Activity-Based Cost Management Practices in India: An Empirical Study

Dr Manoj Anand*
Professor Finance & Accounting Area Indian Institute of Management, Indore Pigdamber, Rau, Indore 453331 (INDIA) e-mail Id: [email protected]

Dr B S Sahay
Director Institute of Management Technology, Ghaziabad (INDIA)

&

Subhashish Saha,
Officer Securities Exchange Board of India, Mumbai (INDIA)

* All correspondence may be made to the first author only. The authors acknowledge the financial support received from the All India Council for Technical Education (AICTE), New Delhi (India)

Activity-Based Cost Management Practices in India: An Empirical Study ABSTRACT This is a study of activity-based cost management practices, in a value-chain analytic framework, being followed by the corporate India. A nationwide survey has been conducted to capture the issues in the design and applications of contemporary cost and management tools. The examination of responses conditional on ABC-adoption revealed that the firms who have adopted ABC were significantly more successful in capturing accurate cost information for value chain analysis and supply chain analysis vis--vis the firms who had not adopted ABC. The extent of ABCM adoption in the service sector had not been found significantly different from that in manufacturing sector. To have detailed information on value added and non-value added activities followed by the need to be competitive in the industry in terms of price quality and performance is the major motivation for the introduction of the activity-based costing. The management motivations for adoption of activity-based costing is significantly higher in case of manufacturing sector firms vis-vis service sector firms only in case of product/service pricing decisions. The need for customer profitability analysis and budgeting led the corporate India to extend their ABC-systems from basic level to advanced level, extending it to facility level and customer level activities.

Activity-Based Cost Management Practices in India: An Empirical Study

INTRODUCTION Johnson & Kaplan (1987)s publication of the book titled 'Relevance Lost' brought revolution in the history of the management accounting. The then management accounting systems failed to provide relevant information for product costing and performance evaluation in the time of rapid technological change, fierce competition, and information processing revolution. The pre-war cost accounting systems were designed to meet the financial reporting and tax planning needs. They failed to provide information for managerial decision-making and control purposes. Drucker (1992) argued that accounting systems should provide answers about their businesses, markets, customers, and environment to information literate manager. Thus, the role of a management accountant expanded in multiple dimensions. They were not just to collect the cost information as accurately as possible but also analyze the utility of the cost information for taking vital managerial decisions. This new paradigm of management accounting called for certain additional skills of the management accountants. Anastas (1997) discussed the changes required in the skill set of the management accountants in view of the Project Millennium: Customers & Future MarketsLooking Ahead to 2007. The newfound utility of cost accounting led to a churning of the whole cost accounting system, its methodology and even it's philosophy in the mid 1980s. The most prominent that emerged out of the whole brain storming process was activity-based cost management system. This system was claimed to have the ability of providing accurate cost information while removing distortions in product/service pricing and customer profitability analysis in a complex manufacturing environment. Cooper (1988a, 1988b, 1989a, 1989b & 1995), Cooper & Kaplan (1988, 1991,1992, 1997 & 1998). For comprehensive review on the subject, see Borden (1990) and Cooper (1996).

The present study plans to identify activity-based cost management practices in corporate India. Further, it investigates whether the corporate India uses contemporary cost management tools in the value chain analytic framework.

REVIEW OF LITERATURE Evolution of Activity-Based Costing Highlighting the limitations of traditional costing systems in overheads cost allocation in a situation of product diversity in terms of volume and complexity Cooper (1988a) illustrated the need for activity-based costing system. Consistent with this research, Cooper (1988b) found that the firms facing high level of competition and having diverse product mix are more likely to benefit from precise cost information and the introduction of activity-based cost systems with an added caution that the activity-based costing system introduction initiative itself should be cost effective. 3

Meanwhile Kaplan (1988) observed that many companies used single cost system to meet their three diverse needs, namely inventory valuation & financial reporting,

product/service/customer costing and providing operational feedback to frontline employees in the plant. However, he apprehended that, in a complex manufacturing environment with product and process diversities, and concern for excellence, single cost system for all the three needs might not suffice. With the help of case studies of Siemens Electric Motor Works, John Deere Component Works, and Schrader Bellows Cooper (1989b) demonstrated that the management objectives and diversity of product mix determine the extent of the complexity in the design of activity-based cost management systems. The competitive environment in which the firm is operating drives the need for activity-based costing. Cooper & Kaplan (1997 & 1998) argued that operational control and activity-based cost systems are two separate systems as they have different purpose and different requirements for accuracy, timeliness, and aggregation. Any attempt to integrate the both be made with utmost care otherwise it would perform neither function well. The operational learning & control system provides economic feedback about process efficiencies by using actual & highly accurate data on continual basis in respect of each responsibility center. The emphasis is on short-term fixed and variable costs and the cost centers are expenses actually recorded in the financial system. Product, customer, and business-unit profitability are the objectives of the activity-based cost systems. It uses standard cost data based on standard cost driver rates and practical capacity of organizational resources and updates it periodically for the entire value chain. The well-designed integrated cost management system will help the management of company to identify opportunities for continuous improvement and point out unused capacity or capacity constraints, if any and will facilitate the introduction of activity-based budgeting in the organization. The activitybased budgeting mindset makes all cost variable and attempts to match resource supply to resource demand.

