ACTIVITY BASED COSTING (ABC)

Historical Development

Activity-based costing (ABC) is a costing approach that assigns resource costs to cost objects such as products, services, or customers based on activities performed for the cost objects. The premise of this costing approach is that a firm’s products or services are the results of activities and activities use resources which incur costs. Costs of resources are assigned to activities based on the activities that use or consume resources (resource consumption drivers), and costs of activities are assigned to cost objects based on activities performed for the cost objects (activity consumption drivers). ABC recognizes the causal or direct relationships between resource costs, cost drivers, activities, and cost objects in assigning costs to activities and then to cost objects.

ABC assigns factory overhead costs to cost objects such as products or services by identifying the resources and activities as well as their costs and amounts needed to produce output. Using resource consumption cost drivers, a firm determines the resource costs consumed by activities or activity centers (activity cost pools) and calculates the cost of a unit of activity. The firm then assigns the cost of an activity to products or services by multiplying the cost of each activity by the amount of the activity consumed by each of the cost objects.

Traditionally cost accountants had arbitrarily added a broad percentage of expenses into the indirect cost. In addition, activities include actions that are performed both by people and machine. However, as the percentages of indirect or overhead cots rose, this technique became increasingly inaccurate, because indirect costs were not caused equally by all products. Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.

Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.

Steps in Developing Activity Based Costing System:

Developing an activity-based costing system entails three steps: (1) identifying resource costs and activities, (2) assigning resource costs to activities, and (3) assigning activity costs to cost objects.

Step 1: Identify Resource Costs and ActivitiesThe first step in designing an ABC system is to conduct an activity analysis to identify the resource costs and activities of the firm. Most firms record resource costs in specific

accounts in the accounting system. Examples of these accounts include supplies, purchasing, materials handling, warehousing, office expenses, furniture and fixtures, buildings, equipment, utilities, and salaries and benefits. However, special effort most likely will be needed to determine appropriate resource costs for activity-based costing because generally several different resource costs may be recorded in a single account or the costs for an activity may be recorded in several accounts.

For example, a firm may use a single factory supplies account for all supplies in its operations that include several manufacturing operations. Costs to complete a purchasing order may be spread over several accounts including accounts for warehousing, purchasing, and receiving. Through activity analyses a firm identifies the work it performs to carry out its operations. Activity analyses include gathering data from existing documents and records, as well as collecting additional data using questionnaires, observations, or interviews of key personnel.

Levels of Activities

To identify resource costs for various activities, a firm classifies all activities according to the way in which the activities consume resources.

A unit-level activity is performed on each individual unit of product or service of the firm.

Examples of unit-level activities include direct materials, direct labor-hours, inserting a component, and inspecting every unit. A unit-level activity is volume-based. The required activity varies in proportion with the quantity of the cost object.

A batch-level activity is performed for each batch or group of units of products or services.

A firm incurs a batch-level activity for each batch or group of units of products or services scheduled to be processed together, rather than for each individual unit of the cost object. Examples are setting up machines, placing purchase orders, scheduling production, conducting inspections by batch etc.

A product-level activity supports the production of a specific product or services.Examples of product-sustaining activities include designing products, administering parts required for products, and engaging in engineering changes to modify products.

A facility-level activity supports operations in general. These activities are not caused by products or customer service needs and cannot be traced to individual units, batches, or products.

Examples include providing security and safety, performing maintenance of general purpose machines, managing the plant, incurring factory property taxes etc. These activities are also called as business or infrastructure sustaining activities.

Step 2: Assign Resource Costs to Activities

Activity-based costing uses resource consumption cost drivers to assign resource costs to activities. Because activities drive the cost of resources used in operations, a firm should choose resource consumption cost drivers based on cause-and-effect relationships.

Typical resource consumption cost drivers include the number of (1) labor hours for labor intensive activities; (2) employees for payroll-related activities; (3) setups for batch-related activities; (4) moves for materials-handling activities; (5) machine-hours for machine repair and maintenance; and (6) square feet for general maintenance and cleaning activities.

The cost of the resources can be assigned to activities by direct tracing or estimation. Direct tracing requires measuring the actual usage of resources by activities. When direct tracing is not available, department managers and supervisors need to estimate the amount or percentage of time (or effort) employees spend on each identified activity.

Step 3: Assign Activity Costs to Cost Objects

The final step is to assign costs of activities or activity cost pools to cost objects based on the appropriate activity consumption cost drivers. Outputs are the cost objects for which firms or organizations perform activities. Typical outputs for a cost system are products and services; however, outputs also can include customers, projects, or business units. Firms use activity consumption cost drivers to assign activity costs to cost objects. Activity cost drivers should explain why the cost of a cost object goes up or down. Typical activity consumption cost drivers are purchase orders, receiving reports, inspection reports or hours, parts stored, payments, direct labor-hours, machine-hours, and setups and manufacturing cycle time.

