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 listing cost factors and assigning them to products based

on artificial allocations, ABC/M examines processes and
The present era of global competition, evolving tech- work-flows to identify actual activities that add costs.
nologies and information systems is leading companies This wider and more realistic view of costs allows man-
toward a renewed commitment to excellence in manu- agers to base strategic decisions on more accurate infor-
facturing. Increasing attention to the introduction of new mation, which should improve the quality of those
products, the quality of products and processes, the level decisions. While an ABC/M system alone will not trans-
of inventories, and the improvement of workforce poli- form a firm into a world-class competitor, it is an
cies have helped companies to become world-class. important tool to help world-class firms make effective
Accurate cost information is critical for every aspect of strategic decisions. A significant amount of research is
a business, from its pricing policies to its product designs available that deals with the design and implementation
and performance reviews. However, most companies are of ABC/M systems (Cooper and Kaplan, 1991; Shank
still using the same traditional cost accounting systems and Govindarajan, 1993; Turney, 1992b; Damito et al.,
that were developed decades ago (Kaplan and Cooper, 2000).
1998). For the last two decades, a new type of account-
ing system, Activity-Based Costing/Management 1.1. Purpose
(ABC/M), has been gaining acceptance in the USA as
well as in Pacific Rim and European-based companies The purpose of this paper is to discuss how ABC/M
(Keegan and Eiler, 1994). ABC/M systems represent a systems can support effective operations decision-mak-
shift from a strictly financial perspective to a ‘whole- ing processes. We propose a conceptual framework,
system’ perspective because they include both financial operations hexagon, which employs ABC/M system to
and non-financial data in its reporting. Rather than just enhance operations decision-making processes (Fig. 1).
The operations hexagon shows how an ABC/M system
provides a mechanism for integrating various OM
* Corresponding author. Tel.: +1-502-852-4783; fax: +1-502-852- decisions. The rest of the paper is organized as follows:
7557. in the next section, we will introduce the basic concepts
E-mail address: [email protected] (M. Gupta). of ABC/M systems. In the third section, we will discuss

0166-4972/02/$ - see front matter  2001 Elsevier Science Ltd. All rights reserved.
doi:10.1016/S0166-4972(01)00093-1
132 M. Gupta, K. Galloway / Technovation 23 (2003) 131–138

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
Fig. 1. Operations hexagon. are identified, but in practice the number of drivers is
usually limited to those that have the most significant
impact on cost.
the managerial implications of ABM systems implemen- Concisely, an ABC/M system development process
tations for operations managers. Finally, we conclude involves: (i) identifying resources (i.e. what is used to
our paper with some general guidelines and recommen- do work); (ii) identifying resource drivers (i.e. what is
dations to managers. 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
2. Activity-based costing and management activities to products based on unique consumption
patterns); and (v) identifying the objects of work (to what
ABC/M systems are designed and implemented on the or for whom work is done) (Cokins, 1993).
premise that products consume activities, activities con-
sume resources and resources consume costs (Sprow, 2.1. Manufacturing changes that led to ABC/M system
1992). ABC/M systems assign costs to activities based
on their consumption of resources, and then activity During the last twenty years, manufacturing has dra-
costs are assigned to products or services in proportion matically changed. Whereas dramatic improvements
to a selected measure of their individual workloads have been made in efficiencies and per-unit costs, profits
(Anderson, 1993; p. 7). ABC/M systems examine all have shrunk; ‘overhead’ has risen dramatically, and busi-
processes (or activities) that are actually relevant to the nesses have seen fierce competition by foreign compa-
production of a product and attempt to determine exactly nies, who are responding to market needs better and fas-
what portion of each resource is consumed i.e. which ter than ever with high quality and innovative products.
activity a particular product uses. The information Manufacturing today, with its focus on continual
ABC/M systems provide can help determine which pro- improvement, minimal inventory and speedy turnaround,
ducts are profitable, which customers are the most valu- bears little resemblance to manufacturing of yesterday,
able, whether processes are value-added or not, and with its forced quality checks on end-stage products,
where efforts toward improvement should be made. large inventory and slow response to market needs and
These systems are being used more commonly than ever orders.
