Integration of ABM and ABC in Dow Chemicals Limited
The Dow chemical, an international chemical company, applied activity based costing in order to enable the global business to report the contribution margins according to the geographical area, specific products and customers. The management believed that the system would assist in better decision making in the use and the deployment of its resources. In the traditional accounting system, the costs were assigned to areas such as sales and purchases. However the method was inappropriate as it resulted to fluctuating cash flows since the main focus of costs was on prime costs. It did not provide the manager with accurate and reliable information for decision making. In ABC, the costs are assigned to the company’s departmental activities enabling one to get the accurate data on production costs.
ABC is the system of costing that assigns costs to specific activities in the departments while ABM is the process of making decisions using the ABC system data. While implementing ABC in the Dow Company, the management instructed the service providers identify the activities of the company, compute activity prices, create cost centers and cost drivers and eliminate non-value adding activities. The service provider also had to benchmark the company to ensure the competitiveness of the activity prices. The service providers and the Dow company managers were to manage the activity resources. Within the company, internal service providers like the human resource department, were asked to carry out activity costing so that the other departments would know the costs of the human resource services. This made the departments more accountable and responsible for their activities. A budgeting system was also implemented.
The company decided to follow the ABC principles consistently. The system was to be implemented globally in the company for standardization. For successful implementation, representatives of the company were chosen from different regions and trained on ABC designs and principles. The representatives were accountants, business manufacturing managers, site general managers and cost centre owners (Damitio, Hayes & Kintzele, 2000). This was to get the support of all the people. After implementation, the company also used components of their information systems to work with the activity based costing system. Their SAP system was used to track activities and determine the production volume, activity and product costs.
The Benefits and Challenges of ABC
The company was able to calculate costs across a geographical region. The time and effort of the product personnel could be calculated and split across regions such as the United States and South America. The system also assisted in balancing the demand and supply of support services resources. The hours required by certain products were identified and balanced with available resources. In implementing the system globally, there were challenges in coordination. The accounting changes had to be investigated whether they were acceptable legally in the different countries. There was a challenge for the company in implementing cost driver metrics without increasing the work in the company. Overall the system has enabled the company to understand its costs. The departments also have the ability to control their consumption of resources. The company has learnt that it is more effective for them to classify their activities rather than break down the activities further into tasks due to its large size. This is to avoid numerous and impractical component sizes for costing.
ABM in Japanese Company
In 1994, a Japanese company, Okayma Co. Ltd, introduced activity based counting in the company and integrated it with Hoshin Management. It is located in West Japan. It is a manufacturer of electronic parts and a subsidiary of one of Japan’s major manufacturers.
The Hoshin Management principles state the importance of systematic activity within an organization in attaining its strategic goals. In implementing ABM, the top management clarified its policies on focusing on new products, technology and the capability to meet customer needs. The management had to do two things to achieve their strategic goals. They had to maintain the current level of production using 70% of the labor force in indirect sectors and the 30% labor reallocated to other sectors. There was also a review of the processes of the company to group them into activities. All processes were reviewed by the department heads. This enabled them to know the number of activities in the company for costing objectives. All the employees had to keep a daily time sheet to record their activities in order to provide costing data. The analysis of the data revealed that 70% of the indirect sector activities were not linked to top management goals and were therefore identified as value-added. These were to be reduced or eliminated as they were deemed less important in achieving strategic goals. The time and effort that the company used for these activities was taken to higher priority activities. Each department was given its indirect cost reduction goals and targets. At the end of an accounting year, the progress made in reducing indirect costs was measured. ABM was used to determine the factors leading to the misallocation and over-utilization of resources. The information helped the company in setting the cost reduction plans for each year.
Benefits of ABM
After three years of integrating ABM and Hoshin Management, the management noted the big impact on the company’s processes. First of all the number of staff in the indirect departments reduced. The workers decreased from 405 to 317 due to attrition and transfers of staff to direct or other indirect departments. Despite the fact that the indirect departments had been increased to achieve strategic goals, the overall indirect cost reduced by over 300 million (Asada, Bailes, Suzuki, 2000)
The strategy in reducing indirect costs was changed from the top down and across the company strategy to bottom-up and section- specific strategy. The company was now aware of the activity costs in the indirect sectors. The staff came to prioritize their activities in order of cost-effectiveness. There was also a policy to get profit from particular indirect activities. The company now considered charging for the provision of technical assistance to oversees subcontractors.
Previously the provision of these activities had been free. The processes carried out across the departments were improved as the company realized that particular indirect costs had to be dealt with in many departments and not just in one department. A taskforce was appointed to handle these indirect costs that cut across several departments. One of the items management had to deal with was the reduction in idle time in the processes that came from the processes followed in receiving orders and shipping of products. The Hoshin management approach had not been effective before in improving productivity in the indirect departments. However ABM assisted the company to effectively manage its indirect costs.
References:
Asada,T., Bailes,J. & Suzuki, K.(2000). Implementing ABM with Hoshin Management
Management Accounting Quarterly. Winter, p1-6.
Damitio, J.,Hayes, G. & Kintzele, P.(2000). Integrating ABC and ABM at Dow Chemical.
Management Accounting Quarterly. Winter, p22-26.
