Activity-based costing: the
right solution for Winair?
A literature study on the suitability of ABC and a case study on
the design and implementation of an ABC-model at Winair.
B.J. Lenferink
Activity-based costing: the
right solution for Winair?
A literature study on the suitability of ABC and
a case study on the design and implementation
of an ABC-model at Winair.
Name:
B.J. Lenferink
Student number:
1407899
University:
Rijksuniversiteit Groningen
Faculty Economics and Business
Organizational and Management Control
Supervision:
First supervisor: Drs. A. Smeenge
Preface
This report contains my master thesis for the master Organizational and Management Control at the Rijksuniversiteit Groningen. This master thesis forms not only the last part of my master but also represents the end of six years studying in Groningen. A period I will always remember as a wonderful time during which I learned a lot.
The master Organizational and Management Control is my second master after completing Small Business and Entrepreneurship last year. The ups and downs of writing my first master thesis gave me a lot of insights to write this report.
I decided to write this master thesis on St. Maarten (Netherlands Antilles) for several reasons. First of all, the experience of going abroad and meeting another culture was very appealing to me. Secondly, the fact that English is the common language on St. Maarten was an important benefit to write this master thesis and to further develop my English speaking and writing skills. I think I do not have to explain to a Dutchman that the weather was a third important reason of wanting to go to a Caribbean island.
I am very pleased and satisfied that the Caribbean airline Winair gave me the opportunity to conduct my research within their company. I had a great time working as an intern at Winair, sitting right next to the CEO Mr. Hodge. I would like to thank all employees of Winair, and especially Mr. Hodge and Mrs. Colbourne, for all the help and support they gave me to design and implement an ABC-system within Winair. Without their help I could not have finished my research and write my master thesis the way I did.
Furthermore, I would like to express my acknowledgements to my first supervisor Mr. Smeenge. It as not always easy to work at such a distance, especially because Mr. Smeenge was appointed as my supervisor when I already was on St. Maarten. However, despite the distance he gave me the help and space I needed to finish my master thesis.
Lastly, I would like to thank my girlfriend for all the help and support she gave me, to write my master thesis. Without her, my time in St. Maarten would not have been as enjoying and memorable as it was.
Executive summary
The executive summary is an informative abstract, giving executives the chance to grasp the essentials of the proposal without having to read the details. As such, the executive summary should include brief statements of the management dilemma and management question, the research objectives, the research questions and the results and benefits of the approach (Cooper, Schindler, 2003, p. 101).
Winair is a St. Maarten based regional airline. The company has 131 employees, is founded in 1961 and is located at the Princess Juliana International airport on St. Maarten. Winair is a government owned company that operates flights to nine destinations. The reason for the government to start the airline was to facilitate travel from and to St. Maarten, but especially from and to Saba and Statia (St. Eustasius). Winair is flying with two different types of aircraft: three Twin Otters (nineteen seats) and three Britten-Norman Islanders (seven seats). The management dilemma of Winair is that the management does not know the exact costs of flying to the various destinations and the cost of flying the two types of aircraft. Hence, there is a need for an improved costing system that provides the management with more accurate information. The management question is: What is the most appropriate kind of costing system that gives a fair and accurate picture of the costs of operating the flights and how would it look like?
In this research activity-based costing (ABC) is hypothesized to be the appropriate costing system for Winair. The main purpose of this research is to critically analyze whether an ABC-system is the right solution for Winair. The key research question is: Is activity-based costing the appropriate costing system for Winair and how can it be applied to assign costs to the products at an accurate way, to facilitate managerial decision-making?
This research is divided into two parts: a literature study and a case study at Winair. Aim of the literature study is to investigate whether ABC has the potential to be the right costing system for Winair. The main objective of the case study is to design and implement an activity-based costing system at Winair that assigns the appropriate costs to the various products. The case study should give insights in how useful an activity-based costing system can be for Winair.
The literature study starts with a detailed description of the ABC-method. The ABC-theory states that almost all costs that a company makes, are made to produce products and services. Hence, almost all costs should be treated as product costs and should be assigned to the cost objects to give an accurate and fair picture of the costs of a cost object. ABC reaches this objective by using a two-stage assignment procedure. Direct costs are directly assigned to the cost objects. Indirect costs are first assigned to activities and then from the activities to the cost objects.
Using ABC gives several advantages. Firstly, ABC achieves greater accuracy than traditional costing (TC) by using multiple cost drivers. Secondly, ABC improves the management and control of overhead. And thirdly, ABC can provide greater visibility of how different products or customers impact profitability. Disadvantages of ABC are that it is not widely used and understood, so employees may resist to the implementation; it is not always possible to determine the cause and effect relationships between costs and the cost objects; and designing and implementing an ABC-system is a timely and costly procedure.
phase. Furthermore, the design and implementation of an ABC-system at Winair has to be adapted to the specific limitations and needs of the company. Winair is a relatively small organization with limited resources and knowledge. To fit the specific circumstances within Winair, a nine-step procedure is developed to design a suitable ABC-system for Winair. The procedure for designing and implementing the ABC-model within Winair is described in the analysis. The procedure is developed based on the extensive literature study and consists of nine subsequent steps to fit the specific circumstances and limitations within Winair. The information needed to construct the model is obtained by interviewing key employees for every activity and especially by meetings and discussions with the CEO Mr. Hodge and the manager of finance Mrs. Colbourne.
Step 1: All costs of Winair are obtained from the accounting system. The cost categories are split and merged into new categories to facilitate the assignment of the costs to the activities or cost objects. A division is made between the direct and indirect costs. Step 2: The main activities of Winair are defined in consultation with the management. Step 3: The appropriate cost objects are defined in consultation with the management.
Winair has two groups of cost objects: the city pairs and the two types of aircraft. Step 4: In this step is determined which activities consume which indirect cost categories;
the EAD-matrix is filled in.
Step 5: The resource cost drivers are determined and resource cost driver rates are filled in the EAD-matrix. The direct cost drivers and direct cost driver rates are determined. Step 6: In this step is determined which cost objects consume which activities; the
APD-matrix is filled in.
Step 7: The activity cost drivers are determined and the rates are filled in the APD-matrix. Step 8: The model is completed, so the profitability of the cost objects can be determined. Step 9: The unused capacity of the cost objects is determined. Because of the way the model
is set up, the unused capacity of the activities cannot be determined.
