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Does your costing system need a tune-up? A CIO gives new energy to an ABC initiative.

Firms of all sizes have adopted activity-based costing (ABC), a cornerstone of modern cost management. Perhaps yours is one of them. But despite initial widespread use, the ABC system in many companies suffers from benign neglect as new initiatives take center stage.

When you reflect on your organization's first ABC rollout, you probably did the following:

* Engaged outside experts during the feasibility planning;

* Established a tone at the top that this was a priority;

* Constructed activity cost pools and drivers with a bottom-up approach;

* Purchased software, provided training, and empowered managers;

* Issued costing reports in a timely manner to process owners; and

* Added cost-reduction expectations to managers' performance evaluations.

If this sounds like your company's initiative, then you did everything all the experts and books told you to do. So why are those ABC reports piling up on your managers' shelves rather than being the actionable documents you envisioned?

To help you reenergize your system, we'll profile JEA, one of the largest municipal utilities in the United States, and the innovative steps they have taken with their ABC system. The lessons learned will help you reignite your company's ABC system or help you avoid similar problems if you haven't gotten there yet.

How Do Things Go Wrong?

As time passes, you must update an ABC system periodically to reflect the ever-changing reality of a company's resources and demands on those resources. Table 1 presents five gaps, such as inadequate or outdated activity drivers, that can become evident when a company hasn't updated its ABC system regularly.
Table 1: Have Gaps Developed in Your ABC Plan?


Lack of decision Activity drivers Managers may simply
usefulness don't display a ignore the
 currently accurate information ABC
 cause-and-effect reports are
 relationship to the providing.
 cost pools for which
 they are assigned.

Inadequate activity Activity drivers Managers may focus on
drivers mainly measure the reducing the
 number of times an frequency of
 activity occurs activities rather
 without taking into than improving the
 account task underlying process
 complexity that time inefficiencies.
 measures can better

Outdated activity drivers Activity drivers Managers may make
 still measure rates cost-reduction
 that were in effect decisions using an
 when ABC was first inaccurate picture of
 initiated in the the company's cost
 company. structure.

Activity driver rate Activity driver rates Managers may reduce
dependency on resource are based on actual the demand on
usage or budgeted use of resources without
 resources rather than realizing the minimal
 resources available reduction of cost to
 at capacity. the company as a

Lack of strategic Activity drivers are Managers may focus on
management focus based on easily reducing their
 computed activity individual
 metrics that don't department's
 focus managers' activities without
 attention on the big regard to the effect
 picture. on other departments
 or the company as a

As Table 1 illustrates, managers' behavior can become dysfunctional because gaps develop in the aging ABC system. This behavior may develop so slowly that, as its decision usefulness declines, the system may fail to describe the organization's financial health--or worse--facilitate improper decision making.

So how did we get into this shape? There are two broad reasons management may find itself in these circumstances: The environment has changed, or the organization has changed. As a result, management's focus tends to shift toward the newest management fads as well as extinguishing fires and away from previous initiatives, such as ABC. Table 2 identifies the potential severity of your company's situation. Your action will depend on the number of deficiencies in your ABC system and how you weigh these influences.
Table 2: Does Your ABC Need Reenergizing?

Answer the following questions to find out.

Since ABC was initiated, has your company experienced Yes No


1. Competitive landscape change?

2. Expansion into global markets?

3. Regulatory change?


4. Change in executive leadership?

5. Management turnover since ABC drivers were developed?

6. Merger and acquisition activity?

7. Systems conversion and update?

8. Change in performance evaluation criteria?

9. Change in product or customer mix?

10. Fascination with the newest management buzzwords (e.g.,
 Lean Production, Six Sigma)?


Let's now look at JEA, a company that found its ABC system on life support and the unexpected white knight that came to its rescue.

Case in Point: JEA Municipal Utility

Founded in 1895, JEA owns, operates, and manages the electric, water, and wastewater systems in Jacksonville, Fla. With revenues in excess of $1.2 billion, JEA is the largest community-owned utility in Florida and the eighth largest in the United States. As part of its overall commitment to low utility rates, JEA has used an ABC system since 2001. (JEA internal documents refer to the costing initiative as process-based-costing [PBC]). Since differences between ABC and PBC aren't related to the focus of this article, we use the more generic ABC terminology for broader understanding and applicability. For details of the PBC initiative in 2001, see "Strategic Alignment and Systems Control of Processes: The Case of JEA" in the Summer 2004 issue of Management Accounting Quarterly.

