Development of activity-based costing after 1992

in terms of pricing products in the current market and technological environment.

After a few years, in the early 1990s (the second generation of ABC), Kaplan’s attitude to variable costing underwent changes. He stated that after introduction of activity cost hierarchy to the concept of ABC “we understood that ABC was a concept based on gross margin, and not a concept which attempted to calculate full unit costs in a more accurate manner” (Kaplan, 1992, p. 59).

To sum up, it needs to be emphasized that by 1992 formulation of the second generation of activity-based costing had finished, and it turned out that the second generation considerably varied from the first one. Instead of a concept based on full costing and concentration on calculation of more accurate unit costs, another concept emerged, which was based on gross margin with two types of resources (provided and used) with a hierarchy of activities, in which calculation of unit cost was disparaged¹⁰. It is worth noting that the changes which appeared in the second generation of ABC system, in comparison to the first generation, were authored by Cooper and Kaplan; Johnson did not take part in the construction of the second generation of activity-based costing. In the late 1980s, when foundations of activity-based costing were established, Johnson had extremely high expectations towards the system of ABC, however, in the early 1990s his views changed. At first Johnson (1991) doubted if activity-based costing could provide operational managers with information, which would be useful in terms of cost reduction and profitability improvement. Later, his point of view became even more radical, he claimed that (Johnson, 1992, p. 26), “as the one, who contributed to activity-based costing diffusion, I feel obliged to warn you, that in my opinion, it went too far.

I am convinced that the concept should be changed and its diffusion slowed down, if not ceased”. He justified his criticism by claiming that information generated by accounting systems, in terms of current global business environment, is unable to facilitate, in the long run, competitiveness and profitability of companies.

39 Mecimore and Bell (1995) distinguished three generations of activity-based costing. They additionally claimed that emergence of the fourth generation was possible in the future. Consecutive generations of ABC, differentiated by the two authors, accentuate different areas:

• the first generation of ABC accentuates activities and cost of product calculation;

• the second generation stresses importance of processes and activities related to them;

• the third generation focuses on the value chain within a company (department);

• the fourth generation accentuates relation between activities and processes among different departments of a given company.

Table 1.2. Comparison of three generations of activity-based costing

Items compared Generations

first second third

Structure cost centre cost centre business unit

Activities product orientation process orientation firm orientation

Costs manufacturing

process – both manufacturing, administration and selling

internal and external

Focus product costing process costing value chain costing

Relationship

between activities no linkage linkage linkage

Cost drivers internal internal internal and external

Planning cost centre cost centre business unit

Controlling cost centre cost centre business unit

Cost analysis tactical tactical strategic

Hierarchy product process firm

Source: Mecimore, Bell (1995), in: Szychta (2007b), p. 283.

The first two generations distinguished by Mecimor and Bell correspond to the development of ABC presented in the previous sections respectively between 1984–1989 and 1989–1992. Foundations of activity-based costing which had been laid by 1992 constitute a model of ABC that is well-known and wide-spread in practice to date. After 1992, the concept, however, underwent further changes, and that enables formulation of other generations of ABC. The third generation (Mecimore, Bell, 1995) concentrates on linking activities to processes and then linking those processes to the complete business unit. Focus is on the way

1. Origin and development of ABC

a company adds value to manufactured products or offered services. In the third generation of ABC, the values, which influence the level of activities, are used to gain competitive advantage by means of value chain analysis. According to Mecimore and Bell (1995), in order to gain competitive advantage, it is necessary to analyze all internal activities within a company and also external ones, which have influence on the business unit. While constructing third-generation activity-based costing system, it is important to design such a process structure, so that it complies with the value chain in the company. In order for the implemented system of ABC to support formulation and realization of strategy, it is crucial to include measuring instruments in the system, which enable measurement of achievement level. Apart from focus on adding value to products and stressing the significance of the value chain concept, in terms of formulation and realization of competitive strategy, the third generation of ABC characterized of a special category of activities i.e. support activities. Support activities are often very expensive and important for a business unit; the third generation of ABC emphasized the need to improve them, and that in the long run, could have influence on improvement of company’s competitiveness. Comparison of the most important features of those three generations of activity-based costing systems is presented in table 1.2.

