ActivityBased Costing

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Activity-Based Costing

• Shannon Anderson
• Jesse H. Jones Graduate School of Management
• Rice University

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Activity-Based Costing A response to
irrelevance, a preamble to strategic alignment

• Shannon Anderson
• Jesse H. Jones Graduate School of Management
• Rice University

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Overview

• New Beginnings
• Cost management in the new manufacturing setting
• Lessons from the field
• Articulation of the ABC model
• The Trajectory of ABC Research
• Investigating the economic model of ABC
• Implementing ABC
• Using ABC Activity-based management

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Field Work and CasesAccounting Lag The
Obsolescence of Cost Accounting Systems(Kaplan,
1985)

• to learn how firms are modifying their
  accounting and control systems to help them
  manage in the new manufacturing environment, I
  visited a select set of innovative firms.

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Cases

• One Company reorganized manufacturing to create a
  smooth production flow, but
• benefits from reorganization were impossible to
  quantify the accounting system accumulated only
  total project costs there was no way to compute
  productivity measures or unit costs for items
  being produced using the new manufacturing
  philosophy

• Two Companies implemented JIT and total quality
  management
• But continued to use a standard costing system
  that allocated all costs based on often obsolete
  direct labor costs, even though direct labor
  represented less than 10 percent of total
  manufacturing cost.

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Conclusion

• I had hoped to be able to document the incidence
  and value of innovative accounting and control
  systems for the new industrial competition
• I found that changes in accounting lag far
  behind changes in the real production phenomena
  they are supposed to represent.

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Field Work and Cases

• Defining the Contours of Cost System Design
• Mayers Tap (Cooper, 1984)
• Seligram, Inc. (Turney and Ittner, 1988)
• Bridgeton Industries (Bost and Cooper, 1990)
• Identifying Activity-based Costing in Use
• Union Pacific (Kaplan, 1985)
• Schrader Bellows (Cooper Wiess, 1985)
• John Deere Component Works (March Kaplan, 1987)
  3 most popular case
• American Bank (Kallapur and Kaplan, 1987)

Did you know that Bob is ranked 8 in all time
cumulative case unit sales with 1.5 M units sold?
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New Beginnings The Design of Cost Management
Systems (Cooper and Kaplan, 1991)

• The previous academic approach emphasized cost
  analysis for isolated, well-specified decisions
• The new approach of this book emphasizes
  principles of cost systems design.

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Activity-based Costing

• Assign costs to ACTIVITIES that are associated
  with
• the production of particular products
• the delivery of particular services
• The COST DRIVERS used to assign costs reflect the
  underlying unit of variability of the cost ---
  costs often vary with activity level rather than
  production volume
• Costs often vary in a hierarchical fashion as
  compared to unit production volume
• e.g., unit, batch, product, facility-sustaining

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Traditional vs. ABC Costing
Some products use no special tooling and require
no advanced engineering support
Overhead Costs e.g., Salaries, Utilities,
Tooling

• Overhead costs
• Direct Labor Costs

1000
What does direct labor have to do with overhead
costs in an automated setting with diverse
processes?
Product A Cost per unit Direct Material 20
Direct Labor 50 Overhead 500
(50 x 1000) Total 570
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Traditional vs. ABC Costing
Overhead Costs e.g., Salaries, Utilities, Tooling
Design Engineering Support Activities
Process A Setup activity
Process A Running Costs

• Proc A O/H costs
• No. of Setups

• Proc A O/H costs
• No. of Mach. Hrs.

• Engg O/H costs
• No. Engg changes

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Extensions Refinements

• Assign costs to activities that are associated
  with new cost objects
• the operation of particular processes
• the support of particular customers
• the use of particular suppliers
• Time-driven ABC
• to reduce the cost of system implementation and
  maintenance
• to reflect the cost of unused capacity
• Use cost accounting data to affect future costs
  rather than simply reflecting past costs
  activity-based management

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Field Work and Cases

• Beyond Products e.g., costs of customers
• Kanthal (Kaplan, 1989) Bobs 1 most popular
  case
• Cooperative Bank (Datar Kaplan, 1995) 4 most
  popular
• Dakota Office Products (Kaplan, 2001)
• Owens and Minor (Narayanan Brem, 2002)
• Beyond Costing Activity-based Management
• Texas Instruments (Ittner Kaplan, 1988)
• Indianapolis City Services (Kaplan, 1996) 7
  most popular

