Ss 03 CCP- AACE.org cost engineering management training- 2017 - dr. moustafa ismail ch 7-8

CCP Cost Engineering Training 1011 BTA - Dr. Moustafa Ismail 2017 LEC- 3 1
Cost Engineering Management
Training Course:
Association for the Advancement
of Cost Engineering
Nov. 2017
LECTURE 3
‫وبركاته‬ ‫هللا‬ ‫ورحمة‬ ‫عليكن‬ ‫السالم‬
2017

Nov. 2017CCP Cost Engineering Training 1011 BTA - Dr. Moustafa Ismail 2017 LEC- 3 2
Section 1 Chapter 7- Economic Costs
4. Payback Period Method
• Is the period of time necessary for the benefits of the project to pay
back the associated costs for the project.
• Differences in the timing of cash flows are not considered, nor are the
benefits and costs beyond the payback period.
• Payback period analysis is approximate and may not yield the same
result as with other more precise methods, like NPV or EUAC criteria.
Ex: An investment of $400,000 with benefits of $100,000/year have a
payback period of 4 years ($400K/$100K = 4 years). However, a
$4,000,000 investment with benefits of $800,000 per year and a payback
period of 5 years ($4,000K/$800K = 5 years) and it might be the best
choice on other criteria.

Section 1 Ch.8- Activity based cost management
Indirect (overhead) expenses are displacing direct expenses
 Direct laborers are employees who perform the frontline, repeatable work
that is closest to the products, customers.
 These employees’ work is highly repeatable at some level, for example, a
teller in a bank. Figure 8.1 is a chart that includes this type of expense,
plus the other two major expense components of any organization’s cost
structure, its purchased materials and its indirect and shared expenses –
commonly referred to as overhead.
Cost
component

 Most companies are experienced at monitor & measuring cost of labors
recurring work, i.e. Standard Cost.(tellers but not indirect/ vice president & higher)
 In Figure 8.1. it reveals that over the last few decades, the indirect support
expenses have been displacing the recurring costs.
 The organization already has substantial visibility of recurring costs, but it
does not have any insights/understanding into its indirect expenses.
 ABC/M can help provide for insights, better understanding and learning.
 ABC/M extends to the indirect expenses the understanding & visibility of
spending that already applied to recurring laborer.(indirect/ vice P and higher)
 ABC/M can then become an organization-wide method of understanding
work activity costs, as well as the standard costs of outputs.(recurring)

 The shift to indirect expenses displacing direct labor reveals the cost of
complexity.
 ABC/M does not fix or simplify complexity, but ABC/M points out where
the complexity is and where it comes from.
Expressing activities with action verb & link outputs with expenses
General ledger:
• It shows the classic monthly responsibility-center statement report that managers
receive.
• It uses chart of account and provides what was spent, Structured around cost
centers to accrue the trades to the relevant accounts, it is transaction oriented.
Activity base cost management- ABC/M: ( Ex: next figure)
• It uses the chart of activities to assign the expenses to some activity, it is
work/activity oriented.
• Estimates the unit costs and denotes the activities by action verb, noun,…/
print/excavate/ inspect/ test and commission (Ex. process customer claim).

Salaries= ⅀ % (labor+ technician + engineer+ accountant) sharing in an activity
%
%
% %
121,000
Incr/decrease
depend. On
claims no i.e
activity driver
SK 6 page 81

Drivers trigger and work load
In the ACB/M the $121,000 can increase, decrease based on the
activity driver( no of claims) and so other activities, each one has its
own driver, ( ACB) no longer recognizing the organizational chart
and artificial boundaries. The focus is now on the work that
organization performs, and what affects the level of the workload.
Cost re-assignment network
• In complex organizations, there can be a substantial chain of indirect
activities prior to work activities that finally trace into the final cost
objects. These chains result in activity-to-activity assignments, and
they rely on intermediate activity drivers in same way that final cost
objects rely on activity drivers to re-assign costs into them.

