Challenges Involved In The Implementation Of An Activity Based Costing System Accounting Essay

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1.0 Executive Summary

This study looks at the various challenges involved in the implementation of an Activity Based Costing system at The Scottish National Blood Transfusion Service (SNBTS). SNBTS is a public sector body which supplies blood and related products to the Scottish population. The company is currently facing increasing challenges from many fronts such as the increasingly complex rules and regulations concerning the collection and testing of blood due to safety concerns about the transmission of diseases such as HIV and Hepatitis, the increasing pressure to reduce costs by the Scottish government which funds the operations and the concern by the management of SNBTS that any further cost reductions would have an impact on 'care' services. This led to the attempt to implement an ABC costing system, followed by Activity Based Management Practices to improve the understanding of how resources are utilized within the company in order to improve process efficiencies and cost control. SNBTS is forced to overcome many challenges during the implementation of the ABC costing system such as difficulties involved in data gathering with regard to relevance of information, time and costs. The company had to also overcome certain amount of resistance due to staff insecurities and an issue regarding cost allocation for joint products. A proper change management program, formulation of a team consisting of the right individuals with the right skills, an implantation approach based on ROI and the streamlining of processes are some of the measures proposed to overcome the challenges, while a physical attribute approach is advocated to address the joint cost issue. Improved cost behavior identification and control, improved quality standards, better pricing methods and improved stock valuation are some of the identified advantages for SNBTS via ABC costing.

2.0 Introduction

2.1 SNBTS Background

Scottish National Blood Transfusion Service (SNBTS) is a none-charitable organization which was established to fulfill the blood supply needs of patients in Scotland which has an approximate population of 5.5 million. SNBTS safely collects and supply blood and related products. All blood collected is through donations. SNBTS is the first nationally organized transfusion organization in Scotland. The employee base is approximately around 1100 ranging from engineers to administrative staff.

SNBTS is comprised of a central headquarters and five regional transfusion centers. These transfusion centers are responsible of collecting, processing, storing and supply blood throughout Scotland. Inanition to these transfusion centers, SNBTS also has a set of research and development centers.

Core purpose

Meeting the transfusion need of patients in Scotland by collecting and supplying sufficient blood and related products.

SNBTS mission statement

SNBTS is the specialist provider of transfusion medicine in Scotland supplying high quality blood, tissues, products and services. SNBTs works with communities, hospitals and professionals to ensure that the donor's gift is used wisely and effectively for the benefits of the patients.

2.1 SNBTS Situation Background

Currently SNBTS has some operational issues. To overcome issues and to create a reliable product cost information system, SNBTS decided to implement a new ABC system (Activity based costing system). Activity-Based Costing (ABC) is a costing model that identifies activities in an organization and assigns the cost of each activity resource to products and services according to the actual consumption by each in order to generate the actual cost of products and services for the purpose of elimination of unprofitable and lowering prices of overpriced ones.

To create a reliable product cost information system, SNBTS decided to implement a new ABC system. The intention of the implementation of this system is to clarify how resources are allocated. To facilitate the implementation of this new ABC system, a new management accountant was recruited. A commercial off the shelves software is to be purchased. The responsibility of the project system is to select the key variables with a general ABC framework of activity cost pools and cost driver rates. The aim of this assignment is to analyze the implementation of this new ABC system identifying the characteristics, benefits joint costing and implementation issues faced.

3.0 Fundamental Analysis

3.1 SWOT Analysis

3.1.1 Strengths

SNBTS is a well established company in the sphere of blood donations and transfusion with over 50 years experience in its field. The existence of five major operating directorates to complement its core offering; i.e. donation and transfusion of blood, such as Supply chain, Clinical, Tissue services, Protein Fractionization Centre (PFC) and Alba Bio Science, make SNBTS the leading organization of its kind in Scotland with high intellectual capital and a wealth of experience.

3.1.1 Weaknesses

The main weaknesses of SNBTS lies primarily with its inventory management, lack of cost visibility and varying product manufacturing cycle times. The differing cycle times for differing products makes it extremely challenging to meet sudden changes in demand. Some of SNBTS's products can take up to 3 months to manufacture. This results in the company having to maintain high levels of inventory which would in turn tie up cash which could be used for improving its quality standards. Furthermore the company's outdated volume based costing methods are making the company less efficient due to the inability to monitor resource utilization.

3.1.1 Opportunities

There are opportunities for SNBTS to procure the services of external consultants to analyze its manufacturing methods and cost structure in order for it to be able to follow world class practices. Other opportunities include increasing sales volumes by selling blood related products to the private sector, entering into joint ventures with other companies to develop new blood products, provide consultancy services to overseas blood transfusion companies, the sale of spare operating capacity and by the support of indigenous bio technology companies. This would provide SNBTS the opportunity to earn revenue, which in turn could be used to further improve its product portfolio, research and development and process efficiencies.

