Activity-based costing

Why activity based costing cannot be overlookedA look into the managerial myth that activity-based costing is too much like hard work!

Activity-based costing (ABC) projects traditionally create visions of armies of accountants locking themselves away in darkened rooms, working for months on end to generate any meaningful results, only to have them finally dismissed by line managers as being out of date and unreliable.

The time-consuming, cumbersome and costly process of manually collecting, and collating non-system data from a large number of contributors to refresh and recalculate the ABC Model means that most management accountants cannot provide reports in line with business managers’ monthly management reporting cycles. Activity-based costing is therefore clearly failing to deliver, but why?

The reason is clear. It is common with ABC to find activity dictionaries that run to many hundreds and occasionally thousands of activities, as extraneous activities that account for minute amounts of cost are included into the ABC system on the basis that "you never know what you might need one day".

Consequently, activity-based costing models become too much hard work, over-complicated, and so complex that managers within the business no longer trust the results and dismiss them - resulting in limited benefit delivered to the organization.

In addition, few responsibility centers carry out only one activity. This means that increasing the number of activities in a model also increases the amount of non-system driver data that needs to be collected across the business, such as the proportion of time spent on each activity, or the number of staff carrying out an activity. Traditionally, this data was collected by paper-based surveys and therefore required collating and re-keying into the ABC model.

Furthermore, the information and insight generated by activity-based costing is worthless until executives and manager’s right across the organization can access it and use it to inform their decision-making. Typically this means exporting the data out of the ABC application into spreadsheets or a business intelligence tool before manipulating it and distributing to management in a variety of different formats that are meaningful to the variety of stakeholders. If the project is supporting multi-dimensional cost and profitability analysis, such as product, customer and channel profitability, that is usually only available to selected managers and requires strict levels of security. As a result the amount of time and cost expended in reporting can be extensive. So is it time to lay ABC to rest?

No. The rise of Web technologies has ultimately placed ABC firmly back upon the corporate agenda. Organized correctly, Web-based activity-based costing can substantially reduce the time, cost and resources traditionally associated with ABC.

As a result, it has the potential to deliver frequent insight into what drives costs and profits across an enterprise and can provide managers with information that enables them to take the guesswork, risk and politics out of decisions such as pricing, key account negotiation and product strategy. So, how can this be achieved?

Rather than starting with the general ledger and working down through activities to cost objects such as products and customers, it is far more effective to start with the cost objects themselves, and understand how the information will be used to support decision-making within the organization. Then it is essential to work back through activities, reallocations and cost pools and only add complexity when it is required for allocating substantive amounts of cost using different drivers. This is achievable using Web-based ABC, and its Web-based functionality also simplifies data collection.

The work management tools associated with Web-based activity-based costing allow administrators to design, schedule and monitor repetitive processes, such as collecting non-system driver data from large numbers of office-based or remote branch contributors. Once configured, the data collection routine can be scheduled time and time again, helping to expedite the collection of data to refresh the ABC models, with little or no human intervention required to manage the process

In addition, if the ABC application is truly multi-dimensional and knows which activities are carried out in which departments, a single screen design will suffice for a large number of contributors, only displaying the activities and drivers that are relevant to them.

Using wizards, administrators can map the data collection process, including such things as e-mail reminders that Web books are awaiting completion or are overdue, alerts to contributor’s superiors to review their submission and even e-mail alerts that deadlines have not been met. ABC project managers can even include alerts to themselves to tell them that the data collection is complete and the ABC model is now calculating, having first run its own self-validation routine to check that every piece of data is in place.

Web books can also be designed for reporting. Again with intelligent context, a single Web book may satisfy the needs of many users, as it will only display information that is relevant to the user’s responsibility center or to which they have authorized access.

Where there is a performance management or business intelligence portal already in place, organizations may prefer to report through data integration tools, such as OLE/DB for OLAP, to access the data from the ABC application.

Furthermore, most organizations that have migrated activity-based costing programs to Web-based applications focus on providing management with more frequent reports, moving from quarterly to monthly reporting in line with traditional management reporting.

Quarterly management accounts allow managers to track their expenditure on resources such as staff. But monthly activity costs allow managers to understand trends in the unit cost of the activities that staff perform and monitor the impact of initiatives designed to improve productivity and reduce costs. This information is particularly important in departments that carry out highly repetitive activities, such as customer contact centers.

In addition, wider employee buy-in can also be gained as Web deployment enables ABC reports to be quickly and easily distributed to a large community of users. This allows managers to do their own analysis wherever they happen to be.

Armed with a deep insight into costs and profitability from Web-based activity-based costing, managers not only make better decisions, but also make those decisions faster, resulting in a more agile organization that will outperform its peers.

Web-based ABC removes many of the obstacles to its wider adoption - the adage that activity-based costing is hard work is now a managerial myth!