Activity based costing in manufacturing:

two case studies on implementation

The Authors
Amrik S. Sohal, Department of Management, Monash University, Australia
Walter W.C. Chung, Department of Manufacturing Engineering, Hong Kong
Polytechnic University, Hong Kong
Acknowledgements
The authors are grateful to the Financial Controller at MelCo and to Mr Richard Siu, now
Deputy General Manager of Ciba Specialty Chemicals (China !td" They are also
than#ful to the $ong %ong Go&ernment 'ndustry Department and The $ong %ong
(olytechnic )ni&ersity ((oly) for pro&iding the funding to complete this paper and to
*immy $o who wor#ed as a Research +ssistant,Student on the +-C pro.ect at (oly)"
Abstract
This paper presents two case studies on the implementation of acti&ity based costing
(+-C" The first case is a company based in Melbourne, +ustralia, which manufactures
engineering components" The second case study is a specialty chemicals company based
in $ong %ong" The case studies discuss the introduction of +-C and the benefits and
problems e/perienced during implementation in each company" -ased on the e/periences
of the two companies, factors critical to successful implementation of +-C systems are
identified"
Article Type:
Case study
eyword!s":
+cti&ity0based costing1 +ustralia1 $ong %ong1 'mplementation"
#ournal:
'ntegrated Manufacturing Systems
$olume:
2
%umber:
3
&ear:
4565
pp:
6370687
Copyright '
MC- )( !td
(SS%:
52970:5:6
(ntroduction
Manufacturing organisations of today are much more comple/ than those of the 62:5s
and earlier years" To manage today;s manufacturing organisations managers re<uire
information which is rele&ant, accurate and readily a&ailable" 'nformation is needed to
formulate and operationalise functional strategies and to ma#e decisions on product mi/
and production costs" +lthough production systems ha&e changed to meet the changing
needs of the mar#etplace, in many organisations the internal management accounting
systems and information systems ha&e remained unchanged" Managers and accountants
ha&e become dissatisfied with con&entional costing systems and ha&e e/pressed concerns
about their suitability in the modern manufacturing en&ironment"
+cti&ity based costing (+-C has emerged as an alternati&e to con&entional costing
systems" 't was de&eloped in the )S+ by $ar&ard -usiness School (rofessors %aplan and
Cooper and is a process of indi&idually listing and measuring the cost of each acti&ity
contributing to the production and deli&ery of a particular product or ser&ice" 'n their
e/ecuti&e summary to a report on +-C published by the Chartered 'nstitute of
Management +ccountants, 'nnes and Mitchell (6225 differentiate acti&ity based costing
from con&entional costing as follows=
+-C differs from con&entional costing in its treatment of non0&olume related o&erhead
costs" Many significant o&erheads are related to specific acti&ities which are relati&ely
independent of production &olume" For e/ample, the purchasing o&erhead may be related
to the number of purchase orders" 't is the &olume of such acti&ities (not the &olume of
production which consume resources and therefore determine the o&erhead cost" These
acti&ities dri&e the o&erhead costs and +-C uses such acti&ities for both production
costing and process control"
-ased on a critical re&iew of acti&ity based costing, 'nnes and Mitchell (6225 pro&ide a
summary of its benefits=
(ro&ides more accurate product line costing particularly where non0&olume
related o&erheads are significant and a di&erse product line is manufactured"
's fle/ible enough to analyse costs by cost ob.ecti&es other than products such as
processes, area of managerial responsibility and customers"
(ro&ides a reliable indication of long0run &ariable product cost which is
particularly rele&ant to managerial decision0ma#ing at a strategic le&el"
(ro&ides meaningful financial (period cost dri&er rates and non0financial (period
cost dri&er &olumes measures which are rele&ant for cost management and
performance assessment at an operational le&el"
+ids identification and understanding of cost beha&iour and thus has the potential
to impro&e cost estimation"
(ro&ides a more logical, acceptable and comprehensi&e basis for costing wor#"
This paper describes the adoption of +-C in two organisations and identifies the factors
that are critical to implementation" 'mplementation is the most difficult stage in adopting
new management philosophies and techni<ues" 't is hoped that the e/periences of the two
companies described in this paper pro&ide useful lessons for managers considering the
adoption of +-C systems"
The need for a new approach to cost management and the design and operation of an
+-C system ha&e recei&ed considerable attention from accounting academics and
researchers and it is not intended to co&er this here in any detail" The +ppendi/ at the end
of this paper pro&ides a brief summary of the need for a new approach and the design and
operation of an +-C system"
)*tent of implementation of A+C systems
+fter almost ten years since it was de&eloped, +-C still has a relati&ely low ta#e0up as
shown by the results of a number of sur&eys conducted in >orth +merica, the )nited
%ingdom and +ustralia"
+ sur&ey conducted in 6225 on behalf of the -ritish Chartered 'nstitute of Management
+ccountants (C'M+ +-C ?or#ing Group in&ol&ing organisations in both the
manufacturing and financial ser&ices sectors found that only : per cent of the responding
firms had commenced implementation and 2 per cent had re.ected +-C ('nnes and
Mitchell, 6226a" The sur&ey which was mailed to 745 organisations resulted in 6@7
useable replies, a response rate of 4: per cent" Slightly o&er 95 per cent of the
respondents had not seriously considered +-C and around one0third were &etting it"
'n 6229 the +ustralian Society of C(+s initiated a ma.or sur&ey on +-C amongst
+ustralian manufacturers" This sur&ey, which was conducted by the )ni&ersity of
Technology, Sydney, in&ol&ed 463 firms co&ering all aspects of +ustralian manufacturing
(Corrigan, 622:1 ?ood, 622:" This sur&ey showed that 89 per cent of the sur&eyed firms