3.1.1 Threats

Primary threats to SNBTS's existence are the continuously changing blood transfusion related regulations and the ever present threat of reduced funding by the government (Christie, 1998).UK Blood Safety & Quality Regulations (BSQR) which is continuously increasing the rules and regulations with regard to the purchase and use of UK plasma, as a precautionary measure against the transmission of vCJD through blood related products poses a great threat to the existence of the Protein Fractionation Centre (PFC). SNBTS would have to improve its current technology and manufacturing quality standards in order to overcome these challenges. Another threat is the inconsistent nature of demand and supply for blood related products which results in a overcautious approach to stock piling. Furthermore, technological advancement by its overseas rivals which could both impede its export figures and have a negative impact on the pricing of SNBTS products which is linked to the international companies.

4.0 Operational challenges faced by SNBTS

Constantly Changing Dynamic Environment

The supply of blood is extremely challenging to predict with any certainty due to the constantly changing environment. Supply tends to be seasonal with a pattern of reduction during the summer period. Supply is also greatly influenced by issues such as the prevalence of HIV, hepatitis and mad cow disease (Prowse, 1994). Other factors such as cancer treatments, transplants, surgical developments, disasters, stringent rules and regulations with regard to the quality of blood used etc further increases the inconsistency in supply.

Varying Shelf Lives of Different Products

The shelf lives of various products differ drastically. For example, whole blood lasts for 35 days, while platelets and red cells last for only 5 days. This causes major strain on effectively matching demand with supply, resulting in a significant amount of buffer stocks. The problem is further compounded by the threat of spoilage. The management of SNBTS invests resources to constantly recruit new donors and maintain relationships with current donors in a bid to ensure the availability of supply during emergencies.

Outdated Costing Methods

The existing product cost related information was based on a series of one off studies based on resource consumption patterns during the late 80's, to early 90's. Costing was done on the functional areas within SNBTS and annually uplifted for inflation. This resulted in a cost structure that wasn't representative of the actual scenario and also made the monitoring and tracking of cost behavior extremely difficult.

Cost Control

Funds for running operations at SNBTS are provided by the government and are constantly under review with a reducing trend in allocation over the recent years. The government considers SNBTS as a cost center and hence it is imperative for SNBTS to be able control its costs in order to be within the allocated budget. SNBTS has been continuously reducing the cost of operations over the years, which has resulted in danger of negatively affecting care activities. However, in order to become more cost efficient it is imperative for SNBTS to be able to identify the cost behavior of operations.

Quality Control

As highlighted before, the stringent quality requirements placed on the company necessitates that it maintains accurate records of all the blood collected and tested from donors in order to be able to trace any contaminations back to the sources. The human form of BSE and HIV are high on the list of 'red flagged' diseases. Accordingly, conducting different tests and implementing various procedures has made it very difficult for SNBTS to be able to keep track of its cost structure.

Meeting the Private Sector Demand

Demand for blood products by the private sector has created further challenges for SNBTS. Donors are not favorable towards the company making profits from the products that were provided to SNBTS by them free of charge. Furthermore staff of SNBTS was concerned that the benefits of subsidized costs would be transferred to the private companies, which resulted in SNBTS having to ensure a full cost recovery from the products sold to the private firms. However, this also required a proper identification of relevant costs by SNBTS.

5.0 A new costing approach at SNBTS

The Drawbacks of the Prevailing Costing Method

The current costing method has significant drawbacks resulting in many implications for the operations at SNBTS. Since the prevailing costing method was carried out during the late 80's, it is highly unlikely that the allocation done at that time would sufficiently represent the true cost structure of SNBTS today. Furthermore, since the costs were based on functional areas a volume based traditional approach would have been used to allocate overhead costs to the products.

The conventional costing approach used at SNBTS dictated that fixed overheads such as building overheads, administration, housekeeping etc were allocated to products based on usual denominators such as labor hours, machine hours etc. This is an ad hoc approach to assigning costs to products and thus leaves room for much inaccuracy, which can have a huge impact on the pricing of products. Furthermore the traditional absorption method tends to impose a heavy 'penalty' in terms of costs for high volume products, while providing low volume products an 'advantage' which further contributes to the inaccuracy of product pricing.

6.0 Benefits of Activity Based Costing at SNBTS

ABC costing addresses most of the disadvantages of the traditional costing approach by allocating costs to activities rather than arbitrarily assigning them to products based on standard volume based denominators (Averkamp, 2009). This is a major shift in the concept of cost behavior, since this method basically treats most fixed costs as variable in nature by linking them to activities generated by the production process.

