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Activity-Based Cost Management Practices in India:An
Empirical Study
Manoj Anand*, B. S. Sahay** & Subhashish Saha***
This is a study of activity-based

cost management practices
Introduction being followed by corporate
India. The aim is to understand
Johnson and Kaplan (1987)’s publication of the book whether corporate India
practices cost management in
‘Relevance Lost’ brought a revolution in the history of a value-chain analytic
management accounting. The management accounting framework. A nationwide survey
systems of that time failed to provide relevant information has been conducted to capture
the issues in the design and
for product costing and performance evaluation at the applications of contemporary
time of ‘rapid technological change’, ‘fierce competition’, cost and performance
management tools. The universe
and ‘information processing revolution’. The pre-war for the present study consisted
cost accounting systems were designed to meet the of the bt-500 private sector
financial reporting and tax planning needs. They failed companies and 75 most
valuable PSUs, which is a fair
to provide information for managerial decision-making representation of corporate
and control purposes. India. Fifty-three completed
questionnaires have been
Drucker (1992) argued that accounting systems should received. The study is essentially
provide answers about their businesses, markets, of large-sized corporate firms
using activity-based cost
customers, and environment to ‘information literate’ management.
managers. Thus, the role of a management accountant The examination of responses
expanded in multiple dimensions. They were there not conditional on ABC-adoption
just to collect cost information as accurately as possible revealed that the firms who have
adopted ABC were significantly
but also to analyse the utility of the cost information for more successful in capturing
taking vital managerial decisions. This new paradigm of accurate cost information for
management accounting called for certain additional skills value chain analysis and supply
chain analysis vis-à-vis the firms
in the management accountants. Anastas (1997) who had not adopted ABC. The
discussed the changes required in the set of skills of the extent of ABCM adoption in the
service sector had not been
management accountants in view of the “Project found significantly different
Millennium: Customers & Future Markets…Looking from that in the manufacturing
sector.
*Professor, Finance & Accounting Area, IIM-Indore, email:manand@iimidr.ac.in

**Professor, Operations Management, Management Development Institute, Gurgaon.
***Executive Trainee, Securities Exchange Board of India, Mumbai.
Decision, Vol. 32, No.1, January - June, 2005

Activity-Based Cost Management Practices in India:An Empirical Study 124
Ahead to 2007”.
In the mid 1980s, the newfound utility of cost accounting led to a churning of the
whole cost accounting system, its methodology and even it’s philosophy. The most
prominent feature that emerged out of the whole brain storming process was activity-
based cost management system. This system was claimed to have the ability of
providing accurate cost information while removing distortions in product/service pricing
and customer profitability analysis in a complex manufacturing environment. Cooper
(1988a, 1988b, 1989a, 1989b and 1995), Cooper and Kaplan (1988, 1991,1992, 1997
and 1998). For a comprehensive review on the subject, see Borden (1990) and Cooper
(1996).
The present study plans to identify activity-based cost management practices in
corporate India. Further, it investigates whether corporate India uses contemporary
cost management tools in the value chain analytic framework.
Evolution of Activity-Based Costing

Highlighting the limitations of traditional costing systems in overhead cost allocation
in a situation of product diversity and in terms of volume and complexity, Cooper
(1988a) illustrated the need for activity-based costing systems. Consistent with this
research, Cooper (1988b) found that the firms facing a high level of competition and
having a diverse product mix are more likely to benefit from precise cost information
and introduction of activity-based cost systems, with an added caution that the activity-
based costing system introduction initiative itself should be cost effective.
Meanwhile, Kaplan (1988) observed that many companies used single cost systems
to meet three diverse needs, namely, inventory valuation and financial reporting, product/
service/customer costing and providing ‘operational feedback to frontline employees’
in the plant. However, he apprehended that, in a complex manufacturing environment
with ‘product and process diversities’ and ‘concern for excellence’, the single cost
system might not suffice for all the three needs.
With the help of case studies of Siemens Electric Motor Works, John Deere Component
Works, and Schrader Bellows, Cooper (1989b) demonstrated that the ‘management
objectives’ and ‘diversity of product mix’ determine the extent of the complexity in
the design of activity-based cost management systems. The competitive environment
in which the firm is operating, drives the need for activity-based costing.
The authors acknowledge the financial support received from the All India Council for Technical Education
(AICTE), New Delhi. The authors would like to thank the anonymous reviewer of the paper and Professor
Satya Prakash Singh of University Business School, Panjab University, Chandigarh for their insightful
comments.

Cooper and Kaplan (1997, 1998) argued that operational control and activity-based
cost systems are two separate systems as they have different purposes and different
requirements for accuracy, timeliness, and aggregation. Any attempt to integrate both
should be made with utmost care, otherwise, it would perform neither function well.
The operational learning and control system provides economic feedback about process
efficiencies by using actual and highly accurate data on a continual basis in with
respect to each responsibility centre. The emphasis is on short-term fixed and variable
costs and the cost centres are expenses actually recorded in the financial system.
Product, customer, and business-unit profitability are the objectives of the activity-
based cost systems. It uses standard cost data based on standard cost driver rates
and practical capacity of organisational resources, and updates it periodically for the
entire value chain. A well-designed integrated cost management system will help the
management of the company to identify opportunities for continuous improvement
and point out unused capacity or capacity constraints, if any, and will facilitate the
introduction of activity-based budgeting in the organisation. The activity-based
budgeting mindset makes all cost variable and attempts to match resource supply
with resource demand.
Activity-Based Costing – Issues in Implementation
The activity-based cost systems, though superior to traditional cost systems, could
fail due to poor implementation process (Ness and Cucuzza ,1995; Player and Keys
1995, Pattison and Arendt, 1994). Jayson (1994) found in response to Management
Accounting ®’s first fax survey that implementing activity-based costing is worth the
investment. The most common problem reported was the difficulty in identifying the
cost drivers.
Shields (1995) and Shields and Young (1989) found that the firm’s top-level manager
‘champions’ the ABC project and cross-functional teams, process orientation and
adequate training to employees on the ABC, linkages between activity-based team
oriented performance metrics to the compensation plan, and decision-making at shop-
floor level by people who have process knowledge. A review of ABC of
implementation initiative in long-term perspective was also a key success factor for
ABC implementation.
Top management support, ABCM-linked performance evaluation and compensation
plans, the number of applications of ABCM in the organisation and time-in-use of
application have been noted to be ABCM success determinants by Foster and Swanson
(1997). Brown et al. (2004) saw an association, between organisational size and
initial interest in activity-based costing, significant.
Based on the survey findings of the Cost Management Group of the Institute of

