Master of CONSTRUCTION MANAGEMENT
Thesis Proposal for Academic Year 2017/2018
Title of Dissertation: ANALYSIS OF ACTIVITY-BASED COSTING IN CONSTRUCTION INDUSTRY IN OMAN
Name: Majid Abdullah Salim ALSulti
Student ID: GCU: 200620232
CCE: 06232
CCE Supervisor: Abby Balkis Gorayah
GCU Supervisor:
Abstract
This research is based on the problem of distributing indirect overheads to construction projects in order to evaluate the performance of every project. Traditional costing (TC) systems and Activity-Based Costing (ABC) are used to allocate the overheads. The questionnaire will be used for gathering data. The participants to whom the questionnaires will be targeted to are the accounting practitioners, accounting consultants & managers of constructions companies in Oman. This method will be used because it saves cost as it is less expensive and is less time consuming. It gives sufficient time to the participants to reflect & give meticulous answers (Clarke & Mullins, 2001). This method ensures transparency which increases the reliability of the findings of the research.
In addition, a case study will be conducted wherein the comparison will be made between two projects, one using the traditional costing system and the other using the Activity based costing system. This will help us to establish as to which is the most effective and feasible costing system to be practiced in Oman.
Through the literature review the aim was to identify gaps and to establish the requirement for this research. It considers the existing findings by previous researchers. According to the participants who responded to the questionnaires the use of TC systems produces misleading project cost results while ABC produces more accurate results when used in the construction industry. However, contractors in Oman are yet to adopted the ABC system and they continue to use TC systems despite their producing misleading project costs. It is recommended that ABC systems be used in the construction industry since it provides accurate project cost. Contractors need to adopt the ABC system to enhance their decision-making.
Key terms:
Traditional Costing, Activity Based Costing, Construction industry, Project Costs
Introduction
In view of the complexity of the businesses, increasing competition and changes in the industry trade and commerce costing has become very vital for the success of any business.
For any construction industry the need for an accurate costing system is imperative. The construction industry is heavily dependent on bidding, where the lowest bidder wins the contract. (Lehtonen 2001) Any contractor winning or losing the bid is determined by the price quoted by him. The contractor is required to maintain an accurate costing system to ensure that the project is neither under-priced nor overpriced. An effective costing system helps the contractor to reduce the cost and helps to determine the performance of the project.
Most companies in the Sultanate of Oman follow the traditional costing method. Therefore, most of the projects cost more than the approved cost, resulting in change orders with additional costs that are sometimes close to the previous cost. Failure of companies to adequately deal with overhead costs leads to corporate or owner losses. (Siskina, Juodis & Apanaviciene, 2009).
The overheads or costs are broadly classified into 2 categories.
A) The home or office expenses and
B) project related overheads.
The former includes material procurement and administrative overheads. The project related over heads include on site costs which are incurred for the project during construction.( Chao, 2008),these costs include supervision, office utilities and services.
Activity Based Costing is the method of measuring the cost and performance of the activities, products and customers. ABC costing produces more accurate information than traditional cost accounting. Of late, many researchers (Cokins,2002, Oker and Ozapc 2013) have criticized traditional cost accounting as one which provides in accurate information and have promoted ABC as most accurate accounting tool. Through ABC costing, it is even possible to reduce the selling price of a loss making product indicating that the product is very profitable (Bhimani, Horngren, Datar and Rajan, 2012).
In view of the above, due to the increased competition, shortened life cycle of the products it becomes imperative for the companies to adopt an alternative cost accounting system hence ABC costing is the best option.
The study establishes a costing system which provides more accurate results and helps in decision making. For any costing system to be successfully implemented in the construction industry in Oman its implementation should be more beneficial than the cost incurred to implement the same. ( Horngren, Bhimani, Datar and Foster.2002 ).
The study therefore investigates as to which is the costing system which produces most accurate results and suits the construction companies in Oman.