Activity-Based Costing Issues in Implementation The activity-based cost systems are superior to traditional costing systems and they could fail due to poor implementation process (Ness and Cucuzza (1995), Player and Keys (1995) and Pattison & Arendt (1994). Jayson (1994) found in response to Management Accounting s first fax survey that implementing activity-based costing is worth the investment. The most common problem reported was the difficulty in identifying the cost drivers. The firms top-level manager champions the ABC project; cross-functional teams, process orientation and adequate training to the employees on the ABC; linkages between activitybased team oriented performance metrics to the compensation plan; decision-making at shop-floor level, who have process knowledge; and review ABC implementation initiative in long-term perspective were the key success factors for ABC implementation found Shield (1995) and Shields & Young (1989).

The top management support, ABCM-linked performance evaluation and compensation plans, number of applications of ABCM in the organization and time-in-use of application have been found to be ABCM success determinants by Foster and Swanson (1997). Brown et al. (2004) found the association between organizational size and initial interest in activity-based costing significant. Based on the survey findings of the Cost Management Group of the Institute of Management Accountants, 1996 Krumwiede (1998) reported the activity-based costing adoption status and factors affecting its success. They got 178 responses with a 16% response rate. The 49% of the respondent firms had adopted the activity-based costing systems. The 25% of the nonadopting companies were considering its introduction in their organization. Only 5% of the respondent firms had rejected it after careful examination. The top management support, information technology sophistication, large size firms, and integration with the financial system were the factors affecting the usage of the activity-based costing. The use of activity-based cost system is found to be positively correlated with the firm size. The organizational factors such as top management support, non-accounting ownership and the training were found to be vital in the successful implementation of the activity-based costing. Shaw (1998) observed that one of the biggest challenges to adoption of activity-based costing/management is increased adoption of enterprise-wide resource planning systems. Will ABC/M system be able to complement the ERP-architecture is an issue. SAP AG, ERP vendor made a substantial equity investment in ABC Technologies (developer & producer of windowbased ABC/M applications OrosTM) in September 1998. Oracle purchased Activa (an ABC/M tool developed by PricewaterhouseCoopers) and PeopleSoft have entered into partnership with KPMG to develop its activity accounting module. The role of the management accountant will thus change from scorekeeping to strategic advisor. Endorsing the role of implementation process, Anderson and Young (1999) in a study of 21 filed research sites of two firms examined the relationship between activity-based costing systems, contextual factors, and factors related to ABC implementation process by using survey and interview process. They found that implementation process has clear influence on the ABCM success and the contextual setting directly influences the process and outcome. The criteria for success of ABC systems is its ability to provide more accurate cost data vis--vis traditional cost systems and usage of ABC cost data for cost reduction and process improvement.

Applications of Activity-Based Costing Innes and Mitchell (1995) survey of activity-based costing practices in the 251 UK companies listed in The Times 1000 (1994) found that 19.5% of the respondents had adopted ABC and 27.1% were considering its adoption. The extent of its adoption in the non-manufacturing sector had not been found significantly different from that found in manufacturing concerns. The ABC users had considered its applications in the areas of cost reduction, product/service pricing, performance measurement, & improvement, and cost modeling. The inventory valuation use had the lowest adoption rate amongst ABC users. Dugdale and Jones (1997) follow-up survey to Innes

and Mitchell (1995) questionnaire of large UK firms adopting activity-based costing has found that only three companies used ABC for stock valuation as against reporting of 14 companies, when strong definition of ABC was applied. Innes et al (2000) 1999 survey of activity-based cost management practices of 177 UK's largest companies had assessed the changes that had occurred in the ABC adoption status over a five-year period. The ABC adoption / under consideration rate has fallen to 17.5% and 20.3% from 21% and 29.5% respectively. The highest adoption rate is in the financial sector. In terms of scale, the median activity-based cost accounting systems design included 40 (1994: 14) cost objects, 52 (1994: 25) activities, 22 (1994: 10) cost pools and 14 (1994: 10) cost drivers. The ABC rejection rate has increased from 13.3% to 15.3% during this period. Cost reduction, pricing, performance measurement / improvement and cost modeling continued to be the most commonly used areas for activity-based costing. The top management support to the ABC implementation initiative and to a lesser extent, with its use to support quality initiative determined its success In a survey of 132 US companies, Foster and Swanson (1997) found that all of them were using activity-based cost management, when they responded. The decision use of ABCM, management use of dollar improvement and the overall net benefits as success measure yields the highest explanatory power. Groot (1999) survey of US food and beverages industry found that 18% of the respondents had implemented activity-based costing and 58% were considering its implementation. Joshi (2001) in a survey of 60 large and medium-sized manufacturing companies in India found adoption rate of 20% for activity-based costing, 13% for activity-based management, and 7% for activity-based budgeting. The size in terms of total assets has been found to be significant factor in adoption of these contemporary management accounting techniques. The traditional management accounting techniques have been emphasized more vis--vis contemporary techniques because of higher perceived benefits. Narasimhan and Thampy (2002) designed activity-based costing system for ascertaining service cost for different customers with a case study of two branches of a large Indian private sector bank. The use of activity-based cost information in benchmarking, branch network restructuring, business process outsourcing, and identification of value-added and non-value added activities has been argued.