Benefits of Activity Based Costing:

Since the 1980s an increasing number of firms have adopted the activity-based costing system. These firms adopt ABC because of the benefits it offers.

BenefitsInitially, many firms adopt activity-based costing to reduce distortions in product costs often found in their volume-based costing systems. Volume-based costing systems, generate product or service costs bearing little or no relationship to activities and resources consumed in operations. ABC clearly shows the effect of differences in activities and changes in products or services on costs. Among the major benefits of activity-based costing that many firms have experienced are:Better profitability measures: ABC provides more accurate and informative product costs, leading to more accurate product and customer profitability measurements and to better-informed strategic decisions about pricing, product lines, and market segments. Better decision making: ABC provides more accurate measurements of activity-driving costs, helping managers to improve product and process value by making better product design decisions, better customer support decisions, and fostering value enhancement projects.Process improvement: The ABC system provides the information to identify areas where process improvement is needed.

From the above discussion it should be evident that not only is ABC useful and powerful to any organization, but a need for companies that want to excel, and efficiently and effectively increase their Sustainable Competitive Advantage (SCA).

1. THE IMPACT OF CONTEXTUAL AND PROCESS FACTORS ON THE EVALUATION OF ACTIVITY-BASED

COSTING SYSTEMSShannon W. Anderson, S. Mark Young

In the face of ABC implementation failures, practitioners have focused on improving the process by which ABC is implemented. In many cases the impediment may be the contextual environment. Improving the implementation process may ease the indirect effect of the contextual environment acting through the implementation process; however, it will not affect the direct association between the contextual environment and evaluations of the ABC system. Although ABC systems that are used for cost reduction are likely to be viewed as accurate, the attainment of accuracy is not a sufficient condition to ensure use.

Another contribution of the paper is investigation of three forms of model instability: firm effects, respondent effects, and effects of ABC system maturity. Although the coefficients of particular variables differ somewhat between firms and respondents, removing the constraint that the model coefficients are identical across sub-samples improves model fit more than could be expected by chance. Also separating the sample into mature and recent implementations of ABC leads to significantly different models; moreover the differences are concentrated in the portion of the model related to use of ABC data.For mature ABC systems, use depends on management support and the reward environment. For recent implementations, use is more closely tied to the ABC development team.

The research indicates that models of ABC system evaluation vary with time and our inability to distinguish between several explanations for this. Specifically, the research design did not permit us to distinguish whether differences are caused by a change in respondents’ uncertainty about the costs and benefits of ABC implementation, by real unmeasured differences between sites that self-selected into the early implementation group, or by differences associated with the maturing process. An experimental research approach is only able to disentangle these effects.

Finally, two opportunities exist for the researcher who can enlarge the research sample byeither including more firms while retaining multiple sites at each firm, or by including a broader cross-section of employees at each site. The first approach would make possible a more thorough investigation of the influence of firm-specific contextual variables on dispersed implementation sites. The second approach would allow to disentangle the effects of role involvement in the ABC project and the evaluator’s level in the organizational hierarchy.

2. IMPLEMENTING ACTIVITY-BASED COSTING (ABC) TO MEASURE COMMERCIAL LOAN PROFITABILITY

Kocakulah, Mehmet C, Diekmann, Douglas

The banking industry is one that has experienced a great amount of change in the last 20 years. In attempts to appease shareholders and stock analysts with continued record growth in earnings, and improvements in efficiency, and returns on assets and equity, banks and bank management have moved aggressively and often blindly into new market areas such as insurance, brokerage, and financial and estate planning. The bank's motive is to find other products that impact earnings but require fewer resources. Often, new products are enormously expensive to set up, and they may be either unprofitable or may not yield to senior management's long run earnings goals.

In light of the wide changes in bank product mix and corporate strategies, research was conducted on a sample of commercial loans held at Indiana Bank (name changed for confidentiality purposes) to compare the reported profit from the traditional income model to the calculated profit from an activity-based costing model. The thought process behind this comparison centered on the Bank's better understanding of the true costs of its core operations; thus returning to core profitable activities and departing from becoming caught up in the industry trend of expand or perish.

ABC is a natural fit for the banking industry because there are easily identifiable cost drivers that can be measured and priced per event. As an example, most demand deposit accounts are priced and measured based on monthly activity and usage. A business is charged a certain cost for each check that is written and for each item that is deposited into the business checking account. Similarly, the concept can be applied to commercial lending transaction activities from the initial loan review and setup to the myriad of advance requests, account maintenance requests, and payment applications.