Literature review
The two costing systems, TC and ABC, are explored.. Weetman (2003) and Charaf and Bescos (2013) suggest that the companies are moving away from the traditional costing systems (TC) and are applying the ABC. The application of ABC system is more common in the developed countries compared to the developing countries where ABC incorporation is still very low (Sartorius & Kamala, 2007). The system of ABC is based on the fact that different jobs, products and services consume resources differently hence using a single or multiple resource based overhead allocation to is done in TC in determining the project cost TC therefore produces distorted cost results (Horngren et al., 2002). This product cost misrepresentation causes product cross-subsidisation, according to Horngren et al. (2002). Therefore, the use of the ABC costing system eliminates the cost distortions and product cross-subsidisation which is caused by the inefficient allocation of overheads in TC, even in the construction industry. Product cross-subsidisation means that one miss-priced product causes the miss- pricing of all the other products in the organisation (Bhimani et al., 2012). As a result, a product which consumes high resources is considered as having a relatively low total cost, according to Bhimani et al. (2012).This product cross-subsidisation happens because TC systems uses an inefficient allocation and does not establish links between expenditure and its causes (Mabberley, 1992). Bhihami et al. (2012) observed that a good example of product cross-subsidisation is when costs are uniformly spread among many users without considering their different need for resources. Hence, a company is unable to establish the real costs of its products (that is, projects in the construction industry) and therefore continue with a loss making products (projects) and ignores profitable products (projects) when decisions are based on TC system information. However, Adamu and Olotu (2009) and Wegmann (2011) suggest that even though TC produces distorted results regarding the project costs more companies still use TC than ABC systems. This research evaluates the defects of the ABC system that may have prevented the construction industry in countries like Oman to adopt the ABC system. It also analyses the benefits of using the ABC system in the construction industry.
Methodology
The research methodology includes obtaining data from literature review. In addition, the questionnaire will be used for gathering data. The participants to whom the questionnaires will be targeted to are the accounting practitioners, accounting consultants & managers of constructions companies in Oman. This method will be used because it saves cost as it is less expensive and is less time consuming. It gives sufficient time to the participants to reflect & give meticulous answers (Clarke & Mullins, 2001)
This method ensures transparency which increases the reliability of the findings of the research.
In addition, a case study will be conducted wherein the comparison will be made between two projects, one using the traditional costing system and the other using the Activity based costing system. This will help us to establish as to which is the most effective and feasible costing system to be practiced in Oman.
Summary
Analysis of TC and ABC systems
The problem discussed in this research study arises from the need to allocate costs to the products so that product costs and thereby the selling prices are assertained accurately and effective decisions can be made. The two types of costs are classified as direct and indirect costs. Allocating direct costs to products is not a tough task (Innes & Mitchell, 1998; Weetman, 2003) as specific recognition with the product line are possible through material issue records in the case of direct material costs which is also called overhead costs, present some challenges when an attempt is made to allocate them. Indirect costs are those which is not directly accountable to project or product. TC and ABC systems deal with the direct costs in the same way. However, Traditional Costing systems use an overhead absorption rate or a series of overhead absorption rates to establish indirect overhead cost. (Fang & Ng, 2011; Mhamdia & Ghadhab, 2011).According to Hansen (1985), the main difference between a TC and an ABC system is the number of cost variables that are used. ABC uses comparatively more cost variables in allocating overheads. (Hansen, 1985). Both systems use a two stage costing system, in the first stage it deals with the allocation of overheads to cost units, usually the production and service units in the case of TC and activities in the case of an ABC system (Kostakis, Boskou & Palisidis, 2011). Secondly, the allocated overheads are assigned from production and service centres (TC systems) or activities (ABC).. Innes and Mitchell (1998). In many modern manufacturing organisations, products and services are not uniform in the way they use allocated resources .According to Hansen (1985). In TC systems, the choice of an OAR for a particular cost variable on the co is determined by the cost variables characteristics. The use of TC system provides distorted results Consequently, the ABC system can be used to eliminate these product cost distortions.
