ABC System of Costing in Educational Institute

The case study of a service industry (educational institute)

A Report submitted to: Dr. Kanhaiya Singh

Team Members: Akul Sharma(221 1!" Ankit #houdhary (221 2$" Ankit Kapoor (221 2!" Ankit %agrath (221 2&" Ashish Arora (221 '!" (tika Aggar)al (221 !*"

ABC System of Costing in Educational Institute

#ontents
Contents................................................................................................................................. 2 1. INTRODUCTION................................................................................................................3 2. ADVANTAGES OF ABC SYSTEM OVER TRADITIONAL COSTING SYSTEM.................4 3. SCOPE AND OBJECTIVES OF T E STUDY....................................................................! 4. RESEARC MET ODOLOGY..........................................................................................!

". T E CASE ANALYSIS.......................................................................................................# !.IMPLEMENTATION OF NE$ COST STRUCTURE............................................................% !.1 ABC &o'e( )o* St+'ent Se*,-.e De/0*t&ent 0t Re1-st*0*2s O))-.e.................................13 #.RECOMMENDATION AND CONCLUSION.......................................................................13 %.LIMITATIONS OF T E STUDY.........................................................................................1" 4.REFERENCES.................................................................................................................. 1"

ABC System of Costing in Educational Institute

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A countrys economy in large depends on industries particularly service sectors such as insurance company, financial institutions, health service, transportation. As more corporate sectors venturing into service industries create competition, they are required to provide a quality customer service at reasonable cost. A number of service firms have gone into bankruptcy as a result of poor control over escalating overhead cost. Thus, the survival of a firm in service industry is largely depending on the availability of timely and quality information for decision-making and the ability to keep the operation cost at marginal level. Consequently, cost and management accounting concepts and techniques are not only used in manufacturing sectors but also in service sectors to provide cost information for decision-making. A study found that the focus of cost management should be on decisions and the various cost management techniques, systems and measurements that spur and help managers to make iser economic decisions. !f the many available cost management systems, research reveals that a bigger number of companies uses Activity- based costing "A#C$ method in comparison ith the traditional costing system in providing timely and quality cost information. %o ever, the implementation of such system is costly and often the idea of implementing the system is drop as a result of time consumption and lack of e&pertise. 'n some cases, the cost for carrying out the A#C analysis is higher than the returns. (evertheless, there is a gro ing body of literature, hich argues that, compared to the traditional costing systems, Activity- #ased costing "A#C$ offers important advantages to organi)ations.

ABC System of Costing in Educational Institute

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*rior to the introduction of A#C costing system, a number of companies, particularly manufacturing sectors, used a traditional costing system called volume- based costing system, hich is volume-based cost driver such as direct-labour hours, direct labour cost, or machine hours. %ere the costs are at the most classified into t o main parts i.e.+ Product cost hich is a cost assigned to goods that ere either purchased or manufactured for resale. Period cost here administration and selling are recogni)ed as e&penses during the period in hich they are incurred. 'f inventories are manufactured, the product cost is relatively easy to trace to production ,ob but manufacturing overhead is not easily traced to ,obs as these costs often bear no direct relationship ith individual ,obs or units of product. -eatures of Traditional costing method+ The conventional or traditional accounting system allocates the manufacturing overhead to the products either plant ide overhead rate or on t o-stage allocation system. The former allocates cost on a single activity base for the entire factory but the latter assigns manufacturing overhead cost based on departmental activities. At the first stage, the manufacturing cost is collected into cost pools and then attached to products by a method based on unit volume of production such as direct labour hours. Thus, the allocation of manufacturing cost depends on the types of resources that the products consume. The greater the products consume the resource, the higher the overhead attached to the products based on one particular activity base such as direct labour hour, machine hour or direct labour cost. This system allo s for cost distortions, hich ill be greater in business units ith a higher proportion of overhead costs. .hile this approach has the advantage of simplicity, it ill result in systematic miscosting here overheads are not volume driven. /esearchers noted that this system failed to reflect other resource or cost of activities that added value to the production. !ther than that, Copper and 0aplan assert that traditional cost and management accounting systems such as those based on standard costing and absorption costing have measured company performance imperfectly because they have not kept up ith the developments in production technology and consumerism. Therefore, to avoid biased cost reporting, the allocation of overheads to cost objects should not be based on a common volume-related measure, such as direct labour hour but on the groups of activities which generate those overheads. An overhead allocation based on activity centres avoids a common consequence of traditional output-based costing system particularly under cost lo volume products. A 3

