Industry Adoption Of Activity Based Costing Systems Accounting Essay

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ABC Adoption History - the Hype Cycle Like many new technologies, adoption is marked by changes in perception and increasing diffusion into the market over time. ABC has been no different. From the initial hype in the 1980's, ABS has gone through subsequent periods of falling out of fashion, then steady periods of development and maturity, finally arriving at the point where it is currently widely accepted and adopted in many industries:

Technology Trigger (1984-1987) Innovations in Cost Accounting

Peak of Inflated Expectations (1987-1991)

Trough of Disillusionment (1991-1995)

Climbing the Slope of Enlightenment (1995-2000)

Plateau of Productivity (2000-2006)

Post Plateau (2006-present)

Figure 1: ABC Hype Cycle - Source: Turney 2010

Technology Trigger (1984-1987)

For many new disciplines discontinuous innovation is driven by external influences which act as a trigger to initiate sudden and dramatic changes within a domain. For accounting one of the trigger's in the development and initial adoption of ABC by western companies was the sudden rise in competition from Japanese manufacturers. This forced western companies to look more closely at their cost accounting systems, adopt more innovative costing methods in order drive ongoing efficiencies in order to compete with Japanese.

Peak of Inflated Expectations (1987-1991)

By 1987 ABC had gained widespread exposure in the literature. The first generation of methods and tools emerged, with the first commercially available ABC software packages introduced around 1990.

Trough of Disillusionment (1991-1995)

Like many other new ideas overinflated expectations and hype results in a failure to live up to expectations. Such was the case with ABC. As a result of a combination of the immaturity of the ABC method, the immaturity of software tools to support it, some well-publicized failures and attention shifting to new management methods, e.g. business process reengineering and enterprise resource planning(ERP) systems, interest in ABC began to decline after 1992.

Climbing the Slope of Enlightenment (1995-2000)

Despite having lost its initial lustre, ABC continued to develop and mature during this period. With these developments ABC became applicable outside the initial scope of cost accounting, to include sales, administration, marketing, R&D and supply chain. ABC implementations expanded into more and more industries, including insurance, healthcare, energy and banking as these industries faced increasing competition. The addition of predictive modelling to ABC expanded its use from a historical cost accounting tool into a planning and analysis tool.

Plateau of Productivity (2000-2006)

In this phase ABC entered the mainstream where the benefits of the model were seen to exceed the cost of adoption. Adoption was driven by the emergence of a new generation of ABC methods and more powerful software to compliment it. While adoption varied from industry to industry, and country to country, several surveys showed adoption rates reaching the 30% typical of this phase of the hype cycle. Gartner (2004) estimated global adoption of ABC by the global top 1000 firms at between 20% and 50%. Research by Business Finance (2004) indicated an adoption rate of 37% for companies with an annual revenue exceeding $1bn.

Post Plateau (2006-present)

The latest phase of ABC development has brought it to a point where its potential has been fully recognised. After 20 years of continuous evolution ABC is now an integral component in a new generation of business performance management tools., including placing ABC at the centre of Performance Management (Figure 2: ABC as the foundation of performance management -Source: Turney 2010).

Figure 2: ABC as the foundation of performance management -Source: Turney 2010

Four Generations of ABC

ABC has greatly evolved over the last two decades, with four distinct generations of development (Figure 3: Four generations of ABC - Source: Turney 2010). At its inception its goal was to be an accurate cost accounting method. Designed to improve the accuracy of product costing using cost pools and drivers.

Over time ABC extended it scope outside the narrow focus of cost accounting and into the areas of predictive modelling and process analysis an aid to drive cost savings. Its third incarnation saw ABC integration with Enterprise Resource Planning(ERP) and Business Intelligence systems to increase the value of information derived. Finally ABC has emerged as a platform for integrated performance management solutions, incorporating profitability management, financial planning and human capital management.

Figure 3: Four generations of ABC - Source: Turney 2010

Factors Influencing ABC Adoption

Activity-Based Costing (ABC) is widely perceived as improving the accuracy of product / service costing and also assisting managers in understanding and evaluating how resources are used across a firm’s value-chain in delivering strategic out-comes. It is attractive to firms in competitive environments that require a continual focus on cost reduction as it provide the data required to make strategic decisions in relation to improving efficiencies.

