Activity Based Costing SHOW SLIDE 1: Activity Based Costing SECTION I. Activity Based Costing ADMINISTRATIVE DATA All Courses Including This Lesson Course Number Version Course Title 01 Planning Programming Budget & Execution Course (PPBE) Academic Hours The academic hours required to teach this lesson are as follows: Resident Academic Hours/Method 0.1 hrs Introduction 2..2 hrs Large Group Instruction 0.6 hrs Practical Exercise 0.7 Summary 3.0 min Conference/Discussion Test Lesson Number Testing(to include test review) Hours -0 hrs Lesson Number - Prerequisite Lesson(s) Lesson Number Lesson Title Clearance Access Security Level: Unclassified Requirements: There are no clearance or access requirements for the lesson. Foreign Disclosure Restrictions FD5. This product/publication has been reviewed by the product developers in coordination with the Fort Jackson Soldier Support Institute foreign disclosure authority. This product is releasable to students from all requesting foreign countries without restrictions. Instructor Requirements Must meet physical qualifications IAW AR 600-9. Materials Required Instructor Materials: Lesson plan slides, DFAS-IN Regulation 37-1, DFAS-IN-MANUAL 37-100-FY, Instructor copy  Student Materials: Activity Based Costing, Practical Exercise #1 and #2, calculator and pencils. Classroom, Training Area, and Range Requirements General Purpose Classroom - 25 Seats Instructional Guidance Note: Before presenting this lesson, instructors must thoroughly prepare by studying this lesson and identified reference material. Also, provide the students with situational awareness of the Operational Environment (OE) variables and actors. Proponent Lesson Plan Approvals Name Rank Position Date Harris, Norman CTR Writer/Developer xx-xxx-xxxx Bonig, Reid GS-12 Chief - FMITD xx-xxx-xxxx Davis, Bobby LTC FM-DOT xx-xxx-xxxx Zellars, Eric COL Commandant xx-xxx-xxxx Show Slide 2 NOTE: Incorporate the political, military, economic, social, information, infrastructure, and physical environment and time (PMESII&PT) into each lesson and classroom work as appropriate. Instructor will illustrate them with appropriate examples from the Current Operating Environment (COE) as it pertains to the lesson. Motivator: As a resource manager, it is important to know where and how your organization fits into Planning, Programming, Budgeting and Execution process. To succeed, you must know the DoD, DA, and ASA(FM&C) organization structures. Knowledge of these structures will enhance your understanding of how resources are allocated and how resource management structures influence or facilitate resource allocation. Military commanders have always been concerned with cost (at least the good ones were). However, they looked at cost in terms of men and equipment. Today’s commanders must also consider cost in terms of resources, or more precisely, dollars. Reduced resources mean that management of resources is more important. The capability to measure cost is a prerequisite to cost management. When working budgets you want to track the resources that are consumed to the activities being performed that provide a product or service. The question you’re trying to answer is what or who is causing me to utilize and consume my resources. Traditionally cost accountants have arbitrarily added a broad percentage of expenses onto the direct costs to allow for the indirect costs. However, as the percentages of indirect or overhead costs have risen, this technique became increasingly inaccurate because the indirect costs were not caused equally by all the products. Traditional costing systems are often unable to determine accurately the actual costs of production and of the costs of related services. Consequently managers were making decisions based on inaccurate data, especially where there are multiple products. The concepts of ABC were developed in the manufacturing sector during the 1970s and 80s. Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products. We use ABC as a cost measurement tool to help understand costs and make informed decisions on funding programs and activities.

