Innovations in Costing Shared Service Centers Anton van der Merwe Principle, Alta Via Consulting Larry R. White, CMA, CPA, CGFM, CFM Executive Director, RCA Institute

Content: Critical Management Information for Shared Services Cost Concepts and Common Costing Errors The RCA Modeling Approach How RCA works at a Major Federal Government SSC Sustainability of Approach & IT Options for RCA

Shared Service Operations General Economic Characteristics? Large fixed infrastructure Building, IT – HW & SW, Trained Support Personnel, Trained Operational Personnel High transaction volume Very high demand for service quality Pressure for cost information & reductions Pressure for transaction level pricing Pressure for Budget/Planning numbers

Critical Economic Information At SSC’s Resource Capacity Issues ID and use Excess Capacity before adding resources Improve Productivity of existing capacity Plan for new capacity & when it will be needed Optimize the Balance of Resource Capacities Throughput What resources will need adjusted for marginal increases/decreases in output(s). ID and optimize relationships between the resources used by various outputs.

Critical Economic Information At SSC’s Cost Accurate Transactional Costs for many types of transactions. Building “step” costs for increases in fixed infrastructure into transactional costs. Accurate marginal/incremental costing to support special situations Quality Cost of poor quality Cost of quality improvements

Critical Economic Information At SSC’s Planning Resource and Cost planning for projected activity levels Information for adaptive planning to address opportunities or challenges. Enterprise Optimization

What is Enterprise Optimization? To Maximize Revenue or Mission Outcomes To Minimize Cost or Redeploy Resources Decisions On: Use of Existing Resources and Capabilities Incremental Changes to existing Resources Major Changes to existing Resources

Modeling… the Organization’s Operations & associated Costs What is Management Accounting’s Contribution to Enterprise Optimization? Decision Support, Planning and Control Over the Value Creating Operations of the Firm By doing what? Modeling… the Organization’s Operations & associated Costs

Resources (also creates any revenues!) What Causes Costs? Resources (also creates any revenues!) Inputs Resource Pool Output Another Pool (s) Or Final Product/Service Organizational Element (Support or Production) Labor Equipment Operating Budget Products Services Support Work Requests (Reflecting Resources Applied)

What Are the Primary Characteristics of Resources? Capability Quality or Qualitative Characteristics Capacity Quantity They Provide Consumption/Cost Consumption/Cost Structure Consumption/Cost Behavior

How Do We Define Capacity? Productive Non-Productive Idle/Excess Questions: Who is Responsible for Idle & Excess Capacity? What can Allocations of Idle & Excess Capacity Do to Costs?

Content: Critical Management Information for Shared Services Cost Concepts and Common Costing Errors The RCA Modeling Approach How RCA works at a Major Federal Govt SSC Sustainability of Approach & IT Options for RCA

Cost/Consumption Concepts Operational Fixed Variable Decision Support Unavoidable Avoidable Opportunity Cost “Relevant Range” Which Cost Concept Must Form the Basis for Cost Modeling? Can be Modeled Basis for Action Divisibility of Resource Information

What Constitutes an Effective Model of Operations & Costs? Key Principles: Causality Attributability Responsiveness Work or Process Visibility Bridging the Gap between Operational & Decision Support Costing requires Resource Divisibility. Resource Divisibility & accurate Cause and Effect modeling is the key to effective Decision Support Information!

Causality Optimization Thinking: Operations and processes create demands for resources…or resource flows. Employees and Manager deal with these primarily. Optimization Thinking: For a Given Outcome Understand the Cause For A Decision Alternative Understand the Effect Cost must reflect the resource flows to be useful for decision making. Cause and Effect relationships between Operations and Costs are vital! The principle of causality is the key to linking management accounting information to operations and operational data. Its application is based on the laws of logic – Rational Inference and Analogy, as they apply to inductive reasoning for decision making and most scientific discovery. Managers and employees engaged in a production or support operation think about and manage resources first, cost is a important constraint, but it is an abstraction. The closer costs are related to resources, the more they will be used logically. Non Causal allocations and assignments of cost rapidly cause cost figures to loose credibility and confidence. Employees and managers engage in economic optimization thinking by first observing an unsatisfactory financial outcome from operations which they want to improve, or a very good outcome they want to replicate. Causality allows that financial outcome to be logically and directly traced back to its operational root cause. Managers and employees then conceptualize solutions or courses of action to resolve the problem or replicate the success. Ideally they will be able to run solution scenarios through the management accounting model and assess which provides the most desirable economic outcome. Cost must reflect operational resource flows from work center to work center within the organization to be useful for decision making at all levels. Cause and effect relationships are the most essential principle for creating a model for economic optimization, and lets be clear the financial accounting and reporting model or GAAP consistently compromises the principle of causality in regard to managers and employees for other objectives associated with external stakeholders.