had ne&er considered adopting +-C (although @@ per cent of those sur&eyed
ac#nowledged awareness of acti&ity0based costing, 42 per cent were still in the process
of considering adopting it, 68 per cent had considered and re.ected it and only 64 per cent
of the firms sur&eyed had actually implemented it" The highest adoption rates of +-C
were found amongst the food, be&erage and tobacco industry with 49 per cent of this
group using this method"
Af those companies which had adopted +-C most had implemented it within one to two
years after ma#ing their decision to adopt it and the ma.ority of these companies belie&ed
that they had achie&ed fi&e goals=
more accurate product costing1
better cost management1
better cost control1
better allocation of o&erheads1 and
more accurate cost information"
The +ustralian sur&ey found that those companies which re.ected +-C claimed that the
uncertainty of benefits and the high cost relati&e to percei&ed benefits were the main
reasons for re.ecting acti&ity based costing" Some companies belie&ed that they already
hade an effecti&e costing system in place or that they hade more important priorities"
Corrigan (622: refers to a similar sur&ey conducted in the )S+ by the 'nstitute of
Management +ccountants which showed a much higher le&el of implementation amongst
+merican firms" Forty0one per cent of the +merican respondents were already using +-C
as their cost management system and 33 per cent belie&ed that they should be using
acti&ity based costing systems"
+nother +ustralian sur&ey conducted by Chenhall and !angfield0Smith (622: e/amined
the e/tent to which large firms had adopted certain traditional and contemporary
management accounting practices1 the benefits recei&ed from these practices1 the
intentions to emphasise certain management accounting practices in the future1 and the
e/tent to which benefits recei&ed from particular practices were related to the effecti&e
implementation of certain management inno&ations such as TBM, *'T, team wor# and
supplier partnerships" The sur&ey, which resulted in 7@ useable responses, was mailed to
685 manufacturing firms selected from the 6228 Business Review Weekly list of
+ustralia;s top 455 companies"
+mongst the 84 management accounting practices listed in the Chenhall and !angfield0
Smith sur&ey, acti&ity based costing was ran#ed 48th in order of the percentage of
respondents who indicated their business had adopted the practice during the past three
years, indicating &ery low adoption of the method" 'n terms of the relati&e benefits
recei&ed from using each practice, +-C was ran#ed 3@th, howe&er, it ran#ed slightly
higher, at 42, in terms of future emphasis to be gi&en to each item "
'n terms of the association of management accounting practices with the effecti&e
application of management inno&ations, the study showed that Cacti&ity based costing
pro&ided relati&ely higher benefits for the high benefit groups in all of the management
inno&ations (although, while still in the low to moderate benefit categoriesD (Chenhall
and !angfield0Smith, 622:" A&erall, the results of the sur&ey indicated Ca preference for
traditional management accounting techni<ues that emphasise financial information"D
+-C was one of the areas where respondents indicated there would be greater future
emphasis" Ather areas identified were strategic planning, product profitability analysis
and benchmar#ing"
)arlier e*periences of implementing A+C
Cobb et al. (6224 used the results of the 6225 C'M+ sur&ey mentioned earlier and
followed up certain of the respondents to in&estigate the problems which they
e/perienced or percei&ed with +-C" They conducted telephone inter&iews with 35 of the
:4 respondents who one year ago were considering +-C and had identified potential
problems in its implementation" They also made &isits to 64 companies which had
implemented +-C including two companies which had implemented and then re.ected it"
This pro.ect was specifically designed to in&estigate problems and issues in&ol&ed in
adopting +-C"
Af the 35 companies inter&iewed by telephone, 45 were still considering its adoption one
year later" The fi&e ma.or problems percei&ed by this group were=
amount of wor# in&ol&ed in installing an +-C system, particularly for small
companies" This problem was percei&ed by 69 out of the 45 companies1
competing uses for resources which were gi&en a higher priority than +-C1
of suitable accounting staff resources to install an +-C system1
computer resources1 and
of selecting suitable cost dri&ers"
'n this group of 45 companies, ma#ing ma.or changes and inno&ations to the management
accounting system was seen as a highly sensiti&e issue due to a combination of the
following factors=
the percei&ed importance of the management accounting system1
the difficulty of accepting that it has been wrong1
management accountant;s lac# of inno&ati&e e/perience1 or
simply continuing doubts about the &alue of +-C"
Three of the 35 companies inter&iewed by telephone had considered and then re.ected
+-C without implementing it" They also &iewed data collection difficulties, other
priorities and the time in&ol&ed for the accountants as ma.or problems" The cost of
implementing and running an +-C system was considered to far e/ceed the benefits
which would be generated" This was also the &iew of the two small companies which had
implemented +-C and then re.ected it (Cobb et al., 6224"
The most common problems identified during the first year of implementing an +-C
system were (in total there were 67 companies in this group, se&en were inter&iewed by
telephone and ten companies were &isited by the research team the amount of time spent
on +-C and the retraining needed both by the accountants and the computer staff" +s
with any other ma.or organisational change pro.ect, +-C also re<uires a change to the
organisational structure" This was found to be a continuing problem in the companies in
this group" The choice of acti&ities, the selection of cost dri&ers, the uncertainty o&er
using +-C for stoc# &aluation for e/ternal financial reporting and the lin#ing of cost
