helps alleviate managers' concerns with their cost-measurement systems.
ABC and Cost Allocation: How Are Indirect Costs Being Assigned to Cost Objects?
Although ABC is more than an allocation method, the primary attribute differentiating it from other methodologies is how it accumulates and allocates resource costs. Our survey asked respondents to identify the methods used to allocate indirect costs. We presented three major methods of allocation along with the option to specify other methodologies in use. These three methods are:
(1)Equal allocation: Resource cost is allocated equally to all objects that consume the resources.
(2)Output-based allocation: Resource cost is allocated according to an output-related allocation base.
(3) ABC allocation: Resource costs are accumulated into activity cost pools. These cost pools are allocated to objects based on how much of the activity is consumed by the objects.
Among those surveyed, the most popular method is output-based allocation, with 60% of organizations using this method for part of their allocations. The second most popular method is ABC, with a usage rate of just under 50%.
ABC is viewed as having value, even among firms that do not currently use that methodology. When asked to specify what the mix of allocation methods would be in the organization's ideal allocation system, managers surveyed had a significant bias in favor of ABC: More than 87% of organizations' ideal costing systems would include some form of ABC. Given that such a high number of respondents envision including ABC as part of their ideal cost allocation system than currently do so (about 50%), adoption of ABC may increase in the future.
Decision Support and ABC
The major types of decisions that are supported by cost-profit-measurement systems are financial, operational, and strategic. How do ABC methods support these decisions compared to others? Survey compares the perceived usefulness of ABC and non-ABC methods to support these decisions. It contains the mean response, on a scale of 0 to 6, to the statement that a given type of costing method supports a given type of decision making.
In general, ABC methods provide greater levels of decision support than do non-ABC methods. This improved level of support spans the spectrum of decision
making across financial, operational, and strategic areas. Furthermore, ABC methods are better integrated with budgeting and planning processes. All this indicates that companies using ABC feel better equipped to apply their results to management decision support (activity-based management).
Product and Customer Profitability Metrics
From a strategic perspective, an essential criterion for any decision support system is the accurate measurement of product and customer profitability. Strategic decisions such as pricing, product and customer mix, and product and customer rationalization are among the most vital to organizational competitiveness. Although product profitability has been the primary focus of management attention for many years, the identification of profitable customers has gained prominence recently. Regardless of the type of costing method used (ABC versus non-ABC), almost all companies agree that both product and customer profitability should be measured. Whereas most (nearly 60%) ABC methods support both product and customer profitability decisions, most (approximately 60%) non-ABC methods do not.
Support for ABC
The value and usage rate of activity-based costing methods have recently been the subjects of debate among practitioners and academics. Prior surveys indicate that the usage rate of ABC has leveled over the past several years and that questions are being raised as to its value relative to its cost of implementation. In this study we examined the usage rate and relevance of ABC as a cost-profit-measurement system. Our results are summarized as follows:
(1)ABC methods are deployed across the internal value chain, and the vast majority of organizations continue to use them.
(2)Managers surveyed believe that accurate overhead allocation and activity cost information is lacking in non-ABC methods, while ABC methods address these needs.
(3)ABC methods alleviate managers' concerns regarding the accuracy of cost allocations, the cause-effect relationship between allocations and resources consumed, the timeliness of cost/profit information, and the capability to update systems.
(4)The substantial gap between current usage rates of ABC methods and their desirability in ideal systems may portend increased use.
(5)ABC methods provide greater support for financial, operational, and strategic decisions.
(6)ABC methods are better integrated into budget and planning processes.
(7)ABC methods support strategic product/customer emphasis decisions better than non-ABC methods.
When Is Activity-Based Costing Appropriate?
Activity-based costing can theoretically be used in almost any industry, because it can be adapted to determine costs at so many different levels. However, ABC is used most effectively in complex companies that are not entirely service-based. Complex companies may see the most benefit from this type of costing because it is most helpful when the costing information is difficult to understand or evaluate. Service industries may not benefit as much from activity-based costing as other industries because their costs can be difficult to assign as they may not have an identifiable cause and effect relationship.
Companies considering using ABC should also keep in mind that while it can be a very powerful management tool, it can be very expensive to start and it does not always conform to generally accepted accounting principles (GAAP) so if using an ABC system a company may have to keep a separate system to track costs in a manner that does conform to GAAP.
Activity-based costing is a type of costing system that can be used to assign costs more accurately to products and departments in today's complex business world. Our results provide ample support for the conclusion that ABC methods do indeed provide significant value to managers. We believe the use of ABC provides companies with superior cost-profitability-measurement systems. Perhaps it is time for more organizations to take another look at adopting activity-based costing methods.