ACTIVITYBASED COSTING BEYOND THE SMOKE AND MIRRORS

This essay ACTIVITYBASED COSTING BEYOND THE SMOKE AND MIRRORS has a total of 3199 words and 20 pages.

ACTIVITYBASED COSTING BEYOND THE SMOKE AND MIRRORS



ACTIVITY-BASED COSTING: BEYOND THE SMOKE AND MIRRORS

Summary

The business environment in the 1990s is markedly different from that
of the past when conventional cost accounting procedures were
established. Activity-based costing (ABC), pioneered in the late
1980s, offered a new costing approach consistent with the changed
environment. However, ABC did not diffuse rapidly into the business
community. This article demonstrates why adopting ABC is important by
documenting the potential of ABC in supporting contemporary managerial
decision making.

Introduction

Everything happens faster in business today. Even new management tools
(some say "fads") follow a meteoric path. For example, the ink on new
articles describing activity-based costing (ABC) was hardly dry before
consulting firms had integrated it into their slick brochures and
presentations. All they needed was someone to use it. To illustrate,
Romano identified only 110 installations by August 1990, nearly two
years after the procedure was developed, with 77 percent of these in
two major firms [13]. Perhaps this phase, in the process of
introducing the new procedure, could be called "the period of wild
over-promise." However, even by the mid-1990s, ABC has not spread
widely throughout the industry and "even in large firms, widespread
success of ABC is not obvious" [16].

According to Ness and Cucuzza, "thousands of companies have adopted or
explored the feasibility of adopting ABC. However, (they) estimate
that no more than ten percent of companies now use activity-based
management in a significant number of their operations" [11]. A survey
conducted by the Institute of Management Accountants\' cost management
group found that only 29 percent of companies used ABC instead of
traditional systems, but this was an increase from 25 percent in the
previous year [10]. Among reasons cited for low adoption were employee
resistance and major organizational changes required with the use of
ABC [11]. Some trace the source of slow adoption of ABC to technical
as well as cultural issues [5]. Others feel that ABC would be more
widespread in industry if it were marketed better by the cost
accounting profession itself [1].

As the dust has settled, ABC has turned out to be less a revolutionary
technique than a useful refinement to proven systems. The costs of
products and services must be accurate, or management can be misled.
Decisions can rarely be better than the information on which they are
based. ABC allocates costs to the things people are doing in companies
and assures that these costs are paid by the products that generated
them. The "corporate socialism" in which some products pay the bills
of other products is exposed. It is the purpose of this article to
illustrate how ABC more accurately reveals the true costs of operating
in the business environment of the mid-1990s and supports managerial
decision making by providing information consistent with this
environment. Beyond the smoke and mirrors, ABC can contribute to
success.

What is ABC?

The full cost of a manufactured product or line of products includes
direct labor, material, variable overhead, and fixed costs. Direct
labor and material are normally observed and measured by manufacturing
and maintained as "standards." The overhead costs are reported by
responsibility centers, such as departments or plants. The difficult
decision is what to do about allocating overhead costs to products or
territories.

The typical business uses a two-step system for absorption costing in
which costs are accumulated in a pool and then allocated to specific
products based on a single, plant-wide base, such as direct labor
hours utilized in producing the product [2]. Other allocation bases
are machine hours or direct labor cost, for example. The wide use of
direct labor hours as an allocation basis is historical. When cost
accounting systems were being developed in the mid-1920s, labor was a
major cost and thus a target of management attention. However, it is
now apparent that the historical model is oversimplified. Direct labor
costs that once accounted for 80 percent of all costs, now account for
no more than eight to 12 percent of all costs in advanced
manufacturing industries [17]. Indeed, "marketing costs make up more
than 50 percent of the total costs in many product lines," not direct
labor costs [8].

Activity-based costing, pioneered by Harvard\'s Cooper and Kaplan,
responded to changes in the business environment with a new approach
that allocated staff and overhead costs to products (or lines or
territories) based on how the products actually consumed or generated
the costs [3]. The process is similar to that used by engineering to
develop a bid or to estimate the cost of a project. ABC identifies
systematic cause and effect linkages between products and costs,
before resorting to across-the-board allocations. In ABC, these
linkages are

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Topics Related to ACTIVITYBASED COSTING BEYOND THE SMOKE AND MIRRORS

Management accounting, Activity-based costing, Cost accounting, ABC, Smoke and mirrors, Mirror

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