Integrated Manufacturing Systems

Activity based costing in manufacturing: two case studies on implementation

Amrik S. Sohal Walter W.C. Chung
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Amrik S. Sohal Walter W.C. Chung, (1998),"Activity based costing in manufacturing: two case studies on implementation",
Integrated Manufacturing Systems, Vol. 9 Iss 3 pp. 137 - 147
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 Activity based costing in manufacturing: two case
studies on implementation
This paper presents two case
studies on the implementa-
tion of activity based costing
(ABC). The first case is a
company based in Melbourne,
Australia, which manufac-
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
tures engineering compo-
nents. The second case study
is a specialty chemicals
company based in Hong
Kong. The case studies dis-
cuss the introduction of ABC
and the benefits and prob-
lems experienced during
implementation in each
company. Based on the
experiences of the two
companies, factors critical to
successful implementation of
ABC systems are identified.
The authors are grateful to
the Financial Controller at
MelCo and to Mr Richard
Siu, now Deputy General
Manager of Ciba Specialty
Chemicals (China) Ltd. They
are also thankful to the
Hong Kong Government
Industry Department and
The Hong Kong Polytechnic
University (PolyU) for pro-
viding the funding to
complete this paper and to
Jimmy Ho who worked as a
Research Assistant/Student
on the ABC project at PolyU.
Integrated Manufacturing
Systems
9/3 [1998] 137–147
© MCB University Press
[ISSN 0957-6061]
Amrik S. Sohal
Department of Management, Monash University, Australia
Walter W.C. Chung
Department of Manufacturing Engineering, Hong Kong Polytechnic University,
Hong Kong
Introduction
Manufacturing organisations of today are
much more complex than those of the 1960s
and earlier years. To manage today’s manu-
facturing organisations managers require
information which is relevant, accurate and
readily available. Information is needed to
formulate and operationalise functional
strategies and to make decisions on product
mix and production costs. Although produc-
tion systems have changed to meet the chang-
ing needs of the marketplace, in many organi-
sations the internal management accounting
systems and information systems have
remained unchanged. Managers and accoun-
tants have become dissatisfied with conven-
tional costing systems and have expressed
concerns about their suitability in the
modern manufacturing environment.
Activity based costing (ABC) has emerged
as an alternative to conventional costing
systems. It was developed in the USA by
Harvard Business School Professors Kaplan
and Cooper and is a process of individually
listing and measuring the cost of each activ-
ity contributing to the production and deliv-
ery of a particular product or service. In their
executive summary to a report on ABC pub-
lished by the Chartered Institute of Manage-
ment Accountants, Innes and Mitchell (1990)
differentiate activity based costing from
conventional costing as follows:
ABC differs from conventional costing in its
treatment of non-volume related overhead
costs. Many significant overheads are
related to specific activities which are rela-
tively independent of production volume.
For example, the purchasing overhead may
be related to the number of purchase orders.
It is the volume of such activities (not the
volume of production) which consume
resources and therefore determine the over-
head cost. These activities drive the over-
head costs and ABC uses such activities for
both production costing and process control.
Based on a critical review of activity based
costing, Innes and Mitchell (1990) provide a
summary of its benefits:
• Provides more accurate product line cost-
ing particularly where non-volume related
overheads are significant and a diverse
product line is manufactured.
• Is flexible enough to analyse costs by cost
objectives other than products such as
processes, area of managerial responsi-
bility and customers.
• Provides a reliable indication of long-run
variable product cost which is particularly
relevant to managerial decision-making at
a strategic level.
• Provides meaningful financial (period cost
driver rates) and non-financial (period
cost driver volumes) measures which are
relevant for cost management and perfor-
mance assessment at an operational level.
• Aids identification and understanding of
cost behaviour and thus has the potential to
improve cost estimation.
• Provides a more logical, acceptable and
comprehensive basis for costing work.
This paper describes the adoption of ABC in
two organisations and identifies the factors
that are critical to implementation. Imple-
mentation is the most difficult stage in adopt-
ing new management philosophies and tech-
niques. It is hoped that the experiences of the
two companies described in this paper pro-
vide useful lessons for managers considering
the adoption of ABC systems.
The need for a new approach to cost man-
agement and the design and operation of an
ABC system have received considerable
attention from accounting academics and
researchers and it is not intended to cover
this here in any detail. The Appendix at the
end of this paper provides a brief summary of
the need for a new approach and the design
and operation of an ABC system.
Extent of implementation of ABC
systems
After almost ten years since it was developed,
ABC still has a relatively low take-up as
shown by the results of a number of surveys
conducted in North America, the United
Kingdom and Australia.
A survey conducted in 1990 on behalf of
the British Chartered Institute of Manage-
ment Accountants (CIMA) ABC Working
Group involving organisations in both the
[ 137 ]
 Amrik S. Sohal and manufacturing and financial services sectors
Walter W.C. Chung found that only 6 per cent of the responding
Activity based costing in firms had commenced implementation and 9
manufacturing: two case per cent had rejected ABC (Innes and
studies on implementation
Mitchell, 1991a). The survey which was
Integrated Manufacturing
mailed to 720 organisations resulted in 187
Systems
9/3 [1998] 137–147 useable replies, a response rate of 26 per cent.
Slightly over 50 per cent of the respondents
had not seriously considered ABC and
around one-third were vetting it.
