THE IMPACT AND IMPORTANCE OF ACTIVITY BASED COSTING ON FINANCIAL PERFORMANCE OF MANUFACTURING FIRM NGUYEN THANH HOA

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1 THE IMPACT AND IMPORTANCE OF ACTIVITY BASED COSTING ON FINANCIAL PERFORMANCE OF MANUFACTURING FIRM BY NGUYEN THANH HOA Graduation Project Submitted to the Department of Business Studies, HELP University College, in Partial Fulfillment of the Requirements for the Degree of Bachelor of Business (Accounting) Hons JUN

2 DECLARATION OF ORIGINALITY AND WORD COUNT I hereby declare that the graduation project is based on my original work except for quotation and citations which have been duly acknowledged. I also declare that it has not been previously or concurrently submitted for any other course/degree at Help University College or other institutions. The word count is 10,663 words. NGUYEN THANH HOA Date: 2

3 ACKNOWLEDGEMENT This research contains a lot of details and varieties, thus it would be difficult to carry out it on one s own. Receiving encouragement and help from many people I feel indebted to their aids, and wish to express my gratitude to them. First of all, I would like to thank our respected supervisor Dr. Le Van Lien for his immense support throughout my research. I would like to express my indebtedness to Dr. Lien for his continuous guidance and support during my project. Without his support, my project would not be completed. I also reserved on priority of my special acknowledgement to Mr. Tran Huu Huan - Financial Director of Dutch Lady Vietnam Company, who gave me useful ideas for my questionnaires. Thanks also go to many financial managers of Dutch Lady Vietnam, Mr. Nguyen Trung Kien, Mr. Doan Le Minh, who had continuously guided me with all the valuable information for my research. And finally, I am extremely grateful to all the staff of Dutch Lady Company who cooperated with me during the survey. 3

4 THE IMPACT AND IMPORTANCE OF ACTIVITY BASED COSTING ON FINANCIAL PERFORMANCE OF MANUFACTURING FIRM BY NGUYEN THANH HOA Jun 2010 Supervisor: Dr. Le Van Lien Abstract The graduation project represents the results of research on impact and importance of Activity Based Costing (ABC) on financial performance of manufacturing firm. The contribution of this project is to improve the financial performance of manufacturing firm by measuring impact and importance of ABC - a way to measure changes in their productivity of manufacturing firms. The objectives of the project were to demonstrate chances in financial performance when manufacturing firms apply ABC approach. Benefits of applying ABC and factors affecting the successful performance of ABC approach will provide managers with useful information in making better decisions on evaluating the application of ABC. To achieve these above objectives, questionnaires were made and given to the financial staff of Dutch Lady Vietnam (DLV) Company. They were required to complete the questionnaires based on their understanding and perceptions of ABC related to financial performance. As can be seen, ABC has had a positive influence on improvement of financial performance at DLV. Thus by applying ABC, managers of manufacturing firms would be given more accurate information and able to take the right actions that would improve the profitability and the financial performance of a company. 4

5 TABLE OF CONTENTS Page Declaration of Originality and word count ii Acknowledgement iii Abstract iv Table of Contents v List of Figures x List of Abbreviations xi Chapter 1 INTRODUCTION 1.1 Introduction 1.2 The elements of the research Research question Research purpose Research objective 1.3 Significant of research 1.4 Structure of research Chapter 2 LITERATURE REVIEW 2.1 Overview 6 5

6 2.2 Conceptualization of financial performance General look at ABC What is Activity Based Costing? Fundamental of ABC Why is ABC needed? Implementation of ABC Cost classification in ABC ABC in application management cost Procedure of ABC cost allocation Comparison with Traditional cost accounting Benefits of ABC Limitation of ABC Case study from the Literature Description of DLV Application of ABC in DLV Cost management in DLV Cost allocation in DLV ABC with financial performance 25 6

7 2.7 Initiative business strategies Hypothesis 26 Chapter 3 METHODOLOGY 3.1 Overview Research methodology Approach Population and sampling procedures Data collection Questionnaire design Reliability Data analysis method 35 Chapter 4 RESULTS OF THE RESEARCH AND ANALYSIS 4.1 Overview Discussion of statistic analysis Respondents Data analysis method Reliability and validity Bias 37 7

8 4.3 Hypothesis analysis Does the use of ABC impact financial performance? General discussion Figures Discussion of results Importance factors impact of ABC and Financial performance General discussion Figures Discussion of results Cost Information technology Business unit complexity Intra company transaction Competition Does the benefits of using ABC lead to improve financial 47 performance? General discussion Figures Discussion of the results

