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ELSEVIER Int. J. Production Economics 5657 (1998) 231-242

Implementation of activity-based costing in manufacturing

A. Gunasekaran*, M. Sarhadi
Department of Manufacturing and Engineering Systems, Brunei University, Uxbridge, Middlesex UB8 3PH, UK

Received 15 April 1996; accepted 25 September 1997

Abstract
This paper discusses the implementation issues of activity-based costing (ABC) in manufacturing. ABC has become an
important aspect of manufacturing/service organizations striving for a major share in the international markets. New
productivity and quality improvement strategies facilitate an increase in the awareness of ABC in present day
manufacturing organizations and an appropriate framework for the management of productivity and quality. Firstly, an
overview of some literature on ABC and the role of ABC in advanced manufacturing systems are presented in this paper.
Then the experiences of some Finnish companies in implementing ABC are discussed. Finally, a framework for the
implementation of ABC in manufacturing is presented. 0 1998 Elsevier Science B.V. All rights reserved.

Keywords: Activity-based costing; Implementation

1. Introduction reported product costs and, in turn, product pricing

Nowadays managers are facing global competi-
tion and increased productivity in new manufactur-
ing environments. Companies attempt to become
customer focused and concentrate on quality prod-
ucts at competitive prices. Under these circumstan-
ces, many firms are interested in determining
various costs more accurately with the objective to
integrate manufacturing and marketing strategies.
Various costing systems are used to provide an
increased accuracy about product costs, product-
mix, pricing and other investment decision-mak-
ings. Some experiences reveal that the distortion in
*Corresponding author. Tel.: + 44 1895 274 000, ext. 2634;
fax: + 44 1895 812 556; e-mail: emstagu@brunel.ac.uk.
could be reduced by using activity-based costing
(ABC).
In traditional cost accounting methods, most
companies have produced a narrow range of prod-
ucts. Applying the same methods for a wide range
of products will lead to a distorted cost informa-
tion. Accurate cost information, such as the pro-
duction costs and value-added activities are very
important since they are used as a decision base for
management and control purposes, from produc-
tion to marketing. ABC aims not only to allocate
overhead costs accurately, but also identifies the
areas of waste. It considers that purchasing, receiv-
ing, setting up and running a machine consume
resources, and products consume activities. These
activities trigger the consumption of resources that
are recorded as costs in the accounts. This lends
ABC to trace the cost of products according to the

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232 A. Gunasekaran, M. SarhadilInt. J. Production Economics 56-57 (1998) 231-242

