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A Passionate Appeal for Activity-Based Costing (ABC)

Usually I am fairly rational and do not let my personal emotions interfere with how I interact with others. However, as the readers of my blogs and articles may have detected, my more recent writings increasingly reflect my frustrations with old school accountants. I cannot disguise my irritation and annoyance with accountants who refuse to be progressive.

Several of the titles of my articles these past few years provide hints and clues as to the source of my frustrations. They include “Are Accountants Homo Accounticus?”, “Some Accountants are the Blind Leading the Blind”, “Movie Sequel – Pirate Accounts of the Caribbean”, “Cowboy Accountants – The Lawless Frontier”, and “Do Accountants Lead or Mislead?”

Each time I post an article I’ve written like those I receive several personal e-mails that are supportive of my view. Some are even more vitriolic. Receiving these e-mails, and also the publicly posted website comments to my written pieces, further motivates me to continue broadcasting my message of frustration often shaming accountants. I call it MBE or “management by embarrassment.”

At this point some of you may be asking yourself, OK. What the heck is bugging Gary that he is so frustrated about?” The simple answer is it is the slow adoption rate of applying activity-based costing (ABC) principles as a replacement for the flawed and misleading traditional “cost allocation” methods from standard cost accounting systems. They typically use non-causal cost allocation factors. Examples are the number or amount of direct labor input hours or currency, units produced, sales volume, headcount, or square feet/meters.

Benefits from applying ABC in comparison to traditional cost allocation methods that violate “costing’s causality principle” are too numerous to list here. Key benefits are: (1) extremely more accurate profit and cost reporting of outputs, products, services, channels and customers; (2) transparency and visibility of the “drivers” for work activities and their magnitude; and (3) past period calibrated cost consumption rates that are essential to multiply against future forecasted demand volume and mix that determine resource capacity requirements – workforce headcounts and spending amounts. These rates are needed for what-if scenario analysis, make-versus-buy decisions, and capacity-sensitive driver-based rolling financial forecasts and budgets.

Causality is at the heart of ABC. For example, if the quantity of the activity driver increases 20% then its activity cost should also increase 20%. The work activities are what consume the resource capacity expenses. My opinion is that any CFO/ financial controller or FP&A analyst who are using traditional cost allocation methods and are not using ABC where it is applicable (which is for most organizations) is being irresponsible in their duty to provide valid information to managers and employees. The information they are providing is faulty, distorted and deceiving. Line managers deserve better to support their decisions.

Now read the first letter of the six prior paragraphs as if together they are a two word sentence. My message is blunt: USE ABC!