The Capital Investment Analysis Application of

Activity-Based Costing Techniques in the EDUC

Electric Distribution Utility Company
Name of Student Nishant Shokeen
CMA Batch Number CMA Batch 16
Country India
Date Program Completed Feb 2018
Title of Assignment The Capital Investment Analysis Application of
Activity-Based Costing Techniques in the EDUC
Electric Distribution Utility Company
Name of Current Employer Primrose Australia
Position in Organisation CFO
Name of Organisation Analysed in EDUC Electric Distribution Utility Company
Assignment
Name of Past Company Used in EDUC Electric Distribution Utility Company
Assignment (if any)
Full CV provided Yes

I. INTRODUCTION

Activity Based Costing is one of the tools and techniques that was covered in the CMA program, and I will
demonstrate that it is very useful in providing decision-oriented information to senior management in my
organisation that will ultimately enhance its corporate value.
The company that is the focus of my study is the EDUC Electric Distribution Utility Company, which serves around
25 percent of the Indian population.
I worked as one of the Financial Controllers of EDUC.

II. THEORETICAL FRAMEWORK

Traditional investment is based on the cash flow impact of each alternative, a process that does not take into
account non-monetary decision parameters such as quality and efficiency (Angelis & Lee, 1996). It compares
investments proposed by department managers based on the benefits to each department, without analysing the
effect of the investment on the activities and strategic goals of the company.
This framework has been applied in EDUC which serves around 25 percent of the Indian population. Its capital
expenditure in 2005 is worth around three percent compared to its total assets.
Activity-Based Costing (ABC) is a methodology that measures the cost and performance of activities, resources

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and cost objects (Miller, 1996).
The resources are classified as: capital expenditures (CAPEX) and operating expenses. For CAPEX, the cost
elements are labor, transportation, contracted services and other expenses. Materials are excluded in the CAPEX
to highlight the cost of performing the activities.
There are two axes to the ABC model (Fig. 1) as developed by the Consortium for Advanced Manufacturing
International (CAM-I). The vertical one deals with the cost assignment view. The “resource” contains all means
upon which the selected activity can draw. The resource cost assignment process contains the structure and tools
to attribute costs to the activity. The “activity” is where work is performed. The activity cost assignment process
contains the tools to assign costs to cost objects, utilizing activity drivers as the mechanism to accomplish this
assignment (Miller, 1996).
The horizontal axis contains the process view. The cost driver is the agent that causes the activity to utilise
resources to accomplish some designated work. In this view the activity is some type of active work centre. The
performance measure of activities entity houses the evaluative criteria by which the organisation can determine
the efficiency and effectiveness of the activities work effort (Miller, 1996).

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III. ACTIVITY-BASED INVESTMENT DECISION ANALYSIS FRAMEWORK

Phase I. Project Analysis Method

Investment decisions are anchored on net present value (NPV) method, internal rate of return (IRR) method and others.
The net present value criterion is the most widely accepted decision rule in academia (Sick, 1997).
In the project analysis method, the NPV and IRR methods will be used in the formulation of investment decisions. ABC
data will be used in the cash flow variables such as initial investment and operating and maintenance expenses.

