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Related Downloads In general, activity based costing is a two step process:
--------------------------------------------------------------------------------------------------------------------------------------------------- Step 1: Determining the
fully
loaded activity cost A) Defining Your
Resources Defining Resources is where we begin to really dig into the heart of Activity Based Costing. While the General Ledger is a very intuitive way to organize costs at a high level, the Ledger is not grouped in a way that lends itself to clarity upon dissection. By defining Resources we are able to re-group the General Ledger accounts into cost groups that make more sense to analyze more granularly. Essentially, there are two basic
kinds of Resources:
The general methodology of defining the Resources for your organization is this:
It is important to get to the root of why an expense exists. For example, on your Ledger you may have a Computer expense category. Why does the Computer expense exist? is it to help the employees do their jobs, or is it because a customer requires for invoices to be wired from a specific terminal? If you decide that the computers are there because an customer has specific requirements about invoice submission, we would want to create a Resource group to silo those dollars so that we could allocate them to the customer directly. B) Defining Your
Activities Everyone in your organization has a primary set of Activities that he or she performs. In this step of building a costing model you create a master list of those activities. Most users find this step to be extremely useful in that, long before any actual cost allocation takes place, you learn a good deal about your organization, specifically what people are doing and what is causing them to do it! Interviews You probably have a very good idea of what the personnel are doing and why they are doing it. Depending on how closely you work with everyone in your organization, it may make sense to sit down with the employees and speak with them about their activities. These mini interviews are easy to perform and should only take between 10 to 20 minutes depending on how complicated the Resource role is. Some Resources may only do one thing - others may do a dozen things, but do not to get caught up in too many small, unimportant activities. As a rule, an Activity should take up at least 20% of a Resource time. Breaking a Resource Group into more than 3 activities should almost never happen. Remember, a good costing model is a balance between accuracy and usability. If you define your activities too granularly, small details will become increasingly important and the exceptions to the rule will begin to overpower your model, making it unusable. As a rule of thumb, you probably should not have more than 10 activities per location. Examples If you want to add a bit more granularity, to give you a flavor for what activities might look like, here are is an example of Activities broken down for the warehouse: Receiving, Picking, Misc Product Handling Or, here is an example list for a sales team: Customer Mgmt, Order Entry When creating the Activity List, also take into consideration that some people may perform the same activity, such as Customer Mgmt. Even though the two people involved might have different primary roles, if they both spend 20% of their time managing customers, then it is the same activity and should therefore be grouped together in the same cost bucket. Lastly, you should create a separate activity for each of the Resource Groups that were created because they were directly associated with servicing specific Products, Customers, Vendors. C) Allocating Ledger to
Resources Once you have all of your Ledger, Resource, and Activity accounts entered, it is time to begin allocating. And the first round of allocations is from the General Ledger Accounts to the Resources. There are 3 main ways that Ledger accounts will pass to Resources
Allocations to
Overhead Ledger expenses that are simply the costs of keeping the doors open should be allocated 100% to the Resource of Overhead. Some examples of these might be: advertising, charity, business insurance, postage, repairs, storage, subscriptions, accounting software J When we build custom costing models for our clients, we explain that Overhead is like an internal tax in that it is simply money that is scraped off of the top of revenue received. Allocations to
Personnel Based Resources Ledger expenses that exist primarily because of the employees should be allocated to the Personnel-Based Resources. For example, say that one of your ledger accounts is Computers. You have six employees, but only two of them have computers. The Computer expense should be divided up among the employees with computers. For another example, consider Rent. You may wish to divide rent up based on square feet if there are some employees which require more room to do their work than others. Since those Resources would consume more rent cost, their Activity costs would increase and ultimately be more accurately passed on to the line items that they service. What these last two examples should illustrate is that much of what happens in this step involves accurately representing the costs of having an employee work in the organization, not for the sake of seeing his or her cost, but rather for understanding how much the activities that they perform are really worth. Some examples of Ledger accounts that we typically allocate to Personnel Based Resources are: communications services, computer, copier, health insurance, parking, rent, salaries, telephone... Allocations to Independent
Flow-Through Resources Ledger expenses that exist primarily because of specific products or customers or customer types should be allocated 100% to themselves as a Resource. This is a nice, simple way of stating that the Ledger account is already grouped in a way that makes very intuitive sense to allocate directly to certain Line items. So there is no need to re-define them in any way. Just keep passing that cost bucket through until the end and then divide it up how you want to. For example, Credit Card Fees. These should be divided to those orders that are paid with a credit card. Another example might be Contract Labor. These dollars are applicable only to those products that the contract labor serviced. D) Allocating Resources
to
Activities Now that your costs are grouped in ways that makes sense for them to be passed along to Activities, allocating to the activities becomes the next step in the process. Several parts of this step are going to be extremely easy. In the last section, we identified 3 main ways that Ledger accounts pass onto activities: either to Overhead, to a Personnel Based Resource, or as a Flow-Through Resource. Overhead and Flow-Through Resources are simple and will be treated the same way, we will get to them in a minute. First we deal with Personnel Based Resources. Allocations From Personnel Based
Resources The rule is this: allocate each Resource to the Activities that the Resource performs based on the percentage of time that the Resource spends doing each activity. As we mentioned in the section on identifying Activities, there is some additional information that should be gathered in your interviews with employees. Aside from just listing Activities, you should also divide those Activities into the percentage amount of time that the Resource (employee or group of employees) spends on them. Sometimes this can be done by just ballpark estimates, other times you may wish to look at the actual workload and run the math. For example, assume that you learn that one activity that a person does is Order Entry, and that it takes about 5 minutes to enter an order. You might then look at the number of orders that your team entered. If it is 50 per day, then you know that they spend about four hours per day entering orders (50 orders per day, times 5 minutes per order), or ~50% of their time if they work a 40 hour week. During the interview, it can be prudent to ask the resource how much time they spend on this Activity as a percentage of their time. If they answer 60%, that is pretty close to your back of the envelope numbers. However, if they answer that they spend 90% of their time performing this activity, it is time to dig further into the matter! Again, there is no exact science to doing this. Good judgment and knowledge of how your organization operates should be your best companions in this process. Allocations From Overhead &
Flow-Through Resources As a rule of thumb, pass the Resource of Overhead 100% to the Activity of Overhead. Similarly, Ledger accounts that were passed onto Resources as their own entity should be passed onto Activities as their own entity as well. So, in a previous example, the Ledger
account Contract Labor was allocated 100% to the Resource Contract
Labor, which should now be allocated 100% to the Activity of Contract
Labor. --------------------------------------------------------------------------------------------------------------------------------------------------- Step 2: Allocating
Activity Costs
to Cost Objects This is certainly the most difficult piece of the ABC Costing model build. Conceptually it is rather straightforward, but implementing it can be challenging. A picture is worth 1,000 words, so please study the Excel example. One practical approach is: Step 1: Decide what you want to allocate costs to, i.e. what are your cost objects? If you have multiple cost objects, determine how they are related. Examples: Customers, Orders, Products, Vendors Jobs Transactions Incidences of Care, patients, payors Step 2: Build a single, denormalized table containing your cost objects in a spreadsheet. At the right of your table, add 2 columns for each of your activities (one to determine activity proportion, the other to calculate activity cost per cost object) Step 3: Build spreadsheet formulas that (1) accurately determine an activity proportion per cost object, and (2) use that proportion to distribute the fully loaded activity cost to those cost objects. Some things to keep in mind when
creating the activity proportion algorithms:
Please do not hesitate to contact us
with any questions or comments. We are
always happy to give pointers or advice to help you get going. (888) PRISMATA (774-7628) |
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