07-ABC_ Productivity and Quality Forum _ Paul KPMG 13022012 (3)

Activity Based Costing for Activity Based Management

Meiklejohn Paul, Director

Management Consulting

17 February 2012

© 2012 KPMG Limited, a Vietnamese limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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Agenda

1. What is Activity Based Costing (ABC)?

1.1 What is ABC and Why should it be used?

1.2 Traditional costing vs ABC

1.3 Activity based costing processes

2. How ABC should be used to manage (Activity based management)?

2.1 When to use ABC?

2.2 How to use ABC for ABM?

2.3 Scoring High - Low value adding activities

2.4 Activity Based Management applications

3. ABC/ABM implementation

3.1 Where ABC has been used

3.2 Steps to develop ABC Cost Flow Model

3.3 ABC Implementation Project

3.3 Challenges and success factors

Appendix: KPMG ABC and Cost Optimisation tools


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1. What is Activity Based Costing? 1.1 What is ABC and Why should it be used?

• Bringing cost and operational information to the level needed for management decisions

• Gaining tighter control over overhead and indirect costs

• Pricing products/services more accurately

• Establishing foundation for activity-based management and performance measurement

• Promoting a continuous improvement framework and mindset

ABC (Activity Based Costing) is a technique for measuring the cost and performance of activities, products and services on the basis of the resources consumed by the various activities which produce that product or service.

What is ABC? (the Definition)

Products and services in themselves do not cause costs to incurred. Rather work itself consumes resources which in turn incur costs.

Why it should be used? (the Benefits)

To put ABC into context as a performance management tool


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1. What is Activity Based Costing? 1.2 Traditional Costing vs ABC - The concept

Traditional Costing Activity Based Costing

Inputs (Resources/Costs) Inputs (Resources/Costs)

Product/Service Product/Service

Volume Related Basis

Resource Drivers

Activities

Activity Drivers

Assumes that costs vary with units produced

Activities consume resources/costs

Products/Services consume different levels of activities


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Activity Based Costing Traditional Costing

Key features

• ABC focuses on activities in the production or service delivery process.

• Costs are traced to activities to products/services, based on the demand for these activities during the production/delivery process.

• More complex

• Focus on the cost of the product only.

• Costs are traced to the product on assumption that resources are consumed in proportion to the volume produced.

• Simpler

Pros

• More accurate product and service costs enable better strategic decisions regarding:

• Product/service pricing

• Product/service mix.

• Make vs buy decision

• Investments in R&D, process automation

• Cost control

• Increased visibility of the activities performed enables a company to:

• Focus more on the management of activities, such as improving the efficiency of high cost activities.

• Identify and reduce non-value added activities

• In the past:

• Small number of products/services which did not differ much in terms of required manufacturing support.

• Labor was dominant component in the cost structure

Cons

• ABC can be expensive to use

• Some arbitrary overhead costs will continue

• Arbitrary volume drivers fail to account for product /service diversity in the form of size or complexity.

• Overhead is an indirect or common cost that generally cannot be traced.

1. What is Activity Based Costing? 1.2 Traditional Costing vs ABC – Feature comparison


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1. What is Activity Based Costing 1.2 Traditional Costing vs ABC - Example

Company A produced two products X and Y in the period ended 31 Dec 2011 with following information: Product X Y

Direct material ($) 800 2,000 Direct labour ($) 150 500 Volume (units) 10 100 Number of production runs 2 8 Number of machine hours 30 100

Traditional Costing Overhead per unit = Total Overhead/Total number of units = $15,400/110 = $140 Cost per unit of each product ($): Traditional costing under allocates overhead costs to low-volume and less complex product (X) and over allocates overhead costs to high-volume and more complex product (Y). This distorts cost information and leads to wrong decision on sales price. ABC attempts to overcome the above problems.

Activity Based Costing Allocate Overhead to Activities ($): Allocate Overhead to Products: Cost per unit of each product ($):

Product X Y Direct material 80 20 Direct labour 15 5 Overhead 140 140 Total cost per unit 235 165 Selling price (20% margin) 294 206

Product X Y Number of machine hours per unit 3 1 Machine-run Costs per unit ($) 90 30 Number of units per production run 5 13 Set-up cost per unit ($) 230 92 Overhead per unit ($) 320 122

Illustrative example in a manufacturing company

Product X Y Direct material 80 20 Direct labour 15 5 Overhead 320 122 Total cost per unit 415 147 Selling price (20% margin) 519 184

Type of Overhead Machine-run

costs Set-up costs

Cost pool (total costs for the period) 3,900 11,500 Cost driver (number of machine hours/production runs) 130 10

