CONTENT

1 INTRODUCTION 1

2 LITERATURE REVIEW 2

2.1 Activity Based Costing (ABC) Adoption 2

2.2 Factors Influencing ABC 3

2.3 Problems of ABC Implementation 4

2.4 Advantages of ABC 5

2.5 Limitations of ABC 6

2.6 Steps in Implementing ABC 7

3 Scenario: ABC Implementation in TM 8

3.1 Company Background 8

3.2 ABC Implementation in TM 9

3.3 Problems Faced During Implementation 11

3.4 Benefits Gained 12

4 Discussion and Conclusion 12

4.1 Understanding ABC 13

4.2 Advantages and Disadvantages of ABC 13

4.3 Conclusion 14

5 REFERECES 15

1 INTRODUCTION

In the traditional accounting approach, everything from marketing expenses to utility

bills and without differentiating divisions according to the type of production is

considered as overhead in determining the cost. The longstanding issues is that

some activities represent more overheads than others. This is unacceptable because

two activities that absorb the same direct costs can use very different amounts of

overhead. A mass-produced car, for instance, can use the same amount of labour

and materials as a customised car. But the customised car uses far more of the

company engineers' time (an overhead) than does the mass-produced one. This

disparity would not be reflected in traditional costing systems. Thus a company that

makes more and more customised products (and bases pricing on traditional

costing) can soon find itself making large losses. As new technologies make it easier

for firms to customise products, the importance of allocating indirect costs accurately

increases.

Activity Based Costing (ABC) is an option to the traditional accounting in which a

business's overheads (indirect costs) are allocated in proportion to an activity's direct

costs. This accounting method identifies the activities that a company performs, and

then assigns indirect costs to products less arbitrarily than traditional methods.

Indirect costs, such as management and office staff salaries are sometimes difficult

to assign to a particular product produced. For this reason, ABC has found its niche

particularly in the manufacturing sector.

ABC became popular in the early 1980s largely because of growing dissatisfaction

with traditional ways of allocating costs. Robert Kaplan, a Harvard Business School

professor sometimes recognized with being its founding father of ABC accounting

method. Together with Robin Cooper, the duo described ABC as an approach to

solve the problems of traditional cost management systems. Activity-based costing

was first clearly defined in 1987 by Robert S. Kaplan and W. Bruns as a chapter in

their book Accounting and Management: A Field Study Perspective. Later in 1999

Peter F. Drucker explained in the book Management Challenges of the 21st Century

1

that traditional cost accounting focuses on what it costs to do something, for

example, to cut a screw thread whereas ABC as such but also records the cost of

not doing, such as the cost of waiting for a needed part. In short, ABC records the

costs that traditional cost accounting does not do.

The ABC implementation in Telekom Malaysia (TM) was initiated by the finance

division of the company in 1996. The key motive for the introduction of ABC was

because of price competition for their products. During that time, TM was losing its

market share. The only way to increase market share is to reduce the price of

services offered and by doing that, it required further cost reduction. For this reason

TM needs to identify different cost drivers so that it can identify which areas the

company can save cost compared to other telecommunication company. As the

traditional accounting system could not identify appropriate cost of each service, the

ABC accounting method have been used to tackle the problem.

2 LITERATURE REVIEW

2.1 Activity Based Costing (ABC) Adoption

“Business is not as usual”. Globalisation has changed the landscape of modern

business. The rapid development of technology offered a new and challenging

environment in doing business. Companies especially for those in the commercial

market need to constantly adopting the suitable approaches or methods in doing

business to keep them relevant and competitive thus ensuring their business is

everlasting. As commercial market aim for highest profitable return, the top

management must be willing to invest and adapt proven techniques and method that

can help in achieving their goals. One of these method is ABC (Kalicanin &

Knezevic, 2013).

ABC was introduced since 1980s and starting to gain its popularity in 1990s. It has

attracted a great attention from scholars and practitioners due to its given benefit.

ABS was claimed to help in process improvement as well as in decision making that

benefit them. It is also widely used in developed countries especially among

2

Westerners for many purposes, such as product-range decisions, customer

profitability analyses, cost reduction, cost modelling, budgeting inventory, valuation,

and performance measurement (Majid & Sulaiman, 2008).

For such given benefit, it is expected that these method will be widely adopt by most

firms and companies around the world. However, previous studies shown contradict

result. Surprisingly, the adoption rate is low for both in developed and developing

countries. Majid and Sulaiman (2008) quoted for example, in developed countries,

the ABC adoption rate in USA (healthcare industry) remain unchanged for 10 years;

16 percent in 1994 and 14 percent in 2004. This situation of low adoption rate

appears the same in Australia (manufacturing company) and Singapore. The same

trend can be seen in developing countries like Malaysia, China and India. There are

numerous reason given: lack of awareness, lack of expertise, lack of management

support, high cost of implementation and also “no reason to change”.