Activity-Based Costing & Firm Value Bromwich and Bhimani (1989) observed that though activity-based costing corrects the product-cost distortions but no such study has been done to demonstrate that it increases the profitability of the firm (Shim and Stagliano 1997). Groth and Kinney (1994) observed that success at cost management could have substantial impact on the firm value. Hubbell (1996) argued in

favour of integrating activity-based cost management systems with the measures of shareholder value such as economic value added. The resultant integrated cost management systems could provide better governance mechanism for improving processes, optimizing the use of capital and thus create shareholder value.

Gordon and Silvester (1999) examined the performance of ten ABC user firms vis--vis their matched size- and industry-controlled counterparts who have not adopted activity-based costing. Though ABC user firms had abnormal returns on the date of announcement but not statistically significantly different from their counterparts. Thus, they questioned the adoption of activity-based costing if it does not lead to creation of firm value. Malmi (1999) found that firm superior performance subsequent to activity-based costing adoption revealed that the ABC adoption decision was rational value-enhancing choice and it was not a fad or fashion or forced selection. Shield and McEwen (1996) reported that 75% of the ABCusers found it financially beneficial decision. The success in ABC implementation is based on top management support, compensation and training (McGowan and Klammer 1997). Ittner et al. (2002) examined the association between the extensive use of activity-based costing and plant level operational & financial performance indicators such as cycle time, quality, manufacturing cost improvements and return on assets. The quality variable was captured through finished product first pass quality yield in percentage terms and scrap & rework cost as a percentage of sales. They survey questionnaire was mailed to 25,361 US firms who have subscribed to Industry Week. They received a response from 2789 firms, resulting in a response rate of 11%. They found 26% of the respondents did use activity-based costing extensively. They found moderate evidence that activity-based costing use is positively associated with the manufacturing performance. They demonstrated through path analysis that activity-based costing use has a positive indirect association with manufacturing cost reduction through improvements in quality and cycle time. No significant association with return on assets of activity-based costing use was observed. Kennedy and Affleck-Graves (2001) examined the link between activity-based costing implementation and creation of shareholder value using Rappaport (1986) framework and event study methodology (Brown and Warner 1980 & 1985). They got responses from 47 ABC users and 187 non-ABC users. They found that choice of management accounting system such as activitybased costing for a sample of UK firms had a significant impact on firm value (27% over the three years from the beginning of the year in which activity-based costing was first introduced). The impact of activity-based costing on firm performance may be indirect through the mediating influence of other variable (Shields et al. 2000). Cagwin and Bouwman (2002) in their survey of 210 internal auditors found that the firms with diverse product portfolio and with high proportion of overheads cost when they have adopted activity-based costing along with other strategic initiatives such as JIT and TQM, it resulted in substantial improvement in their return on investments. The other enabling conditions for the efficacy of the ABC in the organizations are sophisticated information technology systems, absence of excess capacity and competitive environment.

Research Design Nation-wide Management Survey A draft questionnaire was developed based on comprehensive review of existing literature to conduct a survey. It was circulated to a group of prominent academics and Chief Financial Officers (CFOs) of Corporate India for their feedback as a part of pilot study. Their suggestions were incorporated and the questionnaire was revised. The final questionnaire contained 34 questions. A glossary of the terms used in the questionnaire was provided to the respondents for ready reference at the end of the questionnaire. The survey asked the CFOs to respond to the questions such as management motivation on adoption of a particular cost management on the likert scale of 0 to 5 (where 0 means "not used;" 1 means "unimportant;" and 5 means "very important"). This approach has provided data on the method used and relative importance of each method in the decision making process. The management perception of quantum change observed in different decision-making areas because of implementation of Activity-based cost management systems (ABCM) was captured on a scale of 1 to 5 (where 1 means " no change;" and 5 means " very significant change"). HYPOTHESES OF THE STUDY The study plans to test the following hypotheses, which have been developed based on review of existing literature on activity-based cost management. H1 The firms using activity-based costing systems are likely to be more successful in capturing accurate cost and profit information for: a) b) c) d) e) f) H2 product pricing; customer profitability; inventory valuation; value chain analysis; supply chain analysis; and outsourcing decisions vis--vis the firms that follow traditional costing system

The management motivations for adoption of activity-based costing are significantly different between the firms: i) ii) in the manufacturing sector and the service sector; and who have adopted fully integrated cost management and financial reporting systems with ERP and the firms who have introduced activity-based costing systems as supplementary and offline.

H3

The quantum of change and incremental cash benefits observed by the management of the firms in various dimensions of performance varies with: i) ii) the level of adoption of activity-based costing system; and respect to nature of the industry and the extent to which ABCM system has been integrated with the other decision support systems.

H4

The ABCM-user respondent firms use activity-based cost management in a value chain analytic framework. 8