ABC System of Costing in Educational Institute

study found that overheads based on activity centres facilitate the targeting of unnecessary, asteful, resource usage and the costly effects of over-comple& ays of running a business process. This technique, hich is popularly kno n as Activity-Based costing (ABC), is a system that focuses attention on the costs of various activities re!uired to produce a product or service". This system is in favour of many organi)ations in order to provide 1true2 cost information for their strategic decision-making. The A#C, first developed by Cooper and 0aplan, is a system that 3. /educes the level of arbitrary cost allocations associated ith 1traditional2 costing systems and results in more accurate product cost. 4. #esides providing more accurate product costing, A#C also improves the basis upon hich strategic decisions, involving resource allocation, product mi&, pricing and marketing, are made. 3. 's more effective in specific environmental conditions "enabling conditions$ such as manufacturing comple&ity, environments ith specialty product costs and diverse "multiple different$ business environments. 5. Can facilitate the identification of ho individual customer influences the cost of supply. 't as found that hen A#C is used in this ay, customer profitability profiles and analysis are possible and market strategy is enhanced by this intelligence. 6. 'n the beginning, A#C cost management system as common in the manufacturing environment here the identification of activities associated ith the products as still less comple& and in some instances the activities ere direct. %o ever, no even the service sectors adopt A#C cost management, ackno ledging the importance of cost information for survival in the increased competition. A number of researches revealed successful applications of A#C in private as ell in public service sectors, such as financial institutions, hotel sectors, health centres, transport companies, and telecommunication. Thus, the service sectors shift the cost management focus from conventional costing system to the A#C system.

ABC System of Costing in Educational Institute

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The ob,ectives of this research are as follo s+ 3. A costing system that identify and eliminate non-value added costs. These are the costs of activities that can be eliminated ith no deterioration of service quality and performances. 4. A costing system that determines the efficiency and effectiveness of all ma,or activities performed in the 7niversity. 3. A costing system that identify and evaluate ne performance of the 7niversity. activities that can improve the future

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The research methodology of this case study is a combination of both descriptive and quantitative analyses as follo s+ 1. Descriptive analyses A study of the 7niversity Annual /eport A study of the 8epartment budgets and general ledger items 2. Quantitative analyses Computation of !verhead rate 9uggestion of (e cost :odel A costing model based on Activity #ased Costing is developed for /egistrar office as an illustration. A hypothetical case has been developed in order to study the benefits of A#C 9ystem over traditional system in an educational 7niversity. The figures used in the case have been picked up from the Annual /eports of a 7niversity in :alaysia and adapted for a 7niversity in 'ndia. The costs have been allocated to resource and activity centres on a hypothetical basis after studying the Annual reports of different universities online. This has been done in order to compute the overhead base on Activity #ase Costing system.