Management Accountants, 1996, Krumwiede (1998) reported the activity-based

costing adoption status and factors affecting its success. He got 178 responses with
a 16% response rate. 49% of the respondent firms had adopted the activity-based
costing systems. 25% of the non-adopting companies were considering its introduction
in their organisation. Only 5% of the respondent firms had rejected it after careful
examination. Top management support, information technology sophistication, large
size of firms, and integration with the financial system were the factors affecting the
usage of activity-based costing. The use of activity-based cost system is found to be
positively correlated with firm size. The organisational factors such as top management
support, ‘non-accounting ownership’ and training were found to be vital in the
successful implementation of activity-based costing.
Shaw (1998) observed that one of the biggest challenges to adoption of activity-
based costing/management is increased adoption of enterprise-wide resource planning
systems. Whether the ABC/M system will be able to complement the ERP-architecture
is an issue. SAP AG, ERP vendor made a substantial equity investment in ABC
Technologies (developer and producer of window-based ABC/M applications OrosTM)
in September 1998. Oracle purchased Activa (an ABC/M tool developed by
PricewaterhouseCoopers) and PeopleSoft havs entered into partnership with KPMG
to develop its activity accounting module. The role of the management accountant
will thus change from scorekeeping to that of strategic advisor.
Endorsing the role of implementation process, Anderson and Young (1999) in a study
of 21 filed research sites of two firms examined the relationship between activity-
based costing systems, contextual factors, and factors related to the ABC
implementation process by using survey and interview process. They found that
implementation process has a clear influence on ABCM success and the contextual
setting directly influences the process and outcome. The criteria for success of ABC
systems is its ability to provide more accurate cost data vis-à-vis traditional cost
systems and the usage of ABC cost data for cost reduction and process improvement.
Applications of Activity-Based Costing
The Innes and Mitchell (1995) survey of activity-based costing practices in the 251
UK companies listed in The Times 1000 (1994) found that 19.5% of the respondents
had adopted ABC and 27.1% were considering its adoption. The extent of its adoption
in the non-manufacturing sector had not been found to the significantly different from
that found in manufacturing concerns. The ABC users had considered its applications
in the areas of cost reduction, product/service pricing, performance measurement

improvement, and cost modeling. The inventory valuation use had the lowest adoption
rate amongst ABC users. Dugdale and Jones (1997) follow-up survey to the Innes
and Mitchell (1995) questionnaire of large UK firms adopting activity-based costing
has found that only three companies used ABC for stock valuation as against the
reporting of 14 companies, when the strong definition of ABC was applied.
Innes et al’s (2000) 1999 survey of activity-based cost management practices of 177
of the largest companies in the UK had assessed the changes that had occurred in
the ABC adoption status over a five-year period. The ABC adoption / under
consideration rate had fallen to 17.5% and 20.3% from 21% and 29.5% respectively.
The highest adoption rate was in the financial sector. In terms of scale, the median
activity-based cost accounting systems design included 40 (1994: 14) cost objects, 52
(1994: 25) activities, 22 (1994: 10) cost pools and 14 (1994: 10) cost drivers. The
ABC rejection rate had increased from 13.3% to 15.3% during this period. Cost
reduction, pricing, performance measurement/improvement and cost modeling
continued to be the most commonly used areas for activity-based costing. The top
management support to the ABC implementation initiative and, to a lesser extent,
with its use to support quality initiative, determined its success.
In a survey of 132 US companies, Foster and Swanson (1997) found that all of them
were using activity-based cost management, when they responded. The decision to
use ABCM, management use of dollar improvement and the overall net benefits as
success measure yielded the highest explanatory power. Groot’s (1999) survey of the
US food and beverages industry found that 18% of the respondents had implemented
activity-based costing and 58% were considering its implementation.
Joshi (2001) in a survey of 60 large and medium-sized manufacturing companies in
India found an adoption rate of 20% for activity-based costing, 13% for activity-
based management, and 7% for activity-based budgeting. The size in terms of total
assets has been found to be a significant factor in the adoption of these contemporary
management accounting techniques. The traditional management accounting
techniques have been emphasised more vis-à-vis contemporary techniques because
of higher perceived benefits.
Narasimhan and Thampy (2002) designed an activity-based costing system for
ascertaining service cost for different customers with a case study of two branches
of a large Indian private sector bank. The use of activity-based cost information in
benchmarking, branch network restructuring, business process outsourcing, and
identification of value-added and non-value added activities has been argued.
Activity-Based Costing & Firm Value
Bromwich and Bhimani (1989) observed that though activity-based costing corrects

