Why Implement Activity Based Costing

Whether you realize or not, your cost control system may be becoming more and more distorted. At the heart of this distortion is an enormous escalation in overhead costs. According to Robin Cooper, a well-known authority on cost control, many organizations are experiencing super-variable costs within fixed overhead. For example, support staff and programming are exploding for many companies with projects like Enterprise Resource Planning. These types of costs are often classified within traditional cost systems as administrative overhead. Traditional systems allocate these costs based on a single relationship to numerous cost centers. Some experts refer to this traditional approach to cost allocation as "peanut butter" accounting. The end result is an enormous distortion in cost allocation to various cost centers.

Activity Based Costing (ABC) looks at relationships in allocating and reporting costs. Consequently, many of the distortions occurring in traditional cost systems are eliminated due to an itemized allocation approach. Additionally, the ABC Model can be designed to provide profit information by customer, by product, etc. This in turn leads to be better pricing of products and services. It also results in increased profits since resources (such as marketing staff) are redirected where the profits are the highest.

ABC can also fit with other re-engineering and information improvement projects. Implementing ABC isn't easy since it requires extensive analysis of activities, building a three layer cost model, and maintenance after implementation. However, given the increased distortions in traditional systems and with so much emphasis on company improvement projects, ABC needs to be given serious consideration where process improvement is critical.