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Cooper, R., and R. S. Kaplan. 1998. The promise - and peril - of integrated cost systems. Harvard Business Review (July-August): 109-119.

Summary by Samantha Carey
Master of Accountancy Program
University of South Florida, Summer 2001

ABC Main Page | Cost Management Main Page

Cooper and Kaplan discuss the pros and cons of integrating an activity-based cost system and an operational learning and control cost system to provide on-line, real-time information. They say that some real-time information will be beneficial, but some will also cause confusion and error, and deliver information that is much more inaccurate than the information currently being received by managers. They advocate that the two systems can only be partially integrated.

Different Systems, Different Costs

Purpose of the system - The operational-control system provides information about process and business-unit efficiencies, whereas the activity-based cost system provides strategic cost information about the underlying economics of the business.

Definitions of cost - Cost in an operational-control system measures actual expenses incurred in a responsibility center, whereas in an ABC system costs are aggregated across multiple cost and responsibility centers. The cost of a particular resource would be a different number using the two different systems.

Scope and measurement demands - ABC is broader in scope and depends on standard rates and estimates, instead of actual, real-time cost data when tracing costs. Operational control requires more accuracy.

Exhibit 1
Differences between Operational Learning and Control and Activity-Based Costing
Operational Learning
and Control
Activity-Based Costing
Overall purpose Provides managers and operators with economic feedback (financial and nonfinancial) about process efficiencies and responsibility-center performance Allows senior managers to assess product, customer, and business-unit profitability by assigning costs based on usage of company wide resources; also measures activity and process costs and gauges capacity usage
Cost of resources used Actual Standard
Frequency of updating Continual Periodic (quarterly, semiannual, or annual) or as sustainable changes occur
Measurement demands Highly accurate Estimates sufficient; more accuracy only when cost justified
Scope of systems Responsibility center Entire value chain, from suppliers through post-sales service
Definitions of costs Expenses actually recorded in financial system. Cost of resources used based on standard activity costs driver rates and practical capacity of organization resources (difference between the two definitions: the cost of unused capacity plus any short-term spending variances).
Cost variability Emphasis on short-term fixed and variability costs. Degree of variability is not a central feature; managers make almost all costs variable through activity-based budgeting that matches resource supply to resource demand

The Peril of Real-Time Data

The issue of substituting actual costs for estimated costs in an ABC system is addressed. Cooper and Kaplan use an example to illustrate that calculations involving actual costs would include fluctuations in spending, volume, productivity, and yield, which are unrelated to the underlying economics and productivity of activities and business processes. Such fluctuations are said to result in errors in product and customer costs, and in undetected improvement or deterioration in activities and business processes, which could lead to misguided decisions being made by managers. Managers might also be confused about the profitability of products and customers as a result of such fluctuations.

The Promise of Integration

Cooper and Kaplan advocate that the operational-control and ABC systems should exchange information about efficiency, sustained operational improvements, and capacity usage. They identify activity-based budgeting as being the crucial link between these two systems. They feel that "one of the great promises of an integrated system is that it brings activity-based budgeting within the practical reach of managers". Activity based budgeting is said to give managers better control over their cost structure, particularly in transforming so-called fixed costs into variable ones. In contrast to the ABC "north-to-south" cost flow, from resources through activities to products and customers, activity-based budgeting uses a "south-to-north" cost flow through use of the following five steps:

1. Estimate the production and sales volumes 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.

Having budgeted the quantity and expense of committed resources, the ABC system can then feed this information into the operational control system, which monitors the budgeted resource supply and expenses against actual spending.

Some specific benefits associated with such an integrated cost system:

The procedure of updating process standards can be automated - The integrated cost system filters the data from the operational control system and when permanent changes in capacity, efficiency, and input prices are detected, the system updates the activity cost driver rates.

Managers can receive valuable information about capacity usage - The operational-control system can be designed to detect developing resource bottlenecks and the system can then flag the activity cost driver associated with these resources to alert managers of the potential problems.

Differences in actual capacity and estimated capacity can be detected - The operational control system might detect when actual capacity differs from estimated capacity. This information can be fed to the ABC system, enabling the necessary capacity adjustments to be made, and thus producing a more accurate cost driver rate.

The question "Can the ABC and operational-control systems also be used to generate cost of goods sold and inventory valuations for financial reporting purposes?" is also asked. Cooper and Kaplan say "the answer is yes - but with precautions". They say that the operational-control system captures actual expenses, and the ABC system can be used to calculate standard product costs for costs of goods sold and inventory valuation, but such systems will always report profits and balance sheets that are different from those of the financial reporting system. Their recommendation is that ABC be the primary cost-and-profit reporting system, and that reconciliations required to make financial reporting conform with GAAP be performed outside of the ABC system.

Managerial Accounting Comes of Age

There has been a shift in emphasis from external reporting of numbers to internal understanding of the company’s economics. In the past, managers had to struggle to obtain information from financial accounting reports, but now the integrated managerial systems distribute information to the financial accountants, who then reconcile it for reporting purposes. They say that "information technology in the form of enterprise systems promises to increase the relevance and contribution of managerial accounting", but managers must be careful not to use ABC systems for real-time operational control.


 Separate but linked operational control and strategic costing systems will:

Identify the best opportunities for improvement programs.

Guide continuous improvement and learning activities.

Quickly detect both unused capacity and potential capacity constraints.

Make better decisions that enhance the profitability of their company.


Related summaries:

Anderson, S. 1995. A framework for assessing cost management system changes: The case of activity based costing implementation at General Motors, 1986-1993. Journal of Management Accounting Research (7): 1-51. (Summary).

Anderson, S. W., J. W. Hesford and S. M. Young. 2002. Factors influencing the performance of activity based costing teams: A field study of ABC model development time in the automobile industry. Accounting, Organizations and Society 27(3): 195-211. (Summary).

Cooper, R. 1990. Implementing an activity-based cost system. Journal of Cost Management (Spring): 33-42. (Summary).

Cooper, R. and R. S. Kaplan. 1992. Activity-based systems: Measuring the costs of resource usage. Accounting Horizons (September): 1-13. (Summary).

Cooper, R., and R. S. Kaplan. 1998. The promise - and peril - of integrated cost systems. Harvard Business Review (July-August): 109-119. (Summary 2).

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