Terminal Learning Objective Action: Conditions: Standard: Conduct Activity Based Costing (ABC) Given a summary sheet containing DFAS-IN Manual 37-100, DFAS-IN Reg 37-1, and slides. With 80% Accuracy: Administer an Activity Based Costing (ABC) analysis; and integrate cost allocation. SHOW SLIDE 2: Terminal Learning Objective SAFETY REQUIREMENTS. In a training environment, leaders must perform a risk assessment in accordance with FM 5-19, Composite Risk Management. Leaders will complete a DA Form 7566 COMPOSITE RISK MANAGEMENT WORKSHEET during the planning and completion of each task and sub-task by assessing mission, enemy, terrain and weather, troops and support available-time available and civil considerations, (METT-TC). Note: During MOPP training, leaders must ensure personnel are monitored for potential heat injury. Local policies and procedures must be followed during times of increased heat category in order to avoid heat related injury. Consider the MOPP work/rest cycles and water replacement guidelines IAW FM 3-11.4, NBC Protection, FM 3-11.5, CBRN Decontamination. No food or drink is allowed near or around electrical equipment (CPU, file servers, printers, projectors, etc.) due to possible electrical shock or damage to equipment.  Exercise care in personal movement in and through such areas.  Avoid all electrical cords and associated wiring.  In event of electrical storm, you will be instructed to power down equipment. Everyone is responsible for safety.   RISK ASSESSMENT LEVEL. Low. ENVIRONMENTAL CONSIDERATIONS: Environmental protection is not just the law but the right thing to do. It is a continual process and starts with deliberate planning. Always be alert to ways to protect our environment during training and missions. In doing so, you will contribute to the sustainment of our training resources while protecting people and the environment from harmful effects. Refer to FM 3-34.5 Environmental Considerations and GTA 05-08-002 ENVIRONMENTAL-RELATED RISK ASSESSMENT. EVALUATION. You will be given an exam which will cover Activity Based Costing. A passing score on this examination is 80% and for International Students (70%). INSTRUCTIONAL LEAD-IN. Your responsibility is for understanding Activity Based Costing. Activity Based Costing is a method to allocate cost to different processes both in the private sector and in the government. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Introduction Inability to Manage Cost Well Will Result In Excessive Loss of Combat Capability SHOW SLIDE 3: Introduction Concrete Experience (05 minutes) The concrete experience serves as a trigger of past experience, knowledge, and it is also a focusing mechanism for the lesson that follows to support the teaching of new content. The collective intent is to force the student to connect to the lesson and is the precursor to intuitive thinking of experiential learning model. Concrete experience: Q. What was going on during the 80s that caused bad habits in spending for Defense? Cold War. Q. What was President Reagan trying to do, and what was his objective? A. Nuclear Arms Race trying to outspend the Soviets and collapse their economy. Q. Did it work? What happened on November 1989? Fall of the Berlin Wall. Q. Besides the Gulf War, what else happened in 1991? A. The Soviet Union collapsed. December 8, 1991 the Commonwealth of Independent States was formed out of what used to be the Soviet Union. So, President Reagan did indeed achieve his objective although it happened after his Presidency. In the 1990’s, we moved out of the Cold War mentality. The resources that were relatively plentiful during the Cold War years under President Reagan were no longer so readily available. After 9/11, the military again was operating with relatively unlimited resources. However, as GWOT /OCO continues, the public has become war weary and Congress has begun scrutinizing defense budgets. In order to maximize resources we need to have an understanding of what things cost in order to reduce cost and find ways to execute our missions more efficiently. Otherwise, we are poised to lose funds, which will result in a loss of combat capability. Managing costs will become much more important for next couple years. Mr. Stephen G. Barth, the Deputy Assistant Secretary of the Army for Cost Analysis (also heads up the United States Army Cost and Economic Analysis Center) is pushing a Cost Culture from the top Army leadership down to the lowest levels to make us focus more on the money we are spending and gaining efficiencies where possible. Discuss the bridge between the question and lesson to help the students understand the importance of relating past experience to current situations. Instructor Note: To open the discussion canvas the class to see how many have deployed. Find out what they did on the deployment. Publish and Process (15 Minutes) During this phase of the Army Learning Model the instructor will solicit responses of the student’s reaction to the concrete experience. The students will reflect on their experience and knowledge of the topic and they will begin a reconciliation of where they are and, if successful, where they will be at lesson end. The critical portion of this part of the ALM process is to force the students to reflect. As the instructor you can achieve this by asking a series of thought influencing questions, for example: What happened in the video/skit/slide and how could it relate to this lesson? How did it make you feel about the personal responsibility that must be taken to mitigate causing undue hardship to Soldier’s and their Family’s? What did you hear/see that makes you relate it to your own experiences? What was your reaction to the magnitude of miscues? Having the students think critically is the ultimate goal of publish and process. Force the students to explain their answers; meaning, how and why did they arrive at the solution to the questions. As the instructor, you should also be looking for responses that will help the student’s transition from publish and process to generalize new information. During this process, remind the students of lesson objectives as they transition from publish and process into generalize new information. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Consider the Alternatives to Meet a 10% Budget Cut Ineffective: Cut 10% of the Budget Spent on Oil and Lubricants Eliminate Combat Effectiveness Mindless: Salami Slice All 10% Reduce Combat Effectiveness 10%????? Rational: Manage Cost Smarter Maintain or Increase Combat Effectiveness SHOW SLIDE 4: Consider the Alternatives to Meet a 10% Budget Cut The question is not whether the budget cuts are coming but how to deal with them. This slide shows a few of the common ways the Army addresses budget cuts. The first alternative is to cut the budget for oil and lubricants by 10%. This would be rather ineffective because you’ll end up with all your vehicles parked in the motorpool for the last quarter of the fiscal year. The second alternative is to execute a 10% across the board cut to all units and activities. The problem is, who’s worse off , the unit that has a 10% cut of a $1 million budget or the unit that loses 10% of a $100,000 budget. There really isn’t any way of knowing unless you know what you’re cutting. The preferred way to deal with a 10% cut would be to improve productivity by 10%. Therefore, the third alternative is manage your costs smarter. If you can identify what your costs are, then maybe you can find efficiencies that will save money and you can alleviate some of the pain of the 10% cut. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Chief Financial Officers Act Billions Of Dollars Lost Each Year Through ... Mismanagement Losses Could Be Significantly Decreased By Improved Management Great Need Of Fundamental Reform In Financial Management Current Practices Do Not Provide Timely Information Required For Efficient Management SHOW SLIDE 5: Chief Financial Officers Act of 1990 Look at these statements from the Findings Paragraph of the Chief Financial Officers Act of 1990: Billions Of Dollars Lost Each Year Through ... Mismanagement Losses Could Be Significantly Decreased By Improved Management Great Need Of Fundamental Reform In Financial Management Current Practices Do Not Provide Timely Information Required For Efficient Management In this Act: - Congress requires federal agencies to name a Chief Financial Officer to promote financial management and to develop the information needed for better financial management. Congress’s focus on management is obvious. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Cost Management Requires Cost Measurement Management Must Have Cost Measurement to Fight Cost War Cost Measurement Informs Management of Financial Implications of Management Decisions Is Prerequisite to Cost Reduction Eliminates Free Goods Facilitates Best Use of Limited Resources SHOW SLIDE 6: Cost Management Requires Cost Measurement Cost measurement is an important strategy for fighting the cost war. Resource Managers must have an understanding of cost in order to make financially sound decisions. In addition, management can’t reduce costs without first knowing what things cost. Good cost measurement will eliminate free goods. It will also help managers make best use of limited resources by giving them a criteria (cost) for decision making. You don’t want to be saying - “If I had known what this would really cost……” Why have cost measurement and management? - Cost Measurement informs Management of the Financial Implications of Management Decisions. Cost measurement is a Prerequisite to Cost Reduction It eliminates Free Goods It Facilitates Best Use of Limited Resources 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Cost Information Enables Efficient Use of Resources Which Metal is Best for Transmission? Metal A Metal B Metal C SHOW SLIDE 7: Cost Information Enables Efficient Use of Resources Which should you choose? Without cost information - choose Metal C for all power lines since it has the highest conductivity. What if you know that Metal A is copper, Metal B is silver, and Metal C is gold? Although gold has a higher conductivity, is it cost effective to use gold for all power lines? If you Choose A (Copper Wire) - a certain amount of energy will be lost due to resistance in the copper wire. However, the cost of the lost energy does not justify using the gold wire. Maybe you want to split the difference between quality and cost and choose silver. So cost information is necessary if you want to efficiently use your resources. Conductivity + ++ +++ 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

