Activity-based Costing (ABC) Hunter Company Emmanuel Achirem ACC 560-Managerial Accounting Dr. Lotfi Geriesh Strayer University 08/04/2012 Activity-based Costing (ABC) Hunter Company, 1 Introduction Over the past two decade’s adoption of Activity-Based Costing ABC has been tossed around like a hot potato by every size and type of organization. It was adopted by organizations ranging in size from huge multi-national companies like General Motors to the much smaller Alexandria Hospital. Lanen, Anderson, & Maher, 2011) Some companies began the initial processes but stopped short of actual implementation when they discovered more time and resources were needed to effect the change so management ran from it just as they had run from quality improvement concepts from the seventies and eighties. (Romano, 1990) Was this because ABC was not a good fit for the organization or was there a deeper issue? These organizations knew they were not adequately capturing the costs of activities yet they final cost could be. T.
J Rodgers who founded Cypress Semiconductor wrote: “The seeds of business failure are sown in good times, not bad…Growth masks waste, extravagance, and inefficiency. The moment growth slows, the accumulated sins of the past are revealed all the way to the bottom line. ” (Clemmer, 1992) Given the competitive nature of business today organizations both big and small cannot long afford to ignore the 900 pound gorilla in the room. The goal of this paper is to discuss Time-driven ABC cost system can be implemented and how it has benefited some companies such as Hunter Company.
The system was not widely accepted in the beginning, but ABC has play major role in cost accounting today and has help some managers to combat corporate resistance to change when trying to implement it. Operating managers have known for many years that while the traditional costing approach was inaccurate; and archaic it was close enough. Today, because of the global and high speed Activity-based Costing (ABC) Hunter Company, 2 nature of the business environment, the errors of conventional costing are systematic and can affect too many decisions.
Time-driven ABC is not a hypothetical improvement to traditional ABC analysis. It has been applied in dozens of companies, helping them to deliver significant profit improvements quickly. The Hunter Company (disguised name of actual company), a large, multinational distributor of scientific products with over 20 facilities, 300,000 customers, and 460,000 product SKUs, processes more than one million orders each month. Hunter already had an existing activity-based costing model that had been built with the assistance of an external consulting team.
The insights revealed from the model were extremely informative but many in the company questioned if the view was worth the climb. Their main complaints can be summarized as follows: • The model had been cumbersome to build and maintain. With more than 1,000 activities, the monthly survey of department staff of where they had spent their time was complex and costly. Also, tracking the driver quantities for each activity and customer was difficult. • The model did not reconcile with actual financials since activity cost driver rates had not been updated recently. Despite the already large number of activities, the model was still not considered accurate or granular enough. It did not reflect several important differences between orders. To increase accuracy, more activities would have to be added, and employees would have to be re-interviewed. Also, an additional data extract to track the quantities of the new cost drivers would be required. The existing ABC approach was not easily maintainable, and thus not sustainable.
The company called in a software and consulting company to help it implement the time-driven ABC approach. The time-driven approach led to the following changes: For a department, such as the inside sales department, the previous ABC model required employees to estimate, each month, the percentage of their time spent on their three activities: customer set-up, order entry, and order expediting. In the time-driven approach, the ABC team estimated the time required to perform each activity.
For example, the activity to set-up a new customer took 15 minutes. Since a field already existed within Hunter’s ERP system that identified whether a customer was new, assigning a customer set-up cost to a new customer became a simple transaction. For order entry, the team learned that every order took about five minutes to enter the basic order information, plus three minutes for each line item on the order. Again this was a simple calculation to implement since the ERP system already tracked the number of line items for each order.
