Modelling resource supply and demand: Expanding the utility of ABC

Abstract

Users of cost management systems should be able to predict the economic consequences of their actions. Activitybased costing (ABC) systems have proven useful to management for making operational changes based on resource usage, but have failed to inform management about spending changes, and consequently about profitability. This is because ABC was designed to measure the rate of resource demand, not the rate of resource supply (spending). One of the most important established guides for performance measurement used by management, investors, and creditors, is profit. Management uses profitability to evaluate proposed courses of action, creditors use it to assess credit worthiness, and investors use it to determine potential return. Traditionally, costing systems have been designed to translate management decisions into pro-forma balance sheets and income statements. Indeed, the standard by which costing systems have been judged depends largely upon the accurate translation of management's actions into quantified statements of condition and performance. A cost system which does not meet this standard is deficient. This paper suggests that ABC systems can be adapted to provide profitability information. A method for modelling the relationship between resource supply and resource demand, which permits activity-based decisions to be evaluated in terms of their expected economic consequences, is presented.