While ABC implementation rates generally increased during the early 1990’s , worldwide adoption rates have remained relatively low. In some literature it is claimed that the rate of new adoptions is actually declining (Innes et al. 2000).

Byrne et al (2007) collated evidence from the literature to back this assertion. Between 1994 and 1999 in ABC implementation by large UK corporations fell from 21 percent to 17.5 percent. A study in New Zealand reported an adoption rate of 20%. A similar US study reported an adoption rate of on 18% in the food and beverage industry. Other studies indicated even lower rates of 14% in Canada and 13% in Australia.

Industry Perception

Based on their research Byrne et al (2007) concluded that overall ABC is widely regarded within those companies who have successfully adopted it as their costing system. In particular they highlight the following four areas where the perceptions of ABC are positive:

User Attitude: Individuals report positive attitudes toward the implementation of ABC.

Technical Characteristics: Individuals perceive that the technical characteristics of the information produced by their ABC system are superior to those of a traditional cost system.

Perceived Usefulness in Improving Job Performance: Individuals perceive that their ABC system information is more useful in improving their job performance than that of a traditional cost system.

Impact on Organisational Processes: Individuals perceive that the implementation of their ABC system has resulted in more improved organisational processes compared with those of a traditional cost system.

Benefits of ABC

It is widely claimed in the literature that ABC provides many significant benefits over traditional cost accounting systems. This includes improved costing accuracy, more comprehensive costing information and more relevant information for decision making. Abusalama (2008) provides a comprehensive literature search to compile a list of the benefits and advantages of ABC system, namely:

More accurate cost information for product costing and pricing

Improved cost control and performance measurement and assessment

Improved insight into cost causation and behaviour

More accurate customer profitability analysis

Assistance in cost reduction and cost control applications

Improved the calculation of the product profit margin

Improved decisions on sales price, product mix and client mix

Superior decision-making information

Better encouragement of commitment to quality and continual improvement

Increases the effectiveness of budgeting

Increase in profitability and better overhead cost allocation

Improved the inventory valuation

Improved production/service decisions

Improved new product or service design

Provides more in-depth analysis, and value adding decisions

Improved efficiency value-based reporting

Provides more accurate evaluation of capital investment

Facilitate pricing strategy and product line performance on profitability and efficiency

Improvement of the decision making process in relation to product cost

Changes of product mix in order to better suit customer needs

Improvement of outsourcing decision procedures

Motivation of personnel that deals with cost accounting

Identification of ‘loss making’ suppliers

Difficulties in Adopting ABC

While the implementation of ABC appears to result in obtaining and achieving the above

benefits, at the same time the adoption rates are low. Abusalama (2008) performed a comprehensive literature review on this topic. He identified the following areas of difficulty encountered during ABC implementation:

Identifying and aggregating activities

Assigning resources to activities

Selecting cost drivers

Assigning activity costs to cost objects

Internal resistance

Top management support

Uncertainty of ABC benefits

Data collection difficulties

Suitable accounting staff, computer stuff

Inadequate computer software

Amount of work and time needed

Human resource availability

Lack of knowledge/experience

Satisfied with current systems

Categorization of Adoption Barriers

Abusalama (2008) then broke down these barriers to adoption into three separate categories: Technical Issues, Behavioural Issues and Systems Issues (Figure 4: Barriers and difficulties to ABC implementation - source: Abusulama 2008):

Technical Issues: Related to problems in moving to a new costing method, such as defining activities, selecting cost drivers and assigning resources and costs to activities.

Behavioural Issues: Stemming from human related issues, such as lack of support from management, resistance to change amongst staff, lack of appreciation of the benefits that ABC would bring over the current accounting system.

Systems issues: Resulting from inadequacies in the support infrastructure, including hardware, software, data collection and the time and effort required to implement the feature required to support the adoption of ABC.

Figure 4: Barriers and difficulties to ABC implementation - source: Abusulama 2008