today in an effort to obtain more reliable product costs, These changes in the environment have led managers
improve processes and develop improved marketing to search for explanations, which could account for why
strategies. They have led to many improvements in pro- increasing efficiencies was not increasing profitability
duct design, internal processes, supplier relationships and competitiveness. Employing different methods of
and customer satisfaction. costing products, accounting for increasing overhead
Central to the ABC/M systems is the concept of cost costs, and deciding which processes truly add value to a
driver. A “cost driver is an event associated with an product or service have become a necessity. Traditional
activity that results in the consumption of the firm’s management accounting has been challenged to find
resources” (Babad and Balachandran, 1993). Traditional ways to help companies better understand and identify
cost accounting uses one cost driver (direct labor or company processes and costs.
machine hours) as the basis for allocating overhead Perhaps the rationale for the surge in interest in
costs, and this can be inaccurate and misleading because ABC/M can best be seen by looking at some major criti-
 M. Gupta, K. Galloway / Technovation 23 (2003) 131–138 133

cisms of traditional management accounting methods. main focus is to provide information to product designer
These criticisms include: “management accounting fails and process engineers about how to improve the manu-
to capture a company’s progress towards world-class facturing capability of the firm as ‘internally focused
manufacturing performance; product costs in multi-pro- ABC systems.’ They discussed how a number of compa-
duct companies are incorrect due to overhead absorption nies such as Tektronix, Hewlett Packard and Zytec Cor-
methods; and, internal orientation of accounting infor- poration are successfully using such systems. Player and
mation is too narrow for strategic decision making” Keys (1995) also reported a number of successful
(Clarke, 1995). Manufacturers now realize that becom- implementations of ABC/M systems by Arthur Ander-
ing world-class manufacturers means: (i) understanding sen’s Advanced Cost Management Team and the
the true profitability of the sectors it trades in; (ii) under- researchers involved with the Consortium for Advanced
standing product costs and knowing what drives over- Manufacturing-International.
head and having these items drive process improvement; The strategic value of an ABC/M system is that it can
and (iii) the setting of performance measures. It has provide useful insight into decision-making processes
given managers a true picture of overhead costs and has because it not only supplies financial data, but examines
done it in a way that allows them to do something about processes and activities to identify value-added and non-
the costs (Vasilash, 1994). ABC/M systems focus atten- value added activities. When the ABC/M system was
tion on the cost of activities as the cost relates to the first introduced in the 1980s, it was viewed as an upgrade
object of work and forces operations managers to ask or replacement for the general ledger system. However,
questions such as “can I perform an activity less fre- viewing the ABC/M system strictly as an accounting
quently by changing product design or product mix” or system overlooks its true value. The fact that the ABC/M
“can I share the same part with more than one object of system examined activities across departmental bound-
work,” or “Should I outsource this part to China?” It aries forced managers to think about business processes
causes the costs associated with ordering, expediting, and change their mental ‘model’ of the organization.
storage and quality, for example, to be correctly associa- ABC/M system fits into an overall paradigm shift that
ted with an object, rather than being lumped into over- emphasizes the interconnectedness of all aspects of a
head. This shift from a micro-unit focus to a macro, fac- firm. Below, we demonstrate the usefulness of ABC/M
tory focus has led to performance improvement of the systems to operations decision-making, as shown in
entire factory process through simply looking at an Fig. 1.
activity as a whole rather than as a part.

2.2. From ABC to ABC/M system 3. ABC/M systems and its impact on operations
function
In order to address the problems of traditional cost
systems, companies reengineer their accounting systems Generally, the operations management decision-mak-
by incorporating their understanding of cost drivers and ing process has been defined to constitute decision
applying these drivers to the cost of products in pro- responsibility in six major areas: Product planning and
portion to the volume of activity that a product con- design, quality management and control, process design
sumes. This view was termed ‘activity-based costing’ and improvement, inventory management, capacity man-
and primarily used to analyze decisions such as pricing, agement and work force management (Schoreder, 2000).
product mix and product sourcing. The increased knowl- Although in practice a system may vary depending on
edge of ‘cost drivers’ has prompted many companies to particular organizational preferences, culture and his-
reengineer their business processes by monitoring each tory; a general dynamic model, the ‘Operations Hexa-
of their processes and then, eliminating (or improving) gon,’ as shown in Fig. 1, has broad applicability. The
the processes which are non-value added (Keegan and operations function’s circular path traces through each
Eiler, 1994). of the six OM decision-areas, providing internal linkages
The major change in focus required for moving from as well as feedback and the realignment of decisions in
Activity based costing (ABC) to an Activity-based Man- each of these areas. The proposed framework further
agement (ABM) system is one shifting from a cost- depicts that the mechanism for relating these OM
assignment view (i.e. from resources → activities → cost decisions in an integrative manner is the control and
objects) to a process management view (i.e. cost derivers measurement system represented by the circle in the
→ activities → performance measures) (see Fig. 2). Tur- middle. A broad based management accounting system,
ney (1992b) proposes that an ABM system takes the such as an ABC/M system, extracts inputs from internal
information gleaned from ABC and applies it to the focus, while keeping all the outside segments in balance.