Attributability The principle of attributability assigns non-quantifiable costs (common fixed costs) to the most applicable operational level. Attributability is the responsiveness of inputs (and hence their costs) to decisions that change the provision and/or consumption of resources. For cost allocations where the relationship shows little causal link (weak causality), the principle of attributability is applied. 12/31/2018 2:42 PM © RCA Institute 2009 16

Principle of Responsiveness Traditional Principle of Variability: Total Cost to Total Volume Responsivenss

What is Responsiveness? Consumption Behavior must Respond to Causal Relationships Fixed Responsiveness Proportional Responsiveness Integrity of Resource Quantities and their associated Costs must be maintained Requires Careful design of Resource Pools Each Resource Pool must provide Discrete, Homogeneous Resource/Capability Provides Resource Use & Cost Divisibility Insights

RCA Multi-Level P&L Traditional P&L + Revenue - Cost of Goods Sold = Gross Margin - G&A - Depreciation - Interest - Taxes = Net Income

Principle of Work Insights into Process Effectiveness Without the Work Principle: Resource Pool A Product 123 Inputs: Planned Output: 1,000 Hrs Actual Output: 1,100 Hrs Pool A 1,100 Hrs Using the Work Principle: Product 123 Resource Pool A Inputs: Setups Planned Output: 1,000 Hrs Actual Output: 1,100 Hrs Setups (Qty 10) 300 Hrs Run Machine 800 Hrs Run Machine

Content: Critical Management Information for Shared Services Nature of Costs and Common Costing Errors The RCA Modeling Approach How RCA works at a Major Federal Govt SSC Sustainability of Approach & IT Options for RCA

Resource Consumption Accounting RCA Inherits Core Principles from German Cost Management (GPK) Grenzplankostenrechnung (GPK) Translated - Flexible Analytic Cost Planning & Control Well Established Standard Costing System Principles Applied in Practice since the late 1940’s Implemented by 3,000+ Companies RCA Integrates Activity-based Costing and Throughput Concepts RCA Creates an Integrated Economic Model of Operations for Decision Making Enterprise Optimization Principle Based Highlights Resource Divisibility RCA Resource view Advantages Process view GPK ABC Capacity Analysis and Management Process Analysis and Management Capacity-Focused Activity-Focused

RCA Recognition RCA is recognized by IFAC’s International Good Practice Guide – Evaluating and Improving Costing in Organizations A companion piece written by Gary Cokins recognizes RCA as the most mature form of costing short of complete real time simulation. We argue it is necessary to support real time simulation – since many forms of financial information are by nature batch – payroll. RCA has a body of knowldege about how to achieve logical real time simulation.

Costing Continuum/Levels of Maturity Predictive: Demand Planning Driven with Capacity Sensitivity Descriptive: Expense Tracking, Cost Reporting and Consumption Rates Finite systems modeling Attributable costs on all objects, blends activity and direct resource charges, consumes activities back to resources (TDABC); forecast driver quantities X std unit rates; direct cost focus; repetitive work conditions (ABRP); forecast driver quantities X std unit rates, driver-based budgeting Unused capacity costs (estimated) Level 6 with customer & channel profitability reporting; Cost-to-serve Push activity-based costing (ABC), Product costs Individual std costs, project & job costing Add indirect costs Process/ lean accounting Direct cost to outputs Book- keeping 2 Process Visibility 3 Output Visibility 4 Output Visibility 5 Explicit Outputs 6 Explicit Indirect Costs 7 Customer Demand Sensitive 8 Unused Capacity Aware 9 Pull ABC Resource Planning 10 Time- driven ABC 11 R C A 12 Simulation 1 Blind No marginal insights Limited process marginal insights Direct cost marginal insights All output cost marginal insights Output specific marginal insights Explicit output marginal insights Add customer & channel marginal insights Common fixed costs begin to be isolated Increased ability to isolate common fixed costs Increased ability to isolate common fixed costs Explicit resource cost object, supply-based denomina-tor, strong & weak forms of causality catered for No Marginal Insight No change Marginal Insight Awareness Detailed Marginal Insights