9 Chapter 5 CONCLUSION 5.1 Conclusion Limitations Recommendations 52 BIBLIOGRAPHY 54 APPENDICES 59 9

10 LIST OF FIGURES Figure Title Page Chapter 2 Figures 2.1 Figures 2.2 Figures 2.3 Activity Based Costing model Application of ABC in DLV Diagram of cost management in DLV Chapter 4 Figure 4.1 Figure 4.2 Figure 4.3 Figure 4.4 Figure 4.5 Figure 4.6 The perception of respondents about Activity Based Costing system Component bar charts showing the response of yes and no for in questionnaire A The opinion of respondents about factors that affect of Activity Based Costing system on Financial Performance Component bar charts showing the response of yes and no for in questionnaire B The reaction of respondent about benefits of firm when applying Activity Based Costing method Component bar charts showing the response of yes and no for in questionnaire C

11 LIST OF ABBREVIATIONS Abbreviation ABC DLV IT JIT TCA TQM Full Name Activity Based Costing Dutch Lady Vietnam Information Technology Just - in - time Traditional Cost Accounting Total Quality Management 11

12 Chapter 1 INTRODUCTION 1.1 Introduction In the 1990s business strategy played an essential part in financial operation. With the expansion of productivity, and the complexity of business management, efficient financial performance has become a very common term. Researches have shown that cost accounting has been one of the most vital parts of managerial accounting. It is used to control a company s cost and provide management with accurate information on financial operation and performance. At that time Traditional Costing system trace overhead costs to the product based on the assumption that product cause costs. It takes a total cost and assigns it to each part of the process. It is the fact, it relies on an essentially illogical allocation of indirect costs, and thus systems do not give managers accurate product cost information, which leads to inaccurate calculation of product profitability. Therefore Traditional Cost Accounting (TCA) has not reflected the realities of financial performance of manufacturing firm and can mislead and increase production costs and have major negative effects on a company s profits. Introduced by Robin Cooper and Robert S. Kaplan (1991) Activity Based Costing (ABC) was described as a potential approach to solve traditional costing problems. It soon claimed its major advantages and overcame limitations of TCA despite of a rising number of questions 12

13 concerned with adoption and implementation ABC. However Ittner ET all (2002) stated that ABC would only have indirect effect on financial efficiency. Since then various studies have been conducted on the real benefits and the actual influences of ABC on performance of accounting system and production of a company in order to see whether or not applying ABC was the right solution. This project will illustrate the impact and importance of ABC on financial performance of manufacturing firms. In addition, it will focus on the empirical testing of the impact of ABC in Dutch Lady Vietnam (DLV) and the effect of ABC to financial performance. DLV Company is a subsidiary of Friesland Foods a firm operating based on profits. All business activities in DLV are aimed to increase additional values to investors. Its business activities are supposed to gain a profit that can cover its capital cost. This project is based on certain perceptions and experiences on implementing this method in this firm in order to verify these following hypotheses. 1.2 The elements of the research Research question Can the application of ABC on manufacturing firm lead to impact on financial performance? 13

14 1.2.2 Research purpose The purpose of this research is to provide managers with relevant information, for them to be able to make better decisions regarding the usage of ABC on their firms Research objective The objective of this project is to demonstrate hypotheses arising from the use of ABC and how it would play a very significant part in financial performances and the relationships between them. Various researches about ABC have been conducted but none of these studies indicated identical view toward the use ABC. It is shown that financial performance of a firm applying ABC could be different from those who use TCA. Certain factors affecting ABC were also analyzed. Therefore, hypotheses were conducted to study ABC s impact and in order to understand ABC and its role in financial performance. Hypotheses on ABC will be also analyzed by studying manufacturing firms which have been applying ABC for several years. Quantitative research was used to obtain information which focuses on numerical data, financial reports; survey was given to auditors and financial executives of a company to gather information on ABC and its relation to financial performance. This was carried out by discussing the research questions, questionnaire design, the data collection, population and sampling, variables, data analysis and reliability. 14

15 After the statistical analysis was conducted, based on the data gathered, results will reveal the positive effect of ABC and will demonstrate the strong connection between ABC and efficient financial performance. 1.3 Significance of research This project will verify the benefits of ABC which provides accurate information and precise costs and updates daily for financial managers in decision-making, production controls and business operations. Moreover, this project also contributes to other previous researches by studying the impact of using ABC not in general manner but in depth of how ABC influences a firm s accounting process. Being aware of applying ABC successfully, managers can improve their business operations, thereby improving the quality and management activities, increasing competitiveness and economic power in open market economy; and as a result this may also have a great effect on the success of a company. In addition, this project will demonstrate the current limitations of ABC which may enable future researches to make improvements to this model. 1.4 Structure of research The project is organized as follow: Chapter 1 introduces the problem of research. It identifies the research question, the purpose, the objective and the significance of the project; a structure of the project is also included in this chapter. 15

