More is better. At least that’s the message the media has convinced us of during this century. Since the advent of the industrial age, we have been bombarded with the word “more”. It worked for everything …

• When our roads became crowed, we built “more” roads.
• When our cities became rampant with crime, we hired “more police officers and built “more” prisons.
• When sales dropped, we added “more” products.
• When we missed budget, we added “more” performance measures and reports.
• When direct labor became a smaller portion of product cost at Motorola in the 1980’s, I added “more” decimal points to the cost accounting system. I am embarrassed to admit that I had six decimal points on direct labor.

In contrast to the “more” is better philosophy, the most useful and sustainable ABC product and service cost systems are being built with “less” in mind. Complex is out. Simple is in.

It is very common to find anywhere from 50 (small company) to 500 (large company) activities in a company’s activity accounting system. Because most ABC software products allow it, many well intentioned accountants and consultants have developed complex Bills of Activity product cost models. Some ABC models that I have reviewed contain as many as 75 different activity-to-product cost allocation methods. Complex ABC models are certainly more accurate than traditional product cost systems which allocate overhead on a single basis such as labor, material or sales revenue. Complex ABC models, however, are rarely sustained after a pilot project for three reasons:

• There are too many activity-to-cost object data factors (often called second stage cost drivers) to effectively collect.
• There is so much data on the ABC Bill of Activity, the non-financial users of the reports find it too complex to read, interpret and use.
• There are too many data locations to effectively interface or integrate into an ongoing ABC product cost computer system.

A benchmark analysis of ABC implementations shows that best practice organizations limit their activity-to-cost object allocation methods to less than ten (10). For example, an organization with 200 activities was able to effectively allocate cost to hundreds of products and customers using ten ABC allocation methods.

Here are some tips and techniques best practice organizations use to plan their ABC model:

• Print an activity cost ranking report. Do an 80/20 analysis of the activity accounting system. It is very common to find that 20% of the activities consume 80% of the cost. Best practice organizations focus on defining ABC cost object allocation methods for the Top 20 most expensive activities.
• Print a business process report. Do an ABM business process analysis. It is very common to find that 200 activities form 8 to 10 business processes, e.g. Procurement, Order Fulfillment, Budgeting, etc.. Best practice organizations focus on defining ABC cost object allocation methods for the most expensive processes.
• Group all non-traceable activities into one cost pool. Allocate non-traceable activities (i.e. Do Budgets, Issue Payroll Checks) to products, services or customers using a single, fair and logical method. A typical allocation method for the non-traceable cost pool is sales.
• Group activities to match up with your most frequent costing decisions, e.g. feature costing, bid & quote.
• Use common sense to form activity cost pools. Unfortunately, common sense cannot be taught or legislated.

An approximately relevant ABC system is much more valuable than one that is precisely useless. Don’t be unnecessarily exact or complex when creating your ABC product cost system. Create a simple but not simplistic ABC system to match your organization’s decision making needs. Remember, complex is out. Simple is in.