the product-cost distortions, no such study has been done to demonstrate that it
increases the profitability of the firm (Shim and Stagliano 1997). Groth and Kinney
(1994) observed that success at cost management could have substantial impact on
the firm value. Hubbell (1996) argued in favour of integrating activity-based cost
management systems with the measures of shareholder value such as economic value
added. The resultant integrated cost management system could provide a better
governance mechanism for improving processes, optimising the use of capital and
thus create shareholder value.
Gordon and Silvester (1999) examined the performance of ten ABC user firms vis-à-
vis their matched size and industry-controlled counterparts who have not adopted
activity-based costing. Though ABC user firms had abnormal returns on the date of
announcement, they were not statistically significantly different from their
counterparts. Thus, they questioned the adoption of activity-based costing if it does
not lead to the creation of firm value.
Malmi (1999) found that firms superior performance subsequent to activity-based
costing adoption revealed that the ABC adoption decision was the ‘rational value-
enhancing choice’ and it was not a fad or fashion or forced selection. Shield and
McEwen (1996) reported that 75% of the ABC-users found it to be a financially
beneficial decision. The success in ABC implementation is based on top management
support, compensation and training (McGowan and Klammer 1997).
Ittner et al. (2002) examined the association between the extensive use of activity-
based costing and plant level operational and financial performance indicators such
as cycle time, quality, manufacturing cost improvements and return on assets. The
quality variable was captured through finished proudct first pass quality yield in
percentage terms, and scrap and rework cost as a percentage of sales. The survey
questionnaire was mailed to 25,361 US firms who subscribed to Industry Week. They
received a response from 2789 firms, resulting in a response rate of 11%. They found
that 26% of the respondents did use activity-based costing extensively. They found
moderate evidence that activity-based costing use is positively associated with
manufacturing performance. They demonstrated through path analysis that activity-
based costing use has a positive indirect association with manufacturing cost reduction
through improvements in quality and cycle time. No significant association with return
on assets of activity-based costing use was observed.
Kennedy and Affleck-Graves (2001) examined the link between activity-based costing
implementation and the creation of shareholder value using Rappaport’s (1986)
framework and event study methodology (Brown and Warner, 1980 and 1985). They
got responses from 47 ABC users and 187 non-ABC users. They found that choice

of management accounting system such as activity-based costing for a sample of
UK firms had a significant impact on firm value (27% over three years from the
beginning of the year in which activity-based costing was first introduced). The impact
of activity-based costing on firm performance may be indirect through the mediating
influence of other variables (Shields et al. 2000).
Cagwin and Bouwman (2002) in their survey of 210 internal auditors found that the
firms with diverse product portfolio and with a high proportion of overhead cost
when they have adopted activity-based costing along with other strategic initiatives
such as JIT and TQM, resulted in substantial improvement in their return on
investments. The other enabling conditions for the efficacy of the ABC in the
organisations are sophisticated information technology systems, absence of excess
capacity and competitive environment.
Research Design
Nation-wide Management Survey
A draft questionnaire was developed, based on a comprehensive review of existing
literature, to conduct a survey. It was circulated to a group of prominent academics
and Chief Financial Officers (CFOs) of Corporate India for their feedback as a part
of a pilot study. Their suggestions were incorporated and the questionnaire was revised.
The final questionnaire contained 34 questions. A glossary of the terms used in the
questionnaire was provided to the respondents at the end for ready reference.
The survey asked the CFOs to respond to questions such as management motivation
on adoption of a particular cost management item on a Likert scale of 0 to 5 (where
0 means “not used;” 1 means “unimportant;” and 5 means “very important”). This
approach has provided data on the method used and the relative importance of each
method in the decision making process.
The management perception of quantum change observed in different decision-making
areas because of implementation of Activity-based cost management systems
(ABCM) was captured on a scale of 1 to 5 (where 1 means “ no change;” and 5
means “ very significant change”).
Hypotheses of the Study

The study tests the following hypotheses:
H1 Firms using activity-based costing systems are likely to be more successful
in capturing accurate cost and profit information for:

a) product pricing;
b) customer profitability;
c) inventory valuation;
d) value chain analysis;
e) supply chain analysis; and
f) outsourcing decisions vis-à-vis the firms that follow the traditional
costing system
H2 The management motivations for adoption of activity-based costing are
significantly different for firms:
i) in the manufacturing sector and the service sector; and
ii) Firms which have adopted fully integrated cost management and
financial reporting systems with ERP and those which have
introduced activity-based costing systems as supplementary and
offline.
H3 The quantum of change and incremental cash benefits observed by the
management of the firms in various dimensions of performance varies with:
i) the level of adoption of the activity-based costing system; and
ii) With respect to the nature of the industry and the extent to which the
ABCM system has been integrated with the other decision support
systems.
H4 The ABCM-user respondent firms use activity-based cost management in a
value chain analytic framework.
Research Methodology
The activity-based cost and performance management systems are required for
accurate cost and profit analysis, when the organisations have high overhead cost
and diversity in their processes and products. It is expected that only large-size
companies 1 with these characteristics will implement contemporary cost and
performance management systems.
Hence, the universe for the present study consisted of the bt-500 private sector
companies and 75 most valuable PSUs2 , which is a fair representation of corporate
1. The size of company can be captured in terms of their sales, assets, or market capitalization.
2. Every year, Business Today features a report on India’s most valuable 500 companies and ranks them
based on their market capitalization. In its October 6, 2000 issue it carried a report of 500 companies
in the private sector and 75 most valuable Pubic Sector Undertakings (PSUs) for the year 1999-
2000. These 575 companies constituted the universe for the present study.

India. Since the subsidiaries of multinational corporations (MNCs) form a major
constituent of the Indian Corporate sector, an effort was made to get responses from
this segment also3 . Fifty-three completed questionnaires have been received. The
forty-nine responses were from listed companies and four were from unlisted Indian
subsidiaries of MNCs. The industry composition of the sample is shown in Table 1.
The study is essentially of large-sized corporate firms using activity-based cost
management and performance scorecard. The abstinence from response to the
questionnaire may be due to their concern for sensitivity of the cost and performance
measurement data. Given the length (20 pages) and depth (34 questions and morethan
350 subparts) of the questionnaire, this response rate compared favorably with other
academic surveys.
Table 1: Industry Composition of Sample
Industry Sample Size Sample proportion

Consumer Durable, Personal Care & Food Products 7 13.21
Engineering & Capital Goods 6 11.32
Chemicals & Pharmaceuticals 4 7.55
Power Generation & Transmission 4 7.55
Tractors 4 7.55
Automobiles & Auto Ancillary 4 7.54
Construction, Cement & Building Material 3 5.66
Information Technology – Software 3 5.66
Oil & Gas and Petrochemicals 3 5.66
Telecom & Electronics Equipment 2 3.77
Tyres 2 3.77
Diversified 1 1.89
Iron Ore & Non-Ferrous Metals 1 1.89
Textiles 1 1.89
Others (Logistics, Banking, Telecom services
Consultancy airline services trade services etc) 8 15.09
Total 53
3. The four subsidiaries of MNCs were selected for data collection based on the value judgement.

