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Activity-Based Costing (ABC):– A method of assigning costs to products or services based on

the resources they consume.

– ABC is an alternative to traditional accounting in which a business’s overhead amounts (indirect labor, production facility, marketing, etc.) are allocated in proportion to an activity's direct costs.

The concern . . . two activities that absorb the samedirect costs can use or require very different amounts ofoverhead . . . .

Fundamentals

Activity-Based Costing (ABC):– ABC became popular in early 1980’s . . . The primary issues:

1. ABC requires that a business define, break-down andtrack cost details by individual business activities.

2. ABC requires Clean & Accurate DATA.

3. ABC was thought to be a replacement for traditionalaccounting methods . . .it’s a supporting ManagementDecision Tool . . . not a replacement.

Fundamentals

ABC is an “Approach” that provides an effective way to view and interpret information by measuring Cost and Performance of business processes and their outputs.

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The “New & Revised” ABC/M Approach:Beginning in 2005, the approach to ABC/M was modified to focus on:

1. The Cost Per Time Unit associated with supplying resourcecapacity, and

2. The Unit Times of Consumption of resource capacity by products, services and customers.

Fundamentals

What does this mean?Determining and using Cost Drivers . . . examples would be:- Stamping Operation: $/Machine Hour by Cost Center- Food Distributor: $/Distribution Drop- Machine Fabricator: $/Direct Labor Hour- Specialty Meat Producer: Lb./Product Sold by Customer Type

Benefits of an ABC/M Approach:– Provides decision makers with details regarding which

products or services make or lose money.

– Designed to provide profitability information for each segment of a product/service market matrix.

– ABC/M is a Management Tool that can be used understand and address specific products, services or customers that makeor lose money for your organization.

– ABC/M highlights how efficiently & effectively activities are being performed and who arethe benefactors of the activities performed.

Fundamentals

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1. Develop a Cost Management Strategy: Establish a Cost Management Task Force or Team

Map and analyze your Key Processes

Review, analyze, test and validate your General Ledger Detail

Collect and verify the accuracy of your Process Data

2. Develop a Cost Model Establish Fully Loaded Labor Rates

Establish Equipment Replacement Values and Rates

Incorporate Process Maps, Bills of Material, Service Steps, etc.

3. Determine Costs and React Establish unit costs for products or services by customer, product

line, cost/machine center, department, etc.

Recommended Approach to ABC/M

Step 1: Cost Management Strategy

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Costs to Control & Assign

ResourceCosts

Activity-SpecificCosts

Activity-SupportCosts

Customer SupportCosts

UnabsorbedCosts

Non-SpecificCosts

Activity-BasedCosting

Traditional Costs~ Manufacturing Perspective ~

+LABOR

+Process

Cost perunit of output

Total CostTotal Output( )

$/Unit

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Activity Based Costing Approach

Activities and their drivers create a meaningful link

between products, customers, and the

resources they consume

Customer ACustomer A

Customer ACustomer A

Customer ACustomer A

Product 1Product 1

Product 1Product 1

Product 1Product 1

Cost Driver 1Cost Driver 1Cost Driver 1Cost Driver 1Cost Driver 1Cost Driver X

Activity 1Activity 1Activity 1Activity 1Activity 1Activity 1

Costs

Activity Analysis

Internalsupportactivity

Activities with no direct link

Activity driven byproducts, services

& customers

AllocationMethods

AllocationMethods

Allocation Methods

ProductsServices

Customers

Non-SpecificCosts

Activity costs assigned to specific products,

services, customers, cost centers, etc. using the

“Driver Volume” of each activity

Flow of Costs . . .

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Process Mapping – an examination of the expectations and requirements between departments . . . . includes both internal and

external customers

PRODUCT(“Result of a process”)

MONITORING AND

MEASUREMENT OPPORTUNITIES

(Before, during and after the process)

OutputInput PROCESS“Set of interrelated or interacting activities”

EFFECTIVENESS

OF PROCESS =

Ability to achieve

desired results

(Focus of ISO

9001:2000)

EFFECTIVENESS

OF PROCESS =

Ability to achieve

desired results

EFFICIENCY OF

PROCESS =

Results achieved

vs resources used

(Focus of ISO

9004:2000)

EFFICIENCY

OF PROCESS =

Results achieved

vs resources used

(Includes Resources)

Map your “Value Streams”

Process 1

Value Stream Map

Delivery

Value Stream Map

Follow a “product” or “service” from beginning to end. Draw a visual representation of every process in the material & information flow. Identify Value-Added and Non-Value Added steps.

Process 3Process 2

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Strategy Development . . . Review and test your general ledger to identify which

accounts are allocated “what” costs and then validate!

Determine the most appropriate cost drivers to allocate the costs . . . .

Cost Center C

Account $

Cost Center B

Account $

Cost Center A

Account $

Example:

Employment Costs- Fully Loaded Costs:Salaries, taxes, pensions, etc.

Occupancy Costs- Rent, utilities, repairs, etc.

Equipment Costs- Lease, property tax, utilities

Assigning Base Costs to Activities . . .

Activity-SpecificCosts

Costs

General Ledger

ActivityAnalysis

AllocationMethods

Employment Costs: Hours worked per activity or % of time spentOccupancy Costs: Square feet of facility space usedNetwork Costs: Log-on time, Processing time etc.

Activity-related costs are assigned to individual activities on the basis of rational allocation methods

Example:

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Step 2: Develop a Cost Model

VA = SR – (MC + OS)

VA = Value Added

SR = Sales Revenues

MC = Material Costs

OS = Outside Servicing Costs

Structure your operations via a“Value-Added” approach . . .

