07-ABC - Productivity and Quality Forum - Paul KPMG 13022012

Activity Based Costing
for Activity Based

Management
Meiklejohn Paul, Director
Management Consulting
17 February 2012
Agenda
1.
What is Activity Based Costing (ABC)?

1.1 What is ABC and Why should it be used?
1.2 Traditional costing vs ABC
1.3 Activity based costing processes
2.
How ABC should be used to manage (Activity based management)?

2.1 When to use ABC?
2.2 How to use ABC for ABM?
2.3 Scoring High - Low value adding activities
2.4 Activity Based Management applications
3.
ABC/ABM implementation
3.1 Where ABC has been used
3.2 Steps to develop ABC Cost Flow Model
3.3 ABC Implementation Project
3.3 Challenges and success factors
Appendix: KPMG ABC and Cost Optimisation tools
2012 KPMG Limited, a Vietnamese limited liability company and a member firm of the KPMG network of independent member firms affiliated with
KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
1. What is Activity Based Costing?

1.1 What is ABC and Why should it be used?
What is ABC? (the Definition)
ABC (Activity Based Costing) is a technique for measuring the cost and performance of activities,
products and services on the basis of the resources consumed by the various activities which
produce that product or service.
Products and services in themselves do not cause costs to incurred. Rather work itself consumes resources which in turn
incur costs.
Why it should be used? (the Benefits)

Bringing cost and operational information to the level needed for management decisions
Gaining tighter control over overhead and indirect costs
Pricing products/services more accurately
Establishing foundation for activity-based management and performance measurement
Promoting a continuous improvement framework and mindset
To put ABC into context as a performance management tool


1.2 Traditional Costing vs ABC - The concept
Traditional Costing
Inputs (Resources/Costs)
Inputs (Resources/Costs)
Resource
Drivers
Volume Related
Basis
Activities
Activity Drivers
Product/Service
Assumes that costs vary with units
produced
Product/Service
Activities consume resources/costs
Products/Services consume different
levels of activities

1.2 Traditional Costing vs ABC Feature comparison
ABC focuses on activities in the production or service

delivery process.
Costs are traced to activities to products/services, based

Key
on the demand for these activities during the
features
production/delivery process.
More complex
More accurate product and service costs enable better

strategic decisions regarding:
Traditional Costing
Focus on the cost of the product only.
Costs are traced to the product on assumption

that resources are consumed in proportion to the
volume produced.
Simpler
In the past:
Small number of products/services which did
not differ much in terms of required

manufacturing support.
Product/service pricing
Product/service mix.
Labor was dominant component in the cost
Make vs buy decision
structure
Investments in R&D, process automation
Pros
Cost control
Increased visibility of the activities performed enables a

company to:
Focus more on the management of activities, such as
improving the efficiency of high cost activities.

Identify and reduce non-value added activities
Cons
ABC can be expensive to use
Some arbitrary overhead costs will continue
Arbitrary volume drivers fail to account for product

/service diversity in the form of size or complexity.
Overhead is an indirect or common cost that

generally cannot be traced.
1. What is Activity Based Costing

1.2 Traditional Costing vs ABC - Example
Illustrative example in a manufacturing company
Company A produced two products X and Y in the period ended 31 Dec 2011 with following information:
Product
Direct material ($)
Direct labour ($)
Volume (units)
Number of production runs
Number of machine hours
X
800
150
10
2
30
Y
2,000
500
100
8
100
Total overhead ($)
Machine-run costs ($)

(cost driver is number
of machine hours)
15,400
Traditional Costing
Overhead per unit = Total Overhead/Total number of units

= $15,400/110 = $140
Allocate Overhead to Activities ($):
Cost per unit of each product ($):