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ABM Using ABC for Performance Management

• Manage costs
• Continuous Improvement (Kaizen)
• Radical Redesign of Products or Processes (Target
  costing, Business Process Re-engineering)
• - Reduce the usage of the cost
  drivers
• - Reduce the cost per unit of the
  driver
• Set prices relative to competition and value
• Eliminate unprofitable business

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Articulation of the ABC model

• One cost system isnt enough (Kaplan, HBR 1988)
• Measure costs right Make the right decisions
  (Cooper and Kaplan, HBR 1988)
• Contribution margin analysis No longer relevant/
  Strategic cost management The New Paradigm
  (Kaplan, JMAR 1990)
• Profit priorities from activity-based costing
  (Cooper and Kaplan, HBR 1991)
• Activity-based systems Measuring the costs of
  resource usage (Cooper and Kaplan, AH 1992)

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The Influence of ABC on Accounting Research

• Investigating the Economic Model

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Investigating the Economic Model

• Cost drivers and the cost hierarchy Empirical
  Research
• Manufacturing overhead cost driver analysis
  (Foster Gupta, 1990)
• Costs of product and process complexity (Banker
  et al. 1990)
• Simultaneous estimation of cost drivers (Datar et
  al. 1993)
• Are overhead costs strictly proportional to
  activity? Evidence from hospital service
  departments (Noreen Soderstrom, 1994)
• Measuring the impact of product mix heterogeneity
  on manufacturing overhead cost (Anderson, 1995)
• An empirical analysis of manufacturing overhead
  cost drivers (Banker, Potter Schroeder, 1995)
• The activity-based cost hierarchy, production
  policies, and firm profitability (Ittner, Larcker
  Randall, 1997)
• A field study on the limitations of ABC when
  resources are provided on a joint and indivisible
  basis (Maher Marais, 1998)

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Investigating the Economic Model

• Cost drivers and the cost hierarchy Theory
  Research
• Cost driver optimization in ABC (Babad
  Balachandran, 1993)
• A perspective on cost drivers (Dopuch, 1993)
• Aggregation, specification and measurement errors
  in product costing (Datar Gupta, 1994)
• Product costing and pricing (Banker Hughes,
  1994)
• Allocations of sunk capacity costs and joint
  costs in a linear principal-agent model (Hemmer,
  1996)
• On the efficiency of cost-based decision rules
  for capacity planning (Balachandran, et al. 1997)
• Activity-based costing systems and incremental
  costs (Bromwich Hong 1999)

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Investigating the Economic Model

• Cost management with hierarchical cost structure
  and committed resources ? resource usage
• Strategic Cost Analysis The evolution from
  managerial to strategic accounting (Shank
  Govindarajan, 1989)
• Manufacturing configuration, capacity and mix
  decisions considering operational cost (Karmarkar
  Kekre, 1987)
• Relevant costs, congestion and stochasticity in
  production environments (Banker, Datar Kekre,
  1988)
• Explaining plant-level differences in
  manufacturing overhead structural and
  executional cost drivers in the world auto
  industry (Ittner MacDuffie, 1995)
• Direct and indirect effects of product mix
  characteristics on capacity management decisions
  and operating performance (Anderson, 2001)
• Are selling, general, and administrative costs
  "sticky"? (Anderson, Banker Janakiraman, 2003)
• Predicting earnings using a model based on cost
  variability and cost stickiness (Banker Chen,
  2006)

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The Influence of ABC on Accounting Research

• Implementing ABC

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Implementing ABC

• ABC Implementation as Organizational Change
• A Behavioral Model for Implementing Cost
  Management Systems (Shields Young, 1989)
• Implementing an activity-based cost system
  (Cooper, 1990)
• Implementing New Knowledge The Case of
  Activity-based Costing (Argyris Kaplan, 1994)
• A Framework for assessing cost management system
  changes The case of ABC implementation at
  General Motors, 1986-1993 (Anderson, 1995)
• An empirical analysis of firms implementation
  experiences with activity-based costing (Shields,
  1995)
• Towards explaining ABC failure accounting and
  control in a decentralized organization (Malmi,
  1997)
• Cost and Effect Using integrated cost systems to
  drive profitability and performance (Kaplan and
  Cooper, 1998)
• Product diversity and costing system design
  choice field study evidence (Abernethy et al.
  2001)

