Abstract - The widespread environmental change has forced many organizations to change and rethink their business and competitive strategies, particularly cost management system, in order to achieve the competitive edge in the marketplace. Activity-based costing (ABC) (Cooper 1987a, 1987b, 1988), which uses various activities to trace overhead directly to cost objects, such as products, processes, services, etc., avoids the distortions of traditional costing systems. ABC provides accurate cost predictions and effective strategic decision making (Johnson and Kaplan, 1987; Johnson, 1987).
Activity-Based Costing (ABC) is primary used to enhance productivity and efficiency in the business process; to help create budgets and set prices; to identify customer costs and improve customer relations; to make decisions on strategic issues; and to address external negotiation issues. ABC has been often used together with other management tools and methods depending on the overall objectives of specific initiatives.
This paper presents a framework and evaluation of activity-based costing in ERP projects / programs in IT industries. This paper analyzes ABC project implementations in various industries, identifies issues related to such implementations and offers a framework for maximum benefits. The survey investigated the reasons for adopting activity based costing, the perceived and achieved benefits of activity based costing and the reasons for nonadoption. The reasons for adoption were more accurate costing and better use of resources. Thus this case study analyses how an ABC costing system improves operations and helps to meet the needs of IT projects / programs in effective manner.
Introduction
The nature of software development is undergoing a dramatic change, one that strikes at the core of how the industry will build software systems in the coming decade. Various companies are trying different approaches like Agile, Reusability, Modular development and cost reduction. Organizations are faced with many challenges during this time of economic recession. The most common organizational reactions are to button down the hatches, secure the turf, and start chopping staff positions. Forward looking organizations that seek out opportunities during a time of economic recession tend to focus on process improvement initiatives such as, business-process analysis; Activity Based Costing (ABC), life cycle compression metrics, among other things.
A couple of differences between ABC and traditional cost systems are ABC traces costs according to activities rather than by functions or departments.
Organizations are moving from managing vertically to manage horizontally. It is a move from a function orientation to a process orientation. Total quality management (TQM), just-in-time (JIT), benchmarking and business process reengineering (BPR) are all examples of horizontal management improvement initiatives. These initiatives are designed to improve an organization’s work processes and activities to effectively and efficiently meet or exceed changing customer requirements.
Activity-based costing/activity-based management fills this information need by providing cost and operating information that mirrors the horizontal view. The focus of ABC is on accurate information about the true cost of products, services, processes, activities, distribution channels, customer segments, contracts, and projects. Activity-based management makes this cost and operating information useful by providing value analysis, cost drivers, and performance measures to initiate, drive or support improvement efforts and to improve decision-making. ABC has been often used together with other management tools and methods depending on the overall objectives of specific initiatives.
2. Framework of research
Following research questions were analysed to evaluate the effect of Activity Based Costing on various ERP projects. The responses were collected from Project Managers and Accountants of IT Industries from India.
2.1 The Research questions:
a) Check the feasibility of ABC principles to Internal ERP projects / programs in India
b) What is the extent of ABC/M’s adoption in Indian IT Projects?
c) What are the reasons for the introduction of activity based costing in IT Industry in India
d) How companies identify the cost drivers and the performance measures
e) Compare ROI and payback period of ERP projects / programs against traditional costing method and ABC.
f) What are the benefits achieved by those who have adopted ABC/M?
g) What are the rates of non-adoption and why?
2.2 Target Population:
Ø Project / Program managers from major IT industries
Ø >Delivery Heads / Account Managers responsible for cost analysis of the projects
ØBusiness Analysts from Finance department of IT industry who are responsible for allocating overheads for the projects
3. Case Study:
Indirect Cost of the company is allocated to all BUs proportionately. Cost of the cost projects (non revenue project) is allocated to other projects in the same BU.
Gross Contribution is the expected profit earned in a project after deducting the expenses / direct costs from the revenue. Net contribution is the expected profit earned after decuting the indirect costs. Net contribution of about 60% was normally the cut-off for selecting any ERP project.
Net contribution is inaccurate in traditional costing which might lead to faulty selection or rejection of the project. This is overcome by the Activity based costing where exact cost is known for key activities.
Thus determining the true cost plays an important role in strategic decision-making. The ABC system provides more accurate cost management and enables the company Managers to calculate the ‘true’ cost of a project.
4. Discussion
4.1 Case Study:
In a nutshell, the ABC system clearly indicates that it can help the company to understand where the costs are, what drive them to occur, and which costs may be low value-added to the cost object. The system enables the project managers to analyze and see things through the lens of costs and work activities. This definitely will replace their decision-making behavior through intuition and assertions to fact-based.
4.2 Extent of ABC / M adaption:
An analysis of the responses of the survey indicates that 55.76% of the respondents had implemented or had considered implementing an activity based costing system. And 44.34% had not adopted this system in their organization. Further 34.61% have already adapted the ABC and others have considered / initiated adapting the ABC.
4.3 Assessment of accuracy of the costing System:
It was found that traditional costing is the most widely used costing allocation method with 42.30% of the companies employing it in their organization. 59.1% of those find this system an ‘accurate’ way of allocating their overheads. While ABC is the most accurate costing method.
4.4 Reasons for Adoption of ABC /M:
The results are outlined show that the more accurate cost information and better use of resources are the major reasons of adoption of ABC.
4.5 Benefits received after ABC/M implementation:
Respondents, on average, agree that the use of an ABC system enables more accurate costing and improved insight into cost causation.
4.6 Measures taken for successful implementation:
Below table examines the measures deployed by organizations in an attempt to ensure the successful implementation of the ABC system. Many of them used the combination of these measures.
Ø Extensive research into the similar implementations
Ø Involvement of outside consultants
Ø Staff training and education
Ø Benchmarking against the other IT industries who have implemented ABC
4.7 Reasons for no adoption of ABC:
From the responses received, the responses of the companies which have not implemented ABC were analyzed to find the major causes of no adoption of ABC.
The 45% of respondents who have not adopted activity based costing cited the cost and complexity involved with implementation as the main factors in non-adoption. Senior management commitment to such an implementation was also seen as a prohibiting factor.
5. Recommendations and Conclusion:
The ABC system provides more accurate cost management and enables the managers to calculate the ‘true’ cost of a product / service.
New version of ABC, time driven ABC, is to eliminate the problems involved in large scale ABC implementations because of a changed way of obtaining data on time required to perform the activities and a modification of activity cost calculation. Time driven ABC uses time as primary cost driver to allocate resource cost directly to objects e.g. transactions, orders, finished products, services and customers.
In a nutshell, the ABC system clearly indicates that it can help the project managers to understand where the costs are, what drives them to occur, and which costs may be low value-added to the cost object. This definitely will replace their decision-making behavior through intuition and assertions to fact-based. Therefore, the big opportunities of ABC system predicting planning cost estimation and elimination of non-added value activities, which are useful for operational strategic decision. In emerging economies, this change to a company’s cost structure could be especially significant, as many of these economies are notoriously known for high capital costs.
*This blog is based on my MBA dissertation report
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