16 Chapter 2 gives a review of the relevant literature. Specifically it gives information about the principles of ABC and the financial performance. Chapter 2 also includes the application of ABC in DLV; and covers the three hypotheses which indicate the impact and importance of ABC on financial performance. Chapter 3 presents the research methods, techniques as well as data collections. This chapter creates the perception of the staff regarding to the use of ABC in DLV. Chapter 4 presents the three results of the hypotheses which were discussed in chapter 2. All of the cases are based on the company s staffs. The first hypothesis shows the impact of ABC on financial performance; the second hypothesis demonstrates some factors affect of using ABC on financial performance of the company. Finally, the third hypothesis illustrates that using ABC leads to the improvement of financial performance. Chapter 5 includes the conclusions derived from this research and the contribution of this research to existing body of knowledge. It also discusses about limitations of current ABC model and future research opportunities. 16

17 CHAPTER 2 LITERATURE REVIEW 2.1 Overview This chapter consists of main sections such as general aspects of the impact and importance of ABC method on Financial Performance of manufacturing firm; the applying of ABC in DLV Company and the hypotheses. 2.2 Conceptualization of financial performance Financial performance is the measuring of the results of a firm s policies and operations in monetary terms. In the manufacturing firms, financial performance refers to the rate of return for a financial portfolio. The portfolio includes the financial instrument which is used with different level of risk of different rate of return (Cagwin and Bounman, 2002). In current business environment, financial performance has related to the profit of firm. Sales profit and cost was used to evaluate the value of business activities. These values will be measured with current budgets or sales forecast to create business strategy in which to answer the big question : how to maximize sales profit, reduce cost and better financial management. 17

18 2.3 General look at ABC What is Activity Based Costing? Traditionally, the cost of manufacturing a product have categorized as direct material, direct labor and overhead. Traditional cost systems trace overhead costs to the product based on the assumption that products cause costs. (Turney, 1990). On the other hand, ABC focuses on activities in manufacturing the product. ABC is defined by Computer Aided Manufacturing - International (CAM-I) as Activity Based Costing integrates financial and non financial related to activities performed in a firm to produce goods and services. In this instance, costs assigned to products are based on resource consumption of activities to produce goods. As defined in MBA venture line Business Dictionary: Activity Based Costing is a costing system that identifies the various activities performed in a firm and use multiple cost drivers (non volume as well as volume based cost drivers) to assign overhead costs (or indirect costs) to product. ABC recognizes the casual relationships of cost drivers with activities. According to Deepak Mohan & Hemantkumar Patil (2003), Activity Based Costing is a costing model which to measure activity costs, results, resources and cost objects. ABC assigns resources to activities, activities to cost objects according to actual consumption by each and recognizes the 18

19 causal relationship of cost drivers with activities, ABC focuses more on costs and the cause based on process and activities rather than on departments and traditional functions. From the view of Stewart, G.B (1991), Activity Based Costing provides complete data on business activities in financial metric form It can be applied to business according to variable factors thus it is more innovative compared with TCA, ABC has three main objectives: A tool to guide strategic decision making; insights in process of business to allowed resources to be efficiently allocated and minimize costs; an allocation technique in determining internal cost prices and selling prices Therefore, ABC can be defined as a model of aggregated financial and non financial data related to operation activities in a firm to produce goods, by assigning resource consumption in a firm to products and services provided to customers Fundamental of ABC ABC is based on ideas: product design, productivity and distribution require diverse activities to be performed; the performance of the activities demands for the purchase and use resources, these generate costs (Cooper Robin, 1988). ABC includes that: resources lead to costs, activities consume resources and products consume activities (Novin, Adel M, 1992). Thus, a firm s activities are identified, then costs are assigned to those activities or 19

20 activities cost pools based on resources required. After that costs are allocated and traced from activity cost pools to products based on proportional use of each activity. In this theory, ABC is aimed at refining limitation of TCA or Inventory costing method. Activities are works, actions, or specific tasks performed in a firm (Novin, Adel M, 1992). For example, the transportation of raw materials from Warehouse to factory is the activity. Activities selected in establishing ABC system are main operating activities and often performed by a variety of supporting activities. For example, many different activities performed in purchasing such as order preparation, negotiating with suppliers, these activities will be organized within ABC system. Cost drivers are the qualitative measures of consumed resources to produce an activity, used to allocate cost of a consumed resource connected to one or more activities (Novin, Adel M, 1992). Activity drivers are the quantitative measures of the number of activity units performed with a cost pool object, used to allocate activity costs to output (Novin, Adel M, 1992). For example, the number of operating machine hours to produce Dutch Lady sweetened milk at DLV. Cost drivers and activity drivers are the same in nature. Each factor is the basic cause of costs. In general, anything that producer s activities causes activity costs. These factors are related to changes in costs, measuring and determining cost volume. 20

