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HISTORY OF ACTIVITY BASED COSTING
Activity based costing (ABC) as a defined subject matter was first introduced in 1987 by Robert Kaplan and Robin Cooper as a chapter in their book Accounting and Management: A Field Study Perspective. Their focus was on manufacturing environments where increasing technology and productivity improvements have decreased the percentage of costs represented by direct labor and materials. What had historically been relatively low percentages of overhead costs (e.g., depreciation from robotics and other automated manufacturing systems) had grown in significance but was not easy to measure since the same systems were used by multiple products.
Whereas direct labor and materials are relatively easy to trace directly to products, it is more difficult to directly allocate costs to products that use common resources. In addition, products may use common resources differently and require some sort of weighting in the cost allocation process. Any time that multiple products share common costs, the danger of crossproduct subsidies exists, wherein one product gets too little cost, overburdening other products with too much cost.
The first extension of ABC into financial institutions was in 1990 in an article appearing in the Journal of Bank Cost and Management Accounting (Volume 3, Number 2) by Richard Sapp, David Crawford and Steven Rebishcke. The authors identified that financial institutions also have diverse product sets which creates opportunities for cross-product subsidies. In this and a subsequent article in 1991 in the same Journal (Volume 4, Number 1), the authors concluded that ABC techniques could be used to more accurately allocate costs in this environment.
In the past five years, the banking industry has undergone significant changes in terms of its sensitivity to staffing levels and related productivity. And, since personnel expenses represent the largest single component of non-interest expense in financial institutions, it logically follows that the industry would be looking for ways to more accurately allocate such costs to products and customers. Activity based costing, as developed for manufacturing, can be a useful tool for doing so.
OBJECTIVES OF COST MEASUREMENT
Before jumping head first into the nitty gritty of ABC, it is worthwhile to review why it is that we worry about such issues in the first place. The overall objectives of cost measurement, which ABC...