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Activity-Based Supplier Costing and its Implications for Identifying True supplier Costs
  • 9

  • Course Code: ACCT 7019
  • University: Western Sydney University
  • Country: Australia

Executive Summary

Activity-Based Supplier Costing (ABC), a form of cost accounting, allocates costs to activities rather than to conventional drivers, leading to more accurate cost calculation.

In addition to outlining the theoretical foundations of ABC, its practical applicability in various industries, and its benefits, this literature review focuses activity-based supplier costing.

Studies show that ABC improves resource management, cost control, and performance evaluation.

How it can be used in practical circumstances is demonstrated by examples from UPS and HP. ABC fills in the understanding gaps concerning supplier costs left by traditional costing approaches by directly linking expenses to supplier-related activities.

Recommendations promote using ABC to evaluate, choose, and reduce prices for suppliers on a broad scale.  

Introduction

The objective of this report is to examine the idea of activity-based supplier costs and its possible advantages for businesses engaged in manufacturing. Activity-Based Supplier Costing is an advanced costing technique that links costs associated with suppliers to certain activities to give a more precise and in-depth view of supplier costs.

Organisations can reduce total expenses and evaluate suppliers more effectively by understanding the true costs entailed with supplier relationships. In order to understand the benefits of activity-based supplier costing above conventional costing techniques, this research analyses the guiding principles, ideas, and methodology used in this field.

Activity-Based Supplier Costing

The ability of Activity-Based Supplier Costing (ABC), an advanced costing technique, to give industrial organisations a more precise and thorough understanding of supplier costs, has attracted a lot of interest recently.

The objectives of this section are to define ABC and examine the ideas, methodology, and guiding principles used in activity-based supplier costing. It also covers the use of ABC in supplier costing and illustrates the advantages and disadvantages of this strategy in comparison to conventional costing techniques.

1. Definition of Activity-Based Supplier Costing:

Activity-Based Supplier Costing (ABSC) is a variant of Activity-Based Costing (ABC) that focuses on identifying and allocating costs to specific suppliers (Zander, 2006). Using volume-related measures like direct labour hours or machine hours, traditional costing methods frequently assign supplier costs depending on these data.

A more precise depiction of the real cost drivers connected to supplier relationships is provided by ABC, which, in contrast, links costs to specific resource-consuming activities (Akyol, Tuncel, & Bayhan, 2005). Organisations can find cost-saving possibilities and improve supplier selection procedures by analysing the activities associated with dealing with suppliers.

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2. Principles and Theories of Activity-Based Costing:

The cost causation principle is the cornerstone of activity-based costing. According to this theory, costs are caused by the use of resources by activities. According to the level of resource utilisation, ABC assigns costs to the actions that go into producing a good or service (Wegmann, 2008). This strategy is in line with the causality idea and enables organisations to more precisely grasp the underlying variables affecting costs.

3. Application of Activity-Based Costing in Supplier Costing:

According to Agndal and Nilsson (2007), ABC assists organisations in separating supplier-related operations into distinct components and allocating expenses to particular providers in accordance. For instance, each supplier has different expenses associated with tasks like order processing, quality checks, and supplier assessments.

Organisations can improve their supplier evaluation and selection procedures by keeping track of these actions and connecting them to providers in order to find the most affordable and dependable suppliers.

Additionally, ABC gives businesses the ability to identify hidden expenses linked to supplier relationships. Traditional pricing methods frequently ignore these hidden expenses, such as expedited shipment because of delayed delivery or increased quality control procedures (Lin, Collins, & Su, 2001). Organisations can improve their relationships with suppliers, negotiate better terms with them, and optimise their cost structures by precisely tracking these costs.

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4. Benefits and Limitations of Activity-Based Supplier Costing:

There are several significant advantages of using ABC in supplier costing. First off, it gives organisations a more precise understanding of the cost drivers, enabling them to concentrate on tasks that have the biggest effects on costs (Gupta & Galloway, 2003). Improved resource allocation and supplier relationships may result from this knowledge.

Second, ABC makes it easier to identify high-cost suppliers, giving businesses the option of negotiating better deals or looking for substitute suppliers (Agndal & Nilsson, 2007). Additionally, it aids in separating reliable, high-quality suppliers from those that may be more cost-effective but may sacrifice quality.

However, there are some limitations on activity-based supplier costing as well. It can take a lot of time and effort to effectively identify and measure activities when implementing ABC (Kishikawa, 2020). The initial setup expenses may be too high for small and medium-sized businesses, making it more appropriate for larger businesses with vast supply networks.

