activity-based cost management practices in india: an
TRANSCRIPT
Activity-Based Cost Management Practices in India: An Empirical Study
Dr Manoj Anand* Professor
Finance & Accounting Area Indian Institute of Management, Indore
Pigdamber, Rau, Indore – 453331 (INDIA) e-mail Id: [email protected]
Dr B S Sahay Director
Institute of Management Technology, Ghaziabad (INDIA)
&
Subhashish Saha, Officer
Securities Exchange Board of India, Mumbai (INDIA)
* All correspondence may be made to the first author only. The authors acknowledge the financial support received from the All India Council for Technical Education (AICTE), New Delhi (India)
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Activity-Based Cost Management Practices in India:
An Empirical Study
ABSTRACT
This is a study of activity-based cost management practices, in a value-chain analytic framework, being followed by the corporate India. A nationwide survey has been conducted to
capture the issues in the design and applications of contemporary cost and management tools. The examination of responses conditional on ABC-adoption revealed that the firms who have adopted ABC were significantly more successful in capturing accurate cost information for value
chain analysis and supply chain analysis vis-à-vis the firms who had not adopted ABC. The extent of ABCM adoption in the service sector had not been found significantly different from that in
manufacturing sector.
To have detailed information on value added and non-value added activities followed by the need to be competitive in the industry in terms of price quality and performance is the major motivation for the introduction of the activity-based costing. The management motivations for
adoption of activity-based costing is significantly higher in case of manufacturing sector firms vis-à-vis service sector firms only in case of product/service pricing decisions. The need for customer
profitability analysis and budgeting led the corporate India to extend their ABC-systems from basic level to advanced level, extending it to facility level and customer level activities.
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Activity-Based Cost Management Practices in India:
An Empirical Study
INTRODUCTION
Johnson & Kaplan (1987)’s publication of the book titled 'Relevance Lost' brought
revolution in the history of the management accounting. The then management accounting
systems failed to provide relevant information for product costing and performance evaluation in
the time of ‘rapid technological change’, ‘fierce competition’, and ‘information processing
revolution’. The pre-war cost accounting systems were designed to meet the financial reporting
and tax planning needs. They failed to provide information for managerial decision-making and
control purposes.
Drucker (1992) argued that accounting systems should provide answers about their
businesses, markets, customers, and environment to ‘information literate’ manager. Thus, the role
of a management accountant expanded in multiple dimensions. They were not just to collect the
cost information as accurately as possible but also analyze the utility of the cost information for
taking vital managerial decisions. This new paradigm of management accounting called for certain
additional skills of the management accountants. Anastas (1997) discussed the changes required
in the skill set of the management accountants in view of the “Project Millennium: Customers &
Future Markets…Looking Ahead to 2007”.
The newfound utility of cost accounting led to a churning of the whole cost accounting
system, its methodology and even it's philosophy in the mid 1980s. The most prominent that
emerged out of the whole brain storming process was activity-based cost management system.
This system was claimed to have the ability of providing accurate cost information while removing
distortions in product/service pricing and customer profitability analysis in a complex manufacturing
environment. Cooper (1988a, 1988b, 1989a, 1989b & 1995), Cooper & Kaplan (1988, 1991,1992,
1997 & 1998). For comprehensive review on the subject, see Borden (1990) and Cooper (1996).
The present study plans to identify activity-based cost management practices in corporate
India. Further, it investigates whether the corporate India uses contemporary cost management
tools in the value chain analytic framework.
REVIEW OF LITERATURE
Evolution of Activity-Based Costing
Highlighting the limitations of traditional costing systems in overheads cost allocation in a
situation of product diversity in terms of volume and complexity Cooper (1988a) illustrated the
need for activity-based costing system. Consistent with this research, Cooper (1988b) found that
the firms facing high level of competition and having diverse product mix are more likely to benefit
from precise cost information and the introduction of activity-based cost systems with an added
caution that the activity-based costing system introduction initiative itself should be cost effective.
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Meanwhile Kaplan (1988) observed that many companies used single cost system to
meet their three diverse needs, namely inventory valuation & financial reporting,
product/service/customer costing and providing ‘operational feedback to frontline employees’ in the
plant. However, he apprehended that, in a complex manufacturing environment with ‘product and
process diversities’, and ‘concern for excellence’, ‘single cost system’ for all the three needs might
not suffice.
With the help of case studies of Siemens Electric Motor Works, John Deere Component
Works, and Schrader Bellows Cooper (1989b) demonstrated that the ‘management objectives’ and
‘diversity of product mix’ determine the extent of the complexity in the design of activity-based cost
management systems. The competitive environment in which the firm is operating drives the need
for activity-based costing.
Cooper & Kaplan (1997 & 1998) argued that operational control and activity-based cost
systems are two separate systems as they have different purpose and different requirements for
accuracy, timeliness, and aggregation. Any attempt to integrate the both be made with utmost care
otherwise it would perform neither function well. The operational learning & control system
provides economic feedback about process efficiencies by using actual & highly accurate data on
continual basis in respect of each responsibility center. The emphasis is on short-term fixed and
variable costs and the cost centers are expenses actually recorded in the financial system.
Product, customer, and business-unit profitability are the objectives of the activity-based cost
systems. It uses standard cost data based on standard cost driver rates and practical capacity of
organizational resources and updates it periodically for the entire value chain. The well-designed
integrated cost management system will help the management of company to identify
opportunities for continuous improvement and point out unused capacity or capacity constraints, if
any and will facilitate the introduction of activity-based budgeting in the organization. The activity-
based budgeting mindset makes all cost variable and attempts to match resource supply to
resource demand.
