FINANCE BRANCH

Adding Value through Activity Based Costing/Management

Adding Value through Adding Value through Activity Based Costing/ManagementActivity Based Costing/Management

Ministry of Transportation

Financial Management Institute

April 18, 2012

2

Knowledge Objectives for the Day

Establish the context – importance of understanding the true cost of services

Review the language and structure of Activity Based Costing/Management

Discover how Activity Based Costing/Management supports multiple management objectives

Understand the concept of Full Cost Pricing

Explore through examples and a case

3

Quote of the Day

Victor Hugo (French Novelist)

“There is nothing more powerful than an idea whose time has come”

4

Evidence

As per survey conducted by Better Management,

9 out of 10 companies of all sizes are using ABC or considering to use it

(528 companies surveyed )

5

-$30.2B

-$15B

$0

2010-11 2017-18

Ont

ario

Bud

get D

efic

itStatus QuoPreferred Scenario

-$30.2B

-$15B

$0

2010-11 2017-18

Ont

ario

Bud

get D

efic

itStatus QuoPreferred Scenario

Context: Balancing Ontario’s Budget

Current deficit

Balanced Budget

Deficit in 2017-18 if Status Quo is maintained

6

6.9%

5.4%6.0%

8.2%

6.6%

2.5%

1.1%0.5%

-2.4%

0.8%

Health Education Social Services Others Overall Program GrowthA

vera

ge

An

nu

al %

Gro

wth

2001-2011 (Actual) 2011-2018 (Drummond Recommendation)

6.9%

5.4%6.0%

8.2%

6.6%

2.5%

1.1%0.5%

-2.4%

0.8%

Health Education Social Services Others Overall Program GrowthA

vera

ge

An

nu

al %

Gro

wth

2001-2011 (Actual) 2011-2018 (Drummond Recommendation)

Context: Balancing Ontario’s Budget (cont.)

To balance budget

7

What is Costing?

Costing is the process of tracing expenses to products, services or activities to determine their cost

Costs are calculated from relevant expenses

8

Traditional Costing vs Activity Based Costing

Traditional Costing

Resources

(Expenses from IFIS)

Products and Services

Even spread approach

Resources

$ used to do work

Activities

work processes

Cost Objects (Product and Services)

For whom work is done

Activity Based Costing (ABC)

Resource Drivers

Activity Drivers

Stage 1

Stage 2

9

Activity Based Costing

The basic premise behind ABC is simple

ABC assumes that:

clients create need for outputs (services/products), which

create the demand for activities, which in turn

consume resources

10

Traditional vs Activity based view of costs

ABC/M provides a focus on activities not visible through traditional accounting

Actual Plan Favourable/(Unfavourable)

Salaries 300 275 (25)Materials 125 140 15 Supplies 25 52 27 Depreciation 100 100 - Rent 75 75 - Utilities 50 70 20 Oil and Gas 25 15 (10)Total 700 727 27

Chart of Accounts ViewTraditional (IFIS)

Take Orders 70Make Orders Mix Batter 250 Bake Layers 150 Frost Cakes 90Store Cakes 40Deliver Cakes 100Total 700

Activity Based View

11

Total Cost

Unit Cost

Total Cost

Unit Cost

Total Cost

Unit Cost

Take Orders 40 0.80 30 1.20 70 0.93 Mix Batter 150 3.00 100 4.00 250 3.33 Bake Layers 100 2.00 50 2.00 150 2.00 Frost Cake 50 1.00 40 1.60 90 1.20 Store Cakes 10 0.20 30 1.20 40 0.53 Deliver Cakes 70 1.40 30 1.20 100 1.33 Total 420 8.40 280 11.20 700 9.33

# of Units Produced 50 25 75

Cost per Unit 8.40 11.20 9.33

Chocolate Cakes Specialty Cakes Grand Total

ABC

Chocolate Cakes

Specialty Cakes Total

Direct Materials 65 35 100 Direct Labour 100 50 150 Allocated Overhead 300 150 450 Total 465 235 700

# of Units produced 50 25 75

Cost Per Unit 9.30 9.40 9.33

Traditional

Traditional vs Activity based view of costs (cont.)

12

What is a Resource?

Salaries and benefits

Building occupancy charges

Supplies Telephone charges

Equipment depreciation

13

What is an Activity?

Process Billing

Train employees

Provide IT support & maintenance

Provide mail services

Maintain Accounts

14

What is a Cost Object?

