Relevance Lost: The Rise & Fall of

Activity Based Costing

Group: 4
Anand Kumar (2)
Chirag Thakkar (11)
Devansh Saxena (13)
Raj Shah (32)
Rohan Nandi (36)
Shahin Selkar (40)
Souvik Biswas (43)
Vedant Dhakate (49)
Introduction
► Status & roles of Cost accounting systems in organizations
► Different techniques like:
» Contribution/ Direct Costing
» Absorption Costing
» Activity Based Costing, etc.

► Technique selection depends on factors like:

» Evaluation- Theory of Constraints
» Mandatory generally accepted accounting principle for external financial reporting
» Easy decision-making ability

► Extensive use of Contribution pricing

Source: (N. & B., 2005) 2

Critical Review of ABC
Advantages
• Perceived as more accurate & reliable
• E.g. of Teva Pharmaceutical Industries
• Overcoming the shortcoming of Traditional Costing
• Better understanding of Cost drivers
• Suitable for Service organizations
Source: (N. & B., 2005)
Disadvantages
• Refinement of Absorption Costing & so suffers from
its weakness too
• It is Subjective arbitrary cost allocation
• Ignores constraints & doesn’t differentiate a
bottleneck from resources with excess capacity
• It regards relation between activities & resource
consumption as linear, absolute & certain
• E.g. Costing in Flight tickets
• Experience of Managers of firms who had adopted
ABC & lessons learnt
3
Global Decision Making Methodology (GDM)
► Simple practical method for decision making, like:
• Pricing
• Make or Buy
• Capital Investments
• New Product/ services
• Closing Product lines, etc.

» Stage I: Make a global economic decision from CEO’s viewpoint

» Stage II: Taking Strategic considerations

» Stage III: Change and refine local performance measurement (if required)

Source: (N. & B., 2005) 4

Global Decision Making Methodology
► Stage I: Make a global economic decision from CEO’s viewpoint
» Measurement Profile
• Throughput (T)
• Operating expenses (OE)
• Inventory (I)
• Lead time (LT)
• Quality (Q)
• Due-date performance (DDP)

Performance measurements Alternative A Alternative B ….

(T) Throughput
(OE) Operating expenses
(I) Inventory
(LT) Lead time
(Q) Quality
(DDP) Due-date performance

Source: (N. & B., 2005) 5

Global Decision Making Methodology
► Stage I: Make a global economic decision from CEO’s viewpoint
» Cost/Utilization (CUT)
• Simple graphical diagram for decision-making
• Developed originally to analyse utilization of computer system components to costs
• Uses “Theory of Constraints”
• A histogram diagram, (each bar= one resource)
• 3 different systems:
— System with plausible resource constraint
— System with “dummy” constraint
— System with excess capacity

Source: (N. & B., 2005) 6

Global Decision Making Methodology
► Stage II: Taking Strategic considerations
» Long term considerations + intangible benefits
» Strategic customer/ Strategic products/ Strategic territories
» Strategy should have a “price tag” (Cost benefit analysis)

► Stage III: Change and refine local performance measurement (if required)
» Wrongful decision making to maximize local performance measures
» Examine & adjust such measures 8 Enhance goal of entire organization
» E.g. of Call center’s

Source: (N. & B., 2005) 7

Summary of Case
► Case study of large international financial service company using ABC/M
► Major investments in Information systems infrastructure
► Tight competitions due to substitutable services
► ABC system implemented in 1997
► Time consuming analysis
► Complex system resulting in downsizing decision
► The Company developed strong core competence (Core Competence Tree) linking the
costing systems’ main strengths with the goal of firm
► CCT is built by applying a Root-cause analysis

Source: (N. & B., 2005) 8

Facts of Case
» Core Competency Tree

Costing
Knowledge

Established The costing

CEO & CFO methodology for system assisted
Support economic the company
analysis

Systemic Infra for Database at the Query

Information individual responsiveness
Handling customer level ability

Source: (N. & B., 2005) 9

Facts of Case
» Current Reality Tree
6
Some of the data are
irrelevant
1
“Accounting orientation” 2
Emphasizing cost allocation 4 8 9
Over-precision Expensive The cost system does not
maintenance contribute enough to The Firm value is not
improvement sufficiently improved

1 5
Data are not always up
“Cost World” and “Cost per to date
Unit” attitude
3
Essential issues are not
7
measured Some managers don’t use the
system
Root Problems

Source: (N. & B., 2005) 10

GDM adoption
► Main barriers to adoption:
» Emphasis on Cost world & Cost per unit
» Accounting orientation

► GDM implementation:
» Proposal
» “Light ABC” orientation to “throughput world”

Source: (N. & B., 2005) 11

Implementation Guidelines on GDM
► It involves Organizational Change and Adaptation of Information System

» GDM Changes the Organization

• Attributes of Performance measurements
— Global & Effective
— Clear & Simple
— Easy to measure
— Satisfying
— Fit the specific organization

• Modification of Information system

• Conclusions from the case (financial services company)

Source: (N. & B., 2005) 12

DRG Technique
► “Diagnostic Related Grouping” / “Healthcare Resource Group” / “Case Mix Group”
► Patients within a given DRG all suffer from broadly same medical condition and will receive
broadly same treatment
► Hospitals will get paid “standard cost” for each treatment done
► Their efficiency & performance can be measured against Standard treatment times
► It aims to provide a framework for specifying care mix & to reduce hospital costs
► Main Advantage:
» It is an a form of application of standards in a Service industry
► Main Disadvantage:
» Clinician may be tempted to offer standard package to each patient in a DRG even though he/she
may suspect that package to be inadequate/ excessive in some cases.

Source: (Management Accounting, 2016) 13

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