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Identify Pitfalls in a Identify Pitfalls in a Role Based Control Case Study ScenarioRole Based Control Case Study Scenario
Navy Research and Development CaseNavy Research and Development Case
© Dale R. Geiger 2011 1
Ever Wonder Why Overhead is Often Ever Wonder Why Overhead is Often Called “Burden”?Called “Burden”?
Terminal Learning ObjectiveTerminal Learning Objective• Task: Identify Pitfalls in a Role Based Control Case
Study Scenario• Condition: You are training to become an ACE with
access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors.
• Standard: with at least 80% accuracy• Discuss role based control issues related to support
functions• Describe various allocation solutions for support functions• Calculate step-down allocation
© Dale R. Geiger 2011 3
SPAWAR Systems Center-PacificSPAWAR Systems Center-Pacific
• Very high tech R&D funded by project basis• Funding process required total cost by project for
proper reimbursement• Organized into research divisions with numerous
centralized support functions • Safety (as shown in last segment)• Facilities (the focus of this case) and• Many others
Proposed Change in Distribution of Proposed Change in Distribution of Facilities CostFacilities Cost
• Situation: meeting at Navy R&D lab• Reviewing a distribution of San Diego facilities
cost to operating divisions• Existing method allocated based on labor• Proposed method allocated based on square
feet occupied
Division 30 40 50 70 80 TotalLabor Basis ($M) 2.3 5.1 2.4 3.8 3.7 17.3Footage Basis ($M) .0 4.0 4.6 4.1 4.6 17.3Change ($M) 2.3 1.1 (2.2) (.3) (.9) -
Chaos ResultedChaos Resulted
• Division 30 wasn’t represented as they were located in Pennsylvania
• Division 40 didn’t say a word• Divisions 50, 60, and 70 strongly objected to the
methodology, purpose, and change• The meeting deteriorated until the commander
exercised his leadership role
Division 30 40 50 70 80 TotalLabor Basis ($M) 2.3 5.1 2.4 3.8 3.7 17.3Footage Basis ($M) .0 4.0 4.6 4.1 4.6 17.3Change ($M) 2.3 1.1 (2.2) (.3) (.9) -
Leadership Driven ManagementLeadership Driven Management
• The Commander stated:• “Look, we’ve got to get our overhead down”• (Management need awareness)
• “There are two ways to do this. One is to use the Soviet Method and I’ll make all the decisions”• (Centralized management paradigm)
Leadership Driven ManagementLeadership Driven Management
• “The alternative is to use free market economics”• (Decentralized management paradigm)
• “Activity based costing will tell you what things really cost”• (Actionable cost measurement capability)
• “I’ll look to you to make the right decisions. Which do you want?”
NRaD Facilities Allocation RevisitedNRaD Facilities Allocation Revisited
• Simple, direct allocation of facilities to line divisions on the basis of occupied space made sense to the CO
• Division 40 was growing rapidly (and was short space) while Division 50 was declining (and had a lot of space)
Division 30 40 50 70 80 TotalLabor Basis ($M) 2.3 5.1 2.4 3.8 3.7 17.3Footage Basis ($M) .0 4.0 4.6 4.1 4.6 17.3Change ($M) 2.3 1.1 (2.2) (.3) (.9) -
NRaD Facilities Allocation RevisitedNRaD Facilities Allocation Revisited
• HOWEVER, the Commanding Officer had a major concern about the cost model:• Motivated line departments to reduce but• Did not put similar pressure on overhead
• The unintended consequence would be:• Line functions vacating space• Overhead functions moving in
• Advanced allocation issues had to be considered
A Generic Problem: Allocating Overhead to A Generic Problem: Allocating Overhead to Overhead FunctionsOverhead Functions
• Support functions support other support functions• Payroll function serves accounting and
administration• Personnel department consumes facilities
resources• Accounting uses computing services
• How should this be handled?
Learning Check Learning Check
• What was the Commander’s Intent for the R&D lab?
• What problems can arise when support departments support other support departments?
