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9–6 Implement Activity-Based Costing
‘‘high maintenance” customer that results in much lower overall profits, while
abandoning other customers that are really much more profitable. Poor costing
methodologies are at the bottom of many bad corporate decisions.
The solution to this problem is a system called activity-based costing. Under
this approach, a company summarizes all of its costs into a number of cost pools,
then allocates the expenses in those pools to a variety of activities, using a large
number of allocation measures. It becomes much easier to accurately assign the
costs of these activities to various products and customers, based on their usage
of the activities. Though this may seem like nothing more than an elaborate allo-
cation of overhead, it is actually a carefully constructed methodology for deter-
mining the true cost of a company’s products and services. Along with target
costing, it is the most significant advance in costing methodologies in the last few
decades, eminently worth the effort of putting in place.
However, installing an activity-based costing system is not that easy. The
cost pools must be constructed, allocation measures determined, and new sys-
tems created to store, calculate, and report all of this information. In addition, the
cooperation of other departments is necessary to ensure that new allocation mea-
sures are properly and consistently calculated. Finally, management must be
apprised of the content of the new reports that will come out of this system and
how they can be used. Given the considerable cost, time, and training required to
ensure that this system becomes fully operational and accepted by management,
it is no surprise that many such installations have not been completed, and even
completed ones do not enjoy the full support of upper management. Thus, it is
not so strange that activity-based costing is the best cost-accounting tool avail-
able and yet does not enjoy universal popularity or usage.
From the perspective of the accounting department, installing this system is
a difficult chore. Depending on the size of the company, one or more staff people
should be allocated to the project full-time for many months. In addition, the
existing accounting software almost certainly does not track activity-based costs;
a secondary software package must be purchased that takes information from the
general ledger, as well as allocation bases from a variety of locations, summa-
rizes data into cost pools, allocates it to activities, and charges costs to products.
Also, given the newness of this approach and the lack of instruction about it at the
college level, the services of a consultant may be worth the added cost. Further, a
considerable amount of management time must go into planning and controlling
the work effort, so that it is completed on time without exceeding the budgeted
expenditure level.
Cost: Installation time: