Journal of Accounting Research

Vol. 40 No. 3 June 2002

Printed in U.S.A.

The Association Between

Activity-Based Costing and
Manufacturing Performance
C H R I S T O P H E R D . I T T N E R ,∗ W I L L I A M N . L A N E N ,†
A N D D A V I D F . L A R C K E R∗

Received 20 May 1999; accepted 23 October 2001

ABSTRACT

This study examines the association between activity-based costing and man-
ufacturing performance. Results using a cross-sectional sample of manufactur-
ing plants indicates that extensive ABC use is associated with higher quality
levels and greater improvements in cycle time and quality, and is indirectly as-
sociated with manufacturing cost reductions through quality and cycle time
improvements. However, on average, extensive ABC use has no significant
association with return on assets. Instead, we find weak evidence that the asso-
ciation between ABC and accounting profitability is contingent on the plant’s
operational characteristics.

1. Introduction
This paper examines the association between extensive use of activity-
based costing and plant-level operational and financial performance. For
more than a decade, activity-based costing (hereafter ABC) has received

∗ The Wharton School, University of Pennsylvania; †University of Michigan Business School.

We would like to thank PricewaterhouseCoopers LLP for providing access to the data used in
this study, and Kristen Urban and Harold Kahn for their help with this research project. The
comments of Abbie Smith and two anonymous reviewers are appreciated. The financial support
of Ernst & Young LLP is also gratefully acknowledged.

711
Copyright 
C , University of Chicago on behalf of the Institute of Professional Accounting, 2002
712 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

widespread attention in the management accounting literature. Advocates

argue that ABC provides the sophisticated cost data needed to make appro-
priate product mix, pricing, process improvement, and other key decisions
(e.g., Cooper and Kaplan, [1991, chapter 5]). These claims have prompted
a growing number of firms to implement ABC systems. Yet little evidence
exists that organizations using ABC systems have higher performance than
their competitors, despite the professional enthusiasm and academic dis-
cussions surrounding ABC.
Prior research examining ABC success relies almost exclusively on
perceptual outcome measures. Foster and Swenson’s [1997] review groups
the diverse set of success measures in these studies into four categories:
(1) use of ABC information, (2) decisions and actions taken with ABC
information, (3) management evaluations of overall ABC success, and
(4) perceived financial improvements from ABC implementation. In general,
these studies find modest use of ABC information and moderate perceived
benefits from ABC implementation. However, this work has a number of lim-
itations. First, few of the studies attempt to demonstrate that the perceptual
measures are substantively correlated with operational and financial perfor-
mance measures. Second, most use relatively small samples. More important,
none of the studies compares the performance of ABC adopters and non-
adopters.
Using a large sample of manufacturing plants, we find modest evidence
that ABC use is positively associated with manufacturing performance. On
average, extensive ABC use is associated with higher quality levels, greater
decreases in cycle time, and larger increases in first pass quality. Path analysis
also indicates that ABC use has a positive indirect association with manufac-
turing cost reductions through improvements in quality and cycle time.
However, on average, extensive ABC use has no significant association with
return on assets. Instead, we find some evidence that the relation between
ABC and profits varies with the extent to which the decision to use ABC
“matches” the plant’s operational characteristics.
The remainder of the paper consists of four sections. Section 2 provides an
overview of the ABC literature. Section 3 discusses our sample and measures.
Results are presented in section 4. Conclusions and research limitations are
discussed in section 5.

2. Literature Review
The ABC approach measures the costs of objects by first assigning re-
source costs to the activities performed by the organization, and then using
causal cost drivers to assign activity costs to products, services, or customers
that benefit from or create demand for these activities (Cooper [1988]).
ABC proponents contend that this approach captures the economics of
the production process more closely than traditional unit-based cost sys-
tems, thereby providing more “accurate” cost data (e.g., Cooper and Kaplan
[1991, chapter 5]). The activity-based costing literature (e.g., Anderson
 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 713

and Young [1999]; Cooper and Kaplan [1991, chapter 5]) argues that the
potential “strategic” benefits from ABC arise from improved information for
make versus buy, product mix, outsourcing, and other strategic decisions.
The “operational” benefits arise from improved insight into the economics
of production associated with better understanding of production activities
and the root causes or drivers of costs.
The activity-based costing literature highlights three potential types of
operational benefits: lower costs, improved quality, and reduced manufac-
turing cycle time (e.g., Anderson and Young [1999]; Ostrenga et al. [1992]).
ABC advocates (e.g., Cooper and Kaplan [1991, chapter 5]; Ostrenga et al.
[1992]; Carolfi [1996]) claim that activity-based costing systems provide de-
tailed information on the value-added and non-value-added activities per-
formed by the organization, the costs associated with these activities, and the
drivers of activity costs. This information allows managers to reduce costs
by designing products and processes that consume fewer activity resources,
increasing the efficiency of existing activities, eliminating activities that do
not add value to customers, and improving coordination with customers
and suppliers.
The increased information about activities and cost drivers is also ex-
pected to enhance quality improvement initiatives by identifying the activ-
ities caused by poor quality and the drivers of these problems (Armitage
and Russell [1993], Carolfi [1996]). In addition, by highlighting the costs
of quality-related non-value-added activities, ABC systems can help jus-
tify investments in quality improvement activities that might otherwise
be considered uneconomic, and improve the allocation of resources to
the highest valued improvement projects (Cooper et al. [1992], Ittner
[1999]).
Finally, many non-value-added activities such as counting, checking, and
moving increase the duration of a process or are driven by the amount
of time a product takes in an activity. By identifying activities that cause
non-value-added time, ABC can assist in justifying investments in cycle time
reduction and provide the detailed information needed to minimize delays
(Kaplan [1992], Borthick and Roth [1995]).
In contrast to claims by ABC proponents, analytical studies suggest that
the cost data provided by ABC systems need not be more “accurate” than
the costs reported by traditional unit-based systems. Noreen [1991], for
example, demonstrates that ABC systems only provide relevant costs for
decision-making if the linear and separable cost function assumptions em-
bedded in ABC are accurate. Datar and Gupta [1994] show that improving
the specification of cost allocation bases and increasing the number of cost
pools in ABC systems can actually increase product cost measurement errors.
Banker and Potter [1993], Christensen and Demski [1997], and Bromwich
and Hong [1999] add that the desirability and ability of ABC procedures to
produce relatively accurate cost estimates varies with competitive markets,
input markets and the organization’s underlying technology, and conclude
that ABC systems are only preferred under specialized conditions. Thus,
714 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