21 The connection between activities and cost objects are implemented by cost driver activity, this is core of improvements in ABC model. Figure 2.1 Activity based costing model Resources Costs Activity Costs Cost Object Why is ABC needed? ABC is a costing system which is applied in many manufacturing firms. Many researchers noticed ABC method and considered ABC as an innovation in cost management accounting. Many ideas stated that ABC method is necessary to trace overhead costs to cost objects and thus properly account for batch and product- level costs (Cooper 1990). Moreover, Robin Cooper, Robert Kaplan and H.Thomas Johnson reported that ABC method is a costing method employed to assign direct costs to the general audience costs (Cooper, 1998a; 1998b; 1990; Cooper and Kaplan, 1998; Johnson 1990). Thus, ABC method is designed to devise the limitations of TCA. ABC also enables managers to make right decisions, corresponding with product structure and competitive strategy of a company. Although ABC system is 21

22 applied widely in manufacturing firms, according to Rotch (1990); according to Tanju and Helmi (1991), Activity Based Costing can be used in all forms of business firm. Many writers recommend using ABC method to support improvement in Work - in - process (Turney 199Ib) and develop designs of product cost efficiently (Cooper and Turney, 1990). 2.4 Implementation of ABC Cost classification in ABC - Activity levels To determine costs of resources to activity, according to Blocher (1991), a business must classify levels of costs, resources and activities. ABC system often uses a four-level system: + Output unit level costs Output unit level costs are costs of activities performed on each individual unit of products and services which are assigned directly to products (Blocher, 1991). For example, production costs to turn raw materials into units of product. These activities must be performed on each unit such as direct labor costs that are related to activities of running automated machinery. 22

23 + Batch Level costs Batch level costs of activities are related to a group of products and services, which help to produce a batch of product rather than each individual unit of products (Blocher, 1991). A good example is production planning for a batch of product or service, when a business purchases a variety of raw materials, purchasing costs account for a considerable proportion in overhead. Purchasing cost involves costs of order planning, raw material receiving, and payment to suppliers. + Product Sustaining Costs Product sustaining costs are costs of activities undertaken to support individual products or services regardless of the number of units or batches in which units are produced and consumed, such as product design, marketing, advertising, research, etc (Blocher, 1991). + Facility Sustaining Costs Facility sustaining costs are costs of activities performed at each facility that can be seen as periodical costs (Blocher, 1991). They are traced to all activities performed at every stage to support the organization as a whole, such as management costs, facility sustaining cost, taxes and asset assurance. Most activities of facility sustaining costs are assigned to all products and cannot be traced to each individual product because they support the business as a whole. 23

24 2.4.2 ABC in application management cost ABC is one of the best ways to improve costing. ABC system improves costs by focusing on individual activities as the basis of cost objects. An activity is an event, task or a job with a goal defined. For example products design, operating machinery, product distribution. ABC calculates individual activities and allocates these costs to the object. Since direct costs can be charged to each product, ABC can focus on indirect costs, improve cost allocation to departments, processes and products Procedure of ABC cost allocation two steps: According to Cooper (1998c), procedure of ABC cost allocation has Step1: All cost originated during a given period are gathered and assigned to each activity based on appropriate cost consumption. Step2: Base on performance of each activity in production and sales to assign activity costs to product s price A comparison between ABC and TCA Similarities Compton, Ted R. (1996) stated that costs in TCA are allocated to products mainly based on direct or indirect cost classification. Raw material costs are considered as those that are assigned directly to products. Direct labor costs are seen as costs directly connected to product and are based on 24

25 number of working hour. Overhead costs are the biggest concern and are assigned to products based on number of working hours and hours of running machines. Activity Based Costing also gathers cost factors into cost pool and uses suitable cost driver to assign costs to product. Differences Cost centre / Activity centre In Traditional Cost Accounting, costs are gathered into cost centres because this centres are established based on function or purposes, it is convenient in collecting costs originated in the centers. In ABC, activities of a company are objects to analyze; costs are computed based on these activities. Then an organization can decide appropriate activities for their business operation. Coskins, G, (1997) said that there are activities in a business which are not connected to product such as: training, sales representatives, cost of these indirect activities are assigned to main activities which are closely related to products. Cost driver In TCA, costs are allocated based on the number of working hours on hours of running machines. However, in many cases this allocation base is not persuasive, not related to the use of resources, which makes costs wrong, unreliable. 25