The outcomes from the ABC-model have several important managerial implications:
- The ABC-model shows very clearly that the Islander is far more unprofitable than the Twin Otter. The high costs of the Islander are mainly caused by the high maintenance needs of the aircraft. Winair should reconsider the Islander operation.
- All destinations except for St. Barth’s are showing a loss. Winair should put more focus on the St. Barth’s operation, especially because the market share is decreasing. Furthermore, the company should reconsider the most unprofitable destinations. - The outsourced routes are making a loss. The direct costs are covered; however the
flights are also causing indirect costs to be made.
- Caution: terminating a destination or aircraft will not increase profitability by itself. Additional measures should be taken, to save or redeploy the excess resources.
Main conclusion of this research is that ABC has proven to be the appropriate costing system for Winair. The two-stage model assigns the large overhead costs of Winair on a fair basis to the cost objects and sketches a clear picture of the costs and profitability of the various city pairs and the two types of aircraft. The ABC-model and the outcomes of the model were received with great enthusiasm within the management team. The nine-step procedure followed to design and implement the ABC-system for Winair has demonstrated to be a useful procedure to design and implement an ABC-system within a smaller organization with limited technical and financial resources and time.
Table of contents
Preface ……….. 1 Executive Summary ………. 2 Table of contents ……….. 4 Chapter 1: Introduction ……….. 6 1.1Introduction Winair ………... 61.2The management dilemma and the management question ……….. 6
1.3Research objective and research questions ………... 7
1.4Research structure ………... 8
Literature study Chapter 2: How does ABC exactly work? ……….... 10
2.1 Introduction to ABC ………...………. 10
2.2 Definition of ABC ………...……… 11
2.3 How does ABC exactly work ……….. 12
2.4 Unused capacity ……….……….. 13
2.5 How can ABC improve firm performance ………... 14
2.6 Definitions of all constructs within ABC ………. 15
Chapter 3: ABC within the framework of management accounting and control …..17
3.1 Management accounting ………... 17
3.2 Management control ………. 18
Chapter 4: The main advantages and disadvantages of ABC ………. 20
4.1 Advantages of ABC ………. 20
4.2 Academic critique, the disadvantages of ABC ……… 21
4.2.1 The ABC paradox ……… 21
4.2.2 Additional disadvantages of ABC……….. 22
Chapter 5: How can an ABC-system be designed and implemented? ……… 25
5.1 The basic rules of ABC ……… 25
5.2 ABC within small and medium sized companies ……… 26
5.3 The design of an ABC-system: case studies ……… 26
5.3.1 Roztocki, et al. ………. 27
5.3.2 Rezaie, et al. ………. 30
5.3.3 Gunesekaran and Singh ………. 31
5.3.4 Thermido, et al. ………... 32
5.3.5 Bukovinsky, et al……….. 34
5.4 A case study of ABC within the airline industry ………. 34
Chapter 6: Is ABC an appropriate system to implement within Winair ……… 36
6.1 Is ABC better than TC? ……… 36
6.3 Is the ABC-approach also appropriate for smaller companies? ………... 39
6.4 Conclusion ……… 39
Chapter 7: Research design, methods and conceptual model ……….. 40
7.1 Descriptors of the research design ……… 40
7.1.1 Research type ………... 40
7.1.2 Data collection ………. 40
7.1.3 Validity, reliability and verifiability ………. 40
7.2 Research methods ………. 41
7.3 Conceptual model ………. 46
Case study Chapter 8: the analysis ……… 47
8.1 step 1: Obtain all costs from Winair ……… 47
8.2 step 2: Define the main activities of Winair ……… 47
8.3 step 3: Define the appropriate cost objects ……….. 48
8.4 step 4: Determine which activities consume which resources……….. 49
8.5 step 5: Determine the appropriate resource cost drivers ……….. 49
8.6 step 6: Determine which cost objects consume which activities ………. 50
8.7 step 7: Determine the appropriate activity cost drivers ……….... 51
8.8 step 8: Determine the profitability of the cost objects ………. 51
8.9 step 9: Calculate the unused capacities of the cost objects ………... 54
8.10 Managerial implications of the outcomes of the ABC-model ……… 56
Chapter 9: Conclusion and discussion ……… 59
9.1 Summary ………... 59
9.2 Conclusion ……… 60
9.3 Limitations of the research ………... 61
9.4 Contributions and directions for further research ………. 61
References ………. 62 Appendices:
1. Introduction, research questions and research structure
1.1 Introduction of Windward Islands Airways International N.V. (Winair) Winair is a St. Maarten based regional airline. The company has 131 employees, is founded in 1961 and is located at the Princess Juliana International airport on St. Maarten1. This is the second largest airport in the Caribbean region. The legal form of the company is a N.V. but all the shares are owned by the government of the Netherland Antilles. The reason for the government to start the airline was to facilitate travel from and to St. Maarten, but especially from and to Saba and Statia (St. Eustasius).
A second main objective of the government is that Winair can keep its own costs covered. Besides flying to Saba and Statia, Winair is also flying to and in between St. Barth’s, Anguilla, Antigua, Nevis, St. Kitts, Tortola and Montserrat. These islands are larger than Saba and Statia and are perceived as more lucrative destinations.
Winair is flying with two different types of planes: Twin Otters (nineteen seats) and Britten-Norman Islanders (seven seats). The company leases three Twin Otters and three Britten-Norman Islanders. With those planes, Winair provides on average sixty flights a day in the high season and between thirty and fifty flights in the low season. Additional to the scheduled line-flights, the company also provides the ability for individuals or organizations to charter a plain. To give the reader a picture of the organization, an organization chart is depicted in appendix A.
In 2003 Winair went into a moratorium. The company has been led for over a year by two trustees, who prevented bankruptcy with help of the government and made a settlement with all the creditors. Since then, the government is the sole owner of the company.
Since, the company is showing a small growth and a somewhat better performance figures, but it is still struggling to survive. The management perceives that the obligated flights to Saba and Statia are negatively influencing the financial results so the government should financially support the company if they want these destinations to be accessible by air.
The main problem of Winair is that they don not know the exact costs of flying to each destination2. This causes several problems, which are discussed in more detail in the following paragraph.
