Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

Transcription

1 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd Research executive summary series Volume 7 Issue 13 Dr Lana Yan Jun Liu Newcastle University, UK Professor Fei Pan Shanghai University of Finance and Economics, China

2 Key findings: This ABC model is used to capture direct costs and variable overheads, which were lacking in the SOE s traditional costing systems. The ABC experience has successfully induced standardisation in their working practices and processes. Standardisation was not a common notion in Chinese culture or in place in many Chinese companies. ABC also acts as a catalyst to Xu Ji s IT developments first accounting and office computerisation, and later the ERP implementation. The common top-down management style and organisational culture among SOEs worked well when instigating innovative ideas and inducing corporate-wide learning. Top management s commitment to trying out new management ideas and investing in new technology has been the unique feature in this research organisation.

3 Executive summary This project investigated 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 piloted ABC implementation in one of its main production divisions in December 2001, when ABC concepts were at a theoretical level in China (Liu and Pan, 2007). Two more attempts to extend the use of ABC in one of its subsidiaries and sales functions took place in 2005 and Major events took place during the latter research endeavour, including two major acquisitions first by a pension fund and later by the national grid and recent decision to implement an enterprise resource planning (ERP) system. These events provided a unique opportunity to unveil factors pertinent to organisational decisions towards information system implementation, to extract real-life interactions between personnel at various organisational hierarchies; and to evaluate complex relationships between changes, organisational and individual learning. 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 computerisation 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 computerisation before implementing the ABC system which captured direct costs and variable manufacturing overheads before processing. The main achievements of Xu Ji s ten year ABC endeavour are that ABC radically changed the SOE, turned PLC s traditional costing systems and induced standardisation in their working practices and processes. ABC also acts as a catalyst to Xu Ji s IT developments first accounting and office computerisation and later the ERP implementation. Key issues The key issues underlying the research project are whether an ABC technique can be successfully implemented in a Chinese organisational setting and how ABC information can be used effectively to support Chinese management decision making. Many advanced management accounting techniques originated in developed economies for example, ABC from the US and target costing/kaizen costing from Japan. These techniques have inevitable imprints of the cultures from which they originated. Therefore in order to obtain real benefits from these advanced management accounting techniques, one should take serious account of one s own management ethos and organisational and national culture (Nishimura, 2005). The Chinese economy has been booming for three decades, mainly due to the availability of abundant labour at relatively competitive prices in the manufacturing sector. Chinese companies have been advancing their competitiveness through rapidly developed advanced manufacturing and information systems. By contrast, advancements in management accounting techniques and IT-enabled business solutions have been painfully slow. This research coincided with some major organisational changes, including a cash crisis caused by rapid expansions in , two acquisitions during and an ERP implementation that began in 2010 (see Appendix 1). In addition, Xu Ji has decided to delay further refinement of the ABC system until the completion of the ERP implementation. Nevertheless the project provides a rich account of how ABC systems intertwine with organisational changes; how ABC implementation enhances individual and organisational learning; and how the Chinese management ethos promote and/or impede the ABC adoption. One distinctive feature of Xu Ji s ABC experience is the topdown 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 Relay s ABC system and make informed decisions using sales activity analysis. 1 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

4 Findings Xu Ji s ABC systems ABC system at the first production division 1 Prior to the ABC introduction in 2001, Xu Ji operated a traditional Chinese state-enterprise accounting system (see Figure 1). 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. At this time, Xu Ji underwent a series of flotations (Liu and Pan 2007), following China s 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 Ji s 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 labour costs directly to product and client contracts to allocate manufacturing overheads on the basis of up-todate direct labour 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 (see Figure 2). In 2004, the organisation 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 centres switched to other forms of monitoring front-line performance instead of using respective testing labour hours and design hours (see Table 1). Therefore, testing labour hour and design hour information was not updated and perceived to be extra work by front-line data input staff. There have been continuous and rapid organisational structural and management changes since For example, changes to the management structure led to a merger of panel installation, panel wiring and wire labelling activity cost centres, to become one independent profit centre. 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 Figure 1: Xu Ji s traditional costing system Direct material Directly charged to Direct labour Production department 1, 2, 3 Product contract 1, 2, 3 Overheads Allocated based on standard direct labour rate* *Note: In Xu Ji, direct labour cost instead of being charged directly to products was allocated first to production departments then to finished products. This practice was common in some Chinese manufacturing companies as it was relatively difficulty to track direct labour to individual products without using sophisticated tools such as Manufacturing Resource Planning (MRP) systems or some elaborate recording mechanism within a mass production. 1 In 2001, Xu Ji s main production departments comprised of the first production department (FPD) and second production department (SPD). FPD manufactures Xu Ji s high yield products such as high-voltage electric equipment. SPD manufactures relatively low yield products such as safety and automation systems. 2 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