ABC System of Costing in Educational Institute

!. T6/ #AS/ A%A32S(S This is a hypothetical case of a 7niversity hich as established in 'ndia about seven years ago ith a ,oint venture partner ith one of the foreign university. The university recogni)ed ma,or dra backs ith current costing system for not being able to detect and control the escalating operational cost. The present cost management system does not provide accurate cost information in order to facilitate the decision planning particularly in eliminating non added value activities. #ased on analysis, the current costing system does not achieve the ob,ective of directing and controlling operational activities. -or e&ample, in directing, the university requires cost data to be classified according to each departments activity in order to avoid any activities consuming university resources ithout adding any value. As for controlling, the university requires a cost tool to measure the departments performance. Therefore, the university requires a cost management system that not only provides analysis of its products and services but also helps the management ith the strategic planning and control of the organi)ations overall functions. The universitys department operation is managed through budgetary control of responsibility centres, hich is lacking of ;true cost data information. This system requires each department head to forecast numbers in the preset budget. The preset budget only outlines department direct traceable costs such as 9alary < .ages e&penses, *rinting < 9tationary, and Telephone < -a& and -reight < Courier e&penses. !ther indirect costs of university hich are fi&ed in nature, for instance =quipment leasing, 8epreciation e&penses, 7tility e&penses and supplies are not sho n in the budget neither are they absorbed into department budgets. 'n addition, neither direct cost nor indirect cost is disseminated to other sub divisions of the department as per activitiy that drives the cost. This approach gives very little costing information about the departments activities that drive the cost and, therefore, it is not effective ay of cost monitoring. Thus, the disadvantage of the universitys current costing model is that true cost < effectiveness of resources is unkno n, it is difficult to fit mandated activities ithin shrinking budget envelopes and the system is not an appropriate tool as a performance measurement frame ork. As a result, the university requires an alternative costing model that goes beyond the first stage cost allocation to the second stage of cost allocation, hereby the costs are further allocated per activity that drives the cost. The present university costing system only does the first stage allocation and not the second. The suggested costing system based on Activity- #ased Costing "A#C$ is a better form of costing system that meets the demand of the university for continuous improvement and manages business process.

ABC System of Costing in Educational Institute

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Step 1: Analysis of departmental activities The building block of an A#C system is the analysis of activities in order to identify the follo ing: the activities within each department and why, and under what circumstances each activity is done; how often, and for whom, the activity is performed; resources consumed in doing the activity; and, what factors determine or drive the activity or resource. 9imilar to the manufacturing environment, every activity in service organi)ation can be classified into four areas, '$ 7nit Activities, performed on units of products, ''$ #atch Activities, performed on batches of products rather than individual product unit, '''$ *roduct Activities, benefit all units of a product and finally '>$ -acility and !rgani)ational Activities, facilities activities are incurred only to support the ongoing facility operations. -or this case study the analysis of division activities focuses at 9tudent service 8epartment and the activity classification is sho n in Table 3. Table 3 /esource Centre+ 9tudent 9ervice 8epartment Activity Centre Activity 3$ 9tudent Affair 8ivision - *ersonal Counseling - !rientation .eek - 7niversity 9ocial Activity - Career *lacement - ?raduation 4$ 'nternational 9tudent - >isa @ *ermit 8ivision 3$ %ousing 8ivision - !n campus and !ff campus Accommodation 5$ Admission and =nrolment - 7niversity =nrolment 8ivision - 7pdate students academic record 6$ =&aminations 8ivision - Academic /esult - =&amination rules and *rocedures - 'nvigilation 8uties - 7nit =&amination

Activity Classification 7nit

#atch 7nit 7nit #atch 7nit #atch #atch #atch

ABC System of Costing in Educational Institute

Stage 2:Developing cost assignment model for t e university using t e ABC costing system. The model consists of the follo ing elements+ /esources =conomic elements used to perform activities. Activity centre A cluster of related activities /esources 8rivers -actors used to allocate resource or pools of costs to activities Activity Cost *ool Total cost assigned to an activity Cost 8river A factor used to assign cost from an activity enter to other activity cost pools or cost ob,ects Cost =lements The amount paid for a resource and assigned to an activity Cost !b,ect The ultimate goal for performing an activity, and in A#C it represents the final cost assigned to a product or service. Analy)ing and identifying the drivers are important tasks in the A#C costing system. There are t o types of drivers namely 3$ /esource 8river and 4$ Cost or Activity 8river. /esource 8rivers are the links bet een the resources and the activities. As sho n in -igure 4 the resource driver allocates the total budget of registrar office division to each resource centreA hich is the 9tudent 9ervice 8epartment. The resource driver is also used to disseminate the 9tudent 9ervices budget to other sub division of the student service department. The resource driver "allocation base$ is used for the selected general ledger items is sho n in Table 4.

