2013

ACTIVITY BASED COSTING: XU JI ELECTRIC CO. LTD

MANAGERIAL ACCOUNTING

Contents
I. III. IV. Introduction: ................................................................................................................. 2 Xu Jis ABC system at initial stage.............................................................................. 3 Xu Ji Relay developed the ABC system and the outcomes ....................................... 5 II. Xu Ji Electric Co. Ltd prior to ABC implementation: ..................................................... 2

a. The ABC development of Xu Ji Relay: ........................................................................ 5 b. The result of new ABC system: .................................................................................. 7 V. Reference: ..................................................................................................................... 8

Member L Th Thu Huyn Chu Ngc Mai Bnh Ngc H Nguyn Huyn Trang

Student ID 1001010457 1001010600 1001030109 1001020154

I.

Introduction:

This report will investigate the implementation of activity-based costing (ABC) at Xu Ji Electric Co. Ltd (Xu Ji), a large Chinese manufacturing company. Xu Ji is a state-owned enterprise (SOE), turned public limited company (PLC). The company started to try ABC implementation in one of its main production divisions in December 2001, when ABC concepts were at a theoretical level in China Two more attempts to extend the use of ABC took place in 2005 and 2008. Chinese management styles rely more on managing people and relationships Chinese management ethos than on technological systems and management tools. The level of office and accounting computerization and IT-enabled business solutions is not as advanced as those in the west. Xu Ji started from a very basic level, building financial accounting systems and office computerization before implementing the ABC system which captured direct costs and variable manufacturing overheads before processing. The main achievements of Xu Jis ten year ABC endeavor are that ABC radically changed the SOE, turned PLCs traditional costing systems and induced standardization in their working practices and processes. ABC also acts as a catalyst to Xu Jis IT developments first accounting and office computerization and later the ERP implementation. One distinctive feature of Xu Jis ABC experience is the top down instigation and enthusiasm of trying out innovative ideas and inducing corporate-wide learning. While such a top-down approach is not so popular in the west, it is fairly common amongst SOEs, particularly in the northern part of China. This approach worked well in Xu Ji, allowing them to move quickly from imitating western ideas to developing their own independently developed Relays ABC system and make informed decisions using sales activity analysis. Due to the limit of information source because this must be internal information, our report could not be so detailed and complete. Therefore, in this report, we will focus on Xu Ji before and after the implementation of ABC.

II.

Xu Ji Electric Co. Ltd prior to ABC implementation:

Prior to the ABC introduction in 2001, Xu Ji operated a traditional Chinese state-enterprise accounting system. A large amount of manual book keeping work was involved. Accounting was driven predominantly by external financial reporting purposes and inaccuracy of product costs became inevitable.

Direct material

Directly charged to Production department 1, 2,3 Product contract 1, 2,3

Direct labour Overheads

Allocated based on standard direct labour rate

At this time, Xu Ji underwent a series of flotation, following Chinas introduction of free market competition. Xu Ji, as a former SOE used to produce products based on a state production quota and was forced to face up the market competition. The inaccuracy of the traditional costing information seriously impeded Xu Jis ability to compete on pricing. The traditional costing system was much based on process costing system and had the following problems: This costing system cannot trace cost to product and client contracts. It cannot also allocate manufacturing overheads on the basis of up-to date direct labour hours to contracts.

III.

Xu Jis ABC system at initial stage

The inaccuracy of the traditional costing information seriously impeded Xu Jis ability to compete on pricing. Xu Ji urgently needed a better costing system so commissioned ABC implementation. The two main tasks for the ABC system were: To trace direct labor costs directly to product and client contracts To allocate manufacturing overheads on the basis of up-to-date direct labor hours to contracts.

The ABC system was successfully implemented in 2003 after some teething problems were solved. Some problems included compatibility of information systems and misinterpretation of ABC concepts by IT programmers.

Warehouse

Payroll

Fixed assets

General ledgers

External data

Resources: raw material, salaries, depreciation, other expenditures and other data Traceable to product lines Not directly traceable to product lines Activity cost pools Use activity cost drivers to allocate

Activity cost pools Use relevant activity drivers to

Contract costs

Figure: The process of Xu Jis ABC system 2002 There have been continuous and rapid organizational structural and management changes since 2003. For example, changes to the management structure led to a merger of panel installation, panel wiring and wire labelling activity cost pool, to become one independent profit center. A fixed value was decided between top and line managers to assign to each panel, however managers claimed they referred to the original ABC cost to set the value. Nevertheless some quantitative cost drivers e.g. number of leads faced threats of being non-recorded or inaccurately recorded. Managers gradually moved to use profit and/or revenue measures to monitor performances. These changes have limited the impact of ABC system and accuracy of ABC information. In 2004, the organization was restructured into independent companies i.e. electricity grid, industrial electric and energy. Internal management structures were subsequently changed, which resulted in abandonment of some activity cost drivers. For example, new management of

product line testing and engineering design activity cost centers switched to other forms of monitoring front-line performance instead of using respective testing labor hours and design hours. Therefore, testing labor hour and design hour information was not updated and perceived to be extra work by front-line data input staff. Department Production Activity cost pools Panel installation Panel wiring Set of terminals General Basic research and development Marketing General administration Cost drivers Number of panels Number of leads Number of panels Forecasted product line revenue Finished contract revenue Number of employees at each product line

Table: Sample of activity cost pools and cost drivers 2002

IV.