5 drivers e.g. number of leads faced threats of being nonrecorded 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. ABC system at the Relay subsidiary Xu Ji Relay company manufactures many different relay products and sells internally to other Xu Ji subsidiaries as well as outsiders. The organisational structure is independent to the rest of the group and has full financial autonomy. 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 With the lessons learnt from the ABC implementation, Xu Ji s ABC team, together with Relay accountants and the software company which developed FPD s ABC system embarked on developing its own ABC system at Relay in late The cost structure in Relay comprised 85% direct materials and 15% direct labour, variable and fixed overheads. During the implementation, the team realised the main inaccuracy of Figure 2: The process of Xu Ji s ABC system 2002 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 centres Use activity cost drivers to allocate Activity cost centres Use relevant activity drivers to allocate Contract costs 3 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

6 product costs was not the use of out of date planned material cost information but the lack of standardised working practices and lack of inventory control. Relay still recorded inventory manually. Huge discrepancies between accounting figures and physical stock were treated as monthly manufacturing overheads. Xu Ji s top management decided to invest in office computerisation at Relay. The first step was to develop a computerised material cost recording system in order to capture the actual material quantity information and stock movements between warehouse and assembly lines. In addition, standardised 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. Table 1: Sample of activity cost centres and cost drivers 2002 Department Activity cost centres Cost drivers General Basic research and development Forecasted product line revenue Marketing General administration Finished contract revenue Number of employees at each product line Production Panel installation Number of panels Panel wiring Set of terminals Wire labelling Electric case testing Material management Management Warehouse management Number of leads Number of panels Number of leads Test labour hours Finished contract revenue Finished contract revenue Finished contract revenue Department Activity cost centres Cost drivers Product line Customised research & development Contract forecasted revenue Product line testing Engineering design Marketing research Onsite testing and maintenance Management Test labour hours Design hours Finished contract revenue Finished contract revenue Finished contract revenue 4 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

7 After a trial run in 2009, Relay s ABC system started to produce monthly ABC reports (see Figure 3). The ABC system matched its organisational structure and cost drivers for allocating facility sustaining costs are shown in Table 2. 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. Table 2: Relay s activity cost centres and cost drivers Departments Activity cost centres Cost drivers Facility sustaining costs General Executive office Number of assemble line employees Finance Number of assemble line employees Technical support Chief engineer office Proportion of product revenue of assemble lines Technical support office Proportion of product revenue of assemble line Production Production Proportion of product revenue of assemble line Warehouse Proportion of product revenue of assemble line Marketing Marketing Proportion of product revenue of assemble line After-sales Proportion of product revenue of assemble line Assemble line costs Assemble lines Direct relay Intermediate relay Transformer Timer relay Wring assemble WGB assemble Transform relay Intermediate transform replay Signal relay Packaging 5 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

8 Added the manager, In our Relay markets, timing is very important. We can now give quotes in a click of button. We do not keep large stock now and produce on order. Our material cost recording system gives us actual cost information. This in turn has made our staff more aware of cost savings. For example they now make full use of one piece material before discarding it... Figure 3: ABC process at Relay After-sales Technical support Warehouse Marketing Production planning office Finance office Chief engineers office Executive office Raw materials Facility sustaining costs Use appropriate cost drivers to allocate Assemble lines Packaging Signal Relay assemble Intermediate transform Relay assemble Transform Relay assemble Still Relay assemble WGB assemble Wiring assemble Timer Relay Transformer Intermediate Relay Direct Relay Directly traced to Product costs 6 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

