Activity-Based Costing: Introduction
E xc e r p t e d fro m
Cost & Effect: Using Integrated Cost Systems to Drive Proﬁtability and Performance By
Robert S. Kaplan and Robin Cooper
Harvard Business School Press Boston, Massachusetts
Copyright 2006 Harvard Business School Publishing Corporation All rights reserved Printed in the United States of America This chapter was originally published as chapter 6 of Cost & Effect: Using Integrated Cost Systems to Drive Proﬁtability and Performance, copyright 1998 Harvard Business School Publishing Corporation. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior permission of the publisher. Requests for permission should be directed to firstname.lastname@example.org, or mailed to Permissions, Harvard Business School Publishing, 60 Harvard Way, Boston, Massachusetts 02163. You can purchase Harvard Business School Press books at booksellers worldwide. You can order Harvard Business School Press books and book chapters online at www.HBSPress.org, or by calling 888-500-1016 or, outside the U.S. and Canada, 617-783-7410.
Activity-Based Costing: Introduction
We discussed, in Chapter 3, the failures of Stage II standard cost and ﬂexible budgeting systems to provide relevant information about operational improvements and about the costs of organizational processes, products, and customers. Chapters 4 and 5 dealt with the ﬁrst major component of Stage III cost systems, the systems to provide ﬁnancial and nonﬁnancial measurements that will promote employee continuous improvement activities. In this chapter we introduce the innovation of activity-based costing (ABC) as the second major component of Stage III cost systems. ABC systems require a new kind of thinking. Traditional (Stage II) cost systems are the answer to the question, ‘‘How can the organization allocate costs for ﬁnancial reporting and for departmental cost control?’’ ABC systems address an entirely different set of questions: 1. What activities are being performed by the organizational resources? 2. How much does it cost to perform organizational activities and business processes? 3. Why does the organization need to perform activities and business processes? 4. How much of each activity is required for the organization’s products, services, and customers? A properly constructed ABC model provides the answers to these questions. An ABC model is an economic map of the organization’s expenses and proﬁtability based on organizational activities. Perhaps referring to it as an activity-based economic map rather than as a cost system clariﬁes its purpose. Can one drive from one location to another without a map? Can one build a house without a set of architectural drawings? Absolutely. If a
COST AND EFFECT
manager is working in familiar territory (either a drive we’ve taken or a house we have built hundreds of times before), the manager can rely on experience and good judgment for a successful outcome. But when the territory is new, and conditions have changed in important ways from prior experience, that’s when an information system like a good map or a good set of drawings becomes invaluable. For companies operating in stable environments, with mature products that the company has extensive experience producing and with stable customer relationships, the company’s traditional Stage II cost system, or perhaps no cost system at all, can guide operations. But if the company is producing many new products, introducing new processes, reaching new customers, and satisfying many more customer demands, it is easy for the company to get lost, economically, as it operates in a new environment. An activity-based cost system provides companies with an economic...