The Entrepreneurial Executive, 19, 149-167.
Park, K., & Jang, S. (2014). Hospitality finance and managerial accounting research. International Journal of Contemporary Hospitality Management, 26(5), 751-777.
Pavlatos, O., & Paggios, I. (2009). Activity-based costing in the hospitality industry: Evidence from Greece. Journal of Hospitality & Tourism Research, 33(4), 511-527.