This case analyses the ABC and ABM implementation process at Global Electronics Inc (GEI). GEI has been using a traditional costing system which allocates manufacturing overhead costs based on direct labour hours, which is about 10% of total cost. This costing system resulted in operating losses o $100 million although sales have been $650 million. As a result, it was believed that GEI’s costing system is not accurate. GEI’s new top management team believed that an Activity Based Costing (ABC) system would address this profitability issue as they will have more relevant costs to make accurate decisions. Further, they had an ultimate goal to implement an Activity Based Management system to improve the decision making process overall. The first step on the implementation for ABC has been a success overall, while the ABM ideally failed overall. Questions & Analysis
What preexisting conditions (or warning signs) existed within Global Electronics to warrant considering ABC as a possible solution? When these preexisting conditions exist, why does ABC offer a better solution than traditional cost systems?
There were many preexisting conditions at GEI which warranted the implementation of ABC. The first concern surrounds the overall profitability of the company. Although sales were approximately $650 million, and there was no indication that sales were decreasing, operating losses were at $100 million. The reason why businesses operate is to generate a profit, and if the firm is unable to generate a profit, it is a cause of concern.
On a micro level, managers could not identify which products which products were profitable, how much each product cost or were unable to determine fair prices for products. For example, new lower volume specialty products were underpriced while mature high volume product lines were overpriced. This resulted in the company selling more and more products below cost and less sales on profitable products are they were overpriced.
There was an understanding the costing system was inaccurate, and this resulted in the implementation of Product Unit Cost (PUC) costing system. However, since managers had a choice to use either PUC or the standard costing system, this resulted in managers’ choosing the costing system which leans towards their biases.
Finally, there were many threats in the industry which required GEI to make radical changes or it would have resulted in the ultimate demise of the firm. These included increased global competition, decreasing product life cycles, product proliferation and exploding technological capabilities. Therefore, in order for the GEI to survive and turn a profit, an urgent change needed to be made.
It is always important, especially so when these situations exist, to have an accurate costing system. Particularly in this specific case, ABC would prove much superior to a traditional costing system for many reasons. Primarily, by being able to track exact costs to products, we are better able to determine the cost of a product. This can be for a simple manufacturing process or for a highly specialized product which requires many manufacturing processes and materials. By being better able to understand the cost of a product, we can determine a healthy markup on cost or a margin on selling price for sustainable growth. With the current system, it appears GEI did not truly understand the cost, price and profitability of a product. With this solution, we can ensure we are not over pricing products and as a result reduced sales, or underpricing and losing money on sales.
The goal of a business is to turn profit, and this should be the main purpose of operating. If the organization does not understand the proper cost of products, it will ultimately hurt the bottom line and threaten the survival of the business. Therefore, an activity based costing system is far superior to the traditional system if the...
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