Technovation 23 (2003) 131-138

www.elsevier.com/locate/technovation

Activity-based costing/management and its implications for

operations management
M. Gupta *, K. Galloway
College of Business and Public Administration, University of Louisville, Louisville, KY 40292, USA

Abstract
Activity-Based Costing/Management (ABC/M) is an Information System developed in the 1980s to overcome some of the limi- tations
of traditional cost accounting and to enhance its usefulness to strategic decision-making. In this paper, we show how an ABC/M system
can serve as a useful information system to support effective operations decision-making processes. We propose a conceptual framework,
Operations Hexagon, to discuss the managerial implications of an ABC/M system for various operations management decisions related to
product planning and design, quality management and control, inventory management, capacity management and work force management.
By viewing an ABC/M system as an enabler to improve the operations decision-making, we demonstrate that these systems enable an
operations manager to enhance the quality of the decision-making process.
2001 Elsevier Science Ltd. All rights reserved.
Keywords: Activity-based costing; Activity-based management; Operations management; Operations decision-making framework

1. Introduction
The present era of global competition, evolving technologies and information systems is leading companies
toward a renewed commitment to excellence in manufacturing. Increasing attention to the introduction of new
products, the quality of products and processes, the level of
inventories, and the improvement of workforce poli- cies
have helped companies to become world-class. Accurate
cost information is critical for every aspect of a business,
from its pricing policies to its product designs and
performance reviews. However, most companies are still
using the same traditional cost accounting systems that
were developed decades ago (Kaplan and Cooper, 1998).
For the last two decades, a new type of account- ing
system, Activity-Based Costing/Management (ABC/M),
has been gaining acceptance in the USA as well as in
Pacific Rim and European-based companies (Keegan and
Eiler, 1994). ABC/M systems represent a shift from a
strictly financial perspective to a 'whole- system'
perspective because they include both financial and nonfinancial data in its reporting. Rather than just

* Corresponding author. Tel.:1-502-852-4783; fax:1-502-8527557.

E-mail address: [email protected] (M. Gupta).
0166-4972/02/$ - see front matter 2001 Elsevier Science Ltd. All rights reserved.
doi:10.1016/S0166-4972(01)00093-1

listing cost factors and assigning them to products based on

artificial allocations, ABC/M examines processes and workows to identify actual activities that add costs. This wider
and more realistic view of costs allows man- agers to base
strategic decisions on more accurate infor- mation, which
should improve the quality of those decisions. While an
ABC/M system alone will not trans- form a firm into a
world-class competitor, it is an important tool to help
world-class firms make effective strategic decisions. A
significant amount of research is available that deals with
the design and implementation of ABC/M systems (Cooper
and Kaplan, 1991; Shank and Govindarajan, 1993; Turney,
1992b; Damito et al., 2000).
1.1. Purpose
The purpose of this paper is to discuss how ABC/M
systems can support effective operations decision-mak- ing
processes. We propose a conceptual framework, operations
hexagon, which employs ABC/M system to enhance
operations decision-making processes (Fig. 1). The
operations hexagon shows how an ABC/M system
provides a mechanism for integrating various OM
decisions. The rest of the paper is organized as follows: in
the next section, we will introduce the basic concepts of
ABC/M systems. In the third section, we will discuss

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M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

Fig. 1. Operations hexagon.

the managerial implications of ABM systems implementations for operations managers. Finally, we conclude our
paper with some general guidelines and recommen- dations
to managers.

2. Activity-based costing and management

ABC/M systems are designed and implemented on the
premise that products consume activities, activities consume resources and resources consume costs (Sprow,
1992). ABC/M systems assign costs to activities based on
their consumption of resources, and then activity costs are
assigned to products or services in proportion to a selected
measure of their individual workloads (Anderson, 1993; p.
7). ABC/M systems examine all processes (or activities)
that are actually relevant to the production of a product and
attempt to determine exactly what portion of each resource
is consumed i.e. which activity a particular product uses.
The information ABC/M systems provide can help
determine which pro- ducts are profitable, which customers
are the most valu- able, whether processes are value-added
or not, and where efforts toward improvement should be
made. These systems are being used more commonly than
ever today in an effort to obtain more reliable product
costs, improve processes and develop improved marketing
strategies. They have led to many improvements in product design, internal processes, supplier relationships and
customer satisfaction.
Central to the ABC/M systems is the concept of cost
driver. A "cost driver is an event associated with an
activity that results in the consumption of the firm's
resources" (Babad and Balachandran, 1993). Traditional
cost accounting uses one cost driver (direct labor or
machine hours) as the basis for allocating overhead costs,
and this can be inaccurate and misleading because

