| Prepared By Dr. Mir F. Ali
This article is divided
into two sections, the first briefly explain the concept of Activity
Based Costing/Management (ABC/M) and the second illustrates how this
concept was implemented successfully in the science and technology
environment.
1. The Concept of Activity Based Costing/Management for the
Service Industry:
Activity
Based Costing (ABC) has been around for over 40 years but only
recently fiscal constraints became motivating factors for
organizations in the public as well as private sectors to appreciate
and adopt ABC as a means of generating more accurate costing
information than is possible using traditional costing methods. ABC
provides a cross-functional, integrated costing view of the
organization that allows organizations to measure the cost and
performance of activities, resources, cost objects (Services), and
channels of delivery.
1.1
The Activity Structure:
There are
two major components of an ABC model. These components are: An
Activity Structure and A Cost Structure. Both of these structures
are based on the fundamental principle that resources are consumed
by activities and activities are consumed by services. (Please
click here to see Figure1 which illustrates The Activity Structure).
Needless
to say, the focus of ABC is on activities and before proceeding with
the idea of costing activities, these activities have to be
identified. The very first step in this process is to define the
activities in a manner that reflects the current practices of an
organization. The second step is to clearly describe which
activities are being performed when, where, why, and by whom. The
third step is to
determine the percentage of time being spent by each employee on
each activity in order to deliver what service for which client,
using what channel of delivery. The next step would be to classify
each of these activities into one of the following three
categories:
-
Service Activities:
All
activities directly supporting the service. For instance,
“Process a refund application”, is a direct activity that could be
performed in a Refund Department.
-
Support Activities:
All activities performed to support the Service Activities, and
Business Sustaining Activities. For instance, “Provide
administrative support”, or “Provide IT support” are Support
Activities that could be performed to support the Service
Activities and Business Sustaining Activities; and
-
Business Sustaining
Activities:
All activities performed to sustain the business. For instance,
“Prepare business plan”, “Manage budget”, and “Meet with clients
on a regular basis” are Business Sustaining Activities that could
be performed to sustain the business.
1.2
The Cost Structure:
The
Activity Structure presented in figure1 shows how activities are
created and grouped into three categories. It also shows how three
different services are being delivered using three different
channels to their clients. Once the Activity Structure is validated
and accepted by the stakeholders, the following Cost Structure
should because to cost the activities, and services (Please
click here to see Figure2 which illustrates the Cost Structure):
The
Cost Structure presented in Figure 2, illustrates the process that
requires all relevant resources (Salaries, O&M, Capital, and Other)
to be assigned to activities based on the percentage of their use
with the idea of apportioning the cost of the activities. Once
the cost of each activity in each category is calculated, the total
costs of the relevant support activities and business-sustaining
activities are transferred to the respective service activities in
order to determine the total cost of each service.
1.3
Activity Based Costing (ABC):
This will
provide organizations with two major costing views, the horizontal
and vertical. The horizontal view will provide the cost of each
service indicating the cost of the service, support, and
business-sustaining activities whereas the vertical view will show
each cost element (Salaries, O&M, Capital, and Other) for each
category of activities. At the same time it provides the
flexibility to create additional views, depending upon the ways
managers like to view the costing information, for monitoring the
cost and making effective business decisions. It could include the
calculation of unit cost that is based on the number of times a
particular service is provided or the calculation of direct and
indirect costs for a service. The key in this process is that the
total costs of all services must always balance with the total costs
of all resources.
ABC is an
excellent tool to cost activities and services. It provides
managers with the basic information needed to understand the cost of
their services, what percentage of budget was spent on what service,
which service is consuming significant human resources, what the
technology cost for each service is, or why the cost of
administrative services differs from service to service, etc. ABC
however, only answered the question, ‘what
is the cost of providing ServiceA to ClientB through ChannelC?’
