F0572 Management Accounting

Activity-Based Costing
Readings
5-1: Activity-Based Costing and Predatory Pricing: The Case of the Petroleum Retail Industry by Thomas L Burton and John B MacArthur, Management Accounting Quarterly, (S ring 200!"#
The assignment o$ indirect costs in a %o&ume'based costing system can &ead to roduct'cost subsidi(ation)o%ercost high'%o&ume roducts and undercost &o*'%o&ume roducts# +ndercosted roducts can &ead to the a earance o$ redatory ricing *here it actua&&y does not e,ist# This artic&e $ocuses on a &a*suit brought against a ma-or chain o$ retai& motor $ue& (gaso&ine" ser%ice centers $or a&&eged&y se&&ing regu&ar'grade gaso&ine be&o* cost, as de$ined by state statutes# The de$endant em &oyed AB. ana&ysis to su ort its osition that it *as not se&&ing its regu&ar gaso&ine be&o* cost# A$ter the AB. ana&ysis *as resented, the case *as sett&ed, and the -udge &i$ted the initia& in-unction#

!iscussion "uestions:
/# 2# !# 3# 0hat are roduct'cost subsidi(ations1 0hat are ossib&e conse2uences o$ roduct'cost subsidi(ations1 List a&ternati%e a roaches to assign costs in a gaso&ine ser%ice center# 4denti$y cost hierarchy &e%e& grou s in c&assi$ying acti%ities at the retai& &e%e& o$ a gaso&ine ser%ice center and gi%e at &east one e,am &e each# 5# 0hat are o%erheads acti%ity'cost oo&s ertaining to se&&ing gaso&ine in a retai& gaso&ine ser%ice center and *hat is the acti%ity &e%e& $or each o$ the cost oo&s1 5# 4denti$y the acti%ity dri%ers $or o%erheads acti%ity'cost oo&s identi$ied in this study and e, &ain the reasons $or the se&ection1 7# List e,am &es o$ gaso&ine'dis ensing $aci&ities $or a gaso&ine ser%ice center and identi$y *hether each o$ the $aci&ities is a common or a gaso&ine grade's eci$ic asset#

5-#: Activity-Based Benchmar$ing and Process %anagement&%anaging the Case of Cardiac 'urgery by Bea .hiang, Management Accounting Quarterly (Fa&& 2002"#
Through a study o$ resource consum tion, hos ita&s can get a more accurate icture o$ ho* ractices are &in6ed to cost#

!iscussion "uestions:
/# 7escribe brie$&y hos ita&8s costing system# 2# 7escribe ste s in acti%ity'based benchmar6ing $or medica&'care rocesses#

5-( )sing Activity Based Costing To Assess Channel*Customer Profita+ility by 7e0ayne L# Searcy, 9h7#, .MA, .9A, Management Accounting Quarterly (0inter 2003"#
This artic&e e, &ains ho* AB. *as used by a $irm (T:." in the tem orary em &oyment industry to better identi$y the ro$itabi&ity o$ its ser%ice distribution channe&s and indi%idua& customers#

!iscussion "uestions:
/# 0hat are the $our ste s used in im &ementing AB. costing at T:.1 2# 0hat are the acti%ity consum tion dri%ers that T:. has chosen $or each o$ the three acti%ities; $i&&ing *or6 orders, hiring tem oraries, and rocessing ayro&&1

F0572 Management Accounting !# 0hich customer channe& is most ro$itab&e, c&erica& or industria&, and *hy1 3# 0ithin the industria& channe&, *hich c&ass o$ customers is most ro$itab&e and *hy1 5# 4n the study o$ the $our &argest customers, *hich is the most ro$itab&e and *hy1

5-, Cost 'ystem Redesign at a %edium-'i-ed Com.any / by 7a%id :# Stout, 9h#7#, and <regory 9# Bedenis, .94M, Management Accounting Quarterly (Summer 2007", =o&# >, ?o# 3
This artic&e &oo6s at a com any that *as e, eriencing un ro$itab&e gro*th and *ea6 cash'$&o* acti%ity# The authors e,amine ho* an AB. method a&&o*ed the com any to become more com etiti%e, to &oo6 at their current roduct mi, and roduct &ines, and u&timate&y, to im ro%e cash $&o* and roduct ro$itabi&ity# !iscussion "uestions /# 0hy $or any manu$acturer is ro er in%entory management im ortant1 2# 0hat are the e&ements o$ an AB. system1 !# 0hat is a cost ob-ecti%e1 3# 0hy are duration dri%es used in an AB. system1 5# 0hat interna& $actors &imit the AB. mode&8s abi&ity to in$&uence the decision'ma6ing rocess in a com any1

F0572 Management Accounting

Readings

5-1: Activity-Based Costing and Predatory Pricing: The Case of the Petroleum Retail Industry
Abc Ana&ysis @e& ed Sett&e A La*suit Against A <aso&ine Aetai&er, 9ro%ing The .om any @ad ?ot .ommitted 9redatory 9ricing# By Thomas L. Bar Ton And John B. Macarthur 010C)TI20 ')%%AR3; The assignment o$ indirect costs in a traditiona& costing system can &ead to roduct' cost subsidi(ation# This is *here e,cessi%e costs are charged to high'%o&ume roducts and insu$$icient costs are charged to &o*'%o&ume roducts# The resu&t can &ead to increased consumer demand $or the undercosted)and under riced) roducts and reduced customer demand $or the o%ercosted)and thus o%er riced)high'%o&ume roduct# Bne *ay to dea& *ith this rob&em is to em &oy acti%ity'based costing (AB."# 9roduct'cost subsidi(ation a&so may ha%e &ega& conse2uences, *hich AB. can he& address# +ndercosted roducts can &ead to the a earance o$ redatory ricing *here it actua&&y does not e,ist# This artic&e $ocuses on a &a*suit brought against a ma-or chain o$ retai& motor $ue& (gaso&ine" ser%ice centers $or a&&eged&y se&&ing regu&ar'grade gaso&ine be&o* cost, as de$ined by state statutes# The de$endant em &oyed AB. ana&ysis to su ort its osition that it *as not se&&ing its regu&ar gaso&ine be&o* cost# A$ter the AB. ana&ysis *as resented, the case *as sett&ed, and the -udge &i$ted the initia& in-unction# Acti%ity'based costing (AB." *as origina&&y de%e&o ed by com anies to dea& *ith the rob&em o$ roduct'cost subsidi(ation in traditiona& costing systems#/ This is *here the assignment o$ indirect costs &eads to e,cessi%e costs being charged to high' %o&ume roducts and insu$$icient costs being charged to &o*'%o&ume roducts# The resu&t can &ead to increased consumer demand $or the undercosted) and under riced) roducts and reduced customer demand $or the o%ercosted)and thus o%er riced) high'%o&ume roduct#2 Subse2uent&y, AB. has been $ound use$u& $or se%era& other ur oses, such as costing non%a&ue'added acti%ities, &ong'term ricing, and ca acity management#! 0hen rices are based on cost, roduct'cost subsidi(ation can &ead to increased demand $or undercosted and under riced &o*'%o&ume roducts, *hich are robab&y being so&d at un ro$itab&e rices# .on%erse&y, com anies e, erience reduced customer demand $or o%ercosted, o%er riced high'%o&ume roducts and ser%ices# These are un*anted economic conse2uences $rom roduct'cost subsidi(ation that AB. see6s to correct by assigning indirect costs to roducts and ser%ices using a ro riate unit'&e%e& and nonunit'&e%e& acti%ity dri%ers that re$&ect resource consum tion by the cost ob-ects# AB. can a&so he& address any &ega& conse2uences o$ the roduct'cost subsidi(ation rob&em# 405A4 C67'0")07C0' 8R6% PR6!)CTC6'T ')B'I!I9ATI67 State and $edera& &a*s ha%e been enacted against redatory ricing, *hich is the se&&ing o$ roducts be&o* cost as a de&iberate action to dri%e out the com etition#3 A&ternati%e&y, roducts may a ear to be riced be&o* cost because o$ the use o$ unrea&istic, unit'based traditiona& costing systems, *hich resu&ts in the a earance o$ redatory ricing *here it does not e,ist# This occurred in a case brought under the CMotor Fue& Mar6eting 9ractices ActD o$ F&orida# C6'T A''I57%07T )'I75 ABC I7 A

5'!

F0572 Management Accounting R0TAI4 5A'64I70 '0R2IC0 C07T0R The &a*suit *as brought against a ma-or chain o$ retai& motor $ue& (gaso&ine" ser%ice centers, a&&eging that the chain *as se&&ing regu&ar'grade gaso&ine be&o* cost, as de$ined under state statutes# The &ainti$$8s e, ert used a unit'based a roach to assign the gaso&ine ser%ice center8s a%erage month&y costs (as de$ined by statute" to the three grades o$ gaso&ine; regu&ar (>7 octane", &us (>E octane", and remium (E! octane"# 0hen these month&y costs *ere added to the urchase costs o$ the gaso&ine, this a roach su orted the a&&egation o$ redatory ricing# See Tab&e /A $or the resu&ts# Bn the other hand, the de$endant8s origina& e, ert used a sim &e a%erage'cost a roach to assign the a%erage month&y gaso&ine ser%ice center costs e2ua&&y to the three grades o$ gaso&ine (see Tab&e /B", *hich su orted the de$endant8s osition that regu&ar gaso&ine *as not being so&d be&o* cost# The -udge in the case made a re&iminary ru&ing that re-ected the de$endant8s ana&ysis and acce ted the &ainti$$8s# The -udge then issued an in-unction rohibiting the de$endant $rom se&&ing regu&ar gaso&ine be&o* cost as determined in the &ainti$$8s ana&ysis# The de$endant engaged an accounting ro$essor as an e, ert *itness to re%ie* the cost'assignment rocess and ma6e his o*n recommendation as to the most reasonab&e determination o$ cost in a &ying state statutes# The e, ert *itness used AB. as a third a roach to cost assignment (see Tab&e /.", *hich in%o&%ed er$orming acti%ity ana&ysis and se&ecting acti%ity dri%ers# A.T4=4TF A?ALFS4S The urchase, storage, dis ensing, and sa&e o$ gaso&ine at the retai& &e%e& can be di%ided into acti%ities grou ed according to their cost hierarchy &e%e&; Unit-level activities are underta6en $or each ga&&on o$ gaso&ine so&d (such as e&ectricity to o*er um s *hen dis ensing gaso&ine"G Batch-level activities are the same $or each gaso&ine transaction irres ecti%e o$ the %o&ume o$ gaso&ine urchased ($or e,am &e, transactions to rocess customer ayments $or gaso&ine by cash, chec6, or debitHcredit card"G Product-level activities are conducted $or s eci$ic gaso&ine roducts such as regu&ar, &us, and remium gaso&ine and motor oi& ($or instance, gaso&ine tan6s that are dedicated to s eci$ic gaso&ine grades"G ( .ustomer'&e%e& acti%ities are conducted $or s eci$ic gaso&ine customers (such as using bi&&board ad%ertisements to romote the bene$its o$ remium gaso&ine"G and ( Brgani(ationa&'su orting acti%ities are $or the gaso&ine dis ensing organi(ation as a *ho&e and cannot be causa&&y identi$ied *ith units, batches, or indi%idua& roducts (inc&uding ayro&& and many other centra&i(ed acti%ities"# Acti%ities at the same hierarchy &e%e& that share a common acti%ity dri%er cou&d $urther be grou ed into homogeneous acti%ity cost oo&s# The de$endant8s retai& stores consisted o$ t*o main acti%ities; the sa&e o$ gaso&ine and the sa&e o$ con%enience store merchandise, such as bread and mi&6# 0ith &imited data, the e, ert *itness de%e&o ed a straight$or*ard AB. mode& that identi$ied three distinct o%erhead acti%ities in%o&%ed in se&&ing gaso&ine in a retai& out&et# First, it is necessary to ha%e at &east one attendant to recei%e ayments $or the gaso&ine sa&es transactions# Second, it is necessary to ha%e a $aci&ity to house the gaso&ine attendant(s"# This does not re2uire a s ace the si(e o$ a con%enience store, so the e, ert assumed that a sma&& 6ios6 *ou&d be used i$ there *ere no store# Third, it is necessary to ha%e gaso&ine storage and dis ensing assets# Acti%ity .ost 9oo& /; <aso&ine Sa&es Attendants (Labor"# Attendants are needed to recei%e ayments $rom customers *ho do not ay e&ectronica&&y at the gaso&ine um # Attendants a&so can dea& *ith ma&$unctioning gaso&ine um s, security issues, and other rob&ems as they arise# This is a batch'&e%e& acti%ity because ayment transactions occur on&y once $or each urchase o$ gaso&ine, regard&ess o$ the %o&ume o$ gaso&ine urchased# :ach ser%ice center has a con%enience store *ith attendants *ho hand&e ayments $rom the customers $or gaso&ine and $or any urchase o$ $ood, drin6, and other roducts so&d in the store# For the ur ose o$ the case, it *as necessary to estimate the &abor cost inc&uding $ringe bene$its" o$ attendants, assuming that gaso&ine *as the on&y roduct so&d# 4t *as decided that on&y one attendant *ou&d be re2uired $or the gaso&ine sa&es acti%ity in the absence o$ a con%enience store# Mu&ti &e regression ana&ysis resu&ts con$irmed that con%enience store sa&es, not gaso&ine sa&es, *ere the ma-or cost dri%er o$ &abor cost abo%e the base sa&ary and bene$its o$ one sa&es attendant# Acti%ity .ost 9oo& 2; Iios6 Faci&ity and Acti%ity .ost 9oo& !; <aso&ine'7is ensing Faci&ity# +nder state statutes, it *as necessary to determine a Creasonab&e renta& %a&ueD $or the retai& gaso&ine $aci&ity#5 4n the absence o$ a se arate con%enience store, it *ou&d be the renta& %a&ue o$ the 6ios6# 4t can be argued that this is a batch'&e%e& acti%ity, $o&&o*ing &abor, as it $aci&itates the ayment transactions that occur once er gaso&ine urchase#

