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JOFAR: A journal of the Department of Accounting, Nasarawa State University, Keffi, Nasarawa State Nigeria. Pg 3649.
THE PRACTICABILITY OF ACTIVITY BASED COSTING SYSTEM IN HOSPITALITY INDUSTRY
Abdul ADAMU Department of Business Administration Nasarawa State University, Keffi Nasarawa State, Nigeria. and Abdullahi Ismaila OLOTU Department of Accounting Nasarawa State University, Keffi Nasarawa State, Nigeria.
Abstract In this era of intense competition on price and quality, attention is shifting from standardization to customisation of products and services. The traditional costing method has become obsolete because various costs especially overheads are incorrectly allocated to products or services. Thus, the objective of this paper is to examine the applicability of ABC in hotel industry in Nigeria using the hotels in Keffi as case study. Questionnaires were administered to Managers and Accountants of the hotels, simple percentages was used in analysing their responses and it was found that most of the hotels in the study area do not apply ABC system in their costing. It is recommended among others that hotel operators should be educated on the need to have in place an efficient costing system to be in tune with current practices around the globe.
Keywords; Absorption, allocation, and traditional costing system.
Electronic copy available at: http://ssrn.com/abstract=1397255
Introduction The goal of any cost system is to provide relevant and timely information to management. This information supports better management of corporate resources in production of products or provision of services, and improves competitiveness in terms of costs, quality and profitability. Amidst the changes, which the business world has witnessed during last few decades, traditional cost accounting systems have been found to be faltering. The criticism basically revolves around overhead allocation techniques used in traditional cost systems, thus Activity-Based Costing (ABC) is an alternative to the traditional way of accounting. Dandago and Tijjani (2005) noted that the main difference between the two is that the traditional cost accounting systems operate on the assumption that producing goods and services is what causes cost to occur, while ABC assumption is that activities cause cost and that products or services and customers are the reasons that activities must be performed. ABC methodology assigns an organization's resource costs through activities to the products and services provided to its customers (Wikipedia, 2008). It is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives. The ABC method was designed in the United-States during the 80s (Cooper and Kaplan, 1988). It is a refined cost system which enables classifying more costs as direct, to expend the number of indirect-cost pools and to identify cost drivers (Wegmann, 2008). ABC favours better cost allocation using smaller cost pools called activities. Using cost drivers, the costs of these activities are the basis for assigning costs to other cost objects such as products or services. The objective of this study is to examine the applicability of ABC to hotel industry in Nigeria. The study will provide Activity Based Cost accounting users with a better, more focused perspective on how to translate their current accounting systems into the future based upon the shift to the ABC method. Activity Based Costing (ABC) has demonstrated positive results for the companies that made it through the implementation process (Lowder, 2006). As will be demonstrated, newly developed paradigms in cost accounting methodologies are adding to the complexity as to which system provides the best information for decisionmaking purposes. Within the context of these new cost accounting paradigm shifts, a critical
Electronic copy available at: http://ssrn.com/abstract=1397255
issue is arising for current users of ABC. Some of the questions that will be examined in this study are the cost driver used to arrive at cost of service in hotels, handling of their indirect costs, costing of services to their customers, the basis of billing their customers, and the readiness of hotels to implement the ABC system no matter the challenges.
The Concept of ABC System ABC system is a costing principle that relies on activities that have a cause and effect relationship with cost as a basis for allocating such cost to cost objects which jointly cause the cost (Dabor and Eragbhe, 2005).
ABC provides management with a valuable new tool to assist in determining and allocating product costs more realistically. It also provides the means by which to isolate and account for costs in relation to the activities associated with those costs (Lowder, 2006). It is very critical we understand that ABC is not a quality improvement program like process reengineering, or statistical process control. This distinction is important so that we do not classify ABC as a fad or fashion (Cokins, 2002).
