Critical issues to address before you embark on an ABC journey

National Public Accountant, The, Sept, 2003 by Lakshmi U. Tatikonda

Over the past two decades, Activity Based Costing (ABC), a cost system designed to reduce product cost distortions caused by traditional cost accounting systems, became a popular business tool. Numerous articles and cases for and against ABC appeared in both academic and professional publications. As the dust settles, the degree of satisfaction among ABC users appears to vary widely. (1) Proponents describe ABC as a revolution in management accounting, a magic potion for all organizational ailments while opponents describe it as the modern version of a Swiss Army knife and nothing better than a glorified cost allocation method. (2,3)

CRITICAL ISSUES OF ABC IMPLEMENTATION

ABC is a system of linked components including informational, ownership, technical, behavioral, financial, competitiveness, and managerial issues. Failure to address these issues ahead of time may result in abandoning ABC projects before completing them.

Informational Issues

The primary objective of ABC systems is to provide accurate product cost information. High-level accuracy is beneficial when introducing new products, adopting new markets, developing new product strategies, and making product mix and outsourcing decisions. Companies with homogeneous products and labor-intensive operations gain little from ABC. (3)

ABC can be a superior cost management tool or it can simply clog accounting systems and produce confusing cost reports. Using ABC to track cost-driver variances month after month defeats the true intent of ABC. Tinkering with ABC for financial reporting purposes destroys the integrity of ABC data and leads to ineffective decisions.

Ownership Issues

Ownership of ABC systems is a political issue, one that goes beyond accounting. Lack of ownership confuses employees and confused employees do not support ABC. In many companies, employees and managers initially consider ABC exciting. But, shortly after implementation, the initial excitement lades and regular maintenance becomes drudgery. Day-to-day management of the ABC system gets delegated to lower level employees. Responsibility and authority to collect and update ABC data emerges as a thorny issue. Financial personnel may lack understanding of processes and tools such as Design for Manufacturability, Process Improvements, Setup Time Reduction, Just-in-Time, and Total Quality Management. Technical personnel may lack knowledge of cost behavior and cost drivers. Designating a cross-functional team, developing and enforcing guidelines regarding access to ABC data and authority to update ABC systems data helps avoid confusion, misuses of ABC, and turf problems.

Behavioral Issues and Performance Measures

ABC systems are more than data analysis, more than number crunching. ABC systems exist in social settings where employees interact with technical, behavioral, and financial realities. ABC data changes the political landscape of organizations. People resist changes that question their current practices and suspect changes that directly impact their performance. For example, under ABC, product costs and profit margins vary significantly compared to volume-based costing. Baffled managers wonder how their star products of today became dogs overnight. Because ABC is not aligned with the performance evaluation and compensation systems, ABC is perceived by employees to be a threat to their jobs.

Technical Issues

Choice of cost drivers and computer systems are two most critical issues of ABC. Accuracy, complexity, and cost increase with the number of drivers. Driver selection significantly impacts data integrity of ABC data and must be selected with care, using cause and effect analysis. Selecting drivers for the sake of making ABC system design easy ignores the cause and effect relationships, the very foundation of ABC concept. Beware of the "activity creep"--companies tend to acid more and more cost drivers over time, resulting in cost and complexity.

Implementing ABC is more than acquiring a software package. A variety of factors must be weighed, such as ease of use, compatibility with existing systems, expertise needed, availability of support personnel, resources needed for system maintenance, potential for integration of financial and operational systems, and consistency of ABC systems within the company. Off-the-shelf software packages are relatively inexpensive and can be used right away. But they may not be suitable for the company's unique needs and require frequent and costly updates. Developing ABC software in-house assures a better fit, but can be expensive, time consuming, and problematic.

ABC can be used as a stand-alone system, or integrated into a company's current existing cost accounting system. Stand-alone systems provide flexibility, facilitate use of a variety of cost drivers, and do not contaminate cost data needed for external reporting purposes.

Financial Issues

Nothing frustrates managers more than cost overruns. Failure to understand the nature and magnitude of costs could stop ABC systems before they are fully developed and implemented. Costs indude tangible items such as designing, training, implementing, and maintaining, as well as often overlooked intangible costs such as employee morale and political fallout. Benefits include higher revenues from better pricing; savings from eliminating unprofitable products, efficiency and effectiveness gained from better product mix and focused product promotion. Several surveys indicated that poor financial performance is one of the leading reasons for failure of ABC. (4)