2.2 Factors Influencing ABC

There are various factors influencing the success of implementing ABC method in

the organization. Many researchers have found various factors from their research

that must be given attention by companies in order to ensure the success of

implementation. Many researchers agreed that top management support and

involvement together with adequate of resources are the main contributor to the

success factors. Liu and Pan (2007) classified all these success factors into four

categories: (1) technical factors involved with practical knowledge of applying the

conceptual design of an ABC system within an organisational context, selection of

activities that relates to products, linkage between ABC and organisational strategic

objectives, and an understanding of the capability of existing computer systems to

support ABC systems, (2) organisational factors such as top management support,

resource adequacy, implementation training, and structure of organisation and

culture, (3) behavioural factors such as participative manner in the process of

development and implementation of ABC systems and awareness of individual

users’ behaviour and (4) other contextual factors such as competition, task, quality

3

and relevance of cost information to managerial decisions, size of organisation,

compensation and reward, general need for change, and culture.

At the same time, the grounded theory by Abrahamson (1991) is used to categorise

the reasons of companies adopting and implementing ABC. The reasons can be

classified into three different perspectives: (1) the “efficient-choice” perspective; (2)

the “forced” selection perspective; and (3) the “fad” or “fashion” perspective.

The efficient choice of perspective is one of the main factors recognised as

contributor to the implementation of ABC mainly during the initial stage. Malmi (1999)

found that the efficient choice of perspective was the factor that influences ABC

implementation in 114 companies in Finland. Whereas, the fashion perspective

comes in later stage of implementing. While forced selection perspective appear in

the case of involvement and direction from top management. Companies and firms

will adopt ABC when they are forced by their top management. This situation happen

in CM, a subsidiary of an American company in Malaysia that have to apply ABC

techniques because of their parent company in USA used these method (Majid &

Sulaiman, 2008).

2.3 Problems of ABC Implementation

Introduction and implementation of a new method in an organization is not an easy

job. Commonly, people will react negatively to the changes even though the method

is proven for its benefit. Therefore, the process of implementing this new method (in

this case ABC method) could be a very challenging task. One of the major problem

recognised is related to the cost of implementing it especially during the initial phase.

At this point, the high set up cost will incurred. This cost will taking into account the

infrastructure provision, amount of time and energy spent by management in

identifying cost drivers and also numbers of additional accounting staff to run the

project. As a result, a lot of managers viewing the implementation of the ABC

method has taken their time that supposedly used to execute their official job (Majid

& Sulaiman, 2008).

4

Apart from the cost involved, companies or firm should study their employees’

acceptance level. Employees’ acceptance is important as they are the engine to

ensure the success of the implementation. Previous study undertaken by Soin et al.

(2002) revealed those employees are afraid about the impact of ABC on their jobs.

They were suspicious of management’s decision to implement ABC as they

misinterpret it as companies approach to downsize. Therefore, it makes the

management effort to gather information especially in identifying the cost drivers

become more complicated.

Other than that, software used to run the system can become another factor that

affect the success of ABC implementation. In the study by Liu and Pan (2007)

highlighted that the software problem encountered by users nearly foiled the

process. This is due to the failure by the programmer of software company to

understand the technical aspect of ABC. However, the problem was successfully

resolved with a good cooperation from user and programmer. They work closely

together where user tries to provide an understanding about the concept of ABC

model to the programmer. Once the programmer really understands the concept,

they managed to develop the ABC conceptual model into a computerised system.

2.4 Advantages of ABC

Activity based costing (ABC) has been identified as an alternative to overcome the

limitations of traditional costing systems. Previous studies have reported that ABC is

a costing method that can works as a strategic management tool to the organization

as it provides more useful appropriate decisions in the future (Griful, 2001; Malmi,

1997). Swenson (1995) points out that by allocate activity costs to products and

services by applying cost drivers, the analysis is expected to provide more accurate

costing information on costs and utilization of resources which can be used to make

sound planning, controlling and evaluation of business process.

ABC looked into the costs of complexity, variety and change related to the product or

service provided and to the customized customer requirements. ABC helps in

understanding true cost in providing specific service and performs detailed analysis

5

on product and customer profitability as well as identifies activities and processes

which needed improvements. It eventually help the organization recognizes the way

in which customers directly influenced the cost structure of the business.