Activity-Based Costing – Issues in Implementation
The activity-based cost systems are superior to traditional costing systems and they could
fail due to poor implementation process (Ness and Cucuzza (1995), Player and Keys (1995) and
Pattison & Arendt (1994).
Jayson (1994) found in response to Management Accounting ®’s first fax survey that
implementing activity-based costing is worth the investment. The most common problem reported
was the difficulty in identifying the cost drivers.
The firm’s top-level manager ‘champions’ the ABC project; cross-functional teams,
process orientation and adequate training to the employees on the ABC; linkages between activity-
based team oriented performance metrics to the compensation plan; decision-making at shop-floor
level, who have process knowledge; and review ABC implementation initiative in long-term
perspective were the key success factors for ABC implementation found Shield (1995) and Shields
& Young (1989).
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The top management support, ABCM-linked performance evaluation and compensation
plans, number of applications of ABCM in the organization and time-in-use of application have
been found to be ABCM success determinants by Foster and Swanson (1997). Brown et al. (2004)
found the association between organizational size and initial interest in activity-based costing
significant.
Based on the survey findings of the Cost Management Group of the Institute of
Management Accountants, 1996 Krumwiede (1998) reported the activity-based costing adoption
status and factors affecting its success. They got 178 responses with a 16% response rate. The
49% of the respondent firms had adopted the activity-based costing systems. The 25% of the non-
adopting companies were considering its introduction in their organization. Only 5% of the
respondent firms had rejected it after careful examination. The top management support,
information technology sophistication, large size firms, and integration with the financial system
were the factors affecting the usage of the activity-based costing. The use of activity-based cost
system is found to be positively correlated with the firm size. The organizational factors such as
top management support, ‘non-accounting ownership’ and the training were found to be vital in
the successful implementation of the activity-based costing.
Shaw (1998) observed that one of the biggest challenges to adoption of activity-based
costing/management is increased adoption of enterprise-wide resource planning systems. Will
ABC/M system be able to complement the ERP-architecture is an issue. SAP AG, ERP vendor
made a substantial equity investment in ABC Technologies (developer & producer of window-
based ABC/M applications OrosTM) in September 1998. Oracle purchased Activa (an ABC/M tool
developed by PricewaterhouseCoopers) and PeopleSoft have entered into partnership with KPMG
to develop its activity accounting module. The role of the management accountant will thus change
from scorekeeping to strategic advisor.
Endorsing the role of implementation process, Anderson and Young (1999) in a study of
21 filed research sites of two firms examined the relationship between activity-based costing
systems, contextual factors, and factors related to ABC implementation process by using survey
and interview process. They found that implementation process has clear influence on the ABCM
success and the contextual setting directly influences the process and outcome. The criteria for
success of ABC systems is its ability to provide more accurate cost data vis-à-vis traditional cost
systems and usage of ABC cost data for cost reduction and process improvement.
Applications of Activity-Based Costing
Innes and Mitchell (1995) survey of activity-based costing practices in the 251 UK
companies listed in The Times 1000 (1994) found that 19.5% of the respondents had adopted
ABC and 27.1% were considering its adoption. The extent of its adoption in the non-manufacturing
sector had not been found significantly different from that found in manufacturing concerns. The
ABC users had considered its applications in the areas of cost reduction, product/service pricing,
performance measurement, & improvement, and cost modeling. The inventory valuation use had
the lowest adoption rate amongst ABC users. Dugdale and Jones (1997) follow-up survey to Innes
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and Mitchell (1995) questionnaire of large UK firms adopting activity-based costing has found that
only three companies used ABC for stock valuation as against reporting of 14 companies, when
strong definition of ABC was applied.
Innes et al (2000) 1999 survey of activity-based cost management practices of 177 UK's
largest companies had assessed the changes that had occurred in the ABC adoption status over a
five-year period. The ABC adoption / under consideration rate has fallen to 17.5% and 20.3% from
21% and 29.5% respectively. The highest adoption rate is in the financial sector. In terms of scale,
the median activity-based cost accounting systems design included 40 (1994: 14) cost objects, 52
(1994: 25) activities, 22 (1994: 10) cost pools and 14 (1994: 10) cost drivers. The ABC rejection
rate has increased from 13.3% to 15.3% during this period. Cost reduction, pricing, performance
measurement / improvement and cost modeling continued to be the most commonly used areas
for activity-based costing. The top management support to the ABC implementation initiative and
to a lesser extent, with its use to support quality initiative determined its success
In a survey of 132 US companies, Foster and Swanson (1997) found that all of them were
using activity-based cost management, when they responded. The decision use of ABCM,
management use of dollar improvement and the overall net benefits as success measure yields
the highest explanatory power. Groot (1999) survey of US food and beverages industry found that
18% of the respondents had implemented activity-based costing and 58% were considering its
implementation.
Joshi (2001) in a survey of 60 large and medium-sized manufacturing companies in India
found adoption rate of 20% for activity-based costing, 13% for activity-based management, and
7% for activity-based budgeting. The size in terms of total assets has been found to be significant
factor in adoption of these contemporary management accounting techniques. The traditional
management accounting techniques have been emphasized more vis-à-vis contemporary
techniques because of higher perceived benefits.
Narasimhan and Thampy (2002) designed activity-based costing system for ascertaining
service cost for different customers with a case study of two branches of a large Indian private
sector bank. The use of activity-based cost information in benchmarking, branch network
restructuring, business process outsourcing, and identification of value-added and non-value
added activities has been argued.