In 1995 the Australian Society of CPAs
initiated a major survey on ABC amongst
Australian manufacturers. This survey,
which was conducted by the University of
Technology, Sydney, involved 213 firms cover-
ing all aspects of Australian manufacturing
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(Corrigan, 1996; Wood, 1996). This survey
showed that 45 per cent of the surveyed firms
had never considered adopting ABC
(although 88 per cent of those surveyed
acknowledged awareness of activity-based
costing), 29 per cent were still in the process
of considering adopting it, 14 per cent had
considered and rejected it and only 12 per
cent of the firms surveyed had actually imple-
mented it. The highest adoption rates of ABC
were found amongst the food, beverage and
tobacco industry with 25 per cent of this
group using this method.
Of those companies which had adopted
ABC most had implemented it within one to
two years after making their decision to
adopt it and the majority of these companies
believed that they had achieved five goals:
• more accurate product costing;
• better cost management;
• better cost control;
• better allocation of overheads; and
• more accurate cost information.
The Australian survey found that those
companies which rejected ABC claimed that
the uncertainty of benefits and the high cost
relative to perceived benefits were the main
reasons for rejecting activity based costing.
Some companies believed that they already
hade an effective costing system in place or
that they hade more important priorities.
Corrigan (1996) refers to a similar survey
conducted in the USA by the Institute of
Management Accountants which showed a
much higher level of implementation
amongst American firms. Forty-one per cent
of the American respondents were already
using ABC as their cost management system
and 33 per cent believed that they should be
using activity based costing systems.
Another Australian survey conducted by
Chenhall and Langfield-Smith (1996)
examined the extent to which large firms
had adopted certain traditional and
contemporary management accounting
[ 138 ]
practices; the benefits received from these
practices; the intentions to emphasise certain
management accounting practices in the
future; and the extent to which benefits
received from particular practices were
related to the effective implementation of
certain management innovations such as
TQM, JIT, team work and supplier partner-
ships. The survey, which resulted in 78 use-
able responses, was mailed to 140 manufac-
turing firms selected from the 1994 Business
Review Weekly list of Australia’s top 200 com-
panies.
Amongst the 42 management accounting
practices listed in the Chenhall and
Langfield-Smith survey, activity based
costing was ranked 24th in order of the per-
centage of respondents who indicated their
business had adopted the practice during the
past three years, indicating very low adoption
of the method. In terms of the relative bene-
fits received from using each practice, ABC
was ranked 38th, however, it ranked slightly
higher, at 29, in terms of future emphasis to
be given to each item .
In terms of the association of management
accounting practices with the effective
application of management innovations, the
study showed that “activity based costing
provided relatively higher benefits for the
high benefit groups in all of the management
innovations (although, while still in the low
to moderate benefit categories” (Chenhall
and Langfield-Smith, 1996). Overall, the
results of the survey indicated “a preference
for traditional management accounting
techniques that emphasise financial informa-
tion.” ABC was one of the areas where
respondents indicated there would be greater
future emphasis. Other areas identified were
strategic planning, product profitability
analysis and benchmarking.
Earlier experiences of
implementing ABC
Cobb et al. (1992) used the results of the 1990
CIMA survey mentioned earlier and followed
up certain of the respondents to investigate
the problems which they experienced or per-
ceived with ABC. They conducted telephone
interviews with 30 of the 62 respondents who
one year ago were considering ABC and had
identified potential problems in its imple-
mentation. They also made visits to 12 compa-
nies which had implemented ABC including
two companies which had implemented and
then rejected it. This project was specifically
designed to investigate problems and issues
involved in adopting ABC.
 Amrik S. Sohal and Of the 30 companies interviewed by tele-
Walter W.C. Chung phone, 20 were still considering its adoption
Activity based costing in one year later. The five major problems per-
manufacturing: two case
ceived by this group were:
studies on implementation
1 the amount of work involved in installing
Integrated Manufacturing
an ABC system, particularly for small
Systems
9/3 [1998] 137–147 companies. This problem was perceived by
15 out of the 20 companies;
2 other competing uses for resources which
were given a higher priority than ABC;
3 lack of suitable accounting staff resources
to install an ABC system;
4 scarce computer resources; and
5 difficulties of selecting suitable cost
drivers.
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
In this group of 20 companies, making major
changes and innovations to the management
accounting system was seen as a highly
sensitive issue due to a combination of the
following factors:
• the perceived importance of the manage-
ment accounting system;
• the difficulty of accepting that it has been
wrong;
• management accountant’s lack of innova-
tive experience; or
• simply continuing doubts about the value of
ABC.
Three of the 30 companies interviewed by
telephone had considered and then rejected
ABC without implementing it. They also
viewed data collection difficulties, other
priorities and the time involved for the
accountants as major problems. The cost of
implementing and running an ABC system
was considered to far exceed the benefits
which would be generated. This was also the
view of the two small companies which had
implemented ABC and then rejected it (Cobb
et al., 1992).
The most common problems identified
during the first year of implementing an ABC
system were (in total there were 17 companies
in this group, seven were interviewed by
telephone and ten companies were visited by
the research team) the amount of time spent
on ABC and the retraining needed both by the
accountants and the computer staff. As with
any other major organisational change
project, ABC also requires a change to the
organisational structure. This was found to
be a continuing problem in the companies in
this group. The choice of activities, the selec-
tion of cost drivers, the uncertainty over
using ABC for stock valuation for external
financial reporting and the linking of cost
drivers with individual product lines were
also problems experienced by many compa-
nies during the initial stage of implementa-
tion (Cobb et al., 1992).
