Figure 12.1 displays a generic activity-based management (ABM) cost assign- ment network that consists of the three modules connected by cost assignment paths. It initially appears to be overly complicated, but with just a few minutes consideration it is seen to be a logical representation of how input expenses are translated into calculated costs of work and ultimately outputs.
Imagine the cost assignment paths as pipes and straws where the diameter of each path reflects the amount of cost flowing. The power of an ABM model lies in the fact that the cost assignment paths and destinations provide traceabilityto segment costs from beginning to end, from resource expenditures to each type of (or each specific) customer—the origin for all costs and expenses.
ABM uses multiple stages to trace and segment all the resource expenses as calculated costs through a network of cost assignments into the final cost objects.
ABM facilitates more accurate reporting because it honors the costing property of proportional traceability, not broad averages. In complex, support-intensive organizations, there can be a substantial chain of indirect activities prior to the direct work activities that eventually trace into the final cost objects. These chains result in activity-to-activity assignments, and they rely on intermediate activity drivers in the same way that final cost objects rely on activity drivers to reassign costs into them based on their diversity and variation.
Thedirect costingof indirect costs is no longer, as it was in the past, an insur- mountable problem, given the existence of integrated ABM software. ABM al- lows intermediate direct costing to a local process, an internal customer, or a
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required component that is causing the demand for work. In short, ABM con- nects customers to the unique resources they consume—and in proportion to their consumption—as if ABM were an optical fiber network. Visibility to costs is provided everywhere throughout the cost assignment network.
With ABM the demands-on-work are communicated via activity drivers and their driver cost rates. Activity driver cost rates can be thought of as very local burden rates(VLBRs). They reassign expenses into costs at a more local, granu- lar level than in traditional systems, and with arterial flow streams, not with the ACTIVITY-BASED MANAGEMENT MODEL DESIGN AND PRINCIPLES 99
Direct
Material Depreciation
Customers Business Sustaining
Resources
Work Activities
Final Cost Objects
Suppliers
Costs (2)
Support Activities
Equipment Activities
People Activities
Costs Measure the Effects (1) Demands on Work
Products, Services
Cost-to-Serve Paths
Salary, Fringe Benefits
Phone, Travel Supplies
Rent, Interest,
Tax
Figure 12.1 Activity-Based Management Cost Assignment Network
Activity-Based Management Cost Assignment Network: A Tour It may be useful to mentally reverse all the arrowheads in Figure 12.1. This polar switch reveals that all expenses originate with a demand-pull from cus- tomers—and the calculated costs simply measure the effect. The ABM net- work is basically a snapshot view of the business conducted during a specific time period. (Life-cycle costing will be described in Chapter 17’s section on customer intelligence as “customer lifetime value.”)
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100 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS
Activity-Based Management Cost Assignment Network (Continued) Resources, at the top of the cost assignment network in Figure 12.1, are in sum the capacity to perform work because they represent all the available means that work activities can draw on. Resources are where all the period’s expenditure transactions are accumulated into buckets of spending. Examples of resources are salaries, operating supplies, and electrical power. A popular basis for tracing or assigning resource expenses is the amount of time (e.g., number of minutes) that people or equipment spend performing activities.
Percentage splits of time among activities are also popular.
Theactivitieslocated in the middle module are where work is performed.
This is where resources are converted into some type of output. The activity cost assignment step contains the structure to assign activity costs to cost ob- jects (or to other activities), utilizing activity drivers as the mechanism to ac- complish this assignment.
Cost objects, at the bottom of the cost assignment network, represent the broad variety of outputs and services where costs accumulate. The customers are the final-final cost objects; their existence ultimately creates the need for a cost structure in the first place. Cost objects are the persons or things that ben- efit from incurring work activities. Examples of cost objects are products, ser- vice lines, distribution channels, customers, and outputs of internal processes.
Cost objects can be thought of as for whatorfor whomwork is done.
This final cost object module is much more important than the resource and activity cost modules. That is because the inherently diverse and varied outputs that ABM segments and reflects so well with cost data originate as final cost objects. Unfortunately many ABM project teams spend much more of their energy worrying about the resource and activity modules, believing that the definition and design of resources and activities is what will influence ac- curate and useful results. They are misguided by misconceptions. The wiser ABM project teams realize it is best to begin designing their ABM model struc- ture backward from the final cost objects. When the diversity and variation of what things draw on the workload are first modeled, it increases the likelihood that the consumed resource expenses will pile up in proper proportions into the final cost objects that uniquely used (i.e., caused) the resources.
What Are Drivers?
The term driverscan be confusing. Acost driveris something that can be de- scribed in words but not necessarily in numbers. For example, a storm would be a cost driver that results in much clean-up work and the resulting costs. In contrast, the activity driversin ABM’s cost assignments must be quantitative, using measures that apportion costs to cost objects. Activity drivers have their ccc_cokins_12_98-109.qxd 1/14/04 10:28 AM Page 100
ACTIVITY-BASED MANAGEMENT MODEL DESIGN AND PRINCIPLES 101
Activity-Based Management Cost Assignment Network (Continued) own higher order cost drivers. Cost drivers and activity drivers serve different purposes.Activity driversare output measures that reflect the usage of each work activity, and they must be quantitatively measurable. An activity driver, which relates a work activity to cost objects, meters out the work activity based on the unique diversity and variation of the cost objects that are con- suming that activity. Acost driveris that driver of a higher order than activity drivers. One cost driver can affect multiple activities. A cost driver need not be measurable but can simply be described as a triggering event.
Thecost object driverapplies to cost objects after all activity costs have al- ready been logically assigned. Note that cost objects can be consumed or used by other cost objects. For example, when a specific customer purchases a mix of products, similar to you placing different items in your grocery cart than another shopper, the quantities purchased are a cost object driver.
Business Sustaining Expenses
Some activities in an organization do not directly contribute to customer value, responsiveness, and quality. That does not mean those activities can be eliminated or even reduced without doing harm to the business entity. For ex- ample, preparing required regulatory reports certainly does not add to the value of any cost object or to the satisfaction of the customer. However, that type of work activity does have value to the organization because it enables it to function in a legal manner. These types of activity costs are usually traced to a sustaining cost objectgroup, popularly called business sustaining costs.
Business (or infrastructure) sustaining costs are those costs notcaused by products or customer service needs. The consumption of these costs cannot be logically traced to products, services, customers, or service recipients. An- other example is the accounting department’s closing of the books each month. How can one measure which product caused more or less of that work? One cannot. Recovering these costs via pricing or funding may eventu- ally be required, but that is a different issue; the issue here is fairly charging cost objects when no causal relationship exists.
Other categories of expenses that may be included as business sustaining costs are idle but available capacity costs or research and development (R&D). R&D expenses might be optionally assigned into the business sustain- ing costs so that the timing of the recognition of expenses is reasonably matched with revenue recognition for sales of the products or service lines.
Because activity-based costing is management accounting, not regulated fi- nancial reporting, strict rules of GAAP (generally accepted accounting princi- ples) do not need to be followed; however, they can be borrowed.
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traditional accountant’s rigid step-down cost allocation method that reduces costing accuracy.
The key to a good ABM system is the design and architecture of its cost as- signment network. The nodesare the sources and destinations through which all the expenses are reassigned into costs. Their configuration helps deliver the util- ity and value of the data for decision making.