Summary by David Lamb
Master of Accountancy Program
University of South Florida, Summer 2003
The Activity Based Costing (ABC) method has always been debated as to its use and value within a particular organization. After a survey conducted by the Cost Management Group of the Institute of Management Accountants (IMA) in 1996, Krumwiede was able to come to the following conclusions about ABC. Many of the companies that have implemented ABC found it more difficult to adopt than as first suggested. Additionally, more than half of the responding companies that have tried ABC (54%) stated that they were using it for decision making purposes outside their accounting function. Of the companies that actually use ABC, 89% of them said ABC was worth its implementation costs.
Who Tries ABC?
As a result of the survey, Krumwiede was able to determine four factors that seemed to separate the users of ABC from the non-users. Those factors include the potential of cost distortions, decision usefulness of cost information, lack of system initiatives, and the size of the organization (p.32).
Potential for cost distortions
An organization may be more motivated to utilize ABC if they have a high potential for cost distortions. A common example of a significant distortion risk is if an organization were to use only one overhead base. By doing this, under or over costing of particular products may occur.
Cost distortions have the ability to affect many important decisions, including those related to profitability analyses. By placing ABC into affect, an organization may have the ability to determine (by some measure) whether all of their clients are profitable or not. This way, organizations can “fire” (or turn down business from) unprofitable customers to increase their margins.
When there is a lower potential for cost distortions, however, the benefits of ABC may be limited. Single product producing companies may not see a substantial improvement in their cost data through its use. In these cases, an activity analysis is recommended in place of ABC in order to identify nonvalue-added activities. Using an activity analysis would help reduce the potential for cost distortions.
Decision usefulness of cost information
Even if ABC will reduce product cost distortions substantially, it would probably not be implemented unless the company could use the better cost information in its decision-making processes. Companies that sell products dictated by market rates will most likely find little use for ABC because they have little control over the prices they can charge. On the other hand, ABC could be an extremely useful tool for a company selling multiple products within a highly competitive pricing industry. These companies could use the information in negotiations with suppliers for cost reduction efforts.
Lack of system initiatives
The restructuring or implementing of information systems will often impede the adoption of ABC within an organization. There are two reasons for this. First, the implementation of ABC requires considerable time and effort that it will not receive if the organization’s attention is focused elsewhere. Second, ABC needs extremely detailed information that it may not be able to receive because of the organization’s currently lacking information system. In order to implement ABC, these organizations must first await an improvement in their system.
Size of the organization
According to the survey, ABC adopters, on average, tend to have larger sales figures then those that do not adopt ABC. Adopting firms normally had sales figures ranging from $101 - $500 million dollars while non-adopters ranged between $51 - $100 million in sales. Krumwiede attributed these size differences to the availability of resources (people and dollars) and economies of scale in implementing ABC at multiple sites (p. 34).
What Factors Affect ABC’s Success?
According to the survey results, ABC’s implementation success factors are not the same as those affecting its adoption. “Success” with ABC is considered as using its results when making decisions outside of the accounting function. In order for ABC to be a “success,” many companies believed that it was dependent on time, other major initiatives being implemented, existing information technology (IT) sophistication, top management support, integration of ABC into the financial system, and the use of ABC as part of the budgeting system (p.34).
ABC usually takes more time to implement than expected. Once ABC is implemented, it normally takes an even longer period before its conclusions are actually utilized in the decision-making process of the organization. Time seemed to be the most important factor in the study for differentiating usage and non-usage companies.
Other major initiatives
Numerous respondents to the survey stated that they were having trouble implementing ABC because they had other initiatives of higher priority to the organization at the present time. Examples include such priorities as the entering of new products or markets or implementation of new information systems. Many companies find themselves in a position where they have too many good ideas and far too few resources to put them into action.
Information technology sophistication
According to the survey, improvements to the information system often precede both ABC adoption and the reaching of the usage-level of ABC in the decision-making process. IT appears to be an important factor in getting to the usage-stage for the majority of companies surveyed.
The implementation of ABC should be simpler if an organization’s IT system has the following characteristics: good sub-system (e.g. sales system, manufacturing system, etc.) integration; user-friendly query capability; available sales, cost, and performance data going back 12 months; and real-time updates of all these types of data. Although a strong IT system appears to be useful in implementing ABC, it is not required. Many organizations utilize ABC successfully with weak IT systems.
Top management support
Commitment from upper-level management is necessary for any ABC system to survive and be successful. Support includes active participation, adequacy of resources provided, and ties to the competitive strategies of the business unit.
Integration into financial system
Using ABC cost information in financial reporting generally will lead to its use in decision making (the ultimate goal for ABC). Managers often tend to pay attention to the information that is used for outside reporting.
Part of the Budgeting process
The use of ABC information for budgeting purposes appears to be another good way to increase organizational usage. Twice as many ABC users (that responded to the survey) that included ABC data in their budgeting process found it to be “successful” as compared to those that did not. This result supports one trend that everything “will happen naturally” if ABC is included in the budgeting process. As a general rule, companies should report actual costs using the same method that is used to develop their budget (p. 38).
ABC Was Generally Worth It…But Not Always
Of the respondents who have tried ABC, 54% are using it at least somewhat for decision-making and 89% of those companies using ABC said it was worth the implementation costs. However, not all ABC implementations have proven to be beneficial. Many users commented that ABC is not the single answer to all of their needs, but it is one of many tools to be used in order to meet an organization’s long-term goals (p. 38).
The following charts are based on 178 responses from one of the surveys in this study. Other data in the summary above are from 301 responses to another survey that included more questions.