ABC: a Self Made Tool for Managerial Cost Accounting Seek To Understand True Economic Cost Based on Cause-Effect Relationships Reflecting Drivers of Resource Consumption With Reasonable, But Not Precise Accuracy Promote Better Resource Management Eliminate Free Goods Stimulate Behavioral Change Enable Accountability for Cost Management SHOW SLIDE 8: ABC: a Self Made Tool for Managerial Cost Accounting The cost managing method the Army chose is ABC. ABC has two goals: The first goal is to help managers understand true cost. It does this by looking at the cause-effect relationships between cost drivers and resource consumption. It gives a true picture of cost with reasonable accuracy, while avoiding overly detailed precision. The second goal is to promote better resource management. Understanding true cost promotes better resource management by eliminating free goods, and thereby stimulating desired behaviors. Activity Based Costing also gives managers the basis for assigning accountability for cost management decisions. Activity-Based Costing encourages managers to identify which activities are value-added—those that will best accomplish a mission, deliver a service, or meet a customer demand. It improves operational efficiency and enhances decision-making through better, more meaningful cost information. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

managerially useful information A Broad Definition of Managerial Costing raw accounting data managerial costing translation managerially useful information SHOW SLIDE 9: A Broad Definition of Managerial Costing ABC is a tool used to conduct managerial costing. Managerial costing translates raw accounting data into managerial useful information. Why is this translation important? We want to know who or what is consuming our resources and charge them for it. It also allows us to make decisions based on our accounting data. Some examples of Raw Accounting Data is labor, overhead, materials, and supplies. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Why is This Translation Needed? Accounting Systems Usually Measure Input or Source Costs Labor, Overhead, Materials Salaries, Benefits, Supplies, Contracts Managers Want Measurements Based on Output or Consumption Product, Service, Project Consuming Organization, Customer SHOW SLIDE 10: Why Is This Translation Needed? The translation is needed because accounting systems measure input or source costs and managers need cost information based on output or consumption. If your company produced 3 types of tires and one type of tire consumed a large amount of resources and the output/profit margin was low management would need this information to make future decisions. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Managerial Costing Terms managerially useful information raw accounting data cost pool managerial costing translation method of distribution = SHOW SLIDE 11: Managerial Costing Terms ABC Basic Premise Cost objects consume activities Activities consume resources This consumption of resources is what drives costs Understanding this relationship is critical to successfully managing overhead In terms of ABC: Raw accounting data = Cost pool Managerially useful information = Cost object Managerial costing translation = method of distribution managerially useful information cost object 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Terminology (1 of 4) Cost Pool: An Aggregation of Incurred or Source Costs to be Distributed Examples: Salary and Benefits, Supplies, Travel, etc. in Airfield Operations Center Utility Bills for Garrison cost pool SHOW SLIDE 12: Terminology (1 of 4) Activity Cost Pool - A grouping of all cost elements associated with an activity. An activity is a set of tasks, like provide police patrols, that would include cars, POL, officers, materials, etc. Activity cost is the full cost of performing an activity. In practice, organizations have many activities and have to combine activity costs into a few Cost Pools. The pools are distributed to cost objects in proportion to cost drivers. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Terminology (2 of 4) Method of Distribution: The Mechanics of Deriving Management Information from the Cost Pool Example: Determine Unit Cost By Adding All Input Costs and Dividing by Number of Units method of distribution SHOW SLIDE 13: Terminology (2 of 4) Method of Distribution is the mechanics of deriving management information from the cost pool. It is how you divide up the costs. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Terminology (3 of 4) Cost Driver: Good cost drivers distribute cost based on cause and effect, reflecting true cost consumption by a cost object Examples: Activity Cost Driver Heating Square Footage Personnel Training Hours Accounting Reports requested Activity Cost Pool allocation based on cost driver SHOW SLIDE 14: Terminology (3 of 4) To divide up costs we use “cost drivers”. Good cost drivers distribute cost based on cause and effect , reflecting true cost consumption by a cost object. The measure of the use of a shared activity by each of the products is known as the cost driver. The Cost Driver is any activity that causes a cost to be incurred. cost object 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Terminology (4 of 4) Cost Object: The product, service, or object that created the costs Examples: 120mm Tube Product Cost Morale, Welfare, Recreation Cost Financial Management School Cost SHOW SLIDE 15: Terminology (4 of 4) Cost Object is the product, service, or object that created the costs. As in, what made the total costs? Examples: 120mm tube cost is a product cost MWR and Financial Management School costs are service costs A cost object is a tangible input for a product manufactured, or service provided, like labor or material. For example, a cloth manufacturing firm