Recognising the potential of ABC, the
Chartered Institute of Management Accoun-
tants initiated case study research in the
United Kingdom. Initially three case studies
were prepared. Two of the cases were manu-
facturers (High-Tech Electronics and
Traditional Engineering) having one year’s
experiences of organising and implementa-
tion of ABC. The third case was a retail
distribution company with two years of
experience with ABC. These three case stud-
ies are presented in Innes and Mitchell,
(1990).
The three case studies demonstrated the
deficiencies of the cost information produced
by the conventional costing systems used.
This was well recognised by accountants and
managers in the three companies and ABC
was viewed as a means of overcoming many
of the disadvantages associated with the con-
ventional costing system. The credibility of
the cost information, its perceived utility and
its comprehension by management were all
enhanced by ABC in the three companies.
Innes and Mitchell identified a number of
similarities in the approach adopted by the
three companies in implementing ABC.
These included:
1 Setting up of a small team to design and
implement the system. In each case this
team was headed by a very senior
accountant.
2 On-going consultation with all the relevant
managers in the organisation. This
ensured that managers had the opportu-
nity to make an input to the design of the
system and to ensure that proposals were
acceptable and sensible.
3 Keeping the system as simple as possible
by limiting the number of cost pools and
cost drivers. This ensured that a workable
system was up and running in a reason-
able amount of time.
Based on the experiences of the three
companies, Innes and Mitchell concluded
that an organisation can achieve a range of
benefits reasonably quickly from the design
and implementation of ABC. In two of the
companies a substantially different pattern of
product line costs was apparent and in all
three cases ABC increased the “visibility of
overhead cost”. Improved product line cost
would be invaluable for organisations where
price may be cost sensitive and where
product promotion strategies and product
range/mix decisions need to be made
frequently. An improved visibility of over-
head cost enhances the process control of
costs by linking costs to the series of activi-
ties (cost pools) which cause them (Innes and
Mitchell, 1990).
[ 139 ]
 Amrik S. Sohal and Furthermore, in one of the companies cost
Walter W.C. Chung driver rates provided a basis for a detailed
Activity based costing in cost comparison between its manufacturing
manufacturing: two case
plants and enabled management to make
studies on implementation
better location decisions for certain process-
Integrated Manufacturing
Systems
ing work. The design of new products or mod-
9/3 [1998] 137–147 ifications to existing products can also be
improved by the designers as they have a
better understanding of the characteristics of
the product which cause overhead cost.
The three case studies also highlighted a
number of problems with adopting ABC. The
major problem was the high set-up costs
associated with the initial design of the ABC
system, which involved a considerable
amount of management’s and accountant’s
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
time. Two of the companies considered the
time and effort needed to identify cost drivers
and their association with product lines a
costly exercise and one of these companies
thought that the amount of information
generated by the ABC system would require
additional staff in the accounting function.
Innes and Mitchell (1991) also present a
much more detailed longitudinal case study
of ABC implementation at the Daventry (UK)
plant of Cummins Engine Company. Organi-
sation-wide consultation and acceptance and
board level support throughout the period of
implementation were considered to be the
major success factors in this case. The new
information produced by the ABC system
was used to make a range of managerial
decisions which reduced costs in several
areas.
It is clear from the above review that man-
agers need to understand better the processes
involved in adopting ABC and recognise the
factors that are critical to implementation. In
order to add to the body of literature in this
area, the authors investigated the adoption of
ABC in two quite different organisations. The
companies were chosen because they were
know to the authors to have adopted ABC
with some success. Permission was obtained
from each company to document their experi-
ences with ABC and subsequently a number
of in-company interviews were conducted
with company staff who had led the imple-
mentation in their organisation. A structured
interview questionnaire was developed and
used by the authors to record the data
collected.
The next section presents the two case
studies on the implementation of ABC. These
case studies demonstrate the many benefits
that are achievable from a successful imple-
mentation as well as some of the associated
problems. The final section of the paper iden-
tifies the key ingredients for successful
implementation of ABC.
[ 140 ]
ABC implementation case studies
Case study one: MelCo
Note that the name of the company has been
disguised to protect confidentiality.
The company, referred to here as “MelCo”,
is based in Melbourne and manufactures
engineering components. It is the only manu-
facturer of these products in Australia but
has recently experienced considerable com-
petition from overseas producers. MelCo is
part of a larger group of companies and
currently employs just over 100 people. Six
staff are employed in its accounting function,
including a financial controller who was
specifically appointed to introduce ABC into
the company. His previous appointment was
with another Melbourne-based company
which manufactured automotive
components. His attempts to introduce ABC
there had failed because top management
was not convinced of the benefits of activity
based costing.
Within the group there had been no previ-
ous attempts to introduce ABC. MelCo was
the first company in the group to have done so
successfully. Its previous costing system was
a conventional costing system where over-
heads were allocated to products based on
labour hours utilised. The company manu-
factured a very wide product range for a large
customer base using a large variety of
processes and methods ranging from highly
sophisticated and automated processes to
highly manual processes. Orders were
typically for a small number of items pro-
duced to customers’ specific requirements. A
high level of flexibility and responsiveness
was demanded by the marketplace.