extensive use of ABC data may have zero or negative association with man-
ufacturing performance.1

3. Research Design
3.1 SAMPLE
We conduct our study using data from the 1997 PricewaterhouseCoopers
and IndustryWeek Annual Census of Manufacturers. The survey was sent to
25,361 IndustryWeek subscribers, with responses received from 2,789 (11%).
As shown in table 1, the sample’s composition is comparable to the popu-
lation of U.S. manufacturing plants, with somewhat greater representation
in chemical and allied products, primary metals, and electronics and lower
representation in apparel, wood products, and printing and publishing.
3.2 USE OF ACTIVITY-BASED COSTING
Our ABC variable is based on a question asking whether ABC is extensively
used in the plant (1 = yes and 0 = no).2 By focusing on extensive use of ABC
data rather than a continuum of ABC adoption levels, we avoid problems
with plants that are just beginning to implement ABC or that have not
achieved full commitment to the systems (e.g., Anderson [1995]; Gosselin
[1997]; Krumwiede [1998]). However, the lack of additional questions on
cost system characteristics and uses prevents us from validating responses to
the ABC question (e.g., we do not know the criteria the respondents used to
determine whether ABC use is “extensive”) and assessing potential response
biases (e.g., non-ABC users may have been less likely to respond). In our
sample, 26% of the plants use ABC extensively.
3.3 PLANT PERFORMANCE MEASURES
We use six measures to assess plant performance. The first performance
measure is return on net plant assets (denoted ROA). Although a standard
measure of financial performance, ROA is not applicable for the 66.3% of
the plants that are cost centers. Mean (median) ROA is 20.2% (15%) for
the 532 plants providing this information.
Two measures capture operational performance levels. The variable
QUALITY is computed using average standardized responses to two ques-
tions on product quality (finished product first pass quality yield in percent-
age terms and scrap and rework costs as a percentage of sales). Responses
to the two variables load on a single factor that explains 61.5% of the vari-
ance. However, the coefficient alpha of 0.38 indicates relatively low inter-
nal consistency between the two questions. The variable TIME is computed

1 The analytical studies focus on the use of ABC information for strategic decisions rather

than for operational improvement (or activity-based management). Empirical studies investi-
gating the assumptions underlying the ABC concept also provide mixed results. See Ittner and
Larcker [2001] for a review.
2 Specific survey questions and descriptive statistics for the variables used in the study are

available from the authors.

 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 715
TABLE 1
Distribution of Manufacturing Plants by Two-Digit Standard Industrial Classification (SIC) Code
SIC Number of Percent of Percent of U.S.
Industry Sector Code Plants in Sample Sample Manufacturersa
Nondurable Manufacturing
Food & kindred products 20 129 4.63% 5.75%
Tobacco products 21 3 0.11 0.04
Textile mill products 22 61 2.19 1.79
Apparel & other textile products 23 25 0.90 6.37
Lumber & wood products 24 48 1.72 9.47
Furniture & fixtures 25 76 2.72 3.23
Paper & allied products 26 114 4.09 1.77
Printing & publishing 27 72 2.58 17.21
Chemicals & allied products 28 222 7.96 3.37
Petroleum & coal products 29 19 0.68 0.63
Durable Manufacturing
Rubber & plastics products 30 160 5.74% 4.04%
Leather & leather products 31 10 0.36 0.61
Stone, clay & glass products 32 77 2.76 4.50
Primary metal industries 33 150 5.38 1.89
Fabricated metal products 34 307 11.01 10.06
Industrial machinery & equipment 35 470 16.85 14.52
Electronics & electrical equipment 36 359 12.87 4.45
Transportation equipment 37 238 8.53 2.92
Instruments & related products 38 188 6.74 2.88
Miscellaneous manufacturing 39 44 1.58 4.60
Subtotal 2,772 99.39% 100%
Missing industrial classification n.a. 17 0.61 n.a.