dri&ers with indi&idual product lines were also problems e/perienced by many companies
during the initial stage of implementation (Cobb et al., 6224"
Recognising the potential of +-C, the Chartered 'nstitute of Management +ccountants
initiated case study research in the )nited %ingdom" 'nitially three case studies were
prepared" Two of the cases were manufacturers ($igh0Tech Electronics and Traditional
Engineering ha&ing one year;s e/periences of organising and implementation of +-C"
The third case was a retail distribution company with two years of e/perience with +-C"
These three case studies are presented in 'nnes and Mitchell, (6225"
The three case studies demonstrated the deficiencies of the cost information produced by
the con&entional costing systems used" This was well recognised by accountants and
managers in the three companies and +-C was &iewed as a means of o&ercoming many
of the disad&antages associated with the con&entional costing system" The credibility of
the cost information, its percei&ed utility and its comprehension by management were all
enhanced by +-C in the three companies"
'nnes and Mitchell identified a number of similarities in the approach adopted by the
three companies in implementing +-C" These included=
up of a small team to design and implement the system" 'n each case this team
was headed by a &ery senior accountant"
consultation with all the rele&ant managers in the organisation" This ensured that
managers had the opportunity to ma#e an input to the design of the system and to
ensure that proposals were acceptable and sensible"
the system as simple as possible by limiting the number of cost pools and cost
dri&ers" This ensured that a wor#able system was up and running in a reasonable
amount of time"
-ased on the e/periences of the three companies, 'nnes and Mitchell concluded that an
organisation can achie&e a range of benefits reasonably <uic#ly from the design and
implementation of +-C" 'n two of the companies a substantially different pattern of
product line costs was apparent and in all three cases +-C increased the C&isibility of
o&erhead costD" 'mpro&ed product line cost would be in&aluable for organisations where
price may be cost sensiti&e and where product promotion strategies and product
range,mi/ decisions need to be made fre<uently" +n impro&ed &isibility of o&erhead cost
enhances the process control of costs by lin#ing costs to the series of acti&ities (cost
pools which cause them ('nnes and Mitchell, 6225"
Furthermore, in one of the companies cost dri&er rates pro&ided a basis for a detailed cost
comparison between its manufacturing plants and enabled management to ma#e better
location decisions for certain processing wor#" The design of new products or
modifications to e/isting products can also be impro&ed by the designers as they ha&e a
better understanding of the characteristics of the product which cause o&erhead cost"
The three case studies also highlighted a number of problems with adopting +-C" The
ma.or problem was the high set0up costs associated with the initial design of the +-C
system, which in&ol&ed a considerable amount of management;s and accountant;s time"
Two of the companies considered the time and effort needed to identify cost dri&ers and
their association with product lines a costly e/ercise and one of these companies thought
that the amount of information generated by the +-C system would re<uire additional
staff in the accounting function"
'nnes and Mitchell (6226 also present a much more detailed longitudinal case study of
+-C implementation at the Da&entry ()% plant of Cummins Engine Company"
Arganisation0wide consultation and acceptance and board le&el support throughout the
period of implementation were considered to be the ma.or success factors in this case"
The new information produced by the +-C system was used to ma#e a range of
managerial decisions which reduced costs in se&eral areas"
't is clear from the abo&e re&iew that managers need to understand better the processes
in&ol&ed in adopting +-C and recognise the factors that are critical to implementation" 'n
order to add to the body of literature in this area, the authors in&estigated the adoption of
+-C in two <uite different organisations" The companies were chosen because they were
#now to the authors to ha&e adopted +-C with some success" (ermission was obtained
from each company to document their e/periences with +-C and subse<uently a number
of in0company inter&iews were conducted with company staff who had led the
implementation in their organisation" + structured inter&iew <uestionnaire was de&eloped
and used by the authors to record the data collected"
The ne/t section presents the two case studies on the implementation of +-C" These case
studies demonstrate the many benefits that are achie&able from a successful
implementation as well as some of the associated problems" The final section of the paper
identifies the #ey ingredients for successful implementation of +-C"
A+C implementation case studies
Case study one: MelCo
>ote that the name of the company has been disguised to protect confidentiality"
The company, referred to here as CMelCoD, is based in Melbourne and manufactures
engineering components" 't is the only manufacturer of these products in +ustralia but has
recently e/perienced considerable competition from o&erseas producers" MelCo is part of
a larger group of companies and currently employs .ust o&er 655 people" Si/ staff are
employed in its accounting function, including a financial controller who was specifically
appointed to introduce +-C into the company" $is pre&ious appointment was with
another Melbourne0based company which manufactured automoti&e components" $is
attempts to introduce +-C there had failed because top management was not con&inced
of the benefits of acti&ity based costing"
?ithin the group there had been no pre&ious attempts to introduce +-C" MelCo was the
first company in the group to ha&e done so successfully" 'ts pre&ious costing system was
a con&entional costing system where o&erheads were allocated to products based on