Some key benefits of the ABC approach are to change the way an organization thinks about its costing system and to revitalize the bank's penetration strategies and processes.3 ABC also forces a company to consider its activities, to seek efficiencies, and to consolidate tasks in providing services and conducting business. Considering this action for the banking industry immediately shows that this is a win-win scenario in all circumstances. The customer benefits from a higher level of customer service, and the bank benefits from a streamlined, more cost-effective approach to providing services.

3. THE ADOPTION OF ACTIVITY-BASED COSTING IN THAILAND

Wiriya Chongruksut

‘In today’s world of automation and intense competition, more accurate cost allocations are needed’ (Krumwiede and Roth 1997). An activity-based costing (ABC) system was developed and was paid extensive attention because it does not allocate only manufacturing costs to products like the traditional cost systems, but also assigns other costs, such as administrative costs, marketing costs and so on, to cost objects, which includes activities, products and customers (Krumwiede and Roth 1997).

ABC is a mainstream topic in the management curricula at universities and a management innovation for Thailand at the current time. much literature claims huge benefits from ABC, surpassing those of the traditional cost systems. Thus, ABC had received substantial interest from Thai firms and seemed to be considered one of their alternatives in this turbulent time. Most user firms perceived that ABC was very important and necessary in the current environment. They also believed that it had played a part in helping their firms to survive in the changed environment on the grounds that they perceived many key areas of ABC benefits that supported their firms to be able to cope with the crisis. The benefits claimed were more accurate product/service costs, increase in competitive capability, cost control improvement, assistance in cost reduction, better performance measurement, encouragement of commitment to quality and continual improvement and increase in profitability.

This study was conducted to examine the relationship between the adoption of ABC by firms based in Thailand and the Thai economic crisis (1997) through theoretical models of organisational learning and the relationship between the implementation of ABC and the philosophy of organisational learning. A mail questionnaire survey was considered an appropriate method for this study. The sample was selected from firms listed on the Stock Exchange of Thailand (SET) that operate in the Bangkok region (292 firms). 101 questionnaires were returned, generating a 34.59% response rate. Furthermore, the structured interviews with a selfselecting sub-sample were conducted to supplement the survey data. Out of 101 questionnaire respondents, 12 agreed to be interviewed. The quantitative data were processed using a SPSS program and the qualitative data gathered from the interviews were analysed using content analysis.

4. IMPLEMENTATION OPPORTUNITIES OF GREEN ACCOUNTING FOR ACTIVITY-BASED COSTING (ABC)

IN ROMANIA Sorinel Capuneanu

Green accounting observes the specific principles of the Activity-Based Costing method. Green accounting or environmental accounting is interlinked with two basic functions of management accounting: planning and data collection, reporting. In the case of planning, green accounting uses prevision analysis to measure future impacts on environment, such

as target costing or life cycle method. In the second case, environmental data collection and its reporting to management is based on an efficient analysis of data for substantiating decisions. The aim of green accounting is the acknowledgement and attempt to identify ways of diminishing the negative effects of activities and systems on the environment. Observing the basic principles of Activity-Based Costing method (ABC), green accounting completes the terminology and dictionary of terms used by the ABC method.

Green accounting which observes ABC method principles helps measure saving costs as a result of reducing raw materials cost during the recycling or reusing period. As a consequence, ABC or ABM method provide that understanding approach and those target areas for considering the opportunities of designing costs of the main environmental activities. The environmental cost design represents the concept that refers to the design of an environmental target costoriented product or constraints, such as the design terms of de-assembling a product. Recycling design refers to the product design concept that emphasizes the facility of de-assembling and recycling, as well as the end of a product’s useful life cycle. The usefulness and advantages of activity-based costing method can be revealed by green accounting. The application of the ABC method principles is recommended for prompting environment improvement results.

5. ACTIVITY-BASED COST ANALYSIS: A METHOD OF ANALYZING THE FINANCIAL AND OPERATING

PERFORMANCE OF ACADEMIC RADIOLOGY DEPARTMENTS

Mervyn D. Cohen, Donald R. Hawes, Gary D. Hutchins, William D. McPhee, Michael B. La and Robert P. Fallon

In the face of declining collections per relative value unit (RVU), academic radiology departments must understand in much greater detail the relative costs and profits associated with their lines of business—research, teaching, and clinical activity. The traditional subsidization of research and teaching by clinical profits is no longer sustainable because these profits are disappearing. Managers of academic departments must determine the true costs of their teaching and research missions and the effect the pursuit of these missions has on the competitiveness of the clinical enterprise. In addition, far more precise cost estimates are required to bid successfully on managed care contracts. New management concepts such as mission-based management and balanced scorecard management necessitate a new level of accounting sophistication. Today, many radiology department managers rely on information from a cost system that was designed for a simpler technologic age when competition was local rather than global; when products and services were standard rather than customized; and when speed, quality, and performance were less critical for success.

