a study on impacts and effectiveness of abc costing method as a cost effective measurement in coal industry

i
A STUDY ON IMPACTS AND EFFECTIVENESS OF ABC
COSTING METHOD AS A COST EFFECTIVE MEASUREMENT IN
COAL INDUSTRY












BY

NGUYEN THI THU HUYEN
E0600083

Graduation Project Submitted to the Department of Business Studies, Help
University College, in Partial Fulfillment of the Requirements for the degree of
Bachelor of Business (Accounting) Hons



APRIL, 2011

ii
Declaration
I hereby declare that the graduation project is based on my original work except
quotations and citations which has been duly acknowledged. I also declare that it has not
been previously or concurrently submitted for any other course/degree at Help
University or other institutions. The word count is 12,236 Words.

NGUYEN THI THU HUYEN
April, 2011

iii
Acknowledgement
First of all, I am grateful to Ms Van Anh, the professor who gave lots of useful
advices as well as materials for this thesis. And I would like to extent my thanks to all
managers from productions, marketing, and accounting departments and all of
employees in 50 manufacturing companies, who allowed and assisted me to collect all of
necessary information to finish this thesis. My thesis can not be finished without your
supports.

iv
A STUDY ON IMPACTS AND EFFECTIVENESS OF ABC COSTING METHOD
AS A COST EFFECTIVE MEASUREMENT IN COAL INDUSTRY

BY

NGUYEN THI THU HUYEN


APRIL, 2011


Supervisor: Ms Nguyen Van Anh

Abstract:
According to previous researchers, different costing method has different core
competitive advantages to organizations. From the oldest to newest method, decision of
managers is still affected. As a result, finding the best method to reduce the failure rates
and increase the effectiveness of cost allocation is a hard question for both managers and
accountants. Based on the accounting history, there are many types of costing method
such as: traditional or absorption costing method, variable costing method, throughput
costing method, and ABC costing method. Changes in business environments requires a
better method which can help managers control their performance while still enhance the
profit to organizations. Compare to previous method, ABC costing method still inherent
some characters of other method but it changes a little bit to be suitable to the
accounting and business environment. Instead of sharing costs equally among
departments, managers filtered the most profitable products to focus on and try to
increase the number of products within a cost limitation. This is why the author thinks
that ABC can be evaluated as the best method to adopt in manufacturing firm especially

v
in coal industry. Unlike developed countries in the World, Vietnamese business
environment changes rapidly but some characters still maintained the same. Therefore, a
statistic about the number of companies who implement ABC can reflect the

effectiveness, applicability, and impacts of this method on both managerial decisions
and plants’ performance.


vi
Table of Content

Declaration ii
Acknowledgement iii
Abstract: iv

CHAPTER I: Introduction vii
1.1. Introduction about the topic 1
1.2 Need for Research 3
1.2.1 Research question 3
1.2.2 Research objective 3
1.3 Elements of the Research 3

CHAPTER II: Literature review 5
2.1ABC costing method: history and calculation method 5
2.1.1 History of cost accounting methods and ABC general review 6
2.1.2 Cost factors and calculation method 7
2.2SWOT or appreciation and criticism method 10
2.2.1. ABC appreciations 11
2.2.2 ABC critism 14
2.3 Impacts of this method on decision making process of manager as well as its
influences on the organizations 15

CHAPTER III: RESEARCH AND METHODLOGY 20
3.1Research objective 20

3.2Research strategy 20
1.3Research hypothesis 21
3.3.1. Correspondence between ABC method and the capability of manufacturing
companies 22

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3.3.2. Impacts of ABC on performance: whether ABC is the best costing method to
measure the performance of companies? 25
3.4 Measurement of variables 28
3.4.1 Dependent variables (Plant performance) 28
3.4.2 Independent variables 29
3.4.2.1 Activity Based Costing (ABC) implementation 29
3.4.2.2 Plant-level control variables 33
3.5 Research methodology 33
3.6 Data sources and sampling 34
3.6.1 Sample selection 34
3.6.2 Data collection method 34
3.7 Limitation of research 35

CHAPTER IV: ANALYSIS 37
4.1 Results Analysis 37
4.1.1 Percentage method 37
4.1.2. Impact of ABC on plant performance 43
4.2 Discussion 45

