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:
4225

pp:
4360476

Copyright '
MC- )( !td

(SS%:
82960:8:4 (ntroduction Manufacturing organisations of today are much more comple/ than those of the 42:8s 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 (4228 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 (4228 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 4228 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, 4224a " The sur&ey which was mailed to 6@8 organisations resulted in 456 useable replies, a response rate of @: per cent" Slightly o&er 98 per cent of the respondents had not seriously considered +-C and around one0third were &etting it"

'n 4229 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 @43 firms co&ering all aspects of +ustralian manufacturing (Corrigan, 422:1 ?ood, 422: " This sur&ey showed that 79 per cent of the sur&eyed firms had ne&er considered adopting +-C (although 55 per cent of those sur&eyed ac#nowledged awareness of acti&ity0based costing , @2 per cent were still in the process of considering adopting it, 47 per cent had considered and re.ected it and only 4@ 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 @9 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 (422: 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 (422: 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 65 useable responses, was mailed to 478 manufacturing firms selected from the 4227 Business Review Weekly list of +ustralia;s top @88 companies" +mongst the 7@ management accounting practices listed in the Chenhall and !angfield0 Smith sur&ey, acti&ity based costing was ran#ed @7th 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 35th, howe&er, it ran#ed slightly higher, at @2, 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, 422: " 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. (422@ used the results of the 4228 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 38 of the :@ respondents who one year ago were considering +-C and had identified potential problems in its implementation" They also made &isits to 4@ 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 38 companies inter&iewed by telephone, @8 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 49 out of the @8 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 @8 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 38 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., 422@ " The most common problems identified during the first year of implementing an +-C system were (in total there were 46 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., 422@ " 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, (4228 " 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, 4228 " 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 (4224 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 488 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 @9 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 F4,888 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 78098 products which co&ered the whole range of products manufactured by the company" The le&el of detail reduced to @9 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 e pectations 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 4@ 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 422: as a result of the merger between Ciba0Geigy and the pharmaceuticals company SandoG" Ciba Specialty Chemicals employs more than @8,888 employees worldwide" 't generates sales in 446 countries, operates 95 production sites in @2 countries and conducts research in 4@ 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 4@8 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 422: <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 $ong %ong Go&ernment 'ndustry Department, was a uni<ue initiati&e in which go&ernment, industry and academia collaborated to de&elop and implement new manufacturing information systems in local companies and establish these as reference sites for future pro.ects" Details of this initiati&e are gi&en in Chung et al., (4226 " Developing the prototype A!C system The introduction of +-C in C+$% 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 $ong %ong (olytechnic )ni&ersity consisted of e/perts from the computing, accounting and engineering departments" +t the beginning, o&er a period of two months, the pro.ect team spent 49 man0days inter&iewing &arious people in C+$% 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+$% and Ciba Specialty Chemicals as a result of the recent merger" 'n de&eloping the +-C system, the pro.ect team identified budgetary line items from the account lines held in the general ledger" This information was easily e/tracted and categorised into the following si/ budgetary line items in the form of a database= planning and control, sales and mar#eting, general administration, customer ser&ices, information and communication and pro.ect management" The pro.ect team identified o&er 38 acti&ities (e"g" transportation, accommodation, product promotion and used a direct method of allocating e/penses to these acti&ities" 'ndirect e/penses such as rent and e<uipment depreciation were allocated using a weighted factor method" The cost dri&ers identified included sales &alue, sales budget, number of orders, number of samples, number of complaints, etc" The acti&ities and cost dri&ers were continually monitored by the pro.ect team because of the structural and managerial changes ta#ing place within the organisation" The de&elopment and implementation of the +-C system too# appro/imately 45 months" +n e/perienced programmer wor#ed for si/ months on de&eloping the prototype +-C software" This was trialed and tested by the C+$% 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 (4224 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, 4224 "

'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, %" (422: , 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" (422@ , Activity Based Costing - Pro lems in Practice, Chartered 'nstitute of Management +ccountants, !ondon, " JManual re<uestK J'nfotrie&eK Cooper, R" (4255 , HThe rise of acti&ity based costing 0 part one1 what is an acti&ity based cost systemH, !ournal of Cost "anagement, pp"79097" JManual re<uestK J'nfotrie&eK Corrigan, *" (422: , H+-C not easy in +ustralia= sur&eyH, Australian Accountant, pp"940 @" JManual re<uestK J'nfotrie&eK Chung, ?"?"C", !ee, ?"-", Chi#, S"%"A" (4226 , HTechnology transfer at the $ong %ong (olytechnic )ni&ersityH, Proceedings of the #$th Annual %awaii &nternational Conference on 'ystems 'cience, Iol" ''' pp"2:0489" JManual re<uestK J'nfotrie&eK Drury, C" (4228 , H(roduct costing in the 4228sH, Accountancy, pp"4@@0:" JManual re<uestK J'nfotrie&eK 'nnes, *", Mitchell, F" (4228 , Activity Based Costing( A Review with Case 'tudies, Chartered 'nstitute of Management +ccountants, !ondon, " JManual re<uestK J'nfotrie&eK 'nnes, *", Mitchell, F" (4224 , 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" (4224a , H+-C= a sur&ey of C'M+ membersH, "anagement Accounting, pp"@5038" JManual re<uestK J'nfotrie&eK *ohnson, $"T, %aplan, R"S" (4256 , Relevance +ost( The Rise and ,all of "anagement Accounting, $ar&ard -usiness School (ress", "

JManual re<uestK J'nfotrie&eK ?ood, C" (422: , HManufacturers reluctant to count the real costsH, Business Review Weekly, +ugust, pp"2709" 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, 4256 " 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, 4228 " 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, 4228 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, 4228 " Drury (4228 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 4@ 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, 4228 " 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, 4228 = 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, 4228 " Table +', ta#en from 'nnes and Mitchell (4228 , illustrates and contrasts this +-C approach with the con&entional approach" Aperating an +-C system in&ol&es two steps ('nnes and Mitchell, 4228 =

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 (4228 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 (4255 in 'nnes and Mitchell (4228 =

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 98 re<uiring two deli&eries then the use of Cnumber of suppliers; ordersD (assuming each lot of 488 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 two D"

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