They even sponsor their own five-day Core Competency Course, which has been attended by over people. It is important that organizational leaders and managers keep their operations efficient and profitable.
However, implementing new accounting methods can be costly and time-consuming. If managers are able to test new methods and gain the support of stakeholders and team members, activity-based costing can take their organization to the next level. We also know that your MBA should be affordable, engaging, and academically-rigorous. When you earn your MBA online from Ohio University you are making a conscious decision to improve your professional value and position yourself for current and future business opportunities.
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Resources are assigned to activities and activities to cost objects. The latter use cost drivers to attach activity costs to outputs. ABC was first defined in the late s by Kaplan and Bruns.
It can be considered as the modern alternative to absorption costing, allowing managers to better understand product and customer net profitability. This provides the business with better information to make value-based and therefore more effective decisions. ABC focuses attention on cost drivers, the activities that cause costs to increase. Traditional absorption costing tends to focus on volume-related drivers, such as labour hours, while activity-based costing also uses transaction-based drivers, such as number of orders received.
In this way, long-term variable overheads, traditionally considered fixed costs, can be traced to products. The activity-based costing process:. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them.
ABC enables effective challenge of operating costs to find better ways of allocating and eliminating overheads. It also enables improved product and customer profitability analysis.
The team also stressed that the main reason for installing ABC was to help managers expand the business, not shrink it, and it pointed to how ABC had led to hiring, not firing, at the first plants. When Safety-Kleen entered the market for recycling motor oil, it used available tank capacity at hazardous-waste centers in order to reduce transportation costs. Using small trucks, the centers collected the oil from service stations within a mile radius.
Once a center had enough to fill a big tanker truck, it loaded the oil again and transported it 10 to 25 miles to a rail yard, where it was shipped to East Chicago.
Because Safety-Kleen had tank capacity available at its centers, managers considered it a free resource. But an ABC-based analysis showed that the cost of using it certainly was not free. First, the company had not calculated the costs of testing each batch of oil in the truck, unloading it, testing it again in the tank, reloading it into a larger truck, and retesting it in that truck.
Second, the company had not considered the cost of unnecessary paperwork: Although oil is not a hazardous material, the company had to document its handling as if it were in order to comply with regulations for hazardous-waste centers.
Once the company tallied all of those costs and charged them to the oil-recycling business, the practice quickly stopped. The small trucks began taking the oil directly to the rail yard. At every plant, the team stayed until the staff had put at least two or three improvements in place. At every plant where ABC was implemented, the team stayed until the staff was able to put at least two or three items on its top-ten list into action. In instance after instance, plant managers said that ABC helped them make decisions that they previously had had a gut feeling were right but had been reluctant to make without hard data.
ABC, they said, gave them the data they needed. Then, in , Chrysler launched a pilot project at its high-volume stamping plant in Warren, Michigan. The plant had a progressive manager, and company executives believed that its product mix could be improved. Over time, the plant had been pressed into making some low-volume parts, and executives had strong hunches that their true costs were much higher than the traditional cost-accounting system indicated.
The pilot was extremely successful. The ABC numbers showed that the actual costs of some low-volume parts were as much as 30 times the stated costs, which made clear that the company would be much better off outsourcing those parts and making more high-volume parts. In addition, the pilot helped uncover pockets of waste and inefficiency, which plant managers attacked immediately. Two-thirds of the way into the rollout at Warren, the results were already so impressive that Lutz decided to introduce ABC at six more plants.
He assigned Donlon, the controller, the job of getting the effort under way. Donlon handpicked 6 young, aggressive employees to be on the initial ABC implementation team.
All came from the finance department. Chrysler refined the introduction process into a science and methodically rolled out ABC into all areas of the company in order to emphasize that it was for everyone, not just manufacturing. The entire rollout at a work site takes 6 to 15 months, depending on the size of the facility.
First, an advance group conducts 12 weeks of training to pave the way for the actual installation of ABC. During that period, everyone at the work site takes one or more of the courses the company offers, and managers widely distribute videos and newsletter articles on what is to come.