it may apply too much cost to one product and not enough
to another. An ABC/M system achieves improved
accuracy in the estimation of costs by using multiple cost
drivers to trace the cost of activities to those products
associated with the resources consumed by those activities
(Babad and Balachandran, 1993). To identify cost drivers,
the accountant must investigate the process of production to
determine what activities must be performed to produce a
product. Departmental man- agers can often identify these
activities. For example, in the purchasing department, a
portion of product cost might lie in the number of purchase
orders generated for each product. Manufacturing costs
might be based on the machine setups required for each
product run. Each of the activities that have an effect on the
cost of a pro- duct is a cost driver. Ideally, all cost drivers for
a product
are identified, but in practice the number of drivers is
usually limited to those that have the most significant
impact on cost.
Concisely, an ABC/M system development process
involves: (i) identifying resources (i.e. what is used to do
work); (ii) identifying resource drivers (i.e. what is
assigning the cost of the resources to activities based on
effort expended); (iii) identifying activities (i.e. work); (iv)
identifying activity drivers (assigning the cost of the
activities to products based on unique consumption
patterns); and (v) identifying the objects of work (to what or
for whom work is done) (Cokins, 1993).
2.1. Manufacturing changes that led to ABC/M system
During the last twenty years, manufacturing has dramatically changed. Whereas dramatic improvements have
been made in efficiencies and per-unit costs, profits have
shrunk; 'overhead' has risen dramatically, and busi- nesses
have seen fierce competition by foreign compa- nies, who
are responding to market needs better and fas- ter than ever
with high quality and innovative products. Manufacturing
today, with its focus on continual improvement, minimal
inventory and speedy turnaround, bears little resemblance to
manufacturing of yesterday, with its forced quality checks
on end-stage products, large inventory and slow response
to market needs and orders.
These changes in the environment have led managers to
search for explanations, which could account for why
increasing efficiencies was not increasing profitability and
competitiveness. Employing different methods of costing
products, accounting for increasing overhead costs, and
deciding which processes truly add value to a product or
service have become a necessity. Traditional management
accounting has been challenged to find ways to help
companies better understand and identify company
processes and costs.
Perhaps the rationale for the surge in interest in
ABC/M can best be seen by looking at some major criti-

M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

cisms of traditional management accounting methods.

These criticisms include: "management accounting fails to
capture a company's progress towards world-class
manufacturing performance; product costs in multi-product companies are incorrect due to overhead absorption
methods; and, internal orientation of accounting information is too narrow for strategic decision making"
(Clarke, 1995). Manufacturers now realize that becom- ing
world-class manufacturers means: (i) understanding the
true profitability of the sectors it trades in; (ii) understanding product costs and knowing what drives over- head
and having these items drive process improvement; and (iii)
the setting of performance measures. It has given
managers a true picture of overhead costs and has done it in
a way that allows them to do something about the costs
(Vasilash, 1994). ABC/M systems focus atten- tion on the
cost of activities as the cost relates to the object of work
and forces operations managers to ask questions such as
"can I perform an activity less fre- quently by changing
product design or product mix" or "can I share the same
part with more than one object of work," or "Should I
outsource this part to China?" It causes the costs associated
with ordering, expediting, storage and quality, for example,
to be correctly associa- ted with an object, rather than being
lumped into over- head. This shift from a micro-unit focus
to a macro, fac- tory focus has led to performance
improvement of the entire factory process through simply
looking at an activity as a whole rather than as a part.