To develop a methodology for an activity-based cost (ABC) analysis in an academic radiology department, to test the hypothesis that the business of academic radiology can be separated into three distinct businesses clinical activity, teaching, and research and to

determine the effect of the current teaching paradigm on clinical productivity. ABC costing provides a successful understanding of the relative costs of each of the businesses of teaching, research, and clinical activity. It also provided the departmental costs of performing the separate activities typical of each business. Key findings included the following: Faculty spends 72% of time in clinical activities, research is the most expensive service per direct activity hour, and clinical reads (23%) are the single largest departmental cost element. ABC analysis can separate academic radiology into three businesses teaching, research, and clinical—and provide a detailed understanding of the cost structure of each. This analysis identifies opportunities for improved quality of service, productivity, and cost within each business.

6. A MATHEMATICAL PROGRAMMING APPROACH FOR SUPPLIER SELECTION USING ACTIVITY BASED

COSTINGZeger Degraeve and Filip Roodhooft

Vendor selection is an important problem in today's competitive environment. Decisions involve the selection of vendors and the determination of order quantities to be placed with the selected vendors. In this research we develop a mathematical programming model for this purpose using an Activity Based Costing approach. The system computes the total cost of ownership, thereby increasing the objectivity in the selection process and giving the opportunity for different kinds of sensitivity analysis. Moreover, it allows the analyst to objectively evaluate alternative purchasing policies due to the underlying analytic and rigourous decision model.

Management accounting is a system that provides information to decision makers inside the company in order to make better decisions. The analysis of costs throughout the extended value chain of a company is an important topic in today's management accounting literature (Shank and Govindarajan 1992). Activity Based Costing permits to analyze activities and determine cost drivers for the different activities defined. There exists an important literature dealing with possible applications of the system· such as customer profitability analysis, performance management, cost management and pricing decisions. While suppliers are an important part of the total value chain analysis, the application of Activity Based Costing ideas to the vendor selection problem has received little attention. Roehm, Critchfield and Castellano (1992) discuss the use of the system in a purchasing department. They assign additional purchasing costs to products, but not to suppliers. Ellram (1995) studied the total cost of ownership approach based on 11 case studies. She concludes that Activity Based Costing represents an important opportunity for purchasing. She also states that the supplier selection decision is one of the three major uses of these models. a multi-vendor, multi-item, multi-period approach for vendorselection based on activity and cost driver information. Ellram and Siferd (1993) and Benett (1996) give an overview of possible activities and cost drivers that can be used to calculate supplementary internal costs caused by the suppliers. In this approach we recognize a hierarchical structure in activities with respect to the purchasing decision: (1) the supplier level, (2) the order level and (3) the unit level activities. Additional internal costs can be defined on these levels.

7. EXTENDING NEW INSTITUTIONAL THEORY: A CASE STUDY OF ACTIVITY-BASED COSTING IN THE

PORTUGUESE TELECOMMUNICATIONS INDUSTRYMaria Major and Trevor Hopper

a Portuguese telecommunications company Marconi - adopted an activity-based costing system (ABC) in 2000. From the beginning of the 1990’s, following the liberalisation of the Portuguese and European telecommunications industry, Marconi came under considerable pressure to improve its management and cost accounting system (MAS). Pressures for greater efficiency came from several constituencies, particularly the Portuguese telecommunications regulator (ICP), the European Union (EU), the company’s managers, and its parent company, Portugal Telecom (PT). Adopting apparently sophisticated MAS, such as ABC could enable Marconi to demonstrate that they were improving efficiency and competitiveness. Apart from this pressure, there were concerns from public and society (including Marconi’s new competitors) that Marconi/PT might not base interconnection prices on accurate and reasonable costs when interconnecting new operators to their telecommunications network. ABC gave more and better costing information to Marconi’s managers. The most proactive interests in the process of adopting a new cost accounting system were those of top directors and commercial managers. This was because data was needed to support investment decisions in cable submarines and to support other commercial decisions. These reasons were the most decisive ones. However, PT and ICP were also very important factors in choosing the cost accounting model format.