Cost per machine hour/production run 30 1,150

Total overhead ($)

Machine-run costs ($) (cost driver is number of machine hours)

Set-up costs ($) (cost driver is number of production runs)

15,400 3,900 11,500


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Activity: Management Security Auditing

Activity: Opening Closing Withdrawals…

Activity: Introduction Development Advertising

Activity: Marketing Data processing Accounting…

All products /services (facility level):

Product/Service group/batch: Deposit taking Means of payment Loan investment

Types of products/services: Credit accounts Sales discount Mortgage loans

Product/service unit XYZ Credit account XYZ Sales discount XYZ Mortgage loans

Cost drivers

Cost drivers

Cost drivers

Cost drivers

IND

IREC

T C

OST

S

ACTIVITY BASED POOLS HIERARCHY

1.What is Activity Based Costing? 1.3 Activity based costing process – Activity classification – Activity Pool


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Fina

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l Acc

ount

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Cos

t of A

ccou

ntin

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naly

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General service centers

Profit Centers

Cost of operation A,

Cost of operation B,

Cost of operation C

PR

OFIT C

EN

TER

S

Organizational centers

Operational cost centers

Profit centers

Unallocated costs for the

term

Operational cost centre


term

Profit centers


term

Cost Assignment Process

1. What is Activity Based Costing? 1.3 Activity based costing process – Cost assignment to profit centers


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2. How ABC should be used to manage (Activity Based Management)? 2.1 When to use ABC?

• Product lines differ greatly in volume and manufacturing complexity

• Product lines are numerous, diverse, and require differing degrees of support services

• Overhead costs constitute a significant portion of total costs

• The manufacturing process or the number of products has changed significantly

• Production or marketing managers are ignoring data provided by traditional cost systems and are using bootleg cost information to make pricing decisions

When to use ABC?

When Is ABC Most Beneficial?

• When products/services differ significantly in their use of resources

• When resources (overheads) are a significant cost (thus when labor cost is a relatively small component of overall costs)

• What contributes to different usage of resources?

• Product/service diversity (functions used, inspections required, batch sizes,….)

• Production/service complexity

• Customer diversity (order sizes, distribution requirements)


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2. How ABC should be used to manage (Activity Based Management)? 2.2 How to use ABC for ABM?

• ABM is an extension of ABC, from a product/service costing system to a management function, that focuses on reducing costs and improving processes and decision making

• ABM (Activity Based Management) is part of a continuous improvement framework and incorporates strategic cost management techniques

• Analysis of ABC output to provide management with meaningful cost and operational information

• ABC is primarily transaction based

• ABM is mainly driven by business analysis

Managers can use knowledge of costs gained by ABC analysis to make pricing and product-mix/service decisions, to identify and select cost reduction and process improvement projects, including relating to product /service design.

Knowing what costs are related to which product/service allows better analysis of:

which markets to emphasize

which products to consider for CIPs (cost improvement programs)

which customers to target for changes in pricing or service delivery


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2. How ABC should be used to manage (Activity Based Management)? 2.2 How to use ABC for ABM – Cost View vs Process View?

Process View • Activity analysis

• Process mapping

• Benchmarking

• Cost reduction

• Cost of quality and waste

• Continuous improvement

• Process re-engineering

• Cycle time reduction

Activities

Resources

Cost Objects

Resource Drivers

Activity Drivers

Cost Assignment View • Product/service costing;

• New products design;

• Product/service/customer profitability analysis


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High value adding activities are those: Low value adding activities are those:

• Required to meet customer requirements; • That modify or enhance purchased material of a product; • That, if more of them are accomplished, the customer might pay more for the product or service;

• That are critical steps that cannot be eliminated in a business process;

• That are performed to resolve or eliminate quality problems; • That are performed due to a request or expectation of a satisfied customer; and

• That, in general, if time permitted, you would do more of.

• Can be eliminated without affecting the form or function of the product or service;

• Result in waste and add no value to the product or service; • Are performed due to inefficiencies or errors in the process stream; • Are duplicated in another department or add unnecessary steps to the business process;

• Are performed to monitor quality problems; • Are performed due to a request of a dissatisfied customer; • Produce an unnecessary or unwanted output; and • If given the option, you would prefer to do less of.

Objectives: - To eliminate/minimize low-value-adding activities - Optimize higher value-adding activities - Enable employees to focus on the worth of their organization’s work

Benefits: - Reduce costs and improve business process towards better efficiency

- Employees can see how work really serves customers and which activities may be considered wasteful.

- Focus and visibility are enhanced because people can more easily see where costs are big or small and also which costs can be managed in the near term.