Strategic ABC tools also focus on the value-added activities, which proper use of

these tools can help alter product demand and service and operation efficiency, by

eliminating non-value-added or low-value-added activities. Non value-added or low

value-added activities are those activities that bear no or little impact to customers in

their absence. Hence, understanding the expectation of targeted customers will

result more accurate product and service costing. Non-value-added and low-value-

added activities and costs are the cost behaviour that captured the interest of the

managers.

To the public sector, ABC is an option to improve the ineffectiveness of traditional

system and also to build up their accountability level as the generated information

can help the organization to explain, justify and take responsibility for every action

taken (Messner, 2009).

2.5 Limitations of ABC

Activity-based costing is a system to solve the limitation of traditional costing system

but did not represent to be the perfect one. Besides its advantages, lot of time, effort

and cost on collecting, checking and entered the data into the system are also

associated with Activity-Based Costing (Druker, 1999). Difficulty in collecting

accurate data due to cross department activities is among limitations in ABC and

since managers are familiar with traditional costing system before, the managers

face resistance in handling too many details that involved in ABC.

In practice, most managers insist on fully allocating all costs to products, customers

and other costing objects in ABC resulted to overstated costs and understated

margins together with mistakes in critical decision. Therefore, relevant ABC cost data

must be identified before being used in in making significant decision. On the other

hand, incomplete data will affect the analysis result and lead to bad and

unacceptable decision making.

6

Reports generated by ABC systems do not conform to generally accepted

accounting principles. Consequently, organizations that use ABC need to have two

costing systems for internal use and preparing external reports which incurred more

cost to the organization. It may also cause confusion on which system to be believed

and relied on. The technical complexity and higher cost in implementing and

maintaining ABC system could be some of the reason businesses had no intention of

adopting ABC in their organizations.

2.6 Steps in Implementing ABC

ABC was introduced when traditional costing systems were criticized for lack of

relevance, accuracy and timeliness. Under ABC, costs are no longer allocated by

functions instead costs are assigned to the products and services based on the

demand of product and services places on various activities. The ABC

implementation process is broke down into 5 steps involves:

(1) Identifying activities, activity cost pools and activity measures

First major step in implementing ABC system is to identify the activities that will form

the foundation for the system. A common procedure to this is by interviewing people

who work in overhead departments which results a long list of activities. This long list

of activities can be combined into a single activity based on similarity to avoid higher

cost in implementing ABC. Activities should be group together at the appropriate

level such as batch-level, product-level and unit-level. It is best to combine activities

that are highly correlated with each other within the level.

(2) Assigning overhead costs to activity cost pools

Overhead costs are assigned based on the results of a considerable care interviews

with employees who have first-hand knowledge of the activities. Besides that, the

departmental manager are typically interviewed in determining the distribution of

non-personnel cost across the activity cost pools.

(3) Calculate activity rates

7

Activity rates for cost pools are calculated to assign overhead costs to products and

customers.

(4) Assign overhead costs to cost objects

This step is also called second–stage allocation where activity rates are used to

apply overhead costs to products and customers.

(5) Prepare management reports

Most common management reports prepared with ABC data are product and

customer profitability reports. These reports help in channelling resources to most

profitable growth opportunities while highlighting products and customers that drain

profit. Product and customer margin is easily computed using ABC system.

Figure 1: Steps in Implementing ABC

3 SCENARIO: ABC IMPLEMENTATION IN TM

3.1 Company Background

Telekom Malaysia (TM) is a leading company in telecommunication services in

Malaysia. It was formed in 1986 as a result of privatization efforts of the Malaysian

government. Until now, it has an authorised capital reaching nearly RM 3.6 billion

and issued and paid up capital reaching RM 2.5 billion. TM is a public listed

company, with more than 24,000 employees throughout Malaysia and has won many

awards at the national and international level. Below is the organization chart of TM:

8

TM is driven by stakeholder value creation in a highly competitive environment. It

focuses on delivering an enhanced customer experience via continuous customer

service quality improvements and innovations, whilst focusing on increased

operational efficiency and productivity.

3.2 ABC Implementation in TM

Activity Base Costing (ABC) in TM has started in 1996 and was introduced by the

finance division of TM to be implemented within the company. Although the ABC

system has been implemented since 1996, it has not been implemented 100% by

the company. ABC have been implemented in the company starting with the network

or engineering department, followed by the marketing department and eventually,

the support group department. Currently the ABC system is fully implemented in the

network division while ABC implementation is still in progress in the “international”

area of the same division. However the implementation of ABC in the human

resource department and marketing department are still in progress.