133

main focus is to provide information to product designer

and process engineers about how to improve the manufacturing capability of the firm as 'internally focused ABC
systems.' They discussed how a number of compa- nies such
as Tektronix, Hewlett Packard and Zytec Cor- poration are
successfully using such systems. Player and Keys (1995)
also reported a number of successful implementations of
ABC/M systems by Arthur Ander- sen's Advanced Cost
Management Team and the researchers involved with the
Consortium for Advanced Manufacturing-International.
The strategic value of an ABC/M system is that it can
provide useful insight into decision-making processes
because it not only supplies financial data, but examines
processes and activities to identify value-added and nonvalue added activities. When the ABC/M system was first
introduced in the 1980s, it was viewed as an upgrade or
replacement for the general ledger system. However,
viewing the ABC/M system strictly as an accounting
system overlooks its true value. The fact that the ABC/M
system examined activities across departmental boundaries forced managers to think about business processes
and change their mental 'model' of the organization.
ABC/M system fits into an overall paradigm shift that
emphasizes the interconnectedness of all aspects of a firm.
Below, we demonstrate the usefulness of ABC/M systems
to operations decision-making, as shown in Fig. 1.
3. ABC/M systems and its impact on operations
function

2.2. From ABC to ABC/M system

In order to address the problems of traditional cost
systems, companies reengineer their accounting systems by
incorporating their understanding of cost drivers and
applying these drivers to the cost of products in proportion to the volume of activity that a product consumes. This view was termed 'activity-based costing' and
primarily used to analyze decisions such as pricing, product
mix and product sourcing. The increased knowl- edge of
'cost drivers' has prompted many companies to reengineer
their business processes by monitoring each of their
processes and then, eliminating (or improving) the
processes which are non-value added (Keegan and Eiler,
1994).
The major change in focus required for moving from
Activity based costing (ABC) to an Activity-based Management (ABM) system is one shifting from a costassignment view (i.e. from resources activities cost
objects) to a process management view (i.e. cost derivers
activities performance measures) (see Fig. 2). Turney (1992b) proposes that an ABM system takes the
information gleaned from ABC and applies it to the
organization in a continual push for identifying improvement opportunities and ways to improve the processes.
Cooper and Turney (1990) termed systems where the

Generally, the operations management decision-mak- ing

process has been defined to constitute decision
responsibility in six major areas: Product planning and
design, quality management and control, process design and
improvement, inventory management, capacity management and work force management (Schoreder, 2000).
Although in practice a system may vary depending on
particular organizational preferences, culture and his- tory;
a general dynamic model, the 'Operations Hexa- gon,' as
shown in Fig. 1, has broad applicability. The operations
function's circular path traces through each of the six OM
decision-areas, providing internal linkages as well as
feedback and the realignment of decisions in each of these
areas. The proposed framework further depicts that the
mechanism for relating these OM decisions in an
integrative manner is the control and measurement system
represented by the circle in the middle. A broad based
management accounting system, such as an ABC/M
system, extracts inputs from internal focus, while keeping
all the outside segments in balance. In this paper, we show
that an ABC/M system is a natu- ral candidate for this inner
circle on which the operations wheel is mounted.

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M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

Fig. 2.

Activity-based costing/management information system (adapted from Turney, 1992a).

Next, we consider each of the outer segments individually to evaluate compatibility with the ABC/M concepts and demonstrate how many companies have successfully used ABC/M systems with varying
sophistication levels to address various OM decisions.
3.1. Product planning and design
An ABC/M system can provide useful insight into
product design decisions. In a firm, which manufactures
only one product, it is simple to assign costs to that product. However, in a firm with a complex product offer- ing,
cost assignment becomes more difficult. Product
complexity "results in high manufacturing overhead costs
incurred for such activities as supervision, quality control,
inspection, machine and tool maintenance, and production
control" (Cooper and Kaplan, 1991). Cost accounting's
allocation based on machine hours or direct labor hours does
not provide a clear picture of the true allocation of
resources. "Product costs thus become dis- torted, leading
to a biased analysis of design for manu- facturability,
product profitability, outsourcing, and make or buy
decisions" (Banker et al., 1990, p. 270). A clear example of
the impact that ABC data provide is with respect to the
decision of which product line to eliminate. For instance,
imagine a firm that makes pro- ducts to fill orders in large
quantities or small batches. Often small lot sizes appear
more profitable under tra- ditional cost accounting
systems, so the firm might decide to drop the products that
are produced in large lots to concentrate on the more
'profitable' niche pro- ducts.
However, ABC/M information may show that the small
lot product is actually much more expensive than estimated
because ABC data will include factors not usu- ally
considered, such as order processing. Relying on old