High vs. Low value adding activities

Using ABC/M to score activities along their “high- versus low-value-adding” scale

2. How ABC should be used to manage (Activity Based Management)? 2.3 Scoring High – Low value adding activities


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2. How ABC should be used to manage (Activity Based Management)? 2.4 Activity Based Management applications

Activity Analysis

Costing Analysis

Performance Improvement

Transfer Pricing/Service Level Agreements

Resource Planning

Continuous Improvement

• Pricing • Estimating • Life Cycle Costing

• Analysis of products/services customers locations

• Investment Analysis • Insource/Outsource • Business

Rationalisation

• Budgeting/Forecasting • Target Costing

• Activity Value Analysis • Cost Driver Analysis • Performance

Measurement

• Business Process • Best practices • Cultural Assessment


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3. ABC/ABM Implementation 3.1 Where ABC has been used

Industries to use ABC

References: Management Accounting Quarterly . Spring 2009, Vol.10 Dan Swenson and Douglas Barney, “ABC/M: Which Companies Have Success?” The Journal of Corporate Accounting & Finance, March/April 2001

Manufacturing •Metal/Rubber/Plastics •Machinery •Food/Textiles – (i.e. CONCO Food) •Electronics (i.e. ABB Switzerland) •Chemicals •Paper/Printing

•Services •Financial •Wholesale/ Retail Trade •Consulting •Business •Communication/Utilities •Computer/Software •Transportation •Health Care/ Medical / Legal •Education

•Government Sectors •Example: U.S Postal Service, UK National Health Services, Australian Federal Police Department

Characteristics of company which lead to ABC being successfully applied: • A high level of top management support and commitment; • Technical competence of the implementation team; and • Effective change management, that is, companies driven by competitive pressures to strive to better understand their

internal capabilities and external competition.


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3. ABC/ABM Implementation 3.2 Steps to develop ABC Cost Flow Model

1. Collect Financial Data

2. Identify Activities

3. Develop Cost Flow Model

4. Identify Drivers

5. Collect Cost Driver Data

6. Calculate Activity Costs

7. Calculate Unit Costs

Modify Modify Modify

Preliminary


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3. ABC/ABM Implementation 3.3 ABC Implementation Project

• Identify and classify Activities related to products via three approaches: top-down; recycling; interview or participative • Estimate cost of activities • Calculate a cost-driver rate for each activity • Assign Activity Costs to products

Significant indirect cost

Complex products and services

High-volume products and low-volume products

Disagreement by managers

Age of costing system

A pilot “rapid prototyping” workshop

ABC readiness

ABC Appropriateness ABC performance

• Study to get senior manager’s buy in if required • Create and enter cost center allocations in system • Analyse and review output • Refine and adjust as necessary • Gain approval for cost information from new system

ABC roll-out

Product cost based on Activities involved

Bank-wide ABC implementation

Follow-up

Phase 2: Diagnostic

Assessment of ABC Readiness

Phase 1: Preparation and

planning

• Introduce the concept to senior management

• Set up a steering committee

• Evaluate and select cost accounting software

• Engage a consulting firm

• Training for cost center managers and key staff

Steering Committee

ABC project plan

Phase 3: Designing an ABC

system and collecting necessary data

Phase 4: Implementing ABC

ABC Project Management

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Report

Report

Report

Report

Reporting Month

Group CEO/CFO

Central Finance

Business Units

Central Finance

Central Finance

Group CEO/CFO

Central Finance

Business Unit

Central Finance

Business UnitResponsibility

N/APrepare and issue budget analysis

Early Oct

N/A Submit budget

End May

N/A Issue budget instructions and Targets

13Prepare and issue forecast analysis

N/A

Based on Board dates

18-20

7

9

5

Working Day

Early Nov

Late Oct

Review Budget

Green Book Full Year (Jan)

Green Book Qtr 3 (Oct)

Green Book Half Year (July)

Green Book Qtr 1

(April)

Prepare and issue quarter end actuals and forecast analysis

End Nov

End Sept

End July

End March

Review forecast (QPR)

10+2+12

8+4+125+7+122+10+12Submit forecast

Blue Book

Blue Book

Blue Book

Blue Book

Blue Book

Blue Book

Blue Book

Actuals Flash

Prepare and issue actuals analysis

Submit actualsDecNovOctSepAugJulJunMayAprMarFebJanActivity

Report

Report

Report

Report

Reporting Month

Group CEO/CFO

Central Finance

Business Units

Central Finance

Central Finance

Group CEO/CFO

Central Finance

Business Unit

Central Finance

Business UnitResponsibility

N/APrepare and issue budget analysis

Early Oct

N/A Submit budget

End May

N/A Issue budget instructions and Targets

13Prepare and issue forecast analysis

N/A

Based on Board dates

18-20

7

9

5

Working Day

Early Nov

Late Oct

Review Budget

Green Book Full Year (Jan)

