Often, organizations are engaged in running more than one product line, the outputs of which can significantly vary in terms of both the complexity and volume
These products might also require sharing of some activities among themselves. One of the aspects of such operations that frequently troubles managers is the "allocation of overhead costs to different products" that are being manufactured. In other words, if the common practice of assigning the overhead costs as per the departmental overhead rates is followed, it will lead to unjustified and biased assignment of costs to the products.
The key in such cases is to identify the "cost-drivers" in different production processes. This is a two-stage job that comprises "looking for the various activities that go into a given production process" and "determining the overhead cost that is associated with each activity".
Some of the "cost-drivers" of activities include machine set-ups, power consumed, maintenance requests, quality inspections, purchase orders, shipments and material receipts.
For instance, a high-volume product X might demand less machine set-ups when compared to another product "Y", which is from "low-volume" bracket and asks for more number of such set-ups. In this case, if cost allocation is carried by taking "direct wages" or "hours" that go into generating the outcome, it will cause unnecessary and unexplained tilting of "cost-burden" towards X.
Further, the total cost borne by the company in manufacturing a particular product can be calculated depending on the activities that constitute its production process.
The clubbing of all such steps that enable accountants allocate the incurred costs on logical and acceptable grounds makes up what is called "Activity Based Costing" (ABC). This confers various advantages like "better understanding of cost behaviour", "identification of useless efforts", "identifying the more profitable customers, products from less profitable ones", "clear positioning of products", "better marketing mix" and "improved focus on sources of costs". By culminating these facts, one can initiate an altogether new and advanced approach for "budgeting decisions".
This thought was widely accepted and welcomed in Private sector companies; gained attention from several such players in late 1980s but gradually started losing its shine and finally went out of scene almost completely.
The inability to stand the "test of times" can be attributed to the several "inherent" and "practical" implications embedded in this "once-much praised" technique. The former ones include the "fluctuations in the costs associated with activities that make it difficult to keep the things updated"; incorporation of marginal increase in costs will pose problems" and "reflecting the changes related to products and technology too, will give tough times". Also, the implementation of this idea in Government budget programs has not met with great success because of the highly demanding and expensive nature of this technique.
Add to this the severe competition thrown by advanced methodologies like BSC (Balanced Scorecard) and EVA (Economic value Analysis). However, now when ABC seemed to "give-in" to these newly-emerged substitutes, experts opine that this phenomena will soon "re-surface" due to the advantages brought in by it. Some of the benefits include "helping managers dig out ways for increasing profits without a hike in prices" and "retaining the existing customer base and not running after luring the non-gathered ones". Such attempts make even greater sense in the present situation when "recession is the ruler".
Such a "tug-of-war" between the pros and cons of ABC calls for putting in place an effective and strategic management tool to provide a constant feed-back on the process. BSC (Balanced Scorecard), in this sense, fits the bill. Under this, related and relevant indicators are framed in various perspectives.
However, since both the concepts of BSC and ABC were shaped by Dr. Kaplan, these do exhibit similarities in that these aim at "process management'. Superimposing the two takes care of both the top-down organizational view (provided by BSC) and bottom-up study (covered by ABC).
Talking about BSC for monitoring ABC, the perspectives that can be of help are- Cost driver Analysis, Internal Operations, Employee Experience and Learning and Performance.
The indicators for Cost Driver Analysis are- "types of cost drivers", "cost driver identification index", "cost driver effectiveness ratio" and "cost drivers creating non-required activities". Internal Operations can be evaluated using KPIs like "types of resource drivers", "rework costs", "technological barriers to ABC implementation: Total Barriers" and "unit cost variation". Employee Experience and Learning Perspective can be measured using indicators like "number of training sessions held", "employee participation level", "experience enhancement ratio" and "Workforce Alignment ratio". Lastly, Performance Perspective can be had with metrics like "rise in successful decision ratio", "% drop in wastage managed", "best practices adoption rise" and "average time decline".Structuring such and similar indicators to gauge the process of ABC can ensure t hat the organizational group is headed in right direction with right motives.