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FINANCE BRANCH
Adding Value through Activity Based Costing/Management
Adding Value through Adding Value through Activity Based Costing/ManagementActivity Based Costing/Management
Ministry of Transportation
Financial Management Institute
April 18, 2012
2
Knowledge Objectives for the Day
Establish the context – importance of understanding the true cost of services
Review the language and structure of Activity Based Costing/Management
Discover how Activity Based Costing/Management supports multiple management objectives
Understand the concept of Full Cost Pricing
Explore through examples and a case
3
Quote of the Day
Victor Hugo (French Novelist)
“There is nothing more powerful than an idea whose time has come”
4
Evidence
As per survey conducted by Better Management,
9 out of 10 companies of all sizes are using ABC or considering to use it
(528 companies surveyed )
5
-$30.2B
-$15B
$0
2010-11 2017-18
Ont
ario
Bud
get D
efic
itStatus QuoPreferred Scenario
-$30.2B
-$15B
$0
2010-11 2017-18
Ont
ario
Bud
get D
efic
itStatus QuoPreferred Scenario
Context: Balancing Ontario’s Budget
Current deficit
Balanced Budget
Deficit in 2017-18 if Status Quo is maintained
6
6.9%
5.4%6.0%
8.2%
6.6%
2.5%
1.1%0.5%
-2.4%
0.8%
Health Education Social Services Others Overall Program GrowthA
vera
ge
An
nu
al %
Gro
wth
2001-2011 (Actual) 2011-2018 (Drummond Recommendation)
6.9%
5.4%6.0%
8.2%
6.6%
2.5%
1.1%0.5%
-2.4%
0.8%
Health Education Social Services Others Overall Program GrowthA
vera
ge
An
nu
al %
Gro
wth
2001-2011 (Actual) 2011-2018 (Drummond Recommendation)
Context: Balancing Ontario’s Budget (cont.)
To balance budget
7
What is Costing?
Costing is the process of tracing expenses to products, services or activities to determine their cost
Costs are calculated from relevant expenses
8
Traditional Costing vs Activity Based Costing
Traditional Costing
Resources
(Expenses from IFIS)
Products and Services
Even spread approach
Resources
$ used to do work
Activities
work processes
Cost Objects (Product and Services)
For whom work is done
Activity Based Costing (ABC)
Resource Drivers
Activity Drivers
Stage 1
Stage 2
9
Activity Based Costing
The basic premise behind ABC is simple
ABC assumes that:
clients create need for outputs (services/products), which
create the demand for activities, which in turn
consume resources
10
Traditional vs Activity based view of costs
ABC/M provides a focus on activities not visible through traditional accounting
Actual Plan Favourable/(Unfavourable)
Salaries 300 275 (25)Materials 125 140 15 Supplies 25 52 27 Depreciation 100 100 - Rent 75 75 - Utilities 50 70 20 Oil and Gas 25 15 (10)Total 700 727 27
Chart of Accounts ViewTraditional (IFIS)
Take Orders 70Make Orders Mix Batter 250 Bake Layers 150 Frost Cakes 90Store Cakes 40Deliver Cakes 100Total 700
Activity Based View
11
Total Cost
Unit Cost
Total Cost
Unit Cost
Total Cost
Unit Cost
Take Orders 40 0.80 30 1.20 70 0.93 Mix Batter 150 3.00 100 4.00 250 3.33 Bake Layers 100 2.00 50 2.00 150 2.00 Frost Cake 50 1.00 40 1.60 90 1.20 Store Cakes 10 0.20 30 1.20 40 0.53 Deliver Cakes 70 1.40 30 1.20 100 1.33 Total 420 8.40 280 11.20 700 9.33
# of Units Produced 50 25 75
Cost per Unit 8.40 11.20 9.33
Chocolate Cakes Specialty Cakes Grand Total
ABC
Chocolate Cakes
Specialty Cakes Total
Direct Materials 65 35 100 Direct Labour 100 50 150 Allocated Overhead 300 150 450 Total 465 235 700
# of Units produced 50 25 75
Cost Per Unit 9.30 9.40 9.33
Traditional
Traditional vs Activity based view of costs (cont.)
12
What is a Resource?
Salaries and benefits
Building occupancy charges
Supplies Telephone charges
Equipment depreciation
13
What is an Activity?
Process Billing
Train employees
Provide IT support & maintenance
Provide mail services
Maintain Accounts
14
What is a Cost Object?