activities performed on them, giving more accurate The role of activity-based costing and analysis
cost information, with less distortion [l]. has a significant impact on improving productivity
The basic concept behind product costing in an and quality. Each product requires a number of
ABC system is that the total cost of a product activities such as design and engineering, purchas-
equals the cost of the raw materials plus the sum ing, production and quality control, and mainten-
of the cost of all value-adding activities to pro- ance. Each such activity consumes resources of
duce it. The ABC system recognizes that while different categories. For example, purchasing in-
some of the overhead resources increase in pro- volves the order processing, inventory control and
portion to the volume of products produced, the the selection of suppliers. Each such activity con-
rest of the overhead resources do not. The ABC sumes resources such as the working time of pur-
system has the following cost allocation bases or chasing manager, fax, secretarial support, and other
cost drivers: (i) unit-level bases, which assume that personnel support related to purchasing. Cost
inputs increase in proportion to the number of drivers are often measures of the activities per-
units produced; (ii) batch-level bases, which assume formed (e.g. set-up hours, number of set-ups, num-
that inputs vary in proportion to the number of ber of times ordered) instead of the traditional
batches produced; (iii) product-level bases, which volume-related allocation bases. The cost drivers
assume that inputs are necessary to support the are the factors that drive the costs up. For instance,
production of each different type of product; and the number of suppliers and number of compo-
(iv) facility level bases, which simply sustain a facil- nents used in the product influence the total cost of
itys general manufacturing process. Users of the purchasing. The performance measures should de-
ABC system will need to identify the activities termine the relationship between cost drivers of an
which generate cost and then match the activities to activity and resources consumed and therefore the
the level bases used to assign costs to the products. overall effectiveness of the whole production sys-
For batch- and product-level bases, costs are then tem. In the case of purchasing, a reduction in the
amortized over the number of units produced in number of components used in a product and fewer
that batch and the volume of the product, respec- supplier bases with long-term business relationship
tively [2]. can improve the performance of the purchasing
Managers of advanced manufacturing com- function.
panies are vigorously striving for modern manage- Many accounting systems allocate overhead cost
ment techniques to gain a competitive edge. The as a percentage of direct labour hours. While this
Japanese competitiveness of offering quality goods method of allocation is simple and fast, it does not
and services at lower prices has prompted other reflect accurately on the actual product cost. For
countries to seriously think about their productiv- instance, components or products that are more
ity and quality problems. In general, the cost of complex will need more activities. Then, manufac-
a product can be lowered by reducing the cost of turing of high-volume products with large batch
production. A number of technological advances sizes will require fewer activities from some sup-
such as FMS and CIM and concepts such as JIT porting departments per unit manufactured, than
and TQM coupled with Kaizen can be traced to the low-volume products with small batch sizes. There
on-going concern about improving productivity will be fewer set-ups, less production scheduling,
and quality in manufacturing. In the past few years, less frequent issues and retrievals of materials, less
considerable attention has been focused on reduc- inspection and, in general, fewer transactions from
ing the product cost by way of improving the accu- the manufacturing resources areas. As less manu-
racy of measuring the costs and other performance facturing resources are consumed than for products
indicators to support various managerial decision which are produced in smaller batch sizes, it is
makings. ABC can be used to identify non-value- therefore less expensive to produce [3,4]. Also, the
adding activities and eliminate them with the role of direct labour in manufacturing has dimin-
objective to improve the performance of a manu- ished because of the increase of capital intensive
facturing system. production. Therefore, the allocation of overhead
 A. Gunasekaran, M. Sarhadillnt. J. Production Economics 56 57 (1998) 231-242 233