Important Aspect . . .

Incorporate a “Checkbook” Mentality

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Cost Model is used to assign specific activity costs and as a “tool” for management decision making.

BOM

RoutersCosting Model for

Business Decisions

Cost Model Structure

Product, Customer, Business Unit Cost Analysis

Monthly Snap-Shot

Determine your “Fully Loaded” Labor Costs:

Labor Analysis

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Establish a Cost / Hour for all Primary Equipment:

Equipment Analysis

Allocate your Financial Data by Department, Cost Center, Etc.

Department Cost Allocations

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Step 3: Determine Costs

Example . . . Contractor- Cost & Profit per Job Analysis

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0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

Pro

fits

1H 8M 3W 2T 2M 7W 7H 6F 1F 3M 8H 1M 8W 6W 7M 8T 1T 1W 2F 3T 8F 7F 2H 3H 2W

Route

Profits per Drop

Example Project . . . Do we stay or do we go?- Food Distributor - In Business since 1967- 11 delivery trucks - Next Generation Mgmt.- Breakeven - Where’s the future?

Breakeven$121.19/Drop

Profit per Drop

$0.0000 $0.5000 $1.0000 $1.5000 $2.0000 $2.5000

12-1# NS Tortilla Chips

1 # Display

Tortilla Chip 12/14 oz Sea Salt Strips

Sea Salt 12/13 oz Tortilla Chips Deli Style

Guacamole Tortilla Chips - 12/13 oz

Sea Salt 12/6 oz Tortilla Chips Deli Style

Restaurant Style 12/6 oz Tortilla Chips Deli Style

Nacho Cheese Tortilla Chips 12/14 oz

Lime 12/6 oz Tortilla Chips Deli Style

Lime 12/6 oz Tortilla Chips Deli Style - Canadian

Salsa Fresca 12/13 oz Tortilla Chips Deli Style

Lime Habanero 12/13 oz Tortilla Chips Deli Style

Totrilla Chip - Production Cost $/Lb .vs. Selling Price $/Lb

Total Cost $/Lb (Less Other Expenses) Leaving Plant Selling Price $/Lb

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0% 60% 70% 80% 90% 100%10% 20% 30% 40% 50%

Cu

mu

lati

ve P

rofi

ts (

% o

f to

tal p

rofi

ts)

Refine Processes toImprove Profitability

Convert or Disengage

Most Profitable Customers Least Profitable Customers

Profit Distribution Curve

0%

20%

40%

60%

80%

100%

120%

160% Cultivate and Grow

ABC/M Objective . . . Profitability by Customer

Identify and eliminate the unprofitable . . . Up to 30% of products, services or customers may not be profitable:- Determine how resources will be allocated

- Understand the implications of “Elimination”

- Manage the remaining costs . . . . Do Not Transfer!

30% to 40% of products, services andcustomers are marginally profitable or marginally unprofitable

Know which Products, Services, and Customers that drive profitability at your company

ABC/M Objective . . . Profitability by Customer

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Next Step . . . . . . Mobilize

Definition: To make mobile or capable of movement. To assemble, prepare, or coordinate for a purpose.

Implement actions to shift to controllable revenues where unpredictability is the greatest.

Maximize revenues for existing customers:– Mobilize your Sales Force . . .Position for Strategic

Partnerships

– Examine the value chain to increase revenues that can be earned from existing customer.

– Look for Sustainable Cost Reductions verses Short-Term Cost Savings.

What’s our Market Position?

– Develop a strategy to recognize merger, acquisition and potential market growth opportunities.

– Position your company to understand current and future market segment, areas for growth, etc.

– Options:

• Stay as you are in your business and market nitch

• Initiate a diversification strategy / program

• Explore and initiate mergers and/or acquisitions

• Identify and source resources overseas

• Provide a strategic platform for foreign companies

Prepare to Transition & Position

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78 million workers will leave the workforce over the next 16 years. There are only 48 million new entrants:

Look within for Critical Skills and Knowledge

Key Questions to Ask:

Which segments of my workforce create the most value?

Which areas of our organization will be most impacted by

retirements?

What skills do we need now?

What skills will we need in the next 5 years?

Are we actively developing workforce plans?

Establish a Labor Force Strategy

Lean Manufacturing

ISO 9001:2008

Six Sigma

Activity-Based Cost Mgmt.

Balanced Scorecard

Toyota Production System

Business

Improvement

Tools

Goal:

To provide you and your

management team with high-

quality data and business

information.

Objectives:

1. Timely Decisions

2. Value-Added Insight

3. Maintain Control

4. Efficiency and Profitability

Incorporate Productivity “Tools” & Methods

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ABC/M Road Map

DiversificationStrategy?

“Would you tell me, please, whichway I ought to go from here?” asked Alice.

“That depends a good deal on where you want to get

to,” said the cat.

“I don’t much care where,” said Alice.

“Then it doesn’t matter which way you go,” said the cat.

Lewis Carroll, Alice’s Adventures in Wonderland

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In Conclusion . . .

Incorporate a SMART Edge:– Strategy - make sure your long term costing strategy remains

intact and focused.

– Message and Measure - it is vital that your key people understand your cost strategy and know where you are heading.

– Accelerate - the world is changing quickly and you have to change even quicker. This is the time to gain market share.

– Reinvest – Look for opportunities, cost controls, process improvements, etc.

– Talent - is a critical key to achieving and sustaining your business goals and objectives.

Questions?

THANK YOU!Alan Lund

UHY Advisors, Inc.Farmington Hills, Michigan 48334

(248) 355-1040

Alund@uhy-us.com