Activity Based Costing - 2

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ABC: too much activity and not enough costing?
by Brian Rutherford
03 Feb 2001

Diploma in Financial Management
Relevant to Paper D2| |
Activity based costing (ABC) hit the world of financial management with a very large bang in the late 1980s. Within a few years 20% of the UK’s largest companies were using, or at least piloting, ABC systems. By the turn of the millennium, however, the proportion of adopters was no higher, while one third of those adopting the technique earlier had actually abandoned it. Only one third of those companies considering the use of ABC in 1994 had actually adopted the system by 2000. Why are practising financial managers proving so reluctant to embrace this revolution in one of their key disciplines, when it is so widely praised in the literature and so vigourously marketed by consultants? Are we looking at an example (our critics would say yet another example) of the traditional conservatism of our profession? Certainly that’s the view consultants would urge on our fellow-managers. A defender of the profession might first point out that ABC is far from guarenteed to work. Indeed, its claim to provide “accurate” costings - truly breathtaking to accountants brought up to believe in different costs for different purposes - are generally exaggerated because in many situations there will be costs (essentially those relating to non-separable resources) that ABC doesn’t handle much better than traditional costing. Appendix A (see over) illustrates the deficiencies of ABC. Nonetheless, the accusations against traditional (volume-based) costing on the back of which ABC was launched is valid. Where overheads are high and plants produce a range of items with significantly different volumes and complexity, volume-based systems over-cost high volume lines and send the wrong signals about pricing, product choices and resource allocation. But the uselessness of absorption costing for taking decisions in these areas has been understood for years and taught to generations of students - who have, indeed, been examined on the subject in grizzly detail. Are we to believe that once they qualified and hit the streets - or rather the multi-product plants - accountants forget all they have learned and respond like automata to the data emerging from traditional absorption costing systems? It seems more likely that strategic management accountants know that the output of absorption systems must be treated with caution - and look for additional evidence when important decisions have to be taken. There are, of course, well-documented tendencies for the bare numbers to drive decisions - especially where they are made by groups which include non-accountants, who may not appreciate just how complex are the measurement issues involved. Thus, Johnson and Kaplan’s high profile reinforcement of the need to identify relevant costs correctly was to be welcomed. But was the “invention” of a whole new and apparently revolutionary system equally welcome - or even necessary? The installation of ABC systems is inevitably a very complex and expensive business. To the direct costs of creating the new system must be added the risk involved in dismantling legacy systems and managing the transfer. Given that traditional systems work well in some situations and ABC doesn’t always give the right answer, managers are right to be cautious. What should worry our profession is that all the hype surrounding ABC may itself damage good financial management. Companies that feel they must make an “all or nothing” decision, to move to ABC or stay where they are, may miss opportunities to refine their current systems. If they do not make the move to ABC, they may spend a great deal of money for little more benefit than they could obtain from such refinements. Accountants themselves may lose confidence in the fundamentals of their discipline, feeling pressured to adopt the latest fad rather than calmly asking what steps...
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