1.2 The management dilemma and the management question
A management dilemma is a problem or opportunity that requires a management decision. The management dilemma provides the focus of research. The management question restates the management dilemma in question form. (Cooper, Schindler, 2003, p. 5, 66 – 70)
The management dilemma of Winair is that the management does not know the exact costs of flying to the various destinations (product costs) and the cost of flying the two types of aircraft. The only way the costs are assigned to the destinations is by the variable cost per flying hour of each type of aircraft, plus a company wide overhead allocation rate which is the same for the two types of aircraft. The company wide allocation rate is calculated by dividing all overhead costs by the total number of flying hours. However, the management acknowledges that this way of assigning the costs does not give an accurate picture of the product costs. Hence, there is a need to improve the costing system, to provide them with more accurate information, to facilitate decision-making. Accurate product cost information can be used in several ways:
1 The organizational structure of Winair is shown in appendix A, to give the reader a background of the company 2
• Firstly, it can be used to revise the prices of the tickets or of chartered flights.
• Secondly, information of the profitability of the flight destinations can be used to evaluate the destinations, to determine the focus of growth, and hence the focus of marketing efforts.
• Thirdly, the information can be used in negotiations with the government about subsidizing the obligatory flights to Saba and Statia.
The management also wants to get a better insight in the problems with the unused capacity of flights and how it influences the profitability; and product and marketing mix decisions. The management question is: What is the most appropriate kind of costing system that gives a fair and accurate picture of the costs of operating the flights to the destinations and how would it look like?
1.3 The objective of the research and the research questions
This paragraph addresses the purpose of the research, here is laid out exactly what is being planned by the proposed research (Cooper, Schindler, 2003, p. 101). Once a clear statement of the management question is defined, it has to be translated into a research question. A research question is the hypothesis of choice that best states the objective of the research study. A research question can be further broken down to investigative questions. Investigative questions are questions the researcher must answer to satisfactorily arrive at a conclusion about the research question. (Cooper, Schindler, 2003, p. 73, 75).
The problem of Winair demands a cost allocation system as a solution. This cost allocation system should give management an accurate and fair picture of the costs and profitability of flying to the various destinations and of operating the two types of aircraft. In this research activity-based costing (ABC) is hypothesized to be the appropriate costing system for Winair. The reasons for choosing ABC are twofold:
• A first analysis learnt that a large part of the costs of Winair are indirect3. An ABC-system gives an opportunity to allocate these indirect costs as precise as possible, based on a multiple cost driver rates.
• The second reason for choosing ABC is that this system facilitates the calculation of unused capacities of the flights; this can not be done with the traditional \system. The main purpose of this research is to critically analyze whether an ABC-system can be the right solution for Winair. This research is divided into two parts: a literature study and a case study at Winair. Aim of the literature study is to investigate whether ABC has the potential to be the right costing system for Winair. A second aim of the literature study is to place ABC within the framework of management accounting and control. The main objective of the case study is to design and implement an activity-based costing system at Winair that assigns the appropriate costs to the various products. The case study should give insights in how useful an activity-based costing system can be for Winair and whether it can facilitate the decision making process.
The key research question is: Is activity-based costing the appropriate costing system for Winair and how can it be applied to assign costs to the products at an accurate way, to facilitate managerial decision-making?
3
The research question can be subdivided into several investigative questions: Literature study
1. How does activity-based costing exactly work?
2. How does activity-based costing fit within the framework of management accounting and control?
3. What are the main advantages and disadvantages of activity based costing? 4. How can an activity-based costing system be designed and implemented?
Sub-conclusion
5. Has activity-based costing the potential to be an appropriate costing system to implement at Winair?
Case study
6. How can an activity-based costing system be designed and implemented at Winair - In which categories can the costs of Winair be placed?
- Which are the main activities of Winair? - What are the appropriate cost objects?
- What are appropriate resource cost drivers and cost driver rates to assign the costs from the cost categories to the activities?
- What are appropriate activity cost drivers and cost driver rates to assign the costs from the activity cost pools to the products / customers?
- What is the profitability of the different products? 7. What are the unused capacities of the?
8. What are the most important managerial implications of the results of ABC-system? Conclusions
Answer is given to the main research question: Is activity-based costing the appropriate costing system for Winair and how can it be applied to assign costs to the products at an accurate way, to facilitate managerial decision-making?
1.4 Research structure
This research is divided into two main parts: a literature study and a case study. The structure of the research will follow the order of the investigative questions that are proposed in the preceding paragraph. Hence, this thesis is organized as follows:
The actual research will start with an extensive literature study on the subject of ABC. The second chapter covers the theoretical backgrounds of ABC. In the third chapter, ABC is grounded into the theories of management accounting and control. The main advantages and disadvantages of ABC, as described in the academic literature, are analyzed in chapter four. Special attention is given to points of critique from academic articles. How an ABC-system can be designed and implemented is described in chapter five. Chapter six consists of a general conclusion of the literature study. Answer will be given to the question if ABC has the potential to be an appropriate costing system for Winair.
Hereafter, the research will continue with the case study. The largest piece of the case study is covered in chapter eight. The structure of chapter eight will basically follow the two-stage assignment procedure first proposed by Cooper and Kaplan (1988) that will be adjusted to the needs and restrictions of the Winair case. At the end of chapter eight, the total costs and the profitability of the various flight destinations are determined. Subsequently, the unused capacity of the end products will be subject of interest. Chapter eight will end with the managerial implications of the results coming from the entire ABC-system.
Literature review
The literature review examines recent or historically significant research studies that act as a basis for the proposed study (Cooper, Schindler, 2003, p. 101).
Main objective of this research is to critically analyze whether an activity-based costing system is the right solution to the problems of Winair. First step in reaching this objective is performing an extensive literature study on the subject of ABC. Aim of the literature study is to critically analyse the theories on which ABC is founded. A second aim is to ground activity-based costing within the management accounting and control framework.
The literature study starts with chapter two, in which the theoretical backgrounds of ABC are covered. In this part is determined how activity based costing exactly works and what the most important elements of an ABC-system are. ABC is grounded within the general framework of management accounting and control in the third chapter. In the fourth chapter a critical analysis of the theory of ABC is given. What are the advantages and disadvantages of this type of costing system compared to traditional costing (TC)?Extensive attention is given to the main points of critique on the ABC approach. Subsequently, the implications of these points of critique are considered. In the fifth chapter attention is paid to the design and implementation of an ABC-system. Articles of Cooper and Kaplan are used as a starting point for the design of an ABC-system. The article of Roztocki, et al. (2004) will be the leading article on how to design and implement an ABC-system within an organization. In the sixth and last chapter of the literature study the main conclusion of the literature study is given: Does ABC have the potential to be an appropriate costing system in general and in particular for Winair?
