Activity-Based Cost Management in Government

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About the Author

Gary Cokins is an internationally recognized expert, speaker, and author in advanced cost management and performance improvement systems. Gary Cokins was the lead author of the acclaimed An ABC Manager's Primer, sponsored by the Institute of Management Accountants (IMA) and the Consortium for Advanced Manufacturers-International (CAM-I). Gary's second book, Activity Based Cost Management: Making it Work (McGraw-Hill, 1996), was judged by the Harvard Business School Press as "read this book first."
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Product Details

  • ISBN-13: 9781567261103
  • Publisher: Management Concepts, Incorporated
  • Publication date: 11/28/2001
  • Pages: 412

Read an Excerpt

Activity-Based Cost Management in Government

By Gary Cokins

Management Concepts

Copyright © 2001 Gary Cokins
All right reserved.

ISBN: 1567261108

Chapter One

Removing the Blindfold with ABC/M

"Whoever is careless with the truth in small matters cannot be trusted with important matters." -Albert Einstein, German-Swiss-American scientist


Imagine that you and three friends go to a restaurant. You order a cheeseburger and they each order an expensive prime rib. When the waiter brings the bill they say, "Let's split the check evenly." How would you feel?

That is how many products and service lines "feel" when the accountants take a large amount of indirect and support overhead expenses and allocate them as costs without any logic. There is minimal or no link that reflects a true relative use of the expenses by the individual products, service lines, or end-users. This is unfair. Activity-based cost management (ABC/M) "gets it right." It more fairly splits the waiter's check. Many ABC/M practitioners wish the word allocation never existed. It implies inequity to many people based on past abuses in their organization's accounting practices. The word allocation effectively means "misallocation" because that is usually the result. ABC/M practitioners will often say that they do not allocate expenses; instead they trace and assign them based on cause-and-effect relationships.

ABC/M can do much more than simply trace expenses and costs. It provides a tremendous amount of visibility for people to draw insights from and also use for predicting the possible outcomes of decisions. Many operations people cynically believe that accountants count what is easily counted, but not what counts. Outdated, traditional accounting blocks managers and employees from seeing the more relevant costs.

Important Messages for ABC/M Project Teams

It is a mistake for ABC/M project teams to refer to ABC/M as an improvement program or a change initiative. The ABC/M data are simply used as a means to an end. If ABC/M is described as an improvement program, it might be regarded by managers and employees as a fad, fashion, or "project of the month." ABC/M data make visible the economics of the organization and its consumption of resource expenses. Money is continuously being spent on organizational resources whether or not ABC/M measuring is present.

ABC/M is analogous to a physician's stethoscope, which allows a doctor to listen to one's heartbeat. Your heart is beating regardless of the presence of the stethoscope. Similarly, an organization is continuously burning up its resources through its activities into its outputs regardless of whether ABC/M is monitoring these events.

I am deliberately understating ABC/M for an important reason. In the early 1990s, when ABC/M was beginning to receive serious attention, the management consulting community began selling ABC/M engagements as consulting services. Unfortunately the consultants oversold ABC/M as a magic pill that could possibly solve all of an organization's problems (and perhaps solve world hunger, too). This raised management's expectations too high. If the consultants did not solve the problems that their clients engaged them for, some of those clients blamed ABC/M for not working. However, ABC/M worked just fine; some of the consultants just did not adequately understand how to interpret and use the data. Some did not know how to design and construct an effective ABC/M system. When one realizes that ABC/M is fundamentally good data to be used for understanding, discovery, and decision making, then it is better positioned for longer-term use and wider acceptance.

So I am deliberately managing expectations about ABC/M by reducing the perception that it provides all the answers. ABC/M restacks the costs; it does not root them out. ABC/M's data can be a great enabler for providing answers; the key word here is enabler. One controller I met referred to ABC/M as the ultimate question generator. He observed that, equipped with the ABC/M data, employees and managers frequently had reactions like, "What would explain or account for that?"

