abc implementation

8/2/2019 ABC Implementation

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WHITE PAPER

Autr: Richard Barrett and Jim Robinson

Ctributrs: Chris Grundy, MaryLouise Meckler, Jing Zhao

Auiece: CFOs, nancial controllers, nancial managers, and cost accountants.

EXECUTIVE SUMMARYThis paper is the second in a series o three developed to help you understandactivity-based costing (ABC) and activity-based cost management (ABM).This paper discusses the major issues that oten ace ABC implementers.

The other two papers in the series are An Introduction to Activity-Based CostManagement, and Practical Applications o Activity-Based Costing.

ACTIVITY-BASEd CoSTIng

IMplEMEnTATIon ISSUESA Guide to Successul ABC Solutions

ConTEnTS

2 Introductioin4 Selecting Activity Drivers6 Designing the Activity Dictionary

8 Choice o Modeling ToolSpreadsheetor ABC Sotware


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When you implement ABC, remember that yours wont be the rst organization todo so. Many other businesses have already adopted an activity-based approach totheir management processes, and their experiences show that a number o considerationsand issues must be aced. This paper discusses the most requent o those issues.

nUMBER of ACTIVITIES

One issue analysts oten aceironically, usually by those who have embraced theABC concept most enthusiasticallyis the temptation to build an activity list thatgoes down to too ne a level o detail. There are practical problems associatedwith modeling too many activitiescalculating the model takes longer, maintainingthe activity list is an administrative nightmare, and classiying activities to identiywasted activity becomes a more onerous job.

But more importantlyadding more detail doesnt give better information. When amodel contains thousands o activities, it s dicult to home in on pertinentinormationyou cant see the orest or the trees. Many activities will haveinsignicant amounts allocated to them. Its best to consider how you will use

the activity analysis beore you dene the activities, and then choose a level odetail that is appropriate.

For example, i youre preparing a strategic analysis, its probably sucient todene as ew as 20 or 30 activities. In reality, these activities probably would beat a high enough level to be classied as processesor example, a series o relatedactivities that compose the customer sales order processrather than the individualactivities that orm a part o that process, such as take customer order bytelephone. Dividing the process cost by a suitable driver, such as number ocustomer sales orders, gives a measure that can be used to compare the sameprocess in other companies, or or investigating possible outsourcing decisions. Andi you subsequently decide that you want to expand the analysis to, say, 50 or 75activities, its reasonably easy to do so without undamental upheavals in the model.

For tactical modeling, you need to work at a more detailed level. This is a must wheninvestigating wasted costs, because it becomes necessary to analyze activitiesrelated to error correction, duplication, and waiting. More detail is also needed orproduct, customer, and channel costing, so you can apportion dierent activitiesto dierent combinations o activities using dierent cost drivers. A typical tacticalmodel might analyze between 200 and 300 activities and perhaps 10 or 20 drivers.

Business process improvement requires activities to be analyzed at a lowlevelperhaps down to task or, more likely, a combination o task and activity level.I the whole business is to be examined, business process improvement sometimesresults in over a thousand activities. Modeling at such a level could prove to be a

InTRodUCTIon

Busiess objects. Activity-Based Costing Implementation Issues


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complex and lengthy procedure, and the need or such a detailed approach wouldgreatly depend upon the organizations circumstances and its need or such inormation.

Table 1 sets out the possible applications o activity cost inormation at thedierent levels o detail.

One starting point is to develop a relatively simple strategic ABC model, whichpoints management in the direction o areas that need attention. More detailedmodeling exercises can then be run, ocusing on those areas o concern. However,i youre interested in cost-eectiveness, at some point you need to model at thetactical (activity-based) levelotherwise, you cant dierentiate between thoseactivities that add value and those that dont.

Table 1. Applications of Different Levels of Activity Costing

Level Typical Number of Activities Applications

Strategic 20-75 Business Pperformance MeasurementBenchmarkingForecasting and PlanningStrategic Pricing of ServicesIntrabusiness Charging

Departmental Performance MeasurementIdentification of Wasted ActivityValue-Added Analysis

Tactical 75-300

Task 300+ Individual Performance MeasurementBusiness Process Improvement



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One o the most dicult parts o ABC implementation is identiying and selectingsuitable drivers. One reason is because its not always immediately apparent whatdrives a particular activity. For example, the driver or the activity chase customers ontelephone could be the number o overdue invoices, the value o overdue invoices,

the number o calls, or some other measure. Furthermore, although the obviousdriver to this activity might be the number o overdue invoices, the root cause mightbe that aulty goods cause customers to delay payment. As a general guideline, theroot cause driver usually gives management the most useul inormation. However,you wont always know what the root cause is.

Especially in the early phase o ABC implementation, it may not be clear whichdriver is most signicant. It oten doesnt become clear until ater the activity costhas been calculated, but i your sotware solution is fexible enough, its a simpleenough job to switch an activity rom one driver to another. This neednt be aproblem, but you need to be open to the idea that you mayand probably willhaveto change your assumptions about driver assignments. Choose a solution thatallows you to change assumptions easily.

Another potential pitall is that even when a driver is clearly important, the driverdata may not be easily available. Possibly the data isnt recorded anywhere orresources arent available to extract the driver rom the IT systemsso you must beprepared to compromise and perhaps use dierent drivers, even i only temporarilyuntil the appropriate data can be extracted or start to be collected. To alleviate thissomewhat, its a good idea to start driver collection early. Experience shows thatgetting hold o the driver data is oten a bottleneck in ABC projects. Starting earlynot only minimizes the risk o a bottleneck but may also allow the business to startcollecting data that it doesnt currently track.