ABC System of Costing in Educational Institute

*.1 A1# model 8or Student Ser9i:e Department at Registrar;s +88i:e

!nce the general ledger item "cost pool$ and its related cost are allocated to the resource centre i.e. 9tudent 9ervice 8epartment, the resource driver ill disseminate each cost element to other activity centres at the 9tudent 9ervice 8epartment such as e&amination division, student affair division, housing division and etc. The allocation of cost to each activity centre depends on activities that are performed. Any activities that are not related to the specific cost elements are eliminated, as those activities do not add values to the ultimate goal of the division. -or e&ample, cost pools such as ?raduation, !rientation and >isa < *ermit e&penses listed in the 9tudent 9ervice 8epartment are eliminated from the Admission and =nrolment activity centre as this division does not perform any activities related to this e&pense "refer to Table 3$. %o ever, this as not the case under the universitys traditional costing system hereby cost pools ere not classified according to the activity performed by each activity centre. The universitys traditional costing system does not eliminate non added value activities and, thus, this method does not give accurate B ;true cost information to the department head to have better control over the costs. Table 4 /esource 8river Amount "/s.$ 435,DDD 44,3DD E,EDD

?eneral Cedger 'tems -reight and Courier ?raduation =&penses !rientation =&penses

Allocation #ase Traced Traced Traced 3

ABC System of Costing in Educational Institute

*rinting < 9tationery Telephone < -a&es Transportation - ?eneral Traveling =&penses >isa@*ermit 9alaries < .ages =*9!C9! *ayroll Ta&es =quipment Ceasing 8epreciation =&penses 7tility =&penses 9upplies !otal 3F,DDD 6,DDD 3,DDD 5,EDD 3,DDD 35F,4DD 53,FDD 3,DDD ED,DDD 3D,DDD 5D,DDD 3D,DDD 6D,DDD "#$%$&& Allocated by estimated (o Calls and -a&es Allocated Allocated Traced Traced Traced Traced 4DG of .ages 3DG of .ages #y -loor 9pace #y -loor 9pace Allocated by estimates

There are a total of five sub-division of activity centre in the student service department, namely 9tudent Affair 8ivision, 'nternational 9tudent 8ivision, %ousing 8ivision, Admission < =nrolment 8ivision, and =&amination 8ivision, as sho n in Table 3. -or the purpose of illustrating A#C allocation of cost pools the Admission and =nrolment division is used as sho n in Table 3 and 5. The final stage of A#C model is calculating the cost pool rate. A pool rate is calculated by allocating the total of sub division cost to the cost ob,ect by using activity "cost$ driver. The cost ob,ect represents a product and service that the organi)ation generates revenue from. As for the university, the cost ob,ect is the student and the activity or cost driver is the number of students. The cost pool rate for Admission and =nrolment 8ivision of 9tudent 9ervice 8epartment in the /egistrars !ffice is sho n in Table 6. Table 3 Assignment of Costs from /egistrars office "8ivision$ to 9tudent 9ervice 8epartments"/esource Centre$ Cost *ool Amount "/s.$ /esource 8river 9tudent 9ervice 8epartment -reight and Courier 435,DDD Traced 3F,DDD ?raduation =&penses 44,3DD Traced 44,3DD !rientation =&penses E,EDD Traced E,EDD *rinting < 9tationery 3F,DDD Allocated by 34,DDD estimated Telephone < -a&es 6,DDD (o Calls and -a&es 3,DDD Transportation - 3,DDD Allocated FDD ?eneral Traveling =&penses 5,EDD Allocated 4,DDD >isa@*ermit 3,DDD Traced 3,DDD 9alaries < .ages 35F,4DD Traced "5DG$ 33H,4FD =*53,FDD Traced "5DG$ 3E,I4D 9!C9! 3,DDD Traced "4DG$ 4DD *ayroll Ta&es ED,DDD 4DG of .ages 4I,F6E =quipment Ceasing 3D,DDD 3DG of .ages 33,H4F 3