Xu Ji Relay developed the ABC system and the outcomes

Xu Ji Relay is one of Xu Jis subsidiaries after the restructure. We only use Xu Ji Relay as an example for ABC implementation of Xu Ji after this restructure.

a. The ABC development of Xu Ji Relay:

Relay operates in a highly competitive and saturated market, so its main aim has been to survive and avoid closure. An urgent need was to get their product costs right, as commented by one of its managers that: Our selling prices were all over the place as we did not know exactly how much it cost us to make one relay, would one type of relay cost more or less, to top it all, we were making losses, large unsold stocks Xu Jis top management decided to invest in office computerization at Relay. The first step was to develop a computerized material cost recording system in order to capture the actual material quantity information and stock movements between warehouse and assembly lines. In addition, standardized procedures for recording and inventory control were put in place and enforced by building into employees personal key performance indicators (KPIs). It took Relay nearly four years between 2005 and 2008 to fully embed these changes.

ABC process at Relay

Facility sustaining costs Raw materials

Use appropriate cost drivers to allocate Assemble lines

Directly traced to
Product costs

Relays activity cost centres and cost drivers Departments Activity cost pools Cost drivers

Facility sustaining costs General Executive office Finance Technical support Chief engineer office Technical support office Production Production Number of assemble line employees Number of assemble line employees Proportion of product revenue of assemble lines Proportion of product revenue of assemble line Proportion of product revenue of assemble line

Warehouse Marketing Marketing After-sales Assemble line costs Assemble lines Direct relay Intermediate relay Transformer Timer relay Wring assemble WGB assemble Transform relay Intermediate transform replay Signal relay Packaging

Proportion of product revenue of assemble line Proportion of product revenue of assemble line Proportion of product revenue of assemble line

Direct labour hours Direct labour hours Direct labour hours Direct labour hours Direct labour hours Direct labour hours Direct labour hours Direct labour hours Direct labour hours Direct labour hours

b. The result of new ABC system:

With ABC systems, Xu Ji Relay can work more effectively and produce a higher profit. Despite of the traditional costing system which was not even able to directly match direct labour costs to products, the ABC implementations in Xu Ji Relay have made significant improvement and allowed the company to have some accurate product cost information. The sales activity analysis was a good attempt, in that the ABC information enabled Xu Ji top management to understand sales activities better and provide them with an effective tool to have more informed control over sales expenses and sales companies. In January 2000, the need for uniformed technology and accounting system increased and Xu Ji has implemented its computerised accounting system advancement the ERP system - in order to match with the needs. This is one of the things which makes Xu Ji Relay accounting system took the advantages of ABC systems in managing and operated more effectively compared to the Xu Ji Corporation. However it is too early to say whether or not the latest ERP advancement will be the catalyst for further ABC enhancement.

On the other hand, Relays ABC implementation is also different from the ABC implementation in Xu Ji Corporation. The Relay production process and techniques involved are rather stable while Xu Ji Corporation faced with many unstable occurences such as the merge and acquistion, the changes in the organisational structures. As an independent subsidiary, Relay has relative autonomy over its value-chain i.e. purchase, production and sales. Relays ABC system is able to account for the entire process. The most benefit Relay has gained from the ABC implementation is that ABC induces standardised procedures and inventory control. In term of internal benefits, ABC implementation also was a unique chances for staff of Xu Ji Relay get study and do research. It has changed accountants perception of accounting. An experienced accountant commented, This [ABC] allows me to use accounting information for internal purposes. Moreover, it offers fresh graduate students the opportunity to pratice in real things in Xu Ji Relay. A junior accountant noted, I learnt ABC theory at my western accounting module at the university. I never thought that we would be implementing this system. Operations managers from engineering backgrounds accepted the new system quicker than the accountants. They fully embraced the initial ABC implementation and adapted ABC concepts to improve their operations. The concept of non-value added activities and process mapping were conveyed and led operations managers to look into ways to identify waste in their processes. For example, reorganisation of assembly line layout to reduce the moving time and consciously incorporation of standardised components at product designs. Finally, top management became more confident of the accuracy of their core direct costs and accepted ABC methodology as an analytical tool for new/re-organised business functions. ABC system definitely changed and improved the operation of Xu Ji Relay. In 2010 Relay achieved a record annual sales increase of 50% higher than 2009 and a net profit margin increase of 13%. Staff members at Relay gained positive experience from the ABC implementation. The Relay accountant commented: I am now very confident at our product costs. In turn our marketing people can compete faster and better in our market places.

V.

Reference:

Dr Lana Yan Jun Liu, Professor Fei Pan, 2011, Activity based costing in China: a case study of Xu Ji Electric Co. Ltd, Research executive summary series. Available at: http://www.cimaglobal.com/Documents/Thought_leadership_docs/6Activity-based-costingChina.pdf