© Dale R. Geiger 2011 12
Allocation AlternativesAllocation Alternatives
Direct, SimpleDirect, Simple
Step DownStep Down
Reciprocal Reciprocal
Allocation AlternativesAllocation Alternatives
Direct, SimpleDirect, Simple
Step DownStep Down
Reciprocal Reciprocal
Allocation AlternativesAllocation Alternatives
Direct, SimpleDirect, Simple
Step DownStep Down
Reciprocal Reciprocal
Direct, Simple AllocationDirect, Simple Allocation
• Follows methods already covered in this course
• Allocates cost pools directly to cost objects• Advantage: Advantage: easiest to use and explain• DisadvantageDisadvantage: may provide free goods to
support functions
Direct Simple AllocationDirect Simple Allocation
Support XSupport X Support YSupport Y Support ZSupport Z
Core ACore A Core BCore B
Step Down AllocationStep Down Allocation
• Allocates first cost pool to other cost pools and cost objects
• Allocates second cost pool to other cost pools (less first pool) and cost objects
• Etc, Etc, Etc• AdvantageAdvantage: prevents most free goods• DisadvantageDisadvantage: increases the complexity and
cost of cost system
Step Down AllocationStep Down Allocation
Support XSupport X Support YSupport Y Support ZSupport Z
Step Down AllocationStep Down AllocationFirst StepFirst Step
Support XSupport X Support YSupport Y Support ZSupport Z
Core ACore A Core BCore B
Step Down AllocationStep Down AllocationSecond StepSecond Step
Support XSupport X Support YSupport Y Support ZSupport Z
Step Down AllocationStep Down AllocationThird StepThird Step
Support XSupport X Support YSupport Y Support ZSupport Z
Reciprocal AllocationReciprocal Allocation
• Recognizes consumption of all resources by all support functions
• AdvantageAdvantage: prevents free goods• DisadvantagesDisadvantages: • Increases the complexity and cost of cost system
(less affordable)• Decreases the understanding of results
(less credible)• Provides excuses (less useful)
Reciprocal AllocationReciprocal Allocation
Support XSupport X Support YSupport Y Support ZSupport Z
Core ACore A Core BCore B
Reciprocal AllocationReciprocal Allocation
• Create a system of “n” equations in “n” unknowns where:• Matrix [D] represents fraction of services
consumed• Matrix [E] represents the vector of service costs• Matrix [B] is the transpose of the reciprocal cost
vector, • Then: [E] = [B] [D]T
T
Simple Reciprocal Allocation Example:Simple Reciprocal Allocation Example:Two Activities and Two Cost ObjectsTwo Activities and Two Cost Objects
• Payroll costs $700 and supports itself (1%), Receiving (2%), Code 30 (25%) and Code 40 (72%)
• Payroll reciprocal cost (PRC):
• Receiving costs $1000 and supports itself (1%), Payroll (1%), Code 30 (40%) and Code 40 (58%)
• Receiving reciprocal cost (RRC):
• This gives us two equations in two unknowns
PRC = 700 + .01PRC + .01RRCPRC = 700 + .01PRC + .01RRC
RRC = 1000 + .02PRC + .01RRCRRC = 1000 + .02PRC + .01RRC
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 27
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 28
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 29
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 30
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 31
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 32
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 33
Reciprocal AllocationReciprocal AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
7 14 179 517 717
Receiving Cost (add)
10 10 410 594 1024
Allocated(subtract)
-717 -1024 -1741
Final Cost
0 0 589 1,111 1,700
© Dale R. Geiger 2011 34
Learning CheckLearning Check
• What is the primary advantage of the simple, direct method?
• What is the primary advantage of the reciprocal method?