2. How does ABC exactly work?
2.1 Introduction to ABC
From the beginning of the 1980’s more and more organizations found out that important decisions were made based on distorted cost information (Cooper, Kaplan, 1988, 1992; Hardy, et al., 1992; Wizdo, 1993; Pohlen, et al., 1994; Thermido, et al., 2000; Rezaie, et al. 2008). Traditional cost system use volume-driven allocation bases, as direct labor hours, machine hours, direct materials, etc. (Cooper, Kaplan, 1992, p.1). Only the direct costs (direct labor, direct material, etc.) are considered to be traceable directly to the product. Part of the overhead is treated as an indirect cost and is allocated to the products on a volume based rate as direct labor hours or direct machine hours. This assumes that overhead expenses are proportional to volume of units produced. The other part of the overhead costs (such as marketing, finance and administration) are not treated as product costs at all, but as period costs, and are not allocated to the products (Hardy, et al. 1992).
From the early 1980’s the proportion of overhead costs began to rise in comparison to the direct costs, mainly caused by the emergence of automated processes and revolution in the IT-sector. Direct labor now represents a small fraction of corporate costs, while expenses covering factory support operations, marketing, distribution, engineering, and other overhead functions have exploded. But most companies still allocate these rising overhead and support cost by their diminishing direct labor base or, as with marketing and distribution costs, not at all (Cooper, Kaplan, 1992, p.1)
would hide the impact of the incorrect cost allocations; they could keep unprofitable products and customers because the winners would more than compensate for the losers. Nowadays, the margin of error is much slimmer (Thermido, et al., 2000). To make the right decisions, management must have accurate and timely costing information. ABC is a costing method designed to deal with the deficiencies of the traditional costing systems (Roztocki, et al., 2004).
Key aspect of the ABC methodology is the development of models that represent a logical and quantifiable relationship between the utilisation of resources, the performance of activities and the products or services that they provide (Thermido, et al., 2000, p.1). Cooper and Kaplan were the pioneers in the field of ABC and they developed the ABC method for a large part. According to Cooper and Kaplan (1988), the theory behind the method is simple: “Virtually all of a company’s activities exist to support the production and delivery of today’s goods and services. They should therefore all be considered product costs. And since nearly all factory and corporate support costs are divisible or separable, they can be split apart and traced to individual products or product families (cost objects) … Conventional economics and management accounting treat costs as variable only if they change with short-term fluctuations in output. We found out that many important cost categories vary not with short-term changes in output, but with changes over a period of years in the design, mix, and range of a company’s products and customers. An effective system to measure product costs must identify and assign to products these costs of complexity. (Cooper, Kaplan, 1988, p. 1 -2).” ABC achieves this goal by directly linking the cost of performing activities to cost objects. The ABC method uses multiple bases or cost drivers to link the usage of resources to performing activities and then links the usage of activities to the ultimate cost objects. This approach encourages the use of bases that have a cause-and-effect relationship to the production of the product. The focus is on the activities performed to create each product or service. To use ABC you have to calculate the cost of performing each activity, and then the amount of the activity used by a product determines how much of the cost of that activity is assigned to the product (Hardy, et al. 1992, p.4). So, the main difference between traditional costing methods and ABC is that ABC assigns costs to products based on the amount of activities performed on them. Traditional costing methods allocate direct costs and overhead costs on a proportionate basis using volume-based cost drivers.
2.2 Definition of ABC
2.3 How does ABC exactly work?
Cooper and Kaplan (1988) describe in their article how an ABC system exactly works. The first step is to collect accurate data on direct labor and materials costs. These direct costs can be allocated to the products in the same way as within a traditional costing system. The direct costs are assigned based on volume-driven allocation rates, as direct labor or direct materials, to the products. In the next step the demands made by particular products on the indirect resources have to be established (Cooper, Kaplan, 1988). In this more complicated step ABC comes into use. The assumption, made in the definition of ABC, of activities causing costs, enables ABC to adopt a two-stage assignment procedure for assigning costs to a cost object (Pohlen, et al., 1994, p. 6). Cooper (1988) proposes the following two-stage ABC model to assign the costs to the cost objects as is depicted in figure 1.
Figure 1: Relationship among expenses, activities and products. (Roztocki, et al., 2004).
The first step in stage 1 is to split apart the resources and to identify the activities and relevant cost objects (for example products or customers) within the organization. Subsequently, resource cost drivers allocate the costs to the activities, based on the consumption of resources by each activity. A resource cost driver is a variable that shows the causal relationship between an activity and the resources it consumes.
In the second stage the cost of performing specific activities are combined into cost centers at the activity level. Activity cost drivers trace the activity costs to the cost objects, consuming the activities performed in the organization (Pohlen, et al. 1994, p. 7 – 8). An activity cost driver is a variable that shows the causal relationship between a cost object and the activities it consumes.
2.4 Unused capacity
In this paragraph the concept of unused capacity within the ABC approach is discussed in more detail.
The ABC approach not only produces more accurate costing figures by assigning costs based on resources and subsequently activities consumed by cost objects, it also provides information about the amount of resources used and the unused capacity. The concept of unused capacity and how it facilitates decision making is explained by Cooper and Kaplan (1992).
Traditional costing methods do not assign costs to cost objects on an accurate and appropriate manner for two reasons. First, as is stated in the previous paragraphs, traditional costing systems use volume-driven allocation bases, such as direct labor, to assign organizational expenses to individual products and customers. But many of the resource demands by individual products and customers are not proportional to the volume sold. Especially overhead costs, that are allocated based on volume driven allocation bases, cause distorted product costs.
Second, conventional costing systems do not measure accurately the costs of resources used to produce products and services. Traditional costing systems classify the costs of resources spend or supplied. An ABC-system estimates the cost of resources used in organizational activities to produce outputs. The measurement of unused capacity provides the critical link between the costs of resources used, as measured by an ABC model, and the costs of resources supplied, as reported by the organization’s financial statements (Cooper, Kaplan, 1992).
