Accountancy & Management: Businessmen learn their ABC: Roger Trapp reports on an innovative accounting technique that is not quite as simple as it sounds

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The Independent Online
'DO NOT put all your eggs in one basket' is a warning often repeated in business. However, it can be hard for a small company to resist what appears to be a lucrative and secure supply contract from a large operator that sucks up an overwhelming proportion of its capacity.

In truth, though, such an arrangement may not be as good as it seems - and may be unprofitable - as a client of Robin Bellis-Jones, an activity-based cost management consultant, discovered when it examined its finances.

Ordinarily, a company in such a position would be faced with the dilemma of whether to soldier on under the arrangement or to break it off and hope that something more beneficial turned up.

But, Mr Bellis-Jones said, this company was able to present the other business with figures demonstrating its problem and so achieve a change to financial arrangements acceptable to both parties.

It sounds as easy as ABC, the initials by which the concept is known. So why is it not already widespread? Partly because of conservatism and scepticism, but largely because it is not as simple as it sounds. To work effectively, it must be linked with fundamental changes in the way the business is run.

In an effort to spread the word, IBM (UK) is this week holding what is billed as the largest ABC training event in Europe at its offices at Havant, Hampshire. Organised by the Chartered Institute of Management Accountants in association with ABC Technologies, the five-day event features speakers, critical appraisals and workshops.

The proceedings are dominated by IBM, British Aerospace and Black & Decker. This is partly because these are the types of company that are likely to have gone furthest with other management programmes, such as Just In Time and Total Quality. But is also because they have the most to gain from the concept and the resources to implement it.

However, ABC Technologies, co- sponsor of the event, claims that its software makes applying the concept straightforward for the smaller organisation. Thanks to EasyABC, introduced two years ago, 'ABC is no longer a tool for the privileged few', it says.

By putting the technique within the reach of everyone, there is the potential to change the way business is done, it suggests. And, with competition for world markets more intense than ever, the time is ripe for change.

To its adherents, ABC is common sense. Traditional accounting methods were fine when labour and raw materials made up the bulk of a product or service's cost and the proportion of unallocated overheads was insignificant.

But automation and modern manufacturing methods have led to a great rise in that share - often to more than 50 per cent of a product's cost and sometimes to as much as 80 per cent. And, it is argued, traditional accounting methods cannot accurately trace these costs to the individual products or costs.

As a result, management does not really know where it is making money and where it is losing it, and cannot make informed decisions about pricing, mix, design and distribution.

Indeed, Mr Bellis-Jones, director of Develin & Partners, a consultancy specialising in the area, suggests that traditional management accounts can do business a grave disservice by measuring those costs it is convenient to measure rather than the ones that help managers make effective decisions.

As an example of how executives can be misled by conventional thinking, he cites the situation where a company suddenly finds one of its products is gaining market share. Its managers may start congratulating themselves, but the truth might be that competitors are pulling out of that sector to concentrate on a more profitable one.

A true activity-based cost analysis of the situation might reveal that the company is making a loss on that product - despite its rising share of the market.

Since gaining prominence in the late- Eighties, largely as a result of Relevance Lost: the Rise and Fall of Management Accounting, a book by two American professors, H Johnson and Robert Kaplan, ABC has been widely criticised.

But, writing in a report for the Institute of Chartered Accountants in England and Wales, Mr Bellis-Jones and his fellow director, Nick Develin, point out that the list of charges against the existing system is formidable.

'The issue here is management information: in the majority of British companies, the monthly management accounts are the only regular information about the business that managers receive.

'The recurring problem is that management accounts fail sufficiently to reflect the complexities of the operating environment,' they add.

'If the system fails to provide relevant information - that is, it omits (their italics) what is critical or useful, managers are obliged to rely on intuition.'

Their firm defines ABC - which started life as Activity-Based Costing and then grew to embrace Management - as a way of identifying the factors that drive costs.

By also measuring and analysing costs in a way that helps managers understand better the influences on their business, it helps them to exert effective control in achieving their objectives.

A number of banks have been won over to the ideas - Barclays, for instance, recently simplified its accounting procedures and in the process changed the basis by which costs were allocated and profit attributed. ICI, the Stock Exchange, British Airways and Norwich Union have all signed up for ABC Technologies software.

While this package makes the concept easier for all sizes of operation to adopt, even adherents stress that ABC is not for everybody.

Research suggests that the greater the direct labour content of a product and the lower the variability, variety, complexity and change in the product range or customer base, the less likely it is that ABC will produce significantly different product costs than a conventional approach.

But, according to Mr Bellis-Jones and Mr Develin, it is because of the increasing variability between customers' behaviour and in methods of production and the decreasing importance of direct labour costs that the conventional systems are under such pressure.

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