The Limitations of Implementing an Activity-Based
Costing system in Jordanian Manufacturing Industry
Ahmad Al-Hashlmoune
Department of Accounting, College of Business Administration, University of Jordan
I. Introduction:
As the percentages of indirect costs (overhead costs) increased, the traditional costing systems (broad
averaging) became inaccurate, because indirect costs are not distributed equally between or among
products, one product may needs less activities (actions that are performed both by people and
machine) than another, but since the amount of direct labor might be the same, the percentage of
indirect costs assigned to it will be the same, if direct labor hours or costs was the allocation base, here
the Product-Cost Cross-Subsidization rose.
Traditional cost systems, even those with multiple production cost centers, systematically and grossly
underestimate the cost of resources required for specialty, low-volume products and overestimate the
resource cost to producing high-volume standard products. Activity-based cost systems have been
developed to eliminate this major source of cost distortion (Management Accounting, 5ed, Atkinson and
Kaplan).
Accurate cost information is critical for every aspect of a business, from its pricing policies to its product
designs and performance reviews. However, most companies are still using the same traditional cost
accounting systems that were developed decades ago (Kaplan and Cooper, 1998).
Rather than just listing cost factors and assigning them to products based on artificial allocations, ABC
examines processes and work-flows to identify actual activities that add costs. This wider and more
realistic view of costs allows managers to base strategic decisions on more accurate information, which
should improve the quality of those decisions. While an ABC system alone will not transform a firm into
a world-class competitor, it is an important tool to help world-class firms make effective strategic
decisions. (M. Gupta, K. Galloway - Technovation 23 (2003) 131–138)
More accurate cost information results are obtained from ABC than from the traditional cost accounting
systems, because ABC logic relies on the relationship of 'cause and effect' when allocating indirect costs
rather than on only volume-based allocation. Previous results of some ABC studies showed that its
implementation usually led to reduction in costs and improved efficiency in production by decreasing
non value added activities. Traditional cost accounting systems have been under constant criticism due
to the distortions in costing coming from the inability to accurately and fairly allocate indirect costs.
Advantages of this modern costing system encouraged the researcher to propose a model that is based
on Underlying theory. (Khalid A. Abdullah, Marwan Irshaidat, 2009).
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Activity-Based costing systems after defining the activities and identifying the costs related to it, assign
the costs to these activities and then to products according to the extent it use of these activities, rather
than using broadly averaging , so the managerial decisions will be based on more accurate data.
The main purpose of the study is show to what extent activity-based costing (ABC) is applied in
Jordanian Manufacturing Sector, and the Limitations of implementing it, and, we believe, the result will
help in explaining why it is not implemented in all Jordanian manufacturing companies. The purpose of
our study was not to develop a complete, working model, but rather to demonstrate the Limitations of
applying ABC in a Jordanian Manufacturing Sector.
Study Objectives:
1- To what extent Jordanian Manufacturing industry is applying an ABC system?
2- What the factors (limitations) that limits from implementing ABC system in some Jordanian
Manufacturing companies?
II. Literature Review:
The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s
and 1980s. During this time, the Consortium for Advanced Management-International, now known
simply as CAM-I provided a formative role for studying and formalizing the principles that have become
more formally known as Activity-Based Costing.(Consortium for Advanced Manufacturing-International).
The ABC concept was designed as a method which eliminates the shortages of the traditionally used
absorption costing methods. Those shortages or limitations had been very closely described in the
scientific publications (Drury, 2001), (Kim, Y., Ballard, 2002), (Sebestyen, Z., Juhász, 2003), (Stanëk,
2003). The effect that plays a role in determining an inaccurate overhead cost allocation could be
described as “averagization” (Popesko, B" Novak, 2008).
The ABC approach measures the costs of objects by first assigning resource costs to the activities
performed by the organization, and then using casual cost driver to assign activity costs to products,
services, or customers that benefit from or create demand for these activities (Cooper, 1988). ABC
proponents contend that this approach capture the economics of the production process more closely
than traditional unit-based cost systems, thereby providing more “accurate” cost data [e.g. Cooper and
Kaplan, 1991, chapter 5].(Christopher D. Ittner, William N. Lanen, and David F. Larcker, 2002).
