Implementing Activity Based Costing ABC/M without tears
20th August 2007
In the first of this series of seven articles, John McKenzie, FSN contributing editor examined the basics of ABC/M, its principles, its logic and its advantages over traditional accounting processes in the 21 st century business environment. This second article is the first of two which explores ways in which ABC/M can be implemented even in large and complex environments without tears and the minimum of cost and effort.
As we have seen, ABC/M is a fundamentally simple concept. In order to achieve both rapid and cost effective implementation, along with success and sustainability, there are a few common sense rules to follow, Obvious though it may seem, firstly, have a very clear idea of the output you want to achieve, i.e. the goals of the project, whether at one extreme it is a strategic overview of costs around the enterprise or a more detailed understanding for profitability analysis. For example, where value is added and waste incurred as a precursor to re-engineering, or an activity based understanding of costs for budgetary and forecasting purposes.
It is surprising how many ABC/M projects have floundered due to lack of clarity of the end goal or “changing horses mid stream”. The consequential rework mid-project inevitably causes time delays and soaks up resources as well as often resulting in model design that is at best inefficient, at worst impossible to maintain and fails to deliver expectations or any useful output at all.
Secondly, K.I.S.S. (Keep It Simple Stupid). The temptation is often to model down to a very fine level of detail, to encompass thousands of “activities” and to attempt to measure cost allocations to activities at a level of “accuracy” that is both spurious and impractical to sustain.
Third, keep it material. Pareto definitely rules and it will quickly be found that around 90% of the costs in an enterprise are accounted for by relatively few activities and drivers. Get these major items right and be prepared to “guesstimate” or take a broader brush approach to the remainder as little additional insight will be gained by chasing down the last penny or cent. It is essential that you differentiate between the precision required for external accountability and that which is required to provide management with timely insight to make better decisions.
And finally, have a project plan that not only sets out a clear timeline and aggressive milestones, but also embodies the principles above. Strong project management and ownership at a single point is a must for success.
There have been countless ABC initiatives undertaken over the years with varying degrees of success... but a methodology that has been notably successful in delivering satisfactory outputs, rapidly and at minimal effort and cost is examined below. It consists of 7 key steps. The first 2 we focus on here - process mapping and building an activity dictionary. The remainder - Ledger and organisational analysis, Management Briefing and Communication, Data Collection and Interviewing, Driver Collection and finally Modelling will be considered in the next article.
1. Process Mapping
Many organisations may have already undertaken some form of process mapping as a result of a major ERP implementation or as part of seeking ISO or some other quality accreditation. The purpose of process mapping is simple. It is to identify the major workflows and outputs that exist within an enterprise and to provide a framework on which to construct an Activity Dictionary. Below are a few examples of workflows, the deliverables they produce and functions that might be a part of each workflow.
Immediately we see that the process view is a different one to the functional one we hold dear in our current cost centre view for transaction posting, budgeting and reporting. Costs are in reality not incurred by functions! Costs are incurred by the workflows that produce our outputs yet our whole cost management and budgetary focus revolves around cost centres. Workflows or processes are by their nature multi-functional and we lose a great deal of insight – and accountability – with a solely cost centre focus.
2. Construct Activity Dictionary
Taking the process maps as a starting point, the aim is to construct a standard dictionary of activities which becomes the reference point for all subsequent analysis. A process map will describe a process in terms of its starting point and its trigger, its output or deliverable and a number of high level steps (possibly sub-processes) along the way. The task now is to turn each map into something that represents the activities you wish to capture at the appropriate level of detail.
The lure of understanding the cost of activities in a business can trigger great enthusiasm in managers resulting in a “free for all” and an uncontrolled activity dictionary. If the expectations of management are not reined in, there is a risk of producing an analysis which runs to thousands of activities, many of which will be trivial in cost terms and in turn be far too detailed to permit meaningful analysis to be performed. Furthermore, the task of modelling and maintaining the analysis becomes daunting. As stated above, it is vital to decide how the cost analysis is to be used before starting the project. Obviously there are no hard and fast rules, but as a guideline, the following level of activity detail seems to work well according to desired use.
Level of Detail
# of activities
Use
Strategic
80 - 150
High level performance measurement for generating KPI's or populating a balanced scorecard
High Level Forecasting
Input to a traditional budgeting process
Tactical
250 - 400
Departmental performance measurement
Identification of wasteful or non-value added activity
Benchmarking
Costing of products, services, customers, distribution channels and subsequent profitability analysis
Shared service costing
Shareholder Value analysis
Activity Based Budgeting
Task
400+
Cascaded performance measurement
Business Process Re-engineering
Strategic modelling can bring significant benefit alone. It gives management clear signposts for areas of business improvement as well as insights to sharpen up traditional budgeting and forecasting processes. To achieve the greatest benefits in cost management, as well as achieving the other benefits detailed above, it will be necessary to go down to a more tactical level. And for re-engineering, the level of detail needs to be increased yet further to flush out all the non-value added potential as well as demonstrating at a more task level how things might be changed. The golden rule is K.I.S.S. – only analyse to a level of detail which gives utility to what you are trying to achieve.
The two initial steps of an ABC/M project we have considered are vital to get right. The whole direction and likely success is dependent on them as is future sustainability. We continue the methodology next time.