CHAPTER V: CONCLUSION 46
5.1 Implication of research 46
5.2 Conclusion 46

REFERENCES 48

APPENDIX 55

1
CHAPTER I: Introduction
1.1. Introduction about the topic
For many researchers, cost accounting methods are still a major concern for them.
Different method leads to different decisions of the managers therefore profits to the
organizations can not be the same. Most of documents of cost accounting methods were
destroyed in a fire in 1984 (Cunagin, C., & Stancil, J., L., 1992). As a result, following
the sources of these methods is still important and difficult. However, based on the
advantages of these methods, the affects on the decisions of managers can be obvious.
As a result, the author of this thesis hopes that the empirical study of advantages and
disadvantages of ABC in order to judge the effectiveness that this method can bring to
the organizations as well as the impacts of its on the decisions of the managers. SWOTS
model will be applied to analyze this. And a research on a real survey which is done by
20 specific companies in the coal industry can be more reliable and convince to readers.
Based on the statistics, some recommendation about the importance and impacts of cost
accounting method on the managerial decision making process should be released.
As mentioned above, to discuss about any thing, we need to know a little bit of
history of cost accounting methods. Although it is quite difficult to follow exactly the
origin of each costing method, the estimation about the time period of absorption costing
method and variable costing method can be made according to different documents of
various fields (Vangermeersch, R., 1986). Based on most of researching documents,
absorption method can be considered as the leader for all kind of costing methods in
later on. It is easier for both users and managers. As a result, until now, this method is
still applied in many aspects such as administration works. Timing and changes in the

2
business environment lead to the need for new costing methods for new cost objects.
Variable costing was born as a result of the demand of this. According to this method,

only costs which are adjusted to the production process should be concerned by the
managers. However, in the long run, some fixed costs still need to change. As a result, a
new cost accounting method is invented. Instead of sharing equally among various
departments and maintaining the fixed costs in the long run, expenses are divided
differently based on some factors such as labor hours, direct materials and the fixed cost
can be changed based on the need of the production process. None of products needs the
same quantity of direct materials as well as the direct labor hours. So managers should
know how to use and allocate the costs more efficiency. This does not mean the ABC
costing method is perfect, the latest cost accounting methods become more and more
beneficial to the companies.
SWOTs model is the most familiar model which is used to analyze the
advantages and disadvantages fairly in management aspect. This refers to the strengths,
weakness, opportunities and threats. Since the author focus on the management
accounting, this model can be considered as the most useful one. This is quite easy to
see that management accounting does not mean the managers only work with numbers
and calculation; it requires more specific characters from managers such as observation,
critical thinking and flexibility. Through the numbers and statistics, managers should see
the signs that lead the organizations to the highest return when they invest their capitals.
After drawing a draft in their mind, managers will make the best decisions to enhance
the operation process and allocate the right costs to the right departments at the right
time. And comparing the results from year to year by using other costing accounting
methods and ABC can be the best way to implement.

3
However, theory is still the theory if we can not use it in the real business
environment. A real survey including 20 companies should be chosen as an evidence for
what the author said. Based on their own number, the author as well as readers can
figure out how many percents this study is right and how they could apply when they
open a new company. Wrong or unsuitable costing method can destroy a company so
easy. As a result, considering and choosing the best cost accounting methods are really

important.
1.2 Need for Research
1.2.1 Research question
What is the overall direct and indirect impact of ABC on manufacturing firm
performance? And can ABC be considered as the best costing method adopting in plant
to enhance the performance improvement.
1.2.2 Research objective
Generally, most of previous researches only focus on impacts of ABC in theories. But
none of them mentioned about the rate of adopting ABC method in Vietnamese
enterprisers. In order to apply ABC, many
1.3 Elements of the Research
No theories can convince readers without the evidence. As a result, in this part, a
real survey of manufacturing companies will be shown. A short introduction of the
industry will be focused. Core competitive advantages as well as disadvantages of this