Finally, the team learned that order expediting was triggered by a request by the customer to rush the shipment, resulting in an additional 10 minutes of time to coordinate the expediting. The order included a field that identified it is a “rush order. ” The project team could write a simple equation to estimate the Inside Sales Department time required for each order received: Inside Sales Process Time = 15*[New Customer] + 5 + 3*[Number of Line Items] + 10*[Rush]
The Inside Sales Department cost for the order was obtained by multiplying this time by the cost per minute of Inside Sales Department resources. This process was replicated in each department to arrive at the total cost of producing, handling, and fulfilling the order. Note that once the team had created the Inside Sales Process algorithm, it did not need to continually re-interview personnel. Each period, the costs of the department would be assigned based on the volume and nature of the transactions it handled.
Activity-based Costing (ABC) Hunter Company, 4 The Hunter Company identified the following benefits from shifting its ABC model to the time-driven approach. • It reduced the number of activities to maintain. It transformed 1,200 activities (e. g. , set-up new customer, enter orders, expedite orders) to 200 department specific processes (e. g. , the equation used to estimate Inside Sales Department time). Also, it could easily update the resource cost of each cost center and departments so that its process costs were accurate and current. Its cost estimates were more accurate since they were based on actual observations of processing time and actual transaction data, not subjective estimates on where and how people spent their time • It was easier to increase model accuracy and granularity, when wanted, for high cost and heterogeneous processes. Adding more elements to the time equation enabled managers to easily add more variety and complexity to the model when required. This enabled managers to identify specific SKUs, customers, and processes where improvements could be made. The model was easier to validate. The calculated total process time, based on all transactions in a period, could be reconciled to head count (resources supplied during the period). If the total process time exceeded the actual resources supplied, managers received a signal that some of their unit times were likely too high. If total calculated process time was well below the time supplied, but employees felt they were working at or beyond capacity, managers learned that some of their unit times were under-estimated or employees were working less efficiently than anticipated.
Activity-based Costing (ABC) Hunter Company, 5 • The model provided explicit information on processes operating at or beyond capacity, and those operating well below capacity. Managers could take action to relieve bottlenecks expected to persist in future periods, or act to reduce capacity in departments where any unused capacity was expected to persist for several periods into the future. Today, it takes two people, two days per month to load, calculate, validate and report findings, compared to the 10-person team spending over 3 weeks to maintain the previous model.
Employees now spend time generating increased profits from the information rather than just updating and maintaining the information. Over the past 15 years, activity-based costing has enabled managers to see that not all revenue is good revenue, and not all customers are profitable customers. Unfortunately, the difficulties of implementing and maintaining traditional ABC systems have prevented activity-based cost systems from being an effective, timely, and up-to-date management tool. The time-driven ABC approach has overcome these difficulties.
It offers managers a methodology that has the following positive features: 1. Easy and fast to implement 2. Integrates well with data now available from recently installed ERP and CRM systems 3. Inexpensive and fast to maintain and update 4. Ability to scale to enterprise-wide models 5. Easy to incorporates specific features for particular orders, processes, suppliers, and customers Activity-based Costing (ABC) Hunter Company, 6 6. More visibility to process efficiencies and capacity utilization 7.
Ability to forecast future resource demands based on predicted order quantities and complexity These characteristics enable activity-based costing to move from a complex, expensive financial systems implementation to becoming a tool that provides meaningful and actionable data, quickly and inexpensively, to managers. In conclusion, we can see that the methodology behind Activity-Based Costing is sound, and can result in sometimes great savings to a company willing to take the time, effort and expense to implement a plan.
Although there are some pitfalls to the process, with perseverance and a solid commitment from management, ABC can be of great benefit to a manufacturing company. Activity-based Costing (ABC) Hunter Company, 7 References C. Argyris and R. S. Kaplan, “Implementing New Knowledge: The Case of Activity-Based Costing,” Accounting Horizons (September 1994): 83-105. Journal of Cost Management (Winter 1989): 34-46; R. Cooper and R. S. Kaplan, “Measure Costs Right: Make the Right Decisions,” Harvard Business Review (September-October 1988). http://www. hbs. edu/research/facpubs/workingpapers/papers2/0304/04-0