cost based on direct labour hours may not be the Manufacturing cost of a product can be re-
appropriate method. duced by the following: (i) Minimizing the number
An overview of some literature on ABC reveals of parts used in a product, (ii) designing parts for
that the following implementation issues are not ease of handling and assembly, and (iii) selecting the
considered: (i) lack of a suitable practical frame- best material/process combination for economic
work for the implementation of ABC; (ii) alignment manufacture of the individual parts [9]. The final
between business and manufacturing strategies and cost of a product is largely determined by design
the role of ABC; (iii) unavailability of a structured decisions made in its early development stage.
approach to analyse and continually improve the Therefore, tools need to be developed to assist
fundamental activities, such as manufacturing, designers for estimating the manufacturing cost of
marketing, communications, and other major as- their designs and comparing and selecting the
pects of a companys operation; (iv) neglect of be- lowest cost design alternative from a given set of
havioural and managerial issues of implementing design choices. In the absence of such a tool, a de-
ABC in manufacturing; and (v) lack of attention on signer may unknowingly add in more features than
the user-friendly ABC system in practical applica- necessary on the products, which ultimately make
tions. An attempt has been made in this paper to them more complex and costly to manufacture.
discuss these implementation issues of ABC in Manufacturing complex products will require rela-
manufacturing with help of suitable case experien- tively more labour, inventory and capital costs as
ces from Finnish companies. well as requiring more activities such as purchas-
The organization of the paper is as follows: Sec- ing, quality control and production control. This
tion 2 presents the background for the research on leads to escalation in manufacturing cost. However,
the implementation of ABC. Section 3 discusses the they are not reflected adequately in a traditional
importance of ABC in advanced manufacturing cost accounting system and this indicates the im-
systems. Section 4 presents some case experiences portance of ABC.
from Finnish firms on the implementation of ABC. Malik [lo] presented a mixed integer program-
A framework for the implementation of ABC in ming model that utilizes ABC information to deter-
manufacturing is presented in Section 5. The con- mine the optimal product mix and product cost in
clusions of this research are presented in Section 6. a multi-product manufacturing environment. The
model permits interesting insights into the evalu-
ation of marginal cost of products and marginal
2. Background for the research worth of resources for decision making involving
product mix, product costing, and capacity expan-
Taking into account the growing concern about sion/contraction. Gooley [l l] argues that tradi-
competitiveness of the manufacturing industry in tional cost accounting systems have been applied to
the global market, a number of initiatives are now logistics operations over the years. However, they do
under way to improve the competitive position of not provide sufficient information on process costs
firms. One of such initiatives is the implementation and product profitability. Instead, they are designed
of ABC in manufacturing. The development and to focus on the cost of taxes, inventory, materials,
promotion of ABC have been stimulated and largely and employment, assigning expenses to a few stan-
influenced by the work of Cooper and Kaplan dard categories that were developed when manufac-
[3,4]. Despite the continuing debate on its original- turing was managed differently than it is now.
ity as well as its relevance to product costing, ABC Sriram [12] studied how flexible manufactur-
has been gaining acceptance in an increasing num- ing systems (FMS) affect the accounting informa-
ber of organizations ranging from manufacturing tion system of an organization switching to FMS.
to retailing, and from profit oriented businesses to The new accounting techniques appear to change
government institutions [5,6]. The analysis of ABC the role of the accounting information system
highlights four activity-related aspects: costs, qual- from cost measurement and cost control to manag-
ity, time and innovation [2,7,8]. ing flexible automation and increasing overall
234 A. Gunasekaran, M. SarhadiJInt. J. Production
prosperity of an organization. However, these sys-
tems do not relegate their role to studying the costs
of flexible automation but also extend to the study
of the strategic impact of indirect costs such as the
cost of maintaining higher quality, customer satis-
faction, product variability, marketing and distri-
bution costs.
Campbell [13] presented a case study conducted
at Southwestern Ohio Steel Inc. This company is
a successful steel service centre providing steel
sheets by weight and dimension. The main com-
ponent of the companys Hamilton operations
- and the steel plants primary operating bottleneck
- is the blanking or cutting line. In the early 1990s
the blanking line was operating near capacity, and
other approaches to increasing throughput of the
line were needed. ABC has been suggested as an
appropriate tool for guiding and directing the pro-
cess of improvement [14]. They have used steps
such as cycle-time analysis, set-up time reduction
evaluation, cycle-time and idle capacity calculation,
and employee co-operation analysis.
Although initial ABC implementation focused
primarily on the factory, today the ABC approach
has spread to key non-manufacturing functions
such as marketing, engineering and research and
development. Many companies that have been with
ABC for a while are slowly reengineering other
facets of the traditional financial and costing sys-
tems. However, the literature review indicates that
there are no concrete guidelines for the implemen-
tation of ABC, in particular, based on the experien-
ces both from practice and theory. Therefore, there
is a need to develop a framework for the implemen-
tation of ABC based on the literature review and
case studies.
3. ABC in advanced manufacturing systems
Manufacturing systems have undergone a great
change in recent years and so have the accounting
systems. These changes include the consideration
for non-financial measures and ABC. There is
a need for changes in the cost accounting system to
measure the performance of firms more accurately.
Also, the accounting systems help to decide about
the product-mix and capital investments.
Economics 56-57 (1998) 231-242
New concepts in manufacturing such as design
for quality, design for production and design for
distribution are based on ABC that aim to elimin-
ate the non-value-adding activities. When the role
of support services has increased in advanced
manufacturing systems (AMS), the need for con-
trolling the cost of overhead has increased. This has
to be studied in detail while selecting the appropri-
ate criteria for performance measurements. The
non-financial performance measures such as qual-
ity, innovation, flexibility and productivity [l&16]
should be given due consideration. Now the major
task is to determine how to measure these factors in
AMS. The non-financial performance measures
based on ABC are presented in Table 1. The ad-
vances in computer technology have encouraged
the use of non-financial performance measures such
as manufacturing cycle time and number of defects
that are based on the activity-based analysis.
Another example is the just-in-time (JIT) produc-
tion system that encourages the simplification of
production activities. This particular aspect, that is
the simplification has tremendous implications on
the type of cost accounting system to be adopted for
a JIT environment. In this case, some indirect costs
will become direct costs and vice versa. For example,
in traditional cost accounting systems the cost of
maintenance has been treated as an indirect cost.
Since the maintenance is carried out by the operator
of the machine or equipment in a JIT production
environment, then this cost becomes direct cost.
Furthermore, JIT purchasing does not encourage
the inspection of incoming goods. This implies that
non-value-added activities such as inspection, inven-
tory and material handling can be eliminated. This
leads to a simple cost accounting system by avoiding
the complex overhead cost allocation. These exam-
ples illustrate the potential opportunities of ABC in
advanced manufacturing systems. In the following
section, some case experiences from Finnish com-
panies are presented to motivate practitioners in
implementing ABC in their organizations.
4. Case studies
In this section, five different real-life examples
of implementing ABC are presented. All the case
 A. Gunasekaran, M. Sarhadillnt. J. Production Economics 56-57 (1998) 231.-242 235

