Activity-Based Cost Management: An Executive's Guide Order now | More info

Accountants often allocate expenses into "calculated" costs when there is minimal or no link that reflects a true relative use of the expenses by the individual products, service lines, or end-users. This is unfair. The accountants in effect violate their own rule that there should be a causal relationship. Activity-based cost management (ABC/M) "gets it right." It more fairly splits the waiter's check.

Many ABC/M practitioners wish the word allocation never existed. It implies inequity to many people based on past abuses in their organization's accounting practices. The word allocation effectively means "misallocation" because that is usually the result. ABC/M practitioners will often say that they do not allocate expenses; instead they trace and assign them based on cause-and-effect relationships.

 

ABC/M can do much more than simply trace expenses and costs. It provides a tremendous amount of visibility for people to draw insights from and also use for predicting the possible outcomes of decisions. Many operations people cynically believe that accountants count what is easily counted, but not what counts. Outdated, traditional accounting blocks managers and employees from seeing the more relevant costs.

 

It is a mistake for ABC/M project teams to refer to ABC/M as an improvement program or a change initiative. The ABC/M data are simply used as a means to an end. If ABC/M is described as an improvement program, it might be regarded by managers and employees as a fad, fashion, or "project of the month." ABC/M data make visible the economics of the organization and its consumption of resource expenses. Money is continuously being spent on organizational resources whether or not ABC/M measuring is present. In short, ABC/M is fundamentally good data to be used for understanding, discovery, and decision making, then it is better positioned for longer-term use and wider acceptance.

 

In a sense ABC/M restacks the costs; it does not root them out. ABC/M's data can be a great enabler for providing answers; the key word here is enabler. One controller I met referred to ABC/M as the ultimate question generator.

 

Organizational improvement is referred to by a variety of terms, among them total quality management (TQM) and business process reengineering (BPR). They all have one thing in common: a focus on continuing improvement of work and the pursuit of excellence in daily operations. Many of these programs emphasize the following:

A common thread runs through all these improvement techniques: a focus on work activities and their relationship to services or products provided to customers. The ABC/M data can turbocharge these types of popular performance improvement programs.

 

This figure describes how an organization operates as a total system. It is a circulatory system based on the flow of money. This exhibit integrates the critical components to managing an enterprise: strategy, customers, supply chain, profit margins, unused capacity, process-based management, balanced scorecard performance measures, and shareholder wealth creation by good deployment of capital.

 

In one sense the model begins and ends with customers, but it ultimately describes how the creation or destruction of wealth is a result of the organization's efforts. At the center of the model is the ABC/M Cross that is considered the standard for understanding cost management. The end game of the model is for the organization to continue to increase the financial wealth of its shareholders. In life, the organizations that excel in learning win -- but there is no finish line.

 

Gary Cokins is a guest on SmartPros' Financial Management Network. The CPE segment Performance Management: Scorecard or Strategy Tool? is available at an individual rate or with a SmartPros subscription. For more information about a subscription, click here.

 

Activity Based Cost Management: An Executive's Guide describes how ABC/M indeed is integral to displaying a financial view to all of the components -- and more -- in Figure A. It ranks as the #1 'bestseller' activity based costing book on the major book distributor Web sites. On the book's back cover jacket is a the review comment from Tim Jordheim, Manager, ABC/M Center of Expertise, Cargill, Inc., "Gary Cokins has helped light the way for cost and profitability analysis practitioners for many years. His wit and vivid metaphors engage a broad audience of managers and executives, helping generat not only new levels of understanding but also genuine enthusiasm for applying 'accounting' tools to improve bottom line performance."

GARY COKINS is Director of Industry Relations with The SAS Institute (acquirer of ABC Technologies, the leading provider of activity-based information software.) He is an internationally recognized expert, speaker, and author in advanced cost management and performance improvement systems. Gary received a BS degree with honors in Industrial Engineering/Operations Research from Cornell University in 1971. He received his MBA from Northwestern University's Kellogg School of Management in 1974.  He can be reached at gary.cokins@sas.com