Under ABC, product costs are not strictly isolated to manufacturing costs and are expanded to include non-manufacturing costs such as selling, marketing, distribution, and administrative that can be directly traced to the product through activities (Garrison et al, 2006). ABC charges products for the cost of capacity they actually use and not for idle capacity like the absorption method. In addition, ABC does not allow costs shifting of batchlevel or unit-level costs from products produced in smaller volumes to products produced in larger volumes. These distinctions represented a tremendous improvement over the lumpsum allocation method used under the absorption costing methodology where there exists a strict application of manufacturing costs to product costs. However, the true worth of ABC from a managerial perspective is its ability to assign activity costs to cost objects. This enabling characteristic allows management accountants to reassign activity costs across business processes and identify relationships more accurately in decision-making processes. Identifying and allocating costs based upon an activity rate assist in making many types of decisions spanning across functional areas that involve not only products, but also distribution and customer related decisions (Compton, 1996; Gabram, 1997; Cokins, 2002; Friedl, 2005; Hoshower, 1996 in Lowder (2006).
Another important contribution of ABC is the use of specific naming of activity cost pools and activity rates (Lowder, 2006). Under ABC, these activities and rates more precisely link to the actual work or job currently performed. ABC terminology is very work-centric verses absorption costing which is very transaction-centric (Cokins, 2002). As an example, Lowder (2006) said: An assignment occurs between an activity cost pool called customer orders to the activity measure called the number of customer orders. As can be determined, this terminology is function and action driven which provides for a more accurate accounting of each cost and its relationship to specific activities throughout the organization. Because of this work-centric naming convention, ABC provides better tools for decision-making. The main positive characteristic of ABC is its effective influences on decision-making, which has resulted in a decision making process called activity-based management (ABM).
Evolution of Activity-Based Costing Highlighting the limitations of traditional costing systems in overhead cost allocation in a situation of product diversity and in terms of volume and complexity, Anand, Sahay and Saha (2005) illustrated the need for activity-based costing systems. Consistent with this research, Cooper (1988) in Anand et al (2005) found that the firms facing a high level of competition and having a diverse product mix are more likely to benefit from precise cost information and introduction of activity-based cost systems, with an added caution that the Activity-Based Costing system introduction initiative itself should be cost effective.
Meanwhile, Kaplan (1988) observed that many companies used single cost systems to meet three diverse needs, namely, inventory valuation and financial reporting,
product/service/customer costing and providing operational feedback to frontline employees in the plant. However, he apprehended that, in a complex manufacturing environment with product and process diversities and concern for excellence, the single cost system might not suffice for all the three needs.
Cooper and Kaplan (1997, 1998) argued that operational control and activity-based cost systems are two separate systems as they have different purposes and different requirements for accuracy, timeliness, and aggregation. Any attempt to integrate both should be made with utmost care; otherwise, it would perform neither function well. The operational learning and
control system provides economic feedback about process efficiencies by using actual and highly accurate data on a continual basis in with respect to each responsibility centre. The emphasis is on short-term fixed and variable costs and the cost centres are expenses actually recorded in the financial system. Product, customer, and business-unit profitability are the objectives of the activity-based cost systems. It uses standard cost data based on standard cost driver rates and practical capacity of organisational resources, and updates it periodically for the entire value chain. A well-designed integrated cost management system will help the management of the company to identify opportunities for continuous improvement and point out unused capacity or capacity constraints, if any, and will facilitate the introduction of activity-based budgeting in the organisation. The activity-based budgeting mindset makes all cost variables and attempts to match resource supply with resource demand.
Activity-Based Costing Issues in Implementation The activity-based cost systems, though superior to traditional cost systems, could fail due to poor implementation process (Pattison and Arendt, 1994; Ness and Cucuzza ,1995; Player and Keys 1995). Jayson (1994) found in response to Management Accounting first fax survey that implementing activity-based costing is worth the investment. The most common problem reported was the difficulty in identifying the cost drivers.
Shields (1995), and Shields and Young (1989) found that the firms top-level manager champions the ABC project and cross-functional teams, process orientation and adequate training to employees on the ABC, linkages between activity-based team oriented performance metrics to the compensation plan, and decision-making at shop floor level by people who have process knowledge. A review of ABC of implementation initiative in longterm perspective was also a key success factor for ABC implementation.