26 In ABC, Coskins, G, 1997 also reported that many cost allocation bases are identified not only to help a business explain better about variable cost but also improve cost management. Examples of allocation bases are: the number of orders, the number of time operating machines, time of running machines, area uses, etc. Focus on cost The difference between the ABC system and the TCA system is that ABC focuses on all costs not only on costs to produce a good or services (Naughton-Travers Joseph P., 2001). In some organization, costs that are not related to products can sometimes increase much more than production costs; therefore a costing system which focuses mainly on production costs cannot compute accurately the actual costs of the organization. Costs as management costs, advertising costs, financial costs, etc should be assigned properly to products. Cost objects in TCA are tangible products, but in ABC they also include intangible products or services of the business. Other cost objects of business operation in a firm can include customers, channels of distribution, orders or anything which a business wants to change costs. Cost accumulation / Cost management Roztocki, Porter, Thomas and Needy (1998) expressed that TCA system is mainly based on cost accumulation and cost measurement; thus the transactional costing system cannot provide such information as unnecessary 26

27 activities, inefficient advertisements, etc. Therefore one of the main reasons for developing ABC is better cost management. In order to have a proper view of ABC, benefits and limitations of ABC must be considered Benefits of using ABC: Cost Cooper, Robin (1991) reported that ABC system reveals costs for any transactional information; it represents all types of costs to produce that transaction. Thus, even detailed costs are shown clearly and accurately. Cost management in ABC approach is gaining better support in comparison with TCA. Cost driver are allocated based on suitable and detailed procedures, thus this ensures high trust worthiness in cost. ABC focuses on diverse costs which can be obviously seen in over heads. ABC system almost provides a more completed, manageable report on cost structure. The successful implementation of ABC system requires a deep understanding of cost structure of an organization, establishing cost modeling and target costing to perform without an unexpected factor. The most important advantage of ABC system is its attraction to advanced costing system, its unique and logical features of business process. 27

28 Management of activities in a firm When a manufacturing firm applies ABC method, it has to establish system cost drivers and has to be reliable all activities happening in a firm in a given period of production (Cooper Robin 1991). Then a firm needs to determine the cost level for each activity periodically and finally, level of distribution of each activity to each product are decided. With the ability to determine such detailed information, managers can easily classify activities in a firm into pools, pool of high valuable contribution, pool of low contribution and also pool of no valuable contribution for business activity. By understanding the importance of each activity, managers can give out solutions to improve efficiency of business operation in order to reach higher profits, and then improve financial performance. Profitability from customers is considered as a suitable improvement of ABC approach by stating different prospects of profit as profits really come from customers, not from product. Some management processed as quality management, time management, productivity process is implemented more easily by ABC system. Management of business operation can turn from functional management into process management; moreover this reflects better the real function of an organization. Information providing While TCA only provides information on cost levels, ABC method provides information on process and cause of coats (Cooper, Robin and 28

29 Robert S. Kaplan, 1992). When managers are aware of process and cause of costs, they can find proper solutions and cut unnecessary costs; besides, it helps managers to establish criteria to evaluate their staff which contributes to improvement of efficiency Limitations of ABC : ABC system is surely more complicated than Traditional method. In order to provide detailed cost structure, it requires many calculations and analyses to be performed. Plans must be carefully set in detail, management process must be more detailed which will increase input factors (increase cost). Joseph P. Naughton-Travers (2001) stated that when a company decides to implement a more complicated accounting system, it must be taken into consideration if the organization is lack of workforce or management experts, because it may lead to unreliable system due to unreliable information. In summary, gathering costs is vital in proper understanding of the real use of resources in a business to make investment decisions and set a conceivable price. While Traditional costing methods allocate costs based on simple criteria and cannot reflect the relationship, ABC method is based on system of complex criteria to be able to reflect the relationship between cost objects and indirect cost. 29

30 2.5 Case study from the literature Description of DLV DLV operates on a model of a partnership between Friesland Foods- FFs and Binh Duong manufacturing. Friesland Foods is one of the biggest milk groups in the world originated in Netherland and is operating in many different countries. The main objective of DLV is to research and develop dairy development programs in producing nutritional milk products; merchandising marketing and distributing well know dairy products of the company. Accounting in DLV is designed to suit the form and operating features of the company. This is a manufacturing and retail company with the management system based on specialty of each division and management. Accounting in DLV is designed on the model that combines managerial accounting and financial accounting, but there is distinction and specification of responsibilities for work, providing information, as well as the connection between managerial accounting and financial accounting to avoid delays in processing and providing accounting information. Financial accounting records in AIS according to cost objects, in order to conduct plans for detailed analysis and on the other hand to construct financial statements. DLV ensures to follow Vietnamese and international accounting standards. Management accounting is designed to provide quantitative information about financial situation in each division. Management 30