ABC System of Costing in Educational Institute

8epreciation =&penses 7tility =&penses 9upplies !otal 5D,DDD 3D,DDD 6D,DDD "#$%$&& #y -loor 9pace #y -loor 9pace Traced 46,DDD 3F,I6D 4D,DDD
'2(%)')

Table 5 Assignment of Costs from 9tudent 9ervice Centre "/esource Centre$ to Admission and =nrolment 8ivision "Activity Centre$ Cost *ool Amount "/s.$ /esource 8river Cost Assignment to A < = 8ivision. -reight and Courier 3F,DDD Traced 34,DDD *rinting < 9tationery 34,DDD Allocated by F,DDD estimated Telephone < -a&es 3,DDD (o Calls and -a&es 4,DDD Transportation - FDD Allocated 4DD ?eneral Traveling =&penses 4,DDD Allocated FDD 9alaries < .ages 33H,4FD Traced "36G$ 4D,FH4 =*3E,I4D Traced "36G$ 4,6DF *ayroll Ta&es 4I,F6E 4DG of .ages 5,3IF =quipment Ceasing 33,H4F 3DG of .ages 4,DFH 8epreciation 46,DDD #y -loor 9pace 3H,6DD =&penses 7tility =&penses 3F,I6D #y -loor 9pace 33,6DD 9upplies 4D,DDD Traced F,DDD !otal 2(#%'') ('%**#

Table 6 Admission and =nrolment 8ivisions cost pool rate Activity Centre Cost *ool @ Cost 8river J Cost *ool /ate KH3,EEI @ 3E5D students J /s. 6I.33 per students. The service cost of Admission and =nrolment division per students is /s.6I.33.

The ultimate purpose of A#C system is to assign every activity cost incurred to product or service. As in the university case the cost is assigned to student as each activity centre incurred cost as a result of service rendered to the students. The A#C cost activity analysis sho s clearly to the department head ho much cost is incurred by the division in performing services for each student and to kno hether this cost is ,ustifiable to provide the service. This system also eliminates non added value activities as discussed above to sho the true cost that the division incurred. -inally this cost can also be used as a performance evaluation tool to evaluate the division performances from one year to another. 3

ABC System of Costing in Educational Institute

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Traditional Costing is simple but ill result in systematic miscosting here overheads are not volume driven. This system fails to reflect other resource or cost of activities that add value to the production. Traditional cost and management accounting systems such as those based on standard costing and absorption costing has measured company performance imperfectly because they have not kept up ith the developments in production technology and consumerism. Therefore, to avoid biased cost reporting, the allocation of overheads to cost ob,ects should not be based on a common volume-related measure, such as direct labour hour but on the groups of activities hich generate those overheads. An overhead allocation based on activity centres avoids a common consequence of traditional output-based costing system particularly under cost lo volume products. A#C system in hich overheads are based on activity centres facilitate the targeting of unnecessary, asteful, resource usage and the costly effects of over-comple& ays of running a business process. This system is in favour of many organi)ations in order to provide 1true2 cost information for their strategic decision-making. A#C system reduces the level of arbitrary cost allocations associated ith 1traditional2 costing systems and result in more accurate product cost. #esides providing more accurate product costing, A#C also improves the basis upon hich strategic decisions, involving resource allocation, product mi&, pricing and marketing, are made. A#C is more effective in specific environmental conditions "enabling conditions$ such as manufacturing comple&ity, environments ith specialty product costs and diverse "multiple different$ business environments. -urthermore, the refined treatment of overhead cost by using A#C system can facilitate the identification of ho individual customer influences the cost of supply . .hen A#C is used in this ay, customer profitability profiles and analysis are possible and market strategy is enhanced by this intelligence. 3