They also encourage the people who will be responsible for setting up and using the ABC system to attend sessions aimed at making them receptive to new ideas. The first group oversees the efforts to collect data and build the ABC computer model. The second helps with the technical work required to link the ABC model with the general ledger, the manufacturing-planning system, and other support systems.
Both groups work closely with the managers of the operation—to tap their knowledge and to instill in them a sense of ownership of both the rollout and the new ABC system. Chrysler methodically rolled out ABC into all areas of the company to show it was for everyone, not just manufacturing. The alternatives ranged from one to nine. If the company produced only one, that harness would have to contain wires for all the possible options.
On the other hand, if the company produced nine harnesses, each one tailored to a particular type of van, it would waste less material but would incur greater costs and make the design and production processes more complex.
Because design engineers were measured by how well they kept down the materials costs for each vehicle, they voted for nine. Because manufacturing plant managers were rewarded for minimizing inventory and labor, they wanted to produce only one.
But the ABC team showed that making two harnesses would strike the best balance between minimizing waste and maximizing productivity. Once they saw the ABC numbers, neither the design engineers nor the manufacturing managers could dispute that conclusion. After Safety-Kleen had installed the ABC pilot at its New Castle plant, operations and marketing executives took a strategic approach to selecting the next plants. The goal was to use the rollout to get an overview of the relative costs and profitability of each recycling process and line of business.
If the decision between two plants utilizing the same process was a toss-up, they chose the plant whose manager seemed more enthusiastic. Safety-Kleen tried to strike a balance between maximizing the speed of the rollout and minimizing the number of people on the implementation teams. To that end, the company limited the number of work sites at which ABC was being introduced at any one time to two and staggered the two efforts.
A core team of three people—the regional controller, an accounting analyst, and, until the company felt it had mastered the process, a Price Water-house consultant—oversaw each introduction from the beginning to the end.
Five others—analysts who assisted with process mapping, data collection, and activity costing—performed their tasks and then left. Because of the plant-by-plant approach, the corporate accounting department was not able to convert to ABC all at once. The result: Even though ABC requires more data collection, reporting, and analysis than the traditional accounting system did, closing the books each month now takes no longer than before.
Many companies have tried to implement ABC as a shadow or secondary system. Most companies develop stand-alone ABC models, which they install on off-line personal computers. As a result, they quickly become obsolete. In the recycling centers, the company installed a new data-collection system that could update the ABC numbers each month.
It also built automatic links between its corporate general ledger and the ABC system to ensure that the numbers reconciled in both systems every month.
Safety-Kleen now uses ABC numbers to develop its annual budget and to make strategic decisions about closing plants and adding and cutting product lines. Safety-Kleen also has adopted ABC-based performance measures, which involved a fundamental rethinking of the old system. As Safety-Kleen rolled out ABC, its top-level managers realized that some of the old performance measures were not motivating plant managers to make decisions that were best for the company as a whole.
Our consultants can also assist organisations in the selection of an appropriate ABC tool to meet their business needs. ABC models are typically used for specific purposes such as output pricing reviews or competitive tendering and contracting processes. FreebodyCogent is able to assist organisations in their transition to ABM and the identification and development of business process improvement and other resource management strategies and opportunities.
Our consultants can assist clients in the development and implementation of strategic cost management processes such as the benchmarking of costs and ultimately the establishment of defensible target cost levels. FreebodyCogent recognises that many organisations are faced with constraints such as a lack of in-house management accounting and costing skills and systems and inadequate integration of existing models with other corporate systems.
Such assistance may include, but is not limited to, maintenance of the data base structure, data capture and entry of cost data and performance information, generation and review and analysis of monthly management reports and maintenance of integration with other corporate systems. The current management environment demands that managers focus on the delivery of outputs.
This requires managers to:. Hence, organisations must have a robust framework in place to manage cost structures and justify the price of their outputs.
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