5'3

F0572 Management Accounting A&so, it *as necessary to determine a Creasonab&e renta& %a&ueD $or the gaso&ine'dis ensing $aci&ity, *hich, in genera&, can be c&assi$ied as a roduct'&e%e& acti%ity#5 This acti%ity cost oo& inc&udes assets that are s eci$ic to a articu&ar gaso&ine grade and common gaso&ine dis ensing assets# 4n a more com rehensi%e acti%ity ana&ysis, this cost oo& cou&d be di%ided into t*o or more acti%ity cost oo&s that *ou&d be more homogeneous in nature# 4n determining a reasonab&e renta& %a&ue, &ease in$ormation *as obtained $or the assumed renta& o$ a 6ios6 and gaso&ine'dis ensing assets in com arab&e gaso&ine retai& out&ets in the surrounding geogra hica& mar6et area#7 The actua& cost o$ insurance and a%erage cost o$ re airs and maintenance, uti&ities, and rea&H ro erty ta,es *as added to the reasonab&e renta& %a&ue#> The tota& cost *as di%ided bet*een the 6ios6 $aci&ity and gaso&ine'dis ensing $aci&ity in ro ortion to the estimated 6ios6 and actua& gaso&ine'de&i%ery assets

Tab&e /; .om arati%e .ost Assignment Bases in a <aso&ine Ser%ice .enter/

FA.4L4TF'047: .BST A# +nit'Based A roach; A%erage Month&y .ost .ost 9er <a&&on So&d B# Sim &e A%erage A roach; A%erage Month&y .ost .ost 9er <a&&on So&d .# AB. A roach; 9oo& /'Labor 9oo& 2'Iios6 9oo& !'<as 7is ensing Tota& .ost .ost 9er <a&&on So&d
/ 2

TBTAL J25,!00

A.T4=4TF 7A4=:A <as So&d2

A:<+LAA J/5,573 J 0#05> J>,755 J0#0!0 J 5,>E5 /,7!5 3,753 J/2,!>5 J 0#03!

9L+S J5,/2E J0#05> J>,757 J0#0EE J/,>/3 5!3 3,753 J7,/02 J0#0>0

9A:M4+M J3,3E7 J0#05> J>,757 J0#//! J/,5E0 35> 3,755 J5,>/! J0#0>>

J25,!00

/H! each

J E,!00 2,7!7 /3,25! J25,!00

<as So&d2 <as So&d2 /H! each

The origina& in$ormation has been disguised# <aso&ine So&d 9ro,y Transactiona& .ost Assignment Base .a&cu&ations; TBTAL A:<+LAA A%erage ga&&ons o$ gas so&d er month 353,000 2>>,000 (/00#0K" (5!#3K"

9L+S >>,500 (/E#5K"

9A:M4+M 77,500 (/7#/K"

Tab&e 2; :stimated .ost o$ Iios6 and <aso&ine 7is ensing/

!escri.tion .ost o$ <aso&ine'7is ensing Faci&ities .ost o$ the .on%enience Store Bui&ding2 J505,250 Iios6 .ost :stimate %ersus :,isting .on%enience Store /5K 4m uted Iios6 .ost! Tota& 4m uted .ost o$ Faci&ity *ithout .on%enience Store (:,c&uding Land" Aenta&3 and Bther .osts5 Assigned to <aso&ine Sa&es Aenta& and Bther .osts Assigned to Acti%ity .ost 9oo& 2, Iios6 Aenta& and Bther .osts Assigned to Acti%ity .ost 9oo& !, <aso&ine 7is ensing
/ 2 2

Percent J322,000 >!#EK

>/,000 J50!,000 J/7,000 2,7!7 /3,25! J/7,000

/5#/K /00#0K /5#/K >!#EK /00#0K

The origina& in$ormation has been disguised# Asset %a&ues *ere obtained $rom the com any8s $i,ed'asset master &isting# ! 4$ the &ocation had main&y gaso&ine sa&es *ith no &arge, se arate con%enience store, this is the im uted cost o$ a C6ios6D to house an attendant to ring u gaso&ine sa&es# 3 See endnote 7 $or detai&s o$ the sources o$ renta& cost data#

5'5

F0572 Management Accounting

5

The actua& cost o$ insurance and a%erage cost o$ re airs and maintenance, uti&ities, and rea&H ro erty ta,es *as added to the reasonab&e renta& %a&ue o$ the 6ios6 and gaso&ine'dis ensing $aci&ities#

5'5

tota& %a&ue obtained $rom the com any8s $i,ed'asset master &isting (see Tab&e 2"# ACTI2IT3 !RI20R' The %o&ume o$ gaso&ine so&d *as readi&y a%ai&ab&e and *as se&ected as the ro,y acti%ity dri%er $or both the &abor and 6ios6 acti%ity cost oo&s# The a%erage 2uantities o$ the three grades o$ gaso&ine so&d o%er a /3' month eriod (Bctober /EE5'?o%ember /EE7" *ere used to assign the acti%ity costs# This *as

basica&&y the same a roach used by the &ainti$$# The gaso&ine'dis ensing acti%ity cost oo& *as assigned e2ua&&y to the three grades o$ gaso&ine because each grade o$ gaso&ine had e,act&y the same dis ensing in$rastructure# Labor Activity Cost Pool. The %o&ume o$ gaso&ine so&d is a unit'&e%e& acti%ity dri%er but can be -usti$ied $or assigning &abor acti%ity costs to the gaso&ine grades as $o&&o*s;

Tab&e !; <aso&ine'7is ensing Faci&ities

8acilities <aso&ine Sign .ano y .oo&er =au&t <aso&ine Tan6s 9um L Tan6 :2ui ment Mu&ti'9roduct 7is ensers (M97s" 9&umbing :&ectrica&):2ui ment :&ectrica&).ano yHM97s Lighting Fi,tures Area Lighting 4s&ands Tan6 :,ca%ation 9i ing The rinci a& res onsibi&ity o$ a 6ios6 attendant *ou&d be to recei%e ayments $rom customers $or gaso&ine urchases, *hich is a batch'&e%e& acti%ity# The %o&ume o$ gaso&ine so&d can be used as a ro,y acti%ity dri%er $or these ayment transactions i$ the a%erage %o&ume o$ gaso&ine so&d to each customer is about the same, regard&ess o$ the gaso&ine grade, *hich a eared to be true in this case# The %o&ume o$ gaso&ine so&d is a better transaction ro,y cost dri%er than the do&&ar sa&es because recei%ing ayment $rom customers is not dri%en by the do&&ar amount o$ the urchases# 4n the case o$ creditHdebit card ayments made direct&y at the um , an attendant is necessary to monitor these transactions, es ecia&&y i$ the um ma&$unctions, such as not rinting a recei t# 4n any case, it can reasonab&y be assumed that sa&es transactions o$ each grade o$ gaso&ine that in%o&%e an attendant direct&y in rocessing customer ayments are ro ortionate to the tota& ga&&ons so&d o$ each grade o$ gaso&ine# The number o$ gaso&ine sa&es transactions *i&& be a ma-or $actor in determining the number o$ 6ios6 attendants and the hours a gaso&ine station Ty.e of Asset .ommon Fi,ed Asset .ommon Fi,ed Asset .ommon Fi,ed Asset <aso&ine <rade'S eci$ic Fi,ed Asset .ommon and <aso&ine <rade'S eci$ic Fi,ed Assets .ommon Fi,ed Asset .ommon and <aso&ine <rade'S eci$ic Fi,ed Assets .ommon and <aso&ine <rade'S eci$ic Fi,ed Assets .ommon Fi,ed Asset .ommon Fi,ed Asset .ommon Fi,ed Asset .ommon Fi,ed Asset <aso&ine <rade'S eci$ic Fi,ed Asset .ommon and <aso&ine <rade'S eci$ic Fi,ed Assets is o en, *hich direct&y a$$ect the &e%e& o$ sa&ary and bene$its ayments# ios! "acility Activity Cost Pool # The %o&ume o$ gaso&ine so&d can be -usti$ied as an acti%ity dri%er $or the 6ios6 acti%ity cost oo& in the $o&&o*ing *ays; The entire ur ose o$ the 6ios6 $aci&ity is to house the attendants *ho recei%e ayments $rom customers $or gaso&ine urchases# 4t is &ogica& to use the same acti%ity dri%er to assign both the &abor and 6ios6 $aci&ity acti%ity cost oo&s# The e, ected %o&ume o$ gaso&ine sa&es *i&& he& determine the si(e o$ the 6ios6 necessary to house the number o$ attendants, *hich direct&y im acts the im uted renta& ayments# The %o&ume o$ gaso&ine sa&es *i&& determine the hours a gaso&ine station is o en, *hich direct&y a$$ects the &e%e& o$ re airs and maintenance, uti&ities costs, and so on# #asoline-$is%ensing Activity Cost Pool# The $aci&ities used $or dis ensing the three grades o$ gaso&ine are either common $i,ed assets (&i6e the gaso&ine sign" or $i,ed assets that are identica& in si(e and cost $or each grade o$ gaso&ine irres ecti%e o$ the %o&ume o$ gaso&ine so&d ($or e,am &e, the gaso&ine tan6s"# ?ote that the gaso&ine tan6s are identica& in

si(e and cost e%en though the demand is considerab&y higher $or regu&ar gaso&ine %ersus the other t*o grades# Tab&e ! identi$ies the ma-or gaso&ine' dis ensing $i,ed assets and *hether they are common andHor gaso&ine grade's eci$ic $i,ed assets# This commona&ity o$ some gaso&ine'dis ensing $i,ed assets *ith the cost e2ua&ity o$ other, grade' s eci$ic gaso&ine'dis ensing $i,ed assets means, $or e,am &e, that i$ t*o grades o$ gaso&ine *ere so&d instead o$ three, the reasonab&e renta& and other &ong' run %ariab&e costs o$ the gaso&ine'dis ensing $aci&ity *ou&d &i6e&y be one third &ess than is the case *hen three grades are so&d# For e,am &e, one &ess tan6 e,ca%ation and gaso&ine tan6 *ou&d be re2uired# A&so, one'third $e*er um and tan6 e2ui ment items *ou&d be needed, assuming each um ser%es one grade o$ gaso&ine on&y# 4n terms o$ common assets, this *ou&d &i6e&y resu&t in one'third $e*er is&ands, a sma&&er cano y, and so on# 4n the case o$ mu&ti ur ose um s that ro%ide each grade o$ gaso&ine, the com &e,ity and cost shou&d be &o*er $or um s that ser%e t*o %ersus three grades o$ gaso&ine# There$ore, an e2ua& assignment o$ the gaso&ine dis ensing acti%ity costs among the three grades o$ gaso&ine is a reasonab&e acti%ity cost'dri%er measure# ABC A7A43'I' R0')4T' The resu&ts $rom this straight$or*ard AB. ana&ysis can be considered $rom both the &ega& and cost management oints o$ %ie*# Legal &utcome# According to the AB. ana&ysis, the cost er ga&&on so&d actua&&y $e&& in bet*een the amounts deri%ed $rom the &ainti$$8s unit'&e%e& a roach and the de$endant8s e2ua& s &it o$ &abor and o%erhead costs# 4n essence, the AB. a roach s &it the di$$erence bet*een the costs er ga&&on so&d obtained $rom the t*o e,treme a roaches# A$ter this ana&ysis *as resented, the case *as sett&ed and the in-unction &i$ted# Cost Management &utcome# From a cost management ers ecti%e, the AB. mode& obtained a resu&t that he& ed to correct the rob&em o$ roduct' cost subsidi(ation o$ &o*'%o&ume roducts by high' %o&ume roducts, *hich o$ten occurs *hen a ure unit'&e%e& cost assignment base is used# 4n this case, the &o*'%o&ume roducts ( &us and remium gaso&ine" *ere undercosted by the %o&ume'based a roach, *hereas the high'%o&ume roduct (regu&ar gaso&ine" *as o%ercosted# Thus the regu&ar gaso&ine a eared to be more cost&y and riced under cost because o$ the use o$ the ina ro riate unit based cost assignment method# 8)RT:0R R08I70%07T .&ear&y, an AB. a roach im ro%es costing in a gaso&ine dis ensing retai& $aci&ity, but this mode&

cou&d be $urther re$ined# The use o$ ractica& ca acity rather than e, ected or budgeted ca acity may a%oid charging the grades o$ gaso&ine $or the costs o$ unused ca acity#E A &i6e&y re$inement *ou&d be the identi$ication and measurement o$ nonunit'based acti%ity dri%ers $or the &abor and 6ios6 $aci&ity costs# 4t is im ortant to rea&i(e that more dri%er re$inement a*ay $rom unit'based acti%ity dri%ers *ou&d on&y continue to strengthen the de$endant8s case by $urther &o*ering the cost o$ regu&ar gaso&ine er ga&&on# A&so, greater costing re$inement usua&&y entai&s greater in$ormation rocessing costs# 4t is im ortant to ensure that the costs o$ AB. mode&s are -usti$ied by the bene$its obtained#
/