Summarizing the three consecutive generations of activity-based costing, which are presented in table 1.2, it may be concluded that the first one concentrates on improvement of product costs calculation, the second one focuses on providing information needed to improve effectiveness and measure achievements, and the third one stresses the importance of value chain concept in formulation and evaluation of competitive strategy. According to Mecimore and Bell (1995), in the future the fourth-generation ABC may emerge, which would integrate cost accounting system of multiple branches or plants of one company or even multiple companies belonging to one corporation. Creation of such cost accounting systems, which will be integrated in terms of one, big international corporations are possible, especially in the era of globalization, yet implementation of such systems may be extremely difficult.

Development of activity-based costing which took place at the turn of the 20^th and 21^st century led to differentiation of the basic model of ABC that was known at the turn of 1980s and 1990s. This model contained a simple two-stage procedure of cost calculation i.e. first, resource costs were allocated to activities and later activity costs were allocated to products, customers etc. However, this simple procedure did not take into consideration complexity of all the problems, which occur during construction and implementation of ABC systems in companies operating in various lines of business. Besides such previously analyzed modifications as distinction of activity hierarchy and recognition of a concept of provided and used resources, the first-generation activity-based costing also has other extensions to the basic model of cost calculation e.g.:

41

• identification of unusual cost objects – cost accounting systems of some companies have objects, to which costs are assigned, other than the usual ones. In one of the biggest telecommunication companies in Poland, apart from resources, activities and cost objects, to which activity costs are allocated (e.g. motion fractions, products, customers), there are such objects as telecommunication network elements or technical network layers (it should be noted that in ABC of that company, these objects are defined differently than resources);

• cost classification rules – it sometimes happens that in activity-based costing systems functioning in practice, costs are directly allocated not only to resources or products, customers etc., but occasionally they are directly assigned to activities, omitting resources. In ABC system functioning in an average-size manufacturing and trading company costs are allocated to objects, however the following rules must be taken into account: (a) costs (identified in the accounting system according to type of costs and cost centres) are first directly traced to a certain product, customer etc. (b) if the cost cannot be directly traced to a given product, customer etc., then, secondly, it should be attempted to directly trace it to a certain activity, (c) however, if such allocation is impossible, then the cost should be allocated to a given resource;

• calculation of support activities for other activities or resources – apart from basic activities (on the level of a unit, batch or type of product), which may be calculated for products, customers etc., and general activities (activities related to the whole business unit), which cannot be calculated for products, customers etc., support activities have been distinguished. Support activities are defined as those which either support performance of other activities (basic, support or general) or are performed in relation to resources. Thus, in cost accounting systems of some companies, one may find activities (support) whose costs are calculated: (a) for resources, and later from those resources, for example, for basic activities, (b) for basic activities, and later for products, customers etc.;

• calculation of the same activities for different cost objects – it sometimes happens that in activity-based costing systems functioning in practice, calculation of the same activity for different types of cost objects, depending on the needs, occurs. It means that e.g. costs of considering a complaint activity will be calculated for products for the purpose of product profitability analysis (depending on the number of complaints related to a product), and for the purpose of customer profitability analysis, these activity costs may be calculated for customers (depending on the number of complaints filed by a certain group of customers);

• calculation or non-calculation of unused capacity costs – ABC systems which operate in practice may sometimes treat costs of unused capacity in a different manner. These costs, for the purpose of different needs, could be, for instance, demonstrated as a separate item in the profit and loss account (it does not charge products), which is in compliance with the second generation of

activity-1. Origin and development of ABC

based costing, or they could be calculated for products, which is in agreement with the first generation of ABC.

The above examples of the classic activity-based costing modification illustrate but do not exhaust the problem of system’s complex use (and accommodation).

The examples also highlight that the concept of classic activity-based costing may be developed and adapted for the purpose of different company needs. Although, probably in all the systems of activity-based costing functioning in practice (at least those in Polish companies which were analyzed by the author of this work) there is this two-stage cost calculation from resources to activities and from activities to products, customers etc., details of the structure and functioning of those systems differ considerably. The issue will be further analyzed in chapters 4 and 5.