Question
Graham Muller Associates' activity based costing (ABC) clients have included: Through application of its activity based costing methodology Graham Muller Associatesaims to deliver a value-added
Graham Muller Associates' activity based costing (ABC) clients have included:
Through application of its activity based costing methodology Graham Muller Associatesaims to deliver a value-added service to its clients by enhancing business performance and profitability.The first and logical step in any performance enhancement process is the identification and costing of activities, products and services.This results in an initial focus on costs and the efficiency of operations and provides a solid foundation for enhanced business performance.
The typical deliverables of an activity based costing project, such as fully absorbed service line (or product) costing, correct allocation of overheads, and the linking of processes (value chains) to resource allocation within the client business, will assist management in identifying significant opportunities for performance improvement and an optimal deployment of the resources of the organisation.This additional information will significantly enhance decision-making capability throughout the organisation.
ABC will enable management to improve pricing policies and understand the major cost drivers within the organisation, thus giving a perspective on cause and effect of costs, in addition to accurately reporting where costs have been incurred.Costed and charted processes (value chains) give a perspective on where value is generated and an increased awareness of the multidisciplinary process mindset, vital to laying the foundations for better manage systems and structures within client business in order to improve operational effectiveness and reduce costs. ABC is the appropriate methodology for addressing these strategic business issues.
SCOPE AND OBJECTIVES
The opportunities for enhanced cost management will typically encompass issues such as:
- Determining value added and non value added activities
- Developing more accurate and relevant total service line costs in order to determine exactly where profits are being generated
- Correctly allocating overheads, where appropriate
- Matching costs with the various revenue streams
- Providing an indication of appropriateness of service charges
- Setting defendable transfer prices for within group services
- Identifying opportunities for profit enhancement through cost reduction
- Managing costs better through strategic cost information
- Assisting management to deploy resources more effectively
- Training of client staff, and transfer of skills to selected staff members so as to ensure the ongoing continuous support and improvement of the model
- Design of meaningful management information reports
We will address the critical cost management issues discussed above during the project in the following way (see above)
Exhibit 2:Building the Activity Model
Costed Activities and Cost Reduction:
We will identify and document the key activities performed in a typical working day, working week or working year by client personnel. These activities will be costed using an activity-based approach that reconciles to the general ledger.This latter feature is crucial for maintaining the integrity and therefore the credibility of the information we will be working with.We will identify and quantify key cost drivers, value-added activities, and other activity attributes.
Costed Service Lines:
The service line range of the typical client business will include a range of broad product and / or service groups.GMA will identify activities that support more specific service lines within these broad groups. These will be determined together with management at an early stage during the pilot project.We will then "map" these activities to the service lines to identify the true total service line costs.Once complete, we can perform comparisons of total service line profitability using an activity approach with traditional measures.This data will provide the basis of input for any internal benchmarking exercise that is undertaken.This information will assist the client in determining whether current service charge pricing is appropriate, and identify which service lines are truly profitable to determine a more beneficial service line mix.In respect of inter-divisional charges this will also assist in correct transfer pricing.
The goal of the project is to develop the relevant cost information and specific recommendations in seventeen weeks, so that client management can use the new information as soon as possible.The deliverables from the ABC project will be:
- An enhanced view of costs - for activities, processes/value chains, and service lines
- Specific insights regarding cost driver focus, service charges and service line profitability
- A conceptual approach for measuring and managing costs in the future
- Staff trained to sustain and improve the model
APPROACH
Graham Muller Associates has developed a structured approach for executing our ABC methodology that has evolved continually as we have built up our substantial experience in the field over more than twelve years.We focus on building the costing infrastructure and developing cost management recommendations that can be practically used by management.
Once the costing infrastructure is complete, we perform detailed analysis using the activity database together with cost driver information and attributes to rigorously identify cost reduction opportunities.Given this approach, the specific sequence of steps for the client business will be as follows:
Develop Analysis Framework
We will begin the project by training the project team and together with client personnel develop the analysis framework that will guide the rest of the project.To accomplish this task, the project team will identify and review several critical items, with emphasis on the key cost elements and structure of the current cost system. With this information as a basis, we will revise specific plans for the detailed work to be performed.
Exhibit 4:Key Emphasis on Validation of Input Data
Perform the Baseline Activity Costing
We will develop the activity cost infrastructure by means of the process outlined above in Exhibits 3 and 4.Specifically, we will:
DefineActivities:
We will establish, by means of interviews with cost centre responsible managers, an initial set of activities for each department.We will then review these activities with the relevant managers to ensure that our activity set precisely reflects the way client personnel typically spend their working days (or weeks or months).We will also review these inputs at project steering committee level to ensure a full understanding of each department's activities within the overall organisation context.
