In this article, the authors delineate the benefits and the dangers involved when businesses attempt to integrate operational learning and control systems with activity-based cost (ABC) systems.  The integration of these two systems will give managers access to all kinds of real-time cost, pricing, and other financial information.  The ability to access these kind of data at any time can lead managers to make faulty judgments based on extremely short-term variations they perceive as negative, but which may in fact be completely normal. These variations can be caused by numerous factors, including (but not limited to) supplies and resources paid for but not used and daily demand fluctuations.   

Differences between operational learning & control systems and ABC systems

In order to avoid making these kinds of ill-fated decisions, it is imperative that managers understand that the purpose of operational learning and control systems is fundamentally different from that of ABC systems.  It is true that both kinds of systems were created to provide the kind of useful internal information managers cannot find on highly aggregated, external-user-oriented financial statements. However, the types of internal information generated by each system are quite different. Operational systems are designed to provide information about business and process efficiencies.  They focus on continuous improvement, and generate timely, specific information about things like cycle time, defects, and scrap. ABC systems are designed to provide strategic cost information. They link resource costs to activities, and then to finished goods, services, and even customers. Given these different purposes and products, the authors suggest that the two systems can only be integrated partially, and even this partial integration should be accomplished in a cautious, thorough manner.

The primary reason operational and ABC systems cannot be totally integrated is that they each have a different definition of “cost.”  Operational systems use a narrow scope and call “costs” those things that are actual, frequently assessed and calculated expenses, generally within the employees’ control, and based on resources actually supplied to a work center.  ABC systems must aggregate costs across the company, using standard, infrequently recalculated rates (vs. actual expenditures) based on resources used, to determine the “cost” of an activity, process, or customer.  

The authors feel that the best approach is to link (rather than fully integrate) the operational and ABC systems, so that valuable information can be shared. 

Linking ABC to Operational Control: Activity Based Budgeting

For example, once the ABC system has been used to create an “activity-based-budget,” that information can be fed back into the operational system so that actual spending can be monitored against it.  Activity based budgeting gives manager the ability to make all costs variable—a long-term view.  It is ABC in reverse.  The authors list the following steps in creating an activity based budget:

1. “Estimate the production and sales volume for the next period.” 
2. “Forecast the demand for activities.”
3. “Calculate the resource demands.”
4. “Determine the actual resource supply.”
5. “Determine activity capacity.”

Activity based budgeting is simple in concept, but complicated in practice.  It requires the compilation of many more details than conventional budgeting, significantly raising its cost.  The authors believe that if it is done properly, the higher costs of activity based budgeting will be offset by the resulting benefits.

Linking Operational Control to ABC

The authors list three “critical assumptions” utilized by ABC which are monitored by the operational system:

1. “the capacity of the resources supplied;”
2. “the cost of supplying an hour of productive time;” and
3. “the time required to perform the activity.

These data can be input from the operational system into the ABC system to facilitate the calculation of standard cost rates.

The operational system can also provide capacity usage data, and can even compare actual usage to estimated.  Using this information in conjunction with the ABC system, managers can avoid production delays, shortages, and inefficient capacity allocation.

Linking ABC and Operational Control to Financial Reporting

The authors believe this link should be performed with caution.  Managers must realize that the internal systems (i.e. operational and ABC) will always produce slightly different profit and cost measurements than the financial reporting system.  Managers must gain a complete understanding of these differences so as not to be misled by them.  There may always be some ambiguity in this reconciliation, but it will not be unmanageable. 

Conclusion

In short, the authors believe significant effectiveness and efficiency can be achieved through partial, careful integration of operational and ABC systems.  The linking of these two systems will enable managers to be better managers in the long run.

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