Organizational improvement is referred to by a variety of terms, among them total quality management (TQM) and business process reengineering (BPR). They all have one thing in common: a focus on continuing improvement of work and the pursuit of excellence in daily operations. Many of these programs emphasize the following:

Management of processes rather than resources;

Elimination of waste;

Improvement to processes that results in better, faster, and cheaper services to customers; and

Empowerment of employees to create change.

A common thread runs through all these improvement techniques: a focus on work activities and their relationship to services or products provided to customers.

The ABC/M data can turbocharge these types of popular performance improvement programs. It is inevitable that all organizations will eventually rely on some form of an ABC/M information system to assist in effectively managing their affairs. There is no reason to hype or overstate the power of ABC/M; it will continue to claim widespread global acceptance based on its merits and on the utility that the ABC/M information provides.

Organizational Shock from ABC/M

Ninety percent of ABC/M is organizational change management and behavior modifying, and 10 percent of it is the math. Unfortunately most organizations that implement ABC/M initially get those two reversed. They spend far too much time defining and constructing their ABC/M information system and very little time thinking about what their organization will do once they have their new ABC/M data. This is a huge problem.

This poor implementation habit has adversely affected the rate of adoption of ABC/M. When ABC/M systems fall short of manager and employee teams' expectations, it is usually because the initial ABC/M system design was substantially over-engineered. The typical initial ABC/M system is usually excessively detailed and is well past diminishing returns on extra accuracy for each incremental effort of work. One manager reacted to seeing the first ABC/M report by saying, "I feel like a dog watching television. I don't know what I'm looking at!" With a fraction of the effort and in a much shorter time frame, the implementation team could have started to produce results.

It is important to start getting results quickly from ABC/M because of the organizational shock that some managers and employees may experience when they receive the new ABC/M data. That is, it is important to start realizing what kind of new and possibly disturbing information might come from ABC/M.

When people see the ABC/M data for the first time, they will see things they have never seen before-and some of it will not be pretty. For example, there may be a product manager who for years believed that his or her products or service lines were the most profitable in the organization. But when ABC/M finishes more properly tracing the true consumption of expenses, that person's product or service line may appear much less profitable than it did under the traditional broad cost averaging scheme, and perhaps even unprofitable! That product manager will not be happy to see that information or whoever is reporting that information. Do not underestimate the level of resistance that can come from exposing managers and employees to the ABC/M data.

There is an important lesson here: Treat the ABC/M data responsibly. ABC/M is not an accounting police tool. It is an organization-wide managerial information system. Its data are not intended to embarrass anyone, and it should not be used to punish anyone. In many cases no one really knew what their true costs were. Many may have suspected that the existing expense and cost allocation was wrong, but they did not know what the correct calculations would reveal. ABC/M finally gives managers and employee teams the hope that they can see the truth. But seeing the data and using the data are not the same thing. Much more thinking is required when it comes to using the ABC/M data for managing and decision making.

There is an old saying that all truth passes through three phases:

1. It is ridiculed.

2. It is violently opposed.

3. It is accepted as being obvious.

Whether dealing with the ABC/M methodology itself or the output data computed by the ABC/M system, keep the following in mind: There will be resistance to ABC/M, due to people being afraid not so much of change-although that is a factor-as of uncertainty. The irony is that ABC/M brings truth, but until the ABC/M data are revealed, people are not sure what it is going to show or how it might be used.

In short, even if an activity-based cost model is in place, do not expect ABC/M to follow automatically. Using the data is a hurdle.

Overhead Expenses Are Displacing Direct Costs

The direct laborers in organizations are the employees who perform the frontline, repeated work that is closest to the products and customers. However, numerous other employees behind the frontline also do recurring work on a daily or weekly basis. These employees' work is highly repeatable at some level, for example, a teller in a bank. Figure 1.1 is a chart that includes this type of expense plus the other two major expense components of any organization's cost structure, its purchased materials and its overhead.