4
industry will be covered. This background will help the readers understand and draw a
big picture of this industry.
After this, a statistics about the number of companies which adopted ABC will
be explored. Based on this result, we can figure out whether all of advantages of ABC in
the theories are true or not and in what circumstances. Some evidences about the impacts
of ABC on the managers’ decision in the current year compare to the decisions by
adopting other cost accounting method will be mentioned. Depending on these, some
recommendations will be concluded in the next part. And this survey will ensure that the
advantages and disadvantages that the author wrote in the earlier part are correct.
In the last part, a short interpretation with the result of the survey will tell the
readers what decisions that the manager made in two different circumstances: with and
without the ABC costing method they applied to calculate. And some recommendations
will be made to managers to make sure that this can provide the readers an objective
view about the impacts and effectiveness of ABC as a cost effective measurement to

some companies in Coal Industry.

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CHAPTER II: Literature review
2.1. ABC costing method: history and calculation method
In the brief description, cost accounting can be considered as the way the accountants
use to calculate the costs to create a base and establish a price for products based on the
cost calculation foundation. This means managers not only understanding about costs
which are occurred during the business runs such as what kinds of those costs, their
characteristics and classification (Weygandt, J., J.; Kimmel, P., D.; & Kieso, D., E.,
2009). Depending on this analysis of accountants, managers can know how to allocate
costs more effective and efficient. However, bigger scales of business require better cost
accounting methods as well as more precise and probably accounting information. As a
result, we can see that except ABC, there are many kinds of costing methods were
invented.
Before the dawn of industrial century, costs and price of products only depended on
some directed costs which are classified as variable costs today such as: direct labor,
direct materials, and manufacturing overhead. All of these will be divided equally based
on some fixed criteria such as direct labor hours. However, when the accounting
scientists focused more on the costs study aspect, they discovered that except direct
costs as mentioned in documents, there are some other costs which can be considered as
indirect costs like maintenance, tooling, production control, purchasing, quality control,
storage and handling, plant supervision and engineering costs. Unlike directed costs,
these did not be changed during a long period when any changes occurred in the volume
of products (Shim, J., K., Ph.D.; & Siegel, J., G., Ph.D.; 2009). Therefore, they named

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these as “fixed costs” to identify the differences of these costs with directed or variable
costs. Despite of attempt of many accounting researchers during a long time, the
importance of “fixed costs” are only really emphasized since the twenty-first century

(Stenzel, C., & Stenzel, J., 2002).
In this thesis, the author will focus only in ABC method, its impacts and influences on
the managers’ decisions by using SWOT analysis and survey results.
2.1.1 History of cost accounting methods and ABC general review
A fire at the headquarters of the National Association of Accountants (NAA) in 1984
destroyed most of documents related to the costing methods (Cunagin,C., & Stancil, J.,
L., 1992) . Therefore, to identify exactly time when cost accounting were invested is
quite impossible. Previously, variable costing method was used as the only and easiest
way to calculate the costs. This is because it is easy to accountants as well as managers
and shareholders understand the directions of costs since all of directed costs are treated
in the same manners. Development of science brought another method which is called
traditional cost allocation methods or VBC (Volume Based Costing) when the fixed
costs were invented. However, when the organizations want to expansion their business,
more costs are appeared. This leads to a demand for a new costing method which can
adjust and treat both new and old costs in the same way. As a result, ABC costing
method was born. Time by time, this methods proofed more and more advantages since
the scale of businesses increasing as a requirement for industrial age.
In a World when the globalization becomes a trend of the societies, ABC can be
considered as a popular and dominated costing method for most of organizations. In the
past, profit means you had a list of potential customers who can buy a huge quantity of

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products in many times. However, this might be not right in reality. Profitability not only
depends on the quantity but also the differences between the price and the costs. In fact,
the higher differences, the higher profitability. Unlike traditional method which allocates
costs equally among products, ABC divides costs based on the requirements of costs
objects like products, services and jobs (Cooper, R., & Slagmulder, R., 2005). In other
words, we can say this method is the best tool for refining cost systems. For instance, a
shampoo A needs 1hour to produce while shampoo B needs 1.5hours to manufacture.
This means different items will require different cost amounts. As a result, accountants