Analysis and Evaluation:

This report's analysis and assessment part will dive into the drawbacks of conventional costing methods for allocating supplier expenses and emphasise how these methods fall short of offering a complete picture of supplier costs. It will also look at how activity-based supplier costing (ABC), which directly links costs to supplier-related activities, gets through these constraints.

In order to show the usefulness and advantages of this technique in discovering hidden costs related to supplier relationships, a real-life case study of a manufacturing company that adopted ABC will also be given.

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1. Traditional Costing Methods for Supplier Costs Allocation:

Manufacturing companies have long distributed supplier costs using traditional methods of costing like job costing or process costing. To allocate indirect costs to goods or services, these methodologies rely on volume-related measures, such as direct labour hours or machine hours (Kumar & Mahto, 2013). These techniques, however, fall short in capturing the nuances inherent in supplier relationships when it comes to supplier costs.

Traditional approaches, for instance, would assign overhead costs simply based on the quantity of units produced, omitting the possibility that various providers might need various levels of assistance and resources. This can result in inaccurate representations of supplier costs and limit the capacity to select and evaluate suppliers in an informed manner.

2. Limitations of Traditional Costing in Understanding Supplier Costs:

Traditional costing techniques have a number of drawbacks, one of which is their inability to account for hidden or indirect costs related to supplier relationships. These costs are difficult to attribute to specific suppliers using conventional methods, and they may include rush shipping fees because of delayed deliveries or increased quality control charges (Ruiz-de-Arbulo-Lopez, Fortuny-Santos, & Cuatrecasas-Arbós, 2013).

As a result, businesses could make poor supplier decisions since they don't fully understand the true cost of working with particular suppliers.

Furthermore, non-volume-based cost variables that have a big impact on supplier costs are frequently overlooked by standard costing techniques. These factors could be responsiveness to demand variations, product quality, and supplier dependability.

Traditional approaches fall short of giving a complete and accurate picture of the expenses related to specific suppliers because they do not take these crucial elements into account.

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3. Activity-Based Supplier Costing: A Comprehensive Perspective:

By assigning costs to certain activities associated with supplier interactions, activity-based supplier costing provides a workaround for the shortcomings of conventional costing methodologies. By using this strategy, organisations can identify costs that are directly related to specific suppliers, both direct and indirect (Cardos & Pete, 2011).

ABC distributes costs based on the actual resources used, giving a more realistic picture of supplier expenses, by recognising supplier-related activities like order processing, supplier appraisal, or quality inspections.

For instance, companies can learn more about the actual cost of managing supplier relationships by keeping account of the time and resources used in analysing and keeping an eye on each supplier. This information enables businesses to give priority to suppliers who provide the best value in terms of cost-effectiveness, dependability, and quality.

4.Case Study: Implementation of Activity-Based Costing:

a.Case Study 1: UPS (United Parcel Service)

When estimating the expenses of its wide range of services, UPS, a multinational package delivery and logistics corporation, encountered difficulties. It was challenging to optimise their service offerings and pricing strategies using traditional costing methodologies since they did not give a clear picture of the factors that influenced their costs.

After introducing activity-based costing, UPS was able to pinpoint the precise activities that were responsible for cost increases across its supply chain and delivery system (Pfaffinger, 2014). They were able to more precisely allocate costs and comprehend the profitability of each service thanks to this detailed information.

As a result, UPS was able to increase overall efficiency and customer satisfaction by streamlining processes, improving delivery routes, and finding areas of cost savings.

b. Case Study 2: Hewlett-Packard (HP)

The international technology corporation HP had trouble estimating the actual cost of each of their computer products. The vast range of activities involved in the manufacturing process were not taken into account by traditional costing methods based on direct labour or machine hours, which resulted in incorrect product costing and price decisions.

HP improved its grasp of the resources and activities needed to create each computer model after introducing activity-based costing. A precise cost allocation for each product line's design, testing, and support could now be made by the corporation.

As a result, HP was able to boost profitability and create a more competitive product portfolio by identifying the most profitable product lines, getting rid of the least profitable ones, and making better-informed resource allocation and price decisions (Geffken, 1992).

Recommendations

This section offers a series of recommendations for manufacturing organisations on how to use activity-based supplier costing (ABC) to strengthen supplier evaluation and selection procedures and lower total supplier costs based on the conclusions and insights from the analysis and evaluation.

1. Leveraging Activity-Based Supplier Costing for Supplier Evaluation:

Activity-based supplier costing should be implemented by manufacturing organisations to improve their supplier evaluation procedures. Organisations can better identify the real cost drivers for each supplier by examining supplier-related costs and activities. With this information, they are able to look beyond straightforward pricing comparisons and take into account aspects like supplier dependability, product quality, and response.