Most organizations are experienced at monitoring and measuring the work of some of the laborers who do recurring work by using cost rates and standard costs. In the bottom layer of the chart is cost information that also reveals performance-related costs other than the period's spending, such as labor variance reporting. It is in this area of the chart, for example, that manufacturers use labor routings and process sheets to measure efficiency. These costs are well known by the name standard costs. Service organizations also measure this type of output-related information. For example, many banks know their standard cost for each deposit, each wire transfer, and so forth.

Problems occur in the overhead expense area appearing at the top portion of Figure 1.1. The chart reveals that over the last few decades, the support overhead expenses have been displacing the recurring costs. The organization already has substantial visibility of its recurring costs, but it does not have any insights into its overhead or what is causing the level of spending of its overhead. ABC/M can help provide for insights and learning.

In a bank, for example, managers and employee teams do not get the same robustness of financial information about the vice-presidents working on the second floor and higher up in the building as they do about tellers. The only financial information available to analyze the expenses of the vice presidents and other support overhead is the annual financial budget data. These levels of expenses are annually negotiated. The focus is on spending levels, not on the various cost rates. The expense spending is monitored after the budget is published. Spending is only monitored for each department or function for each period to see if the managers' spending performance is under or over their budget or plan.

ABC/M extends to the overhead the understanding and visibility of spending that is already applied to the recurring laborers. ABC/M can then become an organization-wide method of understanding work activity costs as well as the standard costs of outputs.

Impact of Diversity in Products, Service Lines, Channels, and Customers

When you ask people why they believe indirect and overhead expenses are displacing direct costs, most answer that it is because of technology, equipment, automation, or computers. In other words, organizations are automating what previously were manual jobs. However, this is only a secondary factor in the shift in organizational expense components.

The primary cause for the shift is the gradual proliferation in products and service lines. Over the last few decades organizations have been increasingly offering a greater variety of products and services as well as using more types of distribution and sales channels. In addition, organizations have been servicing more and different types of customers. Introducing greater variation and diversity (i.e., heterogeneity) into an organization creates complexity, and increasing complexity results in more overhead expenses to manage it. So the fact that the overhead component of expense is displacing the recurring labor expense does not automatically mean that an organization is becoming inefficient or bureaucratic. It simply means that the company is offering more variety to different types of customers.

For those who may not be convinced by this explanation, go speak with an employee who has been in your organization a long time and is shortly due to retire. Ask him or her: "How thick was our product catalog when you joined the organization and how thick is it now? What types of customers did the founder serve at the inception of our organization and how many more types do we serve now?" The explanation for increasing overhead will become evident.

In short, the shift to overhead displacing direct labor reveals the cost of complexity. ABC/M does not fix or simplify complexity; the complexity is a result of other things. But what ABC/M does do is point out where the complexity is and where it comes from.

How long can organizations go on making decisions with the misinformation reported by their accounting systems? In the 1980s many organizations, reacting to the pressures from high-quality Japanese products, confessed that they had a "quality crisis." In the twenty-first century, organizations may realize that they have an "accounting crisis."


Growing Discontent with Traditional Calculation of Costs

Why do managers shake their heads in disbelief when they think about their company's cost accounting system? I once heard an operations manager complain, "You know what we think of our cost accounting system? It is a bunch of fictitious lies-but we all agree to them." It is a sad thing to see the users of the accounting data resign themselves to lack of hope. Unfortunately, many accountants are comfortable when the numbers all foot-and-tie in total and could care less if the parts making up the total are correct. The total is all that matters, and any arbitrary cost allocation can tie out to the total.

The sad truth is that when employees and managers are provided with reports that have accounting data in them, they use that information regardless of its validity or their skepticism of its integrity. Mind you, they are using the data to draw conclusions and make decisions. This is risky.