9 ABC analysis at the sales companies The sales companies used to be subsidiaries of Xu Ji Group (XJG) see Figure 4. Prior to the realignment, Xu Ji had no direct control over the ways in which the sales companies. operated as XJG decided on selling prices of products transferred from Xu Ji to the sales companies. Being a traditional production unit, Xu Ji did not have any marketing and sales expertise. The realignment of some sales functions with the three companies brought Xu Ji much needed sales and marketing expertise. However Xu Ji top management still did not have enough know-how to manage the sales operations, sales people or expenses control. For example, Xu Ji s CFO commented that, I wanted to know what the industry norm is in terms of selling expenses over sales revenue it gets more complicated when you need to spend or invest now to build relationships, in order to get future business or contracts. What is the balance? Figure 4: A schematic diagram of Xu Ji s data flow process 2001 Customers Suppliers Tender bids Receive contracts Purchase material Sales companies XJG 1 Production planning division Xu Ji PLC 3 Forward customer s contracts Place production plans based on contracts Place component production plans to assembly divisions Xu Ji co. Ltd The first production department 1 The second production Power switch department Other production departments Yi Wan logistic 2 Place material purchase orders Mechanic Chemical Pressure Heat Internal transfer of assembled components Transfer of finished products to sales companies Notes: 1. The sales companies of XJG is an independent business unit, which deals with all sales orders for the group. The sales companies charges Xu Ji for relevant expenses except the salary costs of its sales staff. 2. Yi Wan Logistic is one of the subsidiaries of the group and the sole authorised purchasing company for the group. The company purchases all raw materials and components which are not manufactured internally. Yi Wan Logistics charges a commission of 0.1% for all purchases. 3. The main functions of the production planning division are to set production plans based on customers specifications and place production orders to both production departments and component assembly divisions. Source: Liu and Pan (2007) 7 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

10 The managing director of Electricity Grid stressed that, Our ABC system is basically to capture direct costs and manufacturing overheads, over which an average of 80% is the cost of raw materials, determined by the markets. We have done work to streamline our processes as well as to control our costs since [the ABC implementation]. We managed to become very lean. Other costs such as management and sales expenses have been creeping up year on year and are outside of the ABC system. So it is now time to take a closer look at these costs and find ways to control them The researchers teamed up with the Xu Ji ABC team and set up a project team, aiming at undertaking a detailed analysis of sales activities at the three sales companies. The original objectives were to establish appropriate activity cost drivers which linked sales expenses to contracts and to incorporate the sales expenses into the existing ABC system. Based on detailed analysis, the sales expenses were analysed into stages based on the nature of sales activities and associated cost drivers were proposed in Table 3. Table 3: Activity analysis of sales and proposed activity cost drivers Sales expenses (activity involved) Activity level Proposed cost drivers Front-stage marketing activities to enter new markets and/or general profile-raising activities Salaries* Travelling costs Marketing materials Mid-stage contracts-related Facility-level Average or other subject measures e.g. geographic sales percentage NB: general expenditures with no apparent or specific contracts Salaries of sales staff Sustaining-level Geographic area first trace to geographic areas then allocated to contracts value in geographic area Travelling costs Corporate entertainment Sustaining-level Sustaining-level Material costs of bid pack Batch-level Traceable to contracts Bid cost Batch-level Traceable to contracts Commissions Batch-level Traceable to contracts but unattainable temporary solution is to use contract value Support costs Facility-level Average or other subject measures Final stage after sales Travelling costs Batch-level Traceable to contracts Salaries Batch-level Traceable to contracts Material costs Unit-level Traceable to contracts/clients * This only includes salaries of sales staff members assisting the marketing activities. It does not include those of chief executives and general managers of sales companies. 8 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