ABC linked performance evaluation and compensation plans, the number of applications of ABC in the organisation and time-in-use of application have been noted to be ABC success determinants by Foster and Swanson (1997). Brown et al. (2004) saw an association, between organisational size and initial interest in activity-based costing, significant.
Based on the survey findings of the Cost Management Group of the Institute of Management Accountants in 1996, Krumwiede (1998) in Anand et al (2005) reported the activity-based
costing adoption status and factors affecting its success. He got 178 responses with a 16% response rate. 49% of the respondent firms had adopted the activity-based costing systems. 25% of the non-adopting companies were considering its introduction in their organisation. Only 5% of the respondent firms had rejected it after careful examination. Top management support, information technology sophistication, large size of firms, and integration with the financial system were the factors affecting the usage of activity-based costing. The use of activity-based cost system is found to be positively correlated with firm size. The organisational factors such as top management support, non-accounting ownership and training were found to be vital in the successful implementation of activity-based costing.
Endorsing the role of implementation process, Anderson and Young (1999) in a study of 21 field research sites of two firms examined the relationship between activity-based costing systems, contextual factors, and factors related to the ABC implementation process by using survey and interview process. They found that implementation process has a clear influence on ABCM success and the contextual setting directly influences the process and outcome. The criteria for success of ABC systems is its ability to provide more accurate cost data vis-vis traditional cost systems and the usage of ABC cost data for cost reduction and process improvement.
Various writers have advocated various stages in the implementation of ABC. Hongren et al (2003) as quoted by Dabor and Eragbhe (2005) advocated seven stages which includes; i. ii. iii. iv. v. vi. vii. Identifying the products that are the chosen objects; Identifying costs, direct cost of the product; Selecting the cost allocation basis to use for allocating indirect costs to products; Identifying the indirect costs associated with each cost allocation base; Computing the rate per unit of each cost allocation base used to allocate indirect cost; Computing the indirect cost allocation to the product; and Computing the total cost of the product by adding all direct cost and indirect costs of the product
Applications of Activity-Based Costing The Innes and Mitchell (1995) survey of activity-based costing practices in the 251 UK companies listed in The Times 1000 (1994) found that 19.5% of the respondents had adopted
ABC and 27.1% were considering its adoption. The extent of its adoption in the nonmanufacturing sector had not been found to the significantly different from that found in manufacturing concerns. The ABC users had considered its applications in the areas of cost reduction, product/service pricing, performance measurement improvement, and cost modeling. The inventory valuation use had the lowest adoption rate amongst ABC users. Dugdale and Colwyn (1997) follow-up survey to the Innes and Mitchell (1995) questionnaire of large UK firms adopting activity-based costing has found that only three companies used ABC for stock valuation as against the reporting of 14 companies, when the strong definition of ABC was applied.
Innes et als (2000) in Anand et al (2005) in their 1999 survey of activity-based cost management practices of 177 of the largest companies in the UK had assessed the changes that had occurred in the ABC adoption status over a five-year period. The ABC adoption / under consideration rate had fallen to 17.5% and 20.3% from 21% and 29.5% respectively. The highest adoption rate was in the financial sector. In terms of scale, the median activitybased cost accounting systems design included 40 cost objects, 52 activities, 22 cost pools and 14 cost drivers. The ABC rejection rate had increased from 13.3% to 15.3% during this period. Cost reduction, pricing, performance measurement/improvement and cost modelling continued to be the most commonly used areas for activity-based costing. The top management support to the ABC implementation initiative and, to a lesser extent, with its use to support quality initiative, determined its success.
In a survey of 132 US companies, Foster and Swanson (1997) found that all of them were using activity-based cost management, when they responded. The decision to use ABCM, management use of dollar improvement and the overall net benefits as success measure yielded the highest explanatory power. Groots (1999) survey of the US food and beverages industry found that 18% of the respondents had implemented activity-based costing and 58% were considering its implementation.
