Implementing Activity Based Costingfor Job Shops

Presented byPresented by

Dave LechleitnerDave Lechleitner

Business Productivity AnalystBusiness Productivity Analyst

Exact Software—JobBOSS DivisionExact Software—JobBOSS Division

Your presenter today is Dave Lechleitner

Business Productivity Analyst

Why are we doing this session?

Knowing your “winners” from your “losers” is

critical.

It’s not getting any easier out there—you have

to remain competitive.

Flat shop rates don’t provide a true cost picture.

ABC provides a simple approach to analyze true

cost and is now being applied even to small

job shops.

Key QuestionsWhy do traditional flat shop rates fall short?

What are the characteristics of shops implementing Activity

Based Costing (ABC)?

How does ABC work and how can a shop correctly and

accurately allocate activity costs to jobs?

What key tools should you look for in an ERP system to review

costs and especially application of overhead?

How should a shop implement ABC?

Why Do Flat Shop Rates Fall Short in Determining True Job Cost?

Flat Shop Rate vs. ABC

Flat shop rate costing methods were generally developed

when a shop owner first started the business and may

have increased or decreased based on “gut feel” or “what

the market may bear.”

Normally includes some provision for profit “built in.” Hides the

real picture of what is going on.

Generally has no basis on reality of the true cost structure of

the shop.

Inherent problem in a flat shop rate is that it has an averaging

effect. Difficult jobs are under-quoted/costed and easy

jobs are over-quoted/costed.

Flat Shop Rate vs. ABC

Flat Shop Rate vs. ABC

Two employeesVERY different cost structure

Flat Shop Rate vs. ABC

Opponents of ABC often fall prey to the following arguments or

behavior--

• We don’t charge THAT cost to the customer because the

customer won’t pay it (i.e. engineering, quality control, customer

service, etc.)

• We can’t win the job quoting our actual cycle times so let’s

“fudge” the cycle times to get the price the customer will pay.

• We have to sharpen our pencils and lower our cost estimates (i.e.

ignore the real costs and put down anything to get to the price

the customer will pay.)

Characteristics of Shops Implementing Activity Based Costing

Shop Characteristics“Activity Based Costing is 30% understanding and

using techniques correctly, and 70% the ability to

convince others to accept beneficial change. No

matter how brilliant the measurement, if people

reject it, nothing has been achieved and the

analyst has failed.”

-- Ralf Sorenson (Head of SAS Airlines)

Shop CharacteristicsHas your time come to evaluate a new method of

measuring and collecting data as it relates to job

costing? It has if. . .

1. Your shop is implementing new, technologically

advanced processes into your operations without

making adjustments to your costing processes.

2. You only currently use one basis for charging

manufacturing costs to products—direct labor hours,

direct labor dollars, machine hours.

Shop Characteristics3. You have only one plant wide overhead rate, a

couple of rates, or worse—no overhead rate at

all.

4. You automatically change costing rates as

volume levels change.

5. You find yourself competitive in one product line

but not another or at one volume level but not

another.

Shop Characteristics6. Your shop manufacturing operations do not

always require the same number of operators—

partially attended operations or team operations

—or one employee operating a work cell.

7. It has some customers, markets, or product lines

that require different levels of selling, scheduling,

service, or other support activity but only have

one company wide G&A rate.

What is ABC and How Can Shops Accurately Allocate Costs

What is ABC?Very simple concept and key management tool.

• Jobs and contracts require a company to

perform activities.

• Activities cause a company to incur cost.

• Cost should be associated with jobs and

contracts that made the activity necessary.

What is ABC?

What is ABC?So, how does ABC work?• Identification of “cost pools” or activities which a

product/service must pass.

• Estimation of total cost of each activity must be estimated

for time period.

• Estimation of number of hours spent on each activity for

same time period.

• Determination and assigning of “cost driver” (i.e. quantity,

# of labor hours, # of machine hours, # of parts).

How Does a Shop Allocate Costs?

• Project a normal level of production

activity.

• Review over a longer period of time, such

as a 12-month period.

• Costs based upon shorter periods, such

as weekly or monthly periods, may

fluctuate too much.

How Does a Shop Allocate Costs?

Assign costs that are directly attributable to a job

and not subject to ABC cause/effect analysis

Direct labor (use actual employee rates)

Raw material

Purchased components

Outsourced manufacturing services

Perishable tooling consumed on a job

How Does a Shop Allocate Costs?