Trace Activity Costs to Service Lines / Product Groups:
These costed activities can also be traced through to service line groups.These groups are likely to include in for example various product families.Examples of tracing factors might include time spent on each service line, numbers of set-ups and so on.
As is indicated above in Exhibit 4, above, at each stage of the pilot project, i e after each survey has been completed, we will perform internal project team validation and each cost centre (departmental) manager will be required individually to validate his or her input and results.
To facilitate the handling of the significant amount of data generated through our approach, we suggest the use of proprietary activity based costing software.Such software platforms allow you to organise the information and provide traceability of all information.Specifically, these software packages typically provide:
A solid audit trail from general ledger costs to activities.
Reports that display the new cost information by activity.
Based on our analysis, we will together with management develop recommendations for improving cost management at the client business. These recommendations will be linked by our analysis to the activity cost baseline model.
In addition, we will develop a conceptual approach for future strategic business management.This approach will be designed to provide information that will assist client management in monitoring performance and continually improving the ability to manage costs.
The conceptual approach outlined above will serve as a basis for the client's future efforts to increase the accountability within the organisation with respect to costs.
BENEFITS
The benefits and deliverables arising from the ABC project are as follows:
Graham Muller Associates will establish during a pilot project a management capability at the client business for the implementation of an activity-based management infrastructure, and will develop an appreciation for the power of decision-making using information from the ABC model.Client management and staff will be empowered in the use of the ABC methodology and software.
An implemented ABC pilot project at the client business will include the following deliverables from the ABC software:
- Accurate cost allocations at a responsible manager level for an agreed single accounting period (e.g. the previous financial year actual costs)
- Activity listing with detailed activity definitions
- Activity costing, whereby all activities are costed using activity-based management methods
- Attribute analysis, whereby specific attributes (such as value-added, quality, time) are tagged to activities and analysed accordingly
- Cost driver analysis, whereby the underlying drivers of the cost of each activity are identified using an activity-based approach
- An enhanced and more accurate view of service charges, of service line cost recovery and in certain circumstances customer profitability
- Process / value chain costing and analysis leading to action plans for performance improvement
- Total service line costing, whereby costs per service line group are derived using an activity-based approach
The longer-term benefit from the project arises from designing a management information system that encompasses cost structures within the organisation, particularly with respect to service line costs and service charges. This understanding will form the basis of future decisions to improve the competitive positioning of the client business.
The skills imparted to client personnel will enable management to embark upon subsequent rollout exercises to other divisions within the client business.Other strategic issues such total quality management, business process re-engineering, and other business issues can be addressed in these rollout phases with reduced input from Graham Muller Associates.
WHY GRAHAM MULLER ASSOCIATES?
This project demands practical management skills coupled with specialist advanced cost management expertise.Graham Muller Associates is uniquely placed to provide this skills mix.
Graham Muller Associates (GMA) is a highly focused specialist consultancy committed to capacity building and performance enhancement in client businesses and istheleader in the field of activity based costing (ABC) inSouth Africa.GMA have developed unique methods and proprietary tools to facilitate the data gathering process, thus allowing our consultants to focus on working with client management to resolve significant business issues, such as: -
- The true cost of activities
- Correct allocation of overhead expenses, where appropriate
- Management performance measurements and internal benchmarking
- The true profitability of service lines
- Appropriate pricing and an indication of the appropriateness of service charges
- Correct levels for transfer prices within the company
- Design of management information reports
- Training for client staff to sustain and continuously improve the model
- Planning of resources and equipment for the future
The collective skills and experience base of Graham Muller Associates consultants are impressive and represents a broad set of core competencies. The skills cover management accountants, business science graduates, economists, chartered accountants, engineers and information technologists.Graham Muller Associates has a policy of promoting environmental responsibility in all of its activities and project work.Graham Muller Associates is committed to maximising opportunities for capacity building, empowerment and skills transfer in respect of client personnel involved in the project team.
Graham Muller Associates is extremely well placed to achieve this objective. The firms have established a reputation of leadership in the implementation of activity based costing.
Our consultants have been extensively trained in these techniques and have significant and unrivalled experience in project implementation.
Graham Muller Associates have a well proven methodology for the implementation of activity based costing.Graham Muller Associates have successfully introduced this management approach to numerous sites in southernAfricaincluding successful projects in developing countries such asZimbabweandKenya.
Questions
1.Describe the approach the company used for ABC?
2.Explain 3 different ways in which the term cost driver is used by the company's ABC system?
3.Would you agree that the company needs to make use of ABC and are they using the correct approach in your opinion?
4.Discuss the company's activity model and highlight the features that makes their approach successful.
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