Anand et al (2005) making reference to Joshi (2001) in a survey of 60 large and mediumsized manufacturing companies in India found an adoption rate of 20% for activity-based costing, 13% for activity-based management, and 7% for activity-based budgeting. The size in terms of total assets has been found to be a significant factor in the adoption of these
contemporary management accounting techniques. The traditional management accounting techniques have been emphasised more vis--vis contemporary techniques because of higher perceived benefits.
Narasimhan and Thampy (2002) in Anand et al (2005) designed an activity-based costing system for ascertaining service cost for different customers with a case study of two branches of a large Indian private sector bank. The use of activity-based cost information in benchmarking, branch network restructuring, business process outsourcing, and identification of value-added and non-value added activities have been argued.
Activity-Based Costing & Firm Value Bromwich and Bhimani (1989) observed that though activity-based costing corrects the product-cost distortions, no such study has been done to demonstrate that it increases the profitability of the firm. Anand et al (2005) observed that success at cost management could have substantial impact on the firm value. Hubbell (1996) argued in favour of integrating activity-based cost management systems with the measures of shareholder value such as economic value added. The resultant integrated cost management system could provide a better governance mechanism for improving processes, optimising the use of capital and thus create shareholder value.
Gordon and Sylvester (1999) examined the performance of ten ABC user firms vis--vis their matched size and industry-controlled counterparts who have not adopted activity-based costing. Though ABC user firms had abnormal returns on the date of announcement, they were not statistically significantly different from their counterparts. Thus, they questioned the adoption of activity-based costing if it does not lead to the creation of firm value.
Malmi (1999) found that firms superior performance subsequent to activity-based costing adoption revealed that the ABC adoption decision was the rational value enhancing choice and it was not a fad or fashion or forced selection. Shield and McEwen (1996) in Anand et al (2005) reported that 75% of the ABC-users found it to be a financially beneficial decision. The success in ABC implementation is based on top management support, compensation and training.
Ittner et al. (2002) in Anand et al (2005) examined the association between the extensive use of activity-based costing and plant level operational and financial performance indicators such as cycle time, quality, manufacturing cost improvements and return on assets. The quality variable was captured through finished product first pass quality yield in percentage terms, and scraps and reworks cost as a percentage of sales. The survey questionnaire was mailed to 25,361 US firms who subscribed to Industry Week. They received a response from 2789 firms, resulting in a response rate of 11%. They found that 26% of the respondents did use activity-based costing extensively. They found moderate evidence that activity-based costing use is positively associated with manufacturing performance. They demonstrated through path analysis that activity-based costing use has a positive indirect association with manufacturing cost reduction through improvements in quality and cycle time. No significant association with return on assets of activity-based costing use was observed.
Kennedy and Affleck-Graves (2001) examined the link between activity-based costing implementation and the creation of shareholder value using Rappaports (1986) framework and event study methodology. They got responses from 47 ABC users and 187 non-ABC users. They found that choice of management accounting system such as activity-based costing for a sample of UK firms had a significant impact on firm value (27% over three years from the beginning of the year in which activity-based costing was first introduced). The impact of activity-based costing on firm performance may be indirect through the mediating influence of other variables (Shields, 1995).
Anand et al (2005) noted Cagwin and Bouwman (2002) in their survey of 210 internal auditors found that the firms with diverse product portfolio and with a high proportion of overhead cost when they have adopted activity-based costing along with other strategic initiatives such as JIT and TQM, resulted in substantial improvement in their return on investments. The other enabling conditions for the efficacy of the ABC in the organisations are sophisticated information technology systems, absence of excess capacity and competitive environment.
Necessity for Activity-Based Costing During 1980s, many managers became dismissed with their cost accounting system (Reyhanoglu, 2007). First reason is that disadvantages with the method allocates fixed
overhead, including labour, are often arbitrary, not necessarily related and directly associated to production (Polimeni et al, 1991). Using single pools of indirect costs and overhead application bases such as direct labour hours are no longer considered good enough. In the current manufacturing environment, resources are often unrelated to direct labour. Such misallocations can lead to management effort to place the wrong products.
