This is a critical concept in understanding ABM. Expenses are not the same thing as costs. What are the differences? Expensesare defined as when an orga- nization exchanges money with another party, such as paying suppliers, or pay- ing its employees’ salaries. (Expenses may also be near-cash to reflect the obligation to pay cash in the near future.) In short, currency exits the treasury.
In contrast, costs are always calculatedcosts. Costs reflect the use of the spend- ing of the expenses.
It is important to recognize that assumptions are always involved in the conversion and translation of expenses into costs. The assumptions and busi- ness rules stipulate the basis for the calculation. Expenses occur at the point of acquisition with the other party, including paying employee wages. At that spe- cial moment, value does not fluctuate; it is permanently recorded as part of a legal exchange. From the expenses, all costs follow; they are calculated repre- sentations of how those expenses flow through work activities and into outputs of work.
ACTIVITY-BASED MANAGEMENT’S ACTIVITIES ARE EXPRESSED WITH ACTION VERBS
A key difference between ABM and the general ledger and traditional tech- niques of cost allocation (i.e., absorption costing) is that ABM describes ac- tivities using an “action verb, adjective, noun” grammar convention, such as
“inspect defective products,” “open new customer accounts,” or “process cus- tomer claims.” This gives ABM its flexibility. Such wording is powerful be- cause managers and employee teams can better relate to these phrases, and the wording implies that the work activities can be favorably affected, changed, improved, or eliminated. Note in Figure 11.3 how ABM translates the ledger’s expenses into calculated costs.
When each of the work activities in the ABM view is traced to its product or customer (i.e., final cost object) using the unique activity driver for each activity, ABM would pile up the entire $914,500 into each type of product, service, chan- nel, or customer. This reassignment of the resource expenses would be much 92 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS ccc_cokins_11_85-97.qxd 1/14/04 10:27 AM Page 92
more accurate than any broad-brush cost allocation applied in traditional costing procedures and their broad averages. This cost assignment network is one of the major reasons that ABM calculates more accurate costs of outputs. As earlier mentioned, the terms tracingorassigningare preferable to the term cost alloca- tion. This is because many people associate allocationwith a redistribution of costs that have little to no correlation between source and destinations; hence to some organizations overhead cost allocations are rejected by users as arbitrary and are viewed cynically.
The assignment of the resource expenses demonstrates that all costs actually originate with the customer or beneficiary of the work, not with the general ledger. This is at the opposite pole from where accountants who perform cost al- locationsthink about costs. Cost allocations are structured as a one-source-to- many-destinations redistribution of cost. But the destinations are actually the origin for the expenses. The destinations, usually outputs or people, place de- mands on work, and the costs then measure the effectby reflecting backward through an ABM cost assignment network.
The general ledger uses a chart of accounts, whereas ABM uses a chart of ac- tivities. In translating general ledger data to work activities and processes, ABM preserves the total reported revenues and costs but allows the revenues, budgeted funding, and costs to be viewed differently—and better. The data in thechart of accountsview are inadequate for reporting business process costs IF ACTIVITY-BASED MANAGEMENT IS THE ANSWER . . . 93
Activity-Based View To: ABC Data Base
Key/scan claims Analyze claims Suspend claims Receive provider inquiries Resolve member problems Process batches Determine eligibility Make copies Write correspondence Attend training
Total
$ 31,500 121,000 32,500 101,500 83,400 45,000 119,000 145,500 77,100 158,000
$914,500 Claims Processing Dept
Salaries Equipment Travel expense Supplies Use and occupancy Total
$621,400 161,200 58,000 43,900 30,000
$914,500
$600,000 150,000 60,000 40,000 30,000
$880,000
$(21,400) (11,200) 2,000 (3,900) ––
$(34,500) Plan
Actual Favorable/
(unfavorable) Claims Processing Department
Chart-of-Accounts View From: General Ledger
Activity drivers
Products/customers
In addition to seeing the content of work, the activity view gives insights to what drives each activity’s cost magnitude to fluctuate.