In order to verify how far the sample obtained from the survey is a true representation
of the population, a statistical test was carried out on firm-size profitability and risk
criterion. In this test, certain key attributes, namely, sales, total assets, market
capitalisation, operating profit, return on capital employed, return on net worth, debt
to equity ratio, beta of the population and the sample were compared using non-
parametric Mann Whitney’s-U test. The test (Table 2) revealed that there is no
significant difference between the means of the complete population of bt-500
companies and the sample for all the attributes except beta as a measure of risk. A
difference in the mean values of beta has been observed at the 5% significance level.
The correlation coefficients between the various financial attributes of the respondent
firms and that of the population are examined to judge the quality of the sample and
are reported in Table 3 and Table 4, respectively. There is a significant positive
Table 2: Comparison of various attributes of population vis-à-vis sample
Attributes Population/ Mean Standard Asymp. Sig.

Sample Deviation (2-tailed)
Market capitalization Population 1393.21 4895.48

0.436
(Rs in crores) Sample 3128.0 7966.23
Population 1727.79 7006.86
Sales (Rs. In crores) 0.862
Sample 4120.77 17887.11
Population 4241.36 18995.77
Total assets (Rs in crores) 0.325
Sample 3871.28 10793.11
Population 287.23 1328.47
Operating Profits (Rs in 0.712
crores) Sample 329.68 948.89
Return on Capital Employed 0.866
(%) Sample 23.57 22.69
Return on Net Worth (%) 0.96
Sample 12.91 19.01
Debt to equity ratio 0.63
Sample 1.17 2.35
Beta 0.029
Sample 0.64 0.29

Table 3: Correlation between the various attributes of the respondent

firms
Sales Assets MCAP OP RONW ROCE D/E

Assets 0.854***
Market Capitalisation (MCAP) 0.704*** 0.698***
Operating Profits (OP) 0.749*** 0.956*** 0.802***
Return on Net Worth (RONW) 0.087 0.054 0.351 0.169

Return on Capital Employed 0.005 -0.014 0.204 0.072 0.816***
(ROCE)
Debt to equity ratio (D/E) -0.009 -0.013 -0.100 -0.068 -0.345** -0.107
Beta 0.097 0.166 0.452*** 0.153 -0.085 -0.123 0.375**
***, ** indicate significance at 1% and at 5% respectively.
Table 4: Correlation between the various attributes of the bt-500

companies
Sales Assets MCAP OP RONW ROCE D/E
Assets 0.425***
Market Capitalisation (MCAP) 0.637*** 0.041***
Operating Profits (OP) 0.453*** 0.960*** 0.478***

Return on Net Worth (RONW) 0.01 0.008 0.067 0.096**
Return on Capital Employed 0.068 0.288*** 0.098** 0.331*** 0.378***
(ROCE)
Debt to equity ratio (D/E) 0.016 0.059 -0.005 0.037 -0.022 -0.039
Beta -0.018 -0.039 0.011 -0.048 -0.061 -0.212*** -0.041
***, ** indicate significance at 1% and at 5% respectively.
correlation between the different variables in terms of size (sales, assets and market
capitalisation) both in the sample and the population. There is a significant positive
correlation between the size variable and the operating profits variable both in case of
the sample and the population. There is no significant positive correlation between
the size and the profitability ratios. There is a negative correlation between the debt
to equity ratio and the return on capital employed. It is significant in the case of the
sample.

Since the firm size, profitability and risk attributes are not significantly different between
the sample and the population both individually and in cross section, the sample is
assumed to be a fair representation of the population.Out of the fifty-three responses
to the nation-wide survey of contemporary cost and performance management
practices, twenty-six respondents are using activity-based cost management systems.
Analytic tools used
For the survey questionnaire data analysis, the firms have been classified based on
sector (manufacturing/service), ABC adoption (yes/ no), stage of ABC adoption
(supplementary/ fully integrated), and the level of ABC adoption (manufacturing
overheads / marketing and distribution overheads). The student t-test has been used
to investigate whether the management’s motivation and decision choices differ across
the firms’ cost management systems and sector.
To test the hypothesis that the firms using activity-based costing system are likely to
be more successful in capturing accurate cost and profit information for decision
analysis, the student t-test has been used to investigate the difference between the
mean values of the responses of non-ABCM and ABCM users. Spearman’s rank
correlation coefficient matrices have been developed between decision action taken
and managerial evaluation of success achieved; and incremental cash benefits and
managerial evaluation of success achieved in the Foster and Swanson (1997)
framework.
To find out the difference, if any, in the management motivations for adoption of
activity-based cost systems across sector and its stage of implementation, the student
t-test has been used. To investigate the quantum of change observed by the
management on different performance variables across sectors, ABCM level, and
stage of adoption, the student t-test has also been used. Spearman’s rank correlation
coefficient matrices have been developed between the various measures of decision
action taken and incremental cash benefits
To examine whether activity-based cost management is practised in a value chain
analytic framework, the survey questionnaire asked the ABCM user respondents to
indicate quantum change in different decision areas of cost management subsequent
to its implementation. To test this hypothesis, factor analysis, and two-group linear
discriminant analysis have been used. Principal axis factoring, instead of principal
component analysis, has been used as suggested by Warming-Rasmussen and Jensen
(1998); Kwok and Sharp (1998); Fabrigar et. al. (1999) and Tansey et. al. (2001).
For reporting purpose, items with highest factor loadings have been reported. The
other factor loadings are reported only if the difference from the higher one is less

than 0.20. These are rotated factor loadings obtained using varimax rotation.
Limitations of the Study
Whatever the respondents have said is believed to be their true response and hence,
no statistical test has been performed to study non-response bias and the consistency
of individuals’ responses. Another limitation of the methodology used is that it measures
beliefs and not necessarily actions. Overall, the versatility in the characteristics of
respondents and firms’ allows the present study to examine the practice of activity-
based cost management vis-à-vis theory.
Existing Cost Management Practices
The activity based costing system assumes that products consume activities and
activities consume costs. It leads to a more precise allocation of manufacturing
overheads amongst the products. The activity-based costing system can be extended
to the administration overheads and the marketing and distribution overheads allocation
amongst the products for customer profitability analysis and channel analysis. The
introduction of the ABC system in an organisation can be either supplementary to the
traditional cost accounting system as an offline system or can be fully integrated with
decision support systems such as ERP.
The present study reveals that corporate India has more than one cost management
system in use (Table 5). Half of the respondents use an absorption costing system for
product costing and financial reporting purposes. These results are
Table 5: Present Cost Management Systems being followed by Corporate