organization in a continual push for identifying improve- In this paper, we show that an ABC/M system is a natu-
ment opportunities and ways to improve the processes. ral candidate for this inner circle on which the operations
Cooper and Turney (1990) termed systems where the wheel is mounted.
134 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 indi- methods of cost allocation may lead a company to a
vidually to evaluate compatibility with the ABC/M con- death spiral in which the ‘least profitable’ product lines
cepts and demonstrate how many companies have suc- are dropped one after the other in order to reduce costs.
cessfully used ABC/M systems with varying The critical information ABC supplies is that often the
sophistication levels to address various OM decisions. profitability picture has been distorted in the past. With-
out a true picture of accurate costs for each product, it
3.1. Product planning and design is extremely difficult to evaluate whether or not a pro-
duct is contributing to the profitability of the firm. And,
An ABC/M system can provide useful insight into of course, if evaluating an entire product is difficult, then
product design decisions. In a firm, which manufactures evaluating specific design characteristics becomes
only one product, it is simple to assign costs to that pro- impossible.
duct. However, in a firm with a complex product offer- Product design should be a group process with input
ing, cost assignment becomes more difficult. Product from marketing, finance and operations. Unfortunately,
complexity “results in high manufacturing overhead each of these groups tends to look at design from their
costs incurred for such activities as supervision, quality individual perspectives. ABC assists the process of syn-
control, inspection, machine and tool maintenance, and thesizing these different perspectives by identifying spe-
production control” (Cooper and Kaplan, 1991). Cost cific cost drivers. For example, setup times may be a
accounting’s allocation based on machine hours or direct significant cost driver that was not recognized by cost
labor hours does not provide a clear picture of the true accounting. However, the setup changes might only be
allocation of resources. “Product costs thus become dis- required for a relatively minor feature that marketing
torted, leading to a biased analysis of design for manu- added as a ‘bonus’ or afterthought that does not signifi-
facturability, product profitability, outsourcing, and cantly impact the product’s desirability. Once this driver
make or buy decisions” (Banker et al., 1990, p. 270). A is recognized, product designs can be modified with the
clear example of the impact that ABC data provide is goal of reducing or eliminating unnecessary setup
with respect to the decision of which product line to changes, thus lowering cost.
eliminate. For instance, imagine a firm that makes pro- The implementation of an ABC/M system provides an
ducts to fill orders in large quantities or small batches. opportunity for clearer communication between func-
Often small lot sizes appear more profitable under tra- tional areas on issues of product design. An engineer in
ditional cost accounting systems, so the firm might Hewlett Packard’s Roseville Network Division described
decide to drop the products that are produced in large the impact on their design process as follows: “We cre-
lots to concentrate on the more ‘profitable’ niche pro- ated a lot of tighter relationships among accounting,
ducts. research and development, manufacturing, and market-
However, ABC/M information may show that the ing. We were all learning about the business. We have
small lot product is actually much more expensive than broken the back of the cost system design problem and
estimated because ABC data will include factors not usu- are now refining it and our intuitions about the econom-
ally considered, such as order processing. Relying on old ics of product design. Overall, the whole experience for-
 M. Gupta, K. Galloway / Technovation 23 (2003) 131–138 135

ced us to understand our design process” (Cooper and the customary reports using traditional accounting data
Turney, 1990, p. 296). and was never questioned. Afterwards the causes were
traced and eliminated. The company then found itself
3.2. Quality management and control with the availability of almost one-fourth of the shop’s
workers (Johnson, 1993). ABC/M simplifies the determi-
A major trend in American business is the focus on nation of quality costs by revealing such activities and
continuous improvement of quality — quality products, their costs, which can be used in detecting and cor-
quality systems, quality improvements. The attitude of recting activities.