Determine the costs associated with Operational

Support Activities—Manufacturing Overhead

• Buildings and grounds

• Human resources—administrative staff required to

support employees performing direct activities

• Maintenance

• Plant supervision and production control

How Does a Shop Allocate Costs?

Determine the costs associated with Customer

Support Activities and Other

General/Administrative Overhead

• Different markets or customers may require different

effort to get new business or maintain existing

• Customer service activities– customers who are

“jerks” often cost more to maintain than “sweethearts”

• Accounting

• Sales and marketing

Example of Indirect

Shop Expenses

over previous

12 months

Allocation Calculation

• Determine a best method for allocating

the costs by type of activity—remember

to use the driver of the cost as the basis.– Percentage of direct labor dollars– Dollar rate per direct labor hour– Dollar rate per machine hour

Allocation Calculation

• Using the same $1,000,000 of expenses

for the last 12 months.

• Break expenses out by burden type:– Labor burden– Machine (Manufacturing) burden– G&A (General & Administrative) burden

Allocation Calculation• Same $1,000,000 of expenses allocated by burden

type.• Labor Burden ($300,000) + Machine Burden

($500,000) + General & Administrative Burden ($200,000) = $1,000,000.

Allocation Calculation

• Costs divided by shop hours of operation.

Tools Available in ERP Systems to Analyze Costs and Application of Overhead

ERP System ToolsAccording to NTMA

Key Principles of an ERP System1. Assign a unique job (work order) number for each part

number on an order you receive.2. Identify customer, part, and delivery information on the

order.3. Post cost of material at the time it is purchased and

received or drawn from stock.4. Post all outsourced processing expenses to the order.5. Post hours and rates for direct labor hours and machine

hours to the order when they occur.6. Assign manufacturing, selling, and general and

administrative overhead to order on proportionate basis—key to ABC.

ERP System Tools

ERP System Tools• ERP systems should give you the option to use Actual Employee Rates to drive true

ABC• Application of labor overhead by percentage yields better results if you have wide

variances in employee wages and fringe benefits

ERP System Tools• Once true cost is established, ability to define

global markup or profit goals is practical

ERP System Tools• Should allow ability to define markup

or profit goals specific by quoted quantity and specific part

ERP System Tools• Ability to review estimated, actual, and variance against

direct labor and overhead/burden costs at end of job.

ERP System Tools• Review profitability against order,

produced, and shipped quantity

ERP System Tools• Catch your “losers” before they get out

of control—before it’s too late!

ERP System Tools• Regularly monitor your allocation of your

costs against the activities that drive them.

How Should a Shop Implement ABC?

Implementing ABC• Determine your present expertise level in ABC and commitment to it• Determine cost in both time (effort) and money• Determine a timeline for completion—beginning of a new fiscal year is perfect time• Select a project lead• Establish a pilot project• Determine action plan after pilot

Implementing ABC

Is it worth it?

• For most mid-sized manufacturers an

ABC analysis can be conducted for as

low as 0.08% of total sales for small this

may creep as high as 0.3%.

• Most companies realize an ROI in as little

as 1 – 4 months with benefits that

continue to grow over time.

Implementing ABC

• High-powered decision making tool for

managers and owners

• Remember…not a system but a concept

to embrace and encourage

• Doesn’t have to be complex…so take

small steps

Implementing ABC

ResourcesCosting, Pricing, and Financial Management

-- Published by the National Tooling & Machining Association

(www.ntma.org)

The ABCs of Activity Based Costing-- MMS Online, Mark Albert (Article #119803)

Activity Based Costing for Mold Shops—Parts I – III

-- Moldmaking Technology (October – December 2004)

Costing Traps for Manufacturers-- Manufacturing Engineering (December 1998)

Key QuestionsWhy do traditional flat shop rates fall short?

What are the characteristics of shops implementing Activity

Based Costing (ABC)?

How does a ABC work and how can a shop correctly and

accurately allocate costs to jobs?

What key tools should you look for in an ERP system to review

costs and especially application of overhead?

How should a shop implement ABC?

If you have additional questions,

JobBOSS Customerscontact your Customer Advocate

Prospects contact your Sales Rep

1-800-777-4334