When Dakota Office Supplies was confronted with the problem of reduced profits despite having improved sales the company identified the reason for such a scenario as the weaknesses in the costing system. Therefore the company proposed to introduce ‘Activity Based Costing System’ (ABC) in their organization to improve the costing structure and revise the pricing according to the new costs arrived. It was found that the existing costing system was inadequate since the system could not provide proper costing information even on all the known cost areas including the desktop delivery service and the cost of 10% finance costs the company had to pay a higher level of working capital in the form of accounts receivable. (Kaplan, 2003 p 4) The company found the Activity Based Costing (ABC) system as a better approach to measure performance through identification, description and assigning of the costs and to report on the operations of Dakota Office products. The introduction of ABC system enabled Dakota to identify the areas where the company was incurring excess costs and control them suitably. (Caplan, Melumad & Ziv, 2005) ABC principles are used to focus management’s attention on the total cost to produce a product or service and as a basis for full cost recovery of a production or service process.
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Through the study of the case of Dakota Office Products it is realized that traditional product costing system as employed by Dakota was suitable for companies having one homogenous product with large fixed costs. The system can work well in situations where only a limitation on the data collection techniques and analysis tools is there and where there are below line costs. However this method cannot be found to accommodate the costing needs of an industry like Dakota where there is a highly diversified product mix. Since in Dakota after the implementation of ABC system the costs were allocated to different products by measuring the cost-allocation bases of different activities used by different products which lead to more accurate product costs, the importance of installing a more accurate costing system is realized. Activity Based Costing (ABC) was found to be useful in a meaningful allocation of the cost elements to arrive at a realistic cost base of the product. The necessity of controlling even insignificant cost elements like the negligence of the interest charges is learned as an outcome from the study.
Application of the Knowledge to Construction Industry
The implications of the knowledge gained from the case of Dakota Office Products with respect to the implementation of ABC system to the construction industry can be studied in a construction project perspective. From the construction project perspective the objective is to assign all costs except general administrative costs and direct material costs to different works or job packages under the contract. Usually in the absence of no rational basis for the allocation the general administrative costs are not assigned to the individual jobs. Similarly there is no need to assign the direct material costs also as they are applied to each job individually.
ABC system enables:
- the assignment of overhead costs to each work division, area or individual construction activity,
- cost visibility as to where the costs get accumulated in the various business processes.
This way by engaging ABC costing it is possible to derive accurate costs for each project. This greatly prevents cost distortion. In addition since ABC system is capable of providing detailed activity wise costing information there is the possibility to identify the potential savings by following different procurement routes. In fact this was the major issue with the costing information with Dakota as the company was unable to identify the customer orders which will result in higher earnings to the company.
Another advantage that can be derived by the construction industry by including direct labor under ABC is that the companies can easily identify non-value adding activities like reworks. While the labor costs are allocated on the basis of activity drivers the construction companies can have complete information on labor costs including those incurred on material handling and similar other activities. This may not be possible in the traditional costing systems adopted by the industry. The firms can thus formulate new strategies for different construction activities based on the costs being incurred in each individual activity of construction. This will provide vital and more detailed knowledge on the costing of different projects which so far the firms would not have the chance of assimilating.
Borealis has adopted a new financial and steering system replacing the traditional budget system. The new control tools consist of rolling financial forecasts, balanced score card, activity based costing and investment management which aim at improving the organizational performance at all levels. This case study details the adoption of balanced score card approach in Borealis. One of the key elements implied in introducing the balanced score card approach is to reduce the defects and improving yields in its manufacturing process. In order to improve the quality the company needs to obtain real time data about manufacturing process parameters and to implement advanced process control methods. At the beginning of the year the company specified the objectives, measures, initiatives to achieve the objectives and target performance. The target levels for non-financial measures were based on the competitor benchmarks. They indicated the performance levels needed to meet the customer needs compete effectively and achieve financial goals. Against these targets the actual performance is compared at the end of the year.
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The study of Borealis gave a new perspective to the managerial control in medium and large sized business organizations. While the application of the balanced scorecard approach enabled the company to evolve different metrics for the measurement of the performance of the employees from the financial perspective, Customer perspective, Internal business perspective and Learning and growth perspective, the other techniques of rolling forecasts, ABC system and investment management supplemented the balanced scorecard approach and enabled the company to enhance the profitability from the new strategy. Because cost reduction as compared to the cost of competitors and growth are the key strategy initiatives of Borealis, the financial perspective focuses on how much of operating income and return on capital employed results from reducing costs and selling more units. The company was able to identify and measure the targeted market segments and could evaluate the company’s success in these segments. The study also revealed the use of benchmarking on the basis of the cost analysis of the competitors based on published financial statements, prevailing prices, industry experts and financial analysis. Moreover the use of non-financial metrics to assess the employee capabilities and capabilities in different other functional areas of the company could be appreciated.
Application of the Knowledge
The knowledge gained in the study of Borealis can be applied to the situations in any manufacturing industry including an organization manufacturing and distributing programmable chips to different electronic equipment manufacturers. Here the systems adopted by Borealis can be employed to reduce costs in improving the quality – improving the quality implies the reduction in the number of defective items and improving yield in the manufacturing process. Another area where the companies in this industry can make use of balanced score card and other management control models is the reduction in the costs of order delivery process by undertaking a reengineering in this activity. Reengineering is the fundamental rethinking and redesigning of business processes to achieve improvements in critical measures of performance such as quality, cost, service, speed, and customer satisfaction. This would need the undertaking of an in-depth analysis of all the processes involved from the receiving the raw materials and components till the customer service. For instance there may be inefficiencies in transferring the customer orders through various departments like sales, manufacturing, shipping, billing and accounting which may delay the process of order processing and result in customer dissatisfaction due to delay in order deliveries. Here it may be possible to reengineer the whole process by forming a team comprising of the representatives of the people from all the departments involved. However there is the necessity to establish set performance standards in all the four perspectives of balanced scorecard approach before this process can be undertaken by the company. The reengineering is one of the examples of the metrics of internal business process perspective where the objective is to reduce the delivery time to the customers and the measure is the order delivery time. The initiative shall take the form of reengineering the order delivery process. The target and actual performance may be set in terms of the number of days the order processing time takes. The new strategies that may be adopted by the company for improving the working may take the objectives of revenue growth, customer satisfaction ratings, order delivery time, on-time delivery; percentage of front-line workers empowered to manage processes, and employee satisfaction ratings. However it is important that the balance scorecard is aligned with the company strategies to ensure the success of the management control initiatives.
Caplan, D., Melumad, N. D., & Ziv, A. 2005, ‘Activity-Based Costing and cost interdependencies among products: The denim finishing company’ Issues in Accounting Education, vol. 20 no 1, pp 51.
Kaplan, R., 2003, Dakota office products. Harvard Business School, 9-102-021.