Implementing Activity Based Costing
for Job Shops
Presented by
Dave Lechleitner
Business Productivity Analyst
Exact Software—JobBOSS Division
Your presenter today is
Dave Lechleitner
Business Productivity Analyst
Why are we doing this
session?
Knowing your “winners” from your “losers” is
critical.
It’s not getting any easier out there—you have
to remain competitive.
Flat shop rates don’t provide a true cost picture.
ABC provides a simple approach to analyze
true cost and is now being applied even to
small job shops.
Key Questions
Why do traditional flat shop rates fall short?
What are the characteristics of shops implementing Activity
Based Costing (ABC)?
How does ABC work and how can a shop correctly and
accurately allocate activity costs to jobs?
What key tools should you look for in an ERP system to review
costs and especially application of overhead?
How should a shop implement ABC?
Why Do Flat Shop
Rates Fall Short in
Determining True Job
Cost?
Flat Shop Rate vs.
ABC
Flat shop rate costing methods were generally developed when
a shop owner first started the business and may have
increased or decreased based on “gut feel” or “what the
market may bear.”
Normally includes some provision for profit “built in.” Hides the
real picture of what is going on.
Generally has no basis on reality of the true cost structure of
the shop.
Inherent problem in a flat shop rate is that it has an averaging
effect. Difficult jobs are under-quoted/costed and easy
jobs are over-quoted/costed.
Flat Shop Rate vs.
ABC
Flat Shop Rate vs.
ABC
Two employees
VERY different cost
structure
Employee
#1
Employee
#2
Flat Shop Rate vs.
ABC
Opponents of ABC often fall prey to the following arguments or
behavior-•
We don’t charge THAT cost to the customer because the
customer won’t pay it (i.e. engineering, quality control, customer
service, etc.)
•
We can’t win the job quoting our actual cycle times so let’s
“fudge” the cycle times to get the price the customer will pay.
•
We have to sharpen our pencils and lower our cost estimates
(i.e. ignore the real costs and put down anything to get to the
price the customer will pay.)
Characteristics of
Shops Implementing
Activity Based Costing
Shop Characteristics
“Activity Based Costing is 30% understanding and
using techniques correctly, and 70% the ability to
convince others to accept beneficial change. No
matter how brilliant the measurement, if people
reject it, nothing has been achieved and the
analyst has failed.”
-- Ralf Sorenson (Head of SAS Airlines)
Shop Characteristics
Has your time come to evaluate a new method of
measuring and collecting data as it relates to job
costing? It has if. . .
1. Your shop is implementing new, technologically
advanced processes into your operations without
making adjustments to your costing processes.
2. You only currently use one basis for charging
manufacturing costs to products—direct labor
hours, direct labor dollars, machine hours.
Shop Characteristics
3. You have only one plant wide overhead rate, a
couple of rates, or worse—no overhead rate at
all.
4. You automatically change costing rates as
volume levels change.
5. You find yourself competitive in one product line
but not another or at one volume level but not
another.
Shop Characteristics
6. Your shop manufacturing operations do not
always require the same number of operators—
partially attended operations or team
operations—or one employee operating a work
cell.
7. It has some customers, markets, or product lines
that require different levels of selling, scheduling,
service, or other support activity but only have
one company wide G&A rate.
What is ABC and How
Can Shops Accurately
Allocate Costs
What is ABC?
Very simple concept and key management tool.
•
Jobs and contracts require a company to
perform activities.
•
Activities cause a company to incur cost.
•
Cost should be associated with jobs and
contracts that made the activity necessary.
What is ABC?
Resources
Activities
Cost Objects
What is ABC?
So, how does ABC work?
•
Identification of “cost pools” or activities which a
product/service must pass.
•
Estimation of total cost of each activity must be estimated
for time period.
•
Estimation of number of hours spent on each activity for
same time period.
•
Determination and assigning of “cost driver” (i.e. quantity,
# of labor hours, # of machine hours, # of parts).
How Does a Shop
Allocate Costs?
• Project a normal level of production
activity.
• Review over a longer period of time, such
as a 12-month period.
• Costs based upon shorter periods, such
as weekly or monthly periods, may
fluctuate too much.
How Does a Shop
Allocate Costs?
Assign costs that are directly attributable to a job
and not subject to ABC cause/effect analysis
Direct labor (use actual employee rates)
Raw material
Purchased components
Outsourced manufacturing services
Perishable tooling consumed on a job
How Does a Shop
Allocate Costs?