The main factor that encourages TM to implement ABC was competition. TM had to

lower their product cost to make sure they can compete with other innovative and

competitive product in the market. In addition, there was critical issue with the

overtime costs. The costs were high although they having workers that were under-

utilized. In order to understand this issue, TM needed to understand the work

activities/process of its workers. To understand and help them to identify which

9

activity can reduce the operational cost, the finance manager has decided to use in

1996. Besides this, the change in the business structure of TM had triggered the

management to adopt ABC. Before it was implemented, the management has

identified that the current costing system was not reliable and may not have been

appropriate for the new business structure. Lastly, the urge to try a new tool, that is

claimed to be more relevant to dynamic business environment, also motivated the

company to implement ABC.

At the first stage, the management has formed a committee which consist staff from

the costing department, personnel from the network or engineering departments and

other related personnel. The committee was chaired by an experienced manager

who specialized in strategic cost management. A steering committee which was

participated by the top-level management was also established. The responsibility of

the steering committee was to ensure that the working committee was on the right

track. At the same time, TM hired external consultants to give the necessary training

to the employees before implementing the ABC software that will be use by TM such

as Oros ABC and Net Prophet Expert.

As for the second stage, it involved identifying the relevant cost pools. For this, the

working committee has developed a web-based input via the intranet for TM workers

from all over the country to key in their activities. At first, there were 500 cost pools

identified. After further discussions with related personnel, the number was reduced

to 50. To make sure they receive the full commitment of employees to the system

developed, the working committee invited staff from related departments to work

closely with them. Those employees have to sit with the committee for at least two

days in a week to help identify the right activities and cost drivers. The steering

committee provided further support by introducing the concept of “management buy-

in”. This means, the staff will only involve to perform their normal tasks three days a

week while the remaining two days are spent with the working committee. Indirectly,

this procedure helps to reduce staff workload and at the same time avoiding

problems of workers’ resistance to the implementation of ABC.

In the implementation stage, after two months of training for the software that will be

used, TM managed the implementation on its own. The working committee then

10

improvised the system and created its own ABC schedule analysis to meet the daily

operating needs. Finally, TM used ABC for product pricing, product output decisions,

cost management and reduction, cost budgeting, new product design, customer

profitability analysis, performance measurement, cost modelling and process

improvement. ABC is also used for product output decisions. Additionally, ABC is

used as a performance evaluation tool which they will identify the actual costs

derived from ABC and compared it with previous year’s figures, with competitors’

costs (when available), and with the target costs set.

3.3 Problems Faced During Implementation

At the early stage, did not agree with the idea of implementing ABC within TM. They

assume that ABC is the same as other costing techniques that have been used in

TM. The main concern of the top management perhaps is they were afraid that ABC

would be just a corporate trend and would thus lose its popularity eventually. As a

result, they are reluctant to spend the company’s resources on putting ABC into

practice. Additionally, management has an assumption that they had other more

critical problems to solve then introducing a new system. To convince them, the

finance division, headed by the costing manager, conducted a pilot test on one of its

networks. The success of that pilot test activated interest among top management.

The lower level employees were similarly sceptical of the new system, primarily

because they did not know what ABC was all about. However, when the benefits

from ABC implementation started to be fruitful, the system was fully accepted by the

management.

Another problem encountered in adopting ABC, particularly in the

telecommunications industry, is the rapid change in technology. By the time the

working committee finished studying and understanding the process flow and

activities of existing products, there were new products or services being introduced

by TM. As a result, new process flows especially for the new product would then be

irrelevant. This problem is being addressed by the use of appropriate software.

Further, given the experience of identifying the process flows of past products, the

time taken to chart the process flows of new products may be reduced.

11

3.4 Benefits Gained

The benefits derived from ABC implementation were not immediate. It takes four (4)

years for TM to identify the actual benefits that gain by implementing ABC. ABC has

enabled the company to identify non-value added activities and tasks that were done

inefficiently. This helps managers to make more precise decision to solve any

issues. Additionally, the company was able to reduce wastage and rework time.

Another pertinent issue was the high overtime costs paid by TM. With the

implementation of ABC, an activity map or process flow was developed. This

facilitated managers in identifying the high costs for particular activities.

Through the ABC activity map, managers identify that high overtime costs were due

to workers starting work only after 4.00 pm which then helps reduce in product cost.

The marketing division was also able to identify profitable customers from

unprofitable ones. For example, after the ABC analysis, TM discovered that it was

much more efficient and cheaper to provide services to customers living in

apartments as compared to customers living on landed properties. The

implementation of ABC at TM provided benefits for both engineers and the

accountants. The engineers were able to appreciate the costs of the services

rendered while the accountants now understood the network and engineering

process activities of the company.