should know which costs will be used for what cost object and at what rates. In facts,
one indirect cost can be allocated for more than one cost objects. By this way, managers
can follow costs streams for different costs objects and decide how to allocate those
costs precisely. Moreover, shareholders can have more options when they want to invest
in the organization. Hence, the effectiveness of the business will be enhanced.
2.1.2 Cost factors and calculation method
With variable costing method, only direct costs are calculated, indirect costs will be
treated as expenses on the income statement. This is different with traditional costing
method when both direct and indirect costs are included. Compare to these two methods,
ABC method calculates costs in a unique way. There are four levels which are included
in ABC costing method to classify costs which are output unit level, batch level, product
sustaining and facility sustaining cost. Each level will reflect a specific way to identify
the cost objects. At the first level, costs will be allocated individually to one unit of
products or services. The higher volume of items, the higher costs required. At the
higher level, cost of activities performed will be calculated on a specific group of

8
products or services. In order to do this, managers or accountants will establish some
standards for these groups such as how many items in a group, what is the characteristics
to classify them into a batch and etc. After allocating cost to a group, managers can
divide costs for each item as mentioned in the first level. Different to two levels above,
product sustaining costs refers to other supporting product costs which are necessary for
the producing an individual product or service. For example, when the manufacturer
want to make shampoo B, except ingredients as shampoo A, olive oil is required. As a
result, this cost is still included as a manufacturing cost for shampoo B while it is not
occurred in producing shampoo A. Additionally, this can be considered as a fixed cost
which is not changed when the number of units and batches of individual products or
services changes. Similar the third level, the last level mentions about the costs that are
needed to support for producing but for the whole process. These costs might be not
occurred for an individual product or service however, it is required to finish the

manufacturing. As a result, the name of this level is facility sustaining costs.
Since the costs are divided into different level of cost objects, calculation of ABC
method also differs with traditional and variable costs. As mentioned in the figure 1.2
below, the first step of this method identifies what resources that manufacturers need to
produce chosen products. For example, to make 1000 bottles of shampoo A and 2,000
bottles of shampoo B, manufacturers need to buy ginseng and olive oil. After defining
the necessarily resources, the quantity as well as costs of those should be computed
based on the number of products or services. This means all of costs such as direct
material; direct labor and manufacturing overhead will be included and allocated
separately. In the next step, all of activities during production process should be listed. It
helps to create a standard or foundation to allocate costs which are budgeted. Based on

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this action, managers can know how many activities required for a specific products or
services and establish in their mind a whole picture about cost pool with all of items. By
this way, the reliability of data and measurement will be increased rapidly and the
following cost allocation will be easier for both managers and shareholders. Finishing
identifying activities likes installing, running and maintaining, counted costs will be
traced to different required products or services’ activities. Various companies and
managers, criteria to allocate costs might be distinguished. For example, manufacturing
costs can be divided among products and services based on the cause and effect
relationship. When all of costs are distributed, the total costs for each products or
services as in the last step of this method. The fourth and the fifth step of ABC will help
managers diversify the risks of producing and figure out the best way to use costs more
effective and efficient. As a result, in fact, this method is a little bit more expensive and
complicated compare to traditional and variable method. However, it provides more
precise and useful information to managers therefore it is still the first choice for most
managers and companies.

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Figure 2.1.2: ABC in one
2.2. SWOT or appreciation and criticism method
SWOTs model is the most familiar model which is used to analyze the advantages and
disadvantages fairly in management aspect. This refers to the strengths, weakness,
opportunities and threats. Since the author focus on the management accounting, this
model can be considered as the most useful one. However, in order to be suitable with
the characters of accounting, the author will divide this method into 2 parts only:
appreciation and criticism. This is quite easy to see that management accounting does
not mean the managers only work with numbers and calculation; it requires more
specific characters from managers such as observation, critical thinking and flexibility.