See CJohn 7eere .om onent 0or6s (A",D 'arvard Business (chool Case (eries )-*+,-*-, (Ae%# ?o%ember /E>7"# 2 For a numerica& e,am &e o$ o%ercosting and undercosting roducts, see John B# MacArthur, CActi%ity'Based .osting and Acti%ity'Based Management; An 4ntroduction,D in #uide to Cost Management, Barry J# Brin6er, editor, John 0i&ey L Sons, ?e* For6, ?#F#, 2000, # !E7'3/0# ! For discussion on AB. and ca acity management, see Aobin .oo er and Aobert S# Ia &an, CActi%ity' Based Systems; Measuring the .osts o$ Aesource +sage,D Accounting 'ori.ons, Se tember /EE2, # /'/!# 3 For e,am &e, in F&orida, the CMotor Fue& Mar6eting 9ractices ActD (525#!02" states that; C9redatory ractices and, under certain conditions, discriminatory ractices, are un$air trade ractices and restraints *hich ad%erse&y a$$ect motor $ue& com etition#D This &egis&ation, in section 525#!03, sti u&ates that; C(/"(a" 4t is un&a*$u& $or any re$iner engaged in commerce in this state to se&& any grade or 2ua&ity o$ motor $ue& at a retai& out&et be&o* re$iner cost, *here the e$$ect is to in-ure com etitionD and C(b" 4t is un&a*$u& $or any nonre$iner engaged in commerce in this state to se&& any grade or 2ua&ity o$ motor $ue& at a retai& out&et be&o* nonre$iner cost, *here the e$$ect is to in-ure com etition#D 5 4n F&orida, the CMotor Fue& Mar6eting 9ractices ActD (525#!0!" states; C(E" MAeasonab&e renta& %a&ue8 means the bona $ide amount o$ rent *hich *ou&d reasonab&y be aid in an arm8s &ength transaction $or the use o$ the s eci$ic indi%idua& retai& out&et, inc&uding &and and im ro%ements, uti&i(ed $or the sa&e o$ motor $ue&# The %a&ue o$ the &and and im ro%ements sha&& inc&ude the costs o$ e2ui mentG signageG uti&ities, ro erty ta,es, and insurance, i$ aid by the o*nerG and en%ironmenta& com &iance, such as testing, detection, and containment systemsG but does not inc&ude the costs o$ en%ironmenta& c&eanu and remediation# 4n

determining the reasonab&e renta& %a&ue o$ the s eci$ic retai& out&et, the renta& amount o$ com arab&e retai& out&ets in the re&e%ant geogra hic mar6et sha&& be considered# 0hen motor $ue& is so&d at the retai& &e%e& a&ong *ith other roducts, the reasonab&e renta& %a&ue attributab&e to the sa&e o$ motor $ue& at the retai& out&et sha&& be a&&ocated by the ercentage o$ gross sa&es attributab&e to motor $ue& sa&es#D 5 /bid#

.om arab&e &ease in$ormation *as obtained $rom an outside a raisa& ser%ice# This a&&o*ed the con%ersion o$ asset %a&ue into a reasonab&e renta& %a&ue# > The current actua& cost o$ insurance *as obtained $rom the de$endant com any, and the a%erage cost o$ re airs and maintenance, uti&ities, and rea&H ro erty ta,es *as ca&cu&ated $rom month&y com any data# E See .oo er and Ia &an, Se tember /EE2#

5-#: Activity-Based Benchmar$ing and Process %anagement&%anaging the Case of Cardiac 'urgery
These techni2ues $ocus on in'de th identi$ication o$ best rocesses and ractices through a study o$ resource consum tion# From them, hos ita&s can get a more accurate icture o$ ho* ractices are &in6ed to cost# BY BEA CHIANG, PH.D., CPA The increasing&y com etiti%e nature o$ the hea&thcare mar6et and the managed care system ha%e ut tremendous ressure on hos ita&s to contro& costs, manage ser%ice rocesses, im ro%e 2ua&ity o$ care, and mar6et ser%ices com etiti%e&y# @ea&thcare ro%iders are no* e, ected to manage economic resources rudent&y and need to be on to o$ their costs to ensure that re%enues are su$$icient $or them to sur%i%e# Benchmar6ing is a strategic a roach used *ide&y in the manu$acturing sector to monitor costs# 4t is a continuous rocess o$ measuring roducts, ser%ices, and acti%ities against the best &e%e&s o$ er$ormance# / This a roach can a&so bene$it hea&thcare organi(ations *here the c&ose monitoring o$ resources is critica& to ensure the organi(ation8s e$$ecti%eness# C6'TI75 PR6C0''0' A7! ACTI2IT3-BA'0! B07C:%AR;I75 @ea&thcare organi(ations are increasing&y sharing cost data on a er atient and er case basis $or benchmar6ing the er$ormance o$ indi%idua& units# There are se%era& e,terna& industry benchmar6s that a hos ita& can use to com are its o eration to other hea&thcare ro%iders# :,am &es inc&ude tota& margin, occu ancy, cost er certain medica& rocedure, tota& cost er case, and cost er in atient day# Some o$ these e,terna& benchmar6s, ho*e%er, con$ound direct cost com arisons, as costs may be aggregated in di$$erent *ays by di$$erent hos ita&s# For instance, the se&ection o$ direct cost centers and the methods chosen to s read the indirect costs to other de artments are hos ita& en%ironment s eci$ic and a$$ect the cost accumu&ation rocess $or ser%ices de&i%ered# <enera&&y, the hos ita&8s costing system begins *ith the di%ision o$ each genera& &edger account into cost ty es; %ariab&e direct cost, $i,ed direct cost, and $i,ed indirect cost# At the cost center or de artment &e%e&, each indirect cost center is assigned an a&&ocation base (such as tota& cost, s2uare $eet, or gross re%enue" to be used to s read the indirect costs to the direct cost centers# The de artmenta& direct costs and a&&ocated indirect costs become de artmenta& tota& costs# The direct cost center or de artment is de$ined as a rimary roductHser%ice unit# An e,am &e o$ a rimary roductH ser%ice is a rescri tion, an in-ection, or a bed bath# The ne,t ste is to ca&cu&ate the standard unit cost o$ the rimary roductHser%ice# This is done by $irst a&&ocating the de artmenta& tota& cost based on the re&ati%e %a&ue units (A=+s" mu&ti &ied by the budgeted %o&umes o$ each indi%idua& roductHser%ice to obtain the budgeted tota& cost o$ each basic roductHser%ice#2 Fina&&y, the standard unit cost is ca&cu&ated by di%iding the tota& cost o$ the indi%idua& roductHser%ice by its budgeted %o&ume# Bnce standard unit costs are estab&ished $or rimary roductsHser%ices, they can be summed u into intermediate roducts, such as a surgica& rocedure# These, in turn, can be ro&&ed u into $ina& roductHser%ice, such as in atient days or admissions# The hos ita& costing rocess is resented in Figure /# From the hos ita&8s costing rocedure, the unit cost o$ a roduct actua&&y inc&udes a&&ocated indirect costs that are beyond the contro& o$ hysicians and other medica& ersonne&# 4ndirect cost is the cost that does not re&ate direct&y to the ro%ision o$ medica& ser%ices to atients# :,am &es inc&ude the sa&ary o$ the administrati%e sta$$, the cost o$ the &aundry de artment, ca$eteria, and so $orth# For ricing ur oses, the accounting system needs to a&&ocate these indirect costs to direct cost centers to account $or each unit o$ roductHser%ice# The hysicians or medica& ersonne&, ho*e%er, do not ha%e contro& o%er the method or the amount o$ the indirect cost to be a&&ocated to the de artment# Tota& unit cost, *hich inc&udes both direct and indirect costs, does not re$&ect the e$$iciency o$ acti%ities er$ormed in the medica& rocesses# There$ore, instead o$ tota& cost, acti%ity're&ated measurements such as e2ui ment setu time or surgery time tie in more to the resources consum tion in the rocess and are more a ro riate $or benchmar6ing# I%PR62I75 CAR!IAC CAR0 PR6C0''0' B3 ACTI2IT3-BA'0! B07C:%AR;I75 4n an economic sense, macro'&e%e& costs (&i6e cost er certain diagnosis" are dri%en by numerous and com &e, micro'&e%e& decisions, such as rocedures ta6en or e2ui ment used by hysicians and s ecia&ties# Macro cost contro& can be achie%ed on&y through re$erence to micro'

&e%e& ana&ysis#! There$ore, the benchmar6ing rocess shou&d a&so use interna& rocedures data# This ty e o$ data is more acti%ity s eci$ic and tas6 re&ated# 4t $aci&itates direct benchmar6 com arisons among hysicians or sta$$ so that these grou s can see c&ear&y ho* their ractices need to be im ro%ed# The interna& rocedure &e%e& o$ er$ormance may be identi$ied in an organi(ation through interna& benchmar6ing# The interna& benchmar6s he& the hos ita& as6 *hy its costs di$$er $rom other hos ita&s, *hy costs di$$er among atients *ith the same diagnosis *ithin the same hos ita&, and identi$y *hich ractices can be trans$erred $rom &ess cost'e$$ecti%e to more cost' e$$ecti%e methods# Studies ha%e $ound that hysicians do res ond to benchmar6ing#3 They a&so are more &i6e&y to be ersuaded to change their ractices i$ they see ho* they can use such data to im ro%e their rocesses# 5 Acti%ity'based benchmar6ing $or medica&'care rocesses in%o&%es three ste s; (/" ana&y(ing rocess $&o* and identi$ying ma-or acti%ities, (2" choosing the a ro riate measurement o$ resource consum tion $or benchmar6ing, and (!" identi$ying the best rocess and ractice as benchmar6s# A7A439I75 PR6C0'' 846< A7! I!07TI83I75 %A=6R ACTI2ITI0' The $irst ste in the benchmar6ing rocess is to er$orm an ana&ysis o$ the acti%ity across a&& o erations and rocesses re2uired to mo%e the atient $rom admission to discharge# The case o$ a cardiac atient can be used to i&&ustrate the benchmar6ing rocess# The atient is admitted on the schedu&ed date $or an o en' heart surgery# A$ter going through the administration rocess, the atient *i&& undergo many tests# 4mmediate&y be$ore surgery, the atient *i&& be gi%en s eci$ic reo erati%e medications and *i&& then be C re edD $or surgery# An intra%enous (4=" &ine *i&& be administered# The atient *i&& then be gi%en a s&ee ' inducing medication through the 4= and anesthetic gas to breathe (genera& anesthesia"# A$ter the atient is as&ee , the cardiac surgery rocedure begins# There are a %ariety o$ di$$erent ty es o$ o en'heart surgeries, de ending u on the condition being treated and the o%era&& hea&th o$ the atient# The surgery itse&$ ta6es an a%erage o$ $i%e hours# A$ter surgery, the atient is mo%ed to a hos ita& bed in the cardiac surgica& intensi%e care unit# The atient is care$u&&y monitored in the cardiac intensi%e care unit $or /2'23 hours and then on the genera& $&oor (ste 'do*n units"# Throughout the rocess, $rom admission to discharge, ma-or acti%ities inc&ude genera& administration and atient education, &ab rocedureHtest, medica& e2ui ment and su &ies administration, setu , o eration, nursing, and genera& ser%ices# The summary resented in Figure 2 detai&s the rocess $&o* and

acti%ities engaged in ro%iding the ser%ices# .osts incurred at each stage de end u on ty es o$ ersonne&, e2ui ment, and su &ies in%o&%ed in the rocess# They are &isted as cost in uts# C:66'I75 T:0 APPR6PRIAT0 %0A')R0%07T 86R B07C:%AR;I75 For di$$erent costs, there are di$$erent acti%ity characteristics that dri%e the costs# For e,am &e, nursing costs are di$$erent *hen com aring the o erating room to the cardiac intensi%e care unit because di$$erent ty es and numbers o$ nurses engage in di$$erent acti%ities# To better ca ture cost incurrence in the case o$ a cardiac surgery atient, an acti%ity' re&ated measurement must be se&ected to measure the resource consum tion# Pre-'urgery At the admission stage, the number o$ atients er registration sta$$ or number o$ documents generated er sta$$ hour can be used to measure the e$$iciency o$ the registration rocess# 7uring the re aration $or surgery (ambu&atory care unit", medica& sta$$ e, &ain the o eration rocess to the atient, er$orm additiona& tests, and re are the atient $or surgery# At this stage, the re aration time, atient education time, number o$ tests er$ormed by ty e, and the amount o$ medica& su &ies used can be dra*n on to measure the er$ormance# 6.erating Room The number o$ s ecia&ists and medica& sta$$ assigned to the o erating room are de$ined by the hos ita&8s surgery o&icy and remain consistent $rom atient to atient# Aesource consum tion among hysicians and other medica& ersonne& %aries, ho*e%er, in three signi$icant *ays; surgery time, o erating room setu time, and medica& su &ies usage# Surgery time is a critica& indicator o$ cost# 4t re&ates to costs associated *ith the time $or the o eration, anesthesia, er$usion ser%ice, and nursing sta$$# Setu time is the time re2uired to re are e2ui ment, too&s, and medica& su &ies $or the surgery# 4t is considered a ma-or indicator o$ e$$iciency# 5 Aeducing setu time shortens the &ead'time o$ ser%ice de&i%ery and he& s to 6ee it at a reasonab&e &e%e&# Medica& su &ies and e2ui ment re resent a signi$icant art o$ hos ita& e, enditures and are one o$ the ma-or $actors that dri%e hea&thcare costs#7 Finding the best ractices in using the $aci&ities and su &ies *i&& he& hea&thcare ro%iders manage their costs# Benchmar6s can be estab&ished to measure the er$ormance o$ an o erating room in terms o$ o eration time, setu time, and medica& su &ies usage# Post-'urgery