labour hours utilised" The company manufactured a &ery wide product range for a large
customer base using a large &ariety of processes and methods ranging from highly
sophisticated and automated processes to highly manual processes" Arders were typically
for a small number of items produced to customers; specific re<uirements" + high le&el of
fle/ibility and responsi&eness was demanded by the mar#etplace"
'n order to pro&ide the re<uired le&el of fle/ibility and responsi&eness MelCo had fi&e
years earlier made substantial in&estments in new manufacturing technologies including a
robotics welding cell" The result of this was that the cost structure of the products
manufactured by MelCo had changed <uite dramatically, with labour costs now only
accounting for a proportion of what they were pre&iously" The sa&ings made from the
technology upgrade were not passed on to the customers and e&entually a clear price
disad&antage emerged in the mar#etplace" Many of the company;s buyers wanted to
source from o&erseas, howe&er they preferred to stay with MelCo"
+lthough the company;s o&erall profit margins were increasing, it was slowly losing
many of its customers to o&erseas suppliers" The company was not aware of the areas
which contributed to the impro&ed profit margins" 't was clear to senior management that
the e/isting accounting system was not ade<uate and appropriate decisions could not be
made on pricing, etc" due to insufficient information"
+wareness about +-C came from senior e/ecuti&es within the group1 howe&er, they had
no e/perience themsel&es about how the system wor#ed or how to de&elop and
implement it" They recognised that +-C would pro&ide a solution to the problems
e/perienced by MelCo" $ence, the financial controller was appointed specifically to
implement +-C within MelCo" An ta#ing up his new appointment at MelCo, the
financial controller established a small pro.ect team consisting of himself, an engineer
from the manufacturing area and the cost,systems accountant to de&elop and implement
+-C" A&er a period of three months the pro.ect team held many informal discussions
with other personnel in the company" -oth the engineer and the financial controller
wor#ed full0time while the cost,systems accountant spent about two0thirds of his time on
the +-C pro.ect"
The team established 49 cost pools for the whole of the company and spent a
considerable amount of time agreeing on the cost dri&ers" Some of the cost dri&ers
identified were=
fre<uency of set0ups for the new machines, this included programming the >C
machines1
number of manufacturing orders 0 this was dri&ing many acti&ities from the
original <uoting stage to dispatch of the finished products1
number of purchase order lines 0 this was dri&ing the wor#load in the purchasing
department1
number of store issues to the production departments 0 this was dri&ing the
wor#load in the stores1
number of inspections made 0 sampling inspection was carried out in many areas1
area allocation to processes and machines1
ser&ice personnel costs"
Many of the cost dri&ers were common to se&eral cost pools and the pro.ect team did not
e/perience any ma.or difficulties in allocating cost dri&ers to acti&ities" The system
implemented at MelCo is (C0based, largely consisting of spread sheets de&eloped in0
house by the financial controller" Anly F6,555 was spent on purchasing software but a
substantial amount of effort was made in tailoring the software for the specific needs of
the company" Collecting and inputting data was also &ery time consuming"
The +-C system was initially piloted on a sample of 85095 products which co&ered the
whole range of products manufactured by the company" The le&el of detail reduced to 49
products once their homogeneity was established" The old costing system is still used,
primarily for stoc# &aluation, &ariance analysis and labour efficiencies"
The +-C system can generate true costing and pricing, automatically gi&e performance
measures and product profitability and pro&ide a &ariety of information for management
decision0ma#ing" The current year;s budget is being prepared using data and models
de&eloped from the +-C system"
Management epectations of the A!C system
+t the time of introducing the +-C system at MelCo the general manager was fully
supporti&e and recognised the full potential of its outputs" $owe&er, he was not aware of
the amount of time and effort re<uired to set up the system" +fter only one month of
starting the implementation the general manager demanded results" $e was told politely
by the financial controller that this was not possible with the e/isting resources allocated
to the pro.ect and that if he wanted the pro.ect to be implemented <uic#ly then he would
ha&e to allocate additional resources" The general manager was also under pressure from
head office to show results from the +-C system" To con&ince himself, he made his own
en<uiries to &alidate the claims of the financial controller and established that the time
frame re<uired was reasonable gi&en the resources allocated to the pro.ect" $owe&er,
further resources were not allocated and the implementation proceeded as originally
planned by the financial controller"
Pro"lems during implementation
!ac# of resources was a continuing problem during implementation, particularly when
the general manager was e/pecting fast results" !ac# of a&ailable s#ills in0house meant
that a considerable amount of education and training had to be underta#en" This was
largely underta#en by the financial controller on an informal, as needed, basis with some
formal education of senior management to inform them of what +-C was all about and
how it was being implemented in the company" The training of the cost,systems
accountant was on0going throughout the pro.ect planning and implementation stages"
+s part of the communication and data gathering e/ercise the financial controller had to
deal with the unions on the shop0floor" + number of union officials were inter&iewed to
determine how they spent their time during the day" 'n many cases there was a reluctance