the world-class company has often been summarized as
‘improve quality, and all else will follow.’ The idea that 3.3. Process design and improvement
costs will take care of themselves if managers focus only
on improving quality and reducing lead time makes one ABC offers significant insight into equipment and pro-
wonder how Baldridge Award winners could encounter cess decisions. ABC “challenges manufacturing and
severe financial difficulties. (Kaplan, 1992, p. 60). But financial teams to identify, desegregate, and analyze the
all projects cannot be pursued simultaneously because underlying manufacturing activities that drive overhead”
resources are limited. How can a firm determine what (Owen, 1993, p. 27).
priority to give to the quality improvement and cost Traditionally, accounting systems focused on monitor-
reduction plans it identifies? ing and controlling costs incurred subsequent to the pro-
The ABC/M system can play a significant role in the duct design process. In modern manufacturing environ-
prioritization and cost justification of quality improve- ments where product complexity significantly influences
ment projects. Because it includes non-value added costs, a large portion of the costs is determined at the
activities in the costs, ABC/M can provide information design stage. Banker et al. (1990) reported a develop-
that allows a firm to determine what impact each project ment of an advanced ABC/M system, which analyzes
would have, and therefore a means to determine which the determinants of activities in terms of product and
ones to pursue first. Without this insight into prioritiz- process design features, and thereby provides valuable
ation, a firm can pursue several low impact improvement information to the product designers by supplying the
projects at great cost and little gain, while overlooking cost implications of alternative design choices. The sys-
other projects that might have a tremendous impact. tem can isolate the various factors that are under the
Nutrilite Products, Inc., a food supplement business, control of design engineers and that can be used to
gained ‘focus and direction’ for their process improve- influence manufacturing costs. Lacking such systems,
ment efforts when they adopted ABC/M and found prac- companies tend to add more features and design more
tical applications of information in the area of pricing complex products because the price and market share
and product abandonment decisions. advantages are perceived to outweigh the additional
ABC/M information can also play a role in quan- costs of designing, manufacturing and supporting com-
tifying the costs of quality. What are the costs of quality? plex products. Banker et al. (1990) reported the appli-
There are four categories: (i) prevention (i.e. costs of cation of their ABC/M system to a plant that manufac-
activities performed to prevent errors from occurring); tures a wide variety of rear, park, signal and other lamps
(ii) appraisal(i.e. costs of inspection such as determining for a wide variety of automobiles. Their ABC/M system
if the product conforms to standards); (iii) internal fail- showed that those products classified as outsourcing can-
ure (i.e. the costs of correcting errors before they reach didates were precisely the simpler products that were
the final customer, such as scrap, rework and change being over-cost by the traditional cost system.
orders); and (iv) external failure (i.e. costs associated ABC/M information can also be used by both pure
with errors that reach the final customer, such as cor- cellular manufacturing (CM) or those that combine job
recting the error, handling complaints, and customer ill shop and CM. CM is a configuration of job-shop into
will resulting from the error). These four types of quality mini assembly lines, also called cells, that manufacture
costs fall into two categories: product design and com- similar products. Using an ABC/M system, the distinc-
pliance with standards. Many of these quality costs can tion between a direct and indirect cost disappears in CM
be categorized as non-value added costs that would not as each cost can be traced to a particular cell, rather than
have been identified with traditional cost accounting to individual products in a family (Dhavale, 1992).
(Schneider, 1992). Western Zirconium, a 1988 Baldridge Award recipient
An example of how ABC/M helped operations man- that supplies its parent firm, the Commercial Nuclear
agers to improve quality can be seen with a large tele- Division of Westinghouse, examined its production pro-
communication company. After performing an activity cesses with an ABC perspective and achieved dramatic
analysis of all positions at the company, it was determ- results. “Mapping existing work flow demonstrated that
ined that approximately 30% of personnel times were the work-in-process traveled over two miles during a 45-
spent on reworks. This activity has not been detected on day time span and quickly showed that improvements
136 M. Gupta, K. Galloway / Technovation 23 (2003) 131–138

could be made by rearranging the manufacturing floor Player and Kramer (1995) reported a successful
to cluster the work more efficiently and eliminate implementation of an ABC/M system based automatic
unnecessary movement of in-process production. In replenishment system in more than 50 companies. The
addition, control systems that measured performance on system, initially piloted in TTI Inc. Company, has sig-
overhead absorption and labor efficiency were found to nificantly reduced inventory investment as well as
foster inventory buildup, which is counterproductive to administrative costs. Typically, the purchasing process
achieving total cost competitiveness” (Schneider, 1992; for a manufacturing company begins with the Manufac-
p. 23). Western Zirconium used ABC/M to focus on cost turing Resource Planning (MRP) system determining the
drivers and value-added processes. As a result, a number production requirements for various component parts.