Activity-Based Costing & Firm Value
Bromwich and Bhimani (1989) observed that though activity-based costing corrects the
product-cost distortions but no such study has been done to demonstrate that it increases the
profitability of the firm (Shim and Stagliano 1997). Groth and Kinney (1994) observed that success
at cost management could have substantial impact on the firm value. Hubbell (1996) argued in
favour of integrating activity-based cost management systems with the measures of shareholder
value such as economic value added. The resultant integrated cost management systems could
provide better governance mechanism for improving processes, optimizing the use of capital and
thus create shareholder value.
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Gordon and Silvester (1999) examined the performance of ten ABC user firms vis-à-vis
their matched size- and industry-controlled counterparts who have not adopted activity-based
costing. Though ABC user firms had abnormal returns on the date of announcement but not
statistically significantly different from their counterparts. Thus, they questioned the adoption of
activity-based costing if it does not lead to creation of firm value.
Malmi (1999) found that firm superior performance subsequent to activity-based costing
adoption revealed that the ABC adoption decision was ‘rational value-enhancing choice’ and it was
not a fad or fashion or forced selection. Shield and McEwen (1996) reported that 75% of the ABC-
users found it financially beneficial decision. The success in ABC implementation is based on top
management support, compensation and training (McGowan and Klammer 1997).
Ittner et al. (2002) examined the association between the extensive use of activity-based
costing and plant level operational & financial performance indicators such as cycle time, quality,
manufacturing cost improvements and return on assets. The quality variable was captured through
finished product first pass quality yield in percentage terms and scrap & rework cost as a
percentage of sales. They survey questionnaire was mailed to 25,361 US firms who have
subscribed to Industry Week. They received a response from 2789 firms, resulting in a response
rate of 11%. They found 26% of the respondents did use activity-based costing extensively. They
found moderate evidence that activity-based costing use is positively associated with the
manufacturing performance. They demonstrated through path analysis that activity-based costing
use has a positive indirect association with manufacturing cost reduction through improvements in
quality and cycle time. No significant association with return on assets of activity-based costing
use was observed.
Kennedy and Affleck-Graves (2001) examined the link between activity-based costing
implementation and creation of shareholder value using Rappaport (1986) framework and event
study methodology (Brown and Warner 1980 & 1985). They got responses from 47 ABC users and
187 non-ABC users. They found that choice of management accounting system such as activity-
based costing for a sample of UK firms had a significant impact on firm value (27% over the three
years from the beginning of the year in which activity-based costing was first introduced). The
impact of activity-based costing on firm performance may be indirect through the mediating
influence of other variable (Shields et al. 2000).
Cagwin and Bouwman (2002) in their survey of 210 internal auditors found that the firms
with diverse product portfolio and with high proportion of overheads cost when they have adopted
activity-based costing along with other strategic initiatives such as JIT and TQM, it resulted in
substantial improvement in their return on investments. The other enabling conditions for the
efficacy of the ABC in the organizations are sophisticated information technology systems,
absence of excess capacity and competitive environment.
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Research Design
Nation-wide Management Survey
A draft questionnaire was developed based on comprehensive review of existing literature
to conduct a survey. It was circulated to a group of prominent academics and Chief Financial
Officers (CFOs) of Corporate India for their feedback as a part of pilot study. Their suggestions
were incorporated and the questionnaire was revised. The final questionnaire contained 34
questions. A glossary of the terms used in the questionnaire was provided to the respondents for
ready reference at the end of the questionnaire.
The survey asked the CFOs to respond to the questions such as management motivation
on adoption of a particular cost management on the likert scale of 0 to 5 (where 0 means "not
used;" 1 means "unimportant;" and 5 means "very important"). This approach has provided data on
the method used and relative importance of each method in the decision making process.
The management perception of quantum change observed in different decision-making
areas because of implementation of Activity-based cost management systems (ABCM) was
captured on a scale of 1 to 5 (where 1 means " no change;" and 5 means " very significant
change").
HYPOTHESES OF THE STUDY
The study plans to test the following hypotheses, which have been developed based on
review of existing literature on activity-based cost management.
H1 The firms using activity-based costing systems are likely to be more successful in
capturing accurate cost and profit information for:
a) product pricing;
b) customer profitability;
c) inventory valuation;
d) value chain analysis;
e) supply chain analysis; and
f) outsourcing decisions vis-à-vis the firms that follow traditional costing system
H2 The management motivations for adoption of activity-based costing are significantly
different between the firms:
i) in the manufacturing sector and the service sector; and
ii) who have adopted fully integrated cost management and financial reporting
systems with ERP and the firms who have introduced activity-based costing
systems as supplementary and offline.
H3 The quantum of change and incremental cash benefits observed by the management of
the firms in various dimensions of performance varies with:
i) the level of adoption of activity-based costing system; and
ii) respect to nature of the industry and the extent to which ABCM system has been
integrated with the other decision support systems.
H4 The ABCM-user respondent firms use activity-based cost management in a value chain
analytic framework.
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Research Methodology
The activity-based cost and performance management systems are required for accurate
cost and profit analysis, when the organizations have high overheads cost and diversity in their
processes and products. It is expected that only large-size companies with these characteristics
will implement contemporary cost and performance management systems.