The ABC System
Akyol, Tuncel and Bayhan (2005) define ABC as a tool that measures the cost and performance of activities. Similarly, Reeve, Warren and Duchan (2012) define ABC as an accounting methodology that is based on relating the cost of activities to final cost objects, such as products or customers. The use of ABC system helps service oriented companies to have a better understanding of the costs of meeting their customer needs (Krumwiede & Charles, 2014).. Horngren et al. (2002) evaluate that it is a tool that measures the cost of carrying out activities in order to generate the total costs of objects and information for decision-making. In an ABC system, the main cost item is the activities from which costs are assigned to other cost objects such as products, services or customers. (Horngren et al., 2002). It is a methodology that recognises the cost pools or activity centres in companies and assigns costs to cost drivers based on the number of each activity used (Akyol et al.,2005) .Therefore, the important characteristic of an ABC system is the multiple activity-based overhead absorption rates which may make the system more practical and more applicable than a TC system.
Purpose and Objectives
The research analysed and evaluated the TC and ABC systems and proposed the relevant costing system for the construction industry in Oman.
The objectives of the research were :
• Determine whether the use of TC systems in the construction industry produces misleading project cost information.
• Assertain the reasons of cost distortions in project costing.
• Evaluate whether the use of ABC in project costing eliminates the cost distortions in construction projects.
• Determine the extent to which the ABC system has been adopted in the construction industry in Oman
• Establish which costing system is best suited for construction industry in Oman.
Conclusion
TC and ABC are the systems used to allocate overheads to construction projects. Both systems deal with direct costs in the similar way by allocating them directly to products and services. Both the systems use a two stage costing system by allocating costs to activities in the case of an ABC system and to resource centres in the case of the TC systems. . The two systems differ in the second stage of allocating indirect overheads. While ABC believes that activities drive costs, TC systems treat the costs as influenced by volumes. Consequently, ABC systems utilise more significant cost drivers than TC systems in the allocation of overheads to project cost. As a result, the two costing systems produce different project cost. The project cost results produced by a TC system are distorted. This research deals with comparing the two costing systems and outlines the reasons for the development of the ABC system. The research discusses the application of TC and ABC systems in the construction industry. Some common construction theories upon which costing systems should be based or aligned are described. The research shows that the ABC system produces accurate project cost and helps in improved decision making and is better suited for the construction companies in Oman.
References
Bhimani, A, Horngren, C.T. Datar, S.M & Rajan, M.V. (2012) Management and cost accounting. 5thedition. Essex.
Clarke, P.J. & Mullins T. (2001) Activity based costing in the non-manufacturing sector in Ireland. Irish Journal of Management.
Cokins, G.(2002)” Activities Based Costing: Optional or Required?” AACE International transactions Morgan town, W.V: American Association of Cost Engineers.
Akyol, D.E., Tuncel, G. & Bayhan, G.M. (2005).“A comparative analysis of activity based costing and traditional costing”
Chaol. C (2008) Estimation of contractor’s project overhead rate as research on Building cost proceedings of the International Conference on Building Education and Research (BEAR). Website: 70061177/success – failure- activity- based- costing-systems>.
Weetman, P. (2003). Management Accounting: An Introduction. 3rd edition. London: Pearson Education Limited.
Lehtonen T.W. (2001) “Performance measurement in constructions logistics.” International Journal of production economics.
Sartorius K. & Kamala P (2007) “Design and implementation Of Activity Based Costing”. – A survey.
Siskina. A, Juodis. A & Apanaviciene. R (2009) “Evaluation of competitiveness of overhead cost in construction companies”- Journal of Civil Engineering and Management.
Innes, J. & Mitchell, F. (1998). A Practical Guide to Activity Based Costing. London: Kogan Page Ltd.
Mhamdia, A.B.H.S. & Ghadhab, B.B. (2011). “Value management and activity based costing model in the Tunisian restaurant”. International Journal of Contemporary Hospitality Management.