2. Fundamentals
Activity-Based Costing (ABC):
– A method of assigning costs to products or services based on
the resources they consume.
– ABC is an alternative to traditional accounting in which a
business’s overhead amounts (indirect labor, production
facility, marketing, etc.) are allocated in proportion to an
activity's direct costs.
The concern . . . two activities that absorb the same
direct costs can use or require very different amounts of
overhead . . . .
Fundamentals
Activity-Based Costing (ABC):
– ABC became popular in early 1980’s . . . The primary issues:
1. ABC requires that a business define, break-down and
track cost details by individual business activities.
2. ABC requires Clean & Accurate DATA.
3. ABC was thought to be a replacement for traditional
accounting methods . . .it’s a supporting Management
Decision Tool . . . not a replacement.
ABC is an “Approach” that provides an effective way to view
and interpret information by measuring Cost and Performance
of business processes and their outputs.
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3. Fundamentals
The “New & Revised” ABC/M Approach:
Beginning in 2005, the approach to ABC/M was modified to focus
on:
1. The Cost Per Time Unit associated with supplying resource
capacity, and
2. The Unit Times of Consumption of resource capacity by
products, services and customers.
What does this mean?
Determining and using Cost Drivers . . . examples would be:
- Stamping Operation: $/Machine Hour by Cost Center
- Food Distributor: $/Distribution Drop
- Machine Fabricator: $/Direct Labor Hour
- Specialty Meat Producer: Lb./Product Sold by Customer Type
Fundamentals
Benefits of an ABC/M Approach:
– Provides decision makers with details regarding which
products or services make or lose money.
– Designed to provide profitability information for each segment
of a product/service market matrix.
– ABC/M is a Management Tool that can be
used understand and address specific
products, services or customers that make
or lose money for your organization.
– ABC/M highlights how efficiently & effectively
activities are being performed and who are
the benefactors of the activities performed.
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4. Recommended Approach to ABC/M
1. Develop a Cost Management Strategy:
Establish a Cost Management Task Force or Team
Map and analyze your Key Processes
Review, analyze, test and validate your General Ledger Detail
Collect and verify the accuracy of your Process Data
2. Develop a Cost Model
Establish Fully Loaded Labor Rates
Establish Equipment Replacement Values and Rates
Incorporate Process Maps, Bills of Material, Service Steps, etc.
3. Determine Costs and React
Establish unit costs for products or services by customer, product
line, cost/machine center, department, etc.
Step 1: Cost Management Strategy
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5. Costs to Control & Assign
Resource
Costs
Non-Specific Activity-Specific
Costs Costs
Activity-Based
Unabsorbed
Costs
Costing Activity-Support
Costs
Customer Support
Costs
Traditional Costs
~ Manufacturing Perspective ~
LABOR
+ +
Process
Cost per
unit of output
$/Unit
(
Total Cost
Total Output )
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6. Activity Based Costing Approach
Activity 1
Activity 1
Activity 1
Activity 1
Activity 1
Activity 1
Activities and their
drivers create a
meaningful link Cost Driver 1 Customer A
between products, Cost Driver 1 Customer A
Cost Driver 1 Customer A
Cost Driver 1 Customer A
customers, and the Cost Driver 1 Customer A
Cost Driver X Customer A
resources they
consume
Product 1
Product 1
Product 1
Product 1
Product 1
Product 1
Flow of Costs . . . Costs
Activity Analysis
Allocation Allocation
Methods Methods
Allocation Methods
Activity driven by Internal
Activities with
products, services support
no direct link
& customers activity
Activity costs assigned to
Products specific products,
Services Non-Specific
services, customers, cost Costs
Customers centers, etc. using the
“Driver Volume” of each
activity
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7. EFFECTIVENESS
EFFECTIVENESS
Map your OF PROCESS =
OF PROCESS =
Ability to achieve
“Value Streams” Ability to results
desired achieve
(Focus of ISO
desired results
9001:2000)
Input PROCESS Output
PRODUCT
“Set of interrelated or
(Includes Resources) (“Result of a process”)
interacting activities”
EFFICIENCY
EFFICIENCY OF
OF PROCESS =
MONITORING AND PROCESS =
Results achieved
MEASUREMENT OPPORTUNITIES Results achieved
vs resources used
vs resources used
(Focus of ISO
(Before, during and after the process)
9004:2000)
Process Mapping – an examination of the expectations and
requirements between departments . . . . includes both internal and
external customers
Value Stream Map
Process 1 Process 2 Process 3
Value Stream Map
Follow a “product” or “service” from beginning to
end. Draw a visual representation of every
process in the material & information flow.
Identify Value-Added and Non-Value Added steps. Delivery
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8. Strategy Development . . .
Review and test your general ledger to identify which
accounts are allocated “what” costs and then validate!
Cost Center A
Example:
Account Cost$
Center B
Cost Center C
Account $ Employment Costs
Account $
- Fully Loaded Costs:
Salaries, taxes, pensions, etc.
Occupancy Costs
- Rent, utilities, repairs, etc.
Equipment Costs
- Lease, property tax, utilities
Determine the most appropriate cost drivers to allocate the
costs . . . .
Assigning Base Costs to Activities . . .
Costs
General
Activity-related costs are Ledger
assigned to individual Activity-Specific
activities on the basis of Costs
rational allocation methods Allocation
Methods
Activity
Analysis
Example:
Employment Costs: Hours worked per activity or % of time spent
Occupancy Costs: Square feet of facility space used
Network Costs: Log-on time, Processing time etc.
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9. Step 2: Develop a Cost Model
Important Aspect . . .
Structure your operations via a
“Value-Added” approach . . .
