Activity-Based Costing Offers Big Benefits in Downsizing Era

Article excerpt

Activity-based costing (ABC) clarifies fuzzy issues for managers the same way the Hubble telescope helps astronomers unlock the secrets of the universe.

The example may be overdrawn, but not the fact that ABC generates a new source of information previously beyond the reach of managers facing resource allocation challenges.

It looks at the how rather than the what to help solve problems.

Activity-based costing is a methodology that lets the customer see the true cost of products and services. It measures the cost of resources consumed by activity in the production process.

Problems manifest themselves in many ways: declining or uncertain budgets, declining revenues, dissatisfied customers, frustration among employees challenged to do more with less, obsolete or obsolescent services or products, and pressures from departmental and congressional officials to become lean and mean.

Activity-based analysis, using the ABC costing model as a baseline tool, facilitates identification, assessment, and implementation of solutions to these complex problems.

To remain competitive, organizations must know what activities, products, and services really cost, and understand what drives that cost. This simple rule is almost universally not followed because nearly all forms of cost accounting used in the public and private sectors do not accurately provide that information-activity-based costing can.

Customers and oversight entities, including the administration, Congress, and the public, increasingly demand less cumbersome, more responsive, cost effective, government support.

This is an era of downsizing, rightsizing, outsourcing, privatization, and competition for increasingly scarce resources. Restructuring, downsizing, performance improvement, customer responsiveness, and a new set of legal requirements demand that governmental managers operate on the cutting edge of business practices.

Government agencies must access and use the latest in managerial information to make timely and accurate decisions with managers providing the highest quality service at the lowest possible cost.

The challenges include allocating funds among competing policy objectives, integrating financial and non-financial performance measures, identifying which improvement initiatives should be pursued, what they would cost, and what would be a realistic expectation of return on investment.

Organizations considering ABC projects often are concerned with the time and resources required to conduct even a pilot project. Managers must decide how much of the project can be accomplished in-house and how much assistance is needed from outside ABC practitioners. Even when using outside assistance the organization must commit sufficient personnel-preferably a multi-functional team of three or four specialists-and spend significant time with the project.

A rule of thumb for pilot projects is to get results in 10-12 weeks. A rapid prototyping approach can be used to identify activities at a high level and develop a baseline ABC model in as little as a week. This model then serves as the basis for expansion of ABC in the organization.

Another concern is that ABC becomes a competing accounting system, requiring accountants to keep two sets of books. ABC is management information, and a well designed model will be synchronized to existing systems, providing an audit trail to the fiduciary system. ABC is not intended to replace legacy systems. Its role is an information source to enable management decision making.

The bottom line is that ABC is a tool that can facilitate management of any large, complex organization. It's particularly useful when historical cost data is unavailable or suspect. ABC models reflect how an organization does business, what it costs to do that business, and why costs are incurred. When cost data is combined with process information, value rankings, and performance measures management has a superb analytical tool which enhances its decision making capability. …