Potential Design Flaws In ABC Systems And Suggested Safeguards

ABC systems have received extensive attention in the last decade. The ABC literature has convincingly demonstrated that traditional cost systems systematically distort product costs. It is less widely recognized, however, that ABC systems can also distort costs if improperly designed. One notable cause of distortions in ABC systems is the assumption of constant average costs of all activities. This assumption and the design choices concerning the aggregation and the allocation procedures create great potentials for product and service cost distortions. The present article examines this problem and provides some solutions to enhance the accuracy and power of ABC systems. It will be argued that: (1.) Activity and product costs are not neutral to the process of cost aggregation and allocations; (2.) Many activity costs follow step or other nonlinear patterns. The ABC system designer should examine all activities for these patterns; (3.) Where activities are not proportional to cost drivers, pooling should be avoided; (4.) As product volume and product mix change, unit activity costs and other initial system parameters may change and render the ABC system less reliable. Frequent updating of the system is crucial under these conditions; and (5.) Frequent revisions and updating of the ABC system is equally crucial for companies that operate under rapid technological changes.