Product
Direct material
Direct labour
Overhead
Total cost per unit
Selling price (20% margin)
X
80
15
140
235
294
Y
20
5
140
165
206
Traditional costing under allocates overhead costs to lowvolume and less complex product (X) and over allocates
overhead costs to high-volume and more complex product (Y).
This distorts cost information and leads to wrong decision on
sales price.
ABC attempts to overcome the above problems.
3,900
Type of Overhead
Cost pool (total costs for the period)
Cost driver
(number of machine hours/production runs)
Cost per machine hour/production run
Allocate Overhead to Products:
Product
Number of machine hours per unit
Machine-run Costs per unit ($)
Number of units per production run
Set-up cost per unit ($)
Overhead per unit ($)
Cost per unit of each product ($):
Product
Direct material
Direct labour
Overhead
Total cost per unit
Selling price (20% margin)
Set-up costs ($)

(cost driver is number of
production runs)
11,500
Machine-run
costs
3,900
Set-up
costs
11,500
130
10
30
1,150
X
3
90
5
230
320
Y
1
30
13
92
122
X
80
15
320
415
519
Y
20
5
122
147
184
5
1.What is Activity Based Costing?

1.3 Activity based costing process Activity classification Activity Pool
HIERARCHY
ACTIVITY BASED POOLS
All products /services

(facility level):
Activity:
INDIRECT COSTS
Management
Security
Auditing
Cost drivers
Product/Service
group/batch:
Activity:
Marketing Data
processing
Accounting
Cost drivers
Activity:
Introduction
Development
Advertising
Types of
products/services:
Cost drivers
Credit accounts
Sales discount
Mortgage loans
Product/service unit
Activity:
Opening Closing
Withdrawals
Deposit taking
Means of payment
Loan investment
Cost drivers
XYZ Credit account

XYZ Sales discount
XYZ Mortgage loans

1.3 Activity based costing process Cost assignment to profit centers
Cost of Accounting Analysis
Financial Accounting
General
service centers
Unallocated
costs for the
term
Operational
cost centre
Unallocated
costs for the
term
Unallocated
costs for the
term
Cost of
operation A,
Cost of
operation B,
Cost of
operation C
PROFIT CENTERS
Organizational
centers
Operational
cost centers
Profit centers
Profit
Centers
Profit centers
Cost Assignment Process

2. How ABC should be used to manage (Activity Based Management)?

2.1 When to use ABC?
When to use ABC?
Product lines differ greatly in volume and manufacturing complexity

Product lines are numerous, diverse, and require differing degrees of support services
Overhead costs constitute a significant portion of total costs
The manufacturing process or the number of products has changed significantly
Production or marketing managers are ignoring data provided by traditional cost systems and are using bootleg cost
information to make pricing decisions
When Is ABC Most Beneficial?
When products/services differ significantly in their use of resources

When resources (overheads) are a significant cost (thus when labor cost is a relatively small component of overall costs)
What contributes to different usage of resources?
Product/service diversity (functions used, inspections required, batch sizes,.)
Production/service complexity
Customer diversity (order sizes, distribution requirements)

2.2 How to use ABC for ABM?
Managers can use knowledge of costs gained by ABC analysis to make pricing and productmix/service decisions, to identify and select cost reduction and process improvement projects,
including relating to product /service design.
Knowing what costs are related to which product/service allows better analysis of:
which markets to emphasize
which products to consider for CIPs (cost improvement programs)
which customers to target for changes in pricing or service delivery
ABM is an extension of ABC, from a product/service costing system to a management function, that focuses
on reducing costs and improving processes and decision making
ABM (Activity Based Management) is part of a continuous improvement framework and incorporates
strategic cost management techniques
Analysis of ABC output to provide management with meaningful cost and operational information
ABC is primarily transaction based
ABM is mainly driven by business analysis

2.2 How to use ABC for ABM Cost View vs Process View?
Resources
Process View
Activity analysis
Process mapping
Benchmarking
Cost reduction
Cost of quality and waste
Continuous improvement
Process re-engineering
Cycle time reduction
Resource Drivers
Activities
Activity Drivers
Cost Objects
Cost Assignment View
Product/service costing;
New products design;
Product/service/customer profitability analysis
10

2.3 Scoring High Low value adding activities
High vs. Low value adding activities
High value adding activities are those:
Low value adding activities are those:
Required to meet customer requirements;