Table 1
Advanced manufacturing systems vs. performance measures based on ABC

Advanced manufacturing systems Performance measures based on ABC

Just-in-time Set-up time, manufacturing cycle time, delayed or early deliveries, number of
defects
Flexible manufacturing systems Set-up time, cycle time, idle time of the machines, inventory levels
Computer-integrated manufacturing systems Set-up time, flow time

experiences are from Finnish firms ranging from When considering the resource drivers, the activ-
metal and engineering to food industries. They ity has been identified for an appropriate unit, viz.,
focus on (i) the reasons why the companies wanted 1 drum ( = 200 kg) of pieces. The resource drivers
to implement ABC, (ii) the cost drivers for different are: 3 h of manpower per 18 drums in automatic,
manufacturing environments, (iii) the implementa- 2 h of manpower per 800 kg of strips in manual
tion issues including behavioural and managerial cutter, 1 h of maintenance per 288 drums, and 1 h
aspects, and (iv) the results obtained from the im- of maintenance per 15 600 kg of strips. The cost
plementation of ABC. objects are a drum and a strip. One drum of pieces
requires approximately 25 cuts ( = 4 min). One
strip requires 4 cuts (1.5 min) and the packaging
4.1. Case 1: Company A line is automatic.
The next process considered for activity analysis
The case study presented here is company A is deliveries. The freight cost is fixed due to the use
which operates in the field of metal industry. The of external transportation companies. The activity
company produces seven different products. Two of here is the loading, and the resources required are
these products share almost 60% of the total vol- manpower, electricity and maintenance for the fork
ume of production. The five other products are truck. The resource drivers are: (a) 4 min of man-
mostly customized, for example, different packing power per 1 pellet ( = 4 drums), (b) 1 h of electricity
sizes. Metal is cut into pieces of two strips of vari- for battery loading for every 8 h of loading, (c) 1 h
ous sizes and the packing is done in the same unit of maintenance for the fork truck for every 200 h of
with cutting. , loading. The cost object is loading a container or
The company sells its products to 32 countries in a truck. The value of the activity drivers vary due to
all continents except in Africa, Australia and South various container sizes and trucks. For example,
America. It has several warehouses in various the loading time for a large container is longer than
countries, mainly in the United States and conti- that of the small container. The activities are un-
nental Europe. The products are delivered in con- loading, registration and loading. The resources
tainers by external transportation companies that required are: personnel for loading and registra-
use ships, trucks and trains. tion, power and maintenance for the fork truck.
The cutting, packing, delivery and warehousing The company mostly uses computer for registra-
functions are analyzed from the ABC viewpoint. tion and information. The cost objects are unload-
The cutting is performed with two cutting machin- ing, registration and loading for each shipment.
es. One that cuts little pieces is largely automatic The following are some of the most important
and requires three operators. The second machine, issues obtained from this case study concerning the
used in cutting strips, is manual and requires only implementation of ABC: (i) identification of cost
two operators. The cutting in both machines objects, (ii) allocation of costs based on the re-
should be considered as separate activities because sources consumed, but not averaging costs based
the need for resources such as personnel, power and on the number of machines used for performing the
maintenance varies. operation, (iii) identification of major critical activities
236 A. Gunasekaran, M. SarhadiJInt. J. Production Economics 56-57 (1998) 231-242