31 accounting enables managers to make decisions to choose the most efficient technique. For example: what to produce, how to produce and how to sell these products. In system of accounts, DLV use a chart accounts at Friesland Foods. Accounts accord to the basic of homogenous overhead costs. In cost accounting, DLV use standard costs in setting overall prices as process costing; and analyzes variability of planned costs. This is the analysis of the based difference between real costs and planned cost to evaluate responsibilities and ensure to provide accurate and proper information in a given period. Moreover, DLV improves the model of department costs in the way that realizes benefits of ABC and lessen the use of TCA. For cost pools, the limit to coverage costs that suits the authority and responsibility of each pool in cost controls. DLV sets up a structure of cost pools suitable for the business technology and operation structure to recognize the results of management. DLV employs a number of cost pools (50 cost pools) to establish flexible budgets, all work in a homogenous process Application of ABC in DLV ABC method was applied on DLV in It is used as a separate system to support managerial decisions in order to gather more accurate information used to make managerial decisions every 6 months in DLV. ABC 31

32 model is established according to cost allocation and based on process to provide information about resources, activities and cost objects. 32

33 Figure 2.2 Application of ABC in DLV Process Resources What causes costs? Human resources Costs Cost factors Activities Achievement Cost factors Cost Objects Why to have costs? Make better decisions From the view of cost allocation, DLV applies a multiple stage approach to get closer to actual costs in the company, in order to emphasize the relationship among activities, as well as between activities and cost objects in a chain of stages. Among factors causing overhead costs in DLV, normal costs of a product, variable production cost, cost adjustment, distributing, merchandising costs and part of advertising and promotional costs can be directed to each product when posting to informative system of accounting. Thus, ABC model focuses on indirect costs (includes: management costs, part of advertising and promotion costs which cannot be assigned directly to each product). ABC improves methods of allocation of direct costs to departments, processes, products and other cost objectives. 33

34 ABC model in DLV focuses on individual activities as basic cost objects. These activities are ranked to cost levels: unit level cost, product level cost, corporate level cost. ABC also can be used to make business decisions based on information on profit and profitability for each product, each sales area, and channel of distribution Cost management in DLV DLV realizes that seeking opportunities to improve profit is necessary but how to identify and realize these opportunities? DLV implementations in the following methods of cost management: Identifying costs: to realize costs of products, its contribution to profit and its profitability. Identifying assessable profit for products: assessable profit as well as assessable realized profit, channels of sales, brands, etc is identified by applying specific allocation techniques in budget planning and operation plans. Cost cutting: plans for activities of each division are aimed at lower costs and higher productivity, possible, realistic and benchmarking. Cost management: to measure real costs, in corporation with assessable costs to provide the basic for analysis of variable cost and identify opportunities to improve profits. 34

35 Figure 2.3 Diagram of cost management in DLV Cost Product Norms Cost Allocation Full Production Cost Actual Cost Variances Net Revenue Level of Products Contribution to Profit Other Information Net Profit Balance Sheet Cash Flow & Cash Flow Statement Working Capital Management Cost allocation in DLV Cost allocation is assignment of indirect costs to cost centres or cost units. The allocation is related to cost identified by a particular cost pool. Cost pools includes: manufacturing, administrative, sales, management, etc. Cost allocation in DLV is on the basic of accuracy, cost- treatment, and planned allocation. Indirect costs which are not directly assigned to product will be allocated as follows: Power cost: number of kwh/machinery ability Electricity costs: number of kwh/ electricity areas Cost of maintenance and repair: number of machine hours, total number of labor Labor costs: number of worker 35

36 Depreciation costs: value of machine Insurances costs: (factories, equipment), value of equipment 2.6 Description of Activity Based Costing with the financial performance Some recent researchers gained success in realizing the connection between the use of Activity Based Costing and Financial Performance in particular business environment. Kenedy and Afleck Grave (2001) was successful in connecting the application of Activity Based Costing and the improvement in financial efficiency for producers. Ittner (2002) Cagwin and Bounman (2002) states that Activity Based Costing has indirect rather than direct influence on improvement of financial efficiency. 2.7 Initiative business strategies Activity Based Costing is one of many initiative businesses strategies including Total Quality Management (TQM), Just-in-time (JIT). Although researchers in recent year have tried to link the use of methods in stimulating business operation to improve financial performance, they have not yet come up with a final conclusion and still have a lot of limitations. Huston and Nanda (1995) showed that the use of JIT can improve Earnings per Share after controlling cost units, revenue and profit. Easton and Jarrel (1995) states there are proofs that TQM is related to real financial performance. However, 36