That modify or enhance purchased material of a product;
That, if more of them are accomplished, the customer might pay
more for the product or service;
That are critical steps that cannot be eliminated in a business
process;
That are performed to resolve or eliminate quality problems;
That are performed due to a request or expectation of a satisfied
customer; and
That, in general, if time permitted, you would do more of.
Can be eliminated without affecting the form or function of the

product or service;
Result in waste and add no value to the product or service;
Are performed due to inefficiencies or errors in the process stream;
Are duplicated in another department or add unnecessary steps to
the business process;
Are performed to monitor quality problems;
Are performed due to a request of a dissatisfied customer;
Produce an unnecessary or unwanted output; and
If given the option, you would prefer to do less of.
Using ABC/M to score activities along their high- versus low-value-adding scale
Objectives:
- To eliminate/minimize low-value-adding activities
- Optimize higher value-adding activities
- Enable employees to focus on the worth of their organizations
work
Benefits:
- Reduce costs and improve business process towards better
efficiency
- Employees can see how work really serves customers and which
activities may be considered wasteful.
- Focus and visibility are enhanced because people can more easily
see where costs are big or small and also which costs can be
managed in the near term.
11

2.4 Activity Based Management applications
Transfer Pricing/Service Level Agreements
Costing Analysis
Pricing
Estimating
Life Cycle Costing
Analysis of
products/services
customers
locations
Resource Planning
Investment Analysis
Insource/Outsource
Business
Rationalisation
Activity Analysis
Budgeting/Forecasting
Target Costing
Continuous Improvement
Performance
Improvement
Activity Value Analysis Business Process

Cost Driver Analysis
Best practices
Performance
Cultural Assessment
Measurement
12
3. ABC/ABM Implementation
3.1 Where ABC has been used
Industries to use ABC
Manufacturing
Metal/Rubber/Plastics
Machinery
Food/Textiles (i.e. CONCO Food)
Electronics (i.e. ABB Switzerland)
Chemicals
Paper/Printing
Services
Financial
Wholesale/ Retail Trade
Consulting
Business
Communication/Utilities
Computer/Software
Transportation
Health Care/ Medical / Legal
Education
Government Sectors
Example: U.S Postal Service, UK
National Health Services, Australian
Federal Police Department
Characteristics of company which lead to ABC being successfully applied:

A high level of top management support and commitment;
Technical competence of the implementation team; and
Effective change management, that is, companies driven by competitive pressures to strive to better understand their
internal capabilities and external competition.
References: Management Accounting Quarterly . Spring 2009, Vol.10

Dan Swenson and Douglas Barney, ABC/M: Which Companies Have Success? The Journal of Corporate Accounting & Finance, March/April 2001
13
3.2 Steps to develop ABC Cost Flow Model
1. Collect Financial Data
2. Identify Activities
3. Develop Cost
Flow Model
Modify
Modify
Modify
4. Identify Drivers
Preliminary
5. Collect Cost
Driver Data
6. Calculate
Activity Costs
7. Calculate
Unit Costs
14
3.3 ABC Implementation Project
Phase 1:
Preparation and
planning
Introduce the concept to
senior management
Set up a steering committee
Evaluate and select cost
accounting software
Phase 2:
Diagnostic
Assessment of ABC
Readiness
Significant indirect cost
Complex products and
services
High-volume products and
low-volume products
Engage a consulting firm
Disagreement by managers
Training for cost center
Age of costing system
managers and key staff
A pilot rapid prototyping
Steering Committee
Phase 4:
Implementing ABC
Identify and classify

Activities related to products
via three approaches:
top-down;
recycling;
interview or participative
Estimate cost of activities
Calculate a cost-driver rate
for each activity
Assign Activity Costs to
products
Study to get senior

managers buy in if required
Create and enter cost
center allocations in system
Analyse and review output
Refine and adjust as
necessary
Gain approval for cost
information from new system
ABC performance
ABC Appropriateness
Follow-up
workshop
Phase 3:
Designing an ABC
system and collecting
necessary data
ABC roll-out
Prepare and issue

actuals analysis
Central Finance 9
Submit forecast
Business Unit 7
Prepare and issue

forecast analysis
Central Finance 13
Review forecast
(QPR)
Group
CEO/CFO
18-20
Jan
Feb
Mar
Actuals Blue
Flash Book
2+10+12
End
March
Prepare and issue Central Finance Based on