11
Through the numbers and statistics, managers should see the signs that lead the
organizations to the highest return when they invest their capitals. After drawing a draft
in their mind, managers will make the best decisions to enhance the operation process
and allocate the right costs to the right departments at the right time. And comparing the
results from year to year by using other costing accounting methods and ABC can be the
best way to implement.
2.2.1. ABC appreciations
As mentioned in the calculation part, ABC method brings many benefits to organizations
but in this thesis, the author only summarizes these into some points such as: identifying
key customers and products and services, establishing the most useful pictures about
high and low profitable items and directing the whole companies in the best way to
enhance the profit. Moreover, costs can be considered as the major factor which can
proof the ability of managers in maintaining the efficiencies of financial activities. By
following annually reports, managers can predict the trend of products in next year as
well as figure out the reasons for inefficient financial issues in case it occurs. If the
managing way is suitable, companies can maintain and develop the current directions for

cost allocating and operational process. And the precise accounting information
increases the improvements for managers through reports and shows them required
expenses to achieve those improvements. Based on these reports, accounting department
can corporate with marketing department to design an effective marketing plan using
limitation resources. The last but not the least, both managers and staffs can enhance
their ability in negotiating with the customers and locate the profitable products or
services better.

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None of cost accounting methods can compete with ABC about the ability in
determination the customers as well as the products and direct the whole organizations
in the most profitable way. Since all of direct and indirect costs are computed and
assigned to each products and services, manufacturing expenses are definitely
determined. In order to measure the profitably for each customer, products or services
expenses should be deducted. This will create the correlative relationship between
products or services and customers’ expenses and enhance the effective of the business.
As a result, not only accountants or managers, normal staffs also can grasp, analyze
related expenses of producing and define the way to deliver the value added to the
customers. Moreover, a good understanding foundation can help these ones feel more
confident about their products or services explain and convince the customers better
according to the real facts. This can be mentioned as a continuously process which
includes costs analysis and deduction non value added activities to reach the higher level
of an effective organization operation as a whole (Ittner, 1999, Cooper et al. 1992).
Moreover, with better understanding about allocating costs effectively, R&D department
can create new products or services within a competitive cost compare to other brand
names in the same market. Potential products or services will be focused more if the
organization applies this method. Using a more complicated but high detailed
calculation method, ABC plays an important role in decisions making process as well as
operational process of managers. Cost cutting and cost control savings characters

enhances the position of ABC in developing value added products or services while still
maintain an effective cost resources. One of the most popular implementation of ABC is

13
scorecard balance which provide a fairly judgments among various products and
services. In other words, this is a flexible, precise and detailed costing method.
In previous researches, ABC is referred as a task for accountants to identify the key
products or services, costs drivers and related activities costs assigning (Cooper, 1988;
Ittner et al. 2002). Not only direct materials, direct labors and direct manufacturing
overhead costs but also indirect cost such as indirect materials and installing and
maintenance costs are also distributed depending on the required activities of each
products or services. However, during the production process, there are some other
sustaining costs. This can be individual or group. Therefore, these expenses should be
divided separately to related activities of products or services based on a factor which is
called cost driver rate (Cooper and Kaplan, 1991). This will increase the reliabilities of
data and help managers make the best decisions for specific support productions
activities.
Another benefit that the author wants to discuss in this thesis is evidences for financial
management and operation process. Applying a more detailed calculation, ABC
provides economists a better database with higher level of accuracies and reliabilities
compare to traditional and variable costing methods (Cooper and Kaplan, 1991; Ittner,
1999). In the industrial age, information is the core advantage to all of organizations.
The winners will be the ones who can access and hold the most useful and reliable
information especially accounting information. This enhances the importance of ABC in
the eye of managers. From earlier of the century, many researchers declared that
organizations can gain lots of benefits when they implement ABC costing method
(Anderson and Young, 1999; Cooper and Kaplan, 1991). Other benefits of ABC such as
manufacturing improvement, better product information, allocating limited sources and

14

products mix strategies also emphasize in many different studies of various accounting
scientists (Anderson, 1995; Shields, 1995).
Generally, cost reducing, products quality improvements and saving manufacturing time
can be listed as three main benefits that ABC can bring to organizations in operational
performances aspect (Anderson and Young [1999]; Ostrenga et al. [1992]). Many
researchers affirmed that using cost driver to allocate costs will bring more detailed and
precise information to users (Cooper and Kaplan [1991, chapter 5]; Ostrenga et al.
[1992]; Carolfi [1996]). By this way, wasted are unnecessarily costs during production
process will be reduced and saved. Additionally, potential products or services with
higher profitability will be focused and the company can keep the right development
tract. The relation with customers will be enhanced since more valuable products are
invented and brought to them.
However, in order to explore all of ABC benefits, managers should choose a suitable
management method. Until now, for most of people, TQM or total quality management
is still a favorable method since it can help ABC provide listed benefits as discussed
above.
2.2.2 ABC critism
It is a fact that none of accounting methods can be considered as perfect. Therefore, even
ABC has lots of benefits, there are some problems still exist. Although it is a benchmark
to evaluate the effectiveness of the business, seven steps are not so easy to implement. It
requires time to train the employees and build a complicated facility (McGowan and
Klammer, 1997). Without understanding about the tool that we use, none of business can
be successful. In order to achieve this, companies must have a good and safe financial