Every year, Business Today (bt) features a report on India’s most valuable 500 companies
and ranks them based on their market capitalization. In its issue dated October 6, 2000 it carried a
report of 500 companies in the private sector and 75 most valuable public-sector undertakings
(PSUs) for the year 1999-2000. These constitute the universe of corporate India for the present
study. The subsidiaries of multinational corporations (MNCs) form a major constituent of the Indian
corporate sector; an effort was made to get responses from this segment also. Fifty-three
completed questionnaires have been received. The forty-nine responses were from bt-575
companies and four were from unlisted Indian subsidiaries of MNCs. The industry composition of
the sample is as in Table 1. The study is essentially of large-sized corporate firms using activity-
based cost management and performance scorecard. The abstinence to respond to the
questionnaire may be due to their concern for sensitivity of the cost and performance
measurement data. Given the length (20 pages) and depth (34 questions and more than 350
subparts) of the questionnaire, this response rate compared favorably with other academic
surveys.
Table 1: Industry Composition of Sample
Industry Sample Size Sample proportion
Consumer Durable, Personal Care & Food Products 7 13.21
Engineering & Capital Goods 6 11.32
Chemicals & Pharmaceuticals 4 7.55
Power Generation & Transmission 4 7.55
Tractors 4 7.55
Automobiles & Auto Ancillary 4 7.54
Construction, Cement & Building Material 3 5.66
Information Technology – Software 3 5.66
Oil & Gas and Petrochemicals 3 5.66
Telecom & Electronics Equipment 2 3.77
Tyres 2 3.77
Diversified 1 1.89
Iron Ore & Non-Ferrous Metals 1 1.89
Textiles 1 1.89
Others (Logistics, Banking, Telecom services Consultancy airline services trade services etc)
8 15.09
Total 53
In order to verify how far the sample obtained from the survey is a true representation of
the population, a statistical test was carried out on firm-size profitability and risk criterion. In this
test certain key attributes namely sales, total assets, market capitalization, operating profit, return
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on capital employed, return on net worth, debt to equity ratio, and beta of the population and the
sample were compared using non-parametric Mann Whitney's-U test. The test (Table 2) revealed
that there is no significant difference between the means of the complete population of bt-500
companies and the sample for all the attributes except beta as a measure of risk. The difference in
the mean values of beta has been observed at 5% significance level.
Table 2: Comparison of various attributes of population vis-à-vis sample
Attributes Population/
Sample
Mean Standard
Deviation
Asymp. Sig. (2-
tailed)
Population 1393.21 4895.48 Market capitalization (Rs in crores)
Sample 3128.0 7966.23 0.436
Population 1727.79 7006.86 Sales (Rs. In crores)
Sample 4120.77 17887.11 0.862
Population 4241.36 18995.77 Total assets (Rs in crores)
Sample 3871.28 10793.11 0.325
Population 287.23 1328.47 Operating Profits (Rs in crores)
Sample 329.68 948.89 0.712
Population 24.29 30.29 Return on Capital Employed (%)
Sample 23.57 22.69 0.866
Population 8.03 44.99 Return on Net Worth (%)
Sample 12.91 19.01 0.96
Population 1.04 4.71 Debt to equity ratio
Sample 1.17 2.35 0.63
Population 0.84 0.54 Beta
Sample 0.64 0.29 0.029
The correlation coefficients between the various financial attributes of the respondent firms
and that of the population are examined to judge the quality of the sample and are reported in
Table 3 and Table 4 respectively. There is a significant positive correlation between the different
variables of the size (sales, assets and market capitalization) both in the sample and the
population. There is a significant positive correlation between the size variable and the operating
profits variable both in case of sample and the population. There is no significant positive
correlation between the size and the profitability ratios. There is a negative correlation between the
debt to equity ratio and the return on capital employed. It is significant in the case of the sample.
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Table 3: Correlation between the various attributes of the respondent firms
Sales Assets MCAP OP RONW ROCE D/E
Assets 0.854***
Market Capitalization (MCAP) 0.704*** 0.698***
Operating Profits (OP) 0.749*** 0.956*** 0.802***
Return on Net Worth (RONW) 0.087 0.054 0.351 0.169
Return on Capital Employed
(ROCE)
0.005 -0.014 0.204 0.072 0.816***
Debt to equity ratio (D/E) -0.009 -0.013 -0.100 -0.068 -0.345** -0.107
Beta 0.097 0.166 0.452*** 0.153 -0.085 -0.123 0.375**
***, ** indicate significant at 1% and at 5% respectively.
Table 4: Correlation between the various attributes of the bt-500 companies
Sales Assets MCAP OP RONW ROCE D/E
Assets 0.425***
Market Capitalization (MCAP) 0.637*** 0.401***
Operating Profits (OP) 0.453*** 0.960*** 0.478***
Return on Net Worth (RONW) 0.01 0.008 0.067 0.096**
Return on Capital Employed
(ROCE)
0.068 0.288*** 0.098** 0.331*** 0.378***
Debt to equity ratio (D/E) 0.016 0.059 -0.005 0.037 -0.022 -0.039
Beta -0.018 -0.039 0.011 -0.048 -0.061 -0.212*** -0.041
***, ** indicate significant at 1% and at 5% respectively.
Since the firm size, profitability and risk attributes are not significantly different between
the sample and the population both individually and in cross section the sample is assumed a fair
representative of the population.
Out of the fifty-three responses to the nation-wide survey of contemporary cost and
performance management practices, twenty-six respondents are using activity-based cost
management systems.
Analytic tools used
For the survey questionnaire data analysis, the firms have been classified based on sector
(manufacturing/service), ABC adoption (yes/ no), stage of ABC adoption (supplementary/ fully
integrated), and the level of ABC adoption (Manufacturing overheads / marketing and distribution
overheads). The student t-test has been used to investigate whether management's motivations
and decision choices differ across firms' cost management systems and sector.