India
Sl. No. Cost management system Percentage of
respondents
i. Traditional Cost accounting system
a) Throughput costing 13.2
b) Absorption costing 54.7
c) Variable costing 45.3
d) Standard costing 64.2
ii. Activity-Based Costing system
a) Supplementary / offline 20.75
b) Fully integrated cost management and financial reporting
system with enterprise resource planning (ERP) system. 28.30

consistent with the findings of Joshi (2001) in the Indian context. International surveys
report 50% to 70% of the companies use absorption costing for external reporting
and tax reporting purpose (Inouse, 1988; Blayney and Yokoyama, 1991; and Ask and
Ax, 1997).
The use of standard costing is popular worldwide. More than 75% of the firms use it
in the USA, UK, Ireland, and Sweden ( Cornick et al., 1998; Drury et al. 1993;
Clarke and Brislane, 2000; and Ask and Ax, 1997). Scarbrough et al. (1991) find
65% usage of standard costing in Japan. In India, slightly less than two-thirds of the
respondents use standard costing as a cost control technique as compared to 68%
usage found by Joshi (2001).
The activity-based costing system introduced in corporate India has picked up
momentum as 20.75% of the respondents are using it as supplementary/offline and
28.30% of the respondents have integrated the activity based costing systems with
ERP systems.
Success of existing cost management systems

Table 6 investigates the success of the existing cost management systems in terms of
capturing accurate cost information for product pricing, inventory valuation, value
chain analysis, supply chain analysis and outsourcing decisions. 52.8% of the
respondents have achieved success in the application of their present costing system
in product pricing and inventory valuation. The success ratio in the area of value
chain analysis and supply chain analysis and out-sourcing decisions is 22.7% and
28.3% respectively. The table further exhibits the success of the existing cost
management practices in accurate profit analysis by product, department, process,
and customer. The survey revealed that 54.8% of the firms were successful in accurate
profit analysis by product, 24.6% by process and 30.2% by department and customer.
43.4% find it useful for benchmarking and budgeting while 34% find that it provides
better insight about manufacturing performance.
The examination of responses conditional on ABC-adoption reveals that the firms
who have adopted ABC are significantly more successful in capturing accurate cost
information for value chain analysis (mean score of 2.5385 verses 1.2963) and supply
chain analysis (mean score of 2.2308 verses 1.4444) vis-à-vis the firms who have not
adopted ABC. Thus, the hypothesis H1 to the extent of the success of activity-based
cost management in value chain and supply chain analysis vis-à-vis traditional costing
system is accepted.
Activity- based cost management applications in India.
Activity-based costing technique has gained appreciable acceptance during the post

1990s in India as 26 respondent firms out of 53 are using it for product pricing and
operational feedback. 42.3% of the ABC-user firms have been using ABC in their
company for more than two years. This ABC adoption rate compares favorably with
nearly 38% in India in 1999, 26% in the USA, 20% in the UK and 40% in Norway
(Business Today, 1999; Innes and Mitchell, 1995; Innes, et. al., 2000; Ittner et.al.,
2001; and Bjemenak, 1997).
The study reveals that 76.92% of the ABCM user firms are in the manufacturing
sector and 23.08% in the service sector. The extent of ABCM adoption in the non-
manufacturing sector has not been found significantly different from that in
manufacturing concerns in the UK (Innes and Mitchell, 1995). Interestingly in the
Table 6: Success Achieved in the Application of Present Costing System

to Capture Accurate Cost Information
Sl. Areas Very Mean Score

No. Successful /
Completely Aggregate Non-ABCM ABCM User
Successful User
Accurate cost
i.
information for
a Product pricing 52.8% 3.283 3.00 3.5769
b) Inventory valuation 52.8% 3.0377 2.8148 3.2692
c) Value chain analysis* 22.7% 1.9057 1.2963 2.5385***
d) Supply chain analysis 22.7% 1.8302 1.4444 2.2308*
e) Outsourcing decisions 28.3% 2.1132 1.8148 2.4231
ii. Accurate profit analysis
a) By product 54.8% 3.1321 2.9630 3.3077
b) By process 24.6% 2.0189 1.8519 2.1923
c) By department 30.2% 2.1132 1.6296 2.6154*
d) By customer 30.2% 2.0566 1.8148 2.3077
iii. Better insight for
benchmarking and
budgeting 43.4% 3.0566 2.4074 3.7308***
iv. Better insight about ma-

nufactureperformance 34% 2.6604 2.3333 3.0000
*, **, *** indicate significance at 10%, 5%, and 1% level respectively.

USA, the highest adoption rate of ABCM is in the financial sector ( Innes, et. al.
2000). 57.69% of the ABCM-user firms have fully integrated cost management and
financial reporting systems with the enterprise resource planning system. 57.69% of
the ABCM-user respondent firms have extended their ABC systems to an advanced
stage extending it up to facility level and customer level activities (Table 7). Seventy-
six percent users of the activity-based costing in Canadian firms have implemented
the system as supplementary and offline ( Armitage and Nicholson, 1993).
Management motivations for introduction of activity-based costing