# of
# of
# of
# of
# of
# of
# of
# of
# of
# of
Fixed versus variable classifications get redefined with ABC/M.
Figure 11.3 Each Activity Has Its Own Activity Driver ccc_cokins_11_85-97.qxd 1/14/04 10:27 AM Page 93
that run cross-functionally, penetrating the vertical and artificial boundaries of the organization chart. The general ledger is organized around separate depart- ments or cost centers, thus preventing a view of process costs. Many organiza- tions have been flattened and delayered to the extent that employees from different departments or cost centers frequently perform similar activities and multitask in two or more core business processes. Only by reassembling and aligning the work activity costs acrossthe business processes, such as “process engineering change notices (ECNs)” or “open new customer accounts,” can the end-to-end process costs be seen, measured, and eventually managed.
94 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS
Two Views of Costs: Assignment View versus Process View There are two ways to organize and analyze ABM work activity cost data. The horizontalprocess view sequences and additively builds up costs, whereas theverticalcost assignment view, governed by the variation and diversity of cost objects, transforms resource expenses into output costs by continuously reassigning costs based on causal-based tracing (i.e., cost allocations).
Vertical Axis
The vertical axis reflects costs as they are sensitive to demands from all forms of product, channel, and customer diversity and variety. The work activities consume the resources, and the products and customer services consume the work activities. The ABM cost assignment view is a cost-consumption chain.
When each cost is traced based on its unique quantity or proportion of its dri- ver, allthe resource expenses are eventually reaggregated into the final cost objects. This method provides much more accurate measures of product, channel, and customer costs than the traditional and arbitrary “peanut-butter spreading” cost allocation method.
Horizontal Axis
The horizontal view of activity costs represents the business process view. A business process can be defined as two or more activities or a network of ac- tivities with a common purpose. Activity costs belong to the business processes. Across each process, the activity costs are sequential and additive.
In this orientation, activity costs satisfy the requirements for popular flow- charting and process mapping and modeling techniques. Business process–based thinking, which can be visualized as tipping the organization ccc_cokins_11_85-97.qxd 1/14/04 10:27 AM Page 94
The primary focus in this book is the vertical view, popularly called absorp- tion accounting. Activity-based costing is more closely associated with this latter view.
I am often asked to explain Figure 11.3 in the simplest terms. I humorously reply, “The right side is good because the left side is bad!” Now I did not say the general ledger is a bad thing. In fact, just the opposite; the general ledger is a wonderful instrument for what it was designed to do—to capture and bucketize or accumulate spending transactions into their accounts. But the data in that for- mat is structurally deficient for decision support other than the most primitive form of control, budget variances. Translating it into calculated costs corrects this deficiency.
When managers receive the left-side responsibility center report from Figure 11.3, they are either happy or sad, but rarely any smarter. That is why I often hu- morously ask “What is another name for GL?” The answer is “good luck.” It doesn’t help much for decision support.
In summary, the general ledger view describes what was spent, whereas the activity-based view describes what it was spent for. The ledger records the ex- penses, and the activity view calculates the costs of work activities, processes, and all outputs, such as products. Intermediate output costs, such as the unit cost to process a transaction, are also calculated in the activity view. When em- ployees have reliable and relevant information, managers can manage less and lead more.
IF ACTIVITY-BASED MANAGEMENT IS THE ANSWER . . . 95
Two Views of Costs (Continued)
chart 90 degrees, is now dominating managerial thinking. ABM provides the cost elements for process costing that are not available from the general ledger.
In effect, think of the vertical ABM cost assignment view as being time- blindwithin the period. The ABM process costing view, at the activity stage, is outputmix-blind. The cost assignment and business process costing are two different views of the same resource expenses and activity costs. They are equivalent in amount, but the display of the information is radically different in each view. In summary, the vertical cost assignment view explains what specific things cost, whereas the horizontal process view demonstrates why things have a cost, which provides insights into what causes costsandhow much processes cost.
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