A$ter the surgery, most o$ the resources and time are s ent on monitoring surgery resu&ts, ro%iding

atient education, er$orming additiona& tests, ta6ing %ita& signs,

assessing ost'surgery outcome, and ro%iding genera& and dietary ser%ices# Ma-or cost in uts in this stage inc&ude nursing sta$$, cardio&ogist, &ab technician, genera& ser%ice sta$$, and medica& su &ies# Benchmar6s such as resu&ts'assessment time, nursing care time by nurse ty e, medica& su &y usage, and atient education hours can be estab&ished to measure the er$ormance# 7)R'I75-CAR0 '0R2IC0' ?ursing ser%ices count as a signi$icant art o$ acti%ities in e%ery stage o$ the rocess# The essence o$ the rob&em *ith nursing ser%ices is that the costs usua&&y are a%eraged into room and board in most hos ita&s# As a resu&t, a&& atients in a gi%en unit o$ the hos ita& *i&& recei%e the same dai&y charge $or nursing'care ser%ices# 4t is resumed that a&& atients

consume e,act&y the same amount o$ nursing resources# The $act that di$$erent atients ha%e di$$erent nursing needs does not enter into consideration# For the ur ose o$ im ro%ing the rocess through benchmar6ing, this a roach ro%ides %ery oor in$ormation# The most accurate method *ou&d be to measure the time each nurse s ent *ith each atient# This, ho*e%er, is an im ractica&, cost&y, and time'consuming *ay to account $or the cost# Bne a&ternati%e, suggested by B# 7ieter and J# Moorhead, is assigning each nursing rocedure a redetermined re&ati%e %a&ue unit (A=+" based on the time ta6en to er$orm that tas6# > 4nitia&&y, the re&ati%e %a&ue might be determined according to rior e, erience or by o&&ing $u&&'time sta$$ nurses on the amount o$ time it ta6es them to

com &ete each rocedure# Thus, instead o$ counting nursing time s ent

on each acti%ity *ith each atient, nursing care *i&& be benchmar6ed based on A=+ $or rocedures or tas6s er$ormed# Figure ! summari(es a set o$ benchmar6s estab&ished to measure the er$ormance o$ ma-or acti%ities in the care rocess# Benchmar6s can be estab&ished at a detai&ed acti%ity &e%e& as *e&& as at the case &e%e&# I!07TI83I75 B0'T PR6C0'' A7! B0'T PRACTIC0 A' B07C:%AR;' Tab&e / sho*s an interna& benchmar6ing re ort o$ a hos ita&# The hos ita& combined c&inica& records, nursing &ogs, and surgery &ogs *ith the $inancia& accounting records to benchmar6 er$ormance# The data *ere sorted by 7iagnosis Ae&ated <rou (7A<", rimary rocedure code, and se%erity &e%e&#E Benchmar6s are the cases that ha%e the &o*est' 2uantity usage in terms o$ surgery time, setu time, nursing'care time, &ab testsH rocedures time, and consum tion o$ medica& e2ui ment and su &ies# The benchmar6s *ere determined by data co&&ected $rom 25E atients admitted to the hos ita& $or heart surgery in /EE> and /EEE# The benchmar6ing re ort com ares indi%idua& in$ormation to the o%era&& a%erage o$ the 25E cases and to the best ractice# The $irst art o$ the re ort resents the com arati%e benchmar6ing data o$ t*o cardiac surgeries in the o erating room (cardiac rimary rocedure code !5#/2", er$ormed by hysician N/////, one at se%erity &e%e& 2 and the other at &e%e& ! (?ote; The re ort is sho*n as a subset o$ the resu&ts, so it does not inc&ude a&& benchmar6ing items"# The re ort sho*s that the surgery time ta6en by hysician N///// $or a rinci a& rocedure code !5#// at se%erity &e%e& 2 *as !00 minutes, com ared to an a%erage time o$ 2>/ minutes and 225 minutes $or the best ractice# The same com arisons are made $or anesthesia and er$usion ser%ice# The benchmar6ing a&so sho*s medica& e2ui ment and su &y usage# 4t re%ea&s that some e2ui ment items *ere re2uired $or the surgery, such as a b&ood *armer set (indi%idua&, a%erage, and best ractice a&& sho* one unit"# Some items, such as c&i a &ier, ho*e%er, cou&d be used in a more cost e$$ecti%e *ay; ?ine units o$ c&i a &iers *ere actua&&y used, com ared to an a%erage o$ !#52 units in a&& cases and t*o units $or the best ractice# Some items, such as transducers, *ere used on a%erage in /03 cases out o$ 250 (an a%erage o$ 0#3 usage" but *ere not used at a&& by the best ractice# This raises the 2uestion o$ *hether or not this rocedure can be er$ormed *ithout the use o$ transducers# The re ort ro%ides a genera& interna& ro$i&e o$ ractices in the o erating room# 9hysicians cou&d re%ie* such a re ort to determine e,act&y ho* their

consum tion o$ su &ies com ares to the a%erage consum tion &e%e& in a&& cases and to the consum tion &e%e& o$ the best er$ormer# The re ort a&so is use$u& to hysicians and other c&inica& ersonne& because it high&ights the usage di$$erences in a rinci a& cardiac rocedure and sho*s *hat su &ies *ere not used in the best ractices# The second art o$ the benchmar6ing re ort sho*s re' and ost'surgery data# 4n the interest o$ ro%iding a sim &e i&&ustration, the re ort on&y sho*s a subset o$ benchmar6ing data# For nursing care, di$$erent ty es o$ nurses and nursing assistants, such as registered nurses, &icensed nurses, un&icensed assistants, and a rentice nurses, are em &oyed to ro%ide ser%ices# :ach o$ them has a di$$erent hour rate and s6i&& set# Some tas6s re2uire a s eci$ic ty e o$ nurse $or a s eci$ic tas6G $or e,am &e, the o erating room re2uires cardiac registered nurses $or assistance# 4n the ste 'do*n unit, on&y registered nurses can er$orm certain tas6s, such as an 4= or any in-ection# Bthers, such as a bed bath, ho*e%er, can be er$ormed by &icensed nurses# The benchmar6 re ort sho*s the time (measured by A=+" s ent on each ty e o$ nursing acti%ity# 7etai&ed nursing acti%ities can be re orted by nurse ty e# For e,am &e, %ita& signs too6 30 A=+s o$ a registered nurse8s time, 25 A=+s o$ a &icensed nurse8s time, and /> A=+s o$ an un&icensed assistant8s time# 4n the best ractice, !2 A=+s o$ a registered nurse8s time, !2 A=+s o$ a &icensed nurse8s time, and /7 A=+s o$ an un&icensed assistant8s time *ere de%oted to ta6ing %ita& signs# 4n this instance, the best ractice uti&i(es more &icensed nurses instead o$ registered nurses to ta6e %ita& signs# @a%ing &icensed nurses ta6e %ita& signs instead o$ registered nurses, there$ore, can &o*er costs# The use o$ un&icensed assistants is about the same because o$ restrictions on the use o$ un&icensed assistants $or 2ua&ity considerations# These benchmar6ing data he& the hos ita& monitor nursing ser%ices to ensure the 2ua&ity o$ nursing care# 4n addition, the nursing de artment manager is ab&e to assign the &o*est'cost combination o$ nursing sta$$ to ro%ide the re2uired ser%ices at the desired &e%e& o$ 2ua&ity care# The &ab tests are a&so measured and benchmar6ed by A=+# The er$ormance o$ the cardiac catheteri(ation &ab and res iratory thera y are benchmar6ed by setu time, rocedure time, and medica& su &ies usage# Section three o$ the re ort resents the benchmar6ing data at case &e%e&# This in$ormation $aci&itates com arisons o$ cardiac surgery cases at a broader &e%e&# 4$ the case and benchmar6s sho* signi$icant di$$erences ($or e,am &e, tota& A=+s o$ &ab tests are /,3/> com ared to >EE o$ the best ractice", the case can be traced do*n to the acti%ity &e%e& in order to e, &ore the $actors res onsib&e $or the high cost#

86C)'I75 67 PR6C0'' I%PR620%07T Acti%ity'based benchmar6ing $ocuses on in'de th identi$ication o$ best rocesses and ractices# The best ractices can be $ound through the use o$ interna& benchmar6ing# Bne o$ the bene$its is that *e can obtain s eci$ic and detai&ed in$ormation *ith *hich to $aci&itate rocess im ro%ement# @os ita&s can use benchmar6ing data to identi$y critica& success $actors and a ro riate measures in the ser%ice rocess# Benchmar6ing a&so enab&es us to use both c&inica& and accounting in$ormation more e$$ecti%e&y# 0hen a &ied a&ong *ith e,terna& benchmar6ing measures, interna& rocedure benchmar6ing he& s the organi(ation to determine ma-or areas $or im ro%ement# 4n$ormation ro%ided by the interna& acti%ity benchmar6ing rocess bene$its hos ita&s by high&ighting the resource consum tion o$ articu&ar rocedures in the rocess $&o* so that hysicians and sta$$ ha%e a more accurate icture o$ ho* ractices are &in6ed to cost# More im ortant, acti%ity benchmar6ing ro%ides s eci$ic direction $or the continua& im ro%ement o$ the care rocess and ro%ides an e, &icit means o$ communication among %arious de artments#
/

5 7

>

.har&es T# @orngren, <eorge Foster, and Sri6ant M# 7atar, Cost Accounting0 A Managerial 1m%hasis, 9rentice @a&&, 2000, # 2!5#

The re&ati%e %a&ue unit (A=+" is a measure o$ resource consum tion in the hea&thcare organi(ation# 4t is de$ined as the amount o$ time to com &ete one unit or the amount o$ su &ies $or one unit# Aon :den and .o&in Lay, CBenchmar6ing on costs in hea&thcare,D Management Accounting, March /EE>, # 2>'!/# J# :%ans, 444, F# @*ang, and ?# ?agara-an, C9hysicians8 res onse to &ength'o$'stay ro$i&ing,D Medical Care, =o&# !!, ?o# //, /EE5, # //05#5 <irard Senn, C.&inica& buy'in is 6ey to benchmar6ing success,D 'ealthcare "inancial Management, =o&# 52, ?o# 5, May /EE>, # 35# @orngren, Foster, et al#, # 725# Material Management in 'ealthcare, A ri& 2000, =o&# E, ?o# 3, # 5'E# B# 7ieter, C7etermining the .ost o$ :mergency 7e artment Ser%ices,D 'os%ital Cost Accounting Advisor, =o&# 2, ?o# /, February /E>7, #/, 5'7G J# Moorhead, C.osting Accounting $or :mergency Ser%ices,D 'os%ital Cost Management and Accounting, =o&# /, ?o# 2, May /EEE, # /'7# 7A< is a system used $or c&assi$ication o$ in atient hos ita& ser%ices based on rinci a& diagnosis, secondary diagnosis, surgica& rocedures, age, se,, and resence o$ com &ications# This system o$ c&assi$ication is used as a $inancing mechanism to reimburse hos ita&s and se&ected other ro%iders $or ser%ices rendered#

5-(: )sing Activity Based Costing To Assess Channel*Customer Profita+ility

Better understanding o$ your customers8 ro$itabi&ity icture is im erati%e $or sur%i%a& in today8s com etiti%e en%ironment# @ere the .FB o$ an em &oyment ser%ices com any used AB. to ana&y(e the com any8s ro$itabi&ity icture at the customer'channe& and indi%idua& customer'&e%e&# By Dewayne L.Sea cy, P!.D., C"a, C#a With better information and accounting systems, firms are beginning to disaggregate revenues and costs to customer or account level. This analysis often reveals previously hidden subsidies across customers, products, and markets.1 Most $irms are *e&& a*are o$ the >0H20 ru&e in *hich a
sma&& $raction o$ customers accounts $or a &arge share o$ re%enues and most o$ a $irm8s ro$its# As the abo%e 2uote states, that sma&& $raction o$ ro$itab&e customers subsidi(es the $irm8s other un ro$itab&e or, at best, brea6e%en customers# 4nstead o$ acce ting the >0H20 ru&e, $irms shou&d stri%e to identi$y those subsidi(ed customers and *or6 *ith them in either a&tering the ser%icing o$ those customers (inc&uding ricing" to a more e2uitab&e arrangement or outsourcing the ser%icing o$ those customers a&together# Tem :m &oyment .om any, 4nc# (T:.", a $irm in the em &oyment ser%ices industry, used Acti%ity'Based .osting (AB." in assessing the ro$itabi&ity icture in order to better understand *hich customers *ere ro$itab&e and *hich *ere subsidi(ed# This artic&e describes the -ourney o$ T:.8s chie$ $inancia& o$$icer through the AB. im &ementation and subse2uent ana&ysis# (?ote; The name o$ the actua& com any has been changed and the $inancia& data a&tered to rotect the com any8s con$identia&ity#"

