An ABC Simulation Focusing on Incentives and Innovation

Abstract

Current textbooks advocate activity-based costing (ABC) because it provides more detailed information on resource usage, leading to better cost control and reengineering of production processes. However, there is often little attention paid to how other organizational control features can affect the use of the information provided by ABC systems. This active learning simulation demonstrates that incentives can have a significant impact on how workers use ABC information to manage costs and innovate a production process. The simulation involves two student teams that are furnished with identical ABC cost driver information and either a tournament- or group-based incentive structure. The teams simulate a factory environment by creating products using a simple manufacturing process, while the remaining students observe the process and record differences in communication, innovative activity, and resulting profitability. The teams' outcomes under the two separate incentives illustrate the interaction of a firm's cost system with its incentive system. Typically, we find that more communication occurs among team members, more team-based innovations are created, and profit is higher under group incentives. We conclude that the use of ABC, without consideration of employee incentives, may not result in the desired cost control and process reengineering benefits. In this simulation, students are directly involved in providing the data, so they find the inferences drawn to be compelling.

Success of activity management practices: the influence of organizational and cultural factors

“…Teamwork has been stated in the published studies as being important for the successful operation of activity management. However, such studies have been theoretical, not empirical (see Ansari and Bell, 1997; Landry et al ., 1997; Gering, 1999; Drake et al ., 2001). Our failure to find empirical significance for team orientation might be a consequence of its lesser significance in practice relative to theory, or of a weakness in the measure of team orientation used in our study.…”

“…The link to performance evaluation and compensation is based on the argument that if evaluation and compensation are linked directly to the information produced by the activity management system, employees will use that information. This, in turn, will enhance the information's decision usefulness and increase the likelihood of activity management success (Shanahan and Dance, 1997; Drake et al ., 2001). This argument rests on the broader one that employee behaviour is influenced by the way in which their performance is evaluated and rewarded (Langfield‐Smith et al ., 1998), and has been demonstrated for activity management success by Anderson (1995), Shields (1995) and Foster and Swenson (1997).…”

“…Team orientation is important because activity management requires cross‐functional activities (Ansari and Bell, 1997). Teamwork and its correlates of cooperation and information sharing among organizational members are seen as important for activity management practices to succeed (Landry et al ., 1997; Gering, 1999; Drake et al ., 2001).…”

ABC: Evolution, Problems of Implementation and Organizational Variables

“…The effectiveness of this educational process depends on the training techniques and the learning and communication methodologies used, which implies the need to analyze the behavior of the users of the information, that is, to observe the approach to and way of dealing with the information so as to construct a map of the preferred instruments for the information transfer. Once ABC is adopted it will be successful if there continues to be the motivation to use the information from the model in order to make management more effective; the systems should be linked to the ABC determinations [49,56], and those within the firm should be aware of this. The relation between the success of the implementation and the evaluation and remuneration of performance is justified by the fact that, if the evaluation and remuneration are directly linked to the information produced by the activity based system, then this information will be used [30].…”

Identifying potential bottlenecks through activity under-utilization cost

“…Drake et. al [39] discusses how organizational control features can affect the use of the information provided by ABC systems and the authors demonstrate it through an active learning simulation involving two student teams that are furnished with identical ABC cost drivers but separate incentive plans. Kataoka et.…”