Research background and motivation

Chapter 1 Introduction

1.1 Research background and motivation

Kaplan and Cooper (1998) proposed cost systems in a company in order to perform three primary functions: 1. Inventory valuation and to measure the cost of goods sold for external financial reporting. 2. Estimation of the costs of activities, products, services, and customers. 3. To provide economic feedback to managers and operators about process efficiency. During the industrialization era, there are limited varieties of products and processes, the competition is limited to the domestic market and indirect and support costs are a small fraction of total costs. Thus, a simple traditional cost system meets these three different functions. However, in the knowledge economy era, the traditional cost system is still fine for financial reporting, but one cost system is just not enough to provide managers with relevant information for performance measurement and product cost purposes (Cooper & Kaplan, 1988a).

Because globalization has resulted in complex economic activities, such as enterprises producing diversified products, marketing products in various channels, and offering customers highly customized service, enterprises have significantly increased the varieties of indirect and support costs. Managers need more accurate, valid cost information to aid in their strategic decisions about products, services, and customers.

They also need timely and relevant information to guide operational improvement activities. A big challenge is thus how to satisfy managers’ and operators’ demand for these information requirements in management decisions.

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Activity-based costing (ABC) in the 1980s emerged from American manufacturing, providing innovative techniques in management accounting (Jones & Dugdale, 2002;

Miller & O'Leary, 1993). As shown in Figure 1.1, ABC refines a costing system by identifying individual activities as the fundamental cost objects. An activity is an event, task, or unit of work with a specified purpose for example, designing products, setting up machines, and/or operating machines. To help make strategic decisions, ABC systems identify activities within all functions of the value chain, calculate costs of individual activities, and assign costs to other cost objects such as products, services, and customers on the basis of the mix of activities needed to produce each product or service for each customer (Horngren, Datar, & Rajan, 2012). To help make operational improvements, ABC systems supply cost and non-financial information about the company’s activities and processes. This information directs improvement efforts and provides feedback on what an improvement has accomplished (Turney, 1991).

Compared to the traditional cost system, ABC offers two main advantages: 1. ABC provides a clear, transparent, and traceable causal relationship between cost objects and consumed resources rather than the traditional cost system that uses arbitrary allocations.

2. ABC answers what, why, how, and how much activities will be performed by the organizational resources, versus the traditional cost system answering how the organization can allocate costs for financial reporting and for departmental cost control (Kaplan & Cooper, 1998).

Assignment to Fundamental Other Cost Objects

Cost Objects

Figure 1.1 Relationships between activities and cost objects Source: Horngren, Datar, and Rajan (2012)

Activities Costs of Activities

Costs of

 products

 services

 customers

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Over the past two decades, ABC has experienced its emergence, construction, development, and dissemination (T. Bjørnenak & F. Mitchell, 2002; Jones & Dugdale, 2002; Lukka & Granlund, 2002). At present, ABC still occupies a very important role in the textbooks of cost accounting and management accounting. Querying the key word

‘activity-based costing’ in the Google Scholar database, there are approximately 6,000 articles in 2000, 8,600 articles between 2001 and 2005, and 12,000 articles between 2006 and 2010. This research also queries this key word in the ISI database, and Figure 1.2 indicates a significantly increasing trend, particularly in recent years. The majority of articles present ABC applied to various fields, including engineering, business economics, operations research, management science, computer science, and health care sciences services, etc.

Figure 1.2 Development in the number of ABC articles in ISI Source: this study sort out data from ISI

How about the adoption rate of ABC in practical organizations? As shown in Figure

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1.3, Gosselin (1997) classified activity management into three levels: activity analysis, activity cost analysis, and activity-based costing. These three levels represent the range from simple activity analysis without cost tracing to full activity-based cost reporting.

Owing to a multiplicity of terms, different definitions of terms, and different levels of adoption, prior studies reported that the adoption rates of ABC presented considerable variations (K. M. Baird, Harrison, & Reeve, 2004). Al-Omiri and Drury (2007) indicated approximately an 15% adoption rate among surveyed companies in the UK.

This result is similar to the results of Innes and Mitchell (1995) and Innes et al. (2000) at around 10%~12%. Studies in the U.S. recorded higher rates: Shim and Sudit (1995) had 27%, Green and Amenkhienan (1992) saw 45%, Hrisak (1996) was at 53%. Studies in Australia generally recorded relatively low adoption rates of approximately 12%

(Booth & Giacobbe, 1997), although Baird et al. (2004) and Baird (2007) had them at around 40%. Many articles have ascertained the factors that influence the adoption rate for example, collecting data entails a large amount of time and costs are a big challenge for firms (Kaplan & Anderson, 2004), implementing ABC in organizations causes employees’ resistance (Malmi, 1997), and organizational factors influence the success of ABC implementation (Al-Omiri & Drury, 2007; K. Baird, 2007; K. M. Baird et al., 2004; Foster & Swenson, 1997).

Figure 1.3 Three levels of activity management Source: Gosselin (1997)

Activity Analysis Activity Cost Analysis

ABC

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Over the past two decades, academics, consultants, and practitioners indeed have paid much attention to ABC and have accumulated a bulk of literature. However, Lukka and Granlund (2002) found that different discussion circles within the ABC literature show a fragmented communication structure that hinders the fruitful development of ABC knowledge, even though people in a certain discussion circle are connected by common views, values, and approaches to doing research and speak an understandable language to each other. Merchant et al. (2003) argued that ‘research progress in accounting has been significantly hindered by the fact that most researches focus their theories and perspectives on a single research discipline’. Bjørnenak and Mitchell (2002) noted that communication processes are an important topic for the development and dissemination of knowledge. From our view, we think that mutually understanding each other’s ideas is the premise of dialogue. An individual’s bounded rationality limits him/her from keeping current with the developments and trends of others’ research areas.

Thus, networking among the different discussion circles of ABC is, in many cases, either quite weak or lacking. This phenomenon therefore raises the interest of this study to explore the important dimensions and key parameters in the whole picture of ABC development in terms of the literature in order to provide academics and practitioners with a macroscopic view of ABC.