Research Methodology The activity-based cost and performance management systems are required for accurate cost and profit analysis, when the organizations have high overheads cost and diversity in their processes and products. It is expected that only large-size companies with these characteristics will implement contemporary cost and performance management systems. Every year, Business Today (bt) features a report on Indias most valuable 500 companies and ranks them based on their market capitalization. In its issue dated October 6, 2000 it carried a report of 500 companies in the private sector and 75 most valuable public-sector undertakings (PSUs) for the year 1999-2000. These constitute the universe of corporate India for the present study. The subsidiaries of multinational corporations (MNCs) form a major constituent of the Indian corporate sector; an effort was made to get responses from this segment also. Fifty-three completed questionnaires have been received. The forty-nine responses were from bt-575 companies and four were from unlisted Indian subsidiaries of MNCs. The industry composition of the sample is as in Table 1. The study is essentially of large-sized corporate firms using activitybased cost management and performance scorecard. The abstinence to respond to the questionnaire may be due to their concern for sensitivity of the cost and performance measurement data. Given the length (20 pages) and depth (34 questions and more than 350 subparts) of the questionnaire, this response rate compared favorably with other academic surveys. Table 1: Industry Composition of Sample Industry Consumer Durable, Personal Care & Food Products Engineering & Capital Goods Chemicals & Pharmaceuticals Power Generation & Transmission Tractors Automobiles & Auto Ancillary Construction, Cement & Building Material Information Technology Software Oil & Gas and Petrochemicals Telecom & Electronics Equipment Tyres Diversified Iron Ore & Non-Ferrous Metals Textiles Others (Logistics, Banking, Telecom services Consultancy airline services trade services etc) Total Sample Size 7 6 4 4 4 4 3 3 3 2 2 1 1 1 8 53 In order to verify how far the sample obtained from the survey is a true representation of the population, a statistical test was carried out on firm-size profitability and risk criterion. In this test certain key attributes namely sales, total assets, market capitalization, operating profit, return 9 Sample proportion 13.21 11.32 7.55 7.55 7.55 7.54 5.66 5.66 5.66 3.77 3.77 1.89 1.89 1.89 15.09

on capital employed, return on net worth, debt to equity ratio, and beta of the population and the sample were compared using non-parametric Mann Whitney's-U test. The test (Table 2) revealed that there is no significant difference between the means of the complete population of bt-500 companies and the sample for all the attributes except beta as a measure of risk. The difference in the mean values of beta has been observed at 5% significance level. Table 2: Comparison of various attributes of population vis--vis sample Attributes Market capitalization (Rs in crores) Population/ Sample Population Sample Sales (Rs. In crores) Population Sample Total assets (Rs in crores) Population Sample Operating Profits (Rs in crores) Population Sample Return on Capital Employed (%) Population Sample Return on Net Worth (%) Population Sample Debt to equity ratio Population Sample Beta Population Sample 1393.21 3128.0 1727.79 4120.77 4241.36 3871.28 287.23 329.68 24.29 23.57 8.03 12.91 1.04 1.17 0.84 0.64 Mean Standard Deviation 4895.48 7966.23 7006.86 17887.11 18995.77 10793.11 1328.47 948.89 30.29 22.69 44.99 19.01 4.71 2.35 0.54 0.29 Asymp. Sig. (2tailed) 0.436

0.862

0.325

0.712

0.866

0.96

0.63

0.029

The correlation coefficients between the various financial attributes of the respondent firms and that of the population are examined to judge the quality of the sample and are reported in Table 3 and Table 4 respectively. There is a significant positive correlation between the different variables of the size (sales, assets and market capitalization) both in the sample and the

population. There is a significant positive correlation between the size variable and the operating profits variable both in case of sample and the population. There is no significant positive

correlation between the size and the profitability ratios. There is a negative correlation between the debt to equity ratio and the return on capital employed. It is significant in the case of the sample.

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Table 3: Correlation between the various attributes of the respondent firms Sales Assets Market Capitalization (MCAP) Operating Profits (OP) Return on Net Worth (RONW) Return (ROCE) Debt to equity ratio (D/E) Beta -0.009 0.097 -0.013 0.166 -0.100 0.452*** -0.068 0.153 -0.345** -0.085 -0.107 -0.123 0.375** on Capital Employed 0.854*** 0.704*** 0.749*** 0.087 0.005 0.698*** 0.956*** 0.054 -0.014 0.802*** 0.351 0.204 0.169 0.072 0.816*** Assets MCAP OP RONW ROCE D/E

***, ** indicate significant at 1% and at 5% respectively. Table 4: Correlation between the various attributes of the bt-500 companies Sales Assets Market Capitalization (MCAP) Operating Profits (OP) Return on Net Worth (RONW) Return (ROCE) Debt to equity ratio (D/E) Beta 0.016 -0.018 0.059 -0.039 -0.005 0.011 0.037 -0.048 -0.022 -0.061 -0.039 -0.212*** -0.041 on Capital Employed 0.425*** 0.637*** 0.453*** 0.01 0.068 0.401*** 0.960*** 0.008 0.288*** 0.478*** 0.067 0.098** 0.096** 0.331*** 0.378*** Assets MCAP OP RONW ROCE D/E

***, ** indicate significant at 1% and at 5% respectively.

Since the firm size, profitability and risk attributes are not significantly different between the sample and the population both individually and in cross section the sample is assumed a fair representative of the population. Out of the fifty-three responses to the nation-wide survey of contemporary cost and performance management practices, twenty-six respondents are using activity-based cost management systems. Analytic tools used For the survey questionnaire data analysis, the firms have been classified based on sector (manufacturing/service), ABC adoption (yes/ no), stage of ABC adoption (supplementary/ fully integrated), and the level of ABC adoption (Manufacturing overheads / marketing and distribution overheads). The student t-test has been used to investigate whether management's motivations and decision choices differ across firms' cost management systems and sector. To test the hypothesis that the firms using activity-based costing system are likely to be more successful in capturing accurate cost and profit information for decision analysis student t11