11 However, the project team encountered resistance from the sales companies during the process mapping exercise and activity analysis. This was partly due to the inherited notion that the sales companies were highly regarded by senior management as being the bread-winner. Sales managers and staff members saw this ABC exercise as a threat to their autonomous status, although they became part of the Xu Ji. In addition, non-standardised practices meant that the above proposed traceable costs were unattainable. For example, commissions were highly commercially sensitive and not normally disclosed even in the internal accounting system. There was an implicit and complex link between sales activities and efforts (expenses) and winning contracts (sales). For example, sales people spent some time and money on one client with no success. After a few years, the client gave a contract without Xu Ji needing to spend any money. For the time being, the project team proposed to use contract value to allocate the commission, as some commissions were based on a certain percentage of the contract value. The project team s analysis of sales activities provided the top management with some useful management ideas, including enforcing some standard procedures i.e. sales activity plan, identification of contract numbers/activities when submitting expense claims. These procedures have since been in place. Summary It is evident that ABC systems can work more effectively in a relatively stable environment though may not work so well in a changing/unstable environment. Further major organisational events including acquisition and ERP implementation, can have profound impacts on management s commitment to further develop the ABC system and may adversely affect the use of ABC information. Xu Ji s observed ABC systems were unremarkable, in that they only tackled direct costs and variable manufacturing overheads. Given their traditional costing system was not even able to directly match direct labour costs to products, the ABC implementations have made marked improvement and allowed them to obtain 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. This attempt also marked the beginning of ABC being used as a management tool to enable top management to exercise more informed control over sales expenses and sales companies. ABC as a tool for learning ABC implementation has provided a unique opportunity to accelerate learning throughout Xu Ji. It has changed accountants perception of accounting. The experienced accountants, had previously only performed monthly financial reporting and book keeping. An experienced accountant commented, This [ABC] allows me to use accounting information for internal purposes. The group cost accountant/abc team member commented, Our product cost is more accurate than ever, because I do not get questions since [ABC system was implemented]. The newly graduated accountants were able to have first-hand experience of a real-abc system. 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. 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. Influencing factors on Xu Ji s ABC implementation Technological factor ABC as catalyst to advancement of information systems Xu Ji s initial ABC attempt prompted the company s decision to install a corporate financial accounting system. They used a local IT firm which was specialised in accounting software and new to ABC concepts. After fixing some teething problems, their programmed ABC software worked well with its financial accounting system. This experience paved the way for the ABC implementation at Relay. 9 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

12 Since 2000, Xu Ji has been expanding rapidly to create economies of scale in the face of fierce market competition. The existing financial accounting and ABC systems were no longer able to cope with growing needs for management accounting information. Xu Ji top management realised the bottlenecks that the ABC system faced and decided to implement a corporatewide ERP system 2. It is notable that the initial ABC attempt was the catalyst for Xu Ji s computerised accounting system advancement however it is too early to say whether or not the latest ERP advancement will be the catalyst for further ABC enhancement. Organisational factors continuous changes adversely impacts ABC Xu Ji s organisational and management structure has been continuously changing and growing. They produce customised products, dependent on a customer s specified requirements and the production processes are constantly changing. These changes pose one of the biggest challenges on the validity of the ABC system and relevance of the information it produces. The ABC team spent more time on trying to keep up with the changes and keep the ABC models up-to-date, rather than producing some useful ABC information for management purposes. It is not surprising the operations managers support and zealousness for ABC waned as they did not see any tangible benefits from the ABC information. For example, ABC was not used in divisional performance measures nor included in their KPIs. This was compounded by the fact that ABC was not just implemented in other parts of the value-chain e.g. the sales company. On the other hand, Relay s ABC implementation is a different story. The Relay production process and techniques involved are rather stable. As an independent subsidiary, Relay has relative autonomy over its value-chain i.e. purchase, production and sales. Relay s 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. Cultural factor top-down and malleable Xu Ji demonstrates a strong sense of top-down organisational culture. The former and current CEOs are keen to trial innovative ideas and Western advanced management techniques such as economics-value added, KPIs, six-sigma and ABC. This top down instigation worked quite well in the initial stages of ABC implementation when knowledge was severely lacking. The learning atmosphere at Xu Ji was also induced by forms of training and assessment. For example, middle-line managers were required to present their divisional achievement using these techniques. The effectiveness of this top-down instigation became malleable when knowledge grew, and production managers demanded the use of ABC in sales and other overhead areas. However the transparency ABC brought posed a threat to the sales companies autonomy and its niche so sales managers strongly resisted extending ABC systems to sales activities. External factors market competition To enable its competitiveness and to some extent survival, Xu Ji embarked on a rapid expansion strategy through mergers and acquisitions during This helped Xu Ji to win businesses by creating economies of scale, it also caused serious financial strains. The economic downturn in 2007 worsened Xu Ji s working capital position so they sought a capital injection from a large pension fund company in 2008, which later sold 60% of its stake to the national grid in This quick succession of acquisitions had profound impact on Xu Ji management and staff. Although top managers still supported the ABC project, it was inevitable their focus was forced to move to more pressing matters. The financial strains also meant that limited financial resources were available to support the role out the ABC to the rest of Xu Ji. 2 Ironically, at the initial ERP briefing meeting in 2010, the ERP programmers did not think the ERP system could either create a data-exchange link to the existing ABC system or incorporate the ABC concepts within the ERP programme. However, this view has changed to incorporate the ABC concepts in ERP s management reporting system. 10 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