on the part of the union officials to answer <uestions and they indirectly resisted the
implementation of the +-C system" They were somewhat wary of why +-C was being
implemented and particularly its implications for their .obs" They were told that this was
simply a costing e/ercise" Generally, they recognised the usefulness of the system for the
long0term sur&i&al of the company"
#he results of the A!C system
+ccording to the financial controller, the +-C system implemented at MelCo has
deli&ered many benefits" The benefits include=
more accurate information on costs and pricing and hence competiti&e positioning
of the company in the mar#etplace1
identification of appropriate benchmar#s which can be used against imported
competiti&e products1
better information has enabled the company to outsource many products which
were inefficiently manufactured in0house1
more appropriate capital in&estment decisions being made as a result of better
weighting being determined on &arious aspects of this e/ercise1
many problem areas identified where costs were e/cessi&e" This includes the >C
section where utilisation has been low1
performance measures ha&e been de&eloped which are used to identify
impro&ement initiati&es1
&alidation of annual budgets for specific e/penses"
+lthough 64 months man0time was necessary for implementation, the benefits clearly
outweigh the costs" The o&erall benefit has been the much more accurate and rele&ant
information which can be effecti&ely used by management" +-C pro&ides a tool for
management for commercial decision0ma#ing"
Current status of the A!C system
!ac# of appropriate resources to run the +-C system remains a problem at MelCo" This
may emerge as a ma.or problem in the &ery near future because of the recent change in
senior management in the company" The general manager who initiated the +-C system
at MelCo recently departed and has been replaced by a new general manager who is not
familiar with the +-C system and does not appreciate fully its benefits" The resources
needed to further de&elop and run the +-C system may not be allocated in the future by
the new general manager"
A&erall, the group;s top management recognise the high potential of +-C" The financial
controller sees the +-C system as a good tool for the group to de&elop further and
implement fully in other companies"
$a&ing been in&ol&ed in implementing two +-C systems in two different companies the
financial controller regards acti&ity based costing as Ca necessary system1 it is common
sense and answers many of the <uestions facing manufacturers currently" The <uality of
information pro&ided by the system is high and enables informed decisions to be
underta#en"D
Case study t$o: Ci"a %pecialty Chemicals
Ciba Specialty Chemicals is a leading manufacturer of chemicals and is part of the newly
formed global life sciences group >o&artis which was formed in 622: as a result of the
merger between Ciba0Geigy and the pharmaceuticals company SandoG" Ciba Specialty
Chemicals employs more than 45,555 employees worldwide" 't generates sales in 667
countries, operates 9@ production sites in 42 countries and conducts research in 64
countries"
This case study is based on Ciba +dditi&es $ong %ong (C+$% which is part of the
+dditi&es Di&ision of Ciba Specialty Chemicals (the other di&isions are consumer care
chemicals, pigments, performance polymers and te/tiles dyes" C+$% was charged with
mar#eting and distribution of additi&es products in the South East +sia region and
pro&ided both technical and managerial ser&ices" C+$% employs around 645 people in
the South East +sia region" Aperating costs and e/penses were being allocated using
common allocation bases 0 sales &alue and sales &olumes" This approach was far from the
realistic situation and in early 622: <uestions were being raised as to how operating costs
can be fairly allocated to the &arious cost ob.ects" E/ternal pressure from head0<uarters in
SwitGerland and internal pressure from the local operations built up to challenge the
status <uo" This was an indication for top management to re&iew the current situation and
implement a new costing system"
Ciba had earlier e/perimented with +-C in other di&isions and had learnt some important
lessons" $uman resources support, time a&ailability of the pro.ect champion, top
management support, cost,benefit analysis, detailed pro.ect planning, user participation
and e/ternal e/pertise had all been identified as critical success factors" +t the time
C+$% was considering the introduction of +-C, The $ong %ong (olytechnic )ni&ersity
(Department of Manufacturing Engineering was initiating a research pro.ect focusing on
Manufacturing 'nformation Systems" This pro.ect, funded by the $ong %ong
Go&ernment 'ndustry Department, was a uni<ue initiati&e in which go&ernment, industry
and academia collaborated to de&elop and implement new manufacturing information
systems in local companies and establish these as reference sites for future pro.ects"
Details of this initiati&e are gi&en in Chung et al., (6227"
Developing the prototype A!C system
The introduction of +-C in C+$% started with the establishment of a multi0disciplinary
pro.ect team charged with the design and implementation of an +-C system, including
the de&elopment of the +-C software" The team members consisted of two parties1 a
practitioner team made up of a pro.ect leader with an accounting and finance bac#ground,
a pro.ect champion from information engineering, and user staff members from
information technology who would ta#e o&er the information system prototype for
maintenance" Second, the de&elopment team from The $ong %ong (olytechnic
)ni&ersity consisted of e/perts from the computing, accounting and engineering
departments"
+t the beginning, o&er a period of two months, the pro.ect team spent 69 man0days
inter&iewing &arious people in C+$% to collect rele&ant data" Each month the pro.ect
team met twice to discuss &arious issues relating to the design of the +-C system, the
prototype +-C software, and other technological and organisational aspects" De&eloping
a fle/ible system which could accommodate on0going structural and managerial changes