4n the $irst ste , T:. *as di%ided into acti%ities# 4t *ou&d ha%e been ossib&e to di%ide T:. into se%era& acti%ities, but it *as im ortant to de%e&o a sim &e, yet meaning$u&, system# Three acti%ities *ere de$ined as re&e%ant to the o erations o$ the $irm; /" $i&&ing *or6 orders, 2" hiring tem orary em &oyees, and !" rocessing ayro&&Hbi&&ing# The 2illing 3or! orders acti%ity begins once an order is recei%ed $rom a customer and ends *hen the customer is ro%ided *ith the name(s" o$ the tem orary em &oyee(s" assigned to *or6 $or them# The hiring tem%orary em%loyees acti%ity in%o&%es the rocess o$ hiring em &oyees $or tem orary assignments# This acti%ity begins *hen an a &ication is com &eted and ends once the em &oyee is debrie$ed on com any o&ices and entered in the system# The &ast acti%ity, %rocessing %ayroll4billing, in%o&%es the *ee6&y ayro&& and customer bi&&ing rocess# 'te. #> !etermine ho? much the organi-ation is s.ending on each of its activities> Bnce the acti%ities *ere identi$ied, the .FB assigned the direct costs associated *ith each one# Any resource that cou&d not be direct&y traced to an acti%ity *as initia&&y assigned to a genera& o%erhead account# Bnce the direct&y traceab&e resources *ere assigned to each acti%ity, the genera& o%erhead *as a&&ocated# Tab&e 2 summari(es the resu&ts o$ assigning the costs to the three acti%ities o$ T:.# The genera& o%erhead *as a&&ocated to each acti%ity on the basis o$ the direct&y traceab&e costs o$ each acti%ity to tota& direct&y traceab&e costs# 'te. (> Identify the organi-ation@s .roducts/ services/ and customers> As mentioned ear&ier, T:. o$$ers t*o ser%ices, tem orary em &oyment and ermanent &acements# 0ithin each ser%ice o$$ering, T:.8s customers are se arated bet*een t*o channe&s, industria& and c&erica&, de ending u on the -ob c&assi$ication o$ the osition they are see6ing to $i&&# 4ndustria& customers hire tem orary em &oyees to $i&& touch'&abor ositions (such as assemb&y, machine o erator"# Bn the other hand, c&erica& customers see6 to hire o$$ice ositions (such as rece tionist or secretaria&"#

ABC A7! T:0 8IR%

T:. is a mu&ti'o$$ice em &oyment ser%ices $irm o$$ering tem orary em &oyment and ermanent &acements# The tem orary em &oyment di%ision re resents o%er 70K o$ T:.8s business and is the $ocus o$ this artic&e# Be$ore co%ering ho* T:. used AB. in$ormation to assess its ro$itabi&ity icture, T:.8s AB. im &ementation *i&& be brie$&y discussed# Tab&e / summari(es the $our'ste rocess T:. com &eted in trans$orming its cost management system# 'te. 1> !evelo. the activity dictionary>

'te. ,> 'elect activity cost drivers that lin$ activity costs to the organi-ation@s .roducts/ services/ and customers> The goa& o$ identi$ying a cost dri%er $or an acti%ity is to determine the source that causes the consum tion o$ that acti%ity)*hat dri%es the acti%ity# The cost dri%er identi$ied must be 2uanti$iab&e and reasonab&y accessib&e# The three acti%ities and the re&ated cost dri%ers are discussed ne,t# 8I44I75 <6R; 6R!0R' The $irst acti%ity identi$ied *as C$i&&ing *or6 orders#D As stated ear&ier, customer ser%ice coordinators begin to $i&& *or6 orders once a customer ca&&s in a re2uest $or a tem orary em &oyee# 4$ a customer does not ca&& in an order, there is no *or6 order to $i&&# 4t ma6es sense then that the cost dri%er $or the C$i&&ing *or6 ordersD acti%ity is the number o$ tem oraries ordered

by customers# This is used as the cost dri%er instead o$ the number o$ orders generated because an indi%idua& order can be $or more than one tem orary em &oyee# The more tem oraries on an order, the more ser%icing o$ the account is re2uired# Thus, the number o$ tem oraries ordered is a better indicator o$ resources consumed by the acti%ity than the number o$ orders# :IRI75 T0%P6RAR3 0%P46300' The com any cannot hire tem oraries un&ess someone comes in see6ing em &oyment# The cost dri%er used $or Chiring tem orary em &oyeesD is the number o$ a &icants see6ing em &oyment# :ach erson see6ing em &oyment at T:. re2uires signi$icant resources and time be$ore heHshe is e&igib&e $or a -ob assignment#

PR6C0''I75 PA3R644*BI44I75 9rocessing a aychec6 $or each em &oyee and generating an in%oice $or each customer is er$ormed *ee6&y and is based on the number o$ hours *or6ed# Because each hour *or6ed re2uires this acti%ity, the number o$ hours *or6ed during the eriod in 2uestion a ears to be the best cost dri%er $or the C rocessing ayro&&H bi&&ingD acti%ity# 'te. 5> Calculate activity rates for each activity identified> T:. added another ste , *hich *as to ca&cu&ate the acti%ity rate $or each acti%ity identi$ied# The $o&&o*ing acti%ity rates *ere ca&cu&ated (see Tab&e 2"; Fi&&ing *or6 orders J3>#2!E0 @iring tem orary em &oyees J25#57/0 9rocessing ayro&&Hbi&&ing J 0#/555

The in$ormation co&&ected $rom these $i%e ste s *as used to assess T:.8s ro$itabi&ity at the customer &e%e&# .ustomer ro$itabi&ity ana&ysis *as conducted in three stages# The $irst stage assessed customer' channe& ro$itabi&ity (industria& and c&erica& channe&s"# 4n the second stage, the in$ormation obtained $rom the $irst stage *as used to assess c&asses o$ customers *ithin each channe&# Fina&&y, the third stage in%o&%ed assessing the ro$itabi&ity o$ indi%idua& customers# C:A7704 PR68ITABI4IT3 Tab&e ! dis &ays the ro$itabi&ity icture by customer channe&# 0hen the gross margins are e,amined, ma-or di$$erences bet*een the channe&s become a arent# T:.8s margin in the industria& channe& is

signi$icant&y &ess than its margin in the c&erica& channe&# The industria& customers demand &o*er rates

$or tem orary em &oyees, but the tight &abor mar6et re%ents T:. $rom &o*ering *age rates#

A&so, industria& customers ha%e signi$icant&y higher *or6ers8 com ensation rates than c&erica& customers, *hich *e *i&& discuss &ater# .ustomers in the c&erica& channe& demand 2ua&ity o%er rice, so a higher bi&&' to' ay rate is ermissib&e# 4n a&&ocating acti%ity cost bet*een channe&s $or the Chiring tem orary em &oyeesD acti%ity, the .FB disco%ered there *as

no easi&y accessib&e rocedure $or determining i$ an a &icant a &ied $or c&erica& or industria& em &oyment# That in$ormation is documented on&y i$ the a &icant is hired by T:.# For the initia& ana&ysis, the .FB decided to use the ratio o$ the number o$ tem oraries ordered by channe& to tota& tem oraries ordered across both channe&s#

Mu&ti &ying this ratio by the tota& number o$ a &icants ro%ided the number o$ a &icants $or each channe&# There is some &ogic *ith the $ormu&a# The number o$ tem oraries ordered determines the ty es o$ tem oraries neededG this, in turn, $orces the $irm to $ocus its energies on hiring those ty es o$ tem oraries# 4n other *ords, there is a c&ose re&ationshi bet*een the number o$ tem oraries ordered and the ty e o$ indi%idua&s a &ying $or em &oyment at T:.# 9rocedures *ere instituted to ca ture the re&e%ant in$ormation during the a &ication rocess to assign Chiring tem orary

em &oyeesD costs more accurate&y to the a ro riate channe& in the $uture# As sho*n in Tab&e !, the industria& channe& com rises on&y /5K o$ tota& com any ro$its, *hi&e its sa&es are o%er >5K o$ tota& com any sa&es# The channe&8s net ro$it is on&y 0#!K o$ sa&es# 4n shar contrast, the c&erica& side sho*s ro$its o$ >#2K o$ sa&es# From the initia& ana&ysis o$ Tab&e !, the .FB began to see otentia& signs o$ troub&e# T:.8s &argest customer channe& is on the %erge o$ going into the red# The c&erica& channe& does not ha%e enough sa&es to su ort the entire com any $or any &ength o$ time# .onc&usion; The industria& channe& must be an income roducer $or the o%era&& success o$ the com any# The initia& ana&ysis sho*s

o%era&& signs o$ *ea6ness, but the .FB decided to ana&y(e the industria& channe& in more detai& by a &ying AB. to the three c&asses o$ customers in the industria& channe& to identi$y rob&ems better#

I7!)'TRIA4 C4A'' PR68ITABI4IT3

By e,amining the com osition o$ the industria& channe&, the .FB disco%ered it *as ossib&e to di%ide the channe& into three c&assi$ications by *or6ers8 com ensation (0." rates# As re%ious&y stated, the industria& customers are charged a much higher *or6ers8 com ensation rate than c&erica& customers# 4n addition, there is a *ide range o$ rates charged *ithin the industria& channe&# The industria& customers are di%ided into three c&asses by *or6ers8 com ensation rates; Lo* 0. c&ass (0. rates under J5#00HJ/,000 o$ *ages aid", A%erage 0. c&ass (0. rates J5#00 to J>#EEHJ/,000 o$ *ages aid", and @igh 0. c&ass (0. rates JE#00 and o%erHJ/,000 o$ *ages aid"# Tab&e 3 dis &ays the cost a&&ocation o$ the industria& channe& by *or6ers8 com ensation rates# 4o? <C class The Lo* 0. rate c&ass is 20K o$ the tota& industria& channe&, but it is res onsib&e $or o%er 300K o$ the industria& channe& ro$its# An ob%ious conc&usion is that the com any is incurring &osses e&se*here (i#e#, the Lo* 0. rate c&ass is subsidi(ing other un ro$itab&e customers"# T:. budgeted an />K gross margin $or the industria& channe&G the Lo* 0. c&ass8s gross margin is in &ine *ith the budget# From this ana&ysis, the Lo* 0. c&ass a ears to be contributing to the o%era&& success and ro$its o$ the com any# The goa& o$ T:. shou&d be to maintain the current ricing arrangements $or these customers# The com any a&so shou&d &oo6 into targeting industries that *ou&d $a&& into this c&ass to increase the sa&es %o&ume and, in turn, the net ro$its o$ the com any# :igh <C class As e, ected, the gross margin is &o*er in the @igh 0. c&ass than in the other c&asses due to the &arge increase in the 0. rate# 0hat is sur rising, ho*e%er, is that the *ages aid to the tem orary em &oyees are o%er 7!K o$ sa&es as com ared to -ust o%er 70K $or

Lo* 0. c&ass em &oyees# 4dea&&y, higher rates shou&d be charged to customers *ith higher %ariab&e costs, but the com any is unab&e to do so because o$ the com etiti%e nature o$ the industry# The &o* gross margin is art&y attributab&e to one customer *ho accounts $or near&y 70K o$ the tota& sa&es generated in this c&ass# The customer, a trai&er manu$acturer, is a consistent user o$ &ong'term tem oraries# T:. conceded a rice brea6 to the customer due to the high'%o&ume use o$ tem oraries# The @igh 0. c&ass generates a net ro$it e%en *ith the &o* gross margin# The o%erhead a&&ocation is signi$icant&y &ess than *ith the other t*o c&asses because o$ the &ong'term nature o$ the assignments o$ the tem orary em &oyees in this c&ass# Bn&y /55 tem oraries *ere ordered during the eriod o$ ana&ysis# The &o* number o$ tem oraries ordered (the cost dri%er $or the C$i&&ing *or6 ordersD acti%ity" resu&ts in the c&ass being a&&ocated &ess cost $or the C$i&&ing *or6 ordersD acti%ity# Average <C Class The &ast c&ass in the industria& channe& to e,amine, the A%erage 0. c&ass, is su$$ering $rom a net &oss# The &argest c&ass in re&ation to tota& sa&es %o&ume, it is a&so a&&ocated o%er 77K o$ the o%erhead costs based on the acti%ity ana&ysis and is res onsib&e $or on&y 5EK o$ the industria& sa&es# 4s the A%erage 0. c&ass being ena&i(ed *ith e,cessi%e o%erhead a&&ocation1 ?o# The customers in the A%erage 0. c&ass consume considerab&e time and e$$ort to ser%ice# The ty ica& -ob assignments *ithin this c&ass %ary $rom one day to se%era& *ee6s# .ustomers order $rom one to more than 20 tem oraries $or these assignments, and customer ser%ice coordinators are continua&&y searching $or tem oraries to $i&& these -obs# The $irm8s c&assi$ied ad%ertisements hea%i&y recruit $or em &oyees in this c&ass, and the hea%y recruitment means more indi%idua&s a &y $or em &oyment# The A%erage 0. c&ass shou&d be a&&ocated a &arge ortion o$ o%erhead# The acti%ity ana&ysis accom &ishes that tas6# :,amining the net ro$its sho*n in Tab&e 3 demonstrates the c&assic *ha&e'cur%e e$$ect# The Lo* 0. c&ass generates o%er 300K o$ tota& ro$its *hi&e the A%erage 0. c&ass &oses o%er 300K o$ tota& ro$its# This &ea%es the ro$its generated by the @igh 0. c&ass com rising near&y /00K o$ the industria& channe& ro$its# :%en at this second stage o$ ana&ysis, areas that need $urther in%estigation are re%ea&ed#