In order to provide the required level of
flexibility and responsiveness MelCo had five
years earlier made substantial investments in
new manufacturing technologies including a
robotics welding cell. The result of this was
that the cost structure of the products manu-
factured by MelCo had changed quite dramat-
ically, with labour costs now only accounting
for a proportion of what they were previously.
The savings made from the technology
upgrade were not passed on to the customers
and eventually a clear price disadvantage
emerged in the marketplace. Many of the
company’s buyers wanted to source from
overseas, however they preferred to stay with
MelCo.
Although the company’s overall profit
margins were increasing, it was slowly losing
many of its customers to overseas suppliers.
The company was not aware of the areas
which contributed to the improved profit
margins. It was clear to senior management
 Amrik S. Sohal and that the existing accounting system was not
Walter W.C. Chung adequate and appropriate decisions could not
Activity based costing in be made on pricing, etc. due to insufficient
manufacturing: two case information.
studies on implementation
Awareness about ABC came from senior
Integrated Manufacturing
executives within the group; however, they
Systems
9/3 [1998] 137–147 had no experience themselves about how the
system worked or how to develop and imple-
ment it. They recognised that ABC would
provide a solution to the problems experi-
enced by MelCo. Hence, the financial
controller was appointed specifically to
implement ABC within MelCo. On taking up
his new appointment at MelCo, the financial
controller established a small project team
consisting of himself, an engineer from the
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
manufacturing area and the cost/systems
accountant to develop and implement ABC.
Over a period of three months the project
team held many informal discussions with
other personnel in the company. Both the
engineer and the financial controller worked
full-time while the cost/systems accountant
spent about two-thirds of his time on the ABC
project.
The team established 25 cost pools for the
whole of the company and spent a consider-
able amount of time agreeing on the cost
drivers. Some of the cost drivers identified
were:
• frequency of set-ups for the new machines,
this included programming the NC
machines;
• number of manufacturing orders – this was
driving many activities from the original
quoting stage to dispatch of the finished
products;
• number of purchase order lines – this was
driving the workload in the purchasing
department;
• number of store issues to the production
departments – this was driving the work-
load in the stores;
• number of inspections made – sampling
inspection was carried out in many areas;
• area allocation to processes and machines;
• service personnel costs.
Many of the cost drivers were common to
several cost pools and the project team did
not experience any major difficulties in allo-
cating cost drivers to activities. The system
implemented at MelCo is PC-based, largely
consisting of spread sheets developed in-
house by the financial controller. Only $1,000
was spent on purchasing software but a sub-
stantial amount of effort was made in tailor-
ing the software for the specific needs of the
company. Collecting and inputting data was
also very time consuming.
The ABC system was initially piloted on a
sample of 40-50 products which covered the
whole range of products manufactured by the
company. The level of detail reduced to 25
products once their homogeneity was estab-
lished. The old costing system is still used,
primarily for stock valuation, variance
analysis and labour efficiencies.
The ABC system can generate true costing
and pricing, automatically give performance
measures and product profitability and pro-
vide a variety of information for management
decision-making. The current year’s budget
is being prepared using data and models
developed from the ABC system.
Management expectations of the ABC
system
At the time of introducing the ABC system at
MelCo the general manager was fully
supportive and recognised the full potential
of its outputs. However, he was not aware of
the amount of time and effort required to set
up the system. After only one month of start-
ing the implementation the general manager
demanded results. He was told politely by the
financial controller that this was not possible
with the existing resources allocated to the
project and that if he wanted the project to be
implemented quickly then he would have to
allocate additional resources. The general
manager was also under pressure from head
office to show results from the ABC system.
To convince himself, he made his own
enquiries to validate the claims of the finan-
cial controller and established that the time
frame required was reasonable given the
resources allocated to the project. However,
further resources were not allocated and the
implementation proceeded as originally
planned by the financial controller.
Problems during implementation
Lack of resources was a continuing problem
during implementation, particularly when
the general manager was expecting fast
results. Lack of available skills in-house
meant that a considerable amount of educa-
tion and training had to be undertaken. This
was largely undertaken by the financial
controller on an informal, as needed, basis
with some formal education of senior
management to inform them of what ABC
was all about and how it was being imple-
mented in the company. The training of the
cost/systems accountant was on-going
throughout the project planning and imple-
mentation stages.
As part of the communication and data
gathering exercise the financial controller
had to deal with the unions on the shop-floor.
A number of union officials were interviewed
to determine how they spent their time
during the day. In many cases there was a
reluctance on the part of the union officials to
[ 141 ]
 Amrik S. Sohal and answer questions and they indirectly resisted
Walter W.C. Chung the implementation of the ABC system. They
Activity based costing in were somewhat wary of why ABC was being
manufacturing: two case
implemented and particularly its implica-
studies on implementation
tions for their jobs. They were told that this
Integrated Manufacturing
Systems was simply a costing exercise. Generally, they
9/3 [1998] 137–147 recognised the usefulness of the system for
the long-term survival of the company.
The results of the ABC system
According to the financial controller, the ABC
system implemented at MelCo has delivered
many benefits. The benefits include:
• more accurate information on costs and
pricing and hence competitive positioning
of the company in the marketplace;
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
• identification of appropriate benchmarks
which can be used against imported com-
petitive products;
• better information has enabled the com-
pany to outsource many products which
were inefficiently manufactured in-house;
• more appropriate capital investment
decisions being made as a result of better
weighting being determined on various
aspects of this exercise;
• many problem areas identified where costs
were excessive. This includes the NC
section where utilisation has been low;
• performance measures have been devel-
oped which are used to identify improve-
ment initiatives;
• validation of annual budgets for specific
expenses.
