Describe Common Pitfalls And Ways To Avoid Them In ABC Principles of Cost Analysis and Management © Dale R Geiger 2011 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 © Dale R Geiger 2011 Terminal Learning Objective • • Task: Describe Common Pitfalls And Ways To Avoid Them In ABC • Standard: with at least 80% accuracy: Condition: You are a cost advisor technician with access to the GFEBS training database, PCAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • • Describe limits to precision Describe affordability, credibility and relevance constraints © Dale R Geiger 2011 Choosing Level of Precision • Goal: • • Managerially useful information for cost warrior decision making Question: • How much precision cost warriors need? = managerially useful information © Dale R Geiger 2011 cost object Things to Consider • User needs • • • • Cost environment Cost style Organization Measurement issues • • • Difficulty and cost Limits to precision Impact on behavior © Dale R Geiger 2011 User Defined Relevance • • • • Nearest or 10 minutes Nearest minute or two Nearest or 10 seconds Nearest nanosecond • • • • © Dale R Geiger 2011 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 â Dale R Geiger 2011 $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? © Dale R Geiger 2011 Example: Cost of a Job • • Cost expression for a job: Parts $ + Labor $ + Clerical OH $ + Supplies OH $ Cost measurement for Job A: Actual Parts + Actual Labor+ + $2995.27 + $2012.42 + $960.00 • 12% * $8K $748.82 + $2995.27/$16K * $4K Precision of cost measurement: ± $.01 ± $.01 ± 10%* $960 ± $10 © Dale R Geiger 2011 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 © Dale R Geiger 2011 Over Consumption Pitfalls: Summary • • • • Successful managerial cost systems motivate behavior for better or worse Flaws in the system can inadvertently motivate behavior in wrong direction Having total cost precise and being right “on average” can lead to ruin Be reasonably right Not precisely wrong © Dale R Geiger 2011 51 Sometimes Behavior is More Important than Truth • • Typically we want to cut cost by • • Determining and allocating true cost Encouraging cost reduction behavior Occasionally we don’t want true cost • • • If reduction of activity cost is undesired If reduction of the driver is undesired When emphasis of some other behavior is needed © Dale R Geiger 2011 52 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 © Dale R Geiger 2011 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 • Example: True cost may discourage investment in vital technologies that are in the best interests of the organization It may be desirable in the long run to provide a capability or encourage a change that would be discouraged by true cost © Dale R Geiger 2011 54 Computer Ops Mini Case • • • $1,000,000 fixed cost of operation 2000 hours of services rendered Basis of allocation: Hours used Users Hours A 600 Allocation $300K B 650 $325K C 750 $375K © Dale R Geiger 2011 55 Computer Ops Mini Case • • Due to weather and business reasons C’s usage declines next period The hours of use allocation base shifts cost to A and B Users Hours A 600 Allocation $353K Change B C 650 750 $382K $265K $ 53K $ 57K © Dale R Geiger 2011 -$110K 56 Computer Ops Mini Case • • 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 © Dale R Geiger 2011 57 Computer Ops Mini Case • • A and B significantly reduce use for the next period while C’s usage returns to normal A and B’s reduce usage shifts cost to C Users Hours A 300 Allocation $218K Change B C 325 750 $237K $545K -$134K -$145K $279K © Dale R Geiger 2011 58 Computer Ops Mini Case • • C cannot afford a computer this expensive and stops using Cost per hour jumps to $1600 per hour from the original $500 per hour once the largest user stops using the system Users A Hours 300 Allocation $480K Change B C 325 $520K $262K $283K 0 -$545K © Dale R Geiger 2011 59 Computer Ops Mini Case • • • There is no way A and B can afford this monster They stop using the system Clerk in A logs on accidentally for 30 seconds Users A B Hours 008 Allocation $1000K Change $520K C 0 -$520K 0 © Dale R Geiger 2011 60 A Death Spiral 1600 1400 1200 1000 800 600 400 200 Case A Case B Case C Case D Cost Per Hour or Use © Dale R Geiger 2011 61 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 © Dale R Geiger 2011 62 Summary: Pitfalls • Under costed cost objects are over consumed • Over costed cost objects are under consumed • Coster beware: • • • • The true cost of resources consumed will help motivate rational, desired behaviors It is not in the organization’s best interest to reduce certain activities such as safety and technology Averaging by its nature both under costs and over costs Always consider the behavioral motivations © Dale R Geiger 2011 63 Check on Learning • • How does incorrect cost information affect outsourcing decisions? How might motivating reduced consumption be bad for an organization? © Dale R Geiger 2011 64 Practical Exercise © Dale R Geiger 2011 65 ... Shelves 14 Replenish Line 14 Maintain Equip 14 Total $693 12 Dining Hall Case • • • Accounting spends a day and determines the following distribution basis for food cooling Use the level of detail... Not Free: • • • • • • • Measuring Accumulating Storing Editing Manipulating Reporting Explaining © Dale R Geiger 2011 27 Cost of Cost Methodology • • • • Gut feel, intuition or experience Low $... Allocation for dining hall non food cost cooling food 371 $400 $350 cleaning 223 serving (in 000's) $300 $250 Activity D 99 $200 $150 Activity E $100 All Other $50 $0 breakfast lunch dinner 22 © Dale