Determine the costs associated with Operational
Support Activities—Manufacturing Overhead
•
Buildings and grounds
•
Human resources—administrative staff required to
support employees performing direct activities
•
Maintenance
•
Plant supervision and production control
How Does a Shop
Allocate Costs?
Determine the costs associated with Customer
Support Activities and Other
General/Administrative Overhead
•
Different markets or customers may require different
effort to get new business or maintain existing
•
Customer service activities– customers who are
“jerks” often cost more to maintain than “sweethearts”
•
Accounting
•
Sales and marketing
Example
of Indirect
Shop
Expenses
over
previous
12
months
Allocation Calculation
• Determine a best method for allocating
the costs by type of activity—remember
to use the driver of the cost as the basis.
– Percentage of direct labor dollars
– Dollar rate per direct labor hour
– Dollar rate per machine hour
Allocation Calculation
• Using the same $1,000,000 of expenses
for the last 12 months.
• Break expenses out by burden type:
– Labor burden
– Machine (Manufacturing) burden
– G&A (General & Administrative) burden
Allocation Calculation
• Same $1,000,000 of expenses allocated by burden
type.
• Labor Burden ($300,000) + Machine Burden
($500,000) + General & Administrative Burden
($200,000) = $1,000,000.
Allocation Calculation
• Costs divided by shop hours of operation.
Tools Available in ERP
Systems to Analyze
Costs and Application
of Overhead
ERP System Tools
According to NTMA
Key Principles of an ERP System
1. Assign a unique job (work order) number for each part
number on an order you receive.
2. Identify customer, part, and delivery information on the
order.
3. Post cost of material at the time it is purchased and
received or drawn from stock.
4. Post all outsourced processing expenses to the order.
5. Post hours and rates for direct labor hours and
machine hours to the order when they occur.
6. Assign manufacturing, selling, and general and
administrative overhead to order on proportionate
basis—key to ABC.
ERP System Tools
ERP System Tools
• ERP systems should give you the option to use
Actual Employee Rates to drive true ABC
• Application of labor overhead by percentage
yields better results if you have wide variances in
employee wages and fringe benefits
ERP System Tools
• Once true cost is established, ability
to define global markup or profit
goals is practical
ERP System Tools
• Should allow ability to define markup
or profit goals specific by quoted
quantity and specific part
ERP System Tools
• Ability to review estimated, actual, and
variance against direct labor and
overhead/burden costs at end of job.
ERP System Tools
• Review profitability against order,
produced, and shipped quantity
ERP System Tools
• Catch your “losers” before they get out
of control—before it’s too late!
ERP System Tools
• Regularly monitor your allocation of
your costs against the activities that
drive them.
How Should a Shop
Implement ABC?
Implementing ABC
• Determine your present expertise level
in ABC and commitment to it
• Determine cost in both time (effort) and
money
• Determine a timeline for completion—
beginning of a new fiscal year is perfect
time
• Select a project lead
• Establish a pilot project
• Determine action plan after pilot
Implementing ABC
Is it worth it?
• For most mid-sized manufacturers an
ABC analysis can be conducted for as
low as 0.08% of total sales for small this
may creep as high as 0.3%.
• Most companies realize an ROI in as little
as 1 – 4 months with benefits that
continue to grow over time.
Implementing ABC
• High-powered decision making tool for
managers and owners
• Remember…not a system but a concept
to embrace and encourage
• Doesn’t have to be complex…so take
small steps
Implementing ABC
Resources
Costing, Pricing, and Financial Management
-- Published by the National Tooling & Machining Association
(www.ntma.org)
The ABCs of Activity Based Costing
-- MMS Online, Mark Albert (Article #119803)
Activity Based Costing for Mold Shops—Parts I – III
-- Moldmaking Technology (October – December 2004)
Costing Traps for Manufacturers
-- Manufacturing Engineering (December 1998)
Key Questions
Why do traditional flat shop rates fall short?
What are the characteristics of shops implementing Activity
Based Costing (ABC)?
How does a ABC work and how can a shop correctly and
accurately allocate costs to jobs?
What key tools should you look for in an ERP system to review
costs and especially application of overhead?
How should a shop implement ABC?
If you have additional questions,
JobBOSS Customers
contact your Customer Advocate
Prospects contact your Sales
Rep
1-800-777-4334