test has been used to investigate the difference between the mean values of the responses of nonABCM and ABCM users. Spearman's rank correlation coefficient matrices have been developed between decision action taken and managerial evaluation of success achieved; and incremental cash benefits and managerial evaluation of success achieved in Foster and Swanson (1997) framework. To find out the difference, if any in the management motivations for adoption of activitybased cost systems across sector and its stage of implementation, student t-test has been used. To investigate the quantum of change observed by the management on different performance variables across sectors, ABCM level and stage of adoption, student t-test has been use. Spearman's rank correlation coefficient matrices have been developed between the various measures of decision action taken and incremental cash benefits To examine whether activity-based cost management is practiced in a value chain analytic framework, the survey questionnaire asked the ABCM user respondents to indicate quantum change in different decision areas of cost management subsequent to its implementation. To test this hypothesis, factor analysis, and two-group linear discriminant analysis has been used. The principal axis factoring instead of principal component analysis has been used as suggested by Warming-Rasmussen and Jensen (1998); Kwok and Sharp (1998); Fabrigar et. al. (1999); and Tansey et. al. (2001). For reporting purpose, items with highest factor loadings have been reported. The other factor loadings reported are only if the difference from the higher one is less than 0.20. These are rotated factor loadings obtained using varimax rotation.

Limitations of the Study Whatever the respondents have said is believed to be their true response and hence, no statistical test has been performed to study non-response bias and the consistency of individuals responses. Another limitation of the methodology used is that it measures beliefs and not necessarily actions. Overall, the versatility in the characteristics of respondents and firms allow the present study to examine the practice of activity-based cost management vis--vis theory.

Existing Cost Management Practices The activity based costing system assumes that products consume activities and activities consume costs. It leads to more precise allocation of manufacturing overheads amongst the products. The activity-based costing system can be extended to the administration overheads and the marketing and distribution overheads allocation amongst the products for customer profitability analysis and channel analysis. The introduction of ABC system in an organization can be either supplementary to the traditional cost accounting system as an offline system or it can be fully integrated with the decision support systems such as ERP. The present study reveals that the corporate India has more than one cost management system in use (Table 5). Half of the respondents do use absorption costing system for product costing and financial reporting purpose. These results are consistent with the findings of Joshi (2001) in the Indian context. International surveys reports 50% to 70% of the companies use

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absorption costing for external reporting and tax reporting purpose ( Inouse, 1988; Blayney and Yokoyama, 1991). The use of standard costing is popular worldwide. More than 75% of the firms use it in USA, UK, Ireland, and Sweden ( Cornick et al., 1998; Drury et al. 1993; Clarke and Brislane, 2000; and Ask and Ax, 1997). Scarbrough et al. (1991) finds that 65% usage of standard costing in Japan. In India, slightly less than two-third of the respondents use standard costing as a cost control technique as compared to 68% usage found by Joshi (2001). The activity-based costing system introduction in corporate India has picked up momentum as 20.75% of the respondents are using it as supplementary/ offline and 28.30% of the respondents have integrated the activity based costing systems with ERP systems. Table 5: Present Cost Management Systems being followed by Corporate India Sl. No. Cost management system i. a) b) c) d) ii. a) b) Traditional Cost accounting system Throughput costing Absorption costing Variable costing Standard costing Activity-Based Costing system Supplementary / offline Fully integrated cost management and financial reporting system with enterprise resource planning (ERP) system. 20.75 28.30 13.2 54.7 45.3 64.2 Percentage of respondents

Success of existing cost management systems Table 6 investigates the success of the existing cost management systems in terms of capturing the accurate cost information for product pricing, inventory valuation, value chain analysis, supply chain analysis and outsourcing decisions. 52.8% of the respondents have achieved success in application of their present costing system in product pricing and inventory valuation. The success ratio in the area of value chain analysis & supply chain analysis and outsourcing decisions is 22.7% and 28.3% respectively. The Table further exhibits the success of the existing cost management practices in accurate profit analysis by product, department, process, and customer. The survey revealed that 54.8% of the firms were successful in accurate profit analysis by product, 24.6% by process and 30.2% by department and customer. 43.4% find it useful for benchmarking and budgeting while 34% find that it provides better insight about manufacturing performance. The examination of responses conditional on ABC-adoption reveals that the firms who have adopted ABC are significantly more successful in capturing accurate cost information for value chain analysis (mean score of 2.5385 verses 1.2963) and supply chain analysis (mean score of 2.2308 verses 1.4444) vis--vis the firms who have not adopted ABC. Thus, the hypothesis H1

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to the extent of the success of activity-based cost management in value chain and supply chain analysis vis--vis traditional costing system is accepted. Table 6: Success Achieved in the Application of Present Costing System to Capture Accurate Cost Information Sl. No. i. a) b) c) d) e) ii. a) b) c) d) iii. iv. Very Successful / Completely Successful Mean Score Aggregate Non-ABCM User 3.00 2.8148 1.2963 1.4444 1.8148 2.9630 1.8519 1.6296 1.8148 2.4074 2.3333 ABCM User

Areas Accurate cost information for Product pricing Inventory valuation Value chain analysis* Supply chain analysis Outsourcing decisions Accurate profit analysis By product By process By department By customer Better insight for benchmarking and budgeting Better insight about manufacturing performance

52.8% 52.8% 22.7% 22.7% 28.3% 54.8% 24.6% 30.2% 30.2% 43.4% 34%

3.283 3.0377 1.9057 1.8302 2.1132 3.1321 2.0189 2.1132 2.0566 3.0566 2.6604

3.5769 3.2692 2.5385*** 2.2308* 2.4231 3.3077 2.1923 2.6154* 2.3077 3.7308*** 3.0000

*, **, *** indicate significant at 10%, 5%, and 1% level respectively.