Replacing Marconi’s MAS by an ABC system resulted from the convergence of first, cost accounting demands made by the regulator; second, stock exchange requirements following privatisation; and third, the information demands of managers following market liberalization. As result of this the management accountants frequently received inputs into the ABC system late. From its beginning, Marconi’s ABC system did not generate cost data on time, provoking complaints by commercial managers of the lateness of cost data to support pricing strategies and investment decisions. When establishing prices they usually took the latest available ABC cost data, together with information on the pricing strategies of competitors. When making investment decisions they just used the latest ABC data. They seemed unperturbed by this situation, though they were critical of ABC providing delayed data. When the commercial managers were asked whether the difficulties in obtaining accurate and punctual data affected their use of ABC, they argued that ABC provided more accurate cost information than Marconi’s previous MAS.

8. APPLYING THE ACTIVITY-BASED COSTING TO CUT-TO-LENGTH TIMBER HARVESTING AND TRUCKING

Tuomo Nurminen, Heikki Korpunen and Jori Uusitalo

In the last ten to fifteen years, remarkable changes have occurred in the timber procurement that is based on mechanised cut-to-length (CTL) harvesting.The supply chain of the forest industry has increasingly been adjusted to the customer’s needs for precision and quality. This has changed the operative environment both in the forest and on the roads. As the total removal of timber is increasingly divided into more log assortments, the lot size of each assortment decreases and the time consumed in sorting the logs increases. In this respect, the extra assortments have made harvesting work more difficult and affected the productivity of both cutting and forest transport; this has thus increased the harvesting costs.

An activity-based cost (ABC) management system is introduced for timber harvesting and long-distance transport, based on the cut-to-length (CTL) method, in which the logistic costs are assigned to timber assortments and lots. Supplying timber is divided into three main processes: cutting, forest transport, and long-distance transportation. An ABC system was formulated separately for each of these main operations. Costs were traced to individual stands and to timber assortment lots from a stand. The cost object of the system is thus a lot of timber that makes up one assortment that has been cut, forwarded, and transported from the forest to the mill. Application of the ABC principle to timber harvesting and trucking was found to be relatively easy. The method developed gives estimates that are realistic to actual figures paid to contractors. The foremost use for this type of costing method should be as a tool to calculate the efficiency of an individual activity or of the whole logistic system.

9. FINANCIAL STATEMENT ANALYSIS AND ACTIVITY-BASED COSTING ANALYSIS FOR SHIPPING INDUSTRY:

A DATA ENVELOPMENT ANALYSIS APPROACH Wen-Cheng LIN and Chin-Feng LIU

Ratio analysis is a commonly used analytical tool for verifying the performance of a firm. Easy computed ratios explain their wide appeal although interpretation is problematic, especially when two or more ratios provide conflicting signals. A good ratio analysis management is critical for successful business. However, during the late 1970s and early 1980s, the methodology of ratio analysis was considered suspect, especially by the advocates of the strong form of the efficient market hypothesis. While ratios are easy to compute, which in part explains their wide appeal, their interpretation is problematic, especially when two or more ratios provide conflicting signals. Cheng built a method to measure inefficient companies in shipping industry through identifying the waste and causes. However, shipping industry needs much resource and cost-down to maintain operation efficiency.

Activity-Based Costing (ABC) is an information system developed in the 1980s to overcome some limitations in traditional cost accounting and enhance its usefulness to operation management. Data envelopment analysis (DEA) is a handful method for evaluating DMU’s activities. An overall operation management without ABC cannot reveal specific activity areas. Therefore, there is a need to combine and integrate two separated but widely used models for measuring costs and efficiency performance. The results show that a better operation management of the shipping industry, including product planning and design, quality management and control, process design and improvement, and work force management, could achieve cost reduction and improve efficiency while integrated DEA, financial statement analysis and ABC analysis.

10. ACTIVITY-BASED COSTING AN EMERGING FOUNDATION FOR PERFORMANCE MANAGEMENT

Peter B.B. Turney

The hype cycle is a graphic representation of the maturity, adoption and business application of a technology. It reflects differences in human attitudes to the technology as knowledge increases and risk decreases over its development and deployment cycle1. Early in the cycle there is little practical knowledge about the technology. Thus, an organization’s cost/benefit analysis is often dominated by unknown risk factors making an adoption decision difficult. As knowledge accumulates over the cycle risks reduction occurs facilitating more informed judgments regarding adoption.