If companies want to maximise their profits they have two options. One option is cutting costs. Companies focusing on cutting costs are only asking for trouble. For example, a US based company Thornton Equipment Company needed to lower its overhead cost structure, but they had trouble because of the need of overhead costs (Blaxil and Hout 1991) in Reyhanoglu (2007). Cutting cost is not a solution. Another solution is to correct their product prices and this will leads to management toward the ABC.
Another factor in the move toward ABC is related to the information requirements. Cost Accounting systems exist to provide information to help executives in performing their cost management duties. If managers improve and redesign manufacturing processes, they want their accounting systems to be tailored to the new processes. If the activities are managed well, costs will fall and the resulting products will be more competitive. Companies felt that its existing system was oriented too much towards financial accounting and provided little information in determining product costs, making product mix decisions, and evaluating plant performance (Polimeni, 1991). Developments in information gathering technology made practical the gathering and processing of more detailed information demanded by ABC (Hilton 1994). With these reasons by companies moving to ABC, costs can be better managed and products more accurately costed.
Some indicators can signal the need for a new costing system (Hilton 1994 in Reyhanoglu, 2008). They include: i. ii. iii. iv. v. vi. Managers do not trust the product cost reported; Marketing personnel are unhappy with reported product costs; Some products are reported profitable, although they are priced with market price; Sales are increasing while profits are declining; Some products that have reported high profit margins are not sold by competitors; Overhead cost rates are very high, and increasing;
vii. viii. ix.
Product lines have variety; Company has a small percentage of direct labour; and Some companies products are priced very low by competitors.
The benefits of ABC cannot be overemphasised and these include among others greater accuracy in product costing, greater involvement of production managers, improved management information and improved profitability.
ABC provides insight for analysing customer profitability, distribution channels, brands, region, and other areas that directly affect the profitability of a firm. ABC system generally improves the ability of an analyst to estimate the cash flow (Hilton 1994) in Reyhanoglu (2005). By separating costs into activity pools and identifying a cost driver into each pool, the analyst can more accurately define the levels of various costs that will be incurred.
Research Methodology This section is concerned with the population of the research, sampling technique, method of data collection and the method used in the analysis of the result. Survey design is used to collect data in this study. The population for the study covered five hotels located in Keffi town. Keffi is a local government headquarter of Keffi Local Government Area of Nasarawa State which is located about 50km along Abuja-Akwanga expressway. The researchers used all the hotels for the study. In this study, the researchers used questionnaires and semi-structured personal interview as instruments to collect primary data. In addition secondary sources such as textbooks, journals were consulted especially for literature review. The questionnaire was administered and the interview was conducted with the Accountants and Managers of the Hotels. Simple percentage was used to analyse the data obtained. Results and Discussion Ten questionnaires were administered on Managers and Accountants of the hotels located within Keffi, Nasarawa State Nigeria and all the questionnaire were returned.
Table 1:
Awareness of Activity-Based Costing Respondents 6 4 10 Percentage 67 33 100
Responses Yes No Total Source: Field data (2009)
Table 1 depicts that 67% of the respondents are aware of ABC while 33% are not aware of ABC. Table 2: Method of costing in application Respondents 0 6 4 10 Percentage 67 33 100
Responses Activity Based Costing Traditional Costing Others Total Source: Field data (2009)
From the table 2, none of the hotel uses Activity Based Costing 67% assert that they use absorption costing in arriving at the cost of their services. This means that the use of traditional costing method is common with the hotel. Personal interview revealed that they are objective in costing their services because they put into consideration all direct and overhead cost in arriving at the price of their services and also used knowledge of costing. From this, it can be seen that the hotel to some extent are objective in their billing system because they dont look at the status of their customers in their charges but the quality of their service.
Table 3:
Treatment of indirect cost Respondent 10 10 percentage 100 100
Responses Absorption Apportionment to units Total Source: Field data (2009)