Total 2,789 100% 100%

a
Source: 1997 Statistical Abstract of the United States, 117th edition, U.S. Department of Commerce,
Washington, D.C.

using average standardized responses to two questions on manufacturing

speed (manufacturing cycle time from start of production to completion
of product in hours and standard lead-time from order entry to shipment
in days). Longer manufacturing cycle times and lead times are assumed to
indicate lower performance. The two questions load on a single factor ex-
plaining 77.2% of the variance, with a coefficient alpha of 0.76. The three
remaining performance measures relate to changes in manufacturing costs
(excluding raw materials) (denoted COST ), first pass quality yield (de-
noted QUALITY ), and manufacturing cycle time (denoted TIME ) over
the last five years. Higher values for the three change variables represent
greater improvement.3

3 The largest correlations among the performance measures are among the change variables,

ranging from 0.21 to 0.25 ( p < 0.01, two-tailed). TIME has significant, negative correlations with
QUALITY and all three change variables ( p < 0.01, two-tailed), indicating that slower plants
tend to have lower quality and make smaller operational improvements. Cost and cycle time
changes, in turn, are positively correlated with ROA.
716 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

3.4 CONTROL VARIABLES

We include a number of control variables in our tests. One of the primary
controls is mean industry performance in the plant’s three-digit SIC code
(with each plant’s own value deleted from the computation of the mean).
This variable (denoted INDUSTRY ) controls for the industry-specific por-
tion of plant performance that is unrelated to ABC use. Separate industry
variables are computed for each performance measure.
We also control for operational characteristics using indicator variables
for high or low volume operations (denoted VOLUME, where 1 = high vol-
ume and 0 = low volume), high or low product mix (denoted MIX, where
1 = high mix and 0 = low mix), and the nature of the manufacturing process
(DISCRETE, where 1 = primarily discrete manufacturing process, 0 other-
wise; and HYBRID, where 1 = a combination of discrete and continuous
manufacturing processes, 0 otherwise).4 We include a variable for union-
ized plants to control for union work rules (denoted UNION, where 1 = no
unionized production workers, 2 = some unionized production workers,
and 3 = all unionized production workers). Potential size effects on per-
formance are controlled using the natural logarithm of the number of
plant employees (denoted EMPLOYEES).5 Plant performance is also likely
to be related to the age of the facilities, and we control for this factor us-
ing the number of years since plant start-up (denoted PLANTAGE). Prior
studies suggest that current plant performance is related to past perfor-
mance. While a time series of plant performance data is not available, the
survey includes one question on the extent of downsizing during the last
five years. This variable (denoted DOWNSIZE, where 1 = no downsizing,
2 = some downsizing, and 3 = significant downsizing) proxies for past plant
performance. We assume that downsizing occurs in manufacturing plants
achieving lower than expected operational and financial performance. We
also include the percentage of annual unit production represented by new
or redesigned products (denoted NEWPROD) to control for the possibility
that more modern product lines or more innovative plants achieve higher
performance.
Finally, we control for the adoption of advanced manufacturing prac-
tices (denoted AMP) such as just-in-time, total quality management, em-
ployee empowerment, customer and supplier partnerships, and informa-
tion technologies. Studies indicate that these elements interact to improve
performance, suggesting that advanced manufacturing is a total system so-
lution rather than a set of independent techniques (Milgrom and Roberts

4 The remaining category is plants employing a continuous manufacturing process.

5 Although the questionnaire collected data on the number of employees in terms of ranges,
we convert the one to five scale into the actual number of employees (using the mean number
of employees for each scale point) before taking the natural logarithm. The other variables
converted from categorical variables to the means of the category ranges are the age of the plant,
the percentage of unit volume represented by new products, and the percentage reduction in
cycle time.
 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 717

[1995], MacDuffie [1995], Chenhall and Langfield-Smith [1998]). Similar

to Chenhall and Langfield-Smith [1998], we use cluster analysis to imple-
ment a systems approach for measuring advanced manufacturing practices.
We include responses to 50 questions in the cluster analysis: 4 on human
resource practices, 16 on customer and supplier initiatives, 12 on manu-
facturing practices such as JIT, TQM, and cellular manufacturing, and 18
on information technologies such as advanced MRP II and ERP. We con-
duct the cluster analysis using Euclidean distance and k-means clustering
techniques. Pseudo-F and cubic clustering criterion (CCC) statistics sug-
gest a two cluster solution: (1) 957 plants (34.3%) having relatively high
mean scores for each AMP indicator, and (2) 1,832 plants (65.7%) having
relatively low mean scores for each indicator.6

4. Results
4.1 OVERALL PERFORMANCE IMPLICATIONS OF ABC
Our first set of tests examines claims that, on average, extensive use of
ABC systems is positively associated with financial and operational perfor-
mance. Regression estimates are presented in table 2. Due to missing data,
sample sizes range from 452 for ROA to 2,241 for COST.7 Each model is
statistically significant at the one percent level and displays moderate ex-
planatory power. The results suggest that ABC use is positively associated
with the plant’s conformance quality level and improvements in cycle time
and quality over the previous five years. However, ABC is not significant
using the two financial measures (ROA and COST) as dependent vari-
ables. Although these results imply that ABC use has no direct association
with manufacturing costs, prior research (e.g., Ittner [1994]) suggests that
process improvement tools such as ABC can have significant indirect effects