requires some amount of predetermined labor and predetermined raw material for any amount of cloth being manufactured. The cost of employing labor can be directly fixed as “per man, per day”, so the labor is a cost object as you can directly associate cost with it. Similarly, the raw material like cotton or threads or fabric can be another cost object. Other examples may include services taken by another firm, for example a transportation company or service can be a cost object. Generally, the cost object term is used for fixed cost components of total cost. Otherwise, anything which is incurring some cost can be called a cost object, like an Advertisement. cost object 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Alternative Methods of Distribution Managers Can Obtain the Needed View of Cost in Several Ways Guessing: Gut Feel of Cost Distribution Direct Costing: Detailed Record Keeping of all Incurred Cost Transactions by Every Cost Object Allocation: Distribution of Cost Pool in the Same Proportion as a Cost Driver SHOW SLIDE 16: Alternative Methods of Distribution Remember those Cost drivers… Now that we have looked at the terminology lets go back and look at methods of cost distribution. Lets use the example of heating costs for buildings: We could guess how much cost to distribute to each building. (Not accurate) We could apply direct costing by keeping detailed records on the heating cost for each building (separate meters). ( Costly) We could distribute heating cost based on the cost driver of square footage. (Best) 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Most Systems Combine Methods cost pool detailed record keeping allocation based on cost driver SHOW SLIDE 17: Most Systems Combine Methods Most systems of cost distribution combine methods. You want to allocate based on a cost driver but you want to make sure that people are really paying what they should and not punishing those that aren’t Some offices are larger and tend to always be cold, while other small offices will be like a sauna. Should you make the larger office pay for the smaller ones heat? cost object 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Choosing a Method of Distribution Use Guessing for Simple Decision Making Keep Detailed Records When Accounting Cost is Low and High Accuracy Useful Allocate Overhead, Support, and Indirect Costs When Appropriate Consider Management’s Needs for Precision and Timeliness SHOW SLIDE 18: Choosing a Method of Distribution When determining the best method of distribution guessing is good for simple decision making but not very accurate. Direct costing involves keeping detailed records and is extremely accurate but costs can be high for this method. Allocation is good for overhead, support, and indirect costs but make sure a good cost driver is selected. The best method depends on whether exact precision or timeliness is more important in your organization. We will work a PE in this area later. Let’s decide which method for the example on the next slide? 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Discussion: Telephone Charges Should These be Allocated or Charged Via Detailed, Call-by-Call Records Issues to Consider What Does Management Need? Is Telephoning a Core Mission or Support Function? Are Detailed Records Available? SHOW SLIDE 19: Discussion: Telephone Charges Ask the students what they think. You’ve got four offices and each have a phone. Should telephone charges be allocated evenly or charged via detailed records, call-by-call? It depends…. If telephone charges are extremely important to management and a high cost area for the company, then probably detailed record keeping would be best to distribute cost. If telephone charges are low and not very important to management, allocation would be best. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Two Allocation Methods Rate Method: Uses a Computed Rate per Driver Unit Proportion Method: Computes a Proportional Share of the Total Cost Based on Driver Usage SHOW SLIDE 20: Two Allocation Methods The two allocation methods are rate and proportion. They both yield the same results and represent the same underlying algebra. Lets take a look at the formulas for both and an example. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Reconciling the Two Methods Rate Method Total Cost Pool Total Number of Driver Units Equals SHOW SLIDE 21: Reconciling the Two Methods This is the example we will follow for the next couple of slides. Example: (Write on Board) 4 people went out for dinner. The total cost of the bill was $160.00. The cost pool was the dinner check. The cost objects were the four people who ate dinner. The cost driver was the eaters. Using the rate method the total cost pool was $160.00 and the total number of driver units is 4. 4 divided by 160 is a rate of $40.00 per eater. Using the proportion method, number of driver units used is 1 and the total number of drivers is 4. 