As in most companies, JEA's accounting department conceived and implemented the ABC system with process-owner involvement. Middle management used specialized software, aggregated cost pools along business processes, and developed activity drivers. Shortly thereafter, JEA began to widely disseminate ABC reports throughout the company monthly.

By 2005, the company had undergone several changes that helped perpetuate a steady decline in the system's usefulness:

* Turnover in executive management, including the CEO position;

* A changing regulatory environment;

* Skyrocketing energy prices;

* Major service interruptions because of hurricanes; and

* A recommitment to operational excellence (e.g., Six Sigma) rather than financial metrics of performance.

A Light Goes Out ...

By early 2006, the automated reporting mechanism of JEA's ABC system was producing outdated data that contained little decision usefulness, so recipients generally ignored it. In short, the ABC system was dying. Because of this situation, JEA management "pulled the plug" and suspended the production of ABC reports to management pending further executive management review.

... But Another Light Is Turned On

In another part of the company, the chief information officer (CIO) was pondering a problem of cost transparency. She needed a way to communicate the initial and ongoing costs of technology resources that her internal customers (the C-suite members) demanded. At issue: The current ABC cost-reporting systems did little to illuminate the true cost of technology services (TS).

This costing communication deficiency had developed for cumulative reasons. TS capital costs weren't being allocated to customers, so customers didn't understand the long-term effects of their past and future technology choices. This issue was especially acute since the company supported a large number of legacy systems that generated large excess capacity, driving unnecessary costs. For instance, the company found one specialized server averaging 2% of capacity, yet JEA was adding servers for other internal customers. Although the original ABC reporting system provided some costing information, it was targeted toward the process owners rather than the customers of those processes.

As a strategic cost-savings initiative, the CIO commissioned a study to develop an improved ABC reporting system that would show what technology services individuals consume. Planned with a process emphasis, this ABC system avoids improving individual activities without regard to possible adverse system-wide effects. Also, the ABC system design is flexible enough to support Six Sigma and other quality initiatives that the company may eventually add.

As Table 3 illustrates, the company color-coded TS costs to indicate the effort it would take to reverse those costs. This color-coding scheme also indicated what level of Six Sigma teams might be involved in related cost-savings initiatives. For example, green cost information is easily and directly actionable at the director or middle-management level, yellow cost information falls under the authority of individual vice presidents, and red cost information provides the criteria executive management uses in approving the next generation of major TS projects.
Table 3: Sample ABC Action Analysis Report of Technology Services *

JEA Technology Services, ABC Action Analysis Report, FY 2007

Total TS Resources Consumed by Internal Customer $xx,xxx,xxx


License Fees and Maintenance (xxx,xxx)
Professional Services (xxx,xxx)
Supplies (xxx,xxx)
Labor (xxx,xxx)
Personal Devices (xxx,xxx)
Other (xxx,xxx)
Capital Investment (xxx,xxx)


License Fees and Maintenance (xxx,xxx)
Professional Services (xxx,xxx)
Supplies (xxx,xxx)
Labor (xxx,xxx)
Personal Devices (xxx,xxx)
Other (xxx,xxx)
Capital Investment (xxx,xxx)


License Fees and Maintenance (xxx,xxx)
Professional Services (xxx,xxx)
Supplies (xxx,xxx)
Labor (xxx,xxx)
Personal Devices (xxx,xxx)
Other (xxx,xxx)
Capital Investment (xxx,xxx)

Total TS Resources Consumed by Internal Customer $xx,xxx,xxx

After categorizing costs using this topology, the CIO found that her internal customers were willing to make cost-saving choices when selecting technology services once they realized the costs. For example, the CIO achieved green cost savings from reducing underutilized personal devices and unnecessary printing services. Moreover, an ABC performance metric for TS was integrated for the first time into the CIO's balanced scorecard, which initially was dollars saved through cost transparency. This linkage represents a significant change by using an ABC metric at the strategic level in performance measurement.