Green Book Qtr 3 (Oct)

Green Book Half Year (July)

Green Book Qtr 1

(April)

Prepare and issue quarter end actuals and forecast analysis

End Nov

End Sept

End July

End March

Review forecast (QPR)

10+2+12

8+4+125+7+122+10+12Submit forecast

Blue Book

Blue Book

Blue Book

Blue Book

Blue Book

Blue Book

Blue Book

Actuals Flash

Prepare and issue actuals analysis

Submit actualsDecNovOctSepAugJulJunMayAprMarFebJanActivity Analysis of synergy potentials products/markets

Infrastructure for new products-/market segments

Implementation of a divisional steering conceptNomination of group CROImplementation of KPI based sales controllingImplementation of risk transfer to ACPMImplementation of a strategy for trading/treasuryImplementation of group-wide portfolio structureEnhancement of technical infrastructure in FO and RMIntegration of decision-making processesImplementation of group-wide ACPMEstablishment of integrated planning processesImplementation of planning tools/methods etc.Development of a steering concepts on group levelImplementation of steering methods/instruments etc.Set-up of a management information system

LegendStrong mutual dependencies One-way dependencies

1

3

5

6

4

2

7

8

10

11

9

12

14

15

13

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Development of cooperation model for IT/functional areasDevelopment of documentation standardsDerivation of a roadmap19

18

17

Su

pp

ort

p

roce

sses

Mutual dependencies between categories

4

7

16

15

14

13

12

11

10

9

8

6

5

1

2

3

17

18

19

Str

ateg

icfr

amew

ork

Co

re a

nd

ste

erin

g p

roce

sses


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3. ABC/ABM Implementation 3.4 Challenges and Success Factors

Companies are able to determine how much revenue each of their various products and services generate, but unable to determine with any level of certainty how much it costs to provide these products and services

No way of determining which products are unprofitable and uncompetitive and which products are profitable and underdeveloped.

Reason for application

Generate buy-in from operational managers

Uncertainty in cost-savings

Duplication of effort in collecting information

Occasional lack of creativity on the part of the center managers.

Difficult to gain approval for cost information produced by new allocations

Challenges for application

ABC champion: convince management of the viability and necessity of ABC and create and sustain enthusiasm

Support and cooperation of employees: honest and open communication

Non threatening environment : which would facilitate the change culture

Key to success

Thank you

Meiklejohn Paul

Director

Management Consulting

KPMG Limited

Tel +84 (4) 3946 1600 (ext. 6315)

Mob +84 (0) 914 923 162

[email protected]


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Why’s ABC?

Diversity in Product/Service types or Distribution/Sales Channels More complexity in Operation Overhead cost increase

Strong Development of Technology Organization automate what previously were manual job Proportion of Indirect cost increase

Market becomes saturated

Lost due to inaccurate cost allocation is high

Disagreement by managers over cost allocations

The company need to understand clearly its cost structure

High Indirect Cost

High Competition

To whom that ABC is most beneficial

Appendix – KPMG ABC and Cost Optimisation Tools 1. Activity Based Costing

what you can measure”

Enterprises have a clearer and more detailed view of the profitability structure of different products within the portfolio.

The costs and expenses are allocated to each product type, so enterprises could identify the profit margins for every product line, which aid pricing decisions

Enterprises gain insight into their cost per activity for correct cost optimization opportunity. Enterprises are also able to analyze return on investment based on the detailed cost information

ABC enables enterprises to analyze the efficiency of each activity & improve the processes across the value chain. This enables management to evaluate performance more effectively for longer-term benefits.

Profitability analysis

Cost and Resource Optimization

Cost estimation and Pricing

Performance Measurement and

Improvement

Knowledge

Technology

Change Management

Experience

•Lack of deep understanding of ABC theory

•Lack of strategy on how to use ABC model/data

•Lack of capacity to unify ABC theory and practical situation

•Personnel quality issues

•Reluctance to change in staff •Risk management •Lack of appropriated system to collect data and build ABC model

•Coordinate issues between ABC and the existing system

Challenges in ABC Implementation

Traditional Costing’s short-comings No way of determining which products are uncompetitive No way of determining which products are profitable No way of determining how to cut and optimize costs No way of managing indirect costs and expenses

…Solution is ABC

ABC traces and assigns costs based on cause-effect relationships with activities which consume them.

