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Activity Based Costing/Management

The Implementation of Activity Based Costing/Management (ABC/M) in the Science and Technology (S&T) Environments - A Success Story
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: 

  • R&D for Canadian Forces and DND;
  • S&T Policy and Advice;
  • §         S&T with National Security Partners; and

  • Corporate Management.

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: 

  1. Defence Research Establishment Atlantic (DREA);
  2. Defence Research Establishment Valcartier (DREV);
  3. Defence Research Establishment Ottawa (DREO):
  4. Defence and Civil Institute of Environmental Medicine Toronto (DCIEM); and
  5. 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. 

Copyright 2003 - Automated Information Management Corporation