Phase II. Project Prioritisation Method

The project prioritisation method in Fig. 2, is a tool for systematic selection among various alternatives with several
criteria. It consists of three basic selection methods: cost impact; performance impact; and quadrant analysis.
This presents the application of the analytic hierarchy process as a tool. The attributes are represented by a two-
tiered cost impact model and a three-tiered performance impact model. Table I presents the methodology.
Analytic Hierarchy Process (AHP) was developed to structure complex, multi-attribute problems. It creates a
hierarchical structure based on goals, criteria, sub-criteria and alternatives (Angelis & Lee, 1996; Saaty, 1982).
Formulating the problem (Fig. 3) is the first step. The top level is the objective. Subsequent levels are constructed so
that elements within a level are the same order of magnitude, as they are compared to each other in relation to
elements of the next higher order. The levels below the overall objective are referred to as attributes and sub-attributes
and consist of the decision criteria. The first level of attributes is the strategic goals. Below are activities as the sub-
attributes. At the lowest level are the decision alternatives (Angelis & Lee, 1996; Zahedi, 1986).
The decision maker determines the importance of each element in a level. This is done by pairwise comparisons of
the elements at a given level relative to each of the criteria at the next higher level. Then, calculate the overall rating
of each alternative by multiplying the weights along each path of the hierarchy leading to an alternative, and then
adding these products for each decision alternative.
Cost Impact
Figure 4 illustrates the cost impact model of the new method. By analysing the resources consumed as a company
performs its activities and measures its performance, management can identify areas where change may achieve
significant cost reductions (Angelis & Lee, 1996).
Performance Impact
Figure 5 illustrates the performance impact model of the new method. Performance measures allow management to
influence activities that are critical to strategic goals. Activities provide a tangible link between indices and objectives.
Without this link, management is left with “intangible” benefits from long-term goals that they perceive as important
but unmeasurable (Angelis & Lee).
Quadrant Analysis
Combine the results of the cost and performance models to select the best investment. The models assign a weighted
evaluation to each investment alternative, one for cost and one for performance (Angelis & Lee, 1996). Use a graph in
Fig. 6 to select the best alternative. Investments falling in quadrant III are the most preferred, while those falling in
quadrant II would be the least preferred (Angelis & Lee, 1996).

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IV. METHODOLOGY

The ABC&M office of the company initiated the Activity-Based Management project with focus on ABC information.
One such application is strategic investment planning decisions. Thus, the capital investment decision was developed
based on the principles of capital budgeting and capital rationing.

A. Project Simulation Methodology

The concept was simulated in a pilot application. Project teams were formed to help in the “proof of concept” stage.
There was a meeting after the concept presentation to the steering committee with the heads of the following offices:
Planning; Substation; Distribution and Subtransmission. The electric capital projects were classified into: substation;
sub-transmission line; and distribution line projects.
For the project analysis method, the steering committee members agreed to analyse two projects for each category.
The mandate was to determine: the activities of the initial investment cash out flow variable; the activities of the
operations and maintenance cash outflow variable; the financial viability of each project.
For the project prioritisation method, the steering committee agreed to subject 23 projects for implementation to
undergo the new method and compare the results with the existing method. They agreed to use the proposed
method with modifications subject to the availability of data. The modifications were: the non-inclusion of the
activities; and cost savings will be derived from the benefits of the projects.

B. Project Analysis Method

A workshop was held. Sample projects similar to Tables II, III, & IV, were made available to the participants and they
were guided on how to use ABC data.
Aside from direct costs, ABC resources also include non-electric asset costs and shared services costs. Asset costs are
incurred in the use of company assets, to perform the activities. They come in the form of depreciation, property
taxes, insurance, interest expenses and amortisation on debt expenses. Shared services costs are incurred and passed
on by another internal organisation in providing support to other organisations. The reassignment is from the
performing organisation to the benefiting organisation, then to the benefiting organisation’s activities.
Cash flow variables were identified as investment cost; operation and maintenance expense and overhead expense
variables. The ABC data in this method does not include depreciation expenses of asset costs.
For the investment cost, the existing practice utilises the amount in the work order system. The method offers the
activity cost data of the planning, design and construction activities to replace the labour, transportation, contracted
services and storage costs. The direct material costs from the system will remain part of the method. The activity cost
data shall be derived from the previous year‘s ABC information.
The challenge in the investment cost is the identification of CAPEX activities related to a particular type of project like
substation, subtransmission lines and distribution lines, and identify the number of times an activity will be used. The
activity driver should: correlate with the consumption of the activity; encourage improved performance; and already
be available and/or have a low cost of collection (Miller, 1996).
A second workshop was held to analyse the “Activity-to-Project Maps” each team prepared. This map is a list of
activities of a particular type of project. Each project has two maps, one for the initial investment and the other is for
the operations and maintenance.

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 The initial investment using ABC information (Table III) is made up of capitalised activity costs for a particular type of
project. In this case, the project is an “Upgrading of a 115Kilovolt Subtransmission Line.”
For Table IV, it is important to classify the activities into value-adding and non-value adding. If possible, include only
the value-adding costs as part of the relevant expenses.