Losses on margins and profits Cost Optimization becomes virtual solution to survive and obtain profit.


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Activities

Resources

Cost Objects

Resource Drivers

Activity Drivers

Res

ourc

e 1

Res

ourc

e 2

Res

ourc

e…

Res

ourc

e n

Activity 1 X1 X1 X1 X1

Activity 2 X2 X2

Activity n Xn Xn

Act

ivity

1

Act

ivity

2

Act

ivity

..

Act

ivity

n

Cost Object A Y1 Y1 Yn

Cost Object B Y2 Y2

Cost Object C Y2 Y3 Y3 Yn

ABC Conceptual Methodology Sample Deliverables KPMG Approach

1st stage

2nd stage

• Define and identify key resources • Verify actual costs from reliable information (financial

information, resources statistics, organisational information)

• Define and identify activities • Develop activity dictionary • Trace activities to resources • Define activity drivers • Calculate total activity cost

3rd stage

• Define and identify cost objects • Design cost flow model • Calculate cost-driver rate • Assign activity costs to cost objects

KPMG’s ABC Approach

Appendix – KPMG ABC and Cost Optimisation Tools 1. Activity Based Costing (cont.)

KPMG’s ABC Advisory Services Training Rapid Prototyping

Workshop One time study and support Full ABC implementation ABC for management

What we do

We transfer knowledge and demonstrate case study on ABC

We coach to build ABC model.

Our team conduct ABC based review of the costing structure

We work with clients to apply ABC from start to end.

We support in applying ABC into performance management

What you get

Knowledge and practical insights for ABC readiness

Quick win high level ABC model. Accelerated learning.

A report on your activities and costing structure. Ideas for process improvement and product mix

Effective and efficient ABC implementation Ideas and framework for improvement.

Business Improvement framework ( Where ABC costing system has already implemented ).


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Today's businesses are under constant pressure to reduce costs, yet many find it hard to do so in a sustainable fashion. Ninety percent of cost reduction programs fail to achieve their targets, and the gains that are achieved appear to be short lived. The increasing interdependencies faced by companies – internally between functions and externally with suppliers, customers and other stakeholders - make cost management become a highly complex issue that can only be addressed at a strategic level.

Challenge KPMG research has shown that companies are, on average, achieving only 59% of expected savings. Reasons for this include: cost strategies are failing; revenue growth has eroded cost discipline; cost ownership is unclear and too narrow; cost strategies are too cautious; cost drivers are not clear or transparent; cost discipline is not embedded in the culture. Major causes for the failure of cost strategies include: inadequate processes to drive cost reduction; lack of transparency of information; too much reliance on cost avoidance rather than increased cost efficiency; too many conflicting projects.

How we can help Our cost optimisation program enables companies to:

gain an understanding of your cost structure, identify key cost drivers and create effective cost strategies through the improvement of structures and processes to enable significant cost savings.

access to comparable information to enable the analysis and assessment of performance and costs, which can help position you against benchmark data in order to quantify a performance or cost gap.

KPMG also can assist you with managing and measuring the implementation of cost optimization programs in the most optimal manner and with minimal disruption to your operations.

Plan, Scope and

Agree Goals Design Monitor Implement Opportunities Diagnostic

Industry-based

Hypotheses

KPMG core cost optimisation team working to globally consistent methodology

Industry insight

Private Equity Lens

(Transaction Services)

Investment and

Divestment

Systems and IT Treasury Finance

Function Real Estate Supply Chain, Procurement and Sourcing

Human Resources Tax

Cash and Working Capital

Access to areas of deep specialisation across KPMG

Appendix – KPMG ABC and Cost Optimisation Tools 2. Cost Optimisation


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Benefits/Outcomes Our cost optimisation program enables clients to identify opportunities to reduce their operating costs while improving performance. Our team also can work with clients to help: Identify the risks through a thorough assessment of operating / business costs; Develop a cost reduction program to reduce costs, improve controls and enhance strategic effectiveness; Identify improvements in core processes and organizational structural models and apply industry better practices; Improve the performance of inventory, asset, and channel management activities to drive service, cash flow, and margin enhancements; Evaluate operations and planning processes, and the effectiveness of the supply and distribution networks for both alignment and rationalisation

opportunities. By gaining an in-depth understanding of key processes and cost drivers, clients can initiate and manage effective cost improvement programs.

Our wide-ranging approach can look across the company's overall business:

Appendix – KPMG ABC and Cost Optimisation Tools 2. Cost Optimisation (cont.)


The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International Cooperative (“KPMG International”).

Documents

07-ABC_ Productivity and Quality Forum _ Paul KPMG 13022012 (3)