Although 12 months man-time was necessary
for implementation, the benefits clearly out-
weigh the costs. The overall benefit has been
the much more accurate and relevant infor-
mation which can be effectively used by
management. ABC provides a tool for man-
agement for commercial decision-making.
Current status of the ABC system
Lack of appropriate resources to run the ABC
system remains a problem at MelCo. This
may emerge as a major problem in the very
near future because of the recent change in
senior management in the company. The
general manager who initiated the ABC
system at MelCo recently departed and has
been replaced by a new general manager who
is not familiar with the ABC system and does
not appreciate fully its benefits. The
resources needed to further develop and run
the ABC system may not be allocated in the
future by the new general manager.
Overall, the group’s top management recog-
nise the high potential of ABC. The financial
controller sees the ABC system as a good tool
for the group to develop further and imple-
ment fully in other companies.
[ 142 ]
Having been involved in implementing two
ABC systems in two different companies the
financial controller regards activity based
costing as “a necessary system; it is common
sense and answers many of the questions
facing manufacturers currently. The quality
of information provided by the system is high
and enables informed decisions to be under-
taken.”
Case study two: Ciba Specialty Chemicals
Ciba Specialty Chemicals is a leading manu-
facturer of chemicals and is part of the newly
formed global life sciences group Novartis
which was formed in 1996 as a result of the
merger between Ciba-Geigy and the pharma-
ceuticals company Sandoz. Ciba Specialty
Chemicals employs more than 20,000
employees worldwide. It generates sales in
117 countries, operates 58 production sites in
29 countries and conducts research in 12
countries.
This case study is based on Ciba Additives
Hong Kong (CAHK) which is part of the Addi-
tives Division of Ciba Specialty Chemicals
(the other divisions are consumer care chemi-
cals, pigments, performance polymers and
textiles dyes). CAHK was charged with
marketing and distribution of additives prod-
ucts in the South East Asia region and
provided both technical and managerial
services. CAHK employs around 120 people in
the South East Asia region. Operating costs
and expenses were being allocated using
common allocation bases – sales value and
sales volumes. This approach was far from
the realistic situation and in early 1996
questions were being raised as to how
operating costs can be fairly allocated to the
various cost objects. External pressure from
head-quarters in Switzerland and internal
pressure from the local operations built up to
challenge the status quo. This was an indica-
tion for top management to review the
current situation and implement a new cost-
ing system.
Ciba had earlier experimented with ABC in
other divisions and had learnt some impor-
tant lessons. Human resources support, time
availability of the project champion, top man-
agement support, cost/benefit analysis,
detailed project planning, user participation
and external expertise had all been identified
as critical success factors. At the time CAHK
was considering the introduction of ABC, The
Hong Kong Polytechnic University (Depart-
ment of Manufacturing Engineering) was
initiating a research project focusing on Man-
ufacturing Information Systems. This pro-
ject, funded by the Hong Kong Government
Industry Department, was a unique initiative
in which government, industry and academia
 Amrik S. Sohal and collaborated to develop and implement new
Walter W.C. Chung manufacturing information systems in local
Activity based costing in companies and establish these as reference
manufacturing: two case sites for future projects. Details of this initia-
studies on implementation
tive are given in Chung et al., (1997).
Integrated Manufacturing
Systems Developing the prototype ABC system
9/3 [1998] 137–147
The introduction of ABC in CAHK started
with the establishment of a multi-
disciplinary project team charged with the
design and implementation of an ABC
system, including the development of the
ABC software. The team members consisted
of two parties; a practitioner team made up of
a project leader with an accounting and
finance background, a project champion from
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
information engineering, and user staff
members from information technology who
would take over the information system pro-
totype for maintenance. Second, the develop-
ment team from The Hong Kong Polytechnic
University consisted of experts from the com-
puting, accounting and engineering
departments.
At the beginning, over a period of two
months, the project team spent 15 man-days
interviewing various people in CAHK to
collect relevant data. Each month the project
team met twice to discuss various issues
relating to the design of the ABC system, the
prototype ABC software, and other technolog-
ical and organisational aspects. Developing a
flexible system which could accommodate on-
going structural and managerial changes was
a key requirement. This was especially
necessary given the dramatic changes that
were taking place in CAHK and Ciba
Specialty Chemicals as a result of the recent
merger.
In developing the ABC system, the project
team identified budgetary line items from the
account lines held in the general ledger. This
information was easily extracted and
categorised into the following six budgetary
line items in the form of a database: planning
and control, sales and marketing, general
administration, customer services, informa-
tion and communication and project manage-
ment. The project team identified over 30
activities (e.g. transportation, accommoda-
tion, product promotion) and used a direct
method of allocating expenses to these activi-
ties. Indirect expenses such as rent and equip-
ment depreciation were allocated using a
weighted factor method.
The cost drivers identified included sales
value, sales budget, number of orders,
number of samples, number of complaints,
etc. The activities and cost drivers were con-
tinually monitored by the project team
because of the structural and managerial
changes taking place within the organisation.