methods of cost allocation may lead a company to a death

spiral in which the 'least profitable' product lines are
dropped one after the other in order to reduce costs. The
critical information ABC supplies is that often the
profitability picture has been distorted in the past. With- out
a true picture of accurate costs for each product, it is
extremely difficult to evaluate whether or not a pro- duct is
contributing to the profitability of the firm. And, of course,
if evaluating an entire product is difficult, then evaluating
specific design characteristics becomes impossible.
Product design should be a group process with input
from marketing, finance and operations. Unfortunately,
each of these groups tends to look at design from their
individual perspectives. ABC assists the process of synthesizing these different perspectives by identifying specific cost drivers. For example, setup times may be a
significant cost driver that was not recognized by cost
accounting. However, the setup changes might only be
required for a relatively minor feature that marketing added
as a 'bonus' or afterthought that does not signifi- cantly
impact the product's desirability. Once this driver is
recognized, product designs can be modified with the goal
of reducing or eliminating unnecessary setup changes,
thus lowering cost.
The implementation of an ABC/M system provides an
opportunity for clearer communication between functional areas on issues of product design. An engineer in
Hewlett Packard's Roseville Network Division described the
impact on their design process as follows: "We cre- ated a
lot of tighter relationships among accounting, research and
development, manufacturing, and market- ing. We were all
learning about the business. We have broken the back of
the cost system design problem and are now refining it and
our intuitions about the econom- ics of product design.
Overall, the whole experience for-

M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

ced us to understand our design process" (Cooper and

Turney, 1990, p. 296).
3.2. Quality management and control
A major trend in American business is the focus on
continuous improvement of quality quality products,
quality systems, quality improvements. The attitude of the
world-class company has often been summarized as
'improve quality, and all else will follow.' The idea that costs
will take care of themselves if managers focus only on
improving quality and reducing lead time makes one
wonder how Baldridge Award winners could encounter
severe financial difficulties. (Kaplan, 1992, p. 60). But all
projects cannot be pursued simultaneously because
resources are limited. How can a firm determine what
priority to give to the quality improvement and cost
reduction plans it identifies?
The ABC/M system can play a significant role in the
prioritization and cost justification of quality improvement projects. Because it includes non-value added
activities in the costs, ABC/M can provide information that
allows a firm to determine what impact each project would
have, and therefore a means to determine which ones to
pursue first. Without this insight into prioritiz- ation, a firm
can pursue several low impact improvement projects at
great cost and little gain, while overlooking other projects
that might have a tremendous impact. Nutrilite Products,
Inc., a food supplement business, gained 'focus and
direction' for their process improve- ment efforts when they
adopted ABC/M and found prac- tical applications of
information in the area of pricing and product abandonment
decisions.
ABC/M information can also play a role in quantifying the costs of quality. What are the costs of quality?
There are four categories: (i) prevention (i.e. costs of
activities performed to prevent errors from occurring); (ii)
appraisal(i.e. costs of inspection such as determining if the
product conforms to standards); (iii) internal fail- ure (i.e.
the costs of correcting errors before they reach the final
customer, such as scrap, rework and change orders); and
(iv) external failure (i.e. costs associated with errors that
reach the final customer, such as cor- recting the error,
handling complaints, and customer ill will resulting from
the error). These four types of quality costs fall into two
categories: product design and com- pliance with
standards. Many of these quality costs can be categorized
as non-value added costs that would not have been
identified with traditional cost accounting (Schneider,
1992).
An example of how ABC/M helped operations managers to improve quality can be seen with a large telecommunication company. After performing an activity
analysis of all positions at the company, it was determined that approximately 30% of personnel times were spent
on reworks. This activity has not been detected on

