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There are many variables that need to be considered when determining the type of costing system, such as ABC, that is best for an organization. It is the evaluating and balancing of these many variables that continues to make accountants valuable members of any organization.
Introduction
Activity-based costing (ABC) has become mely popular in recent years [2, 5]. In fact, it is difficult to find an academic or practitioner journal that does not include at least one article on activity-based costing, activity-based management, or activity-based budgeting. As a result, it is difficult for any organization, whether it be a manufacturer, distributor, or service provider not to jump onto the activity-based bandwagon.
However, the use of activity-based concepts is not for everybody. It is vital that accountants and managers understand the organizational conditions in which ABC works best, the underlying assumptions of ABC and the cost distortions that can result from the violation of those assumptions.
This article will attempt to provide guidance in the use of activity-based costing as well as highlight some of the pitfalls assodated with ABC.
History of Activity-Based Costing
First, it may be advantageous to understand the historical origins of ABC. In the early 1960's, General Electric's (GE) finance and accounting people attempted to improve the usefulness of accounting information in controlling ever-increasing indirect costs. The GE staff noted that indirect costs are often the result of "upstream" decisions that are made long before the costs are actually incurred.
For example, engineering design and change orders often resulted in significant increases in parts ordering, machine changeovers, retooling and parts stocking. In addition, the engineering department was never informed of the consequences their actions had on the other parts of the organization. GE's work in this area could be considered what we now call, "activity-based management"
A few business consultants and manufacturing companies accomplished the second phase in the development of ABC in the 1970s and early 1980s. Their impetus was to improve product cost information to assist pricing and product mix decisions [3].
Knowledge of the historical development of activity-based costing is important in order to clearly understand what ABC analysis was originally intended to accomplish. The first intent was to assist in managing indirect costs (Activity-Based Management) and...