The development and implementation of the
ABC system took approximately 18 months.
An experienced programmer worked for six
months on developing the prototype ABC
software. This was trialed and tested by the
CAHK practitioner team and many changes
were made along the way.
The top management team from Ciba
Specialty Chemicals was very supportive
throughout the project and allowed local
Hong Kong management to be fully involved
in the project. The ABC system developed and
implemented assists CAHK in a number of
ways. The system provides realistic cost
information on selected cost objects and
much more accurate information is now
available for business analysis. Currently
both the traditional accounting system and
the ABC system are being used to provide
different cost information for various
purposes.
Problems during implementation
Key staff involved in the ABC project were at
times under considerable pressure as they
were also involved in a number of other
major structural changes taking place within
CAHK. Hence, time availability was a prob-
lem. It is recognised that full-time availability
of key people is a pre-requisite to success.
There was some resistance from a number
of the staff members. This may have resulted
from the overall structural and managerial
changes that were taking place at the time of
the ABC project and to some extent the
uncertainty in the future. The support and
involvement of the top management was vital
in overcoming resistance and fear amongst
some employees.
Benefits of the ABC system at CAHK
The ABC system developed at CAHK provides
more accurate costs, enabling management to
analyse better the customer base and provide
better services. The ABC system has also
enabled CAHK to promote more appropri-
ately relevant product lines and make better
business decisions, particularly those
relating to outsourcing.
As a result of the ABC project and the
collaboration with The Hong Kong
Polytechnic University, CAHK has developed
a number of capabilities:
• superior project planning expertise;
• better leadership and managerial skills
amongst its people;
• ability to learn together;
• learning to be patient; and
• learning to delegate responsibility and
trust others to be responsible.
CAHK is currently extending the ABC system
to cover its manufacturing area which is
[ 143 ]
 Amrik S. Sohal and being established in Southern China. The
Walter W.C. Chung Hong Kong ABC implementation experience
Activity based costing in has taught the company to understand the
manufacturing: two case different culture that exists in China and to
studies on implementation
integrate the different values that each part
Integrated Manufacturing
of the organisation holds. Respect for the
Systems
9/3 [1998] 137–147 individual, open communication, education,
training, career advancement and team work-
ing are absolutely essential and
professional/personal development is vital in
creating a harmonious working
environment.
Discussion and conclusions
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
This paper has described the adoption of
activity based costing in two organisations. It
is clear from the literature reviewed and the
two case studies presented in the previous
section that ABC offers substantial benefits
over conventional accounting systems; how-
ever, it has a relatively low up-take amongst
organisations. Many of the problems and
difficulties associated with introducing ABC
are related to managerial aspects rather than
the technical aspects of the ABC system.
Based on the case study experiences
presented above, the following are identified
as key ingredients for successful implementa-
tion of ABC:
• Total commitment from top management.
They must understand the benefits that
ABC offers the organisation and must get
involved in setting realistic and achievable
objectives. The objectives must be clear and
simple so that everyone in the organisation
can understand them. The objectives must
be regularly reviewed and revised as
changes take place within the organisation
and in the marketplace.
• The establishment of a multi-disciplinary
project team to introduce and implement
the ABC system in the organisation. The
team members must be co-operative and
share similar values and attitudes. A
knowledgeable project leader or champion
can be vital to the overall success of the
project. This person must have adequate
experience in project implementation. The
project team has the responsibility for
clearly defining time frames, actions and
responsibilities. It continuously monitors
the progress of the project and makes the
necessary changes so that targets are being
achieved.
• Education and training of all people in the
organisation to understand the complexity
of the project and its impact on the organi-
sation.
• Adequate resource allocation to the ABC
project. Sufficient time must be allowed for
[ 144 ]
data gathering and analysis during work-
ing hours. Time allowed to gain confidence
with the new system is absolutely
necessary.
• Access to outside expertise, particularly
when new concepts and software are being
developed. The expertise available at the
local university can be invaluable.
• On-going feedback to top management and
lower level employees on the progress of the
ABC project.
• Keeping the implementation as simple as
possible, perhaps introducing it as a pilot
project initially.
A number of potential reasons for failure are
also identified from the two case studies:
• Employee resistance/scepticism,
particularly where education and training
has been inadequate or where other major
organisational changes are also taking
place.
• The ABC project seen as an “accounting”
project by other functional managers.
• Underestimating the cost of data gathering.
• Shortage of appropriate resources, particu-
larly people skills.
Other reasons for failure include too much
reliance on outside consultants, politics
within the organisation and letting the pro-
ject drag on.
To overcome the above problems, thorough
planning must be carried out and the right
person must be appointed to act as the
“champion” of the project. This is not to say
that top management has no hands-on
involvement in the planning and implementa-
tion of the ABC system.
Based on their extensive case study based
research on ABC implementtion, Innes and
Mitchell (1991) concluded that the change
process involved in implementing ABC is an
on-going one and that there are three factor
types which interact together to promote the
cost accounting change. These are;
1 motivators;
2 facilitators; and
3 catalysts (see Table I).
Many of the factors listed in this table are
identifiable in the two cases.
Furthermore, Innes and Mitchell say that
“the effective operation is, however,
ultimately a function of the individuals who
work for the firm. Managers and accountants
must be prepared to question the status quo.