Products and Services Drivers Licenses Permits Cameras Personal Savings Accounts Insurance Policies

Clients

Channel of Delivery

Face to Face E-Channels

Internal External

15

Example: Using a Resource Driver

Resource Resource Driver Activities

Receive drivers license requests

Process drivers license requests

Maintain drivers license records

Salary and Benefits

20%20%

50%50%

30%30%

16

Example: Using an Activity Driver

Activity Activity Driver Cost Object

5 transactions

20 transactions

10 transactions

Drivers license renewal

Drivers license renewal with fine

Drivers license replacement

Process drivers license requests

17

Your Objects of Work?

What are examples of your cost objects?

Note: objects of work can be another office, external client, a product/service, etc.

_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________

Drivers Licenses Building Permits Clients served Quarterly Reports

18

Your Activities?

What are examples of your activities?

_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________

Develop engineering design Forecast expenses Train employees Maintain company vehicles Maintain oversight of highway maintenance Provide legal advice

19

Your Resources?

What are some of the resources used by your office/branch?

_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________

Salaries and benefits Office space Computers Supplies Support received from other offices

20

ABC supports Activity Based Management (ABM)

Performance MeasurementHow well work is done?

(Cost, time, quality)

Cost DriversDrivers of work

Process View (ABM)

Why things have cost Better decision making

What things costResources

$ used to do work

Activitieswork processes

Cost Objects (Product & Services)

For whom work is done

ABC ViewWhat things cost

Resource Drivers

Activity Drivers

21

Cost Drivers

Cost drivers cause work: they are factors that cause the change in the cost of an activity

They may cause excess cost, time and poor quality

Removing/managing cost drivers is the key to improvement

22

Examples of Cost Drivers

Cost drivers cause work!

Activity

Register students to program

Cost Drivers

Part time vs. Full time

Number of registrants

Complexity of forms

23

What causes work in your Office/Branch?

Cost drivers cause work

Activity: _______________________________

Cost Drivers:

_____________________________________ _____________________________________ _____________________________________ _____________________________________ _____________________________________

Cost a program

Complexity of the costing project (Centralized vs Regional delivery)

Scope of the project (No. of issues to look into) Number of briefings required Staff training / capacity

24

Activity Based Management – Adding Value

Activity or Activity or Process Process

StepStep Contributes Contributes to Client to Client

Demands or Demands or Government Government Priorities?Priorities?

Contributes Contributes to to

Government Government Business Business

Demands?Demands?

Alternative service delivery

Efficiency opportunities

Policy changes

Alternative service delivery

Efficiency opportunities

Policy changes

Reallocate resources/discontinue

Reallocate resources/discontinue

Necessary Necessary to Produce to Produce

Output?Output?

NO

YES

NO

NO

YES

YES

• Government regulations• Stakeholder

consultations• Environmental

assessment

• Public safety• Highway maintenance• Transit• Strategic planning

• Duplication of work• Bureaucracy• Outdated processes

25

Cost of a Burger

$0.10 $0.20

$0.50

$0.05

$0.15

$0.10

$0.05

$0.02 $0.02

26

Other Costs of a Burger

RentUtilitiesSignage

AdvertisingKitchen equipment

FurnitureFixtures

Kitchen staffWait staffInsurance

Dishes, cutlery, linen, decorations

Printing (e.g. menus)Cleaning supplies

Licenses

27

Types of Costs

Direct Program costs

Program Support costs

Ministry corporate overhead costs

Other Ministry costs (such as OSS, MGS, MAG, etc)*

Risk Costs (where appropriate)

Ontario Ministry of Finance Costing and Pricing Guidelines classify costs into 5 categories:

* OSS – Ontario Shared Services; MGS – Ministry of Government Services; MAG – Ministry of Attorney General

28

When is ABC Most Useful?

Multiple products / services

Client diversity

Product / service complexity

Different products / services placing different demands on resources

Difficulty in linking resources to outcomes

High overhead costs

Better cost information is needed

29

Tips / Lessons Learned

Activity Based Costing is:

30% understanding and using techniques correctly

70% the ability to convince others to accept beneficial change

Ralf Sorenson(Head of SAS Airlines)

30

Tips / Lessons Learned (cont.)

Need senior management full commitment and buy-in

Involve front-line staff (they know the business)

Keep it simple

Consider all costs

Document assumptions and costing methodology

Target areas that can benefit the most from ABC/M

Cost is a very important dimension of service performance. Also consider quality and efficiency of service

31

What can I do with ABC/M Information?

