An ABC Simulation Focusing on Incentives and Innovation

Article excerpt

ABSTRACT: Current textbooks advocate activity-based costing (ABC) because it provides more detailed information on resource usage, leading to better cost control and reengineering of production processes. However, there is often little attention paid to how other organizational control features can affect the use of the information provided by ABC systems. This active learning simulation demonstrates that incentives can have a significant impact on how workers use ABC information to manage costs and innovate a production process. The simulation involves two student teams that are furnished with identical ABC cost driver information and either a tournament- or group-based incentive structure. The teams simulate a factory environment by creating products using a simple manufacturing process, while the remaining students observe the process and record differences in communication, innovative activity, and resulting profitability. The teams' outcomes under the two separate incentives illustrate the interaction of a firm's cost system with its incentive system. Typically, we find that more communication occurs among team members, more team-based innovations are created, and profit is higher under group incentives. We conclude that the use of ABC, without consideration of employee incentives, may not result in the desired cost control and process reengineering benefits. In this simulation, students are directly involved in providing the data, so they find the inferences drawn to be compelling.

INTRODUCTION

The purpose of this simulation is to demonstrate two issues associated with the use of Activity-Based Costing (ABC). First, some of the benefits of using ABC information occur when workers innovate and change processes affecting nonunit cost drivers. These processes are often under the control of multiple individuals, and to change them requires cooperation. Second, incentives can play a crucial role in the use of ABC information because they affect how workers interact and use information to manage costs and innovate. The active learning simulation described here demonstrates these issues in a way that encourages student involvement and promotes academic learning (Francis et al. 1995; Kurfiss 1988). This simulation is most appropriate for students at the undergraduate or graduate level who have some familiarity with ABC.

The organization of this paper is as follows. We first provide an overview of the cost system and incentive issues that the simulation addresses. We then describe the simulation and provide a guide for conducting the exercise that includes a listing of the time line, procedures, and major points to convey to the students during the simulation. Individual faculty will likely need to alter the details provided here to fit their classroom situation and pedagogical purposes. The concluding sections contain suggestions for debriefing the class and more detailed outcome-assessment information. We also provide several recommended readings that can be assigned in conjunction with the simulation. The last section of the paper consists of Appendices containing easily photocopied forms, tables, and figures to be distributed and used during and after the simulation.

THEORETICAL BACKGROUND

Activity-based costing, which is an extension of traditional volume-based costing, treats manufacturing overhead as a complex set of costs with multiple drivers. Current textbooks advocate activity-based costing (ABC) because it provides more detailed information on resource usage, which can lead to better cost control and reengineering of production processes. Students typically learn the mechanics by calculating assigned overhead based on multiple drivers at differing levels, e.g. unit, batch, and product (cf. Williams et al. 2002, Chapter 17; Hilton 1999, Chapter 5; Horngren et al. 2000, Chapter 5). While mechanical calculations are useful, they are insufficient to enable students to understand concomitant organizational control features necessary for successful ABC implementations. …