Activity- based cost management applications in India. Activity-based costing technique has gained appreciable acceptance during the post 1990s in India as 26 respondents firms out of 53 are using it for product pricing and operational feedback. 42.3% of the ABC-user firms are using ABC in their company for more than two years. This ABC adoption rate compares favorably with nearly 38% in India in 1999, 26% in the USA, 20% in UK and 40% in Norway (Business Today, 1999; Innes and Mitchell, 1995; Innes, et. al. 2000; Ittner et.al.2001; and Bjemenak, 1997). The study reveals that 76.92% of the ABCM users firms are in the manufacturing sector and 23.08% in the service sector. The extent of ABCM adoption in the non-manufacturing sector had not been found significantly different from that in manufacturing concerns in the UK (Innes and Mitchell, 1995). Interestingly in USA, the highest adoption rate of ABCM is in the financial sector ( Innes, et. al. 2000). 57.69% of the ABCM-users firms have fully integrated cost management and financial reporting systems with enterprise resource planning system. 57.69% of the ABCM-user respondent firms have extended their ABC systems to advanced stage extending it up to facility level and customer level activities (Table 7). Seventy-six percent users of the activity-based

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costing in Canadian firms have implemented the system as supplementary and offline ( Armitage and Nicholson, 1993). Table 7: Categorization of the sample ABCM-user firms. Sector ABCM adoption stage ABCM adoption level Manufacturing Service Supplementary Fully Basic Advanced Integrated Number of respondents % of respondents 20 76.92% 6 23.08% 11 42.31% 15 57.69% 11 42.31 15 57.69%

Management motivations for introduction of activity-based costing The major motivations for introduction of activity-based costing are accurate cost information for product/service pricing and profits analysis, improved insight into cost drivers, accurate customer profitability analysis, cost reduction, process improvements, product mix strategy, performance measurement & improvement, and cost modeling. The inventory valuation use had the lowest adoption rate amongst ABC users. ( Armitage and Nicholson, 1993; APQC/CAM-I, 1995; Innes and Mitchell, 1995; Clarke, 1996; and Clarke and Mullins, 2001) Table 8 explores the management motivation for introduction of activity based costing in the organization amongst ABCM-user respondent firms. 73.1% of the ABCM-user respondent firms consider the need to have detailed information on value added and non-value added activities as major motivation followed by the need to be competitive in the industry in terms of price quality and performance (69.3%). The other major motivations are to have increased information about the activities, the cost associated with the activities, and activity cost drivers for customer profitability analysis, product pricing decision and budgeting. The design of performance measurement and control system based on ABC systems is another major motivation (57.7%).

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Table 8: Management motivations for introduction of activity-based costing Most Important Aggregate Mean score Servic e Manufacturi sector ng sector ABCM Offline ABCM fully Integrate d 3.9393 2.5333 3.0667

Motivation

To have detailed information on value-added and non value-added activities To correct the distortion in overheads cost allocation To identify activities that consume non value-added time To have increased activity-wise information on: Budgeting Product pricing decisions Customer profitability analysis Value chain analysis and reengineering Benchmarking Outsourcing decisions Substitute products To be competitive in the industry in terms of price, quality and performance To design ABC-based performance measurement system To compute economic value added* while using activity-based cost information To have improved inventory valuation. To meet the customers conditionalities while tendering To use it as a vehicle for change management in the organization To provide accurate information for transfer pricing

73.1% 42.3% 38.5%

3.7308 2.4231 2.9615

3.75 2.30 2.80

3.667 2.833 3.50

3.4545 2.2727 2.8182

69.3% 61.6% 53.8% 42.3% 42.3% 34.6% 15.3% 69.3% 57.7% 42.3% 38.5% 34.6% 34.6% 26.9%

3.4231 3.1538 2.7692 2.8846 3.00 2.3077 1.4615 3.5769 3.1154 2.6154 2.4615 1.9231 2.1923 1.7308

3.75 3.65 2.65 3.30 3.05 2.50 1.40 3.55 3.0 2.75 2.75 2.20 2.45 1.75

2.3333 1.50* 3.1607 1.50 2.8333 1.6667 1.6667 3.6667 3.50 2.1667 1.50 1.00 1.3333 1.6667 1.3333

3.000 3.00 3.00 2.2727 2.7273 1.9091 1.3636 3.6364 2.7273 2.0000 2.1818 1.8182 1.7273 1.5455 1.0000

3.7333 3.2667 2.60 3.3333 3.20 2.600 1.5333 3.5333 3.40 3.0667 2.667 2.000 2.5333 1.8667 0.6667

Band wagon effect 15.4% 0.8077 0.65 *, **, and *** indicate significant at 10%, 5% and 1% respectively.

