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Whether you believe it or not, the way
you measure your company affects your company. In the United States
we measure profitability, and as a result, much of our efforts are
centered around maximizing profitability. In Japan, the focus is on
market share, and as a result Japanese companies will go to great
lengths and expense in order to gain market share. For example, a
Japanese company may break even one year, but if the market share
increases by a fraction of a percentage, then the company
celebrates. Under communism, companies in Russia measured themselves
based on materials consumed. The general idea is that if more
materials are consumed, then more Russians are employed mining or
harvesting those raw materials, packaging those raw materials, or
transporting those raw materials, etc. Reportedly one Russian
company was honored for doubling it’s consumption of raw materials.
The company made camping gear and when an engineer redesigned the
gear to be twice as thick, the company ended up selling about the
same amount of gear, but because more raw materials were consumed in
the process, the results were considered a success. Meanwhile,
Russians are hiking around with twice as much weight on their backs.
My point is that
measurement does have an impact on results. If you measure your
employees based on hours worked, they will most likely work longer
hours. If you measure them on new customer sales, they will most
likely work harder to generate new customer sales. Here in the
United States, we rely on a measurement concept called “Historical
Cost Accounting”. When consistently applied across the country, this
standard does help Wall Street to compare one company to another to
a certain degree. However “Historical Cost Accounting” is severely
flawed because it usually does not reflect reality. For example,
today it is common to see a company value land on their balance
sheet at $1 million even though it is worth $50 million or more.
Similarly, our depreciation and amortization standards often do not
reflect reality as well.
So what is the
answer? Many experts believe that the best method for measuring a
business may be "Activity Based Costing". Some accounting software
products such as SAP, Syspro IMPACT Encore, and Deltek offer strong
ABC accounting. This method is described and discussed below.
Activity
Based Costing (ABC) Defined - Activity
Based Costing is a method for estimating costs for specific
activities within the organization. For example, a contractor may be
interested in determining how much it costs one work crew to install
shingles on a house compared to a different work crew. Or, the
contractor may be interested in determining how much it costs to
install shingles on a certain house design, compared to a different
house design.
To better
understand Activity Based Costing it is sometimes helpful to think
in terms of subdivided a project into discrete, quantifiable
activities or phases. The activity needs to be definable where
productivity can be measured in units (e.g., number of hours work
compared to units produced, square footage completed, or volume
generated, etc).
As the project is
segmented into its activities, a cost estimate is typically prepared
for each activity. These cost estimates will typically contain
labor, materials, equipment, and subcontracting costs, including
overhead, for each activity. Each activity cost estimate is added to
the others to produce an overall cost estimate for the entire
project.
How Activity
Based Costing is Applied
The results
generated by Activity Based Costing methods are frequently used to
produce reasonable standards on which future estimates can be
calculated. For example, for years construction firms and industry
trade groups have collected cost data on a wide array of
construction projects. The amount of hours associated with those
costs were also collected. As an example, this data included the
cost of the paint, labor, equipment, and overhead to paint a room,
the amount of surface area painted, and the manpower required to
paint the room. This practice has allowed contractors to calculate a
cost per area and manpower per area. These costs are based on an
activity, such as painting, and are known as ABC.
Activity Based
Costing methods are also used to evaluate specific activities within
an organization to determine whether those activities are being
conducted efficiently, whether those activities are necessary,
whether other groups within your organization are performing those
activities better than others, whether certain materials or tools
help your organization complete those activities more efficiently,
etc.
For more detailed
information on Activity Based Costing, you might find the following
link helpful:
http://www.directives.doe.gov/pdfs/doe/doetext/neword/430/g4301-1chp24.pdf |
