Cost analysis methods and applications

Accounting

Kaplan and Anderson (2005) notes that activity-based costing (ABC) systems are not as effective in practice as they are on paper. Among the grievances that Kaplan notes with respect to ABC, the system is not very scalable, losing power as the company gets larger. The textbook version is usually a very simple company with a handful of activities, but in the real world companies can have hundreds of products, thousands of activities and tens of thousands of customers. This presents a challenge, because activity-based costing requires a substantial amount of information in order to be effective. Past a certain scale of organization, activity-based costing does not deliver a good return on investment because of the costs associated with gathering and analyzing this information. Kaplan wrote this in 2005, mind you, when perhaps information gathering and processing capabilities were somewhat worse than they are today. Certainly doing ABC manually is likely to fail to yield a healthy return on investment. Similarly, Kaplan also notes that it is complex and difficult to implement ABC. Even if today's processing capability was brought to ABC, it would be a challenge to set up the systems to gather the needed information and again there is a cost-benefit element to this.

2.

Kaplan prefers an adapted approach to activity-based costing that instead of assigning resource costs to activities and then to products or customer instead "managers directly estimate the resource demands imposed by each transaction, product or customer." Two parameters are required: "the cost per time unit of supplying resource capacity and the unit times of consumption of resource capacity by products, services and customers." He argues that this approach addresses several issues with ABC, including that it "provides more accurate cost-driver rates by allowing unit times to be estimated even for complex, specialized transactions."

This approach is simpler, Kaplan argues, and it is an accurate reflection of costs. He argues the case that only two cost parameters are necessary, time or cubic meters, depending on the type of business. Where traditional activity-based costing may not be scalable, with appropriate software such as enterprise resource planning systems, this new approach to activity-based costing is scalable, removing one of the major issues with activity-based costing that Kaplan had identified.

3.

Time-driven ABC, Kaplan argues, it closely tied with enterprise resource planning. Intuitively, this makes sense because enterprise resource planning simply focuses on making the right resources available at the right times. In part, it does this by carefully measuring the enterprise's resources. In TDABC, the key resources are either time or space, so an enterprise resource planning system that measures these things with respect to either product, customer or transaction will inevitably be more effective. The two therefore work together to allow the enterprise to understand the input resources for each activity and schedule activities accordingly, but also to ensure that the right resources are in place through the ERP. The latter can, for example, allow products or customers with a low return on investment to be dropped in favor of those with a higher ROI, in order to facilitate better organizational outcomes.

TDABC is something that Kaplan argues would not have been possible in the early 1980s when he was developing the original concept for activity-based costing. The information systems could not have supported it. Today, however, ERP systems gather a large amounts of sophisticated data and this allows for success of TDABC to now be possible.

4.

TDABC resolves a couple of issues of ABC. Well, ERP resolves to some extent the cost of acquiring information, though it must still be used and processed to implement in an activity-based costing system. The complexity of ABC as organizations increase in size is cited as a major drawback of the system, rather than any philosophical problem. TDABC does succeed in simplifying the measurement of data, if through no other mechanism than simply applying data that the organization already uses to the ABC concept, rather than seeking out new data. This lowers the cost and therefore should increase the return on investment from ABC to TDABC. Gilbert (2007) notes that Kaplan claims size does not matter in successfully implementing TDABC, in contrast to the more traditional form of ABC. It is interesting that Kaplan does not think a full-fledge ERP is necessary for the benefits of TDABC to be realized, since lower cost of information acquisition is one of the most obvious benefits.