ABC System of Costing in Educational Institute

'n the beginning, A#C cost management system as common in the manufacturing environment here the identification of activities associated ith the products as still less comple& and in some instances the activities ere direct. %o ever, no even the service sectors adopt A#C cost management, ackno ledging the importance of cost information for survival in the increased competition. A number of researches revealed successful applications of A#C in private as ell in public service sectors, such as financial institutions, hotel sectors, health centres, transport companies, and telecommunication. Thus, the service sectors shift the cost management focus from conventional costing system to the A#C system. 8etermining the true cost plays an important role in strategic decision-making. The A#C system provides more accurate cost management and enables the university managers to calculate the ;true cost of a product i.e. cost per students. 't is crucial for effective implementation of the system that the A#C pro,ect team must be released from normal duties and the university must prepare to invest in computer technology. A#C information system is idely available for an effective use of A#C system in the organi)ation. %o ever, Compton "3HHE$ noted that internal control must be placed in order to avoid any unauthori)ed users to make modifications to data in the system. This is especially true if A#C replaces the e&isting cost accounting system that has been traditionally used for supplying information for financial reporting purposes. Therefore, a special monitoring personnel is employed to administer the database. 'n addition to this input, processing and output controls are established in order to control changes and access.

'n a nutshell, the A#C system clearly indicates that it can help the university to understand here the costs are, hat drives them to occur, and hich costs may be lo value - added to the cost ob,ect. The system enables the department heads of the university to analy)e and see things, through the lens of costs and ork activities. This definitely ill replace their decision-making behavior through intuition and assertions to fact -based. Therefore, A#C system helps in - predicting, planning, cost estimation and elimination of non-added value activities, hich are useful for operational strategic decision.

ABC System of Costing in Educational Institute

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Cike all other studies, this report also has certain limitations and the scope to be studied further. The ma,or limitations of the study can be listed as follo s+ 8ue to lack of time and resources, the costs of a :alaysian 7niversity study an 'ndian 7niversity. ere adopted to

The allocation of costs under A#C system as done on a hypothetical basis rather than actual tracing of costs to the various activities.

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Adams, :. "3HHE$. Activity-based costing "A#C$ and the Cife 'nsurance 'ndustry. The 9ervice 'ndustries Lournal, 3E "5$, 633-64E. #aird, 0.:., %arrison, ?.C., < /eeve, /.C. "4DD5$. Adoption of activity management practices+ a note on the e&tent of adoption and the influence on organi)ational and cultural factors. :anagement Accounting /esearch, 36, 343-3HH. #rignall,9. "3HHI$. A contingent rationale for cost system design in service. :anagement Accounting /esearch, F, 346-35E. Cag in, 8. < #ou man, :.L. "4DD4$. The association bet een activity-based costing and improvement in financial performance, :anagement Accounting /esearch, 33, 3- 3H.

ABC System of Costing in Educational Institute

Cotton, ..8.L., Lackman, 9.:. < #ro n, /.A. 4DD3. (ote on a (e Mealand replication of the 'nnes et al. 70 activity B based costing survey. :anagement Accounting /esearch, 35, EI B I4. Cokins,?. "3HHF$. .hy is traditional Accounting -ailing :anagersN AAC= 'nternational Transactions, 33-36. Compton. T./. "3HHE$, 'mplementing activity-based costing. The C*A Lournal, EE "3$, 4D-4I. =strin, T.C., Leffrey, 0. < 8avid, A. "3HH5$. 's A#C suitable for your company, :anagement Accounting, I6 "3D$, 5D B 56. %ilton,/..."4DD6$.:anagerial Accounting BCreating value in a dynamic business environment. (e Oork+ :c?ra -%ill 'r in.