Activity-Based Costing methodology has been described by many authors (Drury, 2001), (Glad, 1996),
(Kaplan, R., Cooper, 1998), (Sebestyen, Z., Juhász, 2003), The ABC process could vary from simple ABC,
using only one level of activities to expanded ABC, comprising various levels of activities and allowing for
mutual allocation of activity costs (Cokins, 2001).
The following table shows the difference between ABC system and traditional costing systems as stated
by (Michael H. Granof, David E. Platt, and Igor Vaysman, 2000):
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Table 1
Difference between ABC and Traditional Costing
ABC Costing Traditional Costing
Cost Pools ABC systems accumulate costs Traditional costing systems
into activity cost pools. These accumulate costs into facility-
are designed to correspond to wide or departmental cost
the major activities or pools. The costs in each cost
business processes. By design, pool are heterogeneous they
the costs in each cost pool are are costs of many major
largely caused by a single processes and generally are
factor—the cost driver. not caused by a single factor.
Allocation ABC systems allocate costs to Traditional systems allocate
Bases products, services, and other costs to products using
cost objects from the activity volume-based allocation
cost pools using allocation bases: units, direct labor
bases corresponding to cost input, machine hours, and
drivers of activity costs. revenue dollars.
Hierarchy of Allows for non-linearity of Generally estimates all of the
Costs costs within the organization costs of an organization as
by explicitly recognizing that being driven by the volume of
some costs are not caused by product or service delivered.
the number of units produced.
Cost Objects Focuses on estimating the Focuses on estimating the
costs of many cost objects of cost of a single cost object
interest: units, batches, unit of product or service.
product lines, business
processes, customers, and
suppliers.
Decision Because of the ability to align Because of the inability to
Support allocation bases with cost align allocation bases with
drivers, provides more cost drivers, leads to over-
accurate information to costing and under-costing
support managerial decisions. problems.
Cost Control By providing summary costs of Cost control is viewed as a
organizational activities, ABC departmental exercise rather
allows for prioritization of than a cross-functional effort.
cost-management efforts.
Cost Relatively expensive to Inexpensive to implement and
implement and maintain. maintain.
Source: Using Activity-Based Costing to Manage More Effectively, 2000.
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Detailed ABC systems are costly to operate and difficult to understand. Many companies are
discouraged from using ABC due to the higher cost of identifying multiple activities and applying
numerous cost drivers. ABC is more complex than traditional costing system. Also we need a team of
dedicated people to develop and implement an ABC system, along with regular consultation with, and
involvement of, relevant staff throughout the organization. In addition, the collation, processing,
understanding and interpreting of the data also involves a lot of time and dedicated manpower
(FMAccounting.com, 2006).
The most prominent of activity based costing limitations is its complex nature that prevents its
widespread application. Activity based costing systems usually remain difficult to comprehend and costly
to operate. Activity based costing requires management to not only estimate the costs of each activities
and identify and measure the cost drivers for such activities, but also update the same on a regular
basis. Traditional management accounting uses a single cost-center approach, and implantation of
activity based costing might require division of costs into multiple pools to represent the many activities.
This takes away much of the organization’s resources such as management time and cost (N. Nayab,
2010)
A significant amount of research is available that deals with the design and implementation of ABC
systems (Cooper and Kaplan, 1991), (Shank and Govindarajan, 1993), (Turney, 1992b), (Damito et al.,
2000).
III. Research Model and Hypotheses
Based on the ABC System Limitations literatures and the research objectives, a research model is
developed to be tested. Figure 1 shows the research model.
Figure, 1. The Research Model
Complexity
Implementing ABC System
Cross Functional Team
Cost & Time Dependent Variable
Company Size
Independent Variables
Moderating Variable
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IV. The Research Hypotheses
Based on the literature review and to achieve the research objectives the following hypotheses are
proposed:
HO1: there is a negative relationship between the complexity of the ABC system and its
implementation.
HO2: there is a negative relationship between the availability of Cross Functional Team required to
implement the ABC system and its implementation.
HO3: there is a negative relationship between the cost of and the time required to design and
implements the ABC system and its implementation.
HO4: Company size effect the relationship between the cost of and the time required to design and
implements the ABC system and its implementation.
V. Operationalization of the Research Variables
All variables in our research are defined in the
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