Adding Value With Activity-Based Costing
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Activity-based costing and management can be used to identify efficiencies and maximize cost effectiveness for a wide range of IT projects.
By Kevin Sawyer
Capturing and quantifying the scope and value of products and services is an important part of ensuring the success of an organization. This requires the development of comprehensive cost models based on a defensible cost allocation methodology. One such methodology is activity-based costing and management (ABC/M). ABC/M is a cost management and reporting tool designed to enhance an organization’s ability to analyze its current structure and evaluate alternatives to drive change and improve performance. It can be used to identify efficiencies and maximize cost effectiveness for projects ranging from IT chargebacks to calculating fees for service.
ABC/M has proven extremely valuable in public and private-sector organizations since the 1980s. As an ABC/M specialist for Vergys LLC, I have been involved in a number of ABC/M projects that have added immense value for our clients. For example, we implemented and currently manage ABC/M for the Department of Homeland Security’s U.S. Citizenship and Immigration Services (USCIS). Vergys identifies and analyzes all inputs necessary to develop ABC/M models which are used to determine fees for service. Our initial analysis revealed that USCIS was undercharging by 86 percent based on its cost structure. Vergys found the true cost of processing immigration benefits using ABC/M, enabling USCIS to recover an additional $1.2 billion annually through increased fees.
How Does ABC/M Work?
ABC/M identifies the people, equipment and facilities (resources) used to perform business processes (activities) which are then used to determine the cost of products and services (cost objects). Resources are assigned to activities using resource drivers which allocate costs based on factors (i.e., number of full-time equivalents or positions) or drive costs directly to a particular business process. Once all of the costs have been assigned to activities, they are assigned to cost objects using activity drivers which allocate costs based on factors (i.e., processing or manufacturing time) or drive costs directly to a particular product or service.
This approach to cost management differs from traditional cost accounting in that it assigns resource costs to the actual activities they support, providing a more accurate representation of how costs flow through the organization to individual products and services. Traditional cost accounting allocates costs, such as overhead and administrative support functions, using rates and surcharges. These rates produce inaccurate representations of the true cost and value of providing products and services as some business processes require more overhead than others. ABC/M provides much more flexibility and accuracy when assigning costs. For example, a traditional allocation of IT costs often involves calculating an overhead rate based on the entire IT budget and spreading this evenly to each business unit. ABC/M identifies each line item, or expenditure, in the IT budget and assigns it to the specific activities and products and services it supports.
Adding Value With ABC/M
ABC/M provides the capability to identify and quantify the activities an organization performs to deliver products and services using budgetary data and performance metrics. This information can be used to develop a clear picture of current business processes how this translates into organizational cost and performance. CIOs, CFOs and operations managers can use ABC/M to support process improvement initiatives in support of mission goals and objectives by enhancing their ability to perform the following:
§ Strategic Decision-Making
§ Align process costs with mission goals and objectives
§ Identify and compare costs of products and services
§ Assess the impact of changes to products and services
§ Operational Decision-Making
§ Identify opportunities for process improvement
§ Measure the cost and performance impact of process changes
§ Determine resource needs for business processes
§ Planning and Budgeting
§ Identify how changes to the budget affect the costs of products and services
§ Forecast resource needs for changes to program requirements
§ Improve reporting to stakeholders