Better Better understanding of understanding of costs enhances costs enhances decision makingdecision making

32

Ministry of Public Works

Professional Services Branch

Division AInfrastructure Division

(ADM's Office)provides inspection services and plans approval for buildings, roads and parks

Service Delivery Branch (Director's Office)

Transfer Payments Branch

Division B

Research and Analysis Office

Plans Approval Unitapproves all building, road and park plans. Plans Approval Unit

provide support to the entire branch

Inspections Unitincludes52 full-time-

equivalent Inspectors and one manager. Inspectors perform all types of inspections. Unit

provides the following services to the public:

1. Building Inspections

2. Road Inspections

3. Park Inspections

Information Unitprovidessupport to the entire

branch

Building Advisors Unit

providessupporting research and analysis for Building Inspections and the Plans

Approval Unit

Case: Ministry of Public Works

* ADM – Assistant Deputy Minister

*

33

Case: Relevant Costs (cont.)

Minister’s /Parliamentary Assistant’s Salary

Infrastructure Division ADM’s Office

Professional Services Branch

Service Delivery Branch Director’s Office

Transfer Payments Branch

Research and Analysis Office

Building Advisor’s Unit *

Plans Approval Unit Inspections Unit

Information Unit

Building Inspections Unit

Road Inspections

Park Inspections

Division A

Division B

* Assumption: cost is fully loaded (i.e. includes overheads e.g. governance cost related to manager/director’s office)

34

Case: Examples of Other Relevant Costs (cont.)

Direct Program Costs Program Support Costs

Costs that are directly attributable to the program/activity Other offices that support the program/activity

Building Inspections Unit (Service Delivery Branch) Plans approval unit (Service Delivery Branch)

Pension – MGS accrues for all ministries Information unit (Service Delivery Branch)Termination Accruals – 1 week of accrued salary for each year per employee Director’s office (Service Delivery Branch)

Amortization Expense – if applicable Building Advisors Unit (Professional Services Branch)

Bad Debt Expense – if applicable ADM’s office (Infrastructure Division)

35

Ministry Corporate Overhead Costs Other Ministry Costs

Ministry administration costs representing organizational units

supporting the entire ministry

Other ministry services consumed by the program/activity

Deputy Minister’s Office Legal ServicesPolicy Audit ServicesCommunications Information SystemsFinance and Administration Ontario Shared ServicesHuman Resources Enforcement and Compliance

Risk costs - if applicable

(e.g. Financial liabilities like service guarantee, environmental liability etc.)

Case: Examples of Other Relevant Costs (cont.)

* To avoid double counting watch for costs that have already been charged to the program

*

36

Questions & Comments

Jalees HafeezSenior Financial Coordinator, Procurement & Costing Office, Finance BranchMinistry of TransportationTel: 905 704 3110E-mail: jalees.hafeez@ontario.ca

37

AppendixAppendix

38

Other Costing Methods

Standard costing – where standard cost rates are established based upon historical data (or other reasonable source) . This costing methodology is appropriate for repetitive type outputs and relies on ongoing comparisons with actual costs to identify any material variances

Process or unit costing – where products are created by flowing through a series of steps, accumulating a unit cost as they flow from one step to the next. This methodology is most appropriate for the production of homogenous goods or services, where the same process is used in the production of each output.

Job order or project costing – where discrete units of work are identified and used to accumulate the appropriate direct costs (via direct assignment) and indirect costs (based on a causal beneficial relationship). This costing methodology is most appropriate for organizations that produce non-repetitive outputs (e.g. engineering and construction, case management.

Cost allocation by operational variable – the use of an operational variable is the easiest method but is not as accurate as the methods demonstrated so far. The operational variables could include the number of FTEs, total budget dollars, program costs, labour costs or capital costs.

39

Unit Cost

Total Cost

of activities performed and products/services produced

Mod

el

Valid

atio

nM

gmt.

sign-

off

ABC/M Modeling Approach

Dat

a C

olle

ctio

nde

fine

activ

ities

, pro

duct

s /

serv

ices

Data ValidationEnsure accuracy of information collected

Model

Building

(using special

software for ABC –

SAS)

Final Costing Report(to be presented jointly with Program Area)

• Financial Analysis• HR alignment to cost centers

• Governance cost analysis• Corporate expenditure analysis

(accommodations, I&IT, PC Fleet, etc)