There is a growing desire among organizations to understand their costs and the behavior of factors that drive these costs. Yet there is confusion over how to go about understanding costs and how to distinguish competing cost measurement methodologies (e.g., activity-based costing, standard costing, throughput accounting, project accounting, target costing, etc.). The result is that managers and employees are confused by mixed messages about which costs are the correct ones. Upon closer inspection, the various costing methodologies do not necessarily compete: they can coexist, be reconciled, and blended.

    In an increasingly competitive business environment, organizations seeking to maintain or improve their competitiveness need cost information that is accurate and relevant. In the past, companies planned and controlled their operations using accounting information that was assumed to accurately reflect the costs of their products and services (and, ideally, their channels and customers as well). In fact, this was often not the case. The costing systems of many companies, with their broad averaging allocation of indirect costs, masked by an illusion of precision, were actually providing misleading information to decision makers. This resulted in suboptimal decision making by these companies’ managers.

    In order to overcome the over-generalizations of traditional costing systems, with their excessively simplified cost allocations and resulting lack of visibility for indirect costs, organizations have been adopting activity-based costing (ABC) systems. These systems are based on cost modeling that traces an organization’s expenses—both direct and indirect—to the products, services, channels, and customers that cause those expenses to be incurred.