Products and Services Drivers Licenses Permits Cameras Personal Savings Accounts Insurance Policies
Clients
Channel of Delivery
Face to Face E-Channels
Internal External
15
Example: Using a Resource Driver
Resource Resource Driver Activities
Receive drivers license requests
Process drivers license requests
Maintain drivers license records
Salary and Benefits
20%20%
50%50%
30%30%
16
Example: Using an Activity Driver
Activity Activity Driver Cost Object
5 transactions
20 transactions
10 transactions
Drivers license renewal
Drivers license renewal with fine
Drivers license replacement
Process drivers license requests
17
Your Objects of Work?
What are examples of your cost objects?
Note: objects of work can be another office, external client, a product/service, etc.
_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________
Drivers Licenses Building Permits Clients served Quarterly Reports
18
Your Activities?
What are examples of your activities?
_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________
Develop engineering design Forecast expenses Train employees Maintain company vehicles Maintain oversight of highway maintenance Provide legal advice
19
Your Resources?
What are some of the resources used by your office/branch?
_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________
Salaries and benefits Office space Computers Supplies Support received from other offices
20
ABC supports Activity Based Management (ABM)
Performance MeasurementHow well work is done?
(Cost, time, quality)
Cost DriversDrivers of work
Process View (ABM)
Why things have cost Better decision making
What things costResources
$ used to do work
Activitieswork processes
Cost Objects (Product & Services)
For whom work is done
ABC ViewWhat things cost
Resource Drivers
Activity Drivers
21
Cost Drivers
Cost drivers cause work: they are factors that cause the change in the cost of an activity
They may cause excess cost, time and poor quality
Removing/managing cost drivers is the key to improvement
22
Examples of Cost Drivers
Cost drivers cause work!
Activity
Register students to program
Cost Drivers
Part time vs. Full time
Number of registrants
Complexity of forms
23
What causes work in your Office/Branch?
Cost drivers cause work
Activity: _______________________________
Cost Drivers:
_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________
Cost a program
Complexity of the costing project (Centralized vs Regional delivery)
Scope of the project (No. of issues to look into) Number of briefings required Staff training / capacity
24
Activity Based Management – Adding Value
Activity or Activity or Process Process
StepStep Contributes Contributes to Client to Client
Demands or Demands or Government Government Priorities?Priorities?
Contributes Contributes to to
Government Government Business Business
Demands?Demands?
Alternative service delivery
Efficiency opportunities
Policy changes
Alternative service delivery
Efficiency opportunities
Policy changes
Reallocate resources/discontinue
Reallocate resources/discontinue
Necessary Necessary to Produce to Produce
Output?Output?
NO
YES
NO
NO
YES
YES
• Government regulations• Stakeholder
consultations• Environmental
assessment
• Public safety• Highway maintenance• Transit• Strategic planning
• Duplication of work• Bureaucracy• Outdated processes
25
Cost of a Burger
$0.10 $0.20
$0.50
$0.05
$0.15
$0.10
$0.05
$0.02 $0.02
26
Other Costs of a Burger
RentUtilitiesSignage
AdvertisingKitchen equipment
FurnitureFixtures
Kitchen staffWait staffInsurance
Dishes, cutlery, linen, decorations
Printing (e.g. menus)Cleaning supplies
Licenses
27
Types of Costs
Direct Program costs
Program Support costs
Ministry corporate overhead costs
Other Ministry costs (such as OSS, MGS, MAG, etc)*
Risk Costs (where appropriate)
Ontario Ministry of Finance Costing and Pricing Guidelines classify costs into 5 categories:
* OSS – Ontario Shared Services; MGS – Ministry of Government Services; MAG – Ministry of Attorney General
28
When is ABC Most Useful?
Multiple products / services
Client diversity
Product / service complexity
Different products / services placing different demands on resources
Difficulty in linking resources to outcomes
High overhead costs
Better cost information is needed
29
Tips / Lessons Learned
Activity Based Costing is:
30% understanding and using techniques correctly
70% the ability to convince others to accept beneficial change
Ralf Sorenson(Head of SAS Airlines)
30
Tips / Lessons Learned (cont.)
Need senior management full commitment and buy-in
Involve front-line staff (they know the business)
Keep it simple
Consider all costs
Document assumptions and costing methodology
Target areas that can benefit the most from ABC/M
Cost is a very important dimension of service performance. Also consider quality and efficiency of service
31
What can I do with ABC/M Information?