37 no one in the researches has evidence for the use of these business initiatives; so the result of each study is specified for each particular business initiative. Another reason for the limitations of most researches is their dependence on information resources which are public. Therefore they can be appropriate sampling size for the research; limitations are due to complete trust in respondents. In this project, the study of impact of ABC method will be revealed through hypotheses; these hypotheses will be tested by the survey and analysis. 2.8 Hypothesis The information generated by the use of ABC method enables manufacturing firms to compare benefits that they can achieve. Although ABC has been studied and realized positively by many researchers, there is no ensure that all ABC systems applied to all manufacturing firms can bring the same benefits. This leads to these hypotheses: Hypothesis 1: There is a direct positive impact of applying ABC on financial performance in manufacturing firm. Hypothesis 2: There are some factors affecting the impact and importance of ABC on financial performance. 37

38 o Costs ( positive) o Information technology (IT) (positive) o Business unit complexity (positive) o Intra company transactions (negative) o Competition (positive) Hypothesis 3: The use of ABC gains positive benefits to increase financial performance. Benefits in the use of ABC will be proven by providing the link between ABC and financial performance. In conclusion, ABC is the most effective tool in management accounting with the complexity and diversifies structure; implementation ABC can be extreme significant to the manufacturing firm as explained in this chapter. The benefits that achieved by ABC could be seen clearly. The successful implementation of ABC system requires a deep understanding of cost structure of an organization. Management of business operation can turn from functional management into process management. Information about accounting information system is provided for managers for decision making. 38

39 By learning and understanding ABC theoretical, hypotheses were constructed for verifying actual usage of ABC to demonstrate factors concerning ABC and financial performance. 39

40 Chapter 3 RESEARCH METHODOLOGY 3.1 Overview The purpose of this chapter is to measure the impact of ABC on financial performance. Research approach is defined by the use of research questions, data collection, population, selecting samples, and questionnaire design and data analysis. 3.2 Research methodology The methodology of this research is quantitative research. Quantitative Research employs a set of structured given questionnaires for all participants. Research allows infer statistic from results obtained by reflection of small sample group to the population as a whole to measure and assess casual relations between variables. It is comparatively easy and quick to carry out research, and the results obtained from a good research can be used to make comparisons by the time or between regions. Quantitative research is mainly concerned with numbers and data easily quantified. The most popular quantitative technique is using survey, often based on a large number of cases, where a broad overview of a market is required. Survey can be administered by mail, telephone, face to face, or 40

41 more recently by the Internet or World Wide Web. This project use quantitative research focus on numerical data, financial report and survey with managers and staffs in company. All of this data are easy to summarize and analyze; the comparison between groups, location can be measure for difference; and researching a small group can give a reliable indication of the views of a larger population. 3.3 Approach The Approach of quantitative research in this project is Survey. It is one of the most familiar methods of collecting primary data, which solicits information from people concerning such things as their income, family size, and opinions on various issues. Survey includes Personal interview, and questionnaire design. Personal interview can be seen as one of the best way to survey people by asking prepared questions. A personal interview has the advantage of having a higher expected response rate than other methods of data collection. However, Personal interview s major disadvantage is that they are expensive and time consuming to carry out. Questionnaire design: whether a questionnaire is self administered or completed by an interview, it must be well designed. 41

42 3.4 Population and sampling procedure Any business firm always aims for the highest profits. A firm always makes decision and has strategy for its survival, such as restructuring or changing technical methods for its business activity. ABC is a good method for managerial accounting, it focuses accurately on each cost for product, and it also can devise the inaccurate information provided by TCA. Thus, ABC provides managers with good benefits which lead to considerate improvement in financial performance. According to Shield (1995), the researchers may have limitations and their results may not be accurate because they were based on bias reactions of respondents. One way to reduce these limitations is to seek internal auditors inside the company. Internal auditors are suitable objectives for this study since they have a good knowledge, understanding and qualifications in order to better understand information related to proposed issues of the research. Most of them are able to realize improvement in financial statistics. Knowledge of ABC method also depends on positions and roles of each individual in the company. Staffs in Accounting and Financial departments are able to understand ABC and financial performance better than those from other departments. Therefore the limitations of mistakes will be reduced in the research, because staffs who are specialized in finance and accounting were employed as respondents. The respondents were required to complete the given 42

43 questionnaires. Most of them are staffs in DLV a big manufacturing firm in Vietnam. The survey includes 135 staffs in all, a sample of 90 is chosen randomly. 3.5 Data collection Data are collected by questionnaires with a lot of question related to different aspects of impact and importance of ABC on financial performance. The questionnaires are sent to financial staff and internal auditors of DLV Company. First, the researcher had some personal interview with some of the managers of each department in the company about their business initiatives, especially in using ABC. After that, s were sent to staff and then the researcher sent them the questionnaires. In the beginning only a few reply arrived so the researcher had to contact them directly through phone. After that, the researcher made contact with the managers of these staffs and persuaded them to encourage their staff to get involved in answering the questionnaires. Moreover, the researcher also used phone to contact each individual staff to persuade them to complete questionnaire. But there are some reasons why some of the respondents did not get involved: They were too busy with the end of the year budget and monthly reports. 43