6 The largest correlation among the predictor variables is 0.22, suggesting no problems with

multicollinearity in subsequent performance tests. Union plants tend to be older and to have
downsized more in the past five years. Plants with more employees are positively correlated with
production volumes and AMP. Higher volume plants also tend to use discrete manufacturing
processes, while advanced manufacturing practices are positively correlated with the use of
ABC. None of the other correlations exceeds 0.15.
7 In addition to missing data, we delete observations with obvious coding errors for the

performance variables (e.g., responses outside the range of possible item responses). This
removes five or fewer observations from each test. We also delete observations with studentized
residuals greater than three standard deviations from the mean to remove outliers. Outlier
deletion removes zero to 2.8 percent of the observations for a given performance variable. The
ABC results without outlier deletion do not change, with the exception of the ROA results in
table 6, which have the same coefficient signs but become marginally insignificant. An analysis
of missing performance data identified no systematic differences in the characteristics of plants
that reported ROA and those that did not ( p < 0.05). In general, continuous process plants
and plants that are older, larger, and more unionized plants were more likely to have missing
operational performance data. We found no evidence that missing performance data were
associated with downsizing (our proxy for past performance) or whether the plant was a cost
center or profit center (except for ROA, which is not applicable to the cost centers).
718 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

TABLE 2
Ordinary Least Squares Regressions Examining the Association Between Extensive Use of Activity-Based
Costing (ABC) and Manufacturing Plant Performance (t-Statistics in Parentheses)

Performance Measure
ROA QUALITY TIME COST QUALITY TIME
Variable (N = 452) (N = 1,392) (N = 1,707) (N = 2,241) (N = 2,078) (N = 2,108)
INTERCEPT 16.021∗∗∗ 0.496∗∗∗ −0.299∗∗∗ 2.107∗∗∗ 3.681∗∗∗ 3.214
(3.129) (3.849) (−3.795) (7.055) (11.469) (1.096)
ABC −1.263 0.070∗ 0.0019 0.056 0.070∗ 2.018∗∗∗
(−0.897) (1.954) (0.844) (0.974) (1.941) (2.596)
INDUSTRY 0.227∗∗∗ 0.196∗∗∗ 0.347∗∗∗ 0.205∗∗∗ 0.059 0.211∗∗∗
(3.081) (3.242) (11.770) (2.752) (0.819) (3.368)
DISCRETE 2.537∗ 0.106∗∗∗ −0.001 0.222∗∗∗ 0.010 2.718∗∗∗
(1.702) (2.569) (−0.071) (3.469) (0.269) (3.121)
HYBRID 1.919 0.052 −0.004∗ 0.049 0.011 1.568∗
(1.247) (1.353) (−1.654) (0.816) (0.285) (1.883)
MIX −0.906 0.014 −0.102∗∗∗ 0.035 0.054# 2.472∗∗∗
(−0.609) (0.373) (−4.174) (0.579) (1.410) (2.986)
NEWPROD 2.499∗∗∗ −0.088∗∗∗ 0.029∗∗ 0.015 0.031# 2.163∗∗∗
(2.800) (−4.022) (2.212) (0.475) (1.484) (4.796)
VOLUME −0.331 0.023 −0.151∗∗∗ 0.074 0.040 −1.899∗∗∗
(−0.256) (0.671) (−6.883) (1.393) (1.178) (−2.585)
UNION −0.157 −0.018 −0.011 −0.022 0.000 −0.527#
(−0.211) (−0.952) (−0.915) (−0.747) (0.047) (−1.286)
EMPLOYEES 0.058 −0.063∗∗∗ 0.041∗∗∗ 0.012 −0.000 0.239
(0.078) (−3.175) (3.347) (0.420) (−0.018) (0.570)
PLANT AGE −0.035 0.002 0.004∗∗∗ −0.009∗∗ −0.002 0.002
(−0.348) (1.251) (2.259) (−2.376) (−0.786) (0.048)
DOWNSIZE −3.177∗∗∗ −0.0075 0.024∗ 0.151∗∗∗ −0.043∗∗ 0.195
(−3.836) (1.137) (1.831) (4.429) (−2.009) (0.422)
AMP 1.099 0.230∗∗∗ −0.110∗∗∗ 0.350∗∗∗ 0.467∗∗∗ 10.865∗∗∗
(0.845) (6.571) (−5.018) (6.280) (13.196) (14.223)
Adjusted R2 0.073 0.059 0.149 0.038 0.094 0.134
( p < 0.01) ( p < 0.01) ( p < 0.01) ( p < 0.01) ( p < 0.01) ( p < 0.01)
∗∗∗ ∗∗ ∗
, , , and # = statistically significant at the 1%, 5% 10%, and 15% levels (two-tailed), respectively.
ROA is return on net plant assets; QUALITY is a construct measuring manufacturing quality (scrap and
rework costs as a percent of sales and finished-product first-pass quality yield for primary products); TIME
is a construct measuring the plant’s manufacturing cycle time (an inverse measure of manufacturing per-
formance encompassing manufacturing cycle time from start of production to completion and standard
customer lead-time from order-entry to shipment); COST is the extent to which manufacturing costs
(excluding raw materials) changed over the last five years (with higher values for larger cost reductions);
QUALITY is the extent to which finished-product first-pass quality yield changed over the last five years
(with higher values for higher yields/fewer defects); and TIME is the percentage change in manufacturing
cycle time over the last five years (with higher values for greater reductions in cycle time).
ABC is an indicator variable equal to one if activity-based costing is used extensively at the plant, zero
otherwise. INDUSTRY is the mean value of each performance measure for the observation’s three digit
industry (excluding the performance of that plant); DISCRETE is an indicator variable equal to one if the
plant is a discrete manufacturing facility, and zero otherwise; HYBRID is an indicator variable equal to one if
the plant is a hybrid manufacturing facility, and zero otherwise; MIX is an indicator variable equal to one if
the plant is a high product mix manufacturing facility, and zero otherwise; VOLUME is an indicator variable
equal to one if the plant is a high volume manufacturing facility, and zero otherwise; UNION is a variable
equal to 1, 2, or 3 if no workers, some workers, or all workers, respectively, are represented by a union.
EMPLOYEES is the log of the number of employees; PLANTAGE is the number of years since the plant’s
start-up; DOWNSIZE is a variable equal to 1, 2, or 3, if there has been no, some, or extensive downsizing,
respectively, in the last five years; NEWPROD is the percent of the plant’s annual unit production represented
by new or redesigned products introduced within the last 24 months; and AMP is an indicator variable if the
plant is in the high advanced manufacturing practices cluster, zero otherwise.
 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 719