C)'T6%0R PR68ITABI4IT3
Tab&e 5 summari(es the acti%ity ana&ysis o$ the $our &argest customers o$ T:. according to sa&es %o&ume# The $our customers account $or a&most 32K o$ the tota& sa&es %o&ume o$ the com any and o%er 3>K o$ the industria& channe& sa&es# +sing acti%ity'based costing, an ana&ysis o$ these $our customers *as underta6en to unco%er rob&em areas *ith them# Chemical Com.any

T:. su &ies /00K o$ the chemica& com any8s roduction and su er%isory ersonne&# 4nitia& resu&ts indicate a net ro$it o$ E#>K, much higher than e%en the c&erica& channe& net' ro$it ercentage# Bne reason $or this is the &o* o%erhead a&&ocation to this customer# For e,am &e, under the C$i&&ing *or6 ordersD acti%ity, on&y >5 tem oraries *ere ordered, a re&ati%e&y &o* number# Bne o$ the reasons $or this is the &ong'term nature o$ the assignments# Another reason is the hiring ractices o$ the com any# The chemica& com any has one erson on'site to recruit em &oyees# Bnce the chemica& com any hires a

recruit, T:. is noti$ied about the ne* em &oyee, and the a &ication is sent to him or her# For these t*o reasons, the o%erhead consumed by the chemica& com any is minima& as com ared to other customers# As &ong as the com any continues the use o$ an on' site coordinator to recruit, it shou&d continue to generate ro$its $or T:.# Trailer %anufacturer Simi&ar to the chemica& com any, the trai&er manu$acturer re2uests &ong'term em &oyees# Brders $or the trai&er manu$acturer are $or norma& turno%er and ea6 eriods o$ roduction# For the eriod under e,amination, on&y 55 tem oraries *ere ordered, norma& $or the time o$ year# The gross margin $or the customer is uncom$ortab&y &o* due to the bi&&ing arrangement *ith the customer and the high 0. rates incurred# Because the customer does not consume a &arge ortion o$ the acti%ities identi$ied, ho*e%er, it is not burdened *ith a high o%erhead a&&ocation and is generating -ust o%er !K net ro$it# As &ong as the trai&er manu$acturer maintains the &o* consum tion o$ acti%ities, T:. shou&d be ab&e to maintain the current ro$it &e%e&# 7e?s.a.er Pu+lisher The ne*s a er com any is a good e,am &e o$ the ty ica& customer in the A%erage 0. c&ass# 4t manages its tem orary em &oyment needs di$$erent&y $rom the other t*o customers discussed# The customer ca&&s dai&y to order the number o$ tem oraries needed that night, usua&&y ranging $rom /0 to 30 indi%idua&s# .ustomer ser%ice coordinators are constant&y searching $or tem oraries to $i&& the needs o$ this customer# The ne*s a er ub&isher consumes a signi$icant&y higher ro ortion o$ acti%ities than the other t*o customers# Bne o$ the ecu&iar situations regarding this com any is the standing re2uest by a $e* o$ the tem orary

em &oyees themse&%es to *or6 at the ne*s a er ub&isher# As a resu&t, the customer ser%ice coordinators on&y ha%e to ca&& the tem oraries and as6 *hat shi$t they *ant to *or6# :%en though the com any re2uested E2> tem oraries during the time eriod in%estigated, some o$ those re2uests *ere $i&&ed rather easi&y# @o* *as the situation hand&ed by the acti%ity'based costing mode&1 Basica&&y, the situation *as ignored# The ne*s a er com any *as a&&ocated the same rate no matter ho* easy or di$$icu&t it *as $or T:. to $i&& the orders# This *as one o$ the de$iciencies o$ the acti%ity ana&ysis er$ormed by the .FB# Tab&e 5 i&&ustrates some start&ing resu&ts $or the ne*s a er ub&isher, the $irst being the &o* gross margin# The cu& rit is the &o* ratio o$ bi&&'to' ay rates# T:. *as re2uired to &o*er its rates to retain the customer# The &o* bi&& rates a&ong *ith the high o%erhead a&&ocation resu&t in a &arge net'&oss situation# The com any is a&&ocated 27K o$ the C$i&&ing *or6 ordersD acti%ity *hi&e accounting $or -ust o%er 5K o$ the industria& channe&8s re%enue# A simi&ar attern ho&ds true $or the Chiring tem orariesD acti%ity# Some tough decisions must be addressed regarding the $uture o$ ser%icing the ne*s a er ub&isher# 8ood Processing Com.any The com any uses tem orary em &oyees $or its roduction &ine on a consistent basis throughout the year, *ith a mi, o$ &ong' and short'term assignments# As dis &ayed in Tab&e 5, the com any generated higher sa&es than the ne*s a er ub&isher, but it on&y had re2uests $or !!2 tem oraries as com ared to E2># The gross margin $or the $ood rocessor is the highest among the customers e,amined, but the high gross margin does not o$$set the acti%ities consumed by the customer# The bottom'&ine resu&t is a net &oss# As *ith the ne*s a er ub&isher, T:. must address the net'&oss situation#

8I7A4 A7A43'I'
The acti%ity ana&ysis conducted by the .FB generated some start&ing resu&ts# 4t rea$$irmed some be&ie$s and destroyed others he&d by T:.8s management# The com any he&d to the notion that the sa&es com osition o$ the com any *as 50K industria& and 30K c&erica&# Tab&e ! c&ear&y indicates the

com osition as >5K industria& and /5K c&erica&# This is one e, &anation $or the o%era&& *ea6 ro$it# As e, &ained ear&ier, the industria& customers traditiona&&y generate &o*er ro$its# 7ri%ing the ana&ysis to the industria& channe& c&ass ro%ides a richer descri tion o$ T:.8s ro$itabi&ity icture# Tab&e 3 sho*s that the &argest industria& c&ass, the A%erage 0. c&ass, is generating signi$icant &osses# 4n

other *ords, a&most 70K o$ the com any8s business is generating &osses# 0hat can be done to re%erse this situation1 An immediate res onse might be to attem t to increase the bi&& rates charged, but the industria& tem orary em &oyment industry is %ery e&astic, and any attem t at increasing rates *i&& roduce an immediate decrease in demand# Another area o$ concern is the ay rates# T:. has been $orced to increase the ay rates due to the &o* unem &oyment rate# The oo& o$ tem orary em &oyees is sma&&, so they demand a higher rate# Because the com any cannot raise bi&&ing rates or &o*er ay rates, the on&y area a%ai&ab&e $or im ro%ement is o%erhead reduction# Some re%ea&ing resu&ts are encountered in Tab&e 5# T:.8s $irst rob&em is *ith the ne*s a er ub&isher# The bi&& rates and ay rates are $i,ed, so can the o%erhead a&&ocated to this customer be &o*ered1 Bne *ay is to change the *ay the customer re2uests and uses tem oraries# As mentioned ear&ier, the customer ca&&s dai&y *ith an order $or tem oraries and is unconcerned *hether the tem oraries are ne* or re eats# A re$erred method *ou&d ha%e the customer ca&&, or be ca&&ed, once a *ee6 *ith an order $or the entire *ee6# The tem oraries cou&d be assigned on a *ee6&y basis# A&so, an ana&ysis o$ the number o$ tem oraries usua&&y ordered *ou&d be he& $u& to determine i$ a sma&& core o$ &ong'term assignments cou&d be em &oyed# This method *ou&d reduce the consum tion o$ acti%ities by the customer and turn it into a ro$itab&e %enture $or T:.# A 6ey oint; A reduction in the o%erhead a&&ocated to a customer *i&& not, in and o$ itse&$, reduce the o%erhead incurred by the com any# Acti%ity'based costing does not reduce costs)it on&y rea&&ocates them based on the consum tion o$ acti%ities identi$ied# As a resu&t, a customer *ho begins to consume $e*er acti%ities

*ithout the simu&taneous reduction in o%erhead by the com any *i&& on&y resu&t in a shi$ting o$ o%erhead a&&ocation to another customer, creating a ossib&e death s ira& e$$ect# Bnce a customer consumes $e*er acti%ities, the com any must either ermanent&y remo%e the associated o%erhead to bene$it $rom the reduction in costs consumed by the customer or uti&i(e the $reed ca acity to generate additiona& re%enue# B%era&&, the acti%ity ana&ysis described here has sho*n that acti%ity'based costing can be used as a strategic too&# 4t roduced use$u& in$ormation to ro%ide management *ith direction $or costing and mar6eting strategies# The AB. mode& used *i&& a&&o* $or better in$ormed decision ma6ing at T:.# Traditiona&&y, T:. used gross margin ana&ysis to set rices and de%e&o budgets# ?o* it can use AB. $or setting rices and de%e&o ing budgets# This case study a&so demonstrates that AB. in$ormation can be used $or more than -ust costing roducts and ser%ices; 4t can be used to de%e&o a $irm8s ro$itabi&ity icture# 7e%e&o ing strategic initiati%es designed to trans$orm T:.8s un ro$itab&e customers into ro$itab&e customers is the .FB8s ne,t cha&&enge# 4n addition, the acti%ity ana&ysis *i&& assist in bidding $or contracts in the $uture# Be$ore the AB. ana&ysis, a bid *as re ared *ithout understanding the true cost o$ ser%icing the contract# As a resu&t, the com any *as a*arded contracts in the ast that did not generate ro$its# By using AB., the com any can better understand the costs associated *ith ser%icing a contract and ro%ide a com etiti%e bid that, i$ *on, *i&& be ro$itab&y ser%iced#
1 J. N. Sheth, R. S. Sisodia, and A. Sharma, The Antecedents and Consequences of Customer-Centric Marketin , Journal of the Academy of Marketing Science, !o". #$, No. 1, #%%%, &&. ''-((.

5-, Cost 'ystem Redesign at a %edium-'i-ed Com.any

By0 $avid 1. (tout5 Ph.$.5 and #regory P. Bedenis5 CP/M Many businesses today are ursuing a gro*th strategy# Ty ica&&y, sma&&' to medium'si(ed enter rises must $und gro*th interna&&y, *hich, in turn, is a $unction o$ the com any8s abi&ity to generate ositi%e cash $&o*s# A domestic e&ectronic consumer roducts manu$acturer, re$erred to in this artic&e as OFP, *as e, eriencing cash'$&o* di$$icu&ties and un ro$itab&e gro*th, so it res onded by im &ementing a sim &e acti%ity'based costing (AB." system# This cost system redesign a&&o*ed OFP to estimate return on sa&es (ABS" and return on in%estment (AB4" resu&ts $or both roduct &ines and customers# 4n short, the AB. system ro%ided the o*ners *ith strategies $or ursuing ro$itab&e gro*th# 0e *i&& &oo6 at ho* AB. im ro%ed OFP8s ricing and roduct decisions and s urred business rocess im ro%ements, a&& o$ *hich a&&o*ed the com any to become more com etiti%e# To he& accountants and managers *ho other*ise might hesitate to engage in a cost'system redesign ro-ect, *e a&so discuss AB. im &ementation issues &i6e&y $aced by sma&&' to medium'si(ed manu$acturers# Bac$ground Founded in /EEE, OFP .or oration caught the 4nternet *a%e s2uare&y by o$$ering domestica&&y roduced, %a&ue'based consumer e&ectronics roducts direct&y to the end user through the com any8s *ebsite# The com any se arates its roducts into si, $ami&ies; 9roduct $ami&y A consists o$ urchased accessories# 9roduct $ami&y T items ha%e te,tured $inishes and can be urchased &oca&&y in sma&&'&ot 2uantities# A&& other $inish ty es must be urchased in ocean container 9roduct $ami&y = com rises items *ith a %iny& $inish# 9roduct $ami&y 0 inc&udes remium *ood $inished items# 9roduct $ami&y + is uni2ue&y designed and e,c&usi%e&y manu$actured items# 9roduct $ami&y S items re resent com &ete assemb&ies, *hich OFP urchases $rom $oreign manu$acturers#