So, traditional costing systems measure the costs of resources supplied, which is relevant for predicting near-term spending. But only measuring expenses as fixed in short-term does not give much insight as to why the resources were acquired, what the resources are currently being used for, and the level of resources needed in the future. ABC measures the cost of resource usage, which fluctuates in the short term, even though supply will not vary in the short term (Cooper, Kaplan, 1992). For each activity cost pool the cost of resources supplied and the cost of resources used are calculated. The following equations show the relation between resources supplied, resources used and the unused capacity:
Activity availability = Activity usage + unused capacity
Cost of resources supplied = Cost of resources used + Cost of unused capacity
Activity availability is the maximum amount of activities that can be done in one period at practical capacity. Practical capacity is the capacity that can be achieved, taking into account for small inconveniences. Practical capacity is determined by taking theoretical full capacity and then allowing for a small loss of capacity due to for example: breaks, arrival and departure time, sickness, maintenance, repair, etc. An other way to determine practical capacity is to review past activity levels and identify the month with the largest amount of output produced without excessive delays, poor quality, overtime, or stressed employees. The difference between the activity availability and the activity usage is the unused capacity. The information about activity usage and unused capacity is useful for managerial decision making for two distinct reasons:
excesses of capacity will occur and can adapt decisions concerning the level of activity that is demanded or the level of activity that will be supplied (Cooper, Kaplan, 1992).
Second, the information about unused capacity can focus management attention to the parts of the organization where there is an excess in resources supplied. This excess of resources supplied can be either redeployed in other areas or can be reduced in the next budgeting cycle.
The figure for unused capacity differs from the volume variance in several ways (Cooper, Kaplan, 1992, p. 3 – 4):
1. Volume variances are reported only in financial terms, since traditional cost systems do not identify the quantity of overhead resources supplied or used. ABC reports both the quantity and the cost of unused capacity.
2. Volume variances are calculated based on budgeted production, unused capacity is based on practical capacity of the resources supplied.
3. Traditional cost accounting calculations that lead to a volume variance use a volume-based allocation base that varies with the number of units produced. Direct labor hours or machine hours are typical allocation bases within a traditional costing system. Implicitly this procedure assumes that resources are used by cost objects in proportion to the volume of units produced. The ABC approach states that this assumption is not valid. Activity based cost drivers are used as an allocation base for each activity. The cost drivers represent the causal relationship between the activity and the resources it consumes. This means that the cost drivers are not necessarily related to the volume of products produced, but can also be batch-related, order related, product-sustaining and customer-sustaining.
2.5 How can the ABC-approach improve firm performance
In this paragraph is discussed in which ways an ABC-system can actually improve the performance of an organization, which should be the ultimate objective of designing and implementing an ABC-system.
The goal of any cost management system is to provide relevant and timely information to management. This information supports better management of corporate resources in production of products or provision of services, and improves competitiveness in terms of costs, quality, and profitability (Bahad, 1993, p. 563). According to Cooper and Kaplan the ABC approach is also suitable to be used to facilitate decision making: “Activity-based costing is not designed to trigger automatic decisions. It is designed to provide more accurate information about production and support activities and product costs so that management can focus its attention on the products and processes with the most leverage for increasing profits. It helps managers make better decisions about product design, pricing, marketing, and mix, and encourages continual operating improvements (Cooper, Kaplan, 1988, p.103).” “Because ABC reveals the links between performing particular activities and the demands those activities make on the organization’s resources, it can give managers a clear picture of how products, customers, facilities or regions both generate revenues and consume resources. The profitability picture that emerges from the ABC analysis helps managers focus their attention and energy on improving activities that will have the biggest impact on the bottom line (Cooper, Kaplan, 1991, p. 130).” But in which ways can the information of an ABC-system be practically used to improve performance?
The first type of action involves using the revised costing information from the ABC-system to adapt pricing, product mix and marketing decisions. Products and services can be reprised: raise prices for products that make heavy demands on resources and potentially lower prices to a more competitive level for more profitable products. If the reprising strategy is successful, the company should arrive at a new product mix that either generates more revenues for the same consumption of resources or makes fewer demands on the resources. (Cooper, Kaplan, 1991, p. 134 – 135). Management should verify that they can eliminate the resources that are no longer needed (Cooper, Kaplan, 1992). An other possible course of action is to redirect the focus of marketing to the more profitable products; this can be done by changing the marketing mix.
The second type of action involves reducing resources spent. The first place to look are the activities with a large unused capacity. The resources supplied to perform these activities should be reduced in the next budgeting cycle, or redeployed in more profitable areas. A second possibility is to reduce resource usage, while holding revenues constant. When resource usage is reduced, some unused capacity will be created which can then be either managed away or used in more profitable activities. There are two ways to reduce resources used: The first way is to reduce the number of times activities are performed. An example is to set minimum order sizes to reduce the large number of activities that is triggered by many small orders (Cooper, Kaplan, 1992, p. 10). The second way is to increase the efficiency of the activities performed. The increased efficiency enables the same quantity of activities to be performed with fewer resources. This can be done by special types of continuous improvement programmes (Cooper, Kaplan, 1992, p. 10 - 11). Just lowering resource usage is not enough. Resources that are freed up must be managed away in the following budgeting cycle or used in more profitable activities.
The third type of action involves using ABC-system as a decision making tool. New strategies can be tried in an ABC-system to see what the changes do with overall profitability (Cooper, Kaplan, 1992).
2.6 Definitions of all constructs within ABC
In this paragraph the definitions are given of all constructs within the ABC approach that are being used in this research.
- Activities are tasks or sets of tasks that require the consumption or utilisation of resources and result in the completion of a specific service, or in the physical transformation of a product from one state to another (White, 1997).
- A cost object is being defined by White (1997) as the final good or service created as a result of the performance of an activity, or of a chain of activities. This definition is to narrow for this research, because it does not include customers as a possible cost object. The definition being used in this research: A cost object is the final destination of costs being assigned within an ABC-system. The costs are assigned to the cost objects based on the amount of resources and subsequently activities that are being consumed by the cost object.
3. How does activity-based costing fit within the framework of management
accounting and control?
In this chapter ABC will be grounded within the current theories about management accounting and control. First, the basics about respectively management accounting and control are described. Subsequently, the role of costing systems in general and for ABC in specific within the management accounting and control framework will be discussed in detail. Babad and Balanchandran (1993, p. 563) state that the goal of any cost management system is to provide relevant and timely information to the management. This information supports better management of corporate resources in the production of products or the provision of services, and improves competitiveness in terms of costs, quality, and profitability. So, the primary task of a costing system is to give management the information that is needed in the different parts of the management process. The management process can be separated along a process continuum involving objective setting, strategy formulation and management control (Merchant, Van der Stede, 2007, p. 6). These three constructs follow each other chronologically. Management decides first which objectives the company will try to achieve. Subsequently, plans are developed to reach the objectives, these are the strategies. Management control includes measures managers take to ensure that employee behaviour is in line with the strategies and objectives of a company. ABC can be used in all three parts of the management process. In the objective setting and strategy formulation phase, the information provided by an ABC-system can be used to facilitate the decision making process. The ABC-system is then used as a management information system (MIS), which is part of the field of management accounting. An ABC-system can be used in the management control phase to get a better control of the costs, especially the overhead costs. The ABC-system is then used as a management control ABC-system (MCS), which is part of the field of management control.