44 They were not allowed to participate in surveys. Information and questionnaires are sensitive to the company. They were busy with other job than answering the questionnaires. feedbacks. Therefore, 135 questionnaires was send to staff, but there were only Questionnaires design Questionnaire are designed and divided in to three aspects which serve the objectives of the researcher: Does the use of ABC affect the financial performance? Importance factors affecting the impact of ABC and financial performance. Do the benefits of using ABC lead to improvement in financial performance? Some questions are designed based on previous researches which enable respondents to easily approach the problem and to analyze them at ease. All question structure is designed as closed questions. This can encourage respondents to have enjoyment and care for answering questions. Each question will raise a factor or a problem related to the use of ABC and 44

45 impact on financial performance; respondents only need to tick the box they find correct: yes or no. There are three questionnaires. Each questionnaire includes three sections: A, B and C; and each section contains from 5 to 8 questions. The concepts of Activity Based Costing and Financial performance are clearly stated in the first part of questionnaires. Section A involves the understanding of respondents about levels of impact of ABC on financial performance. Some factors in the chapter of Literature Review are used in questionnaires. The purpose of section A is to focus on analysis to decide whether using ABC impact on financial performance or not. Section B is aimed to test the knowledge of respondents related to the factors affecting financial performance that DLV got them when applying ABC method. In this section, factors are ranked from 1 to 5. Section C : The purpose of this section is to study whether the respondents realize benefits of applying ABC impact on financial performance; and whether that benefits are numerous or not. This section focuses on the success or failure of using ABC method in DLV. 45

46 3.7 Reliability To ensure the reliability, questionnaires must be carefully examined before handing out; there must be an enclosed letter of the Financial Director. If there is no reply, the researcher has to make contact with the respondents through phone calls in order to carry out the survey. Finally, the researcher use suitable analytic research method after collecting all the data. 3.8 Data analysis method Data collected are analyzed by table and bar chart. The tables include number of answering and this percentage. In conclusion, using quantitative research method, which has well known in researching with numbers and data, is an excellent way of finalizing results and providing or disproving a hypothesis. This project collected data through surveys and gathered information from participants who are either financial executives or internal auditors of DLV. The format of the questions were concerning given hypotheses to learn the opinion and the level of perception of all participants about their knowledge of ABC and the efficacy of it on financial performance. Data was collected and the results will be analyzed in the next chapter. 46

47 Chapter 4: RESEARCH RESULTS AND ANALYSIS 4.1 Overview This chapter includes two aspects: the way of statistic analysis and the results of analysis of questionnaires. The main objective of this chapter is using the analysis of questionnaires in order to test the hypothesis which was stated in chapter Discussion on Statistic Analysis In this chapter, the discussion on statistic analysis is about the respondents, the data analysis method, the reliability and validity, and bias Respondents All 135 questionnaires are sent to financial staffs in DLV in different areas: Managerial Accounting, Financial Accounting and Internal Auditing. They are considered as those whom directly work with ABC system. The 90 questionnaires were returned by specific address. Information of these respondents will be kept and remain private only for this research. 47

48 4.2.2 Data Analysis method Questionnaire surveys often use tables and bar chart to show the percentage of responses. Both positive and negative responses are considered and perform in the chart. The percentage of response can be represented the different aspect of ABC method more explicit Reliability and validity In order to achieve stronger reliability and validity, the researcher used different ways to collect to opinion of respondents. First, the researcher interviewed managers of some main department in DLV Company, in order to have a general overview of their company, their manufacture activities, and their business strategies. The questionnaire is also reviewed by these managers. Then, the researcher used to survey staffs of DLV; as the response rate was very low, the research used telephone call for the sectional head of the financial staff to persuade them encourage their staff answer the questionnaires. To raise the response rate, researcher made some phone call to some specific staffs Bias The result of collecting data according to this way can be non bias. The first rate of replied was very low; the 135 questionnaires were sent, there were only 11 responses, which show the 8.1% of feedback. Then the 48

49 telephone calls were made and questionnaires were ed in six day after the first time. 4.3 Hypothesis analysis : research: The three sections of questionnaires show three objectives of the Does the use of ABC impact to financial performance? Importance factors impact of ABC and financial performance. Do the benefits of using ABC lead to improvement in financial performance? The result of each section is discussed individually with general overview, table, bar chart, detail of the result Does the use of ABC impact financial performance? General discussion Individuals participated in answering questions and showed their opinion based on the application of ABC on their company. In the questionnaires, respondent s choice of yes or no to a question depends on the certain assumption in this question. Respondent only need to tick in the blank of yes or no for each part of answering. 49