• ABC re-assigns the complete cost into the final products, service lines,
channels, customers,
• ABC connects customers to the unique resources they consume.
• The ABC cost assignment network consists of the three modules
connected by cost assignment paths, including:
1.Resources
are the capacity to
perform work, they
are traced to
include/convey
resource expenses in
activity costs. Ex: of
resources are salaries,
operating supplies, or
electrical power
2.Activity module
It is where work is
performed and where
resources are
converted into some
type of output. It
contains the structure
to assign activity costs
to cost objects (or to
other activities).
3.Cost objects
Represent broad variety
of outputs and services
where costs accumulate
customers are the final-
cost objects. Ex: Cost
objects, products, service
lines, outputs of internal
processes, distribution
channels, customers.

Using the attributes of activity based costing
 One role for calculating costs is to help performing organization identify
which of their organization’s work activities are:
• Not required at all and can be eliminated (e.g., a duplication of effort).
• Ineffectively done, can be reduced/redesigned outdated policy/ procedure
• Required to sustain the organization (i.e., the work is not directly caused
by making a product or delivering services through channels to
customers), therefore it may not be possible to reduce or eliminate work
activity- provide plant security, compliance with regulations
• Discretionary and can be eliminated (annual employees’ picnic).
 ABC/M systems provide for distinguishing these work activities, either
by including them in a cost assignment structure (sustaining cost
objects) or, by tagging their costs as an overlay (i.e., attributes).

An example of a range of a tag:
1. Very important versus required versus postponable.
2. High value adding versus- low-value-adding scale
3. How well activity is performed, such as exceeds customer expectation,
meets, or is below.
Saving

Local vs. enterprise-wide ABC/M
• A common misconception is that the scope of an ABC/M system must
be enterprise-wide while ABC/M can also be applied to subsets of the
organization for process improvement, rather than revenue enhancement
and profit margin increases.
• Commercial ABC/M software now enables consolidating some, and
usually all, of the local, children ABC/M models into the enterprise-
wide, parent ABC/M model.

Local vs. enterprise-wide ABC/M- cont.
• local ABC/M model data are used for tactical purposes, often to
improve productivity. In contrast, the consolidated enterprise-wide
ABC/M model is often used for strategic purposes because it helps
focus on where to look for problems and opportunities.
• Enterprise-wide models are popular for calculating profit margin data at
all levels

Application of local ABC/M
• The objective of local ABC/M models is not to calculate the profit
margins of products, service lines, and customers; it is to compute the
diverse/assorted costs of outputs to better understand how they create
organization cost structure
• The application when marketing, recruiting, or promotion department
are trying multiple channels like newspapers, radio, television,
tradeshows, websites, billboards, and so forth.
• ABC/M calculation define the costs versus benefits of all the channel
combinations to rank order least to best return on spending.

Importance of ABC/M
• In the past a company poor decision could be masked by the
profit, but the current competition precludes such masking and a
company can no longer carry unprofitable products and service
lines.
• With activity-based costing visibility, organizations can identify
where to remove waste, low-value-adding costs, and unused
capacity, as well as understanding what drives their costs.
• They can also see the degree of alignment of their cost structure
with their organization’s mission and strategy

ABC/M in advanced, mature users
• Integrating the ABC/M output data with their decision-support systems,
such as their cost estimating, predictive planning, budgeting, driver-
based rolling financial forecasts, Customer Relationship Management
(CRM), and balanced scorecard and dashboards performance
measurement systems
• Collecting and automatically importing data into the ABC/M system.
• Automatically exporting the calculated data out of their ABC/M system.
• For experienced ABC/M users, ABC/M eventually becomes part of their
core information technologies.

Exercise: Test your activity
start
END
mandatory
END
END
END

CCP Cost Engineering Training 1011 BTA - Dr. Moustafa Ismail 2017 LEC- 3 17
Training Course:
Association for the Advancement
of Cost Engineering
Nov. 2017

Ss 03 CCP- AACE.org cost engineering management training- 2017 - dr. moustafa ismail ch 7-8

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Ss 03 CCP- AACE.org cost engineering management training- 2017 - dr. moustafa ismail ch 7-8