VA = SR – (MC + OS)
Incorporate a
VA = Value Added “Checkbook” Mentality
SR = Sales Revenues
MC = Material Costs
OS = Outside Servicing Costs
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10. Cost Model Structure
Cost Model is used to assign specific activity costs and as a
“tool” for management decision making.
BOM
Costing Model for
Business Decisions Routers
Product, Customer, Business Unit Cost Analysis
Monthly Snap-Shot
Labor Analysis
Determine your “Fully Loaded” Labor Costs:
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11. Equipment Analysis
Establish a Cost / Hour for all Primary Equipment:
Department Cost Allocations
Allocate your Financial Data by Department, Cost Center, Etc.
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12. Step 3: Determine Costs
Example . . . Contractor
- Cost & Profit per Job Analysis
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13. Profit per Drop
Profits per Drop
350.00
Example Project . . . Do we stay or do we go?
- Food Distributor - In Business since 1967
300.00
- 11 delivery trucks - Next Generation Mgmt.
- Breakeven - Where’s the future?
250.00
200.00 Breakeven
P r o fits
$121.19/Drop
150.00
100.00
50.00
0.00
1H 8M 3W 2T 2M 7W 7H 6F 1F 3M 8H 1M 8W 6W 7M 8T 1T 1W 2F 3T 8F 7F 2H 3H 2W
Route
Totrilla Chip - Production Cost $/Lb .vs. Selling Price $/Lb
$0.0000 $0.5000 $1.0000 $1.5000 $2.0000 $2.5000
12-1# NS Tortilla Chips
1 # Display
Tortilla Chip 12/14 oz Sea Salt Strips
Sea Salt 12/13 oz Tortilla Chips Deli Style
Guacamole Tortilla Chips - 12/13 oz
Sea Salt 12/6 oz Tortilla Chips Deli Style
Restaurant Style 12/6 oz Tortilla Chips Deli Style
Nacho Cheese Tortilla Chips 12/14 oz
Lime 12/6 oz Tortilla Chips Deli Style
Lime 12/6 oz Tortilla Chips Deli Style - Canadian
Salsa Fresca 12/13 oz Tortilla Chips Deli Style
Lime Habanero 12/13 oz Tortilla Chips Deli Style
Total Cost $/Lb (Less Other Expenses) Leaving Plant Selling Price $/Lb
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14. ABC/M Objective . . . Profitability by Customer
Refine Processes to Convert or
160% Cultivate and Improve Profitability Disengage
Cumulative Profits (% of total profits)
Grow
120%
Profit
100%
Distribution Curve
80%
60%
40%
20%
0%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Most Profitable Customers Least Profitable Customers
ABC/M Objective . . . Profitability by Customer
Identify and eliminate the unprofitable . . . Up to 30% of
products, services or customers may not be profitable:
- Determine how resources will be allocated
- Understand the implications of “Elimination”
- Manage the remaining costs . . . . Do Not Transfer!
30% to 40% of products, services and
customers are marginally profitable or
marginally unprofitable
Know which Products, Services, and Customers
that drive profitability at your company
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15. Next Step . . . . . . Mobilize
Definition: To make mobile or capable of movement. To
assemble, prepare, or coordinate for a purpose.
Implement actions to shift to controllable revenues where
unpredictability is the greatest.
Maximize revenues for existing customers:
– Mobilize your Sales Force . . .Position for Strategic
Partnerships
– Examine the value chain to increase revenues that can be
earned from existing customer.
– Look for Sustainable Cost Reductions verses Short-Term Cost
Savings.
Prepare to Transition & Position
What’s our Market Position?
– Develop a strategy to recognize merger, acquisition and
potential market growth opportunities.
– Position your company to understand current and future
market segment, areas for growth, etc.
– Options:
• Stay as you are in your business and market nitch
• Initiate a diversification strategy / program
• Explore and initiate mergers and/or acquisitions
• Identify and source resources overseas
• Provide a strategic platform for foreign companies
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16. Establish a Labor Force Strategy
78 million workers will leave the workforce over the next 16 years.
There are only 48 million new entrants:
Look within for Critical Skills and Knowledge
Key Questions to Ask:
Which segments of my workforce create the most value?
Which areas of our organization will be most impacted by
retirements?
What skills do we need now?
What skills will we need in the next 5 years?
Are we actively developing workforce plans?
Incorporate Productivity “Tools” & Methods
Toyota Production System
Lean Manufacturing
Goal:
Six Sigma
To provide you and your
ISO 9001:2008
management team with high-
Balanced Scorecard
quality data and business
Activity-Based Cost Mgmt.
information.
Objectives:
1. Timely Decisions
Business 2. Value-Added Insight
3. Maintain Control
Improvement 4. Efficiency and Profitability
Tools
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17. ABC/M Road Map
Diversification
Strategy?
“Would you tell me, please, which
way I ought to go from here?”
asked Alice.
“That depends a good deal on where you want to get
to,” said the cat.
“I don’t much care where,” said Alice.
“Then it doesn’t matter which way you go,” said the
cat.
Lewis Carroll, Alice’s Adventures in Wonderland
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18. In Conclusion . . .
Incorporate a SMART Edge:
– Strategy - make sure your long term costing strategy remains
intact and focused.
– Message and Measure - it is vital that your key people
understand your cost strategy and know where you are heading.
– Accelerate - the world is changing quickly and you have to
change even quicker. This is the time to gain market share.
– Reinvest – Look for opportunities, cost controls, process
improvements, etc.
– Talent - is a critical key to achieving and sustaining your business
goals and objectives.
Questions?
THANK YOU!
Alan Lund
UHY Advisors, Inc.
Farmington Hills, Michigan 48334
(248) 355-1040
Alund@uhy-us.com
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