135

the customary reports using traditional accounting data and

was never questioned. Afterwards the causes were traced
and eliminated. The company then found itself with the
availability of almost one-fourth of the shop's workers
(Johnson, 1993). ABC/M simplifies the determi- nation of
quality costs by revealing such activities and their costs,
which can be used in detecting and cor- recting activities.
3.3. Process design and improvement
ABC offers significant insight into equipment and process decisions. ABC "challenges manufacturing and
financial teams to identify, desegregate, and analyze the
underlying manufacturing activities that drive overhead"
(Owen, 1993, p. 27).
Traditionally, accounting systems focused on monitor- ing
and controlling costs incurred subsequent to the pro- duct
design process. In modern manufacturing environ- ments
where product complexity significantly inuences costs, a
large portion of the costs is determined at the design stage.
Banker et al. (1990) reported a develop- ment of an
advanced ABC/M system, which analyzes the determinants
of activities in terms of product and process design
features, and thereby provides valuable information to the
product designers by supplying the cost implications of
alternative design choices. The sys- tem can isolate the
various factors that are under the control of design
engineers and that can be used to inuence manufacturing
costs. Lacking such systems, companies tend to add more
features and design more complex products because the
price and market share advantages are perceived to
outweigh the additional costs of designing, manufacturing
and supporting com- plex products. Banker et al. (1990)
reported the appli- cation of their ABC/M system to a plant
that manufac- tures a wide variety of rear, park, signal and
other lamps for a wide variety of automobiles. Their
ABC/M system showed that those products classified as
outsourcing can- didates were precisely the simpler
products that were being over-cost by the traditional cost
system.
ABC/M information can also be used by both pure
cellular manufacturing (CM) or those that combine job
shop and CM. CM is a configuration of job-shop into mini
assembly lines, also called cells, that manufacture similar
products. Using an ABC/M system, the distinc- tion
between a direct and indirect cost disappears in CM as each
cost can be traced to a particular cell, rather than to
individual products in a family (Dhavale, 1992).
Western Zirconium, a 1988 Baldridge Award recipient that
supplies its parent firm, the Commercial Nuclear Division
of Westinghouse, examined its production pro- cesses with
an ABC perspective and achieved dramatic results.
"Mapping existing work ow demonstrated that the workin-process traveled over two miles during a 45- day time
span and quickly showed that improvements

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M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

could be made by rearranging the manufacturing oor to

cluster the work more efficiently and eliminate
unnecessary movement of in-process production. In
addition, control systems that measured performance on
overhead absorption and labor efficiency were found to
foster inventory buildup, which is counterproductive to
achieving total cost competitiveness" (Schneider, 1992; p.
23). Western Zirconium used ABC/M to focus on cost
drivers and value-added processes. As a result, a number of
advantages were reported. For example, work-in-pro- cess
inventory was reduced from $12.3 million to $4.2 million.
First-time product acceptance increased from 34% to 92%.
Elapsed production time was reduced from 45 days to 10
days (Schneider, 1992, p. 23).
3.4. Inventory and procurement management
Strategies for inventory reduction, such as JIT, address
the fact that carrying inventory at all stages raw
materials, work-in-process, finished goods increases
costs. However, inventory buildups occur for a reason. The
process of implementing an ABC system can help identify
some of those reasons. For example, if the purchasing
department is rewarded on the basis of lowest cost, large
lots may be ordered to get a quantity discount. If the lot
size is more than what is needed for the tasks at hand,
inventory buildup occurs. If individual units are evaluated
on their throughput, they will pro- duce as much as possible
without regard for whether the product moves on to the next
work stage or into a ware- house. ABC supports measures
that place the emphasis on the whole firm, not individual
units or departments, and thus may make it more feasible
from the unit or department standpoint to lower inventory
levels.
In an ABC/M pilot study carried out at Lord Corporation, numerous revealing insights were found. Rupp
(1995) reported that it only made sense that a 10 cents part
should take a penny's worth of overhead, as our standard
cost system used to show but what ABC/M sys- tem
revealed was that even those inexpensive parts were being
purchased, received, inspected and stocked in a manner
that created significant costs.
Datar et al. (1991) discuss the results of a field study
which illustrates the use of activity-based costing to analyze material handling expenses (which exceeds
$5,000,000 per year and comprise approximately 10% of
total factory costs). They identified relevant material
handing cost drivers, such as 'number of moves' and
'distance moved', and used department cost accounts
pertaining to three stages of material handling
(purchased parts, WIP and finished goods) to create cost
pools and then, allocate to each product (or production
part). Thus, they demonstrated how an ABC/M system can
quantify the potential for actual dollar savings, which
could come from reductions in material handling, labor
force, equipment, supervision etc.