15
issue. Moreover, for most of shareholders, traditional costing method is the best method
when all of costs are calculated in a simple way among different products. As a result,
they might be confused since companies apply a new form of costing method to do
annually reports. Although more detailed and precise information is a huge strength of
ABC, it is also a weakness of this method. In case that too many products or services

are produced at the same time, number of cost pool, costs bases and cost drivers also
increase. This might lead to some small errors and mistakes during the calculation
process (Datar and Gupta, 1994). Too much information will distract the judgments
ability of managers and lead to unsuitable decisions at specific circumstances (Itnner and
Larcker, 2001; Gordon and Silvester, 1999). Moreover, implementing ABC method also
needs many objective factors such as market competitiveness, core business and the
information technology infrastructure quality (Banker and Potter, 1993; Christensen and
Demski, 1997). Lastly, differences about financial situations and operation performance
between adopting and non adopting companies are not so clearly (Shields, 1995;
McGowan and Klammer, 1997; Foster and Swenson, 1997). Therefore, it is quite
difficult to declare that companies should consider ABC as the only one costing method
to apply.
2.3 Impacts of this method on decision making process of manager as
well as its influences on the organizations
According to benefits that ABC owns, influences and impacts of this method on
decisions making process and operational performance can not be denied. Business
environment changes so rapidly. As a result, cost accounting methods also need to

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develop more to adapt with these changes. In table 3.1, compare to the past, lots of
changes occurred.
Table 2.3.1: The changes in manufacturing environment (Sullivan, William G., 1992)
Yesterday
New Paradigm
High volume, long production runs,
long product life cycles
Low volume, short product runs, short
product life cycles
Small number of product variations in a
Domestic market

Large number of product variations in
an international market
Large direct labor component; high cost
of processing information
Relatively high technology costs;
relatively low information processing costs
Small indirect/overhead costs in
relation to direct labor
Large indirect/overhead costs in
relation to direct labor

Globalization becomes a dominated trend in World make business battle more furious.
From a long run manufacturing trend only focusing on the quantity of products with long
life cycles, now, most of companies choose short term production with higher profitable
products or services. By this way, even the quantity of items is much lower than in the
past, profit of the companies still maintain and develops solidly. To achieve this,
information about market and responses as well as expectations from customers should
be updated daily and rapidly (Sullivan, William G., 1992). Based on this comparison, it
is quite easy to see that, other costing methods still can be applied but it will face with
lots of problems since it can not adapt with the changes of the environment. Broaden
market environment means that the variability of products and services will be higher.

17
Uncompetitive products or services will be eliminated. Locally competing trend turns
into international competition.
Instead of paying more money in gathering the information as in the past, internet and
technologies development free companies to access various sources of information
nowadays. Manual works in manufacturing has a negative relation with the number of
machines that are equipped in factories. For example, in the past, a car needs 10 people to
make; but now, to produce a car, only 2-3 persons to control a machine. However, this

increased the indirect manufacturing overhead costs compare to the past. As in figure
3.2, overhead costs are about 35% in total of manufacturing costs compare to 15% if
companies still apply traditional way. Direct labor costs are also reduced from 75% to
10%. This is a big change in the business environment


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Figure 2.3.2: The proportion of material, direct labor and overhead costs in
today’s world









Figure 2.3.3: The proportion of material, direct labor and overhead costs where
traditional cost systems focus their attention.

Materials, 55%
Direct Labor, 10%
Overhead, 35%
Materials
Direct Labor
Overhead
Materials, 10%
Direct Labor, 75%
Overhead, 15%
Materials
Direct Labor
Overhead