(cutting and deliveries) in the whole process that By using ABC, Company B has achieved better
extend the cycle time of the total delivery process, results than before and its ability to compete in the
(iv) analysis of these activities based on different market has also improved. The following are the
resources consumed, (v) selection of appropriate main steps obtained from this case study to imple-
cost drivers, and (vi) selection of appropriate over- ment ABC: (i) Select areas where improvement is
head-cost allocation bases to improve the perfor- needed. (ii) Identify major factors (cost objects) for
mance of activities. In order to alleviate human activity-based analysis. (iii) The cost models should
errors in data handling, computers offer a good be based on ABC principles. (iv) Educate and train
solution. the workers in the new cost management scheme.
(v) Offer suitable incentives to employees for learn-
ing the new cost management system and adopting
4.2. Case 2: Company B it in its fullest extent. For example, incentive
scheme based on the percentage of the quality
Company B is a part of Company A. The turn- goods produced, and the reduction in the level of
over of the whole group is about 670 million FIM; scrappage and manufacturing cycle time. Also, per-
the number of employees is 600. Company B is formance indicators such as delivery reliability and
involved with food production. It produces and reduction in warranty costs can be used to reward
markets canned foods like jam and marmalade. the employees.
Since the company had some problems with the
overall performance, it has started to implement
ABC. To combat aggressive competition it was 4.3. Case 3: Company C
vital to focus on cost reduction which could only be
achieved if the cost information could be gathered. Company C operates in many different fields of
The management of Company B wanted to imple- industries. One of its subsidiaries produces phar-
ment ABC with an objective of cutting costs in the maceuticals and employs over 900 people in six
functions of marketing and sales. The costs of these different places in Finland. The whole company
two activities were too high as compared to the employs over 5000 people in Finland. In this case
turnover. The implementation of ABC in Company study, the accounting manager of the company was
B as a project has lasted for a couple of months. In interviewed. The need for the new cost accounting
this company, marketing is an important function system arose when the company merged with an-
and, therefore, a decision has been made to go for other Finnish pharmaceutical company in 1990.
ABC with the objective to analyse this area. The After the merger the company has plants in six
production margin of every product and client were different places and two different kinds of product
analysed. The results of the product analysis reveal control systems. The basis for the design of the new
that only the so-called large-volume products and system was to aggregate the product control sys-
products with a shorter production cycle time are tems and to unify the business. Also, the purpose of
profitable. The problem was that the old salesmen the new system was to develop an appropriate cost
have difficulties to understand the concept of this system for the transfer pricing. It is important to
new sales model. In their views, the products seem determine the exact product costs and to allocate
to be now more expensive than before due to the the costs to right products. It was found from the
allocation of costs based on cost drivers. However, analysis of the present cost accounting system that
the negative reaction of salesmen to ABC was only it is not truly reflecting the actual product cost.
temporary. Now they understand how the new Also, there is a lack of motivation among em-
sales model works. This was achieved by education, ployees of different divisions. This has led the com-
training and empowerment of employees on the pany to go for a more accurate cost system, namely
new cost system and employee empowerment. Cli- ABC.
ents are also satisfied with results after the imple- The preliminary work was done in groups and
mentation of ABC. the required changes were defined. Also, interviews
 A. Gunasekaran, M. Sarhadijlnt. J. Production Economics 56 57 (1998) 231-242 231