Report quarter end actuals
Board
dates
and forecast analysis
Apr
May
Report
ABC project plan
ABC readiness
Central Finance N/A
Submit budget
Business Units N/A
Prepare and issue

budget analysis
Central Finance N/A
Review Budget
Group
CEO/CFO
Jul
Aug
Blue Blue
Book Book
5+7+12
8+4+12
End
July
Green
Book
Qtr 1
Sep
Oct
Nov
Dec
Blue Blue
Book Book
1
2
3
4
10+2+1
2
End
Sept
Green
Book
Half
Year
(July)
(April)
Issue budget
instructions and
Targets
Jun
Blue Blue
Book Book
End
Nov
Green
Book
Qtr 3
(Oct)
Green
Book
Full
Year
(Jan)
End
May
Core and steering processes
Report
Business Unit 5
5
6
7
8
9
10
11
12
13
14
15
16
N/A
Early
Oct
Late
Oct
Early
Nov
Product cost based on

Activities involved
Support
processes
Report
Working
Responsibility Day
Submit actuals
Strategic
framework
Reporting Month
Activity
17
18
19
Legend
Analysis of synergy potentials products/markets

Infrastructure for new products-/market segments
Implementation of a divisional steering concept

Nomination of group CRO
Implementation of KPI based sales controlling
Implementation of risk transfer to ACPM
Implementation of a strategy for trading/treasury
Implementation of group-wide portfolio structure
Enhancement of technical infrastructure in FO and RM
Integration of decision-making processes
Implementation of group-wide ACPM
Establishment of integrated planning processes
Implementation of planning tools/methods etc.
Development of a steering concepts on group level
Implementation of steering methods/instruments etc.
Set-up of a management information system
Development of cooperation model for IT/functional areas

Development of documentation standards
Derivation of a roadmap
Strong mutual dependencies
One-way dependencies
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
Mutual dependencies between categories
4 Bank-wide ABC
implementation
ABC Project Management

15
3.4 Challenges and Success Factors
Reason for application
Companies are able to determine how much revenue each of their various
products and services generate, but unable to determine with any level of
certainty how much it costs to provide these products and services
No way of determining which products are unprofitable and uncompetitive and
which products are profitable and underdeveloped.
Generate buy-in from operational managers

Uncertainty in cost-savings
Challenges for application
Duplication of effort in collecting information

Occasional lack of creativity on the part of the center managers.
Difficult to gain approval for cost information produced by new allocations
ABC champion: convince management of the viability and necessity of ABC and
create and sustain enthusiasm
Key to success
Support and cooperation of employees: honest and open communication

Non threatening environment : which would facilitate the change culture
16
Thank you
Meiklejohn Paul
Director
Management Consulting
KPMG Limited
Tel
+84 (4) 3946 1600 (ext. 6315)
Mob +84 (0) 914 923 162

pmeiklejohn@kpmg.com.vn
Appendix KPMG ABC and Cost Optimisation Tools

1. Activity Based Costing
Solution is ABC
Traditional Costings short-comings

No way of determining which products are uncompetitive
No way of determining which products are profitable
No way of determining how to cut and optimize costs
No way of managing indirect costs and expenses
ABC traces and assigns costs based on cause-effect

what
you can measure
relationships with activities which consume them.
Whys ABC?
Profitability
analysis
Enterprises have a clearer and more
detailed view of the profitability
structure of different products within
the portfolio.
Cost and Resource

Optimization
The costs and expenses are allocated to
each product type, so enterprises could
identify the profit margins for every
product line, which aid pricing decisions
Performance
Measurement and
Improvement
Cost estimation and