Some of the specific advantages of the ABC costing approach to SNBTS are the following:

Improved costing and control

The prevailing costing approach utilized at SNBTS was identified as one of its major operational weaknesses in the SWOT analysis. The approach is based on an analysis done on the company nearly two decades prior. The management of SNBTS recognized the need for reliable product cost information which would clarify how resources had been employed to deliver outputs. An Activity Based Costing approach directly addresses this issue by its very method of implementation. The fact that ABC costing focuses on drilling down and identifying the activities that create the outputs (and utilization of resources), it automatically lends itself to fulfilling the management's requirement.

Improved accountability

The management of SNBTS is constantly under pressure by the government to be transparent and account for the utilization of the granted funds. This need is amplified by the decision made by the government to reduce the allotted funds to SNBTS, even though the company had been continuously reducing its total cost of operations over many years (and accrued savings of over 5 million pounds).

Figure 1SNBTS Efficiency Savings

The ABC costing method would address this requirement by clearly identifying and mapping out the key activities involved in the utilization resources that create the final output. This would in turn enable the management to present a clear picture of its cost structure and also facilitate accurate stock valuation; i.e. providing a statement of stocks valued at their full cost.

A clear identification of costs would also greatly improve SNBTS's likelihood of being able to justify its annual budget requirements in a logical 'bottom up' approach to counter the government's focus on reduction of the same.

Improved Quality

The overriding aim of SNBTS is to provide clinical support service of the highest quality. One of the key threats identified in the SWOT analysis was the increasing government requirements (Blood Safety & Quality Regulations) with regard to the quality of blood testing and processing. Such can cripple the company due to the need for considerable investment to upgrade the equipment and improve its processes. Quality improvement methods such as six sigma and TQM (Total Quality Management) can be considered by the management with the implementation of an ABC costing approach. Since Six Sigma methodology requires a clear identification of value adding and non value adding processes and TQM advocates incremental improvements, the clear identification of key activities, value adding and non value adding processes etc through ABC costing can pave the way for improved quality standards via the implementation of quality improvement methods that are complementary in nature.

Better pricing and competitiveness

One of the key opportunities identified for SNBTS is the potential for earning revenue to complement its core business which is non profit oriented. These opportunities vary from exporting selected products, to joint ventures, to consultancy services in the field of blood transfusion practices and quality testing procedures. The current pricing strategy applied by SNBTS is to price its products based on the selling prices of similar products in the market. This approach has many obvious flaws such as the lack of control over the pricing of a product, the over pricing and under pricing of products and the inability to sufficiently leverage internal efficiencies to garner an advantage over competing products in the market. ABC costing would enable SNBTS to more accurately identify the costs per product and thereby decide on appropriate prices. This would also assist in strategic decisions with regard to its product portfolio.

Facilitates CVP analysis

The proper identification of variable costs and fixed costs would improve the accuracy of cost volume profit analysis and aid in managerial decision making. Added emphasis on the contribution margins of products would automatically result in tighter control of operational costs which augurs well for the longevity of SNBTS.

Provides the foundation for process improvements

The constant focus on key activities, processes and related costs would force the management to regularly review its processes and constantly make improvements. This would also complement its objective to improve quality.

Facilitates activity based management

ABC costing would result in the identification of financial and non financial measures which could prove beneficial to SNBTS with regard to its manufacturing efficiencies. Although not directly related, a change in management focus from volume based relationships to activity based relationships is the starting point for various operational improvement disciplines.

7.0 Joint costs and their implications for ABC

Figure 2 SNBTS Joint Costs

Joint costs are defined as the costs incurred when two or more products arise from the same manufacturing process. Since these multiple products arise from the same activity it is extremely difficult to accurately predict their costs, making the ABC approach, which specifically relies on activities to allocate costs, no more effective than alternate costing methods with respect to joint cost allocation. Thus joint costs by their very nature, impinge on the proper implementation of ABC costing methods.

One of the challenges faced by the management of SNBTS during the proposed implementation of ABC costing was the nature of the products themselves; i.e. the various outputs from the 'whole blood' source. A majority of the products at SNBTS were derived via the fractionation process of whole blood into individual product outputs, which technically make them joint products which incur joint costs.

The need for the allocation of joint costs by SNTBS include reasons such as stock valuation for accounting purposes, profitability measurement of joint products, pricing decisions and cost reimbursement by the government.