were conducted to identify the activities and cost that caused problems in allocating the costs. In this
drivers. The expected benefit of the new cost system case, an initial investigation with the existing cost
was that it should lead to team work between system has led the company to implement an ABC
production and accounting staffs. There were no system. The objective of the project is to unify the
financial goals and the purpose of the system was to system of cost reporting. The goal has been to
motivate the staff and to provide them with better avoid multiple and unnecessary information hand-
tools for improved productivity and quality. The ling. A consultant was hired to help in the imple-
staff and the management were pleased with the mentation of ABC. Also, seminars were arranged
system. The system is fairly simple, inexpensive, and and group work took place. These groups have
gives appropriate information to different depart- identified how people spent their time and what
ments in the company for various decisions mak- have caused the costs in the production chain all
ing. The implementation process of the new cost the way to the customers. In the company. a new
system is being carried out in a gradual manner and accounting manual was prepared and it says, Un-
plant by plant. It is expected to be ready during derstanding the behaviour of overhead costs and
1996. -1997. their relationship with products is one of the key
From this case analysis, the following are the factors to achieve fair and successful results.
most important observations regarding the imple- In practice, the implementation of ABC must (i)
mentation of ABC: (i) It should support the com- identify the appropriate cost centres and (ii) define
panys corporate strategy such as flexibility, the cost allocation methods. Cost centres should be
productivity and quality. (ii) It should identify suit- identified in each unit taking into account the local
able policy for transfer pricing to make the units needs of the business unit such as variety, product
within the company competitive. (iii) It should cost, and distribution as well as the size and the
identify major cost/profit centres. The cost centre range of sequential activities. These areas have been
has been identified based on the area where high cost centres. In addition, the strategic business unit
value-adding processes take place. Also, it is based has been considered to be a cost centre. Now, after
on the major resources used to complete a set of one and a half year, all the companys units have
tasks. (iv) It should identify activities and cost been reorganized. The changes did not cause any
drivers. (v) Co-operative supported work between problems with the staff after they had the chance of
the production and accounting staff, and user- identifying the activities and their cost drivers.
friendly new cost accounting system, (vi) gradual They found that the system was suitable and en-
implementation of the system and (vii) non-finan- couraging. The accounting and marketing people
cial measures should be adopted. were the most acceptable ones to sell the new cost
system to the managers of different units. The com-
pany now has consistent information about differ-
4.4. Case 4: Company D ent product families and their profitability. Also,
this information can be used for future compari-
Company D is a multinational company. In sons of the system performance.
the 198Os, the company expanded its business to Some of the key observations made from this
Europe and in 1990 to USA mostly by acquisitions. case analysis are: (i) unification of the reporting
Now the company has 13 independent plants all system to simplify the collection and analysis of
over the world. The company produces plasticubes information, (ii) hiring of consultants to help the
and it has five different product families. The com- implementation of ABC and to motivate the em-
pany employs about 3300 people and 225 of them ployees, (iii) establishing an ABC-team for the im-
work at the head office in Finland. In 1993, the plementation process, (iv) arranging seminars on
management has decided to move into the control ABC, (v) identification of major cost centres, (vi)
of strategic business units. This means that the selection of suitable cost allocation methods, and
accounting system had to be changed. Many of the (vii) determination of the most appropriate cost
departments function in different business areas drivers.
238 A. Gunasekaran, M. Sarhadi/Int. J. Production Economics 5657
4.5. Case 5: Company E
Company E is the leading sweet producer in
Finland. It exports products all over the world and
about 60% of the US$400 millions turnover comes
from abroad. The assortment of company E has
a wide scope, that is with the idea products for
everyone. For instance, in 1991 the company mar-
keted over 600 kinds of chocolates. As the range of
products got wider, the complexity of production
increased and managing the business became very
difficult. In the early 1990s company E realized the
need for a new strategy. The cornerstone of the new
strategy is to improve the effectiveness of the sys-
tem using the economies of scale. Nordic countries
are the home market and demand a wide range of
brands of products. To fulfil this strategy, it has
been identified that ABC is required to determine
the actual profitability of the products. It was also
clear that before it could be introduced in the
organization, all the managers have to commit
themselves and believe in ABC. The new system
was implemented during the six-month long pro-
ject and its progress was regularly reported to the
concerned staffs.
An analysis on the product assortment has
shown that, in general, the high-volume products
were more profitable than the low-volume prod-
ucts. This was, of course, quite logical but the old
cost system was unable to report it. Also, the com-
pany has not taken into account the life-cycle as-
pects in the management of operations. Now the
information obtained by using ABC about profit-
ability has easily been used for various decisions
making. Previously, it was thought that all un-
profitable products should be withdrawn and this
would reduce the volume and market share of
products. Now it is realized that activities could be
carried out more effectively by combining the un-
profitable products so that they can use large pro-
duction batch sizes. This has led to more difficulties
in introducing new products. Company E has
divided its products into three categories: Group
A includes strong international brands sold in all
Nordic countries and even globally. Group B in-
cludes profitable domestic and local brands. Group
C includes brands that should be withdrawn in
a way that the market share does not decrease.
(1998) 231-242
Consequently, the number of products has de-
creased by two-thirds of the original amount, but at
the same time the sales and profit have increased.
The reason for this is an increased effectiveness
everywhere in the organization. For instance, set-
up times have decreased due to large batch sizes
and inventories have decreased because there are
fewer brands [17]. Some of the key observations
made from this case study are: (i) top management
commitment to the implementation of ABC, (ii)
regular project meeting, and (iii) strategic position
of the product and product-mix decisions based on
life-cycle management. The summary of findings
from the case studies are presented in Table 2.
5. A framework for the implementation of ABC in
manufacturing
There are four major aspects that need to be
taken before an ABC system can be implemented.
They are about the integration of the system with
the existing system, precision of the system, system
reports historical or future costs, and initial design
of the system. The integration of the ABC system
with existing organizational characteristics has to
be studied to identify the changes required in the
data collection and documentation, and IT skills,
training and education. For example, a matrix or-
ganizational structure will facilitate team work in
the implementation of ABC. A formal team com-
prises of key people such as managers of each
department should be made responsible for the
implementation of ABC. There is a need to analyse
whether the system reports only the historical in-
formation or the information that can be used for
future operations control and costs. This is essen-
tial to make sure that the system designed does not
fall in the same line as the traditional costing sys-
tem. People from all departments should be in-
volved in the initial design of ABC system. This will
motivate the employees on the new cost system
with help of empowerment and sense of responsibil-
ity of implementing ABC for an improved com-
petitiveness of the organization. The design of ABC
system for a particular manufacturing environment
should be tailored to the production process and
the organizational decision making characteristics.
Table 2
A summary of findings from the case studies on the implementation of ABC

