LEARNING NOTE 11.

2
PITFALLS IN USING
ABC INFORMATION

W here unit costs are calculated, ABC systems suffer from the same disadvantages as traditional cost

ADVANCED READING
systems by suggesting an inappropriate degree of variability. For example, to calculate unit product
costs, batch level activity costs are divided by the number of units in the batch and product sustaining
costs are divided by the number of products produced. This unitizing approach is an allocation which
yields a constant average cost per unit of output which will differ depending on the selected output level.
For decision-making there is a danger that what started out as a non-volume-related activity cost will be
translated into a cost which varies with production volume. Consider a situation where the cost per set-up
is £1000 for a standard batch size of 100 units for a particular part, giving an average set-up cost per part
of £10. If a special order requiring the part is received for 50 units then the batch size will differ from the
standard batch size and the average cost of the set-up for processing the parts of £10 is not the
appropriate cost to use for decision-making. There is a danger that costs of £500 could be assigned to
the order. However, if the special order requires one set-up then the activity resources consumed will be
£1000 for an additional set-up, and not £500. Care must therefore be taken when using ABC information.
A further problem is that the concept of managing unused capacity is fine for human resources but it
does not have the same impact for physical resources, such as the acquisition of plant and equipment.
Human resources are more flexible and can be adjusted in small increments. Therefore the supply of
resources can more easily be adjusted to the usage of resources. In contrast, physical resources are
acquired or removed in lumpy amounts and large increments. If resources are supplied to cover a wide
range of activity usage there would have to be a dramatic change in activity for the supply to be changed.
Therefore changes in resource usage would tend not be matched by a change in supply of resources and
spending would remain unchanged. Care must therefore be taken to ensure that the cost of human and
physical resources are not merged (so that they can be separately reported) when costs are assigned to
activity cost centres within the first stage of the two-stage allocation process.
If the changes in physical resource usage arising from potential decisions do not have future cash flow
consequences there is unlikely to be a link between resource usage and spending and the future cash flow
impact for most decisions will be zero. In other words, the cost of resource usage would be treated as fixed
and unavoidable for most decisions which is identical to how these costs would be treated adopting
traditional costing systems. Also traditional costing systems accurately trace the cost of unit-level
activities to products and facility-sustaining costs cannot accurately be assigned to cost objects by any
costing system. Thus, for many organizations the proportion of costs that can be more accurately assigned
to cost objects by ABC systems, and that can be expected to have a future cash flow impact, might be
quite small. For such organizations this would imply that appropriate cost information extracted from
simplistic costing systems may be sufficiently accurate for decision-making purposes.