C. Project Prioritisation Method

The steering committee agreed to subject all 23 projects to the new method and compare them with the existing
method. They divided the projects into: Substation; Subtransmission; and Distribution Lines. They agreed that the
main criteria for the analytic hierarchy process (AHP) should be tied up to the goals of the Company. The AHP main
criteria are: Adequacy refers to the capacity to accommodate new loads; System Reliability and Flexibility refers to
the ability to minimise power interruptions; Public Safety refers to the reduction of hazards; System Loss refers to the
ability to reduce technical system loss; and Power Quality refers to the improvement in the supply of electric power
to sensitive customers.
The discussion was centred on the new method especially on the use of analytic hierarchy process. One main concern
raised during the discussions is the guideline on AHP which states that “no more than nine elements in any cluster.”
The original method on the performance impact model requires the use of AHP on the alternatives. In a utility
company, the number of alternatives may surpass the limit of nine projects.
The issue on the limitations of nine projects was resolved. Instead of AHP on the last level, the revised performance
impact model requires the performance values of each project with respect to the performance driver.
Fig. 7 shows the weights of the main criteria in the pairwise comparison performed by the project team members.
Cost Impact Model
The initial application of the model started with the identification of the main criteria. The projects are then placed
after the main criteria (Fig. 8). The main objective in pursuing this modified model is to sell the concept to prospective
customers without the intricacies involved in the gathering of ABC information. The cost savings information did not
come from the savings on resources consumed by activities. Cost savings were replaced by cost benefits with the use
of the existing financial analysis. Once the prospective users agree that the concept improves their existing method,
ABC information build-up will be the next logical step to pursue the complete ideal model in the theoretical
framework.
Performance Impact Model
Figure 9 is the initial application of the model in the project simulation. Notice that the activities are not included.
The model introduces the performance measures as sub-criteria. These are linked to the main criteria using the
analytic hierarchy process. This model incorporates the performance of each project with respect to the performance
driver of each main criterion contributing to it. There are no limits in the number of alternatives for as long as
performance measures are defined.
Comparative Results Between the Net Present Value and Project Prioritisation Method
In the new method, the ranking is based on shortest distance to the coordinate (1,1) in the cost savings versus
performance graph (Fig. 6).
Tables V, VI and VII show the comparison between the results of Project Prioritisation Method and NPV.

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V. CONCLUSIONS AND RECOMMENDATIONS

A. Project Analysis Method

There were realisations that most activity drivers did not represent realistic consumption of the activities and most
activity drivers and costs did not have accurate data because of the poor utilisation of the work order systems by the
construction, maintenance and operations personnel.
The project teams decided to suspend the implementation of the proposed method pending the resolution of the
following recommendations: determine the possibility of using the work order systems to generate the driver data;
and develop a method to forecast the operation and maintenance activities given the 30-year economic life span of
projects.

B. Project Prioritisation Method

The models are flexible enough to adapt to the present limitations of available information.
This method can be used in various decision analyses such as: to buy or to lease; to outsource or to hire; business
development applications; new product development; performance ratings and other similar applications.

REFERENCES

Angelis, D. I. and Lee, C. Y. (1996) “Strategic Investment Analysis Using Activity Based Costing Concepts and
Analytic Hierarchy Process Techniques”. International Journal for Production Research, Vol. 34, No. 5, 1331-1345.

Miller, J. A. (1996), Implementing Activity-Based Management in Daily Operations, New York, John Wiley & Sons,
Inc.

Saaty, T. L. (1982), Decision Making for Leaders, Lifetime Learning Publications, California.

Sick, G. (1997), Investment Decision Analysis, University of Calgary Press, Calgary.

Zahedi, F. (1986), “The Analytic Hierarchy Process – A Survey of the Method and its Applications”, Interfaces Vol.
16, No. 4, pp. 96-108.