FIG. 1.—Summary of path model coefficients for the direct and indirect associations between
activity-based costing use and changes in manufacturing costs; control variables not reported.
∗∗∗ and ∗ = statistically significant at the 1% and 10% levels (two-tailed), respectively;

n.s. = not statistically significant.

ABC use is coded one if activity-based costing is used extensively by the plant, and zero oth-
erwise. COST is the extent to which manufacturing costs (excluding raw materials) changed
over the last five years (with higher values for larger cost reductions); QUALITY is the extent
to which finished-product first-pass quality yield changed over the last five years (with higher
values for higher yield/fewer defects); and TIME is the percentage change in manufacturing
cycle time over the last five years (with higher values for greater reductions in cycle time).
Coefficients on the direct effects of ABC on QUALITY and TIME are based on regression
models in Table 2. Coefficients on the direct effects of ABC, QUALITY, and TIME on COST
are based on the following model:
COST = β0 + β1 QUALITY + β2 TIME + β3 ABC + β4 INDUSTRY + β5 DISCRETE
+ β6 HYBRID + β7 MIX + β8 NEWPROD + β9 VOLUME + β10 UNION
+ β11 EMPLOYEES + β12 PLANT AGE + β13 DOWNSIZE + β14 AMP + ε
where INDUSTRY is the mean value of each performance measure for the observation’s three
digit industry (excluding the performance of that plant); DISCRETE is an indicator variable for
the discrete manufacturing facilities; HYBRID is an indicator variable for hybrid manufacturing
facilities; MIX is an indicator variable for a high product mix manufacturing facility; VOLUME
is an indicator variable for a high volume manufacturing facility; UNION is a variable equal to
1, 2, or 3 if no workers, some workers, or all workers, respectively, are represented by a union;
EMPLOYEES is the lof of the number of employees; PLANT AGE is the number of year since
the plant’s start-up; DOWNSIZE is a variable equal to 1, 2, or 3, if there has been no, some, or
extensive downsizing, respectively, in the last five years; NEWPROD is the present of the plant’s
annual unit production represented by new or redesigned products; and AMP is an indicator
variable for plants in the high advanced manufacturing practices cluster.

on manufacturing costs through quality and cycle time improvements (e.g.,

reductions in scrap and rework costs and other non-value-added expendi-
tures). To examine this possibility, we estimate a path model linking ABC
directly to COST as well as indirectly to cost reductions through TIME
and QUALITY (results summarized in figure 1). The path model indicates
that ABC has no significant direct effect on manufacturing cost changes,
720 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

but has a significant, positive indirect effect on COST through TIME and
QUALITY.8
A number of control variables are statistically significant. The coefficient
on INDUSTRY is consistently positive and significant in all but one model
(QUALITY ). Older plants have longer cycle times (TIME ) and achieve
smaller cost reductions (COST ). Relative to continuous process plants
(the omitted group), discrete production environments have higher ROA
and quality levels, and achieved greater reductions in manufacturing costs
and cycle time. Hybrid plants exhibit lower cycle time levels, and greater
cycle time improvements than continuous process plants. Surprisingly, high
mix plants report lower cycle times (TIME ) and greater time reductions
(TIME) than plants with low product mix. High volume plants have lower
TIME than low volume plants, reflecting the smaller number of changeovers
and setups in these plants, but made smaller improvements on this perfor-
mance dimension. Union plants also experienced marginally smaller reduc-
tions in cycle time during the past five years. Operational performance levels
tend to be lower in larger plants (EMPLOYEES), which have poorer quality
and longer manufacturing times. Plants engaging in downsizing during the
last five years have lower ROA and quality and longer cycle times. Qual-
ity improvements were also lower in these plants, but cost reductions were
greater. Plants making extensive use of advanced manufacturing practices
have higher quality and lower manufacturing times, and made greater im-
provements in cost, quality, and time over the previous five years. However,
ROA is not significantly different in the high AMP cluster.