Recommendation: Develop an Activity-Based Supplier Costing System:

The development of a strong ABC system that reliably distributes costs to specific suppliers and records supplier-related activity should be prioritised by organisations. From supplier onboarding to order fulfilment, this system should include all pertinent processes, enabling a thorough assessment of supplier expenses.

Recommendation: Implement Performance Metrics:

To analyse supplier performance successfully, use performance measures created from ABC data. Included in these measurements should be lead times, product defect rates, and on-time delivery rates. Organisations can identify high-performing suppliers who provide the best value for money by connecting these KPIs to supplier expenses.

2.Enhancing Supplier Selection Processes with Activity-Based Supplier Costing:

Activity-Based Supplier Costing offers a more comprehensive perspective of the costs and value propositions of potential suppliers, which can greatly enhance supplier selection procedures. By prioritising suppliers exclusively on the basis of their apparent cost advantages, traditional procedures may result in unanticipated hidden costs and quality problems. ABC makes sure that every supplier's genuine cost of doing business is carefully considered.

Recommendation: Consider Total Cost of Ownership (TCO):

When choosing a supplier, incorporate ABC data into the Total Cost of Ownership (TCO) study. The total cost of ownership (TCO) takes into account not just the purchase price but also other cost components including transportation, inventory holding fees, and other quality-related expenditures. Organisations can make more informed decisions that are in line with long-term cost-saving goals by using ABC-derived costs in TCO estimates.

Recommendation: Focus on Long-Term Supplier Relationships:

Use ABC data to pinpoint vendors who, despite having slightly greater upfront prices, ultimately provide the best value. Creating partnerships with suppliers that are solid, dependable, and quality-focused can eventually result in cost savings and increased productivity.

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Conclusion: 

In conclusion, Activity-Based Costing (ABC) is demonstrated to be an efficient and pertinent cost accounting technique for contemporary firms. By linking expenses to particular activities, it provides a more precise picture of costs and gets beyond the drawbacks of conventional allocation techniques. Theoretical underpinnings of ABC challenge volume-based cost drivers and produce more accurate cost allocation.

Its useful applications in numerous fields, such as activity-based supplier costing, highlight its advantages in streamlining procedures and setting prices. Case studies from real-world situations support its efficacy even more.

Organisations that use ABC can better understand cost structures, evaluate suppliers more accurately, allocate resources more efficiently, and perform better overall. ABC continues to be a useful tool for improving cost management and decision-making processes as long as competitive constraints exist.

References

Agndal, H. and Nilsson, U., 2007. Activity‐based costing: effects of long‐term buyer‐supplier relationships. Qualitative Research in Accounting & Management, 4(3), pp.222-245.
Akyol, D.E., Tuncel, G. and Bayhan, G.M., 2005. A comparative analysis of activity-based costing and traditional costing. World Academy of Science, Engineering and Technology, 3(12), pp.44-47.
Cardos, I.R. and Pete, S., 2011. Activity-based costing (ABC) and activity-based management (ABM) implementation–is this the solution for organizations to gain profitability. Romanian Journal of Economics, 32(1), pp.151-168.
Geffken, K., 1992. Activity-Based Costing at Hewlett-Packard's Andover Surface Mount Center. Target, pp.15-19.
Gupta, M. and Galloway, K., 2003. Activity-based costing/management and its implications for operations management. Technovation, 23(2), pp.131-138.
Kishikawa, H., 2020. The clinical benefits, limitations, and perspectives of the ABC method. Internal Medicine, 59(12), pp.1471-1472.
Kumar, N. and Mahto, D.G., 2013. A comparative analysis and implementation of activity based costing (ABC) and traditional cost accounting (TCA) methods in an automobile parts manufacturing company: a case study. Global Journal of Management and Business Research, Accounting and Auditing, 13(4).
Lin, B., Collins, J. and Su, R.K., 2001. Supply chain costing: an activity‐based perspective. International Journal of Physical Distribution & Logistics Management, 31(10), pp.702-713.
Pfaffinger, C., 2014. UPS - Activity Based Costing System. [online] prezi.com. Available at: https://prezi.com/-gu2lykjjdg9/ups-activity-based-costing-system/ [Accessed 30 Jul. 2023].
Ruiz‐de‐Arbulo‐Lopez, P., Fortuny‐Santos, J. and Cuatrecasas‐Arbós, L., 2013. Lean manufacturing: costing the value stream. Industrial Management & Data Systems, 113(5), pp.647-668.
Wegmann, G., 2008. The activity-based costing method: development and applications. The IUP Journal of Accounting Research and Audit Practices, 8(1), pp.7-22.
Zander, M., 2006. Supply chain cost control using activity-based management. CRC Press.

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