Question

I am working on a research paper in relation to running a Rental Car business and what method of costing would be the best. I am looking for some thoughts, ideas, insights to help jump start me as I have reached a writers block of sorts:

*What are some benefits to Activity Based Costing for a rental company that have numerious resources and activties that go into daily operations?

*What is the downside of using ABC with this type of business?

*On the flip side could this same type of company benefit by using standard costs.

*What might the ramifications of costs, quantity, and variances, and the ramifications of using standard costs in the international business environment

Thank you for any help! :)

Answer 1

Benefits of ABC

Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them.

The main goal of using the activity-based costing method is to increase the profitability and overall performance of an organization. The ABC method does this by identifying accurate overhead costs and cost drivers leading to more streamlined business processes. When all direct and indirect costs are allocated to a product, managers begin to get an idea of which business processes are performing well and which are inefficient. They can then streamline these processes by allocating more resources to profitable activities and eliminating practices that are costly and wasteful. As a result of the ABC process, companies are better able to manage manufacturing performance and improve the quality of products and services. Overall, profitability is increased as a result of more accurate product pricing which can allow companies to offer competitive pricing while maximizing their returns.

Major Benefits:

1. PRODUCT CROSS-SUBSIDIZATION

The products which are victims of over costing automatically allow other product’s under costing and vice versa. ABC costing can help eradicate the problem if the implementation of activity based costing system is appropriate.

2. COMPLICATIONS OF PROCESSES

With the growth and development of business, the complications in the processes of providing services will increase significantly. To deal complications in costing created due to processes, ABC is a blessing in disguise.

3. COST SAVING OPPORTUNITIES

It is easy to find cost saving opportunities in this kind of costing system.

Downside of Using ABC

1. NEED SPECIALIZED KNOWLEDGE

Knowledge of costing, cost accounting, costing terms such as cost drivers, allocation, cause and effect relation, etc is a must. It is not a job of a layman.

2. DEEP UNDERSTANDING OF THE ORGANIZATIONAL PROCESS

The people employing this method of costing require vast experience in this industry or in-depth understanding of the processes.

3. TIME CONSUMING

Since there are a lot of steps and groundwork required to come out with a costing based on this system, it is quite a time to consume.

Standard Costing

Benefits

1. Compiling standard costs more carefully can eliminate the weakness of the traditional costing system.

2. Standard costs can be used as a yardstick against which actual costs can be compared. It is an effective tool for planning production costs. Hence, cost control is greatly facilitated.

3. Variance analysis helps management to have regular as well as better checks over costs incurred. It makes the application of the principle of management by exception more easy. That is, the management can concentrate its attention on variances only, leaving the other aspects of cost control to be taken care of at the lower level.

4. It is a valuable guide to management in the formulation of price policies in advance with certainty. It also assists management in the areas of profit planning, product pricing, and inventory pricing, etc.

5. Standard costing makes the reporting of operating data more meaningful and also fast. This makes the interpretation of management reports easy.

6. As the emphasis of standard costing is more on cost variations, it makes the entire organization cost conscious. It makes the employees (drivers) to recognize the importance of efficient operations so that costs can be reduced by joint efforts.

7. Men, machines can be effectively used, and economies can be effected in addition to increased productivity. Standards may also be used as the basis for introducing incentive schemes. Inefficiency are curtailed, eliminated and reduced in all aspects of service process over a period of time if standard costing is in continuous operation.

8. Management can easily fix up responsibility through variance analysis. Variance analysis can determine the persons responsible for each variance; shifting or evading responsibility is not so easy under this system.

Ramification

In the international business Environment, everything is global whether it is resources or customer. Therefore, cost incurred to business is fluctuation prone. This result in lower cost to some business and higher to other which effect the business.

Standard cost in such an environment forms a rigid structure which is loss prone in this flexible business environment.

A renting of car business certainly face difficulty where the labour cost & Fuel cost are inconsistant.

Limitations of Standard Costing:

1. Setting of standards is a very difficult task. It requires a lot of scientific studies such as time-study, motion- study, fatigue study etc. and therefore it is very costly. Small firms may find it very difficult to operate such system.

2. Standards are very rigid estimates and once set, are not changed for a considerable time. This makes the standards highly unrealistic in certain industries, which face fluctuations in prices of products due to frequent changes in material (fuel) and labour costs. Revision of standards is also not easy; in case of revision, costs would be high.

3. The utility of variance analysis depends much more on the standards set. While a loosely set standard may be ridiculed, the very high standards may create frustration in the minds of workers. At the same time setting of correct standards is also very difficult.

4. Fixation of responsibility to a particular person, process or production becomes very difficult as it may not be possible to identify the controllable and non-controllable factors easily.

5. Normally the system is strongly opposed by managers and others as they see it as a threat to their freedom of action. Standards may sometimes create adverse psychological effects on managers and workers, who are operating the system.