Like most technologies, ABC’s life cycle is marked by changing attitudes and increasing diffusion into the marketplace over time. Intense interest at the beginning of its life gave way to criticism and lowered visibility, followed by a longer, unpublicized period of steady growth in adoption rates and functionality. It has now reached maturity and acceptance in the marketplace for management ideas and methods. ABC evolved greatly over more than two decades. Evolving from early experiments in costing, ABC emerged as a tool for profit improvement and ABM was adapted for use in the extended value chain and multiple industries, and enhanced for resource and capacity planning. In its most recent iteration, ABC is a multi-faceted algorithm and database of financial and organizational information. It supports performance management systems where business users can access ABC-derived decision relevant information from their desk top.

One lesson is that ABC is an integrated family of analytic costing methods. A single ABC model can support historical cost measurement, predictive cost measurement, resource planning, capacity planning, performance measurement and other analyses. Another lesson is that the developments of ABC are sometimes misunderstood, and this may lead to confusion and rejection. For example, assessing the value of ABC in lean accounting will result in one answer if the assessment focuses on the first generation ABC costing method. It will result in a different answer if the focus is on ABC as a process-based resource and capacity planning tool. Understanding the cost-effectiveness of today’s ABC is important to assessing its value as a strategic tool in today’s hyper competitive and volatile global economy. Assessing yesterday’s ABC against today’s

requirements is akin to assessing the power, comfort, handling, environmental impact, safety and fuel consumption of today’s automobile based on a study of the Model T Ford.

11. ACTIVITY-BASED MANAGEMENT IN A SMALL COMPANY: A CASE STUDY

A. Gunasekaran, R. Mcneil and D. Singh

The analysis and cost of activities provide financial and non-financial information which is the basis for activity based management (ABM). ABM makes this cost and operational information useful by providing a value analysis, cost drivers and performance measures to initiate, drive or support improvement e€ orts, and hence to improve the decision-making processes. Cost Accounting Management-International (CAM-I) defines ABM as `a discipline that focuses on the management of activities as the route to improving the value received by the customer and the profit achieved by providing this value’. This discipline includes cost drivers analysis, activity analysis and performance measurements. ABM draws on activity-based costing (ABC) as its major source of information (Berliner and Brimson 1988). The goals of ABC can be achieved by managing the activities. It is important to realize that managing activities is not a custodial task. Rather, it is a process of relentless and continuous improvement of all aspects of a business. This involves a continual search for opportunities to improve which in turn involves a careful and methodical study of activities (Kaplan 1984).

Management practices and methods have been changed over the last decade, and organizations are moving from managing vertically to managing horizontally. Activity-based costing and activity-based management provide cost and operating information that mirror the horizontal view. ABC provides accurate cost information and ABM uses this information to initiate improvements. ABC systems produce a large amount of information that is used by the ABM. The costing at part level or subassembly level helps the management in a make or buy decision. The analysis of activities to identify value-added and non-value-added activities and benchmarking at the activity level direct improvement efforts in the right direction.

12. TIME-DRIVEN ACTIVITY-BASED COSTINGRobert S. Kaplan and Steven R. Anderson

The traditional ABC model has been difficult for many organizations to implement because of the high costs incurred to interview and survey people for the initial ABC model, the use of subjective and costly-to-validate time allocations, and the difficulty of maintaining and updating the model as (i) processes and resource spending change, (ii) new activities are added, and (iii) increases occur in the diversity and complexity of individual orders, channels and customers.

Time-driven ABC requires estimates of only two parameters: (1) the unit cost of supplying capacity and (2) the time required to perform a transaction or an activity. A time-driven ABC model:

• can be estimated and installed quickly• is easily updated to reflect changes in processes, order variety, and resource costs• can be data fed from transactional ERP and CRM systems• can be validated by direct observation of the model’s estimates of unit times• can scale easily to handle millions of transactions while still delivering fast

processing times and real-time reporting• explicitly incorporates resource capacity and highlights unused resource capacity

for management action• exploits time equations that incorporate variation in orders and customer behavior

without expanding model complexity.

The heterogeneity in transactions can be handled in two ways by the ABC system. One is to expand the number of activities, into say handling a simple order, an average order, and a complex order. The resource costs then have to be assigned to the three types of order-handling activities, and a transactions driver − number of simple, average and complex orders − defined for each activity. Alternatively, the cost system can use duration drivers, which estimate the time required to perform the task. Examples of duration drivers are setup hours, material handling time, and, of course, direct labor hours and machine hours. While duration drivers are generally more accurate than transaction drivers, they are also more expensive to measure, so cost system designers have typically used transaction drivers whenever they reasonably approximate resource demands by each occurrence of an activity. The approach is simple to adopt and companies that have implemented the approach, enjoyed rapid and significant profit improvements.