To test the hypothesis that the firms using activity-based costing system are likely to be
more successful in capturing accurate cost and profit information for decision analysis student t-
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test has been used to investigate the difference between the mean values of the responses of non-
ABCM and ABCM users. Spearman's rank correlation coefficient matrices have been developed
between decision action taken and managerial evaluation of success achieved; and incremental
cash benefits and managerial evaluation of success achieved in Foster and Swanson (1997)
framework.
To find out the difference, if any in the management motivations for adoption of activity-
based cost systems across sector and its stage of implementation, student t-test has been used.
To investigate the quantum of change observed by the management on different
performance variables across sectors, ABCM level and stage of adoption, student t-test has been
use. Spearman's rank correlation coefficient matrices have been developed between the various
measures of decision action taken and incremental cash benefits
To examine whether activity-based cost management is practiced in a value chain analytic
framework, the survey questionnaire asked the ABCM user respondents to indicate quantum
change in different decision areas of cost management subsequent to its implementation. To test
this hypothesis, factor analysis, and two-group linear discriminant analysis has been used. The
principal axis factoring instead of principal component analysis has been used as suggested by
Warming-Rasmussen and Jensen (1998); Kwok and Sharp (1998); Fabrigar et. al. (1999); and
Tansey et. al. (2001). For reporting purpose, items with highest factor loadings have been
reported. The other factor loadings reported are only if the difference from the higher one is less
than 0.20. These are rotated factor loadings obtained using varimax rotation.
Limitations of the Study
Whatever the respondents have said is believed to be their true response and hence, no
statistical test has been performed to study non-response bias and the consistency of individuals’
responses. Another limitation of the methodology used is that it measures beliefs and not
necessarily actions. Overall, the versatility in the characteristics of respondents and firms’ allow the
present study to examine the practice of activity-based cost management vis-à-vis theory.
Existing Cost Management Practices
The activity based costing system assumes that products consume activities and activities
consume costs. It leads to more precise allocation of manufacturing overheads amongst the
products. The activity-based costing system can be extended to the administration overheads and
the marketing and distribution overheads allocation amongst the products for customer profitability
analysis and channel analysis. The introduction of ABC system in an organization can be either
supplementary to the traditional cost accounting system as an offline system or it can be fully
integrated with the decision support systems such as ERP.
The present study reveals that the corporate India has more than one cost management
system in use (Table 5). Half of the respondents do use absorption costing system for product
costing and financial reporting purpose. These results are consistent with the findings of Joshi
(2001) in the Indian context. International surveys reports 50% to 70% of the companies use
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absorption costing for external reporting and tax reporting purpose ( Inouse, 1988; Blayney and
Yokoyama, 1991).
The use of standard costing is popular worldwide. More than 75% of the firms use it in
USA, UK, Ireland, and Sweden ( Cornick et al., 1998; Drury et al. 1993; Clarke and Brislane, 2000;
and Ask and Ax, 1997). Scarbrough et al. (1991) finds that 65% usage of standard costing in
Japan. In India, slightly less than two-third of the respondents use standard costing as a cost
control technique as compared to 68% usage found by Joshi (2001).
The activity-based costing system introduction in corporate India has picked up
momentum as 20.75% of the respondents are using it as supplementary/ offline and 28.30% of the
respondents have integrated the activity based costing systems with ERP systems.
Table 5: Present Cost Management Systems being followed by Corporate India
Sl. No. Cost management system Percentage of respondents
i. Traditional Cost accounting system
a) Throughput costing 13.2
b) Absorption costing 54.7
c) Variable costing 45.3
d) Standard costing 64.2
ii. Activity-Based Costing system
a) Supplementary / offline 20.75
b) Fully integrated cost management and financial reporting system with enterprise resource planning (ERP) system.
28.30
Success of existing cost management systems
Table 6 investigates the success of the existing cost management systems in terms of
capturing the accurate cost information for product pricing, inventory valuation, value chain
analysis, supply chain analysis and outsourcing decisions. 52.8% of the respondents have
achieved success in application of their present costing system in product pricing and inventory
valuation. The success ratio in the area of value chain analysis & supply chain analysis and out-
sourcing decisions is 22.7% and 28.3% respectively. The Table further exhibits the success of the
existing cost management practices in accurate profit analysis by product, department, process,
and customer. The survey revealed that 54.8% of the firms were successful in accurate profit
analysis by product, 24.6% by process and 30.2% by department and customer. 43.4% find it
useful for benchmarking and budgeting while 34% find that it provides better insight about
manufacturing performance.
The examination of responses conditional on ABC-adoption reveals that the firms who
have adopted ABC are significantly more successful in capturing accurate cost information for
value chain analysis (mean score of 2.5385 verses 1.2963) and supply chain analysis (mean score
of 2.2308 verses 1.4444) vis-à-vis the firms who have not adopted ABC. Thus, the hypothesis H1
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to the extent of the success of activity-based cost management in value chain and supply chain
analysis vis-à-vis traditional costing system is accepted.
Table 6: Success Achieved in the Application of Present Costing System to Capture Accurate Cost Information
Mean Score Sl. No. Areas Very Successful /
Completely Successful Aggregate Non-ABCM User
ABCM User
i. Accurate cost information for
a) Product pricing 52.8% 3.283 3.00 3.5769
b) Inventory valuation 52.8% 3.0377 2.8148 3.2692
c) Value chain analysis* 22.7% 1.9057 1.2963 2.5385***
d) Supply chain analysis 22.7% 1.8302 1.4444 2.2308*
e) Outsourcing decisions 28.3% 2.1132 1.8148 2.4231
ii. Accurate profit analysis
a) By product 54.8% 3.1321 2.9630 3.3077
b) By process 24.6% 2.0189 1.8519 2.1923
c) By department 30.2% 2.1132 1.6296 2.6154*
d) By customer 30.2% 2.0566 1.8148 2.3077
iii. Better insight for benchmarking and budgeting
43.4% 3.0566 2.4074 3.7308***
iv. Better insight about manufacturing performance
34% 2.6604 2.3333 3.0000
*, **, *** indicate significant at 10%, 5%, and 1% level respectively.
