Is Accounting Technology Bringing Back Activity-Based Costing?

Activity-based costing (ABC) has fallen in and out of favor over the last few decades. However, thanks to advances in powerful accounting technology, the drawbacks of the practice have been virtually eliminated. ABC, it seems, is back in style.

Here’s what’s going on.

For about 20 years, companies around the world embraced ABC as an alternative to traditional accounting, a practice where companies charge indirect costs such as lighting, heating and marketing in proportion to a product or service’s direct costs. Traditional costing can cause companies to lose money, ABC proponents claimed, because two products or services absorb the same costs but use vastly different amounts of overhead.

Say, for example, a mass-produced widget required the same amount of material as a custom-made widget. A traditional costing model wouldn’t charge two different prices for the two widgets despite the fact that the latter requires significantly more time from experts in the company. ABC, on the other hand, more accurately assesses the costs of products and services. For companies that offer customized widgets or services, this can prevent huge losses.

The Economist published an article in 2009 about companies that used ABC for just this purpose. In its report, Chrysler “claims that it saved hundreds of millions of dollars through a program that it introduced in the early 1990s.”

“ABC showed that the true cost of certain parts that Chrysler made was 30 times what had originally been estimated, a discovery that persuaded the company to outsource the [manufacturing] of many of those parts,” the Economist explains.

Armed with this powerful information, from the mid-1980s through the early 2000s, manufacturers and businesses everywhere used ABC. But then, suddenly, popularity waned.

What happened? An academic journal article in Management Accounting Quarterly says companies ditched the practice because it was expensive and cumbersome to implement and maintain. Sure, some companies such as Chrysler raked in the benefits — and the cash — but others had operations that were “too complex” to handle an ABC system, the article reported.

According to a survey of nearly 350 companies around the world, which was discussed in the journal article, “ABC proved notoriously difficult in practice” because figuring out how much overhead that each activity used was a lot of work.

“Companies got fed up, and many abandoned it,” the article notes. So, over the last decade, ABC faded away.

Now, that’s all changing.

Thanks to technology advances, financial accounting systems are powerful enough to handle the heavy lifting that ABC demands. The costing method is absolutely becoming more feasible to do now because these systems can handle Big Data analytics.

To succeed in today’s business landscape companies need to have accurate, real-time information at their fingertips. Today’s accounting technology can now satisfy these demands. These automation tools, which are cheaper than ever thanks to the cloud, also mean ABC is no longer manually demanding.

Companies can operate a robust and flexible accounting line with the general ledger structure that allows them to quickly get access to information and reports. The GL structure can tag data, track it and produce remarkable dashboards and reports. For the first time, companies have access to actionable information without having to undertake difficult manual processes from the old days of ABC.

The implications are many. For one, using ABC gives companies the ability to segment their customers. Executives don’t have to rely on a gut feeling to determine if one customer is more valuable than another. They can dig into the numbers and see whether they have a lot of returns or custom orders that cut into their margins, for example. They might find that another customer is actually more profitable.

This kind of information allows companies to make strategic decisions. Sure, a customer might be a lot of work, but it’s important to know whether it’s a flagship company that helps win more business, for instance.

At the end of the day, accounting technology can now make ABC possible for companies to afford, helping them to build a structure that fits their needs today as well as five years from now.