Page 357 - Accounting Information Systems

328 PART II Transaction Cycles and Business Processes

deviations. They must know in real time about a machine breakdown or a robot out of control. After-the-
fact information is too late to be useful.

FINANCIAL ORIENTATION. Accounting data use dollars as a standard unit of measure for compar-
ing disparate items being evaluated. Decisions pertaining to the functionality of a product or process,
improving product quality, and shortening delivery time, however, are not necessarily well served by
financial information produced through standard cost techniques. Indeed, attempts to force such data into
a common financial measure may distort the problem and promote bad decisions.
ACTIVITY-BASED COSTING (ABC)
Many lean manufacturing companies have sought solutions to these problems through an accounting model
called activity-based costing (ABC). ABC is a method of allocating costs to products and services to facili-
tate better planning and control. It accomplishes this by assigning cost to activities based on their use of
resources and assigning cost to cost objects based on their use of activities. These terms are defined below:

Activities describe the work performed in a firm. Preparing a purchase order, readying a product
for shipping, or operating a lathe are examples of activities.
Cost objects are the reasons for performing activities. These include products, services, vendors, and
customers. For example, the task of preparing a sales order (the activity) is performed because a cus-
tomer (the cost object) wishes to place an order.
The underlying assumptions of ABC contrast sharply with standard cost accounting assumptions. Tra-
ditional accounting assumes that products cause costs. ABC assumes that activities cause costs, and prod-
ucts (and other cost objects) create a demand for activities.
The first step in implementing the ABC approach is to determine the cost of the activity. The activity
cost is then assigned to the relevant cost object by means of an activity driver. This factor measures the
activity consumption by the cost object. For example, if drilling holes in a steel plate is the activity, the
number of holes is the activity driver.
Traditional accounting systems often use only one activity driver. For instance, overhead costs, col-
lected into a single cost pool, are allocated to products on the basis of direct labor hours. A company
using ABC may have dozens of activity cost pools, each with a unique activity driver. Figure 7-20 illus-
trates the allocation of overhead costs to products under ABC.

Advantages of ABC
ABC allows managers to assign costs to activities and products more accurately than standard costing
permits. Some advantages that this offers are:

More accurate costing of products/services, customers, and distribution channels.
Identifying the most and least profitable products and customers.
Accurately tracking costs of activities and processes.
Equipping managers with cost intelligence to drive continuous improvements.
Facilitating better marketing mix.
Identifying waste and non–value-added activities.

Disadvantages of ABC
ABC has been criticized for being too time-consuming and complicated for practical applications over a
sustained period. The task of identifying activity costs and cost drivers can be a significant undertaking
that is not completed once and then forgotten. As products and processes change, so do the associated ac-
tivity costs and drivers. Unless significant resources are committed to maintaining the accuracy of activity
costs and the appropriateness of drivers, cost assignments become inaccurate. Critics charge that rather
than promoting continuous improvement, ABC creates complex bureaucracies within organizations that
are in conflict with the lean manufacturing philosophies of process simplification and waste elimination.