Pros and Cons of Proposed Options

The following options are some of the alternatives considered by the management of SNBTS to allocate costs to the joint products:

Physical attributes

This approach advocates the use of a physical attribute of a product as a common denominator to allocate the joint costs amongst the products. As a whole this method has proved challenging for SNBTS due to the various different characteristics of the specific products such as powders, liquids, creams etc. However, SNBTS currently uses the measure of the whole blood input requirement for each product output as a basis for apportionment.

While this approach is relatively straight forward to practice, the drawback is that such allocation does not reflect the value placed on these products in the market and can inadvertently make SNBTS less competitive with the products that have a higher cost allocation.

Sales values

This approach links the costs of each joint product with the total revenue generated by the products concerned. The price per unit would have to be based on the market prices and costs allocated would have to be derived from the pricing.

While this method addresses the market value of the products in question and therefore ensures they are at least equally competitive in the market, there are many drawbacks such as the constantly changing market prices, the lack of 'like for like' products in the market, which would result in comparing 'pears and oranges', the differing levels of purity and volatility etc make it challenging as a sustainable option for the management.

Alternative costs

This approach uses the lowest cost alternative (as opposed to joint processing) as the criteria for costing. However, this is the least practical out of the available options since it is difficult to assess alternative costs of production as a basis of allocation. This makes the allocated costs even more subjective, since most alternative methods of production would be hypothetical in nature to begin with.

Clinical value

This method uses the relative clinical values of each output as a basis for the allocation of costs. Since all products are clinically enhanced in comparison to their initial form; i.e. whole blood, their costs would have to bear a proportion of the fractionation costs based on the same.

While this approach does have some logic to it, it still involves a certain amount of subjectivity in terms of the costs placed on their clinical values, especially since these values are derived based on the subjective opinions of experts and can differ from one to another.


Physical attribute approach

It is important that the ABC costing methodology is used appropriately up to the 'split off point'; i.e. the point where the joint products are formed. Thereafter, however either a market based or a physical attribute based approach would have to be used based on the above mentioned pros and cons. In the case of SNBTS, the market based approach, (where in which market prices are used as a basis for allocation) is less suitable especially since it is primarily a non profit organization and due to the fact that there would be a need to constantly review and amend the values based on the fluctuation in market prices. Therefore a physical attribute approach would be more suitable due to its simplicity in application and due to the relative stability of values in comparison to the market approach.

Optimization of throughput & capacity utilization

Since the management at SNBTS has plans for implementing Activity Based Management practices, this would lend itself to proper capacity planning and throughput optimization. Since costing would be based on ABC methodology up to the 'split off' point, this would facilitate lower transfer prices to other divisions.

8.0 Activity Based Costing Implementation Challenges at SNBTS

The move to implement the ABC costing system was spearheaded by the director of Finance with the help of a newly recruited management accountant and six other stakeholders from cross functional disciplines.

The main objectives for the implementation of ABC costing at SNBTS were to improve the transparency of cost behavior and thereby increase cost control and to have a clear picture on how resources were being employed in order to implement Activity Based Cost Management (ABCM).

The project team had to overcome a fair share of 'hurdles' during the project lifecycle. 'Change' as always does not come easy and it is exceptionally challenging when a set of changes affects the whole company. Even though there wasn't a great deal of resistance to change, there were specific challenges that had to be overcome by the project implementation team.

Lack of Sufficient Knowledge

One of the initial challenges faced by the team was the general lack of knowledge regarding the nuances of ABC costing by the team members and majority of the employees. This caused various operational issues and delays, especially with the collation of data. ABC costing methodology entails a significant amount of time spent on gathering information with regard to the various tasks undertaken by employees and studying the various processes that guide such activities. Initial difficulties were regarding the definition of an 'activity' and ensuring everyone was 'on the same page' with regard to what was expected from them.

Time and Costs

This is often referred to as one of the drawbacks in implementing an ABC costing system. A thorough mapping of all processes, the drill down and filtering of all 'relevant' activities, the identification of cost drivers, deciding on how many activities would be tracked per cost pool etc are enormous challenges and take up much time and resources (Irvine, 2005).

Apart from the amount of information gathered and reviewed, the other challenge was to do with the method of collecting the required information (from over 1100 staff)

Gathering the Right Data

One of the key concerns when collecting information is ensuring that the 'right' activities and right number are chosen to represent the costs allocated to the output. Incorrect data collection and subsequent allocation can result in major setbacks during the implementation stages and can jeopardize the whole project.

Staff Insecurities

Initial resistance was caused due to the issue of staff insecurity. The 'total transparency' concept of ABC can have a negative impact on staff who might perceive it as 'a means to pry into' one's work life; i.e. a sort of 'glorified work study' on staff productivity. This caused some apprehension and reservations amongst certain staff about the real motives of the initiative and the future of their jobs.