Activity- based cost management applications in India.
Activity-based costing technique has gained appreciable acceptance during the post
1990s in India as 26 respondents firms out of 53 are using it for product pricing and operational
feedback. 42.3% of the ABC-user firms are using ABC in their company for more than two years.
This ABC adoption rate compares favorably with nearly 38% in India in 1999, 26% in the USA,
20% in UK and 40% in Norway (Business Today, 1999; Innes and Mitchell, 1995; Innes, et. al.
2000; Ittner et.al.2001; and Bjemenak, 1997).
The study reveals that 76.92% of the ABCM users firms are in the manufacturing sector
and 23.08% in the service sector. The extent of ABCM adoption in the non-manufacturing sector
had not been found significantly different from that in manufacturing concerns in the UK (Innes and
Mitchell, 1995). Interestingly in USA, the highest adoption rate of ABCM is in the financial sector (
Innes, et. al. 2000). 57.69% of the ABCM-users firms have fully integrated cost management and
financial reporting systems with enterprise resource planning system. 57.69% of the ABCM-user
respondent firms have extended their ABC systems to advanced stage extending it up to facility
level and customer level activities (Table 7). Seventy-six percent users of the activity-based
15
costing in Canadian firms have implemented the system as supplementary and offline ( Armitage
and Nicholson, 1993).
Table 7: Categorization of the sample ABCM-user firms. Sector ABCM adoption stage ABCM adoption level Manufacturing Service Supplementary Fully
Integrated Basic Advanced
Number of respondents 20 6 11 15 11 15
% of respondents 76.92% 23.08% 42.31% 57.69% 42.31 57.69%
Management motivations for introduction of activity-based costing
The major motivations for introduction of activity-based costing are accurate cost
information for product/service pricing and profits analysis, improved insight into cost drivers,
accurate customer profitability analysis, cost reduction, process improvements, product mix
strategy, performance measurement & improvement, and cost modeling. The inventory valuation
use had the lowest adoption rate amongst ABC users. ( Armitage and Nicholson, 1993;
APQC/CAM-I, 1995; Innes and Mitchell, 1995; Clarke, 1996; and Clarke and Mullins, 2001)
Table 8 explores the management motivation for introduction of activity based costing in
the organization amongst ABCM-user respondent firms. 73.1% of the ABCM-user respondent
firms consider the need to have detailed information on value added and non-value added
activities as major motivation followed by the need to be competitive in the industry in terms of
price quality and performance (69.3%). The other major motivations are to have increased
information about the activities, the cost associated with the activities, and activity cost drivers for
customer profitability analysis, product pricing decision and budgeting. The design of performance
measurement and control system based on ABC systems is another major motivation (57.7%).
16
Table 8: Management motivations for introduction of activity-based costing
Mean score
Motivation
Most Important Aggregate
Manufacturing sector
Service
sector
ABCM Offline
ABCM fully
Integrated
To have detailed information on value-added and non value-added activities
73.1% 3.7308 3.75 3.667 3.4545 3.9393
To correct the distortion in overheads cost allocation 42.3% 2.4231 2.30 2.833 2.2727 2.5333
To identify activities that consume non value-added time 38.5% 2.9615 2.80 3.50 2.8182 3.0667
To have increased activity-wise information on:
Budgeting 69.3% 3.4231 3.75 2.3333 3.000 3.7333
Product pricing decisions 61.6% 3.1538 3.65 1.50* 3.00 3.2667
Customer profitability analysis 53.8% 2.7692 2.65 3.1607 3.00 2.60
Value chain analysis and reengineering 42.3% 2.8846 3.30 1.50 2.2727 3.3333
Benchmarking 42.3% 3.00 3.05 2.8333 2.7273 3.20
Outsourcing decisions 34.6% 2.3077 2.50 1.6667 1.9091 2.600
Substitute products 15.3% 1.4615 1.40 1.6667 1.3636 1.5333 To be competitive in the industry in terms of price, quality and performance
69.3% 3.5769 3.55 3.6667 3.6364 3.5333
To design ABC-based performance measurement system 57.7% 3.1154 3.0 3.50 2.7273 3.40
To compute economic value added* while using activity-based cost information
42.3% 2.6154 2.75 2.1667 2.0000 3.0667
To have improved inventory valuation. 38.5% 2.4615 2.75 1.50 2.1818 2.667
To meet the customer’s conditionalities while tendering 34.6% 1.9231 2.20 1.00 1.8182 2.000
To use it as a vehicle for change management in the organization 34.6% 2.1923 2.45 1.3333 1.7273 2.5333
To provide accurate information for transfer pricing 26.9% 1.7308 1.75 1.6667 1.5455 1.8667
Band wagon effect 15.4% 0.8077 0.65 1.3333 1.0000 0.6667 *, **, and *** indicate significant at 10%, 5% and 1% respectively.
The management motivations for adoption of activity-based costing is significantly higher
at 10% level of significance in case of manufacturing sector firms vis-à-vis service sector ABCM-
user respondent firms only in case of product/service pricing decision, as evident from Table 8.