Description Case 1 Case 2 Case 3 Case 4 Case 5

What were the problems/ Errors in the cost Poor performance in Unification of business, Unnecessary and multiple To manage the overall
motivation that led to the calculation, wastage of terms of productivity, lack of motivation of information handling, complexity of production
implementation resources cost reduction and employees poor management of
of ABC? management of business business

What were the goals/
objectives for the
implementation?
Reduce the cost of Reduce the cost of Design a cost system Improve business To improve the effectiveness
transportation. products, Increase for an effective transfer performance, estimate of the whole organization,
maximize the utilization profit pricing policies, user- product cost more determination of optimal
of resources, fairness friendly costing system, accurately, accurate product mix
and equity in the cost exact product cost, product-mix decision
allocation procedures allocate the cost to right and information on
products profitability

How was the Determination of cost New sales model based Gradual implementation Identifying activities and Effectiveness of the system
implementation? objects, cost drivers, on the analysis of process, interviews with cost drivers, establishing using economics of scale
resource drivers product margin, employees about activities major cost/profit centres,
simplification of the and cost drivers seminars on ABC.
cost system help of consultant,
identification of strategic
business units

What are the lessons Education and training Education and training, Simple system, gradual Unification of the Top management
learned? for implementation of incentive scheme, implementation, team reporting system, commitment, regular
new cost system, employee empowerment work, no financial goals, external consultant to project meeting, life-cycle
computers in data motivation of employees, implement ABC, management, trust in ABC
handling inexpensive cost system appropriate cost models
ABC team. cost models
240 A. Gunasekaran, M. Sarhadillnt. J Production Economics 5657 (1998) 231-242