1.4
Activity Based Management (ABM):
Activity
Based Management (ABM) is a discipline that helps organizations use
the ABC information intelligently to eliminate functional as well as
informational duplication, overlaps, bottlenecks, and redundancies,
answering the question, what should be the cost of providing
ServiceA to ClientB through ChannelC. It helps to determine the best
way to charge or allocate costs and at the same time it encourages
organizations to explore the possibilities of utilizing enabling
technologies in order to reduce their overhead and improve the
performance of their resources (Please
click here to see Figure3 which illustrates the Activity Based
Management).
Figure 3 illustrates the
process of transforming an ABC Model into an ABM Model. The
following activities are performed in this transformation:
-
Conduct Effectiveness and Efficiency Analysis;
-
Conduct Seamless Services Analysis;
-
Conduct Streamlining
Analysis;
-
Conduct Choices
Analysis;
-
Optimize Process
Flows;
-
Review Best Practices;
-
Identify and Analyze
Revenue Generation and Partnering Opportunities: and
-
Identify Technology
Opportunities.
As a
result, the ABC model can be redesigned to provide faster, cheaper,
and more reliable services. In order to ensure the sustainability of
the overall quality of services, performance measures are developed
and implemented.
2.
The implementation of Activity Based Costing/Management (ABC/M) in
science and technology environments:
2.1
Organizational Background and Business Issues:
Defence
Research and Development Canada (DRDC) became an agency within the
Department of National Defence (DND) in April 2000. Previous to
this DRDC used to be a Branch of the Department and known as Chief
Research and Development (CRAD).
DND
selected AIMCORP-Automated Information Management Corporation to
conduct an Activity Based Costing (ABC) project for their Research
and Development Branch. AIMCORP had just completed a Business
Process Reengineering project with the Branch and had gained
considerable experience in dealing with the Science and Technology
(S&T) environments that became one of the major reasons for their
selection.
It was
envisioned that Activity Based Management (ABM) could provide the
Branch with an approach to:
-
§
Improving efficiency and effectiveness;
-
§
Providing managers of individual laboratories a framework for
assessing their operations; and
-
§
Assisting the Branch in its transition to an Agency.
Specifically, as DRDB moved towards agency status, the organization
entered a most challenging time. The new agency status would
provide the Branch with increased flexibility and visibility, but
would also require them to continue to operate in a more
business-like manner. As such, the organization needed to optimize
its existing resources, processes and structures to deliver S&T
products and services. To this end, DRDB had entered into a number
of initiatives aimed at ensuring these objectives were met. ABM was
one element of the Business Transformation effort, focusing
particularly on Business Administration Efficiency.
While senior managers in DRDB were impressed with the concept of ABC
and they thought ABM would enable them to accomplish their business
objectives, they were not sure if ABC could be applied in the S&T
environment.. Hence the initial phase of the pilot project was
dedicated to determining the possibilities of implementing ABC in
the S&T environment and designing a suitable methodology to
implement ABC throughout the organization.
Under the leadership of Chief Executive Officer, Dr. L. J. Leggat,
Defence R&D Canada, DRDB operates research establishments from coast
to coast. Their programs continue to deliver the best
technology to meet
the Canadian Forces' needs while contributing to major national
objectives such as sustainable job creation and economic growth.
The effects of their scientific effort have also been felt in the
civilian world.. Safe blood products, advanced power sources,
ultra-fast signal processors, humanitarian systems and electronic
commerce software are all results of their efforts to protect the
combat personnel in the Navy, the Army and the Air Force. Canada's
leadership in communications and satellite technology is also a
direct result of the work carried out by defence laboratories in
support of military requirements.
DRDC 's
multi-disciplinary staff comprises more than 1,000 people, most of
them scientists, engineers or technologists. About 35 are members of
the Canadian Forces. The Chief Executive Officer reports to the
Deputy Minister, DND.
DRDC
consists of a headquarters, located in Ottawa, and the following
five Defence Research Establishments
(Please
click here to see the location map of DRDC):
DRDC
delivers services along the following four business lines:
2.2
Implementation of Activity Based Costing:
2.2.1
Pilot Project Phase:
The
criteria for selecting pilot sites were based on common functions
and the two sites selected for the pilot represented almost 90
percent of all the common scientific and administrative functions
that were being performed in the Branch.