13 Reference Jönsson, S. & Lukka, K., Doing Interventionist Research in Management Accounting, GRI-rapport 2005:6, Gothenburg Research Institute. Liu, L.Y.J. & Pan, F., The implementation of Activity-Based Costing in China: An innovation action research approach. British Accounting Review, 39(3), pp Nishimura, A., The Development of Management Accounting and the Asian Position, International Journal of Accounting Literature, Vol. 1, No. 1, pp Additional outputs Results related to the first part of the research were published in 2007 BAR. A second paper is currently under review. Liu, L. Y. J. & Pan, F.. The IT bandwagon: making senses of an activity-based costing system implementation in a Chinese manufacturing firm, information and organisation. Acknowledgments The authors gratefully acknowledge the support of CIMA s General Charitable Trust in the undertaking of the research on which this project is based. They also express their gratitude to all participants of Xu Ji Electrics Co. Ltd. and Xu Ji Group Company for their enthusiastic efforts and contribution that made this project possible. Contact details Accounting and finance Newcastle University Business School Newcastle University E. y.j.l.liu@newcastle.ac.uk E. lana.liu@ncl.ac.uk 11 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

14 Appendix 1 Account of research phases, major organisational events and participants involved Research nature/phase Historical background I II III IV V Total Jun 2003 Jul May 2004 Jun 2004-Nov 2005 Dec Dec 2007 Jan 2008 Mar 2011 Length of time 30 months 11 months 18 months 25 months 39 months 123 mths Part 1: ABC implementation at the first production division Archive research Active design and build ABC model, redesign work processes Design standard ABC system; Ongoing ABC system updates Initiation of rolling out ABC to company wide Verification of ABC models and activities be in line with changed organisational structure Research activities ABC concept training and field study ABC system training, interviews and focus groups in August 2003 Interviews and focus groups in November 2005 Interviews Retrospective study with opinions gathering Participants involved Accounting and operations personnel ABC team and operations managers ABC team and operations managers ABC team, group accountants and top- and middle-line managers Semi-structured interviews with top and front line managers; accounting staff; and ABC team Part 2: ABC analysis at three sales companies (functional units) Initiating and undertaking client-based ABC profitability analysis and sales control system Research activities ABC application training and Interviews Participants involved Top and middle line sales managers, accountants of sales companies. Part 3: ABC development at Xu Ji relay subsidiary wholly driven by Xu Ji ABC team Initiate and undertook ABC feasibility analysis in 2004 and built ABC model in 2005 Established standard inventory control system in 2006 and developed batch-based ABC system ABC user training and refining inventory system 2009 refining ABC system 2010 officially produce ABC monthly report High user acceptance due to the accuracy Research activities Interviews of ABC team members, relay group accountant and ABC information users 12 Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

15 Research nature/phase Major corporate events Historical background I II III IV V Total Management accounting information system development Computerised financial reporting system, concurrent with ABC system implementation Started implementation of a corporate wide ERP system since Jan 2010 Mergers and acquisitions Acquired one of XJG s subsidiaries in 2006 and five subsidiaries in 2007 via shareholding XJG was acquired by a pension fund company in 2008, who subsequently sold 60% to National Grid in Activity based costing in China: a case study of Xu Ji Electric Co. Ltd

16 Chartered Institute of Management Accountants 26 Chapter Street London SW1P 4NP United Kingdom T. +44 (0) E. August 2011, Chartered Institute of Management Accountants