The accountants must then be prepared to
respond to the changing needs and demands
of managers”. These authors identify five key
conditions which they say must be met to
foster a dynamic management accounting
 Amrik S. Sohal and Table I
Walter W.C. Chung Product cost and management decisions
Activity based costing in
manufacturing: two case Historic cost information Future cost
studies on implementation characteristics estimates
Integrated Manufacturing
Conventional costing • Inaccurate product line • Incorporate product line
Systems
9/3 [1998] 137–147 systems costs
• Fixed/variable • Limited as cost estimation
segmentation based only on
production volume
• Accurate product line • Based on accurate past
costs
ABC systems • Cost segmentaion relates • Based on projected
all costs to determinants:
(i) volume driven costs
(ii) activity (various) driven
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
Source: Innes and Mitchell, 1990.
function which will be responsive to manage-
ment requirements. Accounting staff should:
1 be kept familiar with business strategy
and changes therein and be continually
assessing the information demands which
this implies;
2 be familiar with the operational aspects of
the business and changes therein and be
continually assessing the information
demands which this implies;
3 seek and be responsive to management
criticisms of information which they pro-
vide and indeed be critically assessing
outputs regularly themselves;
4 be aware of current developments in their
own discipline; and
5 research and development role acknowl-
edged, provided for, reported on and
assessed by top management (Innes and
Mitchell, 1991).
In this respect, manufacturing and opera-
tions managers can assist accounting staff in
their orgnisations to understand better the
information needs of the manufacturing/
operations function and play a key role in the
adoption of ABC.
References
Chenhall, R.H. and Langfield-Smith, K. (1996),
“Adoption and benefits of management
accounting practices: an Australian study”,
unpublished paper, Department of Account-
ing and Finance, Monash University, Clayton,
VIC, Australia.
Cobb, I., Innes, J. and Mitchell, F. (1992), Activity
Based Costing – Problems in Practice,
Chartered Institute of Management
Accountants, London.
Cooper, R. (1988), “The rise of activity based cost-
ing – part one; what is an activity based cost
Managerial decision
impact
• High potential for
cost inaccuracies misleading information
• Geared to short-run
based primarily on volume decision analysis
changes • Low potential for
misleading information
costs • Product cost information
is geared to long-run
changes in a whole range strategic analysis
of cost determinants • Non financial, cost
driver based
performance in analysis
aids process control in
the short and long run
system”, Journal of Cost Management,
Summer, pp. 45-54.
Corrigan, J.(1996), “ABC not easy in Australia:
survey”, Australian Accountant, November,
pp. 51-2.
Chung, W.W.C., Lee, W.B. and Chik, S.K.O. (1997),
“Technology transfer at the Hong Kong Poly-
technic University”, Proceedings of the 13th
Annual Hawaii International Conference on
Systems Science, Vol. III, pp. 96-105.
Drury, C. (1990), “Product costing in the 1990s”,
Accountancy, May, pp. 122-6.
Innes, J. and Mitchell, F. (1990), Activity Based
Costing: A Review with Case Studies,
Chartered Institute of Management
Accountants, London.
Innes, J. and Mitchell, F. (1991), Activity Based
Costing Management: A Case Study of Develop-
ment and Implementation, Chartered Institute
of Management Accountants, London.
Innes, J. and Mitchell, F. (1991a), “ABC: a survey of
CIMA members”, Management Accounting,
October, pp. 28-30.
Johnson, H.T and Kaplan, R.S. (1987), Relevance
Lost: The Rise and Fall of Management
Accounting, Harvard Business School Press.
Wood, C. (1996), “Manufacturers reluctant to
count the real costs”, Business Review Weekly,
August, pp. 94-5.
Appendix
The need for a new approach to cost
management
The costing systems used in many organisa-
tions today were designed around the turn of
the century to produce a small range of
products which consumed similar amounts of
production support services and when non-
volume related costs were relatively small
(Johnson and Kaplan, 1987). Direct costs
consisting of direct material and direct
[ 145 ]
 Amrik S. Sohal and labour usage are easily identified to product
Walter W.C. Chung lines. Indirect costs or overhead costs
Activity based costing in associated with production support services
manufacturing: two case (i.e. procurement, set-up, maintenance and
studies on implementation
engineering and quality control and quality
Integrated Manufacturing assurance) are allocated on the basis of pro-
Systems
9/3 [1998] 137–147 duction volume. An overhead rate or series of
overhead rates based on individual depart-
ments are attached to product lines in
proportion to a common product characteris-
tic which bears a close causal relationship to
overhead cost (Innes and Mitchell, 1990).
Direct labour based overhead cost allocations
are most commonly used and, since the direct
labour content is dependent on production
levels attained, these overhead costs are
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
ultimately driven by production volume.
In today’s manufacturing environment an
increasing proportion of total costs do not
vary with volume (Drury, 1990) and the
continued use of conventional costing proce-
dures can have serious dysfunctional
consequences for the cost information which
is generated and used within firms (Innes and
Mitchell, 1990). Drury (1990) refers to a survey
of management accounting in advanced
manufacturing technology environments
which found the method of charging over-
heads to products a major area of concern for
managers. The survey also found that direct
labour hours or direct labour wage costs were
widely used as a basis for allocating cost
centre costs to products, even though direct
labour averaged only 12 per cent of total man-
ufacturing cost. Drury concluded that in an
advanced manufacturing environment, direct
labour-based allocation methods are unlikely
to represent a reasonable basis for approxi-
mating the overhead resources demanded by
products and that output is determined by
machines and workers are, in effect, machine
tenders. The survey respondents identified
the development of alternative bases for
assigning overhead costs to products as the
most important area for improving product
costing systems.
