Public Sector Governance and Accountability Series: Budgeting and ...

210 Gary Cokins
processes involved. That is, different types of outputs uniquely consume work
activities in varying ways, but the arbitrarily averaged cost allocation does not
reflect it. Hence, costs of some outputs are overestimated and others must be
underestimated—because it is a zero-sum error situation.
A Simple Way to Understand ABC/M
Here is a simple way to understand the basic principles of ABC/M. Imagine
that four friends go to a restaurant. One orders a small salad, and the
others each order the most expensive item on the menu—a prime rib
steak. When the waiter or waitress brings the bill, the others say,“Let’s split
the check evenly.” How would the first friend feel? He or she would find
this suggestion unfair and inequitable. This is similar to the effect on many
products and service lines in the cost-accounting system when accountants
take a large amount of the indirect and shared support overhead
expenses and allocate it as costs without any logic. There is minimal or no
relationship to how the products or service lines actually consumed the
expenses. This system is inequitable and unfair to each product’s or service’s
cost. It is somewhat like taxation without representation. ABC/M
gets it right. In the restaurant example, ABC/M is equivalent to the waiter
or waitress providing four individual checks—each person is charged for
what he or she consumed.
Allocating costs using broad averages is flawed, inaccurate, and
misleading. In the end, many managers dismiss the calculated costs from
their accounting system as a bunch of lies. They may accurately reconcile
in total, but not in the pieces. Unfortunately, these same managers have
little choice but to go along with the flawed costs. They have little
influence or control over the accountants. The accountants count the
beans, but they are not tasked to grow the beans. ABC resolves this
problem by tracing activity costs to products using factors that reflect
cause-and-effect relationships.
When managers and employee teams do not reliably know what the costs
are for their current outputs, they have a difficult time knowing what the
future costs may be for future levels of demand or for changes in requests for
their outputs. Most managers consciously or subconsciously stick with the
primary view of the costs they are familiar with—their spending. And the
accounting system, which is structured to report spending this way, reinforces
this view. As mentioned, no managers willingly volunteer to continue into a
future year with fewer resources, so they fight for the same or (usually) more
resources at budget-planning time.