The major motivations for introduction of activity-based costing are accurate cost
information for product/service pricing and profits analysis, improved insight into cost
drivers, accurate customer profitability analysis, cost reduction, process improvements,
product mix strategy, performance measurement and improvement, and cost modeling.
The inventory valuation use had the lowest adoption rate amongst ABC users (Armitage
and Nicholson, 1993; APQC/CAM-I, 1995; Innes and Mitchell, 1995; Clarke, 1996;
Clarke and Mullins, 2001)
Table 8 explores the management motivation for introduction of activity based costing
in the organisation among ABCM-user respondent firms. 73.1% of the ABCM-user
respondent firms consider the need to have detailed information on value added and
non-value added activities as major motivation, followed by the need to be competitive
in the industry in terms of price quality and performance (69.3%). The other major
motivations are to have increased information about the activities, the cost associated
with the activities, activity cost drivers for customer profitability analysis, product
pricing decision and budgeting. The design of performance measurement and control
system based on ABC systems is another major motivation (57.7%).
Table 7: Categorisation of the sample ABCM-user firms.
Sector ABCM adoption stage ABCM adoption level

Manufacturing Service Supplementary Fully Basic Advanced
Integrated
Number of
20 6 11 15 11 15
respondents
% of
respondents 76.92% 23.08% 42.31% 57.69% 42.31 57.69%

Table 8: Management motivation for the introduction of activity-based

costing
Motivation Most Mean score
Important Aggregate Manufacturing Service ABCM ABCM fully
e sector sector Offline Integrated
To have detailed information 73.1% 3.7308 3.75 3.667 3.4545 3.9393
on value-added and non value-
added activities
To correct the distortion in 42.3% 2.4231 2.30 2.833 2.2727 2.5333
overheads cost allocation
To identify activities that 38.5% 2.9615 2.80 3.50 2.8182 3.0667
consume non value-added
time
To have increased activity-
wise information on:
Budgeting 69.3% 3.4231 3.75 2.3333 3.000 3.7333
Product pricing decisions 61.6% 3.1538 3.65 1.50* 3.00 3.2667
Customer profitability analysis 53.8% 2.7692 2.65 3.1607 3.00 2.60
Value chain analysis and 42.3% 2.8846 3.30 1.50 2.2727 3.3333
reengineering
Benchmarking 42.3% 3.00 3.05 2.8333 2.7273 3.20
Outsourcing decisions 34.6% 2.3077 2.50 1.6667 1.9091 2.600
Substitute products 15.3% 1.4615 1.40 1.6667 1.3636 1.5333
To be competitive in the 69.3% 3.5769 3.55 3.6667 3.6364 3.5333
industry in terms of price,
quality and performance
To design ABC-based 57.7% 3.1154 3.0 3.50 2.7273 3.40
performance measurement
system
To compute economic value 42.3% 2.6154 2.75 2.1667 2.0000 3.0667
added* while using activity-
based cost information
To have improved inventory 38.5% 2.4615 2.75 1.50 2.1818 2.667
valuation.
To meet the customer’s 34.6% 1.9231 2.20 1.00 1.8182 2.000
conditionalities while tendering
To use it as a vehicle for 34.6% 2.1923 2.45 1.3333 1.7273 2.5333
change management in the
organization
To provide accurate 26.9% 1.7308 1.75 1.6667 1.5455 1.8667
information for transfer
pricing
Band wagon effect 15.4% 0.8077 0.65 1.3333 1.0000 0.6667
*, **, and *** indicate significance at 10%, 5% and 1% respectively.

The management motivations for adoption of activity-based costing is significantly
higher at the 10% level of significance in the case of manufacturing sector firms vis-
à-vis service sector ABCM-user respondent firms only in case of product/service
pricing decision, as is evident from Table 8. The major management motivations in the
banking sector are to have activity-based cost information for budgeting, economic
value added computation, correct allocation of overheads cost and to identify value-
added and non-value added activities. Thus, there is no significant difference in the
levels of management motivation for the introduction of Activity-Based costing between
manufacturing sector and service sector firms. Hence, the hypothesis H2 (i) stands
rejected.
There is no significant difference in the management motivations for adoption of activity-
based costing between the firms who have adopted fully integrated cost management
and financial reporting systems with ERP and the firms who have introduced activity-
based costing systems as supplementary and offline. Hence, the hypothesis H2 (ii)
stands rejected.
The need for customer profitability analysis, budgeting and to identify activities that
consume non value added time, led corporate India to extend their ABC-systems
from basic level to advanced level, extending it to facility level and customer level
activities.
Investment analysis of activity-based costing project
The investment cost in the implementation of ABC is either insignificant or less than
1% of the sales and accordingly the payback period is less than one year. Most of the
ABCM-user respondent firms did not carry out DCF analysis of the activity based
costing implementation project. Table 9 indicates that 7.7% of the ABCM-user
respondents, who did it, found difficulties in identifying the beneficiaries of ABCM
implementation and in quantifying the benefits in terms of cash. 73.1% of the ABCM-
user firms used in-house cross-functional team for ABC implementation in the
organisation as against 3.8% who engaged consultants for this purpose.
Problems in the implementation of activity-based costing
The activity-based costing systems fail because of the poor implementation process (
Ness and Cucuzza, 1995; Player and Keys 1995; and Pattison & Arendt, 1994). The
major problems faced during the implementation of activity based costing by the
ABCM-user respondent firms are developing activity dictionary (34.6%), inability of
the traditional costing system to capture the information needs of ABC (42.3%) and
lack of review of ABC implementation initiative (30.8%), as evident from Table 10.
Interestingly, resources, both management time and funds, have not been found to be

Table 9: DCF analysis of ABCM implementation project

Sl. No Issues Percentage of the respondents
i. Discounted cash flow analysis (DCF) of the investment 7.7
in activity based costing implementation project
ii. Difficulties in identifying the beneficiaries of ABC 23.1

implementation
iii. Difficulties in quantifying the benefits in terms of cash 26.1
Table 10: Problems faced during the implementation of ABCM

Sl. No. Problems faced during ABC implementation Percentage of
respondents
i. Inability of traditional costing system to capture the information needs of 42.3
ABC
ii. Difficulties in developing Activity dictionary 34.6
iii. Lack of review of ABC implementation initiative 30.8

iv. Difficulties in assigning the cost to the activity pools 26.9
v. Difficulties in identifying the cost drivers 23.1
vi. Inadequate computer software and technical expertise 23.1
vii. Lack of team awareness and training 11.5
viii. Lack of adequate resources (management time and funds) 7.7
ix. Lack of employee and middle management support due to the perceived 4
threats of transparency
the limiting factor. The other problem areas are identifying the cost drivers, assigning
the cost to the activity pools and computer software, and technical expertise.
Activity-based costing and firm performance
The introduction of the activity-based costing system among respondent firms has
brought about quantum change and associated incremental cash benefits in different
areas such as a focus on profitable customers, change in product pricing strategy,
elimination of redundant activities throughout the entire value chain, product mix and
outsourcing decisions. It led to change in the strategic focus (Table 11). In the banking
sector, the management of the respondent firms has observed substantial change in
their focus on profitable customers and business process outsourcing, and re-configuring
the value chain subsequent to implementation of activity-based costing. No significant
difference in the quantum of change has been observed among the ABCM-user
respondent firms across sector (manufacturing vs. service) and ABCM stage (basic
vs. advanced). Hence, the hypothesis H3 (i) and H3 (ii) stands rejected.