3.1 Management accounting
In this paragraph the field of management accounting and management information systems are defined. Special attention is given to the role of ABC within this field.
Management accounting is concerned with providing information to managers inside an organization who direct and control its operations (Seal, et al., 2006. p. 2). Seal, et al. (2006) state that management accounting information plays a vital role in the basic management activities. It is more important that the information is relevant, flexible and timely than that it is objective and verifiable. Management accounting information is provided by MISs. A MIS provides information concerning planning, directing, controlling and performance evaluation to the people inside an organization (Seal, et al., 2006, p. 2-5). Management use MISs to get the critical information that is needed to take the right decisions. Seal, et al. (2006, p. 298) state that ABC is a costing method that is designed to provide managers with cost information for strategic and other decisions.
According to Babad and Balanchandran (1993) an ABC-system is the information system that reveals the cost and profitability structure of products and services within an organization. As is stated earlier, the goal of any cost management system is to provide relevant, timely and accurate information to management. An ABC system achieves improved accuracy in estimation of costs by using multiple cost drivers to trace the cost of activities to the products associated with the resources consumed by those activities.
take actions that will drive profits, because an ABC-analysis highlights where decisions will likely have the greatest impact on profits. Decisions can be made involving reprising products or reducing resource usage. This gives the opportunity to redeploy the resources in a more profitable way or to cut spending (Cooper, Kaplan, 1991, p. 134 – 135).
According to Pohlen and La Londe (1994, p. 10) an ABC-system can add non-financial information to the management accounting process. “Activity descriptions include financial and nonfinancial information. The financial view describes the costs or resources necessary for performing the activity. The nonfinancial view describes the activity in terms such as time required, quality or number of transactions. Management can use the nonfinancial information to develop performance measures for each activity.” The performance measures can be used to evaluate the activities and make decisions for the future of the activities. The performance measures can also be used as a management control tool (see in the next paragraph).
Rezaie, et al. (2008, p. 1064) indicate that ABC can be a powerful tool as a MIS in several ways. First, ABC gives accurate information that can be used as a guidance in the decision making process. Second, ABC can indicate areas where a change in operations can be made to permit cost reductions or to allow a company to satisfy customer needs better.
3.2 Management control
The field of management control and control systems are defined in this paragraph. Special attention is given to the role of ABC in particular within this field.
“In the broadest sense, control systems can be viewed as having two basic functions: strategic control and management control. Strategic control involves managers addressing the question: Is our strategy valid and if not should it be changed?” (Merchant, Van der Stede, 2007, p. 7). “Management control includes all devices or systems managers use to ensure that the behaviours and decisions of their employees are consistent with the organization’s objectives and strategies. The systems themselves are commonly referred to as the management control systems (MCSs). The primary function of management control is to influence behaviours in desirable ways. The benefit of management control is the increased probability that the organizations objectives will be achieved.” (Merchant, Van der Stede, 2007, p. 5).
As is shown in the last paragraph, the main use of an ABC-system is to provide information to the management to facilitate decision making. In the same manner ABC can be used as a strategic control tool. According to Cooper and Kaplan (1992), one of the three benefits of ABC is that it can be used within the strategic decision making process. New strategies and the implications they have on costs and profitability can be analyzed with the ABC-system and before a new strategy is implemented. In addition, Pohlen and La Londe (1994, p.9) state the following: “ABC increases management visibility into how products and customers consume work and resources and hence what there impact is on profitability. An organization can more accurately trace costs and determine areas generating the greatest profit or loss.” This information can be used in the strategic decision making process.
ABC can also be used as a management control tool. Hardy, et al. (1992, p. 4) state that an accounting department can more easily control the costs incurred by each activity by using ABC than by simply looking at the umbrella of each departments costs in total.
overhead resources. Managers can determine ways to reduce the spending of resources (by improving the efficiency of activities or by reducing number of times activities are done). Managers can redeploy freed-up resources or eliminate them (Pohlen, La Londe, 1994, p. 8 – 9). An ABC-system can also be used to define performance measures based on nonfinancial information, as is concluded in the last paragraph. These performance measures can be used as management control tools. Targets can be set based on the performance measures and employees can be evaluated based on the actual performance compared to the targets(Pohlen, la Londe, 1994, p. 10)
According to Cooper and Kaplan (1991) ABC can be used to control costs because it pinpoints the areas where costs can be saved. Usually financial managers use income statements to look for broad ways to cut costs or increase revenues. But different products make tremendously different demands on resources. ABC gives a detailed description of the demands made by activities on the various resources. Managers should explore ways to reduce the resources required to perform activities. This can be done either by increasing the efficiency of the activities performed or by decreasing the number of times an activity has to be performed. Furthermore, ABC pinpoints activities that have an unused capacity. This unused capacity should be redeployed or budgeted away (Cooper, Kaplan, 1992).
Cooper and Kaplan (1991) determined that activities consume resources at the unit, batch, product sustaining and the facility sustaining level. The addition of batch, product and facility activities enables ABC to establish a clearer cause and effect relationship between costs and their cost drivers. The result is that a company gets a greater visibility and understanding of how overhead costs will vary with changes in the four levels. This gives a company a higher level of control over those costs (Pohlen, La Londe, 1994).
When ABC is used as a management control tool, an organization needs to determine if managers should be held responsible for all items within an ABC-analysis. Performance reports often segregate controllable from uncontrollable items. According to the controllability principle, employees should only be held accountable for the things that they can control (Merchant, Van der Stede, 2007, p. 533). However, usually the ‘uncontrollable’ items are not totally uncontrollable. Then, the important issue is to determine when employees should pay attention to things over which they have less than perfect control. According to the influenceability principle employees should be held accountable for those areas over which they can have a significant influence (Merchant, Van der Stede, 2007, p. 533).