Going forward, JEA management is integrating TS's ABC information into the annual budget process to ensure that it is systematically kept current and useful. After all, outdated data contributed to the system's failure. At present, JEA is using the data to highlight opportunities that will reduce operating costs, such as adjusting the default settings on all printers to print in duplex, thus saving printing costs in the green cost category. Also, the ABC system is facilitating TS's cost-sharing agreements with external partners (other utility companies) as well as the three service levels it offers to its internal customers: platinum, gold, and bronze. To select the service level that is cost beneficial for their unit, TS customers need to know that it's more expensive to provide them with platinum service (immediate) and gold (within 24 hours) as opposed to bronze (within two to three days).

For the future, JEA plans to use the ABC system to cost their new environmentally friendly initiatives, such as its green data center that minimizes how much electricity the technology uses. The system will identify the cost savings from these energy-reducing initiatives. In sum, management is focused on making TS's ABC information actionable rather than merely reportable.

Lessons Learned

What can you take away from the JEA story? Three main points will help keep your ABC system energized:

ABC is a dynamic process. An ABC system must grow and change with your organization to continue to be relevant in decision making.

ABC is a facilitating process. Your activity-based reporting system isn't an older version of a new management initiative. Your Six Sigma efficiency plan and balanced scorecard performance-measurement evaluation methods best use ABC data as an input.

ABC is everyone's process. The accounting department shouldn't own the activity-based reporting system. Others in the organization, such as the CIO, can obtain organizational costs using data from this system if the system is properly designed, implemented, and updated.

The criteria for updating and maintaining a successful cost-transparency system such as ABC are the same as those for implementing one. Your organization must be vigilant to set a tone at the top, create a bottom-up empowerment system for change, and create value-added information to give managers (both process owners and internal customers) a cost-beneficial system.

GREEN COSTS are variable or mixed and can be reduced directly by director-level decisions. Cost-reduction initiatives involving green costs are appropriately implemented by green-belt-level Six Sigma teams.

YELLOW COSTS are discretionary fixed and can be reduced by vice-president-level decisions. Cost-reduction initiatives involving yellow costs are appropriately implemented by black-belt-level Six Sigma teams.

RED COSTS are structurally fixed and can be reduced by executive-management-level decisions. Cost-reduction initiatives involving red costs are multiperiod in nature and appropriately implemented by master black-belt-level Six Sigma teams.

* The ABC action analysis report with color-coding scheme was adapted from Managerial Accounting by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer.

By Bobby E. Waldrup, CPA; John B. MacArthur, FCCA; and Jeffrey E. Michelman, CMA, CPA

Bobby E. Waldrup, CPA, Ph.D., is the associate dean of the Coggin College of Business at the University of North Florida in Jacksonville, Fla. You can reach Bobby at (904) 620-2590 or

John B. MacArthur, FCCA, Ph.D., is the Kathryn and Richard Kip Professor of Accounting and Cost Management in the department of accounting and finance at the Coggin College of Business. You can reach John at (904) 620-1689 or

Jeffrey E. Michelman, CMA, CPA, Ph.D., is a professor of accounting and director of international relations in the department of accounting and finance at the Coggin College of Business. You can reach Jeffrey at (904) 620-1541 or

Authors' Note: Funding for this research was supported by a grant from JEA. The authors are thankful for the contributions of Wanyonyi J. Kendrick (CIO), Steven M. Schultz, and Sharon Van Den Heuval of JEA, as well as University of North Florida graduate students Parita R. Patel, Delores A. Stewart, and Dana M. Wallace.
COPYRIGHT 2009 Institute of Management Accountants
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Article Details
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Title Annotation:ACTIVITY-BASED COSTING; chief information officer
Author:Waldrup, Bobby E.; MacArthur, John B.; Michelman, Jeffrey E.
Publication:Strategic Finance
Geographic Code:4EUUK
Date:Jun 1, 2009
Previous Article:IMA 2008 salary survey.
Next Article:Fraud in the nonprofit sector? You bet.

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