4 DISCUSSION AND CONCLUSION

Costing systems helps companies determine the cost of a product related to the

revenue it generates. Two common costing systems used in business are traditional

costing and ABC. Traditional costing assigns manufacturing overhead based on the

volume of a cost driver, such as the amount of direct labor hours needed to produce

an item. A cost driver is a factor that causes cost to incur, such as machine hours,

direct labor hours and direct material hours. ABC allocates the costs of

manufacturing a product according to the activities needed to produce the item.

Managers should understand the advantages and disadvantages of both systems to

meet the needs of their business.

12

4.1 Understanding ABC

Activity-based costing provides a more accurate view of product cost, but companies

typically use it as a supplemental costing system. The allocation bases used in ABC

differ from those used in traditional costing. Activity-based costing 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. It can become quite a hassle to identify the actual activity costing since it

is far more complex and makes it more accurate than the traditional costing.

4.2 Advantages and Disadvantages of ABC

Greater costing accuracy is the primary benefit of activity-based costing. Companies

assign cost only to the products that require the activity for production. This method

eliminates allocating irrelevant costs to a product. Other advantages of activity-based

costing include an easy interpretation of cost for internal management, the ability to

enable benchmarking and a greater understanding of overhead costs. Implementing

an activity-based costing system within a company requires substantial resources.

This can prove a disadvantage for companies with limited funds. Another

disadvantage of using activity-based costing is that it is easily misinterpreted by

some users.

ABC provides a way to allocate costs more accurately when overhead costs are not

incurred at the same rate as direct labour dollars. The more activities identified the

more complex the costing system becomes. Computer systems are needed for

complex ABC systems. Some companies limit the number of activities used in the

costing system to keep the system manageable. While this approach may result in

some allocations being arbitrary, using ABC does provide a more accurate estimate

of costs for use in making management decisions.

13

4.3 Conclusion

Whilst ABC is not a perfect science it does offer a sense of financial pragmatism to

the wider management process. The initial premise that activity analysis can

highlight waste (non-value adding) and bureaucracy (secondary or support

activities), activity based techniques have been used for straightforward cost

reduction, process improvement and re-engineering, benchmarking, performance

measurement and a variety of related exercises including activity or priority based

budgeting.

The three generations of activity based costing supplement and complement each

other and one system should not be considered the replacement of either of the

other two. The first generation focuses on product costing, the second generation on

process costing or performance evaluation, and the third generation on value chain

costing to be used in strategic analysis. All three use the same activities database;

differences lie in types of linkage and the extent to which data on activities are to be

gathered.

ABC forces the manager to investigate fixed costs very closely. It therefore helps

management to identify areas of inefficiency as well as recognize costs which we

could have been conceived fixed but, which are in fact, variable or semi-variable to

specific products. As for TM, The implementation of ABC at TM provided benefits as

to appreciate the costs of the services rendered while understood the process

activities of the company.

14

5 REFERECES

Abrahamson, E. (1991). Managerial fads and fashions: the diffusion and rejection of

innovations. Academy of Management Review, Vol. 16, pp. 586-612.

Drucker, Peter F. Management Challenges of the 21st Century. New York:Harper

Business, 1999.

Griful, C. (2001). Activity-Based Costing Methodology for Third-Party Logistics

Companies. IAER, Vol. 7, No. 1, pp. 133-146.

Kalicanin, D., & Knezevic, V. (2013). Activity-based costing as an information basis

for an efficient strategic management process. Economic annals, 58(197), 95–119.

Liu, L. Y. J., & Pan, F. (2007). The implementation of Activity-Based Costing in

China: An innovation action research approach. The British Accounting Review,

39(3), 249–264.

Majid, J. A., & Sulaiman, M. (2008). Implementation of activity based costing in

Malaysia: A case study of two companies. Asian Review of Accounting, 16(1), 39–

55.

Malmi, T. (1999). Activity-based costing diffusion across organizations: an

exploratory empirical analysis of Finnish firms. Accounting Organizations and

Society, Vol. 8, pp. 649-72.

Messner, M. 2009. The limits of accountability. Accounting, Organizations and

Society, Vol. 918-938.

Soin, K., Seal, W. and Cullen, J. (2002). ABC and organizational change: an

institutional perspective. Management Accounting Research, Vol. 13, pp. 249-71.

Swenson, D. (1995). The benefits of activity-based cost management to the

manufacturing industry. Journal of Management Accounting Research, Vol. 7, Fall,

pp. 167-80.

15

16