Pricing
Enterprises gain insight into their cost
per activity for correct cost optimization
opportunity. Enterprises are also able to
analyze return on investment based on
the detailed cost information
To whom that ABC is most beneficial
ABC enables enterprises to analyze the

efficiency of each activity & improve the
processes across the value chain. This
enables management to evaluate
performance more effectively for
longer-term benefits.
Diversity in Product/Service types or

Distribution/Sales Channels
More complexity in Operation
Overhead cost increase
Strong Development of Technology
Organization automate what

previously were manual job
Proportion of Indirect cost increase
Market becomes saturated
Losses on margins and profits
Cost Optimization becomes virtual

solution to survive and obtain profit.
Lost due to inaccurate cost allocation is

high
Disagreement by managers over

cost allocations
The company need to understand

clearly its cost structure
High Indirect Cost
High Competition
Challenges in ABC Implementation

Reluctance to change in staff
Risk management
Lack of appropriated system to
collect data and build ABC
model
Coordinate issues between ABC
and the existing system
Change
Management
Knowledge
Experience
Technology
Lack of deep understanding of ABC

theory
Lack of strategy on how to use ABC
model/data
Lack of capacity to unify ABC theory
and practical situation
Personnel quality issues
18

1. Activity Based Costing (cont.)
KPMGs ABC Approach
Resource Drivers
Resource
n
Activity 1
Resource
Resources
1st stage
Define and identify key resources
Verify actual costs from reliable information (financial
information, resources statistics, organisational
information)
Resource
2
Sample Deliverables
KPMG Approach
Resource
1
ABC Conceptual Methodology
X1
X1
X1
X1
X2
X2
Activity 2
Activity n
Xn
Xn
2nd stage
Define and identify activities
Develop activity dictionary
Trace activities to resources
Define activity drivers
Calculate total activity cost
Activities
Cost Object A
Cost Objects
Define and identify cost objects

Design cost flow model
Calculate cost-driver rate
Assign activity costs to cost objects
Y1
Cost Object B
Cost Object C
Y2
Activity n
Y1
Activity ..
Activity 2
3rd stage
Activity 1
Activity Drivers
Yn
Y2
Y2
Y3
Y3
Yn
KPMGs ABC Advisory Services

Training
Rapid Prototyping
Workshop
One time study and support
Full ABC implementation
ABC for management
What we
do
We transfer knowledge and

demonstrate case study on
ABC
We coach to build ABC

model.
Our team conduct ABC based

review of the costing structure
We work with clients to apply

ABC from start to end.
We support in applying ABC

into performance
management
What you
get
Knowledge and practical

insights for ABC readiness
Quick win high level ABC

model.
A report on your activities and

costing structure.
Effective and efficient ABC

implementation
Accelerated learning.
Ideas for process

improvement and product mix
Ideas and framework for

improvement.
Business Improvement
framework
( Where ABC costing system
has already implemented ).
19

2. Cost Optimisation
Today's businesses are under constant pressure to reduce costs, yet many find it hard to do so in a sustainable fashion. Ninety percent of cost
reduction programs fail to achieve their targets, and the gains that are achieved appear to be short lived. The increasing interdependencies faced by
companies internally between functions and externally with suppliers, customers and other stakeholders - make cost management become a highly
complex issue that can only be addressed at a strategic level.
Challenge
KPMG research has shown that companies are, on average, achieving only
59% of expected savings. Reasons for this include:
cost strategies are failing;
revenue growth has eroded cost discipline;
cost ownership is unclear and too narrow;
cost strategies are too cautious;
cost drivers are not clear or transparent;
cost discipline is not embedded in the culture.
Industrybased
Hypotheses
Opportunities
Diagnostic
Our cost optimisation program enables companies to:
gain an understanding of your cost structure, identify key cost drivers and
create effective cost strategies through the improvement of structures and
processes to enable significant cost savings.
access to comparable information to enable the analysis and assessment of

performance and costs, which can help position you against benchmark data
in order to quantify a performance or cost gap.
KPMG also can assist you with managing and measuring the implementation of
cost optimization programs in the most optimal manner and with minimal
disruption to your operations.
Major causes for the failure of cost strategies include:
inadequate processes to drive cost reduction;
lack of transparency of information;
too much reliance on cost avoidance rather than increased cost efficiency;
too many conflicting projects.