Activity-Based Cost Management Practices in India:An Empirical Study

Table 11: Quantum change subsequent to ABCM implementation in different decision areas
Most Mean score

Motivation Important ABCM at
(%) ABCM at
Aggregate Manufacturing Service ABCM ABCM fully advanced
basic stage
sector sector O f f l i n e Integrated stage
i. Focus on profitable customers 46.2 2.1154 2.10 2.1667 1.6364 2.4667 1.9091 2.2667
ii. Changed pricing strategy 46.2 2.3077 2.45 1.8333 2.00 2.5333 1.9091 2.60
iii. Outsourced activities / processes 34.6 1.9231 2.0 1.1667 1.5455 2.20 2.0909 1.80
iv. Changed strategic focus 34.6 1.9615 2.0 1.8333 1.4545 2.3333 1.00 2.2667**
v. Eliminated redundant activities 34.6 2.1538 2.25 1.8383 1.9091 2.3333 1.9091 2.3333
through the entire value chain
vi. Changed product mix 30.7 1.8462 2.10 1.0 1.6364 2.00 2.0909 1.6667
vii Changed distribution channels 23 1.6923 1.85 1.1667 1.2727 2.00 1.7273 1.6667
viii Changed processes 19.2 1.7308 1.90 1.1667 1.3636 2.00 1.5455 1.8667
ix Changed sourcing decisions 19.2 1.5385 1.50 1.6667 1.4545 1.6000 1.3636 1.6667
x Changed incentive 19.2 1.5769 2.40 2.1667 1.9091 1.3333 1.00 2.00
compensation
*, **, and *** indicate significance at 10%, 5% and 1% respectively.
142
A factor analysis of decision actions taken by the ABCM-user respondent firms

yields two prominent factors as reported in Table 12. The factors are identified as
decision areas beyond the boundaries of the firm and within the boundaries of the
firm as in value chain analysis ( Shields and Young, 1992; Shank and Govindrajan,
1995; Goldsby and Closs, 2000; Hooper et. al., 2001). The model has a KMO score
of 0.743 and a variance explanatory power of 73.421%. The variables included in the
decision areas beyond the boundaries of the firm are focused on profitable customers,
sourcing decisions, elimination of redundant activities, distribution channels, and strategic
focus. The product mix, process simplification, and product pricing are included in the
decision areas within the boundaries of the firm.
Table 12: Factor analysis results of quantum change subsequent to
ABCM implementation in different decision areas
KMO score: 0.743 Percentage of variance explained: 73.421%
Sl. No. Decision action areas Beyond the Within the
boundaries of boundaries of
the firm the firm
i. Changed product mix - 0.829
ii Changed processes - 0.819
iii Outsourced activities / processes 0.622 0.614
iv Focus on profitable customers 0.708 -
v Changed pricing strategy 0.674 0.587
vi Changed strategic focus 0.530 0.408
vii Changed sourcing decisions 0.669 -
viii Eliminated redundant activities through the entire 0.908 -
value chain
ix Changed incentive compensation - -

x. Changed distribution channels - -
Eigen value 6.287 1.055
% of variance explained 62.873 10.548
In order to substantiate the argument, linear discriminant analysis was used with
decision areas as sample and the response of the ABCM-user respondent firms as
variables. A priori classification independent of factor analysis results was used. It
classified decision areas into two categories based on value chain framework, one
beyond the boundaries of the firm and the other within the boundaries of the firm.
The decision areas within the boundaries of the firm were product mix, process
simplification, product pricing and compensation strategy. The decision areas beyond

the boundaries of the firm were focus on profitable customers, sourcing decisions,
elimination of redundant activities, distribution channels, and strategic focus. Based
on a priori classification, the decision areas were completely discriminated (100%
accuracy level). The results of linear discriminant analysis are given in Table 13.
Table 13: Linear Discriminant Analysis results of quantum change

subsequent to ABCM implementation in different decision areas
Eigenvalue 178.449
% of variance explained 100
Cannonical correlation 0.997
Wilks’ λ 0.006
χ2 20.768
Significance 0.008
Correct classification 100
Table 14: Incremental Cash benefits associated with the introduction of

ABCM
Sl. No. Implementation area Significant benefits
(Percentage of Mean score
respondents)
i. Product pricing decision 34.6 1.7692
ii Budgeting 30.8 1.8462
iii Customer profitability analysis 30.7 1.8077
iv Product improvement opportunities 26.9 1.6538
v Working capital management 23 1.6154
vi Process improvement opportunities 19.4 1.4231
vii Make or buy decision 19.4 1.3846
viii ABC-based performance measures 19.2 1.6154
ix Value chain analysis 19.2 1.5000
x. Transfer pricing 11.5 0.9615
xi. Value –based management tools such as EVA / RAVE* 11.5 1.2692
From the foregoing analysis, it can be concluded that two factors identified in the
factor analysis process were actually decision areas beyond the boundaries of the
firm and decision areas within the boundaries of the firm, for cost management.