4.2 PERFORMANCE IMPLICATIONS OF ABC SYSTEM ‘‘MATCH”

The preceding analysis assumes that ABC is equally applicable in all
plants. However, many ABC proponents argue that ABC adoption and use
is an endogenous choice, with the net benefits varying depending upon
the plant’s operational characteristics.9 Cooper [1989a] and Cooper and
Kaplan [1991], for example, argue that the economic benefits from ABC
increase with broader product lines and greater product variety since tradi-
tional unit-based cost systems are unlikely to capture differences in overhead

8 We also estimated these models using two subsamples: (1) plants that are cost centers, and

(2) plants that reported all of the performance variables. The results were consistent with the
discussion in the text.
9 The survey data allow us to compute a crude estimate of ABC system costs in these plants.

To do so, we regress annual investments in information systems and technology as a percent of

plant budget (including hardware, software, training, and support costs) on the ABC indicator
variable and a variable capturing how many technologies and technology-based systems (from
a list of 18) the plant uses extensively. Both the ABC and information technology variables
are highly significant ( p < 0.001, two-tailed). The estimated coefficient on ABC suggests that
plants making extensive use of ABC have information technology expenditures (as a percent
of budget) that are 21 percent larger than non-ABC users, after controlling for the other
information technologies used by the plants.
 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 721
TABLE 3
Logit Model Predicting the Extensive Use of Activity-Based Costing
in Manufacturing Plants (Standard Errors in Parentheses)
ABC Use
(N = 2,328)
INTERCEPT −1.321∗∗∗
(0.161)
DISCRETE −0.654∗∗∗
(0.129)
HYBRID −0.100
(0.113)
MIX 0.168#
(0.116)
NEWPROD 0.086#
(0.061)
VOLUME −0.124
(0.101)
AMP 0.900∗∗∗
(0.099)
Pseudo R2 0.072
( p < 0.01)
∗∗∗
and # = statistically significant at the 1% and 15% levels (two-
tailed), respectively.
ABC use is coded one if activity-based costing is used extensively
by the plant, and zero otherwise. DISCRETE is an indicator variable
for discrete manufacturing facilities; HYBRID is an indicator variable
for hybrid manufacturing facilities; MIX is an indicator variable for a
high product mix manufacturing facility; NEWPROD is the percent of
the plant’s annual unit production represented by new or redesigned
products; VOLUME is an indicator variable for a high volume manu-
facturing facility; and AMP is an indicator variable for plants in the
high advanced manufacturing practices cluster.

consumption by diverse products. Cooper [1989b] adds that ABC is more

beneficial when new product introductions increase because of the system’s
ability to “more accurately” measure differences in overhead usage between
old and new products.
The accounting literature also suggests that the performance effects of
ABC vary with the production process employed by the plant. Reeve [1995]
notes that continuous processors have not adopted ABC because many cost
drivers in ABC systems, such as product changeover activities, are less im-
portant in these operations. Krumwiede [1998], on the other hand, argues
that ABC systems are less likely to be used in discrete, job shop environ-
ments because the uncertainties associated with make-to-order production
may be difficult to handle in an ABC system. Finally, ABC may be more
beneficial when it supports advanced manufacturing practices (Shields and
Young [1989], Kaplan [1992], Cooper [1994]). Studies using perceptual
measures of ABC success, for example, find positive relations between the
adoption of various advanced manufacturing practices and the perceived
success of ABC implementation (see Anderson and Young [1999] for a
review).
722 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

TABLE 4
Ordinary Least Squares Regressions Examining the Association Between the Activity-Based Costing
Prediction Model Residuals and Manufacturing Plant Performance (t-Statistics in Parentheses)
Performance Measure