The Traditional Approach Source Data Capture Operational Quantity Flows Dollar Machinations GL Dollars must be Parsed to Get MA Information Proliferation of GL Parsing Methods in MA 12/31/2018 2:42 PM © RCA Institute 2009 25 25 25

The Traditional Approach Source Data Capture Operational Quantity Flows Dollar Machinations GL Dollars must be Parsed to Get MA Information Proliferation of GL Parsing Methods in MA 12/31/2018 2:42 PM © RCA Institute 2009 26 26 26

RCA Value Chain Integration Keeping Resource Quantities and Their Values Together Value Chain Integration 12/31/2018 2:42 PM © RCA Institute 2009 27 27 27

Principle-Based Approaches – Causality as Primary Focus Principle-based Approaches Get Around the Problem of Having to Parse the G/L by Means of Value Chain Integration (refer the next slide) They are Free to Focus on Causality as the Primary Principle in Management Information and Are Not Bound by the Limitations of FA Information GPK and RCA are the Only Principle-Based Approaches in the Market Place Professional Guidance in MA is Shifting Towards Principle-based

RCA Storyboard Manufacturing Costs Product Support Cost S: Ancillary Production Equipment S: Plant Engineering and Maintenance S: Administration Human Resources & Accounting RP: Admin Labor (Labor hours) Capacity: 17,000 Output Qty: 17,000 Perform HR RP: Dryer (Hours) Capacity: 100 Output Qty: 100 RP: Chiller (Hours) Capacity: 50,000 Output Qty: 50,000 RP: Plant Maintenance (Maint. Labor) Capacity: 30,000 Output Qty: 30,000 Legend S-Support P- Production Perform Accounting Perform Admin P: Extrusion Line Department S: Quality Assurance Resource Pool Abbreviated RP QA Testing RP: QA Labor (Labor hours) Capacity: 14,000 Output Qty: 14,000 RP: Extrusion Labor (Labor hours) Capacity; 32,000 Output Qty: 30,000 RP: Extrusion Machine1 (Machine hours) Capacity; 17,520 Output Qty: 10,000 Activity Product Returns Manufacturing Costs Product Support Cost Budgeted Products Common Fixed Costs Product P & L’s

RCA Information

Content: Critical Management Information for Shared Services Cost Concepts and Common Costing Errors The RCA Modeling Approach How RCA works at a Major Federal Govt SSC Sustainability of Approach & IT Options for RCA

Two Areas Agency Wide Shared Services, including Various HR and Self-service functions Purchase Card Management Credit Card Management Travel Services Information Technology Division Application Development Application Hosting and Maintenance Training and Helpdesk/Problem Solving

Objectives Gain Insight Into What Resources They Have. What The Capacity of Key Resources Are and How Much of It Is Being Used at Any Given Point. The Ability to Project Out and Plan for Required Resources. Understand What It Costs to Serve Their Customers, Particularly External Customers. Drive Both the Efficiency and Effectiveness of Service Provision. Be Able To Answer The Question: “Should We Outsource It?” – Resource Divisibility…

Fixed and Proportional Rates for Each Service Shared Services Costing A Service Facilities Operational Systems Initiate A Card Output Resource Pool: Square Feet Travel Card Services Resource Pool: Labor Hours Handle Exception Output Qty’s Supervision Cancel A Card Resource Pool: Managmnt Time Output Infrastructure Fixed and Proportional Rates for Each Service Resource Pool: Travel Application

Shared Services Charging for A Service WWW Receiver: Access: or Initiate A Card Output Travel Card Services External Customer Resource Pool: Labor Hours Handle Exception Output Internal Customer Cancel A Card Output Access: Infrastructure Resource Pool: Travel Application or WWW

