Voyage of Discovery: For All Its Professed Benefits, Activity-Based Costing Isn't an Easy System to Implement. Selvan Naidoo Draws on His Experiences of Establishing ABC in a Shipping Company to Describe the Key Decisions to Be Made-And the Major Pitfalls to Be Avoided. (How to Activity-Based Costing)

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Activity-based costing (ABC) is often viewed as a daunting task, perhaps quite rightly so. The processes of data accumulation and cleansing demand a lot of effort, but following a few basic principles from the start can help to sharpen your focus and improve results.

Many ABC projects set out in search of costing information, but this can be an extremely broad area and can mean different things at different levels of management. It is therefore critical that you establish at the outset exactly what you want to achieve from the exercise.

First, you need to decide whether or not the results will be used at a strategic level. This will significantly influence the extent of your activity analysis. If only a high-level review is required, then the amount of analysis could be aggregated to a much more manageable level. Conversely, if strategic cost management is the key objective, then it may be necessary to go down to the level of individual tasks. It must be noted that the law of diminishing returns is very much applicable when comparing the objectives of the project with the effort, cost and accuracy of its outputs.

Second, you need to establish whether you want to focus on certain areas--eg, operations, regional support costs and head-office costs. When I participated in a recent ABC implementation in a shipping company, the project team took a phased approach. We first analysed the total cost composition of the business, which then indicated the areas on which we needed to focus.

At this stage it is also important to agree with management the level of accuracy (eg, 80 per cent) that would be acceptable. It is hard, if not impossible, to achieve everything with the first model--ABC modelling is often a repetitive process. Targeting the significant cost pools and producing meaningful information early on should create a tremendous amount of goodwill and credibility for the process, which should help you to tackle the more difficult areas with confidence.

Third, you need to decide which products or services you Want to cost. Often you will find that 20 per cent of your products bring in 80 per cent of the revenues. I am in no way advocating that you shouldn't pay attention to the rest of your products, but you must take careful account of the time, resources, supporting information and maintenance work required to do so.

All these decisions, together with your project plan and key aims, are critical and should be agreed and signed off by the key stakeholders. The involvement of operational staff from the start of the project can also prove extremely valuable, because it lends credibility to what the project team is doing. If these conditions are not in place, you may well be forced to make frequent changes even when the project is at an advanced stage. The main concern is not one of change itself, but of the amount of change that may be required. With the shipping project, all too often we found that we had to rework the entire process owing to a dearth of data, changes in attitude and a lack of initial involvement from the senior management team.

Because ABC, like business process reengineering, is a "top-down" strategy, support from the very top of the organisation is critical. It is important that senior managers not only preach it; they must "live it" to ensure the project's credibility. Their full support is essential for building commitment, ensuring that enough resources are allocated, removing any barriers and ratifying the results.

A note of caution: you do need to manage the expectations of the project's sponsor, the executive committee and the senior management team. Often their hopes are so high that they believe ABC will solve all their business problems. …