Slides 4 1 describe common pitfalls in activity based costin

Describe Common Pitfalls in Activity Based Costing and Ways to Avoid Them What Time is It? • • • • • • 2:00? 2:05? 2:03? 2:02:47? 2:02:46.35? Remember: A broken clock is correct to 10 digits of precision twice a day Terminal Learning Objective • Task: Describe Common Pitfalls in Activity Based Costing and Ways to Avoid Them • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: with at least 80% accuracy: • Describe limits to precision • Describe affordability, credibility and relevance constraints Choosing Level of Precision • Goal: • Managerially useful information for cost warrior decision making • Question: • How much precision cost warriors need? managerially useful information = cost object Things to Consider • User needs • Cost environment • Cost style • Organization • Measurement issues • Difficulty and cost • Limits to precision • Impact on behavior User Defined Relevance • Nearest or 10 minutes • Nearest minute or two • Nearest or 10 seconds • Nearest nanosecond • Good enough for most decisions • Needed to set your VCR • Radio programming • Synchronous data transmission Precision Costs • • • • Nearest or 10 minutes Nearest minute or two Nearest or 10 seconds Nanoseconds • • • • $10 $200 $500 $100,000 Weakest Link Theory • Cost can only be as precise as least precise component • Consider adding very precise numbers to very imprecise numbers • How precise can the total be? Example: Cost of a Job • Cost expression for a job: Parts $ + Labor $ + Clerical OH $ + Supplies OH $ • Cost measurement for Job A: Actual + Actual + Parts Labor 12% * $8K + $2995.27/$16K * $4K $2995.27 + $2012.42 + $960.00 + $748.82 • Precision of cost measurement: ± $.01 ± $.01 ± 10%* $960 ± $10 Data vs Information • We can calculate $6446.51 for the job cost • This data is poor information since: • Total error is plus or minus $106.52 • While labor and parts are accurate to the penny, clerical labor is accurate only to ± approx $100 • Management decision making can be confused and misled $39,999 10 Consider Some Drivers We May Not Want Reduced • Imagine the potential for undesirable behavior if the ABC system allocated • Safety program costs based on number of times safety equipment issued • Patent legal staff based on patents issued • Hazardous materials overhead based on materials turned in for disposal • Maintenance based on preventative maintenance costs 53 Sometimes We Don’t Want the Activity Cost Reduced • Sometimes a higher level view recognizes that just cutting cost is not the goal • Perhaps an investment is being made for the future • Maybe it is desirable in the long run to provide a capability or encourage a change that would be discouraged by true cost 54 Computer Ops Mini Case • $1,000,000 fixed cost of operation • 2000 hours of services rendered • Basis of allocation: Hours used Users A B Hours 600 650 Allocation $300K $325K C 750 $375K 55 Computer Ops Mini Case B • Due to weather and business reasons C’s usage declines next period • • • • Users A Hours 600 Allocation ? Change ? B 650 ? ? C 450 ? ? 56 Computer Ops Mini Case C • A and B see cost increase while their usage did not • They direct their people to cut usage: • To adjust to higher cost per hour • To guard against future rate increase • To make up for budget hit 57 Computer Ops Mini Case C • A and B significantly reduce use for the next period while C’s usage returns to normal Users A Hours 300 Allocation ? Change ? B 325 ? ? C 750 ? ? 58 Computer Ops Mini Case D • C cannot afford a computer this expensive and stops using Users A Hours 300 Allocation ? Change ? B 325 ? ? C ? ? 59 Computer Ops Mini Case D • Cost per hour jumps to $1600 per hour from the original $500 per hour once the largest user stops using the system Users A B C Hours 300 325 Allocation $480K $520K Change $262K $283K -$545K 60 Computer Ops Mini Case E • There is no way A and B can afford this monster • They stop using but a clerk in A logs on accidentally for 30 seconds Users A B C Hours 008 0 Allocation $1000K 0 Change $520K -$520K 61 Computer Ops Mini Case E • There is no way A and B can afford this monster • They stop using but a clerk in A logs on accidentally for 30 seconds Users A B C Hours 008 0 Allocation $1000K 0 Change $520K -$520K 62 A Death Spiral 1600 1400 1200 1000 800 600 400 200 Case A Case B Case C Case D Cost Per Hour or Use 63 A Solution From the National Institutes of Health • Operate genetic resources unit • Provides rare frozen embryos for potential research uses worldwide • Infrequently needed, but would never be used if users charged for use • Solution: Individual research institutes negotiate an allocation based on the relative value of availability 64 Summary: Pitfalls • Under costed cost objects are over consumed • Over costed cost objects are under consumed • Coster beware: • Averaging by its nature both under costs and over costs 65 Learning Check • How does incorrect cost information affect outsourcing decisions? • How might motivating reduced consumption be bad for an organization? 66 Practical Exercise 67 ... Shelves Replenish Line Maintain Equip Total 20 18 18 14 14 14 14 $693 12 Dining Hall Case (cont’d) • Accounting spends a day and determines the following distribution basis for food cooling • Use the... Diminishing Return to Accounting Effort $45 0 Dinner $40 0 $350 Breakfast $300 $250 $200 Lunch $15 0 $10 0 $50 $- 10 11 12 13 14 15 Number of Activities Evaluated 24 Summary on Precision • Engineering... Objects: Activity cooling food cleaning serving Activity D Activity E All Other Total breakfast $ 71 $ 42 $ 22 $ $ $ 88 $ 223 lunch $ $ $ $ $ $ $ 24 24 13 39 99 dinner $ 14 2 $ 54 $ 29 $ $ $ 14 6 $ 371