13.THE ASSOCIATION BETWEEN ACTIVITY-BASED COSTING AND IMPROVEMENT IN FINANCIAL

PERFORMANCEDouglass Cagwin

Activity-Based Costingi (ABC) has been promoted and adopted as a basis for making strategic decisions and for improving profit performance (Kaplan and Norton 1992; Turney 1992; Cooper and Kaplan 1991). In addition, as Kaplan (1990) predicted, ABC information is now also widely used to assess continuous improvement and to monitor process performance. Although ABC has found rapid and wide acceptance, there is significant diversity of opinions, however, regarding the efficacy of ABC (McGowan and Klammer 1997). Despite managers’ insistence that management accounting systems pass the cost-benefit test, there still is no significant body of empirical evidence to validate the alleged benefits of ABC (Shim and Stagliano 1997; McGowan and Klammer 1997). Empirical research is needed to document the (financial) consequences of ABC implementation (McGowan 1998). The research instrument is a cross-sectional mail survey of 1,058 internal auditors, claimed to be knowledgeable and unbiased in the assessment of cost systems (Tanju and Helmi 1991; Ray and Gupta 1992). Confirmatory factor analysis and structuralequations modeling using LISREL8 (Joreskog and Sorbom 1993) are used to test a model hypothesizing the conditions under which there is a positive association between (time-

impacted) use of ABC and change in financial performance. Control is provided for the moderating effects of concurrent use of other strategic management initiatives (e.g., TQM, JIT), and enabling conditions identified by prior research. In addition, this study tests the association between improvement in financial performance and previously used measures of ABC efficacy, as suggested by Foster and Swenson (1997).

Internal auditors furnish information regarding company financial performance, extent of ABC usage, and enabling conditions that have been identified in the literature as affecting ABC efficacy. Confirmatory factor analysis and structural equation modeling are used to investigate if, and under what conditions the use of ABC is associated with improved financial performance. Results show that there indeed is a positive association between ABC and improvement in ROI when ABC is used concurrently with other strategic initiatives, when implemented in complex and diverse firms, when used in environments where costs are relatively important, and when there are limited numbers of intra-company transactions. In addition, measures of success of ABC used in prior research appear to be predictors of improvement in financial performance.

14. ACTIVITY-BASED COSTING IN THE PUBLIC SECTORAthanasios Vazakidis, Ioannis Karagiannis and Anthi Tsialta

In the modern economic environment, the Public Sector aims at the continuous improvement of quality of the provided services. Thus, detailed information with regard to the cost of services is essential along with capable management to take advantage of this information. The study discusses the basic beginnings, the processes of activity-based costing and whether this costing method can be applied in the Public Sector, where the need for precise cost estimating information increases continuously. It refers to the structure of a Greek Prefecture, with all the organized divisions and departments. At first, the new method of cost accounting is analyzed as mentioned in the international bibliography. Activity-Based Costing depends on the analysis of the activities participating in an organization, supposing that these activities create-consume cost in order for the products or services to be produced. Thus, in order to obtain the cost information needed, this method not only notes the activities, but also analyses all the elements regarding the time, the way, the resources of each activity or function (a number of activities).

Thereafter, the advantages of this method were pointed and then, follow the application in a specific Department of the prefecture where the results were delivered to the Administration of department under review, for the decision making. Conclusion: Having analyzed the department of the prefecture, the management can depend on the results to comment on the study done and decide on future plans.

This research can be used as a pilot in any attempt of implementing Activity-Based Costing in Public Sector. The use of this method with the cooperation of new technologies and new methods of management, can resolve all the deficiencies of PublicSector, so as citizens and companies will be better served.

15. FACTORS INFLUENCING ACTIVITY BASED COSTING (ABC) ADOPTION IN MANUFACTURING INDUSTRY

Ruhanita Maelah and Daing Nasir Ibrahim

Today’s business environment, organizations encounter various challenges that require them to adapt effectively in order to remain competitive. For instance, structure of product cost in many contemporary businesses had changed substantially with production and non-production overhead costs growing in relative size and importance. Direct labor, on the other hand, had shrunk dramatically due to increased automation. Despite these changes, traditional accounting system has remained unchanged throughout the period. In traditional cost accounting system, direct labor and machine hours have persisted as major bases of production overhead absorption by products. Both of these bases relate fairly closely to production volume and their use therefore rests on the assumption that overhead incurrence is output driven. In addition, the frequent attachment of non-production overheads to output in proportion to their production cost remains a widely used unitization method. The validity of this practice is questionable, as overhead incurrence may often bear no close relationship to their production cost.