ondly, the activities that are driving the overhead

should be identified. The overhead costs (such as
indirect wages, maintenance and repair, deprecia-
tion and taxes, and fringe benefits) can be analysed
by determining the activities, cost of them, corres-
ponding cost drivers, and the share of the cost in
the total cost of the product. In order to minimize
Implementation human errors in data handling, computers can be
used.
The selection of the cost drivers is the most
important aspect of analysing the activities and
their costs. The classification of activities as value-
added and non-value-added would help to identify
the cost drivers for each activity. This could be
Fig. 1. Implementation of ABC in manufacturing. entrusted to an ABC-team which includes people
from various divisions in the supply chain.
Identify cost allocation methods: Allocation of
various costs, in particular the cost of overheads
For example, the cost system for JIT environment should be based on the resources consumed and
should be different from that of FMS. The major cost drivers. The cost allocation bases such as ma-
elements of implementing ABC are presented in chine hours or labour hours should be selected
Fig. 1. These elements are briefly discussed below. depending upon whether the system is labour-in-
tensive or capital-intensive.
Monitoring the implementation: The implementa-
5. I. Steps of the implementation process tion should be monitored with the original devel-
opment plan and the expected results of such an
The literature survey and case studies on ABC implementation. Hence, there is a need to create
have provided some valuable information for the some sort of ownership feeling among the particip-
development of an implementation framework. The ating personnel in the implementation team of
following are some of the major steps in the imple- ABC by assigning and studying the results of their
mentation of ABC in manufacturing. The frame- responsibilities. Some of the non-financial perfor-
work has been developed in such a way that gives mance measures as noted in Table 1 can be used in
a more generic view of the issues associated with evaluating the performance of the implementation
the implementation of ABC in practice. of process of ABC.
Identify the cost objects: In order to make correct
decisions about improving the overall performance
of the organization, one needs to identify major 5.2. Conditions for a successful implementation
business strategy such as increase in market share
of a set of components/products. The cost of such The successful implementation of ABC depends
products/parts should be calculated more precisely upon the organizational and behavioural charac-
with the objective to make decisions about prod- teristics of the company. The issues such as top
uct-mix and utilization of resources. This empha- management committment, education and training
sizes the need for selecting the components or of employees, incentives to motivate employees
products for which all the costs can be traced and play a major role in the successful implementation
collected easily in a clearly identified manner. This of ABC in practice. This has been observed from
product has been called as cost object. the analysis of the results obtained from the case
Analyse the activities: Firstly, the direct material studies. The details of the conditions for a success-
and direct labour standards should be studied. Sec- ful implementation of ABC are presented below.
 A. Gunasekaran, M. Sarhadi/Int. J. Production Economics 56 57 (1998) 231- 242 241

Top management commitment: The top manage- in the firm. The cost structure must be simple to
ment should commit to a change in the cost ac- understand and use. It must be able to provide cost
counting system. This change program will require information at the highest level in the organization
suitable guidance, motivation and financial and to the lowest element of cost in a process. The
technical support. The top management should en- changes to the accounting systems should include,
courage the implementation of ABC by providing among others, using non-monetary measures of
these supports. performance, use of appropriate cost drivers, re-
Educution and training of employees on ABC: The duced paperwork related to purchasing, simplified
concerned employees of the organization should be accounting for work-in-process, simplification and
equipped with the knowledge of ABC and the bene- continuous improvement of the cost accounting
fits that could be derived from them. This will lead system. The non-financial performance measures
to open communication and better co-operation should be given due consideration in measuring the
for implementing ABC in a cost-effective manner. performance of the system.
Seminars should be arranged to teach and discuss
the concepts of ABC and its implementation issues
in the factory. Another important aspect of the Acknowledgements
implementation of ABC is to empower the em-
ployees in the change efforts with the objective to The authors are most grateful to Professor Robert
motivate them in the implementation process. Grubbstrijm and four anonymous referees for their
Incentives to motivate the employees in implemen- extremely useful and helpful comments on the earlier
ting ABC: A suitable incentive scheme should be versions of the manuscript which helped to improve
formulated both for the accounting personnel and the presentation of the paper considerably.
the people from other functional areas such as
marketing, design and engineering and production
with an objective to obtain the co-operation for the
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