was a #ey re<uirement" This was especially necessary gi&en the dramatic changes that
were ta#ing place in C+$% and Ciba Specialty Chemicals as a result of the recent
merger"
'n de&eloping the +-C system, the pro.ect team identified budgetary line items from the
account lines held in the general ledger" This information was easily e/tracted and
categorised into the following si/ budgetary line items in the form of a database= planning
and control, sales and mar#eting, general administration, customer ser&ices, information
and communication and pro.ect management" The pro.ect team identified o&er 35
acti&ities (e"g" transportation, accommodation, product promotion and used a direct
method of allocating e/penses to these acti&ities" 'ndirect e/penses such as rent and
e<uipment depreciation were allocated using a weighted factor method"
The cost dri&ers identified included sales &alue, sales budget, number of orders, number
of samples, number of complaints, etc" The acti&ities and cost dri&ers were continually
monitored by the pro.ect team because of the structural and managerial changes ta#ing
place within the organisation" The de&elopment and implementation of the +-C system
too# appro/imately 6@ months" +n e/perienced programmer wor#ed for si/ months on
de&eloping the prototype +-C software" This was trialed and tested by the C+$%
practitioner team and many changes were made along the way"
The top management team from Ciba Specialty Chemicals was &ery supporti&e
throughout the pro.ect and allowed local $ong %ong management to be fully in&ol&ed in
the pro.ect" The +-C system de&eloped and implemented assists C+$% in a number of
ways" The system pro&ides realistic cost information on selected cost ob.ects and much
more accurate information is now a&ailable for business analysis" Currently both the
traditional accounting system and the +-C system are being used to pro&ide different
cost information for &arious purposes"
Pro"lems during implementation
%ey staff in&ol&ed in the +-C pro.ect were at times under considerable pressure as they
were also in&ol&ed in a number of other ma.or structural changes ta#ing place within
C+$%" $ence, time a&ailability was a problem" 't is recognised that full0time a&ailability
of #ey people is a pre0re<uisite to success"
There was some resistance from a number of the staff members" This may ha&e resulted
from the o&erall structural and managerial changes that were ta#ing place at the time of
the +-C pro.ect and to some e/tent the uncertainty in the future" The support and
in&ol&ement of the top management was &ital in o&ercoming resistance and fear amongst
some employees"
!enefits of the A!C system at CAHK
The +-C system de&eloped at C+$% pro&ides more accurate costs, enabling
management to analyse better the customer base and pro&ide better ser&ices" The +-C
system has also enabled C+$% to promote more appropriately rele&ant product lines and
ma#e better business decisions, particularly those relating to outsourcing"
+s a result of the +-C pro.ect and the collaboration with The $ong %ong (olytechnic
)ni&ersity, C+$% has de&eloped a number of capabilities=
superior pro.ect planning e/pertise1
better leadership and managerial s#ills amongst its people1
ability to learn together1
learning to be patient1 and
learning to delegate responsibility and trust others to be responsible"
C+$% is currently e/tending the +-C system to co&er its manufacturing area which is
being established in Southern China" The $ong %ong +-C implementation e/perience
has taught the company to understand the different culture that e/ists in China and to
integrate the different &alues that each part of the organisation holds" Respect for the
indi&idual, open communication, education, training, career ad&ancement and team
wor#ing are absolutely essential and professional,personal de&elopment is &ital in
creating a harmonious wor#ing en&ironment"
,iscussion and conclusions
This paper has described the adoption of acti&ity based costing in two organisations" 't is
clear from the literature re&iewed and the two case studies presented in the pre&ious
section that +-C offers substantial benefits o&er con&entional accounting systems1
howe&er, it has a relati&ely low up0ta#e amongst organisations" Many of the problems
and difficulties associated with introducing +-C are related to managerial aspects rather
than the technical aspects of the +-C system" -ased on the case study e/periences
presented abo&e, the following are identified as #ey ingredients for successful
implementation of +-C=
Total commitment from top management" They must understand the benefits that
+-C offers the organisation and must get in&ol&ed in setting realistic and
achie&able ob.ecti&es" The ob.ecti&es must be clear and simple so that e&eryone in
the organisation can understand them" The ob.ecti&es must be regularly re&iewed
and re&ised as changes ta#e place within the organisation and in the mar#etplace"
The establishment of a multi0disciplinary pro.ect team to introduce and implement
the +-C system in the organisation" The team members must be co0operati&e and
share similar &alues and attitudes" + #nowledgeable pro.ect leader or champion
can be &ital to the o&erall success of the pro.ect" This person must ha&e ade<uate
e/perience in pro.ect implementation" The pro.ect team has the responsibility for
clearly defining time frames, actions and responsibilities" 't continuously monitors
the progress of the pro.ect and ma#es the necessary changes so that targets are
being achie&ed"
Education and training of all people in the organisation to understand the
comple/ity of the pro.ect and its impact on the organisation"
+de<uate resource allocation to the +-C pro.ect" Sufficient time must be allowed
for data gathering and analysis during wor#ing hours" Time allowed to gain
confidence with the new system is absolutely necessary"
+ccess to outside e/pertise, particularly when new concepts and software are
being de&eloped" The e/pertise a&ailable at the local uni&ersity can be in&aluable"