Table 3 shows that 100% of the respondents agrees that they are using traditional costing system of absorption costing. Indirect costs are absorbed into the cost of their service. There is no apportionment to various units in the hotel. This confirmed that Activity-Based Costing is not applied in the hotel and their knowledge of its application was not also developed. Table 4: Satisfaction with current level of profit Responses Yes No Indifferent Total Source: Field data (2009) From the above table 4, 80% of the respondents accepted that most time, targeted profits were met and their profit is normally adequate, and 20% were indifferent about their profit. This is so because of their proximity to the FCT and the quality of their service which is not too bad. The hotels are well patronized most especially during weekends when people from Abuja do come to Keffi. Respondents 8 0 2 10 percentages 80 20 100
Table 5:
Appropriateness of current level of billing Respondents 10 0 10 Source; Field data (2009) Percentage 100 100
Responses Yes No Total
The response in table 5 was 100%. During the interview, the accountant further explained that bill are charged according to the service provided and by taking into consideration most of the cost elements necessary for the provision of those services. Further clarification was sought on the cost drivers in arriving at the cost of a room for instance. The Manager of one of the hotels clarify that they have a standard room and a double room in the same location but with different prices. That in arriving at the price for the room, the cost driver taking into consideration comprises of the size of the room, the facilities in the room, and the promptness of service in the room. In view of this, it can be deduced that the hotels are satisfied with their billing system as it is convenient and make them meet their targeted profit always. Since they are also satisfied with their current billing system, it may be difficult for them to start thinking of changing to ABC system. Table 6: preference to the installation of ABC system Responses Yes No Indifferent Total Source: Field data (2009) Respondents 5 2 3 10 Percentage 50 20 30 100
50% of the respondent would like to install ABC system in their organization provided it will lead to efficient and effective ways of their billing system while 20% and 30% said no and indifferent respectively. This is because they are contented with their present billing system. They believe that changing to ABC system will involve incurring so much cost. Some of their indirect costs include water bill, electricity bill, and internet services in some of the hotels, room intercom, and attractive frames and artworks in rooms. In arriving at the price of their rooms, most of the costs associated to them are indirect. Table 7: customers response to billing method Responses Yes No Total Source: Field data (2009) In table 7, 40% of their customers contested their bill as they feel the bill was too high for hotels in town like Keffi as they are not in a big city. This is explained by the proximity of Keffi to the FCT. Some reasons given by the management for their charges includes proximity to the FCT, quality of services, state of the art facilities which are only obtainable in big cities and natural garden bar that attracts customers. Respondents 4 6 10 percentage 40 60 100
Conclusion and Recommendations Competition requires that companies continually improve and innovate. New products and service must be developed to replace those that become obsolete. New processes must continually be developed to make production more efficient. But hotels and other companies globally are realising that product and service mix was wrongly priced because of the old fashion traditional accounting systems. With these problems, Activity-Based Costing offer planning and behavioural considerations that help make significant improvement over the traditional approaches. ABC has emerged as
a tremendously useful guide to management action that can translate directly into higher profit. ABC also has problems such as difficulty in implementation, costly, staff resistance, timeless, and difficulty in gathering information and questionable gathered information. Based on the findings of the study, the authors recommend that there should be awareness by way of seminars and workshop for relevant staff of the hotels on the advantage of ABC. Hotel operators should be educated on the need to have in place an efficient costing system to be in tune with current practices around the globe. In addition, efforts should be geared towards identifying reliable costs drivers that would serve as basis for costing services.
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JOFAR: A journal of the Department of Accounting, Nasarawa State University, Keffi, Nasarawa State Nigeria. Pg 3649.

THE PRACTICABILITY OF ACTIVITY BASED COSTING SYSTEM IN HOSPITALITY INDUSTRY

Keywords; Absorption, allocation, and traditional costing system.

Electronic copy available at: http://ssrn.com/abstract=1397255

Electronic copy available at: http://ssrn.com/abstract=1397255

vii. viii. ix.

Awareness of Activity-Based Costing Respondents 6 4 10 Percentage 67 33 100

Responses Yes No Total Source: Field data (2009)

Treatment of indirect cost Respondent 10 10 percentage 100 100

Responses Absorption Apportionment to units Total Source: Field data (2009)

Responses Yes No Total

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