The management motivations for adoption of activity-based costing is significantly higher at 10% level of significance in case of manufacturing sector firms vis--vis service sector ABCMuser respondent firms only in case of product/service pricing decision, as evident from Table 8. The major management motivations in the banking sector are to have activity-based cost information for budgeting, economic value added computation, correct allocation of overheads cost and to identify value-added and non-value added activities. Thus, there is no significant difference

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in the levels of management motivation for introduction of Activity-Based costing between manufacturing sector and service sector firms. Hence, the hypothesis H2 (i) stands rejected. There is no significant difference in the management motivations for adoption of activitybased costing between the firms who have adopted fully integrated cost management and financial reporting systems with ERP and the firms who have introduced activity-based costing systems as supplementary and offline. Hence, the hypothesis H2 (ii) stands rejected. The need for customer profitability analysis, budgeting and to identify activities that consume non value added time led the corporate India to extend their ABC-systems from basic level to advanced level, extending it to facility level and customer level activities. Investment analysis of activity-based costing project The investment cost in implementation of ABC is either insignificant or less than 1% of the sales and accordingly payback period is less than one year. Most of the ABCM-user respondent firms did not carry out DCF analysis of activity based costing implementation project. Table 9 indicates that 7.7% of the ABCM-user respondents, who did it, found difficulties in identifying the beneficiaries of ABCM implementation and in quantifying the benefits in terms of cash. 73.1% of the ABCM-user firms used in-house cross-functional team for ABC implementation in the organization as against 3.8% who engaged consultants for this purpose.

Table 9: DCF analysis of ABCM implementation project Sl. No i. ii. iii. Issues Discounted cash flow analysis (DCF) of the investment in activity based costing implementation project Difficulties in identifying the beneficiaries of ABC implementation Difficulties in quantifying the benefits in terms of cash Percentage of the respondents 7.7 23.1 26.1

Problems in the implementation of the activity-based costing The activity-based costing systems fail because of the poor implementation process ( Ness and Cucuzza 1995; Player and Keys 1995; and Pattison & Arendt, 1994). The major problems faced during the implementation of activity based costing by the ABCM-user respondent firms are developing activity dictionary (34.6%), inability of traditional costing system to capture the information needs of ABC (42.3%) and lack of review of ABC implementation initiative (30.8%), as evident from Table 10. Interestingly resources, both management time and funds have not been found to be limiting factor. The other problem areas are identifying the cost drivers, assigning the cost to the activity pools and computer software & technical expertise.

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Table 10: Problems faced during the implementation of ABCM Sl. No. Problems faced during ABC implementation i. ii. iii. iv. v. vi. vii. viii. ix. Inability of traditional costing system to capture the information needs of ABC Difficulties in developing Activity dictionary Lack of review of ABC implementation initiative Difficulties in assigning the cost to the activity pools Difficulties in identifying the cost drivers Inadequate computer software and technical expertise Lack of team awareness and training Lack of adequate resources (management time and funds) Lack of employee and middle management support due to the perceived threats of transparency Percentage of respondents 42.3 34.6 30.8 26.9 23.1 23.1 11.5 7.7 4

Activity-based costing and firm performance The introduction of activity-based costing system amongst respondent firms has brought quantum change and associated incremental cash benefits in different areas such a focus on profitable customers, change in product pricing strategy, elimination of redundant activities through the entire value chain, product mix and outsourcing decisions. It led to change in the strategic focus (Table 11). In banking sector, the management of the respondent firms has observed substantial change in their focus on profitable customers & business process outsourcing, and reconfiguring the value chain subsequent to implementation of activity-based costing. No significant difference in the quantum of change has been observed among the ABCM-user respondent firms across sector (manufacturing vs. service) and ABCM stage (basic vs. advanced). Hence, the hypothesis H3 (i) and H3 (ii) stands rejected.

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Table 11:

Quantum change subsequent to ABCM implementation in different decision areas Most Mean score Aggregat e 2.1154 2.3077 1.9231 1.9615 2.1538 1.8462 1.6923 1.7308 1.5385 1.5769 Manufactur ing sector 2.10 2.45 2.0 2.0 2.25 2.10 1.85 1.90 1.50 2.40 Service sector 2.1667 1.8333 1.1667 1.8333 1.8383 1.0 1.1667 1.1667 1.6667 2.1667 ABCM Offline 1.6364 2.00 1.5455 1.4545 1.9091 1.6364 1.2727 1.3636 1.4545 1.9091 ABCM fully Integrate d 2.4667 2.5333 2.20 2.3333 2.3333 2.00 2.00 2.00 1.6000 1.3333 ABCM at basic stage 1.9091 1.9091 2.0909 1.00 1.9091 2.0909 1.7273 1.5455 1.3636 1.00 ABCM at advanced stage 2.2667 2.60 1.80 2.2667** 2.3333 1.6667 1.6667 1.8667 1.6667 2.00

Motivation

Important (%)

i. ii. iii. iv. v. vi. vii viii ix x

Focus on profitable customers Changed pricing strategy Outsourced activities / processes Changed strategic focus Eliminated redundant activities through the entire value chain Changed product mix Changed distribution channels Changed processes Changed sourcing decisions Changed incentive compensation

46.2 46.2 34.6 34.6 34.6 30.7 23 19.2 19.2 19.2

*, **, and *** indicate significant at 10%, 5% and 1% respectively.