Better Better understanding of understanding of costs enhances costs enhances decision makingdecision making
32
Ministry of Public Works
Professional Services Branch
Division AInfrastructure Division
(ADM's Office)provides inspection services and plans approval for buildings, roads and parks
Service Delivery Branch (Director's Office)
Transfer Payments Branch
Division B
Research and Analysis Office
Plans Approval Unitapproves all building, road and park plans. Plans Approval Unit
provide support to the entire branch
Inspections Unitincludes52 full-time-
equivalent Inspectors and one manager. Inspectors perform all types of inspections. Unit
provides the following services to the public:
1. Building Inspections
2. Road Inspections
3. Park Inspections
Information Unitprovidessupport to the entire
branch
Building Advisors Unit
providessupporting research and analysis for Building Inspections and the Plans
Approval Unit
Case: Ministry of Public Works
* ADM – Assistant Deputy Minister
*
33
Case: Relevant Costs (cont.)
Minister’s /Parliamentary Assistant’s Salary
Infrastructure Division ADM’s Office
Professional Services Branch
Service Delivery Branch Director’s Office
Transfer Payments Branch
Research and Analysis Office
Building Advisor’s Unit *
Plans Approval Unit Inspections Unit
Information Unit
Building Inspections Unit
Road Inspections
Park Inspections
Division A
Division B
* Assumption: cost is fully loaded (i.e. includes overheads e.g. governance cost related to manager/director’s office)
34
Case: Examples of Other Relevant Costs (cont.)
Direct Program Costs Program Support Costs
Costs that are directly attributable to the program/activity Other offices that support the program/activity
Building Inspections Unit (Service Delivery Branch) Plans approval unit (Service Delivery Branch)
Pension – MGS accrues for all ministries Information unit (Service Delivery Branch)Termination Accruals – 1 week of accrued salary for each year per employee Director’s office (Service Delivery Branch)
Amortization Expense – if applicable Building Advisors Unit (Professional Services Branch)
Bad Debt Expense – if applicable ADM’s office (Infrastructure Division)
35
Ministry Corporate Overhead Costs Other Ministry Costs
Ministry administration costs representing organizational units
supporting the entire ministry
Other ministry services consumed by the program/activity
Deputy Minister’s Office Legal ServicesPolicy Audit ServicesCommunications Information SystemsFinance and Administration Ontario Shared ServicesHuman Resources Enforcement and Compliance
Risk costs - if applicable
(e.g. Financial liabilities like service guarantee, environmental liability etc.)
Case: Examples of Other Relevant Costs (cont.)
* To avoid double counting watch for costs that have already been charged to the program
*
36
Questions & Comments
Jalees HafeezSenior Financial Coordinator, Procurement & Costing Office, Finance BranchMinistry of TransportationTel: 905 704 3110E-mail: [email protected]
37
AppendixAppendix
38
Other Costing Methods
Standard costing – where standard cost rates are established based upon historical data (or other reasonable source) . This costing methodology is appropriate for repetitive type outputs and relies on ongoing comparisons with actual costs to identify any material variances
Process or unit costing – where products are created by flowing through a series of steps, accumulating a unit cost as they flow from one step to the next. This methodology is most appropriate for the production of homogenous goods or services, where the same process is used in the production of each output.
Job order or project costing – where discrete units of work are identified and used to accumulate the appropriate direct costs (via direct assignment) and indirect costs (based on a causal beneficial relationship). This costing methodology is most appropriate for organizations that produce non-repetitive outputs (e.g. engineering and construction, case management.
Cost allocation by operational variable – the use of an operational variable is the easiest method but is not as accurate as the methods demonstrated so far. The operational variables could include the number of FTEs, total budget dollars, program costs, labour costs or capital costs.
39
Unit Cost
Total Cost
of activities performed and products/services produced
Mod
el
Valid
atio
nM
gmt.
sign-
off
ABC/M Modeling Approach
Dat
a C
olle
ctio
nde
fine
activ
ities
, pro
duct
s /
serv
ices
Data ValidationEnsure accuracy of information collected
Model
Building
(using special
software for ABC –
SAS)
Final Costing Report(to be presented jointly with Program Area)
• Financial Analysis• HR alignment to cost centers
• Governance cost analysis• Corporate expenditure analysis
(accommodations, I&IT, PC Fleet, etc)