ROA QUALITY TIME COST QUALITY TIME

Variable (N = 452) (N = 1,393) (N = 1,707) (N = 2,241) (N = 2,078) (N = 2,108)
INTERCEPT 18.848∗∗∗ 0.494∗∗∗ −0.301∗∗∗ 2.092∗∗∗ 3.647∗∗∗ 4.919#
(3.441) (3.485) (−3.440) (6.665) (11.182) (1.534)
POS− ABC− −7.835∗ 0.065 0.023 0.104 0.160# −0.116
RESID (−1.803) (0.587) (0.336) (0.594) (1.432) (−0.049)
NEG− ABC− 13.332# 0.062 −0.005 −0.048 −0.138 7.261#
RESID (1.507) (0.254) (−0.036) (−0.124) (−0.551) (1.357)
INDUSTRY 0.234∗∗∗ 0.193∗∗∗ 0.344∗∗∗ 0.205∗∗∗ 0.059 0.211∗∗∗
(3.175) (3.178) (11.570) (2.756) (0.817) (3.361)
DISCRETE 1.580 0.101∗∗ −0.002 0.223∗∗∗ 0.019 2.080∗∗
(0.965) (2.228) (−0.086) (3.170) (0.430) (2.171)
HYBRID 1.810 0.054# −0.035# 0.050 0.012 1.568∗
(1.177) (1.397) (−1.430) (0.816) (0.316) (1.883)
MIX −0.619 0.014 −0.100∗∗∗ 0.035 0.053# 2.472∗∗∗
(−0.014) (0.358) (−4.045) (0.574) (1.359) (2.986)
NEWPROD 2.554∗∗∗ −0.086∗∗∗ 0.028∗∗ 0.015 0.030# 2.244∗∗∗
(2.867) (−3.869) (2.121) (0.472) (1.436) (4.949)
VOLUME −0.639 0.018 −0.155∗∗∗ 0.074 0.041 −1.899∗∗∗
(−0.487) (0.525) (−6.995) (1.388) (1.195) (−2.585)
UNION −0.179 −0.017 −0.008 −0.022 0.001 −0.527#
(−0.240) (−0.897) (−0.698) (−0.739) (0.067) (−1.286)
EMPLOYEES 0.102 −0.062∗∗∗ 0.040∗∗∗ 0.013 −0.000 0.239
(0.135) (−3.111) (3.208) (0.420) (−0.021) (0.570)
PLANT AGE −0.026 0.003 0.004∗∗∗ −0.009∗∗ −0.002 0.002
(−0.263) (1.205) (2.591) (−2.379) (−0.797) (0.048)
DOWNSIZE −3.207∗∗∗ −0.074∗∗∗ 0.027∗∗ 0.151∗∗∗ −0.043∗∗ 0.195
(−3.878) (−3.448) (1.990) (4.429) (−2.011) (0.422)
AMP 2.353# 0.246∗∗∗ −0.104∗∗∗ 0.350∗∗∗ 0.459∗∗∗ 11.741∗∗∗
(1.507) (5.937) (−3.926) (5.212) (10.811) (12.907)
Adjusted R2 0.076 0.057 0.145 0.038 0.094 0.134
( p < 0.01) ( p < 0.01) ( p < 0.01) ( p < 0.01) ( p < 0.01) ( p < 0.01)
∗∗∗ ∗∗ ∗
, , , and # = statistically significant at the 1%, 5%, 10%, and 15% levels (two-tailed), respectively.
ROA is return on net plant assets; QUALITY is a construct measuring manufacturing quality (scrap and
rework costs as a percent of sales and finished-product first-pass quality yield for primary products); TIME
is a construct measuring the plant’s manufacturing cycle time (an inverse measure of manufacturing perfor-
mance encompassing manufacturing cycle time from start of production to completion and standard cus-
tomer lead-time from order-entry to shipment); COST is the extent to which manufacturing costs (exclud-
ing raw materials) changed over the last five years (with higher values for larger cost reductions); QUALITY
is the extent to which finished-product first-pass quality yield changed over the last five years (with higher
values for higher yields/fewer defects); and TIME is the percentage change in manufacturing cycle time
over the last five years (with higher values for greater reductions in cycle time).
POS− ABC− RESID equals the residual from the logit model in Table 3 if the residual was positive (i.e.,
the plant uses ABC extensively but the predicted probability of use is less than one), and zero otherwise.
NEG− ABC− RESID equals the residual from the logit model in Table 3 if the residual was negative (i.e., the plant
does not use ABC extensively and the predicted probability of use is greater than zero), and zero otherwise.
The expected coefficient sign on POS− ABC− RESID is negative (i.e., ABC users with low predicted probability
of use are expected to achieve lower performance). The expected coefficient sign on NEG− ABC− RESID is
positive (i.e., plants not using ABC but having a high predicted probability of use are expected to achieve
lower performance).
INDUSTRY is the mean value of each performance measure for the observation’s three digit industry
(excluding the performance of that plant); DISCRETE is an indicator variable for discrete manufacturing
facilities; HYBRID is an indicator variable for hybrid manufacturing facilities; MIX is an indicator variable for
a high product mix manufacturing facility; VOLUME is an indicator variable for a high volume manufacturing
facility; UNION is a variable equal to 1, 2, or 3 if no workers, some workers, or all workers, respectively, are
represented by a union; EMPLOYEES is the log of the number of employees; PLANT AGE is the number of
years since the plant’s start-up; DOWNSIZE is a variable equal to 1, 2, or 3, if there has been no, some, or
extensive downsizing, respectively, in the last five years; NEWPROD is the percent of the plant’s annual unit
production represented by new or redesigned products; and AMP is an indicator variable for plants in the
high advanced manufacturing practices cluster.
 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 723

The endogenous choice of ABC raises a potential problem in assessing the

association between ABC use and performance. If all plants in the sample
are optimizing with regard to this accounting system choice, there should
be no association between performance and observed (endogenous) ABC
use, once the exogenous determinants of this choice are controlled in the
model. An alternative perspective is that all firms may be moving toward
their optimal practices, but at any point in time some firms will be “off
equilibrium.”10 This allows performance differences to be examined by as-
sessing the extent to which performance is associated with deviations from
“optimal” practice.
We adopt this approach to examine the performance differences associ-
ated with the “match” between ABC adoption and the plant’s manufactur-
ing characteristics. We first estimate the probability that the plant makes
extensive use of ABC as a function of four sets of variables that the activity-
based costing literature claims are determinants of ABC adoption or success.
These include manufacturing practices (DISCRETE and HYBRID, with con-
tinuous manufacturing processes omitted), product mix and volume (MIX
and VOLUME ), new product introductions (NEWPROD), and advanced
manufacturing practices (AMP). We assume that, on average, plants have
optimally decided to use or not use ABC, and that this systematic prediction
model captures “optimal” practice. Our two-stage approach at least partially
controls for endogeneity if these predictor variables were chosen before the
ABC choice. However, this approach also assumes that all of the plants may
be dynamically learning and moving toward their optimal ABC use, but that
at the time of the survey the cross-sectional sample consisted of observations
distributed around the optimal choice.
The logit prediction results are presented in table 3. The model is sta-
tistically significant ( p < 0.01), with a pseudo R2 of 0.072. Consistent with
Krumwiede [1998], discrete operations are less likely to make extensive use
of ABC than continuous process plants (the omitted category). ABC use is
marginally higher in high mix plants and in plants with more recent product
introductions ( p < 0.15, two-tailed), but is not significantly associated with
production volume. ABC use is positively associated with advanced manu-
facturing practices, consistent with claims that ABC is more applicable in
advanced manufacturing environments.
We assume that the residuals from this model represent the extent to
which the plant has “over-invested” or “under-invested” in ABC. For exam-
ple, a plant making extensive use of ABC (ABC = 1) and having an estimated