Player and Kramer (1995) reported a successful

implementation of an ABC/M system based automatic
replenishment system in more than 50 companies. The
system, initially piloted in TTI Inc. Company, has significantly reduced inventory investment as well as
administrative costs. Typically, the purchasing process for a
manufacturing company begins with the Manufac- turing
Resource Planning (MRP) system determining the
production requirements for various component parts.
Following the determination, the company may obtain
competitive bids and then place an order. The purchasing
department then receives, inspects, and inventories each
item. All these activities must occur before the parts can be
used. Under this new program, the team performed an
activity analysis of the procurement process, and reduced
15 traditional purchasing steps to three and reduced the
purchase cycle-time from 9 weeks to 1 week.
3.5. Capacity and investment management
Cokins (1993) argued that most organizations have very
little insight and understanding about the location and cost
of their unused and non-productive capacity. In addition,
there is a tendency to load all costs onto pro- ducts
delivered, which hides these costs, and conse- quently, the
firms lose the opportunity to decrease them. ABC/M
systems help firms understand the link between increasing
owner's wealth and minimizing unused capacities. With an
ABC/M system, these costs are iso- lated and measured in
three segments: idle (i.e. unused and available), nonproductive, and productive. Equipped with this insight,
firms can act on this new data, motivating operations
managers to decrease the non-productive capacity which
will increase idle capacity and then, in turn, provide
incentive to either fill the idle capacity with more customer
orders or remove the idle capacity. Baxendale and Gupta
(1998) discussed how a small custom screen-printing
company benefited from implementing an ABC/M system.
The system pro- vided information on unused capacities of
activities as well as the relative profitability of the various
products. The owners of the firm were able to embark on a
con- tinuous improvement process by focusing their efforts
on the most constrained activitiy (i.e. the activity with no
unused capacity).
Long-term capacity decisions involve choices between the
alternative uses of resources, such as acquiring or
disposing of capacity. Just as ABC/M systems can
improve the accuracy of cost data to help in prioritizing
quality improvement projects, they can provide information to help assess capacity decisions. When pro- cesses
are evaluated in the ABC/M implementation pro- cess,
bottlenecks caused by inadequate or outdated equipment
can be identified. Decisions between alterna-

M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

tives on how to address these equipment needs are supported by ABC data.
Traditional cost accounting may provide misleading
information regarding the costs of equipment that bias
decisions about upgrading or replacing equipment. New
technologies are often expensive, and many companies
require detailed justification proposals for new purchases. Preparing comparisons of current versus pro- posed
equipment becomes clearer using ABC/M sys- tems.
A survey cosponsored by the National Association of
Accountants and computer-aided Manufacturing International concluded that even though most US firms attach
a critical importance to the strategic justification of
advanced manufacturing technologies, they fail to
explicitly incorporate the firm's strategy into the investment analysis. Brimson (1989) suggested an activity- based
investment analysis system that analyzes in detail the
impact of a new technology on the cost, performance, and
interdependence of key activities. The system pro- vides a
mechanism to systematically decompose the company
goals and objectives into a base set of activities that are
impacted by the investment.
Thus, Brimson (1989) argued that the activities pro- vide
a consistent basis for analyzing investment and monitoring
the actual results through an ABC/M system.
3.6. Work force management
The ABC process can have a significant impact on a
firm's employees, particularly in areas of employee
empowerment and accountability, roles and responsibilities, and performance measures. (Turney, 1993) ABC
starts with identifying activities that are performed in a
firm. An excellent starting point for gathering ABC
information is the front-line employee.
3.6.1. Empowerment and accountability
ABC takes information that was previously couched in
pure financial terms and translates it into terms that relate
to specific activities. With ABC, performance measures
can be described in meaningful terms. An employee
becomes aware of how his activities contribute to the firm's
financial performance. ABC gives the employee the tools
he needs to evaluate not only how he is currently
contributing, but how he might improve his performance to
increase that contribution.
"Operators, who know the full cost of the raw
materials and the full cost of reworking defective units, are
able to decide whether to scrap bad production or rework
it, without intervention by more senior manage- ment."
(Armitage and Russell, 1993, p. 7) Empowering employees
to make these types of decisions can help prevent costly
reworking or poor quality product. It can also have an
impact on employee commitment and mor- ale.