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Implementing ABC

• ABC Implementation an International Phenomena
• A Survey of ABC in the U.K.s largest companies
  (Innes Mitchell, 1995)
• Diffusion and accounting The case of ABC in
  Norway (Bjornenak, 1997)
• National culture and ABC systems (Brewer, 1998)
• ABC costing diffusion across organizations An
  exploratory empirical analysis of Finnish firms
  (Malmi, 1999)
• ABC in the U.K.s largest companies A comparison
  of the 1994 and 1999 survey results (Innes et
  al., 2000)
• Note on a New Zealand replication of the Innes et
  al. U.K. ABC survey (Cotton et al., 2003)
• Managers divided Implementing ABC in a
  Portuguese telecommunications company (Major
  Hopper, 2005)

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Implementing ABC

• Evaluating the Impact of ABC Implementation
• Case and Field studies
• The impact of contextual and process factors on
  the evaluation of activity based costing systems
  (Anderson Young, 1999)
• Factors influencing the performance of activity
  based costing teams (Anderson, Hesford Young,
  2002)
• Large sample surveys and archival financial data
• Measuring the success of activity-based cost
  management and its determinants (Foster Swenson
  1997)
• The association between activity-based costing
  and manufacturing performance (Ittner, Lanen
  Larcker, 2002)
• The impact of ABC techniques on firm performance
  (Kennedy Affleck-Graves, 2001)
• The association between ABC and improvement in
  financial performance (Cagwin Bouwman, 2002)

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The Influence of ABC on Accounting Research

• Using ABC in decision-making Activity Based
  Management

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Using ABC in decision-making ABM

• Implementing Activity-based Cost Management
  Moving from Analysis to Action (Cooper, Kaplan,
  Maisel, Morrissey Oehm, 1992)
• Flexible budgeting in an ABC Framework (Kaplan,
  1994)
• New Roles for Management Accountants (Kaplan,
  1995)
• Cost and Effect Using integrated cost systems to
  drive profitability and performance (Kaplan
  Cooper, 1998)
• Measuring and managing customer profitability
  (Kaplan Narayanan, 2001)
• The incidence, perceived merit and antecedents of
  customer accounting (Guilding McManus, 2002)
• The value of ABC in competitive pricing decisions
  (Cardinaels et al., 2004)
• Interorganizational cost management and
  relational context (Cooper Slagmulder, 2004)
• The adoption of total cost of ownership for
  sourcing decisions (Wouters et al., 2005)

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Using ABC in decision-making ABM

• Cognitive Effects of ABC on Decision-making
• An experimental investigation of the effect of
  cost information and feedback on product cost
  decisions (Gupta King, 1997)
• Fairness, Ethics and the effect of management
  accounting on transactions costs (Luft, 1997)
• The effects of alternative types of feedback on
  product-related decision performance (Briers et
  al. 1999)
• Cost knowledge and cost-based judgment
  performance (Dearman Shields, 2001)
• Avoiding accounting fixation Determinants of
  cognitive adaptation to differences in accounting
  method (Shields, 2005)

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Current Research Issues in ABC and Cost Management

• Economics of modern production (and service)
• Increased infrastructure costs
• Cost behavior (e.g., stickiness)
• Interorganizational (boundary of the firm) cost
  management transaction costs, trust and
  intangible assets
• Risk management managing uncertainty and
  volatility of costs
• Managerial Behavior
• Cognitive bias and other behavioral influences on
  cost management decisions
• Agency issues in cost management

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Conclusion

• I had hoped to be able to document the incidence
  and value of innovative accounting and control
  systems
• I found that changes in accounting lag far
  behind changes in the real production phenomena
  they are supposed to represent.

Effective managerial accounting systems must
reflect the value-creating activities of
companies in operations, in marketing and sales,
and in product and process development (Kaplan,
1985)