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 SUMMARY OF FIGURES AND TABLES

Investments
Investments
Project Analysis
Method (PAM)
Project Prioritization
Method (PPM)

Resources
Resources
What
Whatisisused
used
totododowork
work

Resource
Resource
ResourceCost
Cost
Assignment Drivers
Assignment

Cost Performance
Performance
Cost Drivers
Drivers Activities
Activities
Activities Measures Investments
Why
Why work
work isisdone
done
Measures Investments
Work
Work
Work How
Howwell
wellwork
workisisdone
done

Activity Activity
ActivityCost
Cost
Assignment
Assignment Drivers

Cost
CostObjects
Objects
To
Towhat
whatwork
work
isisdone
done

Fig. 1. CAM-I Cross with Investment Impacts

Cost Impact Model Performance Impact Model

Quadrant Analysis

Fig. 2. Project Prioritisation Method

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 TABLE I
INPUT – PROCESS - OUTPUT FRAMEWORK

Input Process Output

Step 1 - Link the activities to - Critical activities
- Strategic Goals the strategic goals using - Priority weights
- Activities analytic hierarchy of each strategic
process. goal to activity
Step 2 For each investment: - Net change in cost
- Resource - Determine the cost for each activity
Consumption savings under each
- Critical Activities - Distribute resources to investment scenario
activities using drivers
Step 3 - Link performance - Priority weights
- Performance measures to activities of performance
Measures using analytic hierarchy measure to activity
- Critical Activities process.
Step 4 - Connect the activities - Cost score for
- Priority weights of to the investment each investment
goal to activity alternatives in the cost alternative
- Net change in cost impact model
for each activity
Step 5 - Create the performance - Performance
- Priority weights of impact model score for each
goal to activity investment
- Priority weights of alternative
performance measure
to activity
Step 6 - Combine the results of - Best investment
- Cost scores the models using the alternative(s)
- Performance scores cost savings versus
performance graph

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 Level
Decision
◼ One Objective

Decision Decision Decision

◼ Two
attribute 1 attribute 2 attribute n

◼ Three Decision Decision Decision

sub-attribute 1 sub-attribute 2 sub-attribute n

◼ Four Decision Decision Decision

sub-subattrib1 sub-subattrib2 sub-subattribn

Decision Decision Decision

◼ Five
alternative 1 alternative 2 alternative n

Fig. 3. Analytic Hierarchy Process Model

Investment
Decision

Criteria 1 Criteria 2 Criteria N

Activity 1 Activity 2 Activity 3 Activity 4 Activity N

Cost Savings

Project 1 Project N

Fig 4. Cost Impact Model

Investment
Decision

Criteria 1 Criteria 2 Criteria N

Activity 1 Activity 2 Activity 3 Activity 4 Activity N

Driver 1 Driver 2 Driver 3 Driver 4 Driver 5 Driver N

Performance Measurements
Project 1 Project N

Fig. 5. Performance Impact Model

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 1.0

Cost Savings
I III

0.5

II IV

0.0 0.5 Performance 1.0

Fig. 6. Cost Savings vs. Performance

TABLE II
COMPARATIVE CASH FLOW VALUES

Variables Existing (Rs) With ABC (Rs)

st
Cash Outflows (1 year)
Initial Investment 15,311,328.35 11,443,826.09
Operations & Maintenance Costs 765,566.42 1,049,194.88
Overhead Costs 627,764.46 None
Interest Costs 1,419,560.00 978,630,.00
Purchased Cost of Power 3,061,010.00 3,061,010.00
Cash Inflows
Sales Revenues (1st yr) 3,276,950.00 3,276,950.00
Deferred Capacity Investment (1st 61,710.00 61,710.00
yr)
Salvage Value 378,000.00 378,000.00
Financial Indicators
Internal Rate of Return 35.91% 38.28%
Net Present Value 1,302,300,060.00 1,525,146,470.00
Benefit / Cost Ratio 1.17 1.16

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TABLE III
INITIAL INVESTMENT

Activity Description Cost (Rs)

Formulate projects 250,069.25
Secure right-of-way 1,428,999.76
Survey subtransmission lines 205,758.24
Design subtransmission lines 34,553.64
Haul materials 310,299.63
Construct foundation 822,884.72
Erect poles 476,938.55
Install dressings 420,060.10
String conductors 397,004.93
Install special line equipment 16,716.50
Retire poles 230,384.09
Retire dressings 230,384.09
Retire conductors 232,771.13
Total Direct Labor 5,056,824.63
Total Direct Material 6,387,001.46
Total Initial Investment 11,443,826.09

