Learning to Love ABC
Why CPAs stumble on activity-based costing projects. Hard as it is to believe, activity-based costing (ABC) works best with a minimum amount of detail and estimated cost figures. By training and inclination accountants are detail oriented, abhorring lack of precision and vagueness. Unfortunately, these qualities that accountants excel in are incompatible with ABC. As a result, when CPAs undertake an ABC project, they typically become overwhelmed with data. It's ironic. Because ABC is designed to provide useful financial insights into a company's operations, it's a process that should be well within accountants' sphere of expertise. Yet the fact remains: CPAs and ABC don't mix. What's behind this incompatibility? Those who have successfully implemented ABC say that, when gathering the underlying data for ABC, close enough is not only good enough, it's often key to its success. But, typically, when accountants try to apply ABC, they strive for a level of exactness that is both difficult to attain and time-consuming--and that eventually becomes the project's kiss of death. The goal of this article is not to make accountants scapegoats for failed ABC projects. Quite the contrary: It's to get CPAs to see that activity-based costing is not that hard to implement, and it truly can enhance their roles as business partner and consultant. THE POWER OF ABC To illustrate the potential of ABC, consider the following two financial reports or a department's expenses. One is taken from a general ledger and the other from an ABC analysis: How much financial insight is a manager likely to get from the chart of accounts report? Although it provides the same total as the ABC report, the ABC report provides information that can be applied to cost management. The ledger information, although accurate, fails to report the business-process costs that run cross-functionally--that is, across an organization's departmental boundaries. It fails to show the true total cost of fulfilling a customer order that passes through many hands. And that's understandable: After all, the general ledger is structured to collect transactions by departments--not to provide insights into work-related costs. As a result, the general ledger is effective: for bookkeeping, but it's structurally deficient for assisting in decision making. Chart of Accounts View Salaries $621,400 Equipment 161,200 Travel expenses 58,000 Supplies 43,900 Use and occupancy 30,000 Total $914,500 Activity-Based Costing View Key/scan claims 32,000 Analyze claims 121,000 Suspend claims 32,500 Receive provider inquiries 101,500 Resolve member problems 83,400 Process batches 45,000 Determine eligibility 119,000 Make copies 145,000 Write correspondence 77,100 Attend training 158,000 Total $914,500 ABC is not a replacement for traditional general ledger accounting. Rather, it's a way to translate general ledger data into a format that helps managers make decisions. ABC corrects for the limitations of traditional costing by identifying all the work activities--and their costs--that go into manufacturing a product, delivering a service or performing a process. When the individual costs are added up, a clear picture of the total cost of a process comes into view. ABC can even distinguish the cost of servicing different customers. The traditional cost management approach--in which cost allocation is based on labor hours, gallons, pounds or other units of output--rarely reflects the true cause-and-effect relationship between indirect and overhead costs and individual products, services, channels or customers. ABC was developed as a practical solution for problems associated with traditional cost management--a technique that usually fails to allocate costs correctly because: * Too many of the costs are lumped together in some categories. …