Plan, Scope and
Agree Goals
How we can help
Design
Implement
Monitor
KPMG core cost optimisation team working to

globally consistent methodology
Industry insight
Access to areas of deep specialisation across KPMG

Supply Chain,
Procurement
and Sourcing
Private Equity
Lens
(Transaction
Services)
Systems
and IT
Treasury
Cash and
Working
Capital
Finance
Function
Real Estate
Human
Resources
Investment
and
Divestment
Tax
20

2. Cost Optimisation (cont.)
Our wide-ranging approach can look across the company's overall business:
Benefits/Outcomes
Our cost optimisation program enables clients to identify opportunities to reduce their operating costs while improving performance. Our team also can
work with clients to help:
Identify the risks through a thorough assessment of operating / business costs;
Develop a cost reduction program to reduce costs, improve controls and enhance strategic effectiveness;
Identify improvements in core processes and organizational structural models and apply industry better practices;
Improve the performance of inventory, asset, and channel management activities to drive service, cash flow, and margin enhancements;
Evaluate operations and planning processes, and the effectiveness of the supply and distribution networks for both alignment and rationalisation
opportunities.
By gaining an in-depth understanding of key processes and cost drivers, clients can initiate and manage effective cost improvement programs.
21
2011 KPMG Limited, a Vietnamese limited liability

company and a member firm of the KPMG network of
independent member firms affiliated with KPMG
International Cooperative (KPMG International), a
Swiss entity. All rights reserved.
The KPMG name, logo and cutting through
complexity are registered trademarks or trademarks
of KPMG International Cooperative (KPMG
International).

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Activity Based Costing

for Activity Based

What is Activity Based Costing (ABC)?

How ABC should be used to manage (Activity based management)?

Appendix: KPMG ABC and Cost Optimisation tools

1. What is Activity Based Costing?

Why it should be used? (the Benefits)

To put ABC into context as a performance management tool

1. What is Activity Based Costing?

Activity Based Costing

1. What is Activity Based Costing?

ABC focuses on activities in the production or service

Costs are traced to activities to products/services, based

More accurate product and service costs enable better

Focus on the cost of the product only.

Costs are traced to the product on assumption

not differ much in terms of required

Labor was dominant component in the cost

Make vs buy decision

Investments in R&D, process automation

Increased visibility of the activities performed enables a

improving the efficiency of high cost activities.

ABC can be expensive to use

Some arbitrary overhead costs will continue

Arbitrary volume drivers fail to account for product

Overhead is an indirect or common cost that

1. What is Activity Based Costing

Total overhead ($)

Machine-run costs ($)

Activity Based Costing

Overhead per unit = Total Overhead/Total number of units

Allocate Overhead to Activities ($):

Cost per unit of each product ($):

Set-up costs ($)

1.What is Activity Based Costing?

ACTIVITY BASED POOLS

All products /services

XYZ Credit account

1. What is Activity Based Costing?

Cost of Accounting Analysis

Cost Assignment Process

2. How ABC should be used to manage (Activity Based Management)?

Product lines differ greatly in volume and manufacturing complexity

When Is ABC Most Beneficial?

When products/services differ significantly in their use of resources

2. How ABC should be used to manage (Activity Based Management)?

2. How ABC should be used to manage (Activity Based Management)?

Cost of quality and waste

Cycle time reduction

New products design;

Product/service/customer profitability analysis

2. How ABC should be used to manage (Activity Based Management)?

Low value adding activities are those:

Required to meet customer requirements;

Can be eliminated without affecting the form or function of the

2. How ABC should be used to manage (Activity Based Management)?

Activity Value Analysis Business Process

Characteristics of company which lead to ABC being successfully applied:

References: Management Accounting Quarterly . Spring 2009, Vol.10

1. Collect Financial Data

Engage a consulting firm

Training for cost center

Age of costing system