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 TABLE IV
OPERATIONS & MAINTENANCE

Activity Description Activity Cost Value-Adding

(Rs) Cost (Rs)
Repair minor conductor defects 32,715.23
Repair minor pole dressing and pole defects 32,895.94
Repair minor special line equipment defects 35,748.42
Formulate preventive maintenance for existing 71,222.26 71,222.26
facilities
Conduct pole-to-pole inspection of existing 308,070.03 308,070.03
facilities
Conduct routine inspection of existing facilities 132,975.34 132,975.34
Conduct ultrasonic detection tests on existing 48,236.53 48,236.53
facilities
Perform technical analysis of existing system 13,511.50
problems
Perform tree trimming 40,793.72 40,793.72
Perform preventive maintenance of special line 4,596.62 4,596.62
equipment
Correct overheating components 16,196.25
Correct minor pole dressing and pole problems 17,344.45
Correct minor special line equipment problems 17,344.45
Replace conductors 138,490.08 138,490.08
Replace dressings 47,288.66 47,288.66
Replace special line equipment 7,165.31 7,165.31
Conduct switching 230,282.68 230,282.68
Monitor and control outage 20,073.65 20,073.65
Total Operations & Maintenance 1,214,951.12 1,049,194.88

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 Investment
Decision
Factor Weights

0.46 0.22 0.08 0.02

0.16 0.08
Adequacy Reliability System Loss Power Quality

Flexibility Safety

Note: Pairwise Comparison by Electric System Planning Department

Fig. 7. Main Criteria

Investment
Decision
.46 .22 .16 .08 .08 .02
Adequacy Reliability Flexibility System Loss Safety Power Quality

Cost Savings

Project 1 Project 2 Project 3 Project 4 Project 5 Project 6

Fig. 8. Cost Impact Model – Initial Application

Investment
Decision
.46 .22 .16 .08 .08 .02
Adequacy Reliability Flexibility System Loss Safety Power Quality

.88 .75
.11 .14 .86 .25 1 1 1

Percent Voltage Unserved KWHR No. of PQ

IFR CIT Cost
Loading Variation Energy Loss Complaints
x2 Performance Measurements xn
x1
Project 1 Project 2 Project 3 Project 4 Project 5 Project 6

Fig. 9. Performance Impact Model – Initial Application

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 TABLE V
SUBSTATION PROJECTS

No Project Prioritisation Net Present Value

Method
Project Distance Project NPV (x 1000)
1 SUBS0001 0.147368 SUBS0002 1,175,361
2 SUBS0002 0.296583 SUBS0003 749,743
3 SUBS0003 0.371244 SUBS0006 603,626
4 SUBS0004 0.688264 SUBS0001 420,306
5 SUBS0005 0.954497 SUBS0005 351,963
6 SUBS0006 1.021830 SUBS0004 181,901

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 TABLE VI
SUBTRANSMISSION LINE PROJECTS

No Project Prioritisation Net Present Value

Method
Project Distance Project NPV (x 1000)
1 TRANS0001 0.813280 TRANS0005 4,541,785
2 TRANS0002 0.889997 TRANS0003 3,648,752
3 TRANS0003 0.951913 TRANS0002 3,608,765
4 TRANS0004 1.178159 TRANS0006 2,305,475
5 TRANS0005 1.188171 TRANS0001 1,386,190
6 TRANS0006 1.252522 TRANS0008 1,302,300
7 TRANS0007 1.321534 TRANS0004 1,214,438
8 TRANS0008 1.337378 TRANS0007 837,332

TABLE VII
DISTRIBUTION LINE PROJECTS

No Project Prioritisation Net Present Value

Method
Project Distance Project NPV (x 1000)
1 DIST0001 0.297871 DIST0002 17,935
2 DIST0002 0.638105 DIST0005 16,199
3 DIST0003 1.132476 DIST0006 5,428
4 DIST0004 1.253097 DIST0007 3,199
5 DIST0005 1.280691 DIST0003 3,056
6 DIST0006 1.349003 DIST0004 2,515
7 DIST0007 1.375788 DIST0009 2,076
8 DIST0008 1.409026 DIST0008 468
9 DIST0009 1.413214 DIST0001 51

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