Annua& sa&es $or a&& roducts amount to a ro,imate&y JE mi&&ion# .urrent&y, the com any shi s a&& orders $rom a sing&e +#S# manu$acturing $aci&ity# OFP se&&s roducts direct&y to domestic customers, but $oreign customers urchase items through an e,c&usi%e dea&er net*or6# The com any has three o*ners and /5 em &oyees, most o$ *hom *or6 at home in %arious arts o$ the country# Since OFP8s $ounding, the com any8s com etiti%e ad%antage has been &o* o%erhead costs and high customer ser%ice)a combination that e2uates to high %a&ue in the customer8s mind# OFP8s rimary com etitors inc&ude &o*'cost 4nternet direct distributors that urchase com &ete roducts $rom $oreign manu$acturers and high'end roduct manu$acturers that distribute merchandise %ia s ecia&ty retai& sho s# Technica& inno%ations and ne* roduct o$$erings rinci a&&y $ue& gro*th in the industry in *hich OFP com etes# 7uring each o$ its $irst $i%e years, the com any e, erienced signi$icant sa&es gro*th# The $irst three years sa* 30K sa&es %o&ume and re%enue gro*th er year $o&&o*ed by 20K gro*th in each o$ the ne,t t*o years# Sa&es %o&ume and tota& re%enues are sti&& increasing, a&though cash $&o* is becoming a rob&em $or the com any# Shrin6ing di%idend ayouts and s&o*ing ayment cyc&es to su &iers suggested that the ro%erbia& Cedge o$ the c&i$$D $or this com any *as $ast a roachingQ <ro*th in sa&es re%enues is a desired outcome $or most businesses, as it is *ith OFP, but gro*th in sa&es *ithout su$$icient cash to $ue& e, ansion may actua&&y be counter roducti%e# This cou&d occur, $or e,am &e, *hen gro*th is $ue&ed by ne* roduct o$$erings that do not reco%er their $u&& costs# 4n short, cash $&o* and *or6ing ca ita&, not sa&es re%enue or sa&es %o&ume, are the &i$eb&ood o$ a business#2 .ontinued success $or OFP *as there$ore being -eo ardi(ed by the &ac6 o$ su$$icient cash $&o*# +nderstandab&y, the o*ners *anted to 6no* the

causes o$ the deteriorating situation, so they ut together a cross $unctiona& team consisting o$ the chie$ $inancia& o$$icer, &ant manager,! and director o$ engineering to in%estigate the situation# A$ter considerab&e de&iberations, the team identi$ied the $o&&o*ing rob&em areas; 9oor in%entory management, Lac6 o$ contro& o$ o%erhead (i#e#, manu$acturing su ort" costs, and 4ne$$icient business rocesses ($or e,am &e, disorgani(ed in%entory in$ormation"#

*as ne%er an area o$ $ocus $or the com any, but no* it *as becoming a strategic issue# 4n short, su ort costs $or OFP *ere esca&ating ra id&y, o%errunning ro$its and draining cash# 4ncreased in%entory ho&dings and e,cessi%e o%erhead s ending combined to reduce the com any8s net cash $&o*# 7etermining *hich in%entory items to reduce and *hich o%erhead costs to $ocus on, ho*e%er, *as unc&ear to the o*ner'managers# The necessary cost' contro& too&s and su orting business rocesses *ere not in &ace at OFP to guide these decisions, so the cross'$unctiona& team u&timate&y decided to critica&&y e,amine the com any8s accounting system# Cost-'ystem Refinement OFP had been using a traditiona& cost system that *as $air&y rudimentary# 4n $act, the %ie* o$ the o*ners *as that the cost system *as necessary on&y $or com i&ing data $or income'ta, ur oses and eriodica&&y $or re aring $inancia& re orts (e#g#, to su ort a ban6 &oan re2uest"# As a resu&t, the com any had done no budgeting or $orecasting to trac6 and contro& costs# Thus, OFP8s e,isting cost system cou&d not ca ture the under&ying economics o$ the com any8s roduction $unction and, there$ore, cou&d not assist the com any in res onding to the deteriorating situation in *hich it $ound itse&$# The &ant manager had -ust com &eted an MBA course in management accounting and *as intrigued by the ros ect o$ introducing a rudimentary acti%ity based costing system at OFP# This *as the rimary ro osa& that the three' erson team dea&t *ith o%er an ensuing si,'month eriod# .om anies use AB. systems to im ro%e roduct andHor customer costing rinci a&&y because such systems ro%ide better (i#e#, more accurate" estimates o$ the resource demands (or resource consum tion" o$ an organi(ation8s out uts, its customers, and its distribution channe&s# The &ant manager at OFP thought that use$u& insights $or im ro%ing cash $&o* and ro$itabi&ity might be ossib&e i$ the com any had a better hand&e on the resource demands o$ its %arious roduct o$$erings and distribution choices# Such insights, the team ho ed, *ou&d enab&e the com any to res ond to the strategic cha&&enges it *as $acing# Further, the &ant manager read an artic&e in the Fa&& 2005 issue o$ Management Accounting Quarterly, C9roduct Line and .ustomer AB4; The ?e,t <eneration o$ AB.,D *hich introduced him to using AB. data to e%a&uate roduct' and customer'&e%e& AB4#5 The artic&e asserts that AB. conce ts can be

Pro+lem '.ecification&A !ee.er 4oo$ For %irtua&&y any manu$acturer, ro er in%entory management ensures the a%ai&abi&ity o$ the right items at the right time and in the right &ace# This, in turn, su orts organi(ationa& ob-ecti%es o$ customer ser%ice, roducti%ity, ro$it, and return on in%estment (AB4"# There are, ho*e%er, both out'o$' oc6et and o ortunity costs associated *ith in%entory ho&dings# For e,am &e, in%entory ties u ca ita&, uses storage s ace, re2uires hand&ing, deteriorates, becomes obso&ete, incurs ro erty ta,es, re2uires insurance, and sometimes is &ost or sto&en# For OFP, increased in%entory ho&dings to accommodate antici ated sa&es increases *ere straining cash $&o*# Further, in%entory &e%e&s increased at OFP *hen the com any *as ursuing a gro*th strategy o$ roduct'&ine di%ersity# Aea&i(ed sa&es increases, ho*e%er, *ere not su$$icient to o$$set the increased in%estment in in%entory $or the com any, *hich, conse2uent&y, *as robbing the com any o$ much'needed &i2uid assets# 4n addition, OFP *as e, eriencing increased s ending on ca acity're&ated (i#e#, short'term $i,ed" costs and manu$acturing su ort costs (e#g#, su &y' chain management"# OFP8s humb&e beginning is robab&y simi&ar to that o$ many start'u manu$acturers# Batch 2uantities $or the com any *ere initia&&y sma&&, &abor content *as high, and o%erhead *as re&ati%e&y &o*# As the com any matured and sa&es increased, &abor content decreased because o$ greater returns to sca&e, &earning'cur%e e$$ects, and in%estments in an im ro%ed in$rastructure# 0ith increases in sa&es %o&ume and a changing sa&es mi, that OFP *as e, eriencing, su ort costs *ere esca&ating# .a acity're&ated costs as *e&& *ere increasing dis ro ortionab&y to increases in sa&es# 4ndirect &abor costs, ca ita& e, enditures (e#g#, too&ing costs", and $actory o%erhead costs *ere a&& increasing $aster than sa&es re%enue# OFP had a&*ays e,ce&&ed at de&i%ering and su orting a su erior roduct# As such, cost contro&

e,tended to encom ass the a&&ocation o$ assets to acti%ities# Just as resources under AB. are assigned to acti%ities (e#g#, roduction setu s" $or costing ur oses, assets can simi&ar&y be assigned to acti%ities# Bnce the &e%e& o$ assets associated *ith a gi%en acti%ity is determined, it is ossib&e to assign assets to customers and roducts in the same $ashion that AB. assigns costs to roducts and customers# Thus, the &ant manager at OFP *ondered *hether the com any cou&d use a sim &e AB. system to guide strategic decisions such as those re&ated to roduct mi,, roduct se&&ing rice, o%erhead cost contro&, and business rocess im ro%ement# ABC 0lements

Figure / i&&ustrates the genera& e&ements o$ an AB. system; resources, acti%ities, resource dri%ers, cost ob-ects, and acti%ity cost dri%ers# Aesources are de%oted to the er$ormance o$ acti%itiesG they are the sources o$ cost# :,am &es o$ resources *ou&d be direct materia&, direct &abor, o$$ice su ort sta$$, ro$essiona& sa&aries, o$$ice s ace, and ad%ertising costs# At OFP)and common to many accounting systems *e obser%e today)most resource costs are gathered in $unctiona& or descri ti%e accounts# Thus, OFP8s genera& &edger (the source o$ resource e, enditures" *as u&timate&y redesigned to accommodate the ro osed AB. system# For e,am &e, mar6eting, accounting, customer ser%ice, engineering, assemb&y, and &ant management *ere designated as resources $or the AB. mode&#

Aesources that are not $unctiona& areas at OFP inc&ude $aci&ities and materia&s#

Acti%ities are units o$ *or6 er$ormed by the organi(ation8s resources# Ty ica& acti%ities AB. ca tures inc&ude things such as creating a customer order, rocessing returns, creating in%oices, and

hand&ing materia&s# 4n an AB. system, acti%ities ty ica&&y are organi(ed in a master &ist ca&&ed an Acti%ity 7ictionary# Tab&e / is a ortion o$ the Acti%ity 7ictionary OFP de%e&o ed# This e,am &e inc&udes the ma-or acti%ities er$ormed by the customer'ser%ice resource and the corres onding cost &e%e& hierarchy $or each identi$ied acti%ity# The cost &e%e& hierarchy is a $rame*or6 $or c&assi$ying acti%ities according to the &e%e& at *hich costs are incurred# +nit &e%e&, batch'&e%e&, roduct sustaining, and business sustaining are acti%ity &e%e&s in con%entiona& AB. im &ementations# Ae&ated acti%ities are grou ed in acti%ity cost centers, *hich at OFP inc&ude order rocessing, in%entory, *arehousing, engineering and mar6eting, assemb&y,

customer ser%ice, and accounting# These acti%ity centers ara&&e& OFP8s organi(ation chart# The acti%ity cost center8s ur ose is to organi(e acti%ities in a meaning$u& *ay and, u&timate&y, to $aci&itate business rocess im ro%ements and strategic cost management# For instance, the order' rocessing acti%ity cost center in Figure 2 grou s acti%ities s eci$ic to the customer order'entry rocess at OFP# 6esource drivers assign costs $rom descri ti%e accounts contained in an organi(ation8s e,isting cost system to acti%ities# Aesource dri%ers &in6 resources and acti%ities and are chosen to a ro,imate the resources acti%ities use# For e,am &e, in Figure 2, customer ser%ice and accounting resource costs are traced to $i%e order' rocessing acti%ities#

Most resource dri%er amounts are based on estimates o$ the e$$ort e, ended on each acti%ity# OFP used inter%ie*s and 2uestionnaires to generate these estimates# Bther resources, such as materia&s, are assigned to acti%ities using more e,act in$ormation# 9in oint accuracy is not re2uired $or AB. systems, articu&ar&y $or initia& system de%e&o ment

and $or a sma&&' to medium'si(ed com any such as OFP# The cost ob7ect is the $ina& oint to *hich costs are assigned and is the reason *or6 is er$ormed# For e,am &e, it can be a roduct, a ser%ice, a customer or customer grou , or a distribution channe&#

.ost ob-ects can a&so %ary in detai& de ending on the AB. system8s ur ose and the organi(ation8s nature#

For OFP8s initia& AB. mode&, the cost ob-ects consist o$ the a$orementioned si, roduct $ami&ies

and t*o distribution channe&s# The roduct $ami&ies and distribution channe&s are distinct because o$ di$$erences in resource re2uirements# Activity cost drivers assign the costs o$ acti%ities to cost ob-ects by measuring the &e%e& o$ acti%ity consum tion by each cost ob-ect# 4n con%entiona& AB. systems, there are three basic ty es o$ acti%ity dri%ers#> Transaction dri%ers count the $re2uency o$ an acti%ity and are the &east e, ensi%e cost dri%er# Transaction dri%ers, ho*e%er, may be the &east accurate dri%ers because they assume the same 2uantity o$ resources is re2uired e%ery time an acti%ity is er$ormed# For e,am &e, the acti%ity Cnumber o$ admissionsD is a ossib&e transaction dri%er $or a&& hos ita&'re&ated su ort costs associated *ith the admissionsHdischarge rocess# :ach admissionHdischarge is counted as a sing&e acti%ity, and this in$ormation is readi&y obtainab&e $rom admission records# Figure ! sho*s the in%entory'

management cost center $or OFP# A&& acti%ity dri%ers in Figure ! are transaction acti%ity dri%ers# $uration dri%ers re resent the amount o$ acti%ity er$ormed# 7uration dri%ers are used in an AB. system *hen signi$icant %ariation e,ists in the amount o$ acti%ity re2uired $or di$$erent out uts# For e,am &e, in a hos ita& setting a &ogica& duration dri%er $or routine care (Croom and boardD" costs *ou&d be number o$ atient daysG in a manu$acturing setting, a duration dri%er regarding setu acti%ity *ou&d be number o$ setu hours# Figure 3 contains a re resentation o$ the mar6eting and engineering cost center $or OFP in *hich a duration dri%er *as used in a uni2ue *ay# To assign engineering and mar6eting acti%ity costs at OFP, the roduct $ami&y8s osition in the roduct &i$e cyc&e *as used# The roduct &i$e cyc&e *as s &it into $our stages; introduction, gro*th, maturity, and dec&ine# :ach roduct $ami&y *as a&&otted the a ro riate numerica& %a&ue based on its stage in the roduct &i$e cyc&e#