© Dale R. Geiger 2011 35
Demonstration Problem Demonstration Problem (part 1)(part 1)
• Payroll costs $700 and supports itself (1%), Receiving (2%), Code 30 (25%) and Code 40 (72%)
• Receiving costs $1000 and supports itself (1%), Payroll (1%), Code 30 (40%) and Code 40 (58%)
• Prepare a step-down distribution allocating payroll first and then receiving
© Dale R. Geiger 2011 36
Step Down AllocationStep Down Allocation
• Step one: define the hierarchy of support• May be based on significance (largest first)• Or on desired behaviors (eliminate free goods)
• In our case, we want to motivate wise consumption of payroll resources
• We will allocate payroll first• Ignore payroll’s allocation from itself and from
receiving• Allocate payroll to receiving and to codes 30 and 40
© Dale R. Geiger 2011 37
Step Down AllocationStep Down AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
Receiving Cost (add)
Allocated(subtract)
Final Cost
© Dale R. Geiger 2011 38
Step Down AllocationStep Down AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
14 177 509 700
Receiving Cost (add)
Allocated(subtract)
Final Cost
© Dale R. Geiger 2011 39
Step 2: Allocate first support activity to support and line functions
Step Down AllocationStep Down AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
14 177 509 700
Receiving Cost (add)
Allocated(subtract)
-700
Final Cost
© Dale R. Geiger 2011 40
Step Down AllocationStep Down AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
14 177 509 700
Receiving Cost (add)
414 600 1014
Allocated(subtract)
-700
Final Cost
© Dale R. Geiger 2011 41
Step 3: Allocate second support activity to line functions
Step Down AllocationStep Down AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
14 177 509 700
Receiving Cost (add)
414 600 1014
Allocated(subtract)
-700 -1014 -1714
Final Cost
© Dale R. Geiger 2011 42
Step Down AllocationStep Down AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
14 177 509 700
Receiving Cost (add)
414 600 1014
Allocated(subtract)
-700 -1014 -1714
Final Cost
0 0 591 1109 1700
© Dale R. Geiger 2011 43
Discussion on Step-DownDiscussion on Step-Down
• Theoretically we would repeat the steps for each activity in the hierarchy
• What are the implications?• What solutions might you suggest?
© Dale R. Geiger 2011 44
Suggested Step Down HierarchySuggested Step Down Hierarchy
© Dale R. Geiger 2011 45
Most Important Most Important Support ActivitySupport Activity
XXSupport YSupport Y Support ZSupport Z
Suggested Step Down HierarchySuggested Step Down Hierarchy
© Dale R. Geiger 2011 46
Most Important Most Important Support ActivitySupport Activity
XXSupport YSupport Y Support ZSupport Z
Suggested Step Down HierarchySuggested Step Down Hierarchy
© Dale R. Geiger 2011 47
Most Important Most Important Support ActivitySupport Activity
XXSupport YSupport Y Support ZSupport Z
Demonstration Problem Demonstration Problem (part 2)(part 2)
• Ignore the allocations from and between payroll and receiving• Apply direct simple allocation• Report Code 30 and Code 40 allocations cost
• Compare the results from the three methods
© Dale R. Geiger 2011 48
Direct, Simple AllocationDirect, Simple AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
Receiving Cost (add)
Allocated(subtract)
Final Cost
© Dale R. Geiger 2011 49
Direct, Simple AllocationDirect, Simple AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
180 520 700
Receiving Cost (add)
Allocated(subtract)
-700
Final Cost
© Dale R. Geiger 2011 50
Direct, Simple AllocationDirect, Simple AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
180 520 700
Receiving Cost (add)
408 592 1000
Allocated(subtract)
-700 -1000 -1700
Final Cost
© Dale R. Geiger 2011 51
Direct, Simple AllocationDirect, Simple AllocationPayroll Receiving 30 40 Total
Cost Incurred
700 1000 1700
Payroll Cost (add)
180 520 700
Receiving Cost (add)
408 592 1000
Allocated(subtract)
-700 -1000 -1700
Final Cost
0 0 588 1112 1700
© Dale R. Geiger 2011 52
Compare the Three MethodsCompare the Three MethodsPayroll Receiving 30 40 Total
Reciprocal 0 0 589 1111 1700
Step-Down 0 0 591 1109 1700
Simple 0 0 588 1112 1700
© Dale R. Geiger 2011 53
What have you learned?
• What is the first step in the step-down allocation process?
• What is the main advantage of the step-down method
© Dale R. Geiger 2011 54
Learning CheckLearning Check
Recommendations – Pitfall AvoidanceRecommendations – Pitfall Avoidance
• Keep it simple • Allocate most support functions directly to
cost objects• Take exception rarely and thoughtfully• Facilities• Automated data processing
• Handle exceptions with step down method instead of reciprocal
Step Down Method Recommended Step Down Method Recommended to NraD Commanding Officerto NraD Commanding Officer
• Facility overhead first allocated to all line and overhead functions
• Overhead functions included this cost in their budgets and subsequent direct, simple allocations
• Small impact on cost distribution• Significant impact on behavior
NRaD Facilities Conclusion: ResultsNRaD Facilities Conclusion: Results
• Leaders of core functions chose role based control process over “Soviet” Method• Both core and support functions quickly
identified space no longer needed• 35,000 square feet freed in first year with cost
savings and cost avoidance evaluated at $2.3 million per year
• Monthly AAR still conducted 15 years later• Why do you think this process has continued?