Costing is a fundamental principle that all manufacturing industries, as well as business organizations, pay due respect. The primary goal to achieve with it is developing designs of operations that cut costs of operations (Atkinson, 1998). There are various costing systems that business organizations use. However, traditional costing methods have dominated most industries and business until the launch of the Activity-Based Costing (ABC) system. Contemporary accounting systems like the ABC are products of massive technological advancements that rendered labor-focused activities obsolete while stimulating high-technology and efficiency in manufacturing industries such as Genpharm (Kaplan, 1986). The ABC system has a tag of efficiency, quality, and accuracy, and this accounts for its widespread usage among mature processing industries. On the other hand, traditionally-used costing systems are still fighting to regain their lost glory. Thus, critical analysis and comparison reveal the truth on which is viable.
Costing systems are useful in companies as well as the general economy. The most significant role they play is the identification of viable and profitable operations. In the Middle East, Genpharm established profitable and productive operations through such methods. However, because most states in the region depend on oil for economic purposes, there is a shift in ideology that directs and commands economic diversification as well as value addition in their services. Costing methods have been used across several Gulf States in pursuit of alternative economic activities as well as fundamental determinants of economic development (Alodadi & Benhin, 2014). This shows the various uses of costing systems because their uses are not limited to the estimation of operation costs in business organizations.
ABC Vs. Traditional Costing Systems
The ABC help pharmaceutical companies answer crucial questions about their operations. questions addressed through the use of this system include, "what are the organizational activities performed by the business, and how much do they cost?" "Why is it necessary for the organization to carry out such activities, and to what length are they necessary for consumer satisfaction?" (Cooper & Kaplan, 1991). At this length, the ABC system is a fundamental map system that routes profitability as well as the expenditure of pharmaceutical companies. It is clear that the ABC system narrows down to the specific operational activities and quantifies their estimated costs. As such, a pharmaceutical company allocates the right amount of resources enough for such activities.
Unlike traditional costing systems, the ABC system is more or less similar to Total Quality Management (TQM). The justification of this argument lies in the fact that it unearths insufficient and uncompetitive pharmaceutical processes, poor business-supplier relationships, unprofitable products, products of poor quality (Johnson, Kaplan & Robert, 1987). This shows that traditional costing systems have always left business venturing into activities that do not generate reasonable revenue against the resources invested. This explains why Genpharm, a pharmaceutical company is the Middle East, intensively deploys this form of cost. As a result, the company enjoys some advantages that it did not enjoy while using traditional costing systems.
Advantages of ABC
Efficiency and Dynamism
The ABC system has helped Genphsrm's management execute operational strategies that yield accurate and efficient operations (Staubus, 1971). In such a manner, the pharmaceutical manufacturing firm has been able to relate to the various operational managers and commercial partners such as suppliers in a way that each party remains satisfied. For instance, it enables the procurement department to secure and purchase the required materials for the various departments such as quality control, inspection, packaging as well as manufacturing. The net effect of this is that a business organization takes care of all the demands of their industry no matter how dynamic they are.
The ABC is an accurate approach, especially in cases of overhead costing as it enables the management to allocate costs to individual overheads individually (Staubus, 1971). The benefit of this is that the management can keep a history of each operation. The net effect of this phenomenon is a situation where a business organization, Genpharm for instance, establishes viable operations with good returns. As such, they keep off operations that are not profitable. The point of accuracy touches at the at heart of Genpharm. The point is the company manufacture a wide range of pharmaceutical products. As such, this technique breaks down the resource requirements of all operations that ensure all the production processes succeed.
Disadvantages of ABC
Questionable Cost-Benefit Revenues
Critics of this costing system question the net effect it has on a business organization after heavy capital investment to establish it. In most cases, the organizational behavior exhibited when operating and implementing the system is quite high, and as such, small business organizations may not adopt it. Again, its economic measurements are not viable (Staubus, 1971).
In overhead costing, the ABC system is one of a kind. However, the major setback it faces is the need for historical data in its approach to estimating the costs (Staubus, 1971). Some of such data could be biased if available. In other cases, they would be unavailable. Again, if the company has significantly expanded, historical data could be unrealistic because of the increased scale of operation.
Advantages of Traditional Costing System
Accuracy in Large Productions
Overhead costing is a fundamental practice in traditional costing system. The advantage it brings along is the fact that when there is a large production in process, any differences in the overhead costs do not substantiate massive differences while calculating the costs of the goods and services produced (Cooper & Kaplan, 1991). This justifies the use of traditional costing systems in large scale operations. It this becomes a viable option for a company like Genpahrm that produce large batches of pharmaceutical products.
Low Overhead Costs
Traditional costing methods display characteristic low costs of overheads as compared to direct costing (Johnson & Kaplan, 1987). This feature is fundamental in the manufacturing industry, and it is an attribute that Genpharm can exploit to cut its costs of production. It also features arbitrage qualities in which the overhead burdens can be applied across all the goods and services produced by a firm. The net effect of this is high profits. For instance, if Genpharm manufactures various batches of pharmaceutical products, it will levy production costs across all of them (Shank, & Govindarajan, 1989). In such practice, there are cases where the costs of productions are surprisingly low. When marketed at the market prices, the company stands a chance of making large profit margins.
Disadvantages of Traditional Costing Systems
Unlike the ABC system, traditional costing options do not offer room for the prediction and forecasting of probable costs of operations that inform budgeting as well as the allocation of resources to various departments (Horngren et al., 2010). This makes these costing provisions unreasonable and unviable in cases where prediction and plans are necessary. This makes the system irrelevant to a large-scale operating firm like Genpharm. Typically, such a company would want to forecast its operations, and subsequently allocate resources early enough to facilitate efficient and quick production. However, it cannot deploy this system because it does not serve the demands on the table.
Traditional costing techniques do not levy operational costs on each item a company manufactures, or instead, a good or service a business organization deals in. The net effect is that costs spread over profitable as well as non-profitable operations. Per this phenomenon, TQM becomes a thing of the past because the business organization will not differentiate those profitable and non-profitable operations. Such organizations end up investing in ventures that do not generate reasonable returns. Worse still, they do not produce individual and actual costs of each operation. As such, the business stagnates at crossroads while pricing their goods and services (Shank & Govindarajan, 1989). Its nature of inaccuracy may cost the business organization resources. Thus, most large-scale operating firms do not adopt such systems.
Costing procedures enable business organizations to establish the costs of their operations. It also functions in the pricing of the goods and services provided by the business organizations. Typically, a faulty costing system will mislead the processes of budgeting, allocation of resources to the various operational levels as well as triggering inaccurate pricing of the products. Traditional costing systems were effective. However, they displayed some length of inaccuracy for small scale business organizations. A typical is the use of overhead costs in pricing that accurately works for large scale operations. The good news is that contemporary pricing techniques such as the ABC are more specific to various operational levels. In this fashion, operational level and activity account for its use of resources. It also makes pricing of goods and services more accurate.
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Cooper, R., & Kaplan, R. S. (1991). The Design of Cost Management Systems: text, cases, and readings. Prentice Hall.
Horngren, C. T., Foster, G., Datar, S. M., Rajan, M., Ittner, C., & Baldwin, A. A. (2010). Cost accounting: A managerial emphasis. Issues in Accounting Education, 25(4), 789-790 Horngren, C. T., Bhimani, A., Datar, S. M., Foster, G., & Horngren, C. T. (2002). Management and cost accounting. Harlow: Financial Times/Prentice Hall.
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Staubus, G. J. (1971). Activity costing and input-output accounting. RD Irwin.
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