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The factor analysis of decision actions taken by the ABCM-user respondent firms yields two prominent factors as reported in Table 12. The factors are identified as decision areas beyond the boundaries of the firm and within the boundaries of the firm as in value chain analysis ( Shields and Young, 1992; Shank & Govindrajan, 1995; Goldsby & Closs, 2000; Hooper et. al., 2001). The model has a KMO score of 0.743 and variance explanatory power of 73.421%. The variables included in the decision areas beyond the boundaries of the firm are focus on profitable customers, sourcing decisions, elimination of redundant activities, distribution channels, and strategic focus. The product mix, process simplification, and product pricing are included in the decision areas within the boundaries of the firm. Table 12: Factor analysis results of quantum change subsequent to ABCM implementation in different decision areas KMO score: Sl. No. Decision action areas I ii iii iv v vi vii viii ix x Changed product mix Changed processes Outsourced activities / processes Focus on profitable customers Changed pricing strategy Changed strategic focus Changed sourcing decisions Eliminated redundant activities through the entire value chain Changed incentive compensation Changed distribution channels Eigen value % of variance explained 0.743 Percentage of variance explained: 73.421% Beyond the Within the boundaries of the boundaries of the firm firm 0.829 0.819 0.622 0.708 0.674 0.530 0.669 0.908 6.287 62.873 0.614 0.587 0.408 1.055 10.548

In order to substantiate the argument, linear discriminant analysis was used with decision areas as sample and ABCM-user respondent firms response as variables. A priori classification independent of Factor analysis results was used. It classified decision areas into two categories based on value chain framework, one beyond the boundaries of the firm and other within the boundaries of the firm. The decision areas within the boundaries of the firm are product mix, process simplification, product pricing and compensation strategy. The decision areas beyond the boundaries of the firm are focus on profitable customers, sourcing decisions, elimination of redundant activities, distribution channels, and strategic focus. Based on a priori classification the decision areas were completely discriminated (100% accuracy level). The results of linear discriminant analysis are as in Table 13.

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Table 13: Linear Discriminant analysis results of quantum change subsequent to ABCM implementation in different decision areas Eigenvalue 178.449 % of variance explained 100 Cannonical correlation 0.997 0.006 Wilks' 2 20.768 Significance 0.008 Correct classification 100 From the foregoing analysis, it can be concluded two factors identified in the factor analysis were actually decision areas beyond the boundaries of the firm and decision areas within the boundaries of the firm, for cost management. Thus, the hypothesis H4 that ABCM-user respondent firms use activity-based cost management in value chain analytic framework stands accepted. The respondent firms in their estimate of incremental cash benefits subsequent decision action taken as a result of activity based costing implementation found appreciable results in the area of product pricing budgeting, customer profitability analysis and product improvement opportunities (Table 14). Table 14: Incremental Cash benefits associated with the introduction of ABCM Sl. No. Implementation area i. ii. iii. iv. v. vi. vii. viii. ix. x. xi. Product pricing decision Budgeting Customer profitability analysis Product improvement opportunities Working capital management Process improvement opportunities Make or buy decision ABC-based performance measures Value chain analysis Transfer pricing Value based management tools such as EVA / RAVE* Significant benefits (Percentage of respondents) 34.6 30.8 30.7 26.9 23 19.4 19.4 19.2 19.2 11.5 11.5 Mean score 1.7692 1.8462 1.8077 1.6538 1.6154 1.4231 1.3846 1.6154 1.5000 0.9615 1.2692

CONCLUSIONS The present study of activity-based cost management practices in the Indian industry is unique in terms of its scope and methodology followed. It not only deals with traditional cost management techniques but also with contemporary management tools such as activity-based costing. The hypotheses in general deal with the difference in the practices across sectors, stages, and level of adoption of contemporary techniques. Factor analysis has been used to verify the existence of normative approach to the cost management in Indian industry. The survey shows an encouraging response of the Indian corporate sector to the activitybased costing with 49% (n = 26) of the respondents adopting it. The firms are successful in 21

capturing accurate cost and profit information from their ABC cost systems for their value chain and supply chain analysis vis--vis non-ABC user firms. The need for activity-wise cost information in budgeting, product pricing decision and customer profitability analysis has urged the management of the Indian firms to adopt activity-based costing systems. No significant difference has been found in the in the motivation to adopt ABCM across the manufacturing as well as service sector and across the stages of activity-based cost system adoption

(supplementary/offline). This implies that activity-based costing has equal opportunities in both the sectors and the motivations are uniform over the stages of adoption. The major difficulties faced by the ABCM-user respondent firms while designing activity-based cost systems are developing activity dictionary & cost drivers and lack of review of ABCM implementation initiative. Application of activity based costing has resulted in changes in various management decision areas, prominent among them, being focus on profitable customers, pricing strategies, and sourcing decisions. However, the quantum of change observed is not found to be a characteristic of sector (manufacturing vs. service) and level or stage of ABC implementation. Application of ABCM has impact not only on the decisions within the firm but also on the decisions beyond the boundaries of the firm as evidenced by the factor analysis and linear discriminant analysis of responses of activity-based costing user firms. The decision areas beyond the boundaries of the firm include focus on the profitable customers, sourcing decisions, elimination of redundant activities, distribution channel, and strategic focus. The product mix, process simplification, and product pricing are included in decisions within the boundaries of firm. Thus, it can be inferred that ABCM in India is practiced in the value chain analytic framework. Due to limited scope of the present study, a number of research issues are not attempted but are felt in the course of study. Some of them are one, to follow up the respondents claim on the impact of activity-based costing on their firm performance either through a case study or through an event study using stock market data. Two, to examine the relationship between the

organizational influences & technological factors and the adoption of activity-based costing system by the firm.

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