Design and operation of an ABC system
The allocation of overhead costs purely on the
basis of volume produced, as is the case with
the traditional management accounting
systems, is no longer appropriate. In the
modern, high technology industries many of
the most important contemporary overheads
are largely unaffected by alterations to pro-
duction volume and can be viewed as
resulting from specific transactions or
activities which are relatively independent of
production volume (Innes and Mitchell, 1990).
The costs of these overhead transactions and
activities have risen dramatically in recent
years. Consider for example the costs
[ 146 ]
associated with product development, prod-
uct testing, quality control/assurance, pro-
curement and marketing which nowadays
can be several times the direct cost of some
products. It is the volume of these activities
which consumes resources and hence deter-
mines the level of overhead cost. ABC
attempts to obtain a greater understanding of
cost behaviour by trying to understand the
forces behind these costs, which are
described as cost drivers. Examples of some
of the activity based cost drivers which have
been recommended by various writers
include the number of receiving orders for
the receiving department, the number of
production runs undertaken for scheduling
and set-up costs, the number of purchase
orders for the purchasing department, and
the number of dispatch orders for the dis-
patch department (Drury, 1990):
Therefore if products are to be costed in a
manner which reflects their actual con-
sumption of resources then their share of
overhead must be absorbed by them on the
basis of these activities. If this is done then
overhead is absorbed in proportion to
activities (and hence cost) caused by each
individual product, batch of products or
product line (Innes and Mitchell, 1990).
Table AI, taken from Innes and Mitchell
(1990), illustrates and contrasts this ABC
approach with the conventional approach.
Operating an ABC system involves two
steps (Innes and Mitchell, 1990):
1 Charging overhead cost to activity based
cost pools.
2 Deriving and using a series of cost driver
based rates to attach the pooled costs to
product lines.
There are three key factors which influence
the design and operation of an ABC system:
• the choice of cost pools;
• the selection of means of distributing over-
head costs to the cost pools; and
• the choice of cost driver for each cost pool.
These are important factors to consider
which require that sufficient consultation
takes place between management
accountants and departmental managers.
The establishment of homogeneous overhead
cost pools in step one requires the identifica-
tion of all major activities which cause over-
head costs. Initially a very large list may
emerge and some of these activities may turn
out to be insignificant. A balance needs to be
achieved between the accuracy of the output
from the ABC system and the costs and diffi-
culties associated with operating a more
complex ABC system. Innes and Mitchell
(1990) suggest that the activities must be
reduced to ensure a practical and cost
 Amrik S. Sohal and Table AI
Walter W.C. Chung The structure of factors influencing the change to ABC
Activity based costing in
manufacturing: two case Factor type
studies on implementation
Motivators (continuous, long-lived, postive influences
Integrated Manufacturing
for change)
Systems
9/3 [1998] 137–147
Catalysts (factors directly associated with the change)
Facilitators (factors without whose existence change
could not proceed)
Downloaded by University of Sri Jayewardenepura At 21:33 03 September 2016 (PT)
Source: Innes and Mitchell, 1991
effective ABC system is finally designed.
They suggest that to effect this reduction the
accountant will require to know:
• the significance of the cost of each activity
listed (in order to judge if it is material
enough to justify a separate cost pool) and
• the factor or factors which influence the
cost of each activity (namely the cost
driver) in order to judge whether there is
homogeneity in the cost behaviour of
separate activities (which may be combined
into one cost pool, at least for product cost
purposes).
The cost of some activities may not have
specific cost drivers and in this case these
must be reapportioned to the other activities.
In addition, a number of the cost drivers may
be closely related. In this situation a detailed
analysis of the factors should be carried out,
as outlined by Cooper (1988) in Innes and
Mitchell (1990):
• Product diversity should be analysed to
understand the extent to which final prod-
ucts consume the overhead activities in
different proportions. If product diversity is
high then costing accuracy is lost by merg-
ing cost pools and eliminating cost drivers.
Factor
Market strategy and target costing
Production strategy and method changes
e.g. JIT
Deterioration in relevance of conventional
costing
MBA undertaken by financial controller
Publicity given to ABC
Support of top mangement
Continued enthusiasm of all managers
involved
Provision of accounting and systems staff
resources
Existence of suitably interested and
knowledgeable accounting staff
• The relative cost of the activities aggregated
should be analysed to understand the
significance of the cost of pooled activities
in relation to the total pooled cost.
• Volume diversity should be analysed: where
products are produced in different batch
sizes and the demand for activities (and
hence for overhead cost) relates to batches
rather than units of output. Thus, if one
product is made in ten batches of ten units
and each batch has a specific delivery of
material associated with it, while another
product is made in two batches of 50 requir-
ing two deliveries then the use of “number
of suppliers’ orders” (assuming each lot of
100 units requires only one supplier order)
would result in an undercosting of the for-
mer product (which required ten deliveries)
and an overcosting of the latter (which
required only two)”.
From the above it is clear that a considerable
amount of data will need to be collected and
analysed in order to operate an ABC system.
Many organisations do not have in place the
mechanisms to do this effectively and require
new recording procedures to be developed
and implemented.
[ 147 ]
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