of advantages were reported. For example, work-in-pro- Following the determination, the company may obtain
cess inventory was reduced from $12.3 million to $4.2 competitive bids and then place an order. The purchasing
million. First-time product acceptance increased from department then receives, inspects, and inventories each
34% to 92%. Elapsed production time was reduced from item. All these activities must occur before the parts can
45 days to 10 days (Schneider, 1992, p. 23). be used. Under this new program, the team performed
an activity analysis of the procurement process, and
3.4. Inventory and procurement management reduced 15 traditional purchasing steps to three and
reduced the purchase cycle-time from 9 weeks to 1
Strategies for inventory reduction, such as JIT, week.
address the fact that carrying inventory at all stages —
raw materials, work-in-process, finished goods —
3.5. Capacity and investment management
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, Cokins (1993) argued that most organizations have
if the purchasing department is rewarded on the basis of very little insight and understanding about the location
lowest cost, large lots may be ordered to get a quantity and cost of their unused and non-productive capacity. In
discount. If the lot size is more than what is needed for addition, there is a tendency to load all costs onto pro-
the tasks at hand, inventory buildup occurs. If individual ducts delivered, which hides these costs, and conse-
units are evaluated on their throughput, they will pro- quently, the firms lose the opportunity to decrease them.
duce as much as possible without regard for whether the ABC/M systems help firms understand the link between
product moves on to the next work stage or into a ware- increasing owner’s wealth and minimizing unused
house. ABC supports measures that place the emphasis capacities. With an ABC/M system, these costs are iso-
on the whole firm, not individual units or departments, lated and measured in three segments: idle (i.e. unused
and thus may make it more feasible from the unit or and available), non-productive, and productive.
department standpoint to lower inventory levels. Equipped with this insight, firms can act on this new
In an ABC/M pilot study carried out at Lord Corpor- data, motivating operations managers to decrease the
ation, numerous revealing insights were found. Rupp non-productive capacity which will increase idle
(1995) reported that it only made sense that a 10 cents capacity and then, in turn, provide incentive to either fill
part should take a penny’s worth of overhead, as our the idle capacity with more customer orders or remove
standard cost system used to show but what ABC/M sys- the idle capacity. Baxendale and Gupta (1998) discussed
tem revealed was that even those inexpensive parts were how a small custom screen-printing company benefited
being purchased, received, inspected and stocked in a from implementing an ABC/M system. The system pro-
manner that created significant costs. vided information on unused capacities of activities as
Datar et al. (1991) discuss the results of a field study well as the relative profitability of the various products.
which illustrates the use of activity-based costing to ana- The owners of the firm were able to embark on a con-
lyze material handling expenses (which exceeds tinuous improvement process by focusing their efforts
$5,000,000 per year and comprise approximately 10% on the most constrained activitiy (i.e. the activity with
of total factory costs). They identified relevant material no unused capacity).
handing cost drivers, such as ‘number of moves’ and Long-term capacity decisions involve choices between
‘distance moved’, and used department cost accounts the alternative uses of resources, such as acquiring or
pertaining to three stages of material handling disposing of capacity. Just as ABC/M systems can
(purchased parts, WIP and finished goods) to create cost improve the accuracy of cost data to help in prioritizing
pools and then, allocate to each product (or production quality improvement projects, they can provide infor-
part). Thus, they demonstrated how an ABC/M system mation to help assess capacity decisions. When pro-
can quantify the potential for actual dollar savings, cesses are evaluated in the ABC/M implementation pro-
which could come from reductions in material handling, cess, bottlenecks caused by inadequate or outdated
labor force, equipment, supervision etc. equipment can be identified. Decisions between alterna-
 M. Gupta, K. Galloway / Technovation 23 (2003) 131–138 137

tives on how to address these equipment needs are sup- 3.6.2. Roles and responsibilities
ported by ABC data. With accountability and empowerment moved to its
Traditional cost accounting may provide misleading lowest level, the roles and responsibilities of employees
information regarding the costs of equipment that bias versus supervisors can shift. Rather than performing as
decisions about upgrading or replacing equipment. New ‘organic robots’ that basically follow orders without
technologies are often expensive, and many companies using critical thinking, employees “can accept responsi-
require detailed justification proposals for new pur- bility, and participate in business decisions%Managers,
chases. Preparing comparisons of current versus pro- freed from some of their traditional responsibilities,
posed equipment becomes clearer using ABC/M sys- spend more time as coaches, facilitators, communicators,
tems. and resources” (Turney, 1993, p. 31). Rather than spend
A survey cosponsored by the National Association of time looking over an employee’s shoulder to ensure he
Accountants and computer-aided Manufacturing Inter- does what he is supposed to do, managers can concen-
national concluded that even though most US firms trate on enabling employees to maximize their potential.