10 For example, studies indicate that firms often experiment with ABC systems before decid-

ing to retain or abandon them, while others suggest that uncertainties over the value of new
accounting practices or internal barriers can prevent the timely adoption of beneficial manage-
rial accounting practices (Dunk [1989], Foster and Ward [1994], Bjornenak [1997]). Although
no analytical model exists to describe non-optimizing behavior, Milgrom and Roberts [1992,
page 43] draw on Nelson and Winter’s [1982] evolutionary theory of economic change to argue
that this behavior is a necessary condition to test any economic theory involving performance
effects. See Ittner and Larcker [2001] for additional discussion of this issue.
724 C . D . ITTNER , W . N . LANEN , AND D . F . LARCKER

probability of ABC use of 0.90 is assumed to have “over-invested” less in ABC

than a user with an estimated probability of 0.20 (residual = 0.10 for the
former and 0.80 for the latter). Similarly, a non-user (ABC = 0) with an es-
timated probability of 0.20 is assumed to have “under-invested” less in ABC
use than a non-user with an estimated probability of 0.90 (residual = −0.20
for the the former and −0.90 for the latter).
We compute separate variables for positive and negative residuals to allow
for potential differences between “over-investment” and “under-investment”
in ABC. We define POS− ABC− RESID as the residual from the model in
table 3 if the residual is positive (i.e., the plant uses ABC extensively but
the predicted probability of use is less than one), and zero otherwise.
NEG− ABC− RESID equals the residual from the model if the residual is nega-
tive (i.e., the plant does not use ABC extensively and the predicted probabil-
ity of use is greater than zero), and zero otherwise. The expected coefficient
signs are negative for POS− ABC− RESID (i.e., ABC users with low predicted
probability of use are expected to be associated with lower performance)
and positive for NEG− ABC− RESID (i.e., plants not using ABC but having a
high predicted probability of use are expected to be associated with lower
performance).
Performance regressions using residuals from the logit model are re-
ported in table 4. The ROA results provide weak evidence that the as-
sociation between ABC and profitability is a function of the “match” be-
tween the plant’s operating environment and ABC use. The coefficient
on POS− ABC− RESID is negative and significant ( p < 0.10, two-tailed), in-
dicating that plants making extensive use of ABC when the model predicts
they should not be doing so are associated with lower accounting returns.
Conversely, plants that do not use ABC when the model predicts they
should (NEG− ABC− RESID) are also marginally associated with lower ROA
( p < 0.15, two-tailed).
In contrast, the residuals explain little of the variation in the other perfor-
mance measures. As predicted, NEG− ABC− RESID has a marginally sig-
nificant positive association with TIME ( p < 0.15, two-tailed). But
the coefficient on POS− ABC− RESID is also marginally positive in the
QUALITY model, opposite our prediction. None of the coefficients on
POS− ABC− RESID or NEG− ABC− RESID is significantly different than zero in
the other models ( p < 0.15, two-tailed). Together with the operational re-
sults in table 2, this evidence suggests that the associations between ABC and
improvements in quality and cycle time are not contingent on the produc-
tion setting. However, the ROA results indicate that the association between
net financial benefits and ABC use varies with the plant’s operational char-
acteristics.

5. Summary and Conclusions

This paper provides the first large-sample evidence on the association
between activity-based costing and manufacturing performance. Results
 ACTIVITY - BASED COSTING AND MANUFACTURING PERFORMANCE 725

using a cross-sectional sample of manufacturing plants provide some evi-

dence that extensive ABC use is associated with higher quality levels and
greater improvements in cycle time and quality, and is indirectly associated
with manufacturing cost reductions through quality and cycle time improve-
ments. However, on average, extensive ABC use has no significant association
with return on assets. Instead, we find weak evidence that the association
between ABC and accounting profitability is contingent on the plant’s op-
erational characteristics.
There are several important limitations to our study. One concern is the
endogeneity of cost accounting choices, and the potential inconsistency in
our parameter estimates. Although we attempt to deal with this issue using
our two-step residual approach, the effect of endogeneity on our results
remains a concern. A second issue is potential self-selection biases in our
sample, especially given the low response rate to this survey. These potential
biases make it difficult to generalize our results to other manufacturing
plants. Third, some of our measures have unknown psychometric properties
(e.g., a single item for extensive ABC use). Fourth, we do not know when
the respondents adopted ABC. If there are significant time lags between
ABC adoption and performance improvements, our survey may not pick up
these gains. Finally, it is impossible to determine causality in cross-sectional
tests such as ours, only associations. The most promising avenue for future
research in this area is longitudinal studies that allow the researcher to
evaluate performance before and after ABC implementation.

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