An0going feedbac# to top management and lower le&el employees on the progress
of the +-C pro.ect"
%eeping the implementation as simple as possible, perhaps introducing it as a
pilot pro.ect initially"
+ number of potential reasons for failure are also identified from the two case studies=
Employee resistance,scepticism, particularly where education and training has
been inade<uate or where other ma.or organisational changes are also ta#ing
place"
The +-C pro.ect seen as an CaccountingD pro.ect by other functional managers"
)nderestimating the cost of data gathering"
Shortage of appropriate resources, particularly people s#ills"
Ather reasons for failure include too much reliance on outside consultants, politics within
the organisation and letting the pro.ect drag on"
To o&ercome the abo&e problems, thorough planning must be carried out and the right
person must be appointed to act as the CchampionD of the pro.ect" This is not to say that
top management has no hands0on in&ol&ement in the planning and implementation of the
+-C system"
-ased on their e/tensi&e case study based research on +-C implementtion, 'nnes and
Mitchell (6226 concluded that the change process in&ol&ed in implementing +-C is an
on0going one and that there are three factor types which interact together to promote the
cost accounting change" These are1

and
(see Table '"
Many of the factors listed in this table are identifiable in the two cases"
Furthermore, 'nnes and Mitchell say that Cthe effecti&e operation is, howe&er, ultimately
a function of the indi&iduals who wor# for the firm" Managers and accountants must be
prepared to <uestion the status <uo" The accountants must then be prepared to respond to
the changing needs and demands of managersD" These authors identify fi&e #ey
conditions which they say must be met to foster a dynamic management accounting
function which will be responsi&e to management re<uirements" +ccounting staff should=
#ept familiar with business strategy and changes therein and be continually
assessing the information demands which this implies1
familiar with the operational aspects of the business and changes therein and be
continually assessing the information demands which this implies1
and be responsi&e to management criticisms of information which they pro&ide
and indeed be critically assessing outputs regularly themsel&es1
aware of current de&elopments in their own discipline1 and
and de&elopment role ac#nowledged, pro&ided for, reported on and assessed by
top management ('nnes and Mitchell, 6226"
'n this respect, manufacturing and operations managers can assist accounting staff in their
orgnisations to understand better the information needs of the manufacturing, operations
function and play a #ey role in the adoption of +-C"
#a"le &Product cost and management decisions
#a"le A&The structure of factors influencing the change to ABC
-eferences
Chenhall, R"$", !angfield0Smith, %" (622:, H+doption and benefits of management
accounting practices= an +ustralian studyH, Department of +ccounting and Finance,
Monash )ni&ersity, Clayton, I'C, +ustralia, unpublished paper, "
JManual re<uestK J'nfotrie&eK
Cobb, '", 'nnes, *", Mitchell, F" (6224, Activity Based Costing - Prolems in Practice,
Chartered 'nstitute of Management +ccountants, !ondon, "
JManual re<uestK J'nfotrie&eK
Cooper, R" (62@@, HThe rise of acti&ity based costing 0 part one1 what is an acti&ity based
cost systemH, !ournal of Cost "anagement, pp"89098"
JManual re<uestK J'nfotrie&eK
Corrigan, *" (622:, H+-C not easy in +ustralia= sur&eyH, Australian Accountant, pp"9604"
JManual re<uestK J'nfotrie&eK
Chung, ?"?"C", !ee, ?"-", Chi#, S"%"A" (6227, HTechnology transfer at the $ong %ong
(olytechnic )ni&ersityH, Proceedings of the #$th Annual %awaii &nternational
Conference on 'ystems 'cience, Iol" ''' pp"2:0659"
JManual re<uestK J'nfotrie&eK
Drury, C" (6225, H(roduct costing in the 6225sH, Accountancy, pp"6440:"
JManual re<uestK J'nfotrie&eK
'nnes, *", Mitchell, F" (6225, Activity Based Costing( A Review with Case 'tudies,
Chartered 'nstitute of Management +ccountants, !ondon, "
JManual re<uestK J'nfotrie&eK
'nnes, *", Mitchell, F" (6226, Activity Based Costing "anagement( A Case 'tudy of
)evelo*ment and &m*lementation, Chartered 'nstitute of Management +ccountants,
!ondon", "
JManual re<uestK J'nfotrie&eK
'nnes, *", Mitchell, F" (6226a, H+-C= a sur&ey of C'M+ membersH, "anagement
Accounting, pp"4@035"
JManual re<uestK J'nfotrie&eK
*ohnson, $"T, %aplan, R"S" (62@7, Relevance +ost( The Rise and ,all of "anagement
Accounting, $ar&ard -usiness School (ress", "
JManual re<uestK J'nfotrie&eK
?ood, C" (622:, HManufacturers reluctant to count the real costsH, Business Review
Weekly, +ugust, pp"2809"
JManual re<uestK J'nfotrie&eK
Appendi*
The need for a new approach to cost management
See Table +'" The costing systems used in many organisations today were designed
around the turn of the century to produce a small range of products which consumed
similar amounts of production support ser&ices and when non0&olume related costs were
relati&ely small (*ohnson and %aplan, 62@7" Direct costs consisting of direct material
and direct labour usage are easily identified to product lines" 'ndirect costs or o&erhead
costs associated with production support ser&ices (i"e" procurement, set0up, maintenance
and engineering and <uality control and <uality assurance are allocated on the basis of
production &olume" +n o&erhead rate or series of o&erhead rates based on indi&idual
departments are attached to product lines in proportion to a common product
characteristic which bears a close causal relationship to o&erhead cost ('nnes and
Mitchell, 6225" Direct labour based o&erhead cost allocations are most commonly used
and, since the direct labour content is dependent on production le&els attained, these
o&erhead costs are ultimately dri&en by production &olume"
'n today;s manufacturing en&ironment an increasing proportion of total costs do not &ary
with &olume (Drury, 6225 and the continued use of con&entional costing procedures can
ha&e serious dysfunctional conse<uences for the cost information which is generated and