Addressing Indirect Support Activities

Indirect support activities that could not be traced directly to the final outputs of SNBTS had to be accounted for and allocated within the product costs. Costs incurred by services such as computing, finance, personnel and training had to be allocated in a suitable manner. Though it was decided upon that a cost cascade approach would be used, the challenge was to get the acceptance of the stakeholders would be 'lower down' the cascade, since they would have to bear a portion of the overheads from the preceding level on the cascade.

Joint Costs

Another challenge was deciding on the most suitable method of allocating costs for joint products, since a high portion of the output was from a common source (This is addressed in detail in section 4.0)

Allocating Costs from Legacy Activities

In ABC costing, not all fixed costs would be would be computed as variable in nature. However, certain fixed costs such as research and development costs, specific project costs etc cannot be attributable to the cost of current products. This created a dilemma with regard to the 'correct' allocation method for research such costs.

9.0 Operationalzing Activity Based Costing at SNBTS

Forming the Right Team

One the factors that contributed to the challenges faced by the project team was the lack of adequate awareness and experience with the intricacies of ABC costing and project implementation. Taking into account the fact that the new costing approach would have an impact on the whole organization, it is of vital importance that the team consists of members experienced in the implementation of projects of such magnitude.

SNBTS management should look at the feasibility of gaining the services of an eternal party to drive the project, especially since it also deals with employee sensitivities and cost issues. This would help mitigate resistance to change and improve the objectivity of the project management team.

Change Management

Changes within an organization of this magnitude cannot be implemented without taking the right steps to ensure it occurs in a smooth and timely manner. The management at SNBTS should implement the new costing method only once all employees are exposed to the three stages of change management such as 'unfreezing', change and 're freezing'. This can be achieved through proper creation of awareness regarding the nuances of ABC costing, the main objectives of its proposed implementation and the resultant benefits for all staff. A proper change management program would greatly assist the project team with the implementation of the project.

A proper change management program will also go a long way in alleviating the fears and insecurities of the staff with regard to their job security.

Ensuring Sufficient ROI

When deciding on the level of detail required with regard to the activities that contribute to resource utilization, it is important that the management continuously weighs the returns with cost incurred in additional data collection. This is important since one of the main drawbacks of implementing ABC costing is the amount of time and resources spent on information gathering.

Process Optimization

ABC costing cannot be successfully implemented in any organization unless the organization already has a well documented set of processes which are constantly reviewed and revised. It is important for the management at SNBTS to ensure that all processes are documented and categorized into critical and non critical processes to facilitate the implementation of ABC costing.

10.0 How the future looks for SNBTS

A review of the internal and external challenges faced by SNBTS provides an insight into the possible steps that could be undertaken during the short term and long term for future growth.

10.1 Short Term

Improved efficiencies

Successful implementation of ABC costing and the subsequent implementation of Activity Based Management would provide SNBTS a great opportunity to improve its cost structure, remove non value adding processes and continuously improve itself with much more success compared to the years prior. This would make SNBTS on par with the best in the world.

Improved Quality Standards

ABC costing would facilitate improved quality standards at SNBTS and could be used as a stepping stone for added quality improvement initiatives. However, the management should ensure that SNBTS is always 'one step ahead' of the government's ever increasing rules and regulations and cease being reactive and become pro active instead. This is important for the sustainability of SNBTS in this industry.

Improved customer focus

SNBTS should utilize the benefits of improved cost control and efficiencies to attract new customers. A company that has transparent finances will provide customers added confidence in doing business with it.

Intellectual capital and People Development

The company should utilize its staff's experience and potential and provide adequate training and development to further their skills. This would be a long term investment for the company, which would hold it in good stead for the future.

10.2 Long Term Growth

SNBTS should look for opportunities for growth in the long term, rather than to merely ensure status quo. Apart from the obvious financial impact, a company that grows will also result in a high level of staff motivation and engagement.

Transform the business model

SNBTS should consider changing from being solely a nonprofit organization into an organization that is also focused on profits. This could be achieved by exporting its products to foreign markets, renting out spare capacity to other companies and providing consultancy services.


SNBTS with its experience of over 50 years can look at opportunities for opportunities for joint ventures in areas such as designing new types of blood bags.

11.0 Conclusion

A comprehensive analysis on SNBTS and its operations all indicate the merits of implementing an activity based costing approach. This would provide SNBTS the right opportunities at the right time to convert its image from being a cost centre to an organization that provides genuine value to the country with regard to the service it provides it's the citizens of Scotland and the revenue it earns through its exports and other services.