Subse2uent&y, engineering and mar6eting costs *ere assigned to roduct $ami&ies based on their com arati%e roduct &i$e'cyc&e osition# The roduct &i$e'cyc&e duration dri%er *as used because a transaction dri%er or traditiona& duration dri%er $or mar6eting and engineering, such as number o$ engineering change notices, *as not a%ai&ab&e#

<oing $or*ard, OFP *i&& need to determine i$ the additiona& accuracy that comes $rom using a transaction dri%er such as number o$ engineering change notices is *orth the additiona& in$ormation' co&&ection costs that *ou&d be in%o&%ed#

/ntensity dri%ers charge direct&y $or the resources used each time an acti%ity is er$ormed and are genera&&y the most accurate acti%ity cost dri%ers# They a&so are the most e, ensi%e to im &ement# 4n a manu$acturing setting, an intensity dri%er $or setu acti%ity might be direct'cost tracing $or &abor# For OFP, engineering acti%ity costs (see Figure 3" cou&d be assigned more accurate&y i$ &ogs *ere used to trac6 an indi%idua&8s time *or6ed on each roduct $ami&y (A, T, 0, etc#"#

A&though sti&& in its nascent stage, the AB. system at OFP has yie&ded a number o$ $inancia& and rocess re&ated bene$its# "inancial 8Pro2it-Loss9 122ects The com any used initia& AB. data to construct a %ro 2orma ro$it and &oss (9LL" statement by roduct $ami&y and distribution channe& (see Tab&e 2"# The AB. mode& *as used to assign re%enue, manu$acturing costs, and o erating e, enses across roduct $ami&ies# 9rior to the AB. system, OFP *as unab&e to generate $inancia& in$ormation to this &e%e& o$ detai&# Based on the in$ormation in Tab&e 2, se%era& recommendations emerged $or im ro%ing cash $&o* and $or ma,imi(ing AB4 across cost ob-ects#

Benefits from the Initial ABC Im.lementation

)se of Common Com.onents: A recent&y re&eased study conc&udes that automa6ers can increase ro$itabi&ity by using common com onents across &at$orms#E The study re orts that Toyota sa%es an estimated J/,000 er %ehic&e o%er $i%e years by using common com onents# The decision team at OFP re%ie*ed roduct con$igurations and estimated that the com any cou&d reduce in%entory in%estments by a ro,imate&y J/!2,000 by em hasi(ing a common' com onent strategy in roduct $ami&y T, roduct $ami&y =, and the $oreign distribution channe&# For e,am &e, roduct $ami&ies T and = use uni2ue e&ectrica& com onents that can be re &aced by e&ectrica& com onents used by other roduct $ami&ies#

4n addition, most $oreign dea&ers re2uire their e&ectrica& com onents to acce t 220% o*er in ut# These com onents can be e&iminated by adding a %o&tage se&ection s*itch to the domestic //0% e&ectrica& com onent e2ui%a&ent# Tab&e ! sho*s the e, ected resu&ts o$ the ro osed changes# 0ith the AB. mode&, OFP is ab&e to re%ea& the ositi%e $inancia& e$$ects o$ using common com onents# Product-%iA !ecisions: 0hen roducts and customers are ser%ed $rom the same constrained asset, *hich $or OFP is do&&ars o$ *or6ing ca ita&, it is necessary to determine the a ro riate roduct mi, that *i&& ma,imi(e ro$its sub-ect to the constraint#

Based on its re%ie* o$ ro$itabi&ity $igures $or a&& roduct $ami&ies and roducts (see Tab&e 2", the decision team recommended e&iminating some roduct o tions# That is, $rom a ro$itabi&ity ers ecti%e, sometimes C&ess is more#D .on%entiona& accounting systems can obscure the cost o$ roduct'&ine com &e,ity and roduct ro&i$eration)costs that AB. systems attem t to unco%er# For roduct $ami&y 0, the *a&nut'$inished roducts *ere e&iminated because o$ *ea6 sa&es g&oba&&y# That recommendation *as easy to e, &ain because *a&nut $inished roducts made u on&y 2K o$ the *ood $inished roducts so&d *hi&e accounting $or an estimated /0K o$ the in%entory in%estment in the roduct $ami&y# The other roduct'mi, recommendation o$ e&iminating o$$'co&or $inishes $rom

roduct $ami&y = *as more di$$icu&t to -usti$y# For roduct $ami&y =, o$$'co&or roducts account $or 20K o$ sa&es# Bn the sur$ace, it8s hard to *a&6 a*ay $rom that amount o$ sa&es unti& you rea&i(e that, because o$ minimum'order 2uantity re2uirements $rom the su &ier, one'third (i#e#, J30,000" o$ the com any8s in%entory in%estment in the roduct $ami&y is tied u in o$$'co&or roducts# Tab&e 3 sho*s the estimated $inancia& e$$ect o$ e&iminating o$$'co&or in%entory at OFP#/0 The &esson here is straight$or*ard; 0ith cash' $&o* constraints, it may be necessary to e&iminate roducts that se&& and that ha%e good ro$it margins but that tie u too much cash in in%entory# This insight is a direct resu&t o$ the estimated cost data ro%ided by the ne* AB. system# The &ast recommendation $rom the team *as sur rising# 9roduct $ami&y + com rises the $irst

roducts designed and manu$actured by OFP# 9roducts in this &ine are uni2ue in the mar6et &ace but are C&ong in the tooth#D Because roduct $ami&y +8s sa&es *ere shrin6ing in com arison to tota& sa&es, it *as assumed that these roducts *ere at the end o$ their &i$e cyc&e# Bn the contrary, based on AB. data, roduct $ami&y + had the highest ABS and AB4# 4t *as, in e$$ect, OFP8s cash co*# As such, the team recommended that OFP do e%erything ossib&e to increase sa&es, inc&uding e, anding mar6ets, reintroducing roducts *ith im ro%ed aesthetics, and initiating a com &ete redesign o$ the roduct &ine# 4ncreasing sa&es in roduct $ami&y + *ou&d not decrease abso&ute in%entory &e%e&s, but it *ou&d increase o%era&& ABS and AB4# Because o$ the cash'$&o* issues, the decision team8s main $ocus *as reducing in%entory to increase cash $&o* and roduct'&e%e& AB4# Aecommendations $ocusing on using common com onents and e&iminating oor er$orming roducts account $or an estimated in%entory reduction o$ J/72,000# Bther recommendations, inc&uding renegotiating minimum' order 2uantities on urchased com onents, accounted $or an additiona& esti'mated in%entory reduction o$ J!5,000# The e, ected resu&t o$ a&& recommendations combined is an estimated in%entory reduction o$ J207,000 and a !7K increase in o%era&& AB4# Process-Related Im.rovements As i&&ustrated re%ious&y, organi(ations ty ica&&y im &ement AB.'ty e systems to rea&i(e im ro%ed $inancia& er$ormance (based on im ro%ed ricing decisions, better roduct'mi, decisions, im ro%ed cost contro&, etc#"# AB. im &ementations, ho*e%er, can ro%ide additiona& bene$its in the $orm o$ im ro%ed business rocesses# 4n the case o$ OFP, rocess im ro%ements in the accounting and in%entory contro& systems *ere attributed to the AB. im &ementation# The starting oint $or estab&ishing the $&o* o$ costs in an AB. system is the genera& &edger# As noted ear&ier, the genera& &edger at OFP *as recon$igured to accommodate the AB. im &ementation# Aedundant and re&ated accounts (e#g#, %arious $actory o%erhead accounts" *ere combined to reduce the number o$ re2uired ca&cu&ations, and singu&ar income and cost'o$' goods'so&d accounts *ere disaggregated by roduct' $ami&y &e%e&# For e,am &e, the o%era&& sa&es re%enue account associated *ith the o&d accounting system *as s &it into mu&ti &e sa&es re%enue accounts, one $or each roduct $ami&y# Simi&ar&y, se&ected e, ense accounts (e#g#, $ringe bene$its" *ere subdi%ided to obtain resource costs easi&y#/2 A&& these changes re resented

im ro%ements to the com any8s accounting system and *ere re&ated direct&y to the AB. im &ementation# Another signi$icant rocess change attributed to the AB. im &ementation *as the institution o$ s ending budgets# An AB. system is ab&e to attribute costs to s eci$ic roducts or roduct $ami&ies, but s ending budgets are better e2ui ed to manage costs# OFP had been a*are o$ the need to im &ement s ending contro&s, but it &ac6ed moti%ation# 0ith a better understanding o$ ABS and AB4 because o$ the AB. im &ementation, OFP *as no* in a osition to em &oy s ending budgets to im ro%e ro$itabi&ity# The time and e$$ort re2uired to create the AB. mode& made it e%ident that considerab&e changes to the management in$ormation system (M4S" at OFP *ou&d be re2uired to ma6e the costing rocess e$$icient and accurate# 9rob&ems *ith the e,isting M4S came rimari&y $rom in$ormation si&os that e,isted throughout the com any, ma6ing in$ormation gathering di$$icu&t# Sa&es re%enues, manu$acturing costs, and o erating e, enses *ere a&& maintained in se arate systems# ?o cost in$ormation cou&d be shared or reconci&ed e&ectronica&&y# To e&iminate the in$ormation si&os and im &ement the ne* costing system e$$ecti%e&y, the in%entory contro& and order'shi ing rocesses at OFP *ere incor orated into the e,isting accounting in$ormation system# A&& in%entory contro& $unctions are no* er$ormed in Ruic6Boo6s :nter rise So&utions# This integration rocess a&&o*s re%enue in$ormation and manu$acturing costs to be re&ated to shi ments, *hich e,tends the AB. in$ormation re&ated to roduct $ami&ies and distribution channe&s# 4n addition, a&& costing in$ormation no* resides in one database# 4essons 4earned C0or6 is in$initeG time is $inite# There$ore, you must manage your time, not your *or6#DManaging time $or an AB. im &ementation means managing the access, $&o*, and &e%e& o$ in$ormation# 4n this section, *e o$$er some recommendations based on the AB. im &ementation e, erience at OFP# 0hen ossib&e, reorgani(e the genera& &edger and income statement to accommodate AB.# The reorgani(ation o$ the $inancia& in$ormation a&&o*s easy accessibi&ity to data# 4ntegrating %ita& in$ormation systems contro&s the $&o* o$ in$ormation and automates many o$ the re2uired ca&cu&ations needed to de%e&o the AB. mode&, thereby reducing the amount o$ time re2uired to generate cost data# 4n addition, system integration im ro%es data accuracy and the

abi&ity to re &icate the in$ormation'generation rocess# Fina&&y, *hen im &ementing an AB. mode&, it is im ortant to embrace the conce t o$ Cgood enoughD *hen determining the re2uired $ineness o$ the data and $or getting the AB. ro-ect o$$ the ground# As <enera& <eorge S# 9atton said, CA good &an, %io&ent&y e,ecuted no*, is better than a er$ect &an ne,t *ee6#D Another o%erriding &esson is that an organi(ation8s structure and $inancia& status in$&uence the duration and e$$ecti%eness o$ its AB. im &ementation# Many interna& $actors, inc&uding cor orate cu&ture, a%ai&ab&e in$ormation systems, and current $inancia& er$ormance, ha%e a bearing on the abi&ity o$ the AB. mode& to in$&uence the organi(ation8s decision'ma6ing rocess# OFP8s decision'ma6ing rocess had been rimari&y sub-ecti%e in nature, *ith &itt&e $inancia& ana&ysis# Thus, considerab&e time *as re2uired to educate the decision team and board members on AB., 9LL statements, and AB4# 4ne$$icient business rocesses at OFP, in$ormation si&os, and &ac6 o$ in$ormation *ere obstac&es that had to be o%ercome as art o$ the AB. mode&'creation rocess#

Fina&&y, the most im ortant &esson *as that signi$icant change does not occur *ithout crisis# Br as Louis =# <erstner, $ormer chairman o$ 4BM, ut it; C?o organi(ation is going to change in a $undamenta& *ay un&ess it be&ie%es there8s rea& ain staying the *ay *e are#D OFP *as o en to the recommendations $rom the decision team because the com any $ound itse&$ in the midst o$ a crisis# 7e%e&o ing so&utions be$ore rob&ems reach crisis ro ortions is most rudent, a&though the message may not be $u&&y recei%ed# Benefits of Cost-'ystem Redesign AB. systems are not meant so&e&y $or &arge com anies# Sma&&' to medium'si(ed com anies, such as OFP, can bene$it $rom data ro%ided by an AB. mode&# 4n the resent case, the AB. in$ormation moti%ated business rocess changes (e#g#, in accounting", reduced roduct com &e,ity $or se%era& roduct &ines (e#g#, mo%ing to the use o$ common com onents", and in$&uenced changes in the com any8s roduct mi, (e#g#, by high&ighting under er$orming roducts"# .o&&ecti%e&y, these changes he& ed im ro%e cash $&o*, roduct and channe& ro$itabi&ity, and the organi(ation8s com etiti%e osition#