The major management motivations in the banking sector are to have activity-based cost
information for budgeting, economic value added computation, correct allocation of overheads cost
and to identify value-added and non-value added activities. Thus, there is no significant difference
17
in the levels of management motivation for introduction of Activity-Based costing between
manufacturing sector and service sector firms. Hence, the hypothesis H2 (i) stands rejected.
There is no significant difference in the management motivations for adoption of activity-
based costing between the firms who have adopted fully integrated cost management and financial
reporting systems with ERP and the firms who have introduced activity-based costing systems as
supplementary and offline. Hence, the hypothesis H2 (ii) stands rejected.
The need for customer profitability analysis, budgeting and to identify activities that
consume non value added time led the corporate India to extend their ABC-systems from basic
level to advanced level, extending it to facility level and customer level activities.
Investment analysis of activity-based costing project
The investment cost in implementation of ABC is either insignificant or less than 1% of the
sales and accordingly payback period is less than one year. Most of the ABCM-user respondent
firms did not carry out DCF analysis of activity based costing implementation project. Table 9
indicates that 7.7% of the ABCM-user respondents, who did it, found difficulties in identifying the
beneficiaries of ABCM implementation and in quantifying the benefits in terms of cash. 73.1% of
the ABCM-user firms used in-house cross-functional team for ABC implementation in the
organization as against 3.8% who engaged consultants for this purpose.
Table 9: DCF analysis of ABCM implementation project Sl. No Issues Percentage of the respondents
i. Discounted cash flow analysis (DCF) of the investment in activity based costing implementation project
7.7
ii. Difficulties in identifying the beneficiaries of ABC implementation 23.1 iii. Difficulties in quantifying the benefits in terms of cash 26.1
Problems in the implementation of the activity-based costing
The activity-based costing systems fail because of the poor implementation process (
Ness and Cucuzza 1995; Player and Keys 1995; and Pattison & Arendt, 1994). The major
problems faced during the implementation of activity based costing by the ABCM-user respondent
firms are developing activity dictionary (34.6%), inability of traditional costing system to capture the
information needs of ABC (42.3%) and lack of review of ABC implementation initiative (30.8%), as
evident from Table 10. Interestingly resources, both management time and funds have not been
found to be limiting factor. The other problem areas are identifying the cost drivers, assigning the
cost to the activity pools and computer software & technical expertise.
18
Table 10: Problems faced during the implementation of ABCM
Sl. No. Problems faced during ABC implementation Percentage of respondents
i. Inability of traditional costing system to capture the information needs of ABC 42.3 ii. Difficulties in developing Activity dictionary 34.6 iii. Lack of review of ABC implementation initiative 30.8 iv. Difficulties in assigning the cost to the activity pools 26.9 v. Difficulties in identifying the cost drivers 23.1 vi. Inadequate computer software and technical expertise 23.1 vii. Lack of team awareness and training 11.5 viii. Lack of adequate resources (management time and funds) 7.7 ix. Lack of employee and middle management support due to the perceived threats of
transparency 4
Activity-based costing and firm performance
The introduction of activity-based costing system amongst respondent firms has brought
quantum change and associated incremental cash benefits in different areas such a focus on
profitable customers, change in product pricing strategy, elimination of redundant activities through
the entire value chain, product mix and outsourcing decisions. It led to change in the strategic
focus (Table 11). In banking sector, the management of the respondent firms has observed
substantial change in their focus on profitable customers & business process outsourcing, and re-
configuring the value chain subsequent to implementation of activity-based costing. No significant
difference in the quantum of change has been observed among the ABCM-user respondent firms
across sector (manufacturing vs. service) and ABCM stage (basic vs. advanced). Hence, the
hypothesis H3 (i) and H3 (ii) stands rejected.
19
Table 11: Quantum change subsequent to ABCM implementation in different decision areas
Mean score
Motivation
Most
Important
(%) Aggregat
e Manufacturing sector
Service sector
ABCM
Offline
ABCM fully
Integrated
ABCM at basic stage
ABCM at advanced
stage
i. Focus on profitable customers 46.2 2.1154 2.10 2.1667 1.6364 2.4667 1.9091 2.2667
ii. Changed pricing strategy 46.2 2.3077 2.45 1.8333 2.00 2.5333 1.9091 2.60
iii. Outsourced activities / processes 34.6 1.9231 2.0 1.1667 1.5455 2.20 2.0909 1.80
iv. Changed strategic focus 34.6 1.9615 2.0 1.8333 1.4545 2.3333 1.00 2.2667**
v. Eliminated redundant activities through the entire value chain 34.6 2.1538 2.25 1.8383 1.9091 2.3333 1.9091 2.3333
vi. Changed product mix 30.7 1.8462 2.10 1.0 1.6364 2.00 2.0909 1.6667
vii Changed distribution channels 23 1.6923 1.85 1.1667 1.2727 2.00 1.7273 1.6667
viii Changed processes 19.2 1.7308 1.90 1.1667 1.3636 2.00 1.5455 1.8667
ix Changed sourcing decisions 19.2 1.5385 1.50 1.6667 1.4545 1.6000 1.3636 1.6667
x Changed incentive compensation 19.2 1.5769 2.40 2.1667 1.9091 1.3333 1.00 2.00
*, **, and *** indicate significant at 10%, 5% and 1% respectively.
20
The factor analysis of decision actions taken by the ABCM-user respondent firms yields
two prominent factors as reported in Table 12. The factors are identified as decision areas beyond
the boundaries of the firm and within the boundaries of the firm as in value chain analysis ( Shields
and Young, 1992; Shank & Govindrajan, 1995; Goldsby & Closs, 2000; Hooper et. al., 2001). The
model has a KMO score of 0.743 and variance explanatory power of 73.421%. The variables
included in the decision areas beyond the boundaries of the firm are focus on profitable customers,
sourcing decisions, elimination of redundant activities, distribution channels, and strategic focus.
