Activity-based Costing in Service Industries

Activity-based Costing in Service Industries

ACC 560 Managerial Accounting

McDonalds is a USA company that would benefit from the use of the time driven ABC costing system (ABC). McDonald’s was founded by Ray Kroc. Ray Kroc was born in Oak Park, Illinois, on October 5, 1902. When he was 17 years old, he lied about his age in order to join the Red Cross. However, the war stopped his training and allowed him to venture into employment opportunities that include a piano player, a paper cup salesman and a multi-mixer salesman. While he was employed as a multi-mixer salesman, an order caught his interest from a restaurant in San Bernardino, California in 1954 (www.franchises.about.com). He discovered a small business that was very successful, efficient, and effective. The business was operated by two brothers, Dick and Mac McDonald. Kroc was extremely impressed at how the effective the operation was ran. Although the menu was limited, it allowed them focus on the quality of every step of the daily operation of the business. Inspired by the success of the business, Kroc presented the idea of expanding the business across the world (www.mcdonalds.com). In 1955, the first McDonald’s opened in Chicago, which is when the organization became the McDonald’s Corporation. Six years later Ray bought out the founding brothers. By 1965 there were more than 700 sites in existence across the United States (www.franchises.about.com).

The focus on quality that initiated with the McDonald brothers lead to Kroc’s focus on quality. Every single ingredient was tested, tasted and perfected. Kroc also established relationships with meat, produce and dairy suppliers. The focus on quality expanded to these suppliers, which developed an efficient and innovative supply system in the food service industryindustries. Kroc even started a Hamburger University in 1961. Located in Elk Grove Village, Illinois, this university was launched in order to properly train employees on the daily operations of McDonald’s and to instill the same focus on quality that began with the initial business. It also had its own research and development team that constantly developed new cooking, freezing, storing and serving methods. Today, more than 80,000 people have graduated from the program. On January 14, 1984, Ray Kroc died at age 81. He left behind his legacy, which is his passion for innovation and efficiency, relentless pursuit of quality, and many charitable contributions (www.mcdonalds.com).

The initial efficiency of this company was based on the detail to quality. That same focus can be used to implement theABC system(ABC) (www.smallbusiness.chron.com). This system a more accurate view of product cost since it, determines every activity associated with producing an item and allocates a cost to the activity. The cost assigned to the activity is then assigned to products that require the activity for production. This costing system provides accurate costs of production, which allows companies to effectively and efficiently plan and make forecasts (www.smallbusiness.chron.com). First, they need to identify theproduct or service. In this case it would be burgers or French fries. Once the product or service is selected, then the direct costs associated with that product or service would be identified. The hamburger, for example, would have direct costs like the cost of the hamburger patty. Next, the cost driver would be determined. With this product, the number of daily orders for burgers would be to cost driver. Each direct cost associated with the burger would be determined in this manner. Once all of this information is gathered, the rate per cost driver can be determined. Likewise, the indirect costs associated with the burger must also be identified. To make this determination, the activity for the product is multiplied by rate per driver. The final step is to compute the total costs of the product. This computation is determined by adding the direct costs to the indirect costs.

Although there are other advantages to using the ABC system, the most important one is the fact that is provides accurate costs for activates associated with providing a product or service (www.acconting4management.com). Some other advantages that the company will get from this ABC system are:

ACB system provides a better understanding of overhead costs since provides details about activities involved in providing products and services.

• The ABC system provides more accurate costing of products, services, customers, and distribution channels.

ABC system is easy to understand, which would eliminate any confusion about procedures of the costing system.

The ABC system allows management to determine which activities are not efficient or effective. Therefore, management will be able to determine which activities to eliminate and which ones need perfecting.

• The ABC system uses the unit cost rather than just total cost. This will assist with determining the individual cost of an activity. It will also allow management to determine the cost of certain projects or campaigns. The result would be in increase efficiency in the quality control and handling of materials.

The ABC system integrates with improvement programs and allows management to determine the performance of its employees on all levels.

Activity Based Costing reflects the true work performed by the company, which plays an important role in management decisions.

In today’s diverse market, it is vital to keep costs at a minimal without sacrificing the quality of your product. This action is vital with the intense global competition that exists. The ABC system would reflect the actual work done during the daily operation of a company. By knowing the most accurate cost for daily activities, management is able to determine the correct cost for services rendered, or even services to be rendered. They would also be able to determine if products are worth the cost to add to the daily production line. Unlike the ABC system, the traditional costing uses a technique that reflects costs at a higher rate than they really are. Thus, management is not able to truly predict the actual of a product or service, which could cost the company or business lots of money. However, the ABC system would distribute the cost activity wise. The costs would be allocated according to the utilization of the material in the process of the production of the product. Thus revealing the actual cost of the material used in the production process.As stated previously, the indirect costs are computed by taking the activity for the product is multiplied by rate per driver. This computation would obtain the actual indirect cost of the product or service. Therefore, the overall costs would be discovered by adding the indirect and direct costs of that product or service. In this system it is not necessary that the product of higher volume will give the higher costs and the product of lower volume will reflect the low costs of the product. It will show the actual cost of the product. Thus it is more beneficial for the company as they will get to know their actual cost of the activities utilized in the production process. This knowledge will prove to be extremely valuable since it will allow the company to minimize its costs without sacrificing the quality of its products and services. It will allow management to make more informed decisions about capital projects and even acquisitions. Therefore, the company can be more competitive with its competitors on a domestic and international level.

The impact of the ABC system on services provided online can be impressive. First of all, the ABC system would allow the company to determine if it is even possible to establish any online services. Then the ABC system would allow the company to establish the exact cost of providing that service online vs. the cost of providing that service through traditional channels. The ABC system would allow management to determine rather they should continue to provide the service online or through traditional channels. Thus, it will allow management to make decisions that would maximize its customer base, increase sales, and minimize costs while maintaining or even increasing the quality of its services.

References

Advantages, Disadvantages and Limitations of Activity Based Costing (ABC) System. (n/d). Retrieved April 26, 2013 from www.acconting4management.com website: http://accounting4management.com/limitations_of_activity_based_costing.htm

How ABC Can HelpService Organizations. Lambert, Don. Whitworth, John. (n/d). Retrieved April 27, 2013 from www.focusedmanagement.com website: http://www.focusedmanagement.com/knowledge_base/articles/fmi_articles/middle/abcserv.htm

The Ray Kroc Story. (n/d). Retrieved April 26, 2013 from www.mcdonalds.com website: http://www.mcdonalds.com/us/en/our_story/our_history/the_ray_kroc_story.html

The Ray Kroc Story – McDonald’s Facts and History: Ray Kroc Biography and McDonald’s Facts. (n/d). Retrieved April 27, 2013 fromwww.franchises.about.comwebsite: http://franchises.about.com/od/mostpopularfranchises/a/ray-kroc-story.htm

Traditional Costing Vs. Activity-Based Costing. Johnson, Rose. (n/d). Retrieved April 26, 2013 from www.smallbusiness.chron.com website: http://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html