The issue of controllability is particular important for the concepts of indirect costs and unused capacity. A survey conducted for the National Association of Accountants found that 46% of the participating firms allocated indirect costs to business units explicitly to stimulate the business unit managers to put pressure on corporate managers to control service costs. This indicates that organizations see the importance of the indirect costs and that they feel the need to control these costs efficiently. However, the indirect costs can only be controlled if it is clear who is responsible for which part of the indirect costs. Here comes ABC into place, it helps an organization to assign the indirect costs to the activities that are responsible for those costs.
4. The main advantages and disadvantages of activity based costing
In this chapter critique from academic literature will be used to analyse the advantages and disadvantages of ABC. Aim is to determine if ABC is a useful costing system, in which situation it is appropriate to apply ABC and to describe common pitfalls of ABC-methods.
4.1 Advantages of ABC
ABC links the performance of particular activities with the demands these activities make on the organization’s resources, the revenues from products or services can be directly matched with the resources consumed (Cooper, Kaplan, 1992). The ABC-system provides managers with an economic map of their enterprise; it identifies where money is being made and lost (Cooper, Kaplan, 1998). Because of the improved causal relationship between the resources consumed and the final products or customers, ABC should give more accurate product costs, which will lead to several advantages. Pohlen and La Londe (1994, p. 8 - 10) give an accurate description of those advantages:
1. ABC achieves greater accuracy than traditional costing techniques by using multiple cost drivers. Cooper and Kaplan (1991) state that activities consume resources at the unit, batch, product sustaining and facility sustaining levels. Volume-based drivers imply costs vary and can only be controlled at the unit level. The addition of batch, product sustaining and facility sustaining activities enables ABC to establish a clear cause and effect relationship between costs and their cost drivers. As a result, management obtains greater visibility and understanding of how overhead costs will vary with changes at all four levels (Pohlen, La Londe, 1994, p. 9).
2. The ABC-approach improves the management and control of overhead. Within the ABC approach the factors driving the requirement of overhead resources are determined. An ABC-analysis will allow managers to pinpoint the activities, products, services or customers that are consuming the overhead resources. Then, it is easier for management to determine ways to reduce the spending of resources, and redeploy the freed-up resources or eliminate them (Pohlen, La Londe, 1994, p. 8).
3. The ABC-approach can provide greater visibility of how different products or customers impact profitability. By using ABC an organization can more accurately trace costs and determine areas generating the greatest profit or loss. This information can be used in important product mix, marketing, pricing and other decisions, to enhance profitability (Pohlen, La Londe, 1994, p. 9).
4. The ABC descriptions include financial and nonfinancial information. The financial view describes the costs of resources necessary for performing the activity. The nonfinancial view describes the activity in terms as time required, quality, number of transactions, or schedule attainment. The company can use the nonfinancial information to develop performance measures for the activity. The performance measures can be used to evaluate employees or to pinpoint activities that should get more attention. This information can also be used to encourage continuous improvement (Pohlen, La Londe, 1994, p. 10).
The advantages of ABC over TC stated by Pohlen and La Londe (1994) are almost the same as the ones cited by Gunasekaran and Singh (1999) and Rezaie, et al. (2008) which are in short:
1. Overhead costs have grown larger than the direct costs. 2. Traditional costing provides inaccurate product costs.
4. A good costing system should encourage improvements.
Hardy, et al. (1992) make a comparison between TC and ABC from which several advantages of ABC can be derived. They state that the main advantage of TC is that it is widely used and understood. However, firstly TC provides distorted allocation of overhead cost, negatively affecting decisions about pricing, marketing focus and cost control. The problem that the allocation of overhead is distorted becomes even larger because of the shift from direct costs to overhead costs in the last decades.
Hardy, et al. (1992) identified the following strengths of ABC. Firstly, ABC lends itself better to assign costs in situations with a higher proportion of indirect costs. Secondly, it attempts to find a better causal relationship between the product and the costs incurred. And thirdly, it expands the costs of producing and selling a product, by incorporating overhead costs as product costs. Hence, ABC provides more accurate information for decision making.
Another limitation of TC is the problem of data fixation. Data fixation exists when decision makers display an inability to look behind the labs attached to accounting numbers in order to judge the appropriateness of the information to a given decision (Briers, et al., 1997). Briers, et al. (1997) set up an experiment designed to investigate whether decision makers are able to overcome data fixation in a setting involving the use of product cost information.
The results of the experiment indicate that there was in general evidence of data fixation among the TC subjects. Even after feedback that their decision led to suboptimal performance, the subjects did not adapt their decision in the next round of decision making. Within the ABC-subjects there was no evidence of data-fixation. However, this is no surprise because Briers, et al. (1997) assumed that ABC produces accurate cost information. So, if the ABC-subjects use the provided ABC information in a rational way, they come up with the best possible performance. Hence, ABC is not a way to overcome data fixation. But, when ABC is used, employees are provided with more accurate data, resulting in less serious problems when data fixation is in place.
A survey held in 100 companies (Pohlen, La Londe, 1994) identified the following practical advantages of ABC that are experienced by the respondents: better identification of the cost drivers (65%), improved cost information (59%), better pricing (47%), eliminate redundant work (41%), better performance measures (41%), better control of the cost (23% of the respondents).
4.2 Academic critique: the disadvantages of ABC
In the last paragraph the main advantages of ABC are summed up. However, there are also points of critique on ABC that can be found in academic literature. This critique is analyzed in the following paragraph.
4.2.1 The ABC paradox
Gosselin (1997) gives the strongest argument against the ABC-methodology, known as the ABC paradox: “if ABC has demonstrated benefits, why are more firms not actually employing it?” Kennedy and Affleck-Graves (2001) found three main reasons why this paradox can exist.
product costs within TC can be easily depicted in a diagram. And the idea of attaching direct costs to a product, becoming period costs only when a product is sold is generally accepted. Employees, who are working with traditional costing for years and are often satisfied with the results, may resist to a change of costing system. This hinders ABC acceptance and use (Hardy, et al., 1992).
Moreover, the causal relationship between a cost object and the use of an activity is not always clearly determinable, which makes implementation of ABC for all products problematic (Hardy, et al., 1992).
Kaplan and Anderson (2004) state that many companies abandoned activity-based costing because it did not capture the complexity of their operations, took too long to implement, and was too expensive to build and maintain. A second problem that they have identified is that within implementing an ABC system, a lot of information has to be gathered from employees. If they have to estimate the period of time spent on a list of activities, the percentages always add up to 100%. No one is going to say that part of his working time is idle time. But in practise, this is normally the case.