The product mix, process simplification, and product pricing are included in the decision areas
within the boundaries of the firm.
Table 12: Factor analysis results of quantum change subsequent to ABCM implementation in different
decision areas
KMO score: 0.743 Percentage of variance explained: 73.421%
Sl. No. Decision action areas Beyond the
boundaries of the firm
Within the boundaries of the
firm I Changed product mix - 0.829
ii Changed processes - 0.819
iii Outsourced activities / processes 0.622 0.614
iv Focus on profitable customers 0.708 -
v Changed pricing strategy 0.674 0.587
vi Changed strategic focus 0.530 0.408
vii Changed sourcing decisions 0.669 -
viii Eliminated redundant activities through the entire value chain
0.908 -
ix Changed incentive compensation - -
x Changed distribution channels - -
Eigen value 6.287 1.055
% of variance explained 62.873 10.548
In order to substantiate the argument, linear discriminant analysis was used with decision
areas as sample and ABCM-user respondent firms’ response as variables. A priori classification
independent of Factor analysis results was used. It classified decision areas into two categories
based on value chain framework, one beyond the boundaries of the firm and other within the
boundaries of the firm. The decision areas within the boundaries of the firm are product mix,
process simplification, product pricing and compensation strategy. The decision areas beyond the
boundaries of the firm are focus on profitable customers, sourcing decisions, elimination of
redundant activities, distribution channels, and strategic focus. Based on a priori classification the
decision areas were completely discriminated (100% accuracy level). The results of linear
discriminant analysis are as in Table 13.
21
Table 13: Linear Discriminant analysis results of quantum change subsequent to ABCM implementation in different decision areas
Eigenvalue 178.449 % of variance explained 100 Cannonical correlation 0.997 Wilks' λ 0.006 χ2 20.768 Significance 0.008 Correct classification 100
From the foregoing analysis, it can be concluded two factors identified in the factor
analysis were actually decision areas beyond the boundaries of the firm and decision areas within
the boundaries of the firm, for cost management. Thus, the hypothesis H4 that ABCM-user
respondent firms use activity-based cost management in value chain analytic framework stands
accepted.
The respondent firms in their estimate of incremental cash benefits subsequent decision
action taken as a result of activity based costing implementation found appreciable results in the
area of product pricing budgeting, customer profitability analysis and product improvement
opportunities (Table 14).
Table 14: Incremental Cash benefits associated with the introduction of ABCM
Sl. No. Implementation area Significant benefits
(Percentage of respondents)
Mean score
i. Product pricing decision 34.6 1.7692 ii. Budgeting 30.8 1.8462 iii. Customer profitability analysis 30.7 1.8077
iv. Product improvement opportunities 26.9 1.6538 v. Working capital management 23 1.6154
vi. Process improvement opportunities 19.4 1.4231 vii. Make or buy decision 19.4 1.3846
viii. ABC-based performance measures 19.2 1.6154
ix. Value chain analysis 19.2 1.5000 x. Transfer pricing 11.5 0.9615
xi. Value –based management tools such as EVA / RAVE* 11.5 1.2692
CONCLUSIONS
The present study of activity-based cost management practices in the Indian industry is
unique in terms of its scope and methodology followed. It not only deals with traditional cost
management techniques but also with contemporary management tools such as activity-based
costing. The hypotheses in general deal with the difference in the practices across sectors, stages,
and level of adoption of contemporary techniques. Factor analysis has been used to verify the
existence of normative approach to the cost management in Indian industry.
The survey shows an encouraging response of the Indian corporate sector to the activity-
based costing with 49% (n = 26) of the respondents adopting it. The firms are successful in
22
capturing accurate cost and profit information from their ABC cost systems for their value chain
and supply chain analysis vis-à-vis non-ABC user firms. The need for activity-wise cost information
in budgeting, product pricing decision and customer profitability analysis has urged the
management of the Indian firms to adopt activity-based costing systems. No significant difference
has been found in the in the motivation to adopt ABCM across the manufacturing as well as
service sector and across the stages of activity-based cost system adoption
(supplementary/offline). This implies that activity-based costing has equal opportunities in both the
sectors and the motivations are uniform over the stages of adoption. The major difficulties faced by
the ABCM-user respondent firms while designing activity-based cost systems are developing
activity dictionary & cost drivers and lack of review of ABCM implementation initiative.
Application of activity based costing has resulted in changes in various management
decision areas, prominent among them, being focus on profitable customers, pricing strategies,
and sourcing decisions. However, the quantum of change observed is not found to be a
characteristic of sector (manufacturing vs. service) and level or stage of ABC implementation.
Application of ABCM has impact not only on the decisions within the firm but also on the
decisions beyond the boundaries of the firm as evidenced by the factor analysis and linear
discriminant analysis of responses of activity-based costing user firms. The decision areas beyond
the boundaries of the firm include focus on the profitable customers, sourcing decisions,
elimination of redundant activities, distribution channel, and strategic focus. The product mix,
process simplification, and product pricing are included in decisions within the boundaries of firm.
Thus, it can be inferred that ABCM in India is practiced in the value chain analytic framework.
Due to limited scope of the present study, a number of research issues are not attempted
but are felt in the course of study. Some of them are – one, to follow up the respondents’ claim on
the impact of activity-based costing on their firm performance either through a case study or
through an event study using stock market data. Two, to examine the relationship between the
organizational influences & technological factors and the adoption of activity-based costing system
by the firm.
23
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