SElECTIng ACTIVITY dRIVERS



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Maximize the benet o your work by adopting a ew simple principles when itcomes to choosing activity drivers. First, try to limit the number o drivers. You canprobably choose 10 or 20 drivers that t most activities, and those related to themost costly activities. For a ew low-cost activities, the benet o spending a lot o

time and eort on getting data or a ew esoteric drivers likely wont be worth thetrouble. For those ew low-cost activities, assign the best-t driver rom the remaininglistor accept that the activity has no relationship with customers or products, andtreat it as unallocated. On a similar tack, when collecting data, prioritize your timeso you concentrate on the most costly drivers.

I you need to, its quite valid to estimate the most important drivers. When a driveris in the top 10 but data isnt immediately available, use your management teamand stas experience to estimate the volumes, or i appropriate, sample the dataor a short period to provide an estimate o the annual driver volume. Although bydenition estimates and samples are less than 100% accurate, its better to haveinormation that is useul and nearly right rather than no inormation at all. As longas managers and sta who are close to the process are involved, the estimates will

prove to be remarkably accurateand certainly good enough to produce a reasonableallocation o cost to customers and products.



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The activity dictionary is more than just a list o activitiesit also acts as a templateor collecting the time spent by sta on activities. So as well as providing an inputto the model building, it becomes a valuable resource during the data collectionstage. This section discusses the various principles that govern the construction o

a useul activity dictionary.A design workshop should be held where key managers meet to discuss andagree on a set o processes and activities that are to be modeled. The workshop isextremely important, not only because it allows the project to benet rom thebusiness knowledge and experience o your managers, but also because iteducates them in the methodology and allows them to appreciate the reasons orthe projectthus encouraging their ull participation and cooperation with theconclusions o the analysis.

During the workshop, remember what we discussed in the previous section aboutthe number o activities. Limit the level o detail to what is required and to what willprovide the necessary results at the end o the analysis. More detail than necessaryresults in a cumbersome modelone thats hard to maintain and rom which

conclusions are hard to draw. Also, remember the salient points about identiying theactivities that are related to process ailure. I you want to make process improvementsas a result o the ABC analysis, its important that your activity dictionary lists wasteactivities, such as error correction, duplication, waiting, checking, and transportation.

A requent obstacle to successul ABC modeling is the inability to obtain good-qualityactivity driver data. Your design workshop should initially allocate drivers to activities,and then attempt to reduce the number o drivers to a maximum o, say, 20. Get allmanagers involved to review the original choice o drivers, so they agree on what itis really the cause o the activity.

dESIgnIng ThE ACTIVITY dICTIonARY



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Sometimes you wont be able to get hold o the right inormation or your rst-choicedriver, so be prepared to compromise. In cases where activities are known to becaused by a driver or which data wont be available, and no alternative best t isavailable, you can split the activity by customer/product group in the dictionary and

ask managers to estimate the split when completing the dictionary. This is illustratedin Table 2.

Activities % Staff Time Available Drivers Estimate(Data Not Available)

Print & Mail Invoices

Allocate Receipts

Issue Credit Notes

Plan, Organize,& Monitor Staff

Total

30 Number of Orders

Number of Return Notes

Number of Orders

Unallocated

600

20

50

400

Chase Customeron Telephone

Customer A

Customer B

Customer C

100

Activity Dictionary-Credit Control department (6 employees)

29%

71%

0%

Table 2. Estimating Customer/Product Split in the Activity Dictionary



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There is, simply, no getting away rom the act that some sort o sotware solution isnecessary. The rst question is whether you should invest in a dedicated ABC tool,or i its possible to get away with building your own spreadsheet-based solution.

For a high-level, strategic model, its just about possible to get away with a homegrown

spreadsheet solution. For a prototyping, proo-o-concept exerciseaimed atestablishing the methodology and making the case or ABCdedicated applicationsotware might not be necessary.

However, once the project moves orward to more detailed levels, or when usersrequire ad hoc queries, or when you need to maintain the model, a spreadsheetsolution looks more problematic. For example, take the issue o data volumes. Atypical strategic model might have 20 departments, 30 accounts, 50 activities,50 customer/product groups, and 10 drivers. Although this isnt a hugely detailedmodel, it can result in 1.5 million calculation entities. Any spreadsheet takes a longtime to recalculate ater even a simple data change. Additionally, spreadsheets lackthe capability to trace back costs in simple report orm to determine source.

A bigger risk is that the spreadsheet solution becomes extremely complex anddicult to maintaineven or the person or persons who built it. I the spreadsheetcreator should leave, experience suggests that the model has to be rebuilt or italls into disuse because no one has the knowledge or condence to unravel thecomplex interrelationships contained within the spreadsheet.

For these reasons alone, reliance on spreadsheet models is not recommended orthe medium or long-term development o ABC.

A number o ABC sotware tools are available that make the process o modelbuilding, data capture, and analysis o the results much easier, both in the initialbuilding phase and during the ongoing lie o the project.

A common misconception is that adopting an ABC system implies the need toreject the existing costing system and invest large amounts o capital and eort ina new system. In act, the most successul ABC implementations are ones in whichorganizations already employ systems that provide reliable data and a good costingdiscipline in the organization. In such organizations, ABC is more likely to integrateinto the existing system rather than replace it.

ChoICE of ModElIng ToolSpREAdShEET

oR ABC SofTWARE



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Notes



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Notes

Busiess objects. Activity-Based Costing Implementation Issues 10


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Notes

Busiess objects. Activity-Based Costing Implementation Issues 11


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