2. ABC, may not add value, but may merely be correlated with other variables that are the true value drivers (Kennedy and Affleck-Graves 2001).
Piper and Walley (1990) suggest that advocates of the ABC-approach only show success stories and in doing so, attribute all or most of that success to one item: the ABC system (Piper, Walley, 1990). They describe this as a ‘logical fiction’ as, in reality, any result is due to a number of separate events. To attribute all blame or credits to one particular reason is not always correct.
3. There has been little evidence presented that documents a direct link between a change to an ABC-system and increases in either shareholder value or firm profitability (Gordon, Silvester, 1999).
Using a sample of ten US firms Gordon and Silvester (1999) find no evidence of an increase in firm value, directly after the announcement that they are going to implement an ABC-system. However, Kennedy and Affleck-Graves (2001) prove that the choice of a management accounting system such as ABC may have a significant impact on firm value. Specifically, for a sample of UK firms, they show that firms adopting ABC-techniques outperform matched non-ABC firms by approximately 27 percent over 3 years. The results of Kennedy and Affleck-Graves (2001) look more robust than the analysis of Gordon and Silvester (1999). The sample is larger and they look further than only short-term performance, indicating that ABC could need a longer period to pay off. The findings of Kennedy and Affleck-Graves (2001) accentuate Gosselin’s paradox. The implementation of ABC increases firm value, why do not more companies use it?
4.2.2 Additional disadvantages of ABC
Asides from the three reasons identified by Kennedy and Affleck-Graves (2001), there are more possible disadvantages of ABC that can explain the ABC-paradox.
Noreen (1991) first showed that using data from linear cost systems could create problems because of the assumed linear relation between costs and activities. Maher, et al. (1998) prove that there exist limitations in using straight line ABC when resources are provided on a jointly and indivisible basis.
sleep out room. Hence, the costs of the nurses that are assigned to the operations that use the new antistatic decrease, because of the smaller number of minutes spent in the sleep out room, when ABC is used. However, the real costs of the nurses does not change because this resource is provided at a jointly and indivisible basis. Firstly, because every nurse serves more than one patient at a time (joint provision of resources), it does not matter if one of the patients is in the sleep out room shorter, the nurse has to stay for the other patients. Secondly, if a nurse has some idle time, the resources can not be saved, because the nurses’ shifts are scheduled in four hour shifts (indivisible provision of resources). The main conclusion is that the new antistatic does not create real nurse cost savings, but the use of ABC will give the signal that nurse costs decrease. So, if resources are supplied at a joint or indivisible basis, ABC may give unreliable signals.
Ramani (1996) takes the critique at ABC to another level. He states that the usage of ABC can lead to ethical problems within a society. According to Ramani (1996) companies and organizations will get an even larger fixation on the accounting numbers, when they start to use ABC, because of the increased level of accuracy provided by an ABC-system. The result is that contacts between organizations which were based on a good relationship and community orientation in the past tend to move to a more transaction type of relationship. Ramani (1996) gives the example of the relationship between a small business owner and a local bank. In the past loans were provided based on the long term relationship of the owner with the bank. With the use of ABC the bank starts to focus on the short term profitability of each customer. The banker encourages the transaction approach and is now contracting an exit strategy with a business, which will involve liquidation of the assets when trends indicate possible dilution of the underlying assets pledged by the business as collateral for a loan. Ramani states that a bank should not only take the hard figures of ABC into account, but should also consider the long term relation, experience and trust that is built over the years. Because when the banker implements the exit strategy this can bring a chain reaction that affects employees, customers, vendors and consequently the community (Ramani, 1996, p. 2) Pohlen and La Londe (1994) found the following practical disadvantages that companies experienced while implementing ABC: the implementation process is time consuming, the costs of implementation were too high caused by expensive consultants, it is difficult to identify cost drivers in a complex and diverse product line, ABC requires a change in perspective of the employees and employee resistance can cause problems in the implementation process.
5. How can an activity-based costing system be designed and implemented?
In this chapter, literature is reviewed about how to design and implement an ABC-system within an organization. First, the theories of Cooper and Kaplan (1988, 1991) are used as a fundament for designing an ABC system. Subsequently, more practical examples from case studies will be used to determine how to design and implement an ABC-system within a SME-like organization. Next, an empirical study of cost drivers in the US airline industry will be analyzed to shed a light at ABC within the airline industry.
5.1 The basic rules of ABC
Cooper and Kaplan (1988) explain the general basic rules of designing an ABC system. The first step, as stated in the last chapter, is to collect accurate data on direct labor and materials costs. These direct costs are assigned based on volume-driven allocation rates, as direct labor or direct materials, to the products. This part of the ABC procedure is the same as in traditional costing. The next step is to examine the demands made by particular products on indirect resources. Three rules should guide this process (Cooper, Kaplan, 1988, p. 98):
1. Focus on expensive resources; this will lead to resource categories where ABC has the potential to make big differences in product costs.
2. Emphasize resources whose consumption varies significantly by product; look for diversity. This will lead to resource categories with the greatest potential of distortions under traditional costing systems.
3. Focus on resources whose demand patterns are uncorrelated with traditional allocation measures like direct labor, processing time, and materials. This will also lead to resource categories with the greatest potential of distortions under traditional costing systems
Cooper and Kaplan (1988) suggest to look at the parts of the organization that grow as the company increases the diversity of the product line, customer base, its marketing channel, etc. They also state that the process of tracing costs, first from resources to activities and then from activities to specific products, cannot be done with surgical precision. However it is better to be basically correct with ABC, within 5% or 10% of the actual demands a product makes on organizational resources, than to be precisely wrong, perhaps as much as 200%, using traditional allocation techniques (Cooper, Kaplan, 1988, p. 99 – 100).
Cooper and Kaplan (1988) suggest a two-stage assignment procedure to assign costs to cost objects. The first step in stage 1 is to split apart the resources and to identify the activities and relevant cost objects (for example products or customers) within the organization. Then, resource cost drivers allocate the costs to the activities, based on the consumption of resources by each activity. A resource cost driver is a variable that shows the causal relationship between an activity and the resources it consumes.
In the second stage the cost of performing specific activities are combined into cost centers at the activity level. Activity cost drivers trace the activity costs to the cost objects, consuming the activities performed in the organization (Pohlen, et al. 1994, p. 7 – 8
Seal, et al. (2006, p. 303 - 309) give a more detailed description of the procedure that has to be followed to implement an ABC-system, which is described below:
