Yes, ABC Is for Small Business, Too
A challenge to conventional wisdom. In the decade since activity-based costing (ABC) was introduced, small and midsize companies were advised to steer clear of it. They were warned, mostly by those who labored long and hard--and often unsuccessfully--to implement ABC for Fortune 1000 enterprises, that its installation takes massive resources. It's time to debunk the notion that size matters. My experience, and the experience of a growing number of other ABC experts, indicates that ABC doesn't require a massive effort to implement and that it is effective for any size business. Why has ABC been seen as inappropriate for smaller organizations? The negative assessment was originated by managers of large companies who toiled unsuccessfully to implement the program. (For more on why ABC projects fail, see "Learning to Love ABC," by Gary Cokins, page 37.) The reality is they failed to fully understand ABC. Despite the bad press, smaller organizations are beginning to see that ABC can work as effectively for them as it does for large companies. The concept of activity-based costing is actually very simple. We can summarize it like this: An organization has to perform certain activities to provide the products and services it sells, and those activities cost money. The cost of each of those activities is measured and assigned only to those products and services requiring the activity, using appropriate assignment bases (called drivers). In that way it's possible to get an accurate picture of the real cost of producing each product or providing each service. In fact, the data can be formatted to provide the cost of serving each customer, too. Nonactivity costs--such as direct materials or direct outside services--don't need to be included because they already are attributable to specific products or services. A WALK THROUGH To demonstrate how easy it is to apply ABC, let's walk through one of my ABC engagements. I've changed the company name and some identifying details to protect the confidentiality of the client. Small Company is a $10-million manufacturer of components for the automobile industry: It makes the products by hot forging and machining. To understand how the ABC process was applied, it's necessary to understand the company's product-related operating activities. Here they are in summary: * Small Company buys steel bars from outside vendors. * Upon delivery, Small Company workers test the steel and move it to storage. * When the bars are needed for an order, workers move them to the preforging area, where they're sandblasted and cut to desired lengths. Most of the bars are large and heavy, and they are moved in bins that hold from 20 to 50 pieces. * After sizing the bars, workers move them to a forging operation, where they're shaped and then moved again to an in-process storage facility. In some cases, the steel needs to be forged as many as three times. * For each forging procedure, workers move the bars from in-process storage to the forging area and then back to in-process storage. * After the final forging, workers move the steel parts from in-process storage to the machining area, where they are finished and sent to a finished-goods storage facility. * Finally, the parts go to the shipping area to be sorted, packed and loaded into trucks for delivery to customers. Before adopting ABC, the company assigned manufacturing costs to products using a plantwide costing rate based on direct labor. It included setup costs in manufacturing overhead. Nonmanufacturing costs were assigned to products via a general and administrative (G&A) rate that was calculated as a percentage of total cost. Both rates were based on the company's actual results for the preceding year. This was done despite the fact that it was obvious to management that the direct-labor-based, plantwide manufacturing rate didn't accurately reflect the cost of individual products. …