Thus, hypothesis H4 that ABCM-user respondent firms use activity-based cost

management in value chain analytic framework stands accepted.
The respondent firms in their estimate of incremental cash benefits subsequent to
decision taken as a result of activity based costing implementation found appreciable
results in the area of product price budgeting, customer profitability analysis and
product improvement opportunities (Table 14).
Conclusion
The present study of activity-based cost management practices in the Indian industry
is unique in terms of its scope and methodology followed. It not only deals with
traditional cost management techniques but also with contemporary management tools
such as activity-based costing. The hypotheses in general, deal with the difference in
the practices across sectors, stages, and level of adoption of contemporary techniques.
Factor analysis has been used to verify the existence of the normative approach to
cost management in Indian industry.
The survey shows an encouraging response of the Indian corporate sector to activity-
based costing with 49% (n = 26) of the respondents adopting it. The firms are successful
in capturing accurate cost and profit information from their ABC cost systems for
their value chain and supply chain analysis vis-à-vis non-ABC user firms. The need
for activity-wise cost information in budgeting, product pricing decision and customer
profitability analysis has urged the management of the Indian firms to adopt activity-
based costing systems. No significant difference has been found in the motivation to
adopt ABCM across the manufacturing as well as service sector and across the
stages of activity-based cost system adoption (supplementary/offline). This implies
that activity-based costing has equal opportunities in both the sectors and the
motivations are uniform over the stages of adoption. The major difficulties faced by
the ABCM-user respondent firms while designing activity-based cost systems were
developing an activity dictionary and cost drivers, and the lack of review of the
ABCM implementation initiative.
The application of activity based costing has resulted in changes in various management
decision areas, prominent among them being a focus on profitable customers, pricing
strategies, and sourcing decisions. However, the quantum of change observed is not
found to be a characteristic of sector (manufacturing vs. service), level or stage of
ABC implementation.
The application of ABCM has an impact not only on the decisions within the firm but
also on the decisions beyond the boundaries of the firm as evident in the factor analysis
and linear discriminant analysis of responses of activity-based costing user firms.

The decision areas beyond the boundaries of the firm include a focus on profitable
customers, sourcing decisions, elimination of redundant activities, distribution channel,
and strategic focus. The product mix, process simplification, and product pricing are
included in decisions within the boundaries of the firm. Thus, it can be inferred that
ABCM in India is practised in the value chain analytic framework.
Due to the limited scope of the present study, a number of research issues were not
attempted but were felt in the course of the study. Some of them are – one, to follow
up the respondents’ claim on the impact of activity-based costing on their firm
performance either through a case study or through an event study using stock market
data. Two, to examine the relationship between organisational influences and
technological factors and the adoption of an activity-based costing system by the
firm.
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This is a study of activity-based

*Professor, Finance & Accounting Area, IIM-Indore, email:manand@iimidr.ac.in

Decision, Vol. 32, No.1, January - June, 2005

Evolution of Activity-Based Costing

Decision, Vol. 32, No.1, January - June, 2005

Decision, Vol. 32, No.1, January - June, 2005

Management Accountants, 1996, Krumwiede (1998) reported the activity-based

Applications of Activity-Based Costing

Decision, Vol. 32, No.1, January - June, 2005

Decision, Vol. 32, No.1, January - June, 2005

Decision, Vol. 32, No.1, January - June, 2005

Hypotheses of the Study

Decision, Vol. 32, No.1, January - June, 2005

Decision, Vol. 32, No.1, January - June, 2005

Table 1: Industry Composition of Sample

Industry Sample Size Sample proportion

Decision, Vol. 32, No.1, January - June, 2005

Table 2: Comparison of various attributes of population vis-à-vis sample

Attributes Population/ Mean Standard Asymp. Sig.

Market capitalization Population 1393.21 4895.48

Decision, Vol. 32, No.1, January - June, 2005

Table 3: Correlation between the various attributes of the respondent

Sales Assets MCAP OP RONW ROCE D/E

Market Capitalisation (MCAP) 0.704*** 0.698***

Operating Profits (OP) 0.749*** 0.956*** 0.802***

Return on Net Worth (RONW) 0.087 0.054 0.351 0.169

Beta 0.097 0.166 0.452*** 0.153 -0.085 -0.123 0.375**

***, ** indicate significance at 1% and at 5% respectively.

Table 4: Correlation between the various attributes of the bt-500

Market Capitalisation (MCAP) 0.637*** 0.041***

Operating Profits (OP) 0.453*** 0.960*** 0.478***

Beta -0.018 -0.039 0.011 -0.048 -0.061 -0.212*** -0.041

***, ** indicate significance at 1% and at 5% respectively.

Decision, Vol. 32, No.1, January - June, 2005

Decision, Vol. 32, No.1, January - June, 2005

Table 5: Present Cost Management Systems being followed by Corporate

Decision, Vol. 32, No.1, January - June, 2005

Success of existing cost management systems

Decision, Vol. 32, No.1, January - June, 2005

Table 6: Success Achieved in the Application of Present Costing System

Sl. Areas Very Mean Score

iv. Better insight about ma-

Decision, Vol. 32, No.1, January - June, 2005

Management motivations for introduction of activity-based costing

Table 7: Categorisation of the sample ABCM-user firms.

Sector ABCM adoption stage ABCM adoption level

Decision, Vol. 32, No.1, January - June, 2005

Table 8: Management motivation for the introduction of activity-based

*, **, and *** indicate significance at 10%, 5% and 1% respectively.

Decision, Vol. 32, No.1, January - June, 2005

Decision, Vol. 32, No.1, January - June, 2005

Table 9: DCF analysis of ABCM implementation project

ii. Difficulties in identifying the beneficiaries of ABC 23.1

iii. Difficulties in quantifying the benefits in terms of cash 26.1

Manoj Anand, B. S. Sahay & Subhashish Saha

Market Capitalisation (MCAP) 0.704* 0.698*

Operating Profits (OP) 0.749* 0.956* 0.802***

Beta 0.097 0.166 0.452* 0.153 -0.085 -0.123 0.375

*, indicate significance at 1% and at 5% respectively.

Market Capitalisation (MCAP) 0.637* 0.041*

Operating Profits (OP) 0.453* 0.960* 0.478***

*, indicate significance at 1% and at 5% respectively.

, , and indicate significance at 10%, 5% and 1% respectively.