Accounting for action

It is becoming more and more evident that only those companies that can keep their costs low while delighting the customer with exceptional quality — of products and services — are going to survive. This may sound paradoxical. We have been used to paying more for better quality and not less. But, this is what the customer of today actually wantsbetter quality of lower prices.But how does one cut costs while improving quality. ABC is one such tool that will help. ABC stands for Activity Based Costing, a term coined by Harvard University dons Robert S. Kaplan and Robin Cooper in 1987.

ABC is designed to overcome the inadequacies in the conventional accounting system, by providing more accurate cost information for better management. One of the inadequacies in conventional accounting is that it is not accurate in spreading overhead costs. Spreading of overhead costs assumes significance considering the fact that during the last 30 years, the cost of direct labour has been reducing steadily due to use of industrial engineering concepts and high technology equipment in manufacturing. During the same period the overhead costs has increased considerably. Most of the overhead costs is due to coordinating, supervising and managing business process. In most cases business processes have just evolved or have been designed for doing business in the fifties, hence are inefficient and expensive, thus increasing the overhead cost while decreasing the quality of service. Also, the conventional accounting system, cannot answer questions likewhat products are more profitable? Which customers are more profitable? What is the profitability by market segment? And many such questions which are important for making strategic decisions. ABC helps in answering these questions and reducing overhead costs.However ABC is a much misused word. Many times ABC and ABMActivity Based Management are confused with each other. And, many who claim to have implemented ABC are just be paying lip service to it. ABC involves assigning costs to products and services in an integrated cost accounting system whereas, ABM involves using the cost information of the various activities (work) in an organisation to manage its processes — business processes — better.

ABC requires a change in the accounting system and will necessitate installation of an integrated cost accounting system. ABM involves streamlining business processes and helps in identifying and eliminating wasteful and non-value added work. This helps in reducing cost and improving the quality of services. In many cases upto 25 per cent reduction in overhead costs have been achieved.The decision to implement ABC or ABM depends on size of the overhead costs and the quality of business processes. It is best to first start with ABM, streamline the business processes, reduce overhead costs as much as possible and then install a full fledged Activity Based Costing System.The author is manager corporate technical in Asea Brown Boveri.