Scholars tout benefits of activity-based costing

Activity-based costing should be implemented in government agencies because it helps managers make better spending decisions, according to a new study.

To demonstrate the benefits of activity-based costing, Michael H. Granof, David E. Platt and Igor Vaysman, professors at the University of Texas at Austin, applied the accounting model to a department at a large university business school. The study was funded by the PricewaterhouseCoopers Endowment for the Business of Government.

"We trust that this report will be useful to executives at all levels of government who are now involved in quantifying their performance and financial costs," the study said.

Activity-based costing is an accounting tool designed to break down in detail the costs of all of an organization's activities. The assumption is that such detailed information will give managers the information they need-and have historically lacked-to make sound business decisions.

The benefits of activity-based costing are not unknown in the federal government. Many agencies have begun changing their accounting methods to provide more accurate cost data. The Government Performance and Results Act of 1993 and the rise in reimbursable federal programs have prompted better accounting methods at many agencies.

But to those agencies that remain unconvinced, the report details how a government agency could be better managed with precise cost information.

Activity-based costing is particularly helpful for large organizations, such as universities and government agencies, that administer multiple programs simultaneously, the report said. Traditionally, these organizations are run on funding-based accounting systems designed to insure legal compliance with appropriations law rather than better management decisions.

In the university case study, the authors found that the greatest benefit of activity-based costing is to front-line managers, because it identifies "circumstances in which goals and objectives are out of line with spending decisions," the report said.

But in university and government settings, such systems must be flexible to work. "Rigid allocation rules cannot readily be imposed upon organizations characterized by decentralized management systems," the report said.

Activity-based costing highlights inefficiencies so managers can redirect resources to where they are most beneficial and can indicate when gradual changes have had a large impact on cost activities.

At the university program to which it was applied, activity-based costing resulted in information "more useful for virtually all decisions that faculty and administrators are likely to make," the report said.