The
plan was to gain acceptance of the pilot implementations and then
gain approval for implementing the approach in the remaining 4
labs/regions, incorporating the lessons learned as well as
addressing the peculiarities associated with each lab.
2.2.2
Roll-out Phases:
Based on the success of
the pilot project, a plan was prepared and presented to seek
approval for implementing the ABC system in the remaining Defence
Research Establishments. It was decided to divide the project into
two phases:
-
Phase 1 included the
Defence Research Establishments Ottawa and Valcartier; and
-
Phase 2 included the
Defence Research Establishments in Toronto and Halifax.
Initially, there were six ABC models built – one for each lab plus
one for the headquarters. At the end of the Roll-out Phase 2, the
following activities were performed to consolidate those models:
-
Link activities with
the Material Group Business Planning Framework (MGBPF) to allow
for variance analysis and activity based budgeting. This linkage
allows actual costs to be tracked against the planned expenditures
in the Resource Planning Module (now BMIS) {what does BMIS stand
for???;
-
Provide managers
useable cost reports using Cognos Powerplay Cubes;
-
Assist managers to
conduct initial analysis of ABC data to assess process efficiency
and highlight areas for further detailed analysis;
-
Train the Business
Management Team (BMT) to maintain and sustain the system in the
future;
-
Establish linkages
between the local BMT team and the NDHQ {define NDHQ} BMT team to
make sure that the ABC knowledge is shared; and
-
Develop a consolidated
ABC computer model for the Branch.
2.2.3
ABC Results:
All planned activities were conducted successfully, on
time and within budget, and produced the following deliverables for
the sites:
-
A consolidated
Activity Dictionary/Work Profile. Describes activities at the
Branch level and the time spent performing them by each employee;
-
Activity costs. Costs
are reflected at the Section, Directorate, DG and Branch levels
and are applied to relevant activities;
-
Full computer model
that provides the full life cycle costs of the services provided
by the organizations; and
-
Powerplay Cubes
providing summary ABC data for management decision making support;
and
-
A consolidated ABC
computer model.
As a result of these deliverables being available
Branch-Wide {Agency-Wide???}, the organization had the management
information necessary to provide:
-
Supporting data for
changes in Service Delivery Models;
-
Baselines for
comparisons with other similar organizations;
-
Key elements of a
business case to obtain Special Agency Status – identifying
current costing structure, and providing a baseline to estimate
and track anticipated changes in the cost of operations under the
new arrangement; and
-
Data to assess
opportunities for the redistribution of administrative workload
from Technical staff back to Administrative/Support staff.
2.3
Implementation of Activity Based Management:
The domain of this project
included the headquarters in Ottawa plus the following five labs:
-
Defence Research
Establishment Atlantic (DREA);
-
Defence Research
Establishment Valcartier (DREV);
-
Defence Research
Establishment Ottawa (DREO):
-
Defence and Civil
Institute of Environmental Medicine Toronto (DCIEM); and
-
Defence Research
Establishment Suffield (DRES).
Please click here to see Figure4 which
illustrates Activity Based Costing/Management (ABC/M) Methodology.C
2.4
ABM Results:
All
planned activities were conducted successfully, on time and within
budget, and produced the following deliverables for the sites:
-
Opportunities for Agency-Wide improvement (Horizontal);
-
Opportunities for improvement within the labs/Regions (Vertical);
and
-
Organizational change considerations.
All of the
above opportunity profiles were supported by ABC information,
providing elements for mini business cases and the quantification of
efficiency gains.
As a result of these efforts, the Branch:
-
Approved
the initial opportunities for improvement for implementation,
potentially increasing efficiency in excess of $6 million;
-
Identified the need to undertake the analysis of ABC data on a
continuous basis; and
-
Identified the need to maintain the ABC system on a more
continuous basis through automated activity time reporting.
The bottom line is that ABM is a strategic tool
that allows organizations to reduce the costs of their services and
helps them to enhance the performance of their resources. As a
result of this implementation, DRDC was empowered to deliver their
services cheaper, faster and without having to compromise the
quality.
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