used within firms ('nnes and Mitchell, 6225" Drury (6225 refers to a sur&ey of
management accounting in ad&anced manufacturing technology en&ironments which
found the method of charging o&erheads to products a ma.or area of concern for
managers" The sur&ey also found that direct labour hours or direct labour wage costs were
widely used as a basis for allocating cost centre costs to products, e&en though direct
labour a&eraged only 64 per cent of total manufacturing cost" Drury concluded that in an
ad&anced manufacturing en&ironment, direct labour0based allocation methods are
unli#ely to represent a reasonable basis for appro/imating the o&erhead resources
demanded by products and that output is determined by machines and wor#ers are, in
effect, machine tenders" The sur&ey respondents identified the de&elopment of alternati&e
bases for assigning o&erhead costs to products as the most important area for impro&ing
product costing systems"
,esign and operation of an A+C system
The allocation of o&erhead costs purely on the basis of &olume produced, as is the case
with the traditional management accounting systems, is no longer appropriate" 'n the
modern, high technology industries many of the most important contemporary o&erheads
are largely unaffected by alterations to production &olume and can be &iewed as resulting
from specific transactions or acti&ities which are relati&ely independent of production
&olume ('nnes and Mitchell, 6225" The costs of these o&erhead transactions and
acti&ities ha&e risen dramatically in recent years" Consider for e/ample the costs
associated with product de&elopment, product testing, <uality control,assurance,
procurement and mar#eting which nowadays can be se&eral times the direct cost of some
products" 't is the &olume of these acti&ities which consumes resources and hence
determines the le&el of o&erhead cost" +-C attempts to obtain a greater understanding of
cost beha&iour by trying to understand the forces behind these costs, which are described
as cost dri&ers" E/amples of some of the acti&ity based cost dri&ers which ha&e been
recommended by &arious writers include the number of recei&ing orders for the recei&ing
department, the number of production runs underta#en for scheduling and set0up costs,
the number of purchase orders for the purchasing department, and the number of dispatch
orders for the dispatch department (Drury, 6225=
Therefore if products are to be costed in a manner which reflects their actual consumption
of resources then their share of o&erhead must be absorbed by them on the basis of these
acti&ities" 'f this is done then o&erhead is absorbed in proportion to acti&ities (and hence
cost caused by each indi&idual product, batch of products or product line ('nnes and
Mitchell, 6225"
Table +', ta#en from 'nnes and Mitchell (6225, illustrates and contrasts this +-C
approach with the con&entional approach"
Aperating an +-C system in&ol&es two steps ('nnes and Mitchell, 6225=
o&erhead cost to acti&ity based cost pools"
and using a series of cost dri&er based rates to attach the pooled costs to product
lines"
There are three #ey factors which influence the design and operation of an +-C system=
the choice of cost pools1
the selection of means of distributing o&erhead costs to the cost pools1 and
the choice of cost dri&er for each cost pool"
These are important factors to consider which re<uire that sufficient consultation ta#es
place between management accountants and departmental managers" The establishment
of homogeneous o&erhead cost pools in step one re<uires the identification of all ma.or
acti&ities which cause o&erhead costs" 'nitially a &ery large list may emerge and some of
these acti&ities may turn out to be insignificant" + balance needs to be achie&ed between
the accuracy of the output from the +-C system and the costs and difficulties associated
with operating a more comple/ +-C system" 'nnes and Mitchell (6225 suggest that the
acti&ities must be reduced to ensure a practical and cost effecti&e +-C system is finally
designed" They suggest that to effect this reduction the accountant will re<uire to #now=
the significance of the cost of each acti&ity listed (in order to .udge if it is material
enough to .ustify a separate cost pool and
the factor or factors which influence the cost of each acti&ity (namely the cost
dri&er in order to .udge whether there is homogeneity in the cost beha&iour of
separate acti&ities (which may be combined into one cost pool, at least for product
cost purposes"
The cost of some acti&ities may not ha&e specific cost dri&ers and in this case these must
be reapportioned to the other acti&ities" 'n addition, a number of the cost dri&ers may be
closely related" 'n this situation a detailed analysis of the factors should be carried out, as
outlined by Cooper (62@@ in 'nnes and Mitchell (6225=
Product diversity should be analysed to understand the e/tent to which final
products consume the o&erhead acti&ities in different proportions" 'f product
di&ersity is high then costing accuracy is lost by merging cost pools and
eliminating cost dri&ers"
The relative cost of the activities aggregated should be analysed to understand the
significance of the cost of pooled acti&ities in relation to the total pooled cost"
-olume diversity should be analysed= where products are produced in different
batch siGes and the demand for acti&ities (and hence for o&erhead cost relates to
batches rather than units of output" Thus, if one product is made in ten batches of
ten units and each batch has a specific deli&ery of material associated with it,
while another product is made in two batches of 95 re<uiring two deli&eries then
the use of Cnumber of suppliers; ordersD (assuming each lot of 655 units re<uires
only one supplier order would result in an undercosting of the former product
(which re<uired ten deli&eries and an o&ercosting of the latter (which re<uired
only twoD"
From the abo&e it is clear that a considerable amount of data will need to be collected and
analysed in order to operate an +-C system" Many organisations do not ha&e in place the
mechani