1 divided by 4 is .25 or 25%. The proportion each will pay is 25% of the total cost pool. 2 Methods giving the same result Proportion Method Number of Driver Units Used Total Number of Driver Units 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Split the Dinner Check Saluda’s Fillet and Lobster 35.00 Chicken Kiev 15.00 Top Sirloin 20.00 Caesar Salad 9.00 Coffee 2 @1.00 2.00 House Wine 4 @5.00 20.00 Champagne 24.00 Ice Cream 4.00 Chocolate Cheesecake 6.00 Sampler 10.00 Soup/Salad 8.00 Aperitif 7 .00 Total $160.00 Carol Alice SHOW SLIDE 22: Split the Dinner Check We will continue to look at this example using snap shots of an excel spreadsheet. Bob, Ted, Carol and Alice went out to dinner and decided to split the dinner check of $160.00. Thank You Bob Ted 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Allocation by Proportion 1. Determine Proportion of Consumption Usage by Cost Object ÷ Total diners = % Bob 1 4 25% Ted Carol Alice 100% 2. Multiply Proportion by Total Cost Cost Object % x dinner check Allocation 160 40 $ SHOW SLIDE 23: Allocation by Proportion Lets use the Proportion Method to determine how much of the dinner check will be allocated to each person or cost object. We said the formula was: Number of Driver Units Used / Total Number of Driver Units Number of driver units used is 1 and the total number of drivers is 4 1 / 4 = 25% $160 * 25% = $40.00 / cost object or person We allocate $40 to each person 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Allocation by Rate Method 1. Determine Overhead Rate: Total Cost ÷ Total diners = Rate per diner $ 160 ÷ 4 = $ 40 2. Compute Allocation: Usage by Cost Object x Rate = Allocation SHOW SLIDE 24: Allocation by Rate Method Lets use the Rate Method to determine how much of the dinner check will be allocated to each person or cost object: We said the formula was: Total Cost Pool / Total Number of Driver Units The total cost pool was $160.00 and the total number of driver units is 4 $160 / 4 = $40 We allocate $40 to each person Bob 1 x $ 40 = $ 40 Ted 1 x $ 40 = $ 40 Carol 1 x $ 40 = $ 40 Alice 1 x $ 40 = $ 40 Total $ 160 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL The Results Cost Allocation for dinner check based on diners $40 $30 Bob Ted $20 Carol SHOW SLIDE 25: The Results The results are each person will be allocated cost at $40.00 per person using the proportion or rate method . Could we have cross subsidization occurring here? i.e. - Someone getting over? (Next slide) Alice $10 Print $- Reset 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Cross Subsidization Is This Fair? SHOW SLIDE 26: Cross Subsidization Is there cross subsidization occurring if everyone ordered something at different costs. Bob ordered lobster at $60.00 and Alice ordered a large salad at $15.00. They both will be allocated $40.00. Is this fair? Consumption Cost allocation 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

What Happens if Bob Spends $10 More? Incremental Effects What Happens if Bob Spends $10 More? 90 80 70 60 Original 50 40 Incremental Change SHOW SLIDE 27: Incremental Effects What Happens if Bob Spends $10 More? Bob decides he wants a bottle of wine with his lobster. He decides to spend 10 dollars for a bottle of wine. The dinner check is now $170.00. Everyone will now pay $42.50. Bob just pays $2.50 more even though he consumed $10 dollars more. Getting over? 30 20 10 Bob Consumes Bob Pays 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

What Happens if Bob Spends $10 Less? Incremental Effects What Happens if Bob Spends $10 Less? 80 70 60 Incremental Savings 50 40 Decreased Amount 30 SHOW SLIDE 28: Incremental Effects What Happens if Bob Spends $10 Less? Bob decides he wants chicken instead of lobster. Chicken is 10 dollars less than lobster. The dinner check is now $150.00. Everyone will now pay $37.50. Still getting over? Alice still had a salad for $15.00 20 10 Bob Consumes Bob Pays 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Measurement Affects Motivation Managerial Costing Inevitably Impacts Behavior Design of Managerial Costing Systems Must Recognize and Anticipate This Effect Consider in this Example What Incentives Exist to Spend More? What Incentives Exist to Spend Less? What Would You Do if You Went to Dinner with Them Tonight? SHOW SLIDE 29: Measurement Affects Motivation Managerial costing does impact the behavior of all activities involved. When you design a managerial costing system you must anticipate the effect it will have. If you check every phone call made and then charge people for calls - it will change their calling behavior. Your managerial costing system must recognize this effect. 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

FINANCIAL MANAGEMENT SCHOOL Conclusion Allocation Based on Number of Diners Failed to Reflect Resource Consumption Results: Unfair Cross-Subsidizations The Creation of Almost Free Incremental Goods Dysfunctional Behavioral Motivation Detailed Record Keeping May be Best in This Problem -- i.e. Separate Checks SHOW SLIDE 30: Conclusion Looking at our example of the 4 people/cost objects that went out for dinner it failed to reflect resource consumption by cost object. So, it resulted in an unfair split of costs, 11/14/2018 FINANCIAL MANAGEMENT SCHOOL

Check On Learning Q. What is the definition of Managerial Costing? Slide 24 3131

Terminal Learning Objective Conduct Activity Based Costing (ABC). Given a summary sheet containing DFAS-IN Manual 37-100, DFAS-IN Reg 37-1, and slides. With 80% Accuracy: Administer an Activity Based Costing (ABC) analysis; and integrate cost allocation. Action: Conditions: Standard: SHOW SLIDE 31: Terminal Learning Objective The objective of activity-based costing is to understand overhead and the profitability of products and customers. ABC is a cost measurement tool used by the Army to help local managers understand their costs and make informed decisions. ABC traces the resources that are consumed to the activities being performed to provide a product or service. Do PE!!! 11/14/2018 FINANCIAL MANAGEMENT SCHOOL