137

3.6.2. Roles and responsibilities

With accountability and empowerment moved to its
lowest level, the roles and responsibilities of employees
versus supervisors can shift. Rather than performing as
'organic robots' that basically follow orders without using
critical thinking, employees "can accept responsi- bility, and
participate in business decisions%Managers, freed from
some of their traditional responsibilities, spend more time
as coaches, facilitators, communicators, and resources"
(Turney, 1993, p. 31). Rather than spend time looking over
an employee's shoulder to ensure he does what he is
supposed to do, managers can concen- trate on enabling
employees to maximize their potential.
3.6.3. Performance measures
A serious problem with performance evaluation is that
managers are often evaluated on measures that cause them
to act against the best interests of the firm in order to
improve their departmental or unit rating. To combat this
narrow, department-focused view and steer man- agers
toward integrated, company-wide goals, ABC can be used
to establish benchmarks, which can be used as a basis for
performance evaluation. Once these bench- marks have
been created, "the actual achievement of them needs to be
continually assessed not just against absolute cost levels
but also against other important cri- teria such as service
levels, quality and timeliness, as well as against other
equally important performance areas, e.g. those relating to
customers" (Connolly and Gary, 1994, p. 33). ABCs focus
on processes that affect costs and it emphasizes the
interconnectedness of each department, crossing functional
boundaries to support processes that produce most
efficiently.

4. Conclusion
Traditional cost accounting methods, which allocate
overhead costs on the basis of one driver (e.g. direct labor
or machine hours) are inaccurate and misleading as these
methods often allocate too much cost to one product and
not enough to another. To address this prob- lem, activitybased accounting was developed to provide a means to
create a more accurate representation of how activities
performed in the creation of a product or ser- vice actually
impact its cost. ABC/M systems examine processes or
activities to determine their effects on costs. An ABC/M
system can be used by any firm which is able to identify
activities that drive costs and allocate those costs to its
particular products or services. Rather than allocating
overhead on the basis of one variable, such as direct labor,
ABC/M systems use multiple cost drivers to present a more
accurate foundation for over- head allocation. Cost drivers
are identified by actually reviewing the entire production
process to uncover what activities cause those costs. ABC/M
systems can be inte-

138

M. Gupta, K. Galloway / Technovation 23 (2003) 131-138

grated with TQM, employee empowerment, and many

other changes taking place in business today. While discussion of ABC/M systems was at first limited to its use as
a placement for cost accounting, the focus has shifted to the
identification of processes and their effects on costs.
What is the future for ABC/M systems? The next logi- cal
step would seem to be linking activities between business
units together, creating an ABC/M system that provides
information for the whole company (Mecimore and Bell,
1995). However, it is important to realize that all functional
areas must be involved in implementing an ABC/M system
at the business unit level. Account- ants have the important
role of deciphering what activi- ties are of value to the
customer and to the organization, but it is the operations
manager who should do the implementation (McConville,
1993). The company should work together to first improve
the value received by customers, and then to improve the
products by pro- viding this value (Turney, 1992a).
Acknowledgements
We acknowledge the constructive comments made by the
anonymous reviewers on the earlier version of this
manuscript.
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Mahesh Gupta ia an associate professor in the Department of Manage- ment,
University of Louisville. He obtained his MCom from the University
of Jammu, India, his MSc from the University of Manitoba, Canada, and
his PhD from the University of Louisville, USA. Dr Gupta has published in
numerous journals including International Journal of Operations and
Production Management, International Journal of Production Research,
European Journal of Operational Research, and Production and Inventory
Management. Dr Gupta is a member of APICS, DSI, INFORMS, ASQ, and
POMS.
Karen Galloway was a graduate student at the Business School at the time the
research presented in this article was conducted.