Slides 13 2 navy research and development case

• Standard: with at least 80% accuracy • Discuss role based control issues related to support functions • Describe various allocation solutions for support functions • Calculate step-do

Identify Pitfalls in a Role Based Control Case Study Scenario

Navy Research and Development Case

Ever Wonder Why Overhead is Often

Called “Burden”?

Terminal Learning Objective

• Task: Identify Pitfalls in a Role Based Control Case

Study Scenario

• Condition: You are training to become an ACE with

access to ICAM course handouts, readings, and

spreadsheet tools and awareness of Operational

Environment (OE)/Contemporary Operational

Environment (COE) variables and actors

• Standard: with at least 80% accuracy

• Discuss role based control issues related to support

functions

• Describe various allocation solutions for support functions

• Calculate step-down allocation

SPAWAR Systems Center-Pacific

• Very high tech R&D funded by project basis

• Funding process required total cost by project for proper reimbursement

• Organized into research divisions with numerous centralized support functions

• Safety (as shown in last segment)

• Facilities (the focus of this case) and

• Many others

Proposed Change in Distribution of

Facilities Cost

• Situation: meeting at Navy R&D lab

• Reviewing a distribution of San Diego facilities cost to operating divisions

• Existing method allocated based on labor

• Proposed method allocated based on square feet occupied

Labor Basis ($M) 2.3 5.1 2.4 3.8 3.7 17.3 Footage Basis ($M) .0 4.0 4.6 4.1 4.6 17.3 Change ($M) 2.3 1.1 (2.2) (.3) (.9) -

Chaos Resulted

• Division 30 wasn’t represented as they were located

in Pennsylvania

• Division 40 didn’t say a word

• Divisions 50, 60, and 70 strongly objected to the

methodology, purpose, and change

• The meeting deteriorated until the commander

exercised his leadership role

Labor Basis ($M) 2.3 5.1 2.4 3.8 3.7 17.3 Footage Basis ($M) .0 4.0 4.6 4.1 4.6 17.3 Change ($M) 2.3 1.1 (2.2) (.3) (.9) -

Leadership Driven Management

• The Commander stated:

• “Look, we’ve got to get our overhead down”

• (Management need awareness)

• “There are two ways to do this One is to use the Soviet Method and I’ll make all the

decisions”

• (Centralized management paradigm)

Leadership Driven Management

• “The alternative is to use free market economics”

• (Decentralized management paradigm)

• “Activity based costing will tell you what things really cost”

• (Actionable cost measurement capability)

• “I’ll look to you to make the right decisions

Which do you want?”

NRaD Facilities Allocation Revisited

• Simple, direct allocation of facilities to line divisions

on the basis of occupied space made sense to the CO

• Division 40 was growing rapidly (and was short

space) while Division 50 was declining (and had a lot

of space)

Labor Basis ($M) 2.3 5.1 2.4 3.8 3.7 17.3 Footage Basis ($M) .0 4.0 4.6 4.1 4.6 17.3 Change ($M) 2.3 1.1 (2.2) (.3) (.9) -

NRaD Facilities Allocation Revisited

• HOWEVER, the Commanding Officer had a major concern about the cost model:

• Motivated line departments to reduce but

• Did not put similar pressure on overhead

• The unintended consequence would be:

• Line functions vacating space

• Overhead functions moving in

• Advanced allocation issues had to be considered

A Generic Problem: Allocating Overhead to

Overhead Functions

• Support functions support other support functions

• Payroll function serves accounting and

administration

• Personnel department consumes facilities

resources

• Accounting uses computing services

• How should this be handled?

Learning Check

• What was the Commander’s Intent for the R&D lab?

• What problems can arise when support departments support other support departments?

Allocation Alternatives

Direct, Simple

Step Down

Reciprocal

Allocation Alternatives

Direct, Simple

Step Down

Reciprocal

Allocation Alternatives

Direct, Simple

Step Down

Reciprocal

Direct, Simple Allocation

• Follows methods already covered in this course

• Allocates cost pools directly to cost objects

• Advantage: easiest to use and explain

• Disadvantage: may provide free goods to support functions

Direct Simple Allocation

Step Down Allocation

• Allocates first cost pool to other cost pools and cost objects

• Allocates second cost pool to other cost pools (less first pool) and cost objects

• Etc, Etc, Etc

• Advantage: prevents most free goods

• Disadvantage: increases the complexity and cost of cost system

Step Down Allocation

Step Down Allocation

First Step

Step Down Allocation

Second Step

Step Down Allocation

Third Step

Reciprocal Allocation

• Matrix [E] represents the vector of service costs

• Matrix [B] is the transpose of the reciprocal cost vector,

• Then: [E] = [B] [D]T

T

Simple Reciprocal Allocation Example: Two Activities and Two Cost Objects

• Payroll costs $700 and supports itself (1%), Receiving (2%), Code 30 (25%) and Code 40 (72%)

• Payroll reciprocal cost (PRC):

• Receiving costs $1000 and supports itself (1%),

Payroll (1%), Code 30 (40%) and Code 40 (58%)

• Receiving reciprocal cost (RRC):

• This gives us two equations in two unknowns

PRC = 700 + 01PRC + 01RRC

RRC = 1000 + 02PRC + 01RRC

Demonstration Problem (part 1)

• Payroll costs $700 and supports itself (1%), Receiving (2%), Code 30 (25%) and Code 40 (72%)

• Receiving costs $1000 and supports itself (1%),

Payroll (1%), Code 30 (40%) and Code 40 (58%)

• Prepare a step-down distribution allocating payroll first and then receiving

Step Down Allocation

• Step one: define the hierarchy of support

• May be based on significance (largest first)

• Or on desired behaviors (eliminate free goods)

• In our case, we want to motivate wise

consumption of payroll resources

• We will allocate payroll first

• Ignore payroll’s allocation from itself and from

receiving

• Allocate payroll to receiving and to codes 30 and 40

Step Down Allocation

Step Down Allocation

Step 2: Allocate first support activity

to support and line functions

Step Down Allocation

Step Down Allocation

Step Down Allocation

Step Down Allocation

Discussion on Step-Down

• Theoretically we would repeat the steps for each

activity in the hierarchy

• What are the implications?

• What solutions might you suggest?

Suggested Step Down Hierarchy

Suggested Step Down Hierarchy

Suggested Step Down Hierarchy

Demonstration Problem (part 2)

• Ignore the allocations from and between payroll and receiving

• Apply direct simple allocation

• Report Code 30 and Code 40 allocations cost

• Compare the results from the three methods

Direct, Simple Allocation

Direct, Simple Allocation

Direct, Simple Allocation

Direct, Simple Allocation

Compare the Three Methods

• What is the first step in the step-down allocation

Recommendations – Pitfall Avoidance

• Automated data processing

• Handle exceptions with step down method instead of reciprocal

Step Down Method Recommended

to NraD Commanding Officer

• Facility overhead first allocated to all line and

overhead functions

• Overhead functions included this cost in their

budgets and subsequent direct, simple allocations

• Small impact on cost distribution

• Significant impact on behavior

NRaD Facilities Conclusion: Results

• Leaders of core functions chose role based control process over “Soviet” Method

• Both core and support functions quickly

identified space no longer needed

• 35,000 square feet freed in first year with cost savings and cost avoidance evaluated at $2.3

million per year

• Monthly AAR still conducted 15 years later

• Why do you think this process has continued?