In the 1980’s much criticisms were raised regarding the ability of traditional cost accounting to provide relevant, timely, and accurate information to the management. During that period, ABC has emerged as one of the management accounting tools that recognizes such concern. Since then ABC has gained its popularity and has received substantial attention from various parties including the academicians, practitioners, and industries. ABC has also been studied from various perspectives for quite some time in many countries. Unfortunately, studies have found that the level of ABC adoption is still considered low. Many organizations still use the traditional cost accounting methods in dealing with overhead costs. This study investigates the status of ABC adoption among manufacturing organizations in Malaysia, and the factors influencing its adoption. Mail survey questionnaires were distributed to manufacturing organizations throughout the country using purposive judgment sampling. The questionnaires were directed to the accountants or heads of accounts of selected manufacturing organizations. The study found that ABC adoption in Malaysia is at infancy stage, with 36% adoption rate. The factors that influence ABC adoption are decision usefulness of accounting information, organization support, and internal measures of performance.

References:

Barbato, M., Collini, P. and Quagli, A.1996, ‘Management Accounting in Italy: Evolution within Tradition’, in Management Accounting: European Perspectives, edited by Bhimani, A., Oxford University Press, Oxford.

Baxandale, S.J.1999, ‘Activity-Based Costing for A Claims Processing Operation’, CPCU Journal, Summer, Vol.52, Issue.2, pp.84-89.

Brooks, A. and Oliver, J.1993, ‘Activity-Based Costing Systems in Service Oriented Organisations: Some Field Study Evidence’, Management Accounting Research Conference, San Diego, USA, Unpublished.

Bruggeman, W., Slagmulder, R. and Waeytens, D.1996, ‘Management Accounting Changes: The Belgian Experience’, in Management Accounting: European Perspectives, edited by Bhimani, A., Oxford University Press, Oxford.

Dervitsiotis, K.N.1998, ‘The Challenge of Managing Organisational Change: Exploring the Relationship of Re-engineering Developing Learning Organisations and TQM’,Total Quality Management, Vol.9, Issue.1, February , pp.109-112.

Fiol, C.M. and Lyles, M.A.1985, ‘Organisational Learning’, Academy of Management Review, Vol.10, No.4, pp.803-813.

Garvin, D.A.1993, ‘Building a Learning Organisation’, Harvard Business Review, July- August, pp.78-91.

Shields, M.D. An Empirical Analysis of Firms’ Implementation Experiences with ABC // Journal of Management Accounting Research, 1995. – No 7. – pp. 148-166.

Yau, F.S., Z.A.Robani, Linkage Between Intensity of Competition and Use of Performance Measures in Malaysian Manufacturing Firms. Akauntan Nasional, 1998. – February-March. – pp. 45-50.

Vazakidis, A. and I. Karagiannis, 2006. Activity-based costing in higher education: A study of implementing activity-based costing in University of Macedonia. Proceeding of the 5th Conference of the Hellenic Finance and Accounting Association, Dec. 15-16, ScientificCommens, Thessaloniki, Greece, pp: 1-1. http://en.scientificcommons.org/41575796

http://www.deada.gr/index.php?option=com_content&task=view&id=57&Itemid=74

http://www.customwritten.com/Writing/activity-based-costing-research.html

http://www.sciencedirect.com/science/article/pii/S1044500500901355

http://www.ijtef.org/papers/26-C130.pdf

http://www.hbs.edu/research/facpubs/workingpapers/papers2/0304/04-045.pdf

http://www.irc.caltech.edu/pdf/courses/Activity%20Based%20Costing.pdf

http://www.nesc.wvu.edu/ndwc/articles/OT/SU04/ActivityBasedWS_WI99.pdf

http://www.easts.info/publications/journal_proceedings/journal2010/100306.pdf

http://www.sas.com/resources/whitepaper/wp_5073.pdf

http://www.offtech.com.au/abc/ABC_PDF/1999-04.pdf

http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.pdf

www.businessperspectives.org/journals_free/imfi/2007/imfi_en_2007_02_Maelah.pdf

http://www.sciencedirect.com/science/article/pii/S0361368299000112

http://www1.umassd.edu/charlton/birc/abc_sme.pdf

http://www.scipub.org/fulltext/jss/jss63376-382.pdf

http://www.hbs.edu/research/facpubs/workingpapers/papers2/0304/04-045.pdf

http://www.ejbe.org/EJBE2010Vol03No06p85WNUKPEL.pdf

http://www.instituteofat.org/magazine/design_implementaion.pdf

http://www.aabri.com/manuscripts/08075.pdf

http://www.offtech.com.au/abc/ABC_PDF/virginia98.pdf

http://www.academicjournals.org/AJBM/PDF/pdf2010/18July/Blagojevic%20et%20al.pdf