Cost effectiveness is a key element of business competitiveness (Goulden & Rawlings, 1997). In the competitive business environment, management needs accurate information for decision making. That information traditionally has come from the accountants who analyze the company's records for controllable expenses. Since the 1970s, or roughly the same time frame that the Japanese began developing their JIT manufacturing ("Just in Time") the topic of Activity Based Costing (ABC) has been discussed at length in management literature.
One of the more astute observers of ABC trends and techniques, Paul Sharman, describes the concept thus. "An approach known as activity based costing (ABC) can provide management with relatively accurate overhead attribution to product cost and therefore a better understanding of profitability. ABC also provides cost information on major activities undertaken by the business as well as the cost of business processes, all of which can be captured in a comprehensive cost model relatively cheaply" (Sharman, 1992, 13).
Let us consider a typical example that will clarify the power of ABC. Assume as a model that there is a production line, in which a component, "E," is assembled from four other components, A,B,C, and D, and two workers are assigned to the station. In the pre-ABC accounting concepts, the accountant would consider the cost of labor times a 40-hour week and the divide that figure by the cost of components to determine the "cost" of "E."
In the ABC structure, which owes much to the time study work of Galbraith, the "activity" of the assembly process is analyzed. Various elements, as different as the "locations" of the components A through D, the way the components are picked up, the number of steps in the assembly are all considered.
This study gives a raw cost of assembling a component, a cost which can then be controlled. The control might be as simple as revising the ste...