A Passionate Appeal for Activity-Based Costing (ABC)

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Old school accountants, and there appear to be many of them, are providing a disservice to the users in their organization. User need accuracy of the costs for their organizations plus what drives those costs. These types of accountants are downright irresponsible with their duties.

Usually I am fairly rational and do not let my personal emotions interfere with how I interact with others. However, as the readers of my blogs and articles may have detected, my more recent writings increasingly reflect my frustrations with old school accountants. I cannot disguise my irritation and annoyance with accountants who refuse to be progressive.

Several of the titles of my articles these past few years provide hints and clues as to the source of my frustrations. They include “Are Accountants Homo Accounticus?”, “Some Accountants are the Blind Leading the Blind”, “Movie Sequel – Pirate Accounts of the Carribean”, “Cowboy Accountants – The Lawless Frontier”, and “Do Accountants Lead or Mislead?”

Each time I post an article I’ve written like those I receive several personal e-mails that are supportive of my view. Some are even more vitriolic. Receiving these e-mails, and also the publicly posted website comments to my written pieces, further motivate me to continue broadcasting my message of frustration often shaming accountants. I call it MBE or “management by embarrassment.”

At this point some of you may be asking yourself, OK. What the heck is bugging Gary that he is so frustrated about?” The simple answer is it is the slow adoption rate of applying activity-based costing (ABC) principles as a replacement for the flawed and misleading traditional “cost allocation” methods from standard cost accounting systems. They typically use non-causal cost allocation factors. Examples are the number or amount of direct labor input dollars, units produced, sales volume, headcount, or square feet/meters.

Benefits from applying ABC in comparison to traditional cost allocation methods that violate “costing’s causality principle” are too numerous to list here. Key benefits are: (1) extremely more accurate profit and cost reporting of outputs, products, services, channels and customers; (2) transparency and visibility of the “drivers” for work activities and their magnitude; and (3) past period calibrated cost consumption rates that are essential to multiply against future forecasted demand volume and mix that determine resource capacity requirements – workforce headcounts and spending amounts. These rates are needed for what-if scenario analysis, make-versus-buy decisions, and driver-based rolling financial forecasts and budgets.

Causality is at the heart of ABC. For example, if the quantity of the activity driver increases 20% then its activity cost should also increase 20%. The work activities are what consume the resource capacity expenses. My opinion is that any CFO or financial controller who are using traditional cost allocation methods and are not using ABC where it is applicable (which is for most organizations) is being irresponsible in their duty to provide valid information to managers and employees. The information they are providing is faulty, distorted and deceiving.

Now read the first letter of the six prior paragraphs as if together they are a two word sentence. My message is blunt: USE ABC !   

Discuss this Blog Entry 9

Rajen Patil (not verified)
on Feb 12, 2014

Hi Gary

I can really understand your feelings. you have been part of the evolution of this concept since its early days. I have been part of this a decade now. I always had a feeling that this scenario of not accepting the concept of ABC is only limited to India (where I belong). But it seems that the same could be the case at other places also.

Adam Zak (not verified)
on Feb 14, 2014

Better yet, why not go really radical and move directly to #Lean accounting?

on Feb 14, 2014

Gary,
I totally agree. However, if their CEO and/or Board of Directors are oblivious of the technical differences, it can be a very difficult position for a CFO to be in. Being progresssive requires leadership skills that are very rare and do not come with a title. So much for fudiciary responsibility.

Anonymous (not verified)
on Feb 14, 2014

I hardly ever hear about ABC any more and am glad that it is still in use and that organizations, including those in the federal government, willing to quantify their mission accomplishment costs, to the benefit of American taxpayers, can do so.

Andrew Balint (not verified)
on Feb 17, 2014

Gary put ABC in a poignant context at a Seminar I attended recently at Villanova University. Go out with some friends and split the restaurant bill. Have a salad while the rest have Filet Mignon and drinks. Then imagine your reaction when they suggest "let's just split the bill".

roslyn54 (not verified)
on Feb 25, 2014

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Daniel Dubé (not verified)
on Mar 3, 2014

Great article Gary. Happy that you still have the flame. It is an embarrassment to cost management that the words ABC have become taboo.

on Mar 5, 2014

Right on, Brother Gary! Preach it! Activity-Based Costing IS a powerful tool that helps management understand its profitability (product, customer or channel) and assists in critical decision-making. ABC supports strategic performance, it directs where investments would have the most impact, it helps with pricing, it nudges sales toward profit over volume, it suggests when customers should be terminated, and it points out where cost savings might be realized. If “Cash is King” and “Profit is Everything,” then it’s hard for me to see why most companies haven’t already implemented ABC. And yet, they haven’t…

A recent “2014 Finance Priorities Survey” by Protiviti ranks twenty-four finance process capabilities in order of importance, and ABC ties for “dead-last” alongside payroll tax processing. Strategic planning(1), budgeting(3), profitability analysis(5), margin management(7), profitability reporting by product(8), and profitability reporting by segment(9), all make the top ten process capabilities. How does any company get to those capabilities without implementing ABC? There’s a clear disconnect between what matters most and the one tool that would help move a company closest to their highest priority capabilities. What’s going on here? What drives the disparity between these process priorities?

While it appears contradictory, I believe the very reasons for building an ABC system are some of the very same reasons why ABC remains buried in the financial consciousness. Yes, “Cash is King,” but – would you expend cash flow in this economic climate on a tool that requires time, money and resources to implement? And yet, once implemented, ABC would indicate where (customer and product) the bleeding occurs. In the public sector, agencies have wandered from budget crisis to budget crisis as Congress debates funding – would you commit money to build an ABC tool when you’re managing on Continuing Resolutions and temporary funds? And yet, once implemented, ABC would allow agencies to surgically target sequestration cuts and provide similar levels of service. Where does anyone find the time, let alone the money, to implement ABC when you’re consumed with immediate profitability, business intelligence, cash flow, etc.? Ironically, ABC would help with the very issues that today may preclude its implementation.

It seems like a number of items are at play here. Perhaps, we, as managerial accountants, have not done an adequate job explaining the benefits inherent in activity-based costing. Have we fully explained just what ABC is and its potential benefits? Perhaps, most finance executives come from the “old school” accounting you mentioned above. Do GAAP and regulatory reporting take so much effort and executive focus that they naturally exclude other cost reporting projects? Whatever the reason or the cause, I believe we have to keep PUSHING ABC, we have to keep its VALUE in front of management and the accounting community at large.

I don’t know where Activity-Based Costing is headed; I wish I had a crystal ball to provide me with an answer. There seems to be some ABC traction in the healthcare and education industries. What I do know, with certainty (and twenty-five years experience), is that a well-implemented ABC system is a powerful financial tool that supports corporate decision-making and product/customer profitability. We would be foolish not to look at this tool, and its potential solutions, long and hard.

Topogane (not verified)
on Mar 6, 2014

Great article, thanks for the information!

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Gary Cokins shares his advanced cost management and performance improvement systems expertise with the Business Finance community.

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