Excerpted from Activity-Based Cost Management in Government by Gary Cokins Copyright © 2001 by Gary Cokins. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

1. The Utility of ABC/M in Government: Some Opening Comments
2. Understanding ABC/M: A Few Basic Truths
3. If ABC Is the Answer, What is the Question?
4. Fundamentals: What Is ABC/M
5. Using ABC/M Attributes to Assess Quality and Value
6. ABC/M and Balanced Scorecard Performance Measures
7. Activity-Based Budgeting: Myth or Reality?
8. Supply Chain Management and E-Commerce: Where Does ABC/M Fit?
9. Implementing ABC/M through Rapid Prototyping
10. Examples of ABC/M in the Public Sector
11. Common Misconceptions about ABC/M and Employee Buy-In
12. ABC/M Integrates with Other Software Tools
13. The Future of Government

Appendix A : U.S. Reform Commissions
Appendix B: Federal Regulations
Appendix C: ABC Software

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  • Anonymous

    Posted February 20, 2003

    Very Informative!

    Gary's book sheds light on a subject that I have heard a great deal about but had no practical experience in. The use of ABC/M tools and techniques is growing rapidly in the federal government. This book is an essential primer for managers within the Federal government as well as government consultants. I particularly enjoyed reading about the example projects in Chapter 18.

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  • Anonymous

    Posted November 15, 2002

    A leading resource in the ABC/ABM field.

    Gary Cokins does an excellent job explaining Activity Based Costing and Activity Based Management from beginning to end. By reading the first chapter alone, one can tell he is an expert in his field. He begins explaining the subject matter with the basics and continues through using an easy to follow logic. For public sector organizations that are considering ABC/M, or already using it, this book is a master guide for its methodology. The text has very helpful charts which the author uses in his explanation,making the material easy for the reader to follow. I have spent over 30 years in government, and the one aspect always apparent is that the government is always looking for ways to improve performance with fewer resources, and therefore recognizes the need for activity based costing. This book is, by far, the leading reference to refer to for guidance on how to implement ABC/M. Performance measurement is getting much attention lately, and Cokins does an excellent job showing how this technique can not only improve its performance, but also improve how an organiztion displays its performance measurement. The reader does not have to be a cost accountant to comprehend the methodology or technique used to implement ABC/M. The author cites actual cases in the public sector where federal or local agencies have implemented this technique and the successes made. He begins with the issue or problem and cites the solution, the model structure used, the results, and the lessons learned. These actual case examples help show how ABC/M can resolve problems in the real world. Overall, I found this book to be an excellent resource in its field, as it is easily understood, yet comprehensive. I strongly recommend it to any government manager that wants to help their organization excel.

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  • Anonymous

    Posted October 28, 2002

    A Must -Read

    For any public sector organization considering or currently implementing activity based costing, Gary Cokins' excellent book is a must-read. Although government agencies are increasingly required to improve performance with fewer resources and recognize the need to implement a cost accounting system, there has been little published guidance on ABC applicable to the public sector. Comprehensive, well-written and easily understandable, this book exceptionally fills that gap for novice and experienced cost accountant alike. Cokins begins with a thorough introduction to the fundamentals of activity based cost management and its applicability to a government setting in such areas as outsourcing/privatization stides, fees for service, process improvement, performance measurement and budgeting. All basic concepts are covered such as views of cost assignment, cost drivers, level of data collection required and allocation of support costs. Everything is explained in easy to understand language and copiously illustrated with visuals and actual government examples. Practical advice on successful implementation and pitfalls to avoid is offered throughout. After laying a solid foundation, chapters 5-8 address other more advanced topics including utilizing ABC/M to assess quality and value, balanced scorecard performance measures, activity based budgeting, and supply chain management. Using ABC for these purposes, although probably not attainable in its initial implementation, are important to bear in mind as longer term goals. I found chapters 9-11 essential for agencies beginning ABC implementation. In Chapter 9, Cokins discusses the value of rapid prototyping with a few key employees in order to produce a repeatable, reliable and relevant production system and guides you through the process step by step. Chapter 10 presents case studies of successful ABC implementation in the public sector, and Chapter 11 discusses what you need to obtain employee buy-in. Overall, I found this book to be an exptremely valuable resource and recommend it highly.

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  • Anonymous

    Posted October 21, 2002

    A must for government managers

    A good read for government managers who want to incorporate activity based costing into their financial analyses.

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