attach a critical importance to the strategic justification
of advanced manufacturing technologies, they fail to 3.6.3. Performance measures
explicitly incorporate the firm’s strategy into the invest- A serious problem with performance evaluation is that
ment analysis. Brimson (1989) suggested an activity- managers are often evaluated on measures that cause
based investment analysis system that analyzes in detail them to act against the best interests of the firm in order
the impact of a new technology on the cost, performance, to improve their departmental or unit rating. To combat
and interdependence of key activities. The system pro- this narrow, department-focused view and steer man-
vides a mechanism to systematically decompose the agers toward integrated, company-wide goals, ABC can
company goals and objectives into a base set of activities be used to establish benchmarks, which can be used as
that are impacted by the investment. a basis for performance evaluation. Once these bench-
Thus, Brimson (1989) argued that the activities pro- marks have been created, “the actual achievement of
vide a consistent basis for analyzing investment and them needs to be continually assessed — not just against
monitoring the actual results through an ABC/M system. absolute cost levels but also against other important cri-
teria such as service levels, quality and timeliness, as
3.6. Work force management well as against other equally important performance
areas, e.g. those relating to customers” (Connolly and
The ABC process can have a significant impact on a Gary, 1994, p. 33). ABCs focus on processes that affect
firm’s employees, particularly in areas of employee costs and it emphasizes the interconnectedness of each
empowerment and accountability, roles and responsi- department, crossing functional boundaries to support
bilities, and performance measures. (Turney, 1993) ABC processes that produce most efficiently.
starts with identifying activities that are performed in
a firm. An excellent starting point for gathering ABC
information is the front-line employee. 4. Conclusion

3.6.1. Empowerment and accountability Traditional cost accounting methods, which allocate
ABC takes information that was previously couched overhead costs on the basis of one driver (e.g. direct
in pure financial terms and translates it into terms that labor or machine hours) are inaccurate and misleading
relate to specific activities. With ABC, performance as these methods often allocate too much cost to one
measures can be described in meaningful terms. An product and not enough to another. To address this prob-
employee becomes aware of how his activities contribute lem, activity-based accounting was developed to provide
to the firm’s financial performance. ABC gives the a means to create a more accurate representation of how
employee the tools he needs to evaluate not only how activities performed in the creation of a product or ser-
he is currently contributing, but how he might improve vice actually impact its cost. ABC/M systems examine
his performance to increase that contribution. processes or activities to determine their effects on costs.
“Operators, who know the full cost of the raw An ABC/M system can be used by any firm which is
materials and the full cost of reworking defective units, able to identify activities that drive costs and allocate
are able to decide whether to scrap bad production or those costs to its particular products or services. Rather
rework it, without intervention by more senior manage- than allocating overhead on the basis of one variable,
ment.” (Armitage and Russell, 1993, p. 7) Empowering such as direct labor, ABC/M systems use multiple cost
employees to make these types of decisions can help drivers to present a more accurate foundation for over-
prevent costly reworking or poor quality product. It can head allocation. Cost drivers are identified by actually
also have an impact on employee commitment and mor- reviewing the entire production process to uncover what
ale. 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 Damito, J., Hayes, G., Kintzele, P., 2000. Integrating ABC and ABM at
other changes taking place in business today. While dis- Dow chemical. Management Accounting Quarterly Winter, 22–26.
Datar, S., Kekre, S., Mukhopadyay, T., Svaan, E., 1991. Overloaded
cussion of ABC/M systems was at first limited to its use overheads: activity-based cost analysis of material handling in cell
as a placement for cost accounting, the focus has shifted manufacturing. Journal of Operations Management 10 (1), 119–
to the identification of processes and their effects on 136.
costs. Dhavale, D., 1992. Activity-based costing in cellular manufacturing
What is the future for ABC/M systems? The next logi- systems. Industrial Engineering 24, 44–46.
Johnson, H.T., 1993. To achieve quality, you must think quality. Finan-
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