Slides calculate cost of a service and job with multiple cost

Calculate Cost Of A Service/Job With Multiple Cost Pools/Drivers Principles of Cost Analysis and Management © Dale R... Terminal Learning Objective• Task: Calculate Cost Of A Service/Job

Calculate Cost Of A Service/Job With Multiple Cost

Pools/Drivers

Principles of Cost Analysis and Management

© Dale R Geiger 2011 1

Why did this cost measurement method fail?

Thank You

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Total $160.00

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Carol

Alice

Terminal Learning Objective

• Task: Calculate Cost Of A Service/Job With Multiple Cost Pools/Drivers

• Condition: You are a cost advisor technician with access to all

regulations/course handouts, and awareness of Operational Environment

(OE)/Contemporary Operational Environment (COE) variables and actors

• Standard: with at least 80% accuracy:

• Distinguish drivers as transactional, duration, or intensity

• Describe need for homogeneity in pools/drivers

• Describe need for correlation between pool and driver

• Select suitable driver for cost pool 

© Dale R Geiger 2011 3

Assumptions

Homogeneity and Averaging

consume resources equally

buildings consume facilities resources equally

© Dale R Geiger 2011 5

Homogeneity and Averaging

• To simplify the allocation process

• To minimize the cost of measurement

• To avoid detailed record keeping for every cost object

Types of Cost Drivers

• Unit-based:

© Dale R Geiger 2011 7

Types of Cost Drivers

• Duration-based:

Types of Cost Drivers

• Intensity-based:

© Dale R Geiger 2011 9

Cause and Effect Relationships

• Increasing driver usage will cause more consumption of resources

• Decreasing driver usage will cause less resource consumption

• Allocating cost based on this driver will reflect the underlying economics of cost

consumption and approximate true cost

Cause and Effect Relationships

• Managing the driver usage will result in managing cost

• Instead of over-consuming goods and services that appear to be free or low-cost

© Dale R Geiger 2011 11

Common Examples of

Cause - Effect Cost Drivers

Check on Learning

will also decrease

© Dale R Geiger 2011 13

Contracts Office Case

• The contracts office at Fort Apache incurs annual costs of $1 million These costs are

currently distributed to companies A, B, and C on the basis of their number of

soldiers

• How much is each company allocated?

Company A

Company B

Company C Number of

Contracts Case: Questions

© Dale R Geiger 2011 15

Contracts Case: Results

Company A

Company B

Company C Number of

Contracts Case:

Discussion Questions

© Dale R Geiger 2011 17

Contracts Office: Case B

• Company C’s captain finds his allocation unacceptable He rejects being charged $450K when he does not have any contracts and suggests using number of contracts as the cost driver.

• How is cost allocated with this cost driver?

Contracts Case B: Questions

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Contracts Case B: Results

Balloon Squeezing

• If one command’s allocation goes DOWN by $1000 Then

• Someone else’s allocation has to go UP by $1000

• (Zero sum game requires support of top management in order to succeed)

© Dale R Geiger 2011 21

Contracts Case B: Discussion Questions

resources?

Contracts Office: Case C

• Company B labels these results wrong and points out that its contracts are relatively

simple and that it always complies with contracts’ procedure and lead time requests The Company CO suggests that a survey of contracts’ efforts be used as the cost driver.

• How are costs allocated on this basis?

© Dale R Geiger 2011

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Contracts Case C: Results

• Who do you think is upset now?

Contracts Office: Case D

• Company A argues strongly that it cannot afford $600k for contracts without

compromising its mission The company CO, the most senior and forceful of the

company CO’s, demands that “something fair, like the number of soldiers wearing

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Contracts Case: Results

Cost Consumption Method Results:

Cost Driver Distribution Profiles:

Contracts: Discussion Questions

• (Never forget that we accountants are trained to deal with nonsense)

• If you are any of the company commanders?

• If you are the installation commander?

© Dale R Geiger 2011 27

Driver Selection:

Issues to Consider

• Less driver causes less resource

• More driver causes more resource

• Cost conscious managers will work to reduce the driver

• Does less driver benefit the organization?

Contracts Case: Lessons

• So count on them

• Design system to motivate desired behavior

© Dale R Geiger 2011 29

Check on Learning

Why Level of Effort Analysis?

• Less true in manufacturing

• Very true in service

• Produces a customized driver of reasonable accuracy allocation

based on cost driver

© Dale R Geiger 2011 31

Overhead: Likely Candidate for Level of Effort (LOE)

• Work Usually Specialized and Not Consumed Uniformly by Line Organizations

• Like the Contracts Office

• i.e Square Feet, Direct Labor Hours, Mileage, etc., Do not Adequately Correlate to Cost Object Consumption of Overhead Resources

Developing LOE as a Driver

Cost Object if Activity was a Business and Cost Object was a Customer

© Dale R Geiger 2011 33

Precision and LOE

Beneficial By-Products

• It’s easy for staff to think they are line

line customers as paying the bills

© Dale R Geiger 2011 35

Level of Effort Example

• Staff manager has good idea of where people work and who they support

• The bottom line represents a “proportional” method allocation basis for the staff

Don’t Forget Homogeneity Assumption

• Effort costs the same for each person

• Other costs proportional to people

• Use weighting factor, or

• Make two separate activities if bias is significant

© Dale R Geiger 2011 37

Random Error

• Random error tends to offset

• This error is probably not significant

• Both LOE estimates capture the major effects

updown

Criticism of Level of Effort

• Recent problems are fresh in mind

• Suppose C had a big problem last month

• Produces significantly more error

updown

Example: Returns Driver in IRS Audit Office

IRS Quality Control

Level of Effort Analysis

5.0 2.0 0.8 0.0 7.8 28.8

5.0 5.5 0.8 0.0 11.3 41.8

0 0 0 0 0 0

0.0 4.0 0.4 0.0 4.4 16.3

1.0 0.5 0.0 2.0 3.5 12.9

people complex corporate other simple other individual individual districts

© Dale R Geiger 2011 41

corporate complex other simple other

individual individual districts

Cost of a Job

Cost of a Job

Cost Driver Analysis

Cost Driver Analysis

Cost of a Job

Allocation Spreadsheet

Enter activities and cost driver data as shown

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• How might this shift affect management decisions?

Practical Exercise

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