Ali, H. F. 1994. A multicontribution activity-based income statement. Journal of Cost Management (Fall): 45-54. (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).
Argyris, C. and R. S. Kaplan. 1994. Implementing new knowledge: The case of activity-based costing. Accounting Horizons (September): 83-105. (Summary).
Baxendale, S. J. and P. S. Raju. 2004. Using ABC to enhance throughput accounting: A strategic perspective. Cost Management (January/February): 31-38. (Summary).
Carter, T. L., A. M. Sedaghat and T. D. Williams. 1998. How ABC changed the post office. Management Accounting (February): 28-32, 35-36. (Summary).
Cokins, G. 1999. Using ABC to become ABM. Journal of Cost Management (January/February): 29-35. (Summary).
Cokins, G. 2002. Integrating target costing and ABC. Journal of Cost Management (July/August): 13-22. (Summary).
Cooper, R. 1990. Implementing an activity-based cost system. Journal of Cost Management (Spring): 33-42. (Summary).
Cooper, R. 1996. Activity-based management and the lean enterprise. Journal of Cost Management (Winter): 6-14. (Summary).
Cooper, R. and R. S. Kaplan. 1992. Activity-based systems: Measuring the costs of resource usage. Accounting Horizons (September): 1-13. (Summary).
Corbett, T. 2000. Throughput accounting and activity-based costing: The driving factors behind each methodology. Journal of Cost Management (January/February): 37-45. (Summary).
Gosselin, M. 1997. The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, Organizations and Society 22(2): 105-122. (Summary).
Hughes, S. B. and K. A. Paulson Gjerde. 2003. Do different cost systems make a difference? Management Accounting Quarterly (Fall): 22-30. (Summary).
Ittner, C. D., D. F. Larcker and T. Randall. 1997. The activity-based cost hierarchy, production policies and firm profitability. Journal of Management Accounting Research (9): 143-162. (Summary).
Jones, T. C. and D. Dugdale. 2002. The ABC bandwagon and the juggernaut of modernity. Accounting, Organizations and Society 27(1-2): 121-163. (Summary).
Kaplan, R. S. 1990. The four stage model of cost systems design. Management Accounting (February): 22-26. (Summary).
Kaplan, R. S. 1998. Innovation action research: Creating new management theory and practice. Journal of Management Accounting Research (10): 89-118. (Summary).
Kaplan, R. S. and M. E. Porter. 2011. How to solve the cost crisis in health care: The biggest problem with health care isn't with insurance or politics. It's that we're measuring the wrong things the wrong way. Harvard Business Review (September): 46-64. (Time-driven ABC applied to health care). (Summary).
Kaplan, R. S. and S. R. Anderson. 2004. Time-driven activity-based costing. Harvard Business Review (November): 131-138. (Summary).
Kaplan, R. S. and S. R. Anderson. 2007. The innovation of time-driven activity-based costing. Cost Management (March/April): 5-15. (Summary).
Kaplan, R. S., M. E. Porter and M. L. Frigo. 2017. Managing healthcare costs and value. Strategic Finance (January): 24-33. (Summary).
Kaplan, S. E. and J. T. Mackey. 1992. An examination of the association between organizational design factors and the use of accounting information for managerial performance evaluation. Journal of Management Accounting Research (4): 116-130. (Summary).
Kee, R. C. 2001. Implementing cost-volume-profit analysis using an activity-based costing system. Advances in Management Accounting (10): 77-94. (Summary).
Keys, D. E. 1994. Tracing costs in the three stages of activity-based management. Journal of Cost Management (Winter): 30-37. (Summary).
Keys, D. E. and R. J. Lefevre. 1995. Departmental activity-based management. Management Accounting (January): 27-30. (Summary).
Landry, S. P., L. M. Wood and T. M. Lindquist. 1997. Can ABC bring mixed results? Management Accounting (March): 28-30, 32-33. (Summary).
Mangan, T. N. 1995. Integrating an activity-based cost system. Journal of Cost Management (Winter): 5-13. (Summary).
Martin, J. R. Not dated. Chapter 7: Activity Based Product Costing. Management Accounting: Concepts, Techniques & Controversial Issues. Management And Accounting Web. https://maaw.info /Chapter7.htm
Martin, J. R. Not dated. Chapter 8: Just-In-Time, Theory of Constraints, and Activity Based Management Concepts and Techniques. Management Accounting: Concepts, Techniques & Controversial Issues. Management And Accounting Web. https://maaw.info /Chapter8.htm
Mecimore, C. D. and A. T. Bell. 1995. Are we ready for fourth-generation ABC? Management Accounting (January): 22-26. (Summary).
Palmer, R. J. and M. Vied. 1998. Could ABC threaten the survival of your company? Management Accounting (November): 33-36. (Summary).
Ruhl, J. M. and B. P. Hartman. 1998. Activity-Based Costing in the Service Sector. Advances in Management Accounting (6): 147-161. (Summary).
Sandison, D., S. C. Hansen and R. G. Torok. 2003. Activity-based planning and budgeting: A new approach. Journal of Cost Management (March/April): 16-22. (Summary).
Troxel, R. and M. Weber. 1990. The evolution of activity-based costing. Journal of Cost Management (Spring):14-22. (Summary).
Turney, P. B. B. 1990. Ten myths about implementing an activity-based costing system. Journal of Cost Management (Spring): 24-32. (Summary).
West, T. D. and D. A. West. 1997. Applying ABC to healthcare. Management Accounting (February): 22, 24-26, 28-30, 32-33. (Summary).
Zeller, T. L. 2000. Measuring and managing e-retailing with activity-based costing. Journal of Cost Management (January/February): 17-30. (Summary).