Information Technology Software Development/Implementations Developers Facilities Asset Resource Pool: Developer Hrs > $2 Mil Resource Pool: Square Feet Project Users Resource Pool: User Hrs < $2 Mil Infrastructure Expense Resource Pool: Network Training Development Resource Pool: Training Hrs Execution

Information Technology Infrastructure SAN A/C & Heat Resource Pool: Disk Space Users Resource Pool: Cubic Feet Utilities Print Servers Resource Pool: KwH’s Computer Room Resource Pool: CPU Min Users Resource Pool: Square Feet Network Servers Facilities Resource Pool: CPU Min Network Resource Pool: Square Feet dB Admin Application Servers Resource Pool: dB Admin Hrs Resource Pool: CPU Min Applications

Information Technology Network Router & Switches Resource Pool: Minutes Utilities Resource Pool: KwH’s Network Servers Network Resource Pool: CPU Minutes Resource Pool: # of Devices Devices Facilities Resource Pool: Square Feet Network Engineers Resource Pool: Engineer Hrs

Information Technology Applications Development Resource Pool: Developer Hrs Maintenance Application Users Resource Pool: Maint. Hrs Resource Pool: # of Users Application Support/Helpdesk Application Servers Resource Pool: CPU Minutes

Information Technology Application Support & Shared Services Facilities Resource Pool: Square Feet Ticket: Class 1 Users Supervision Helpdesk Resource Pool: Mngmnt Hrs Resource Pool: Desk Hours Ticket: Class 2 Users Application Servers Ticket: Class 3 Users Resource Pool: # of Users

Self Service Terminals Shared Services Landscape Self Service Terminals Facilities Device HR Internal Users Service 1 Utilities Network Credit Card Services External Customer Service 2 Hardware Applications Software Helpdesk Service 3

Challenges In A Service Industry – Robust Operational Systems and Operational Information. Compromises – e.g., the Cost of Measuring Network Bandwidth Consumption vs Simply Charging by Device. Behavioral Aspects Around Information – Charging for A Helpdesk Ticket Reduces the Number of Calls into the Desk: Good or Bad? Lack of General Systems Integration. An Organizational Culture that is Funding Oriented as Opposed to Cost Conscious. Managing Model Complexity.

Content: Critical Management Information for Shared Services Cost Concepts and Common Costing Errors The RCA Modeling Approach How RCA works at a Major Federal Govt SSC Sustainability of Approach & IT Options for RCA

Simple Modeling Example Support 1 IT Service A Service P&L Help Desk Service B Support 2 Human Res

RCA Modeling Example Service P&L Desktop Support 1 Ticket IT Service A Qtys Qtys Qtys Service A Service P&L Qtys Help Desk Qtys Service B Process Payroll Support 2 Human Res Qtys Qtys

Maintenance Nightmare It typically does not make sense to try and periodically (i.e., monthly) capture all this data and then feed it into the cost model. RCA uses the ability to imputed standard relationships to significantly reduce data collection needs. Consider the relationship between a machine and the utilities it uses. 200 Kilowatts per Machine Hour Electricity Machine Hours 12/31/2018 2:42 PM © RCA Institute 2009

Imputing Actual Quantities The standard relationship is defined in planning. For actual consumption all you have to do is tell the system the actual number of machine hours worked and the cost model will impute the actual electricity consumed. Actual Machine hours worked: 500. Actual KwH’s Consumed is 100,000. 200 Kilowatts per Machine Hour Electricity Machine Hours 12/31/2018 2:42 PM © RCA Institute 2009

Imputing Quantities Imputing consumption quantities in RCA can occur for any relationship or any series of relationships if a standard can be defined. Consider a purchasing example. 2.5 Hours of Work P.O. Qty: XX $: YY 10 P.O.s 15 Min. per P.O. Service A Purchasing 12/31/2018 2:42 PM © RCA Institute 2009

Imputing A Series of Quantities If one has a standard quantifiable relationship between the P.O.’s and the Service the only data you would have to provide the RCA model is the number of Services produced. P.O. Qty: XX $: YY 15 Min. per P.O. 1 P.O. per Client The Service Purchasing 12/31/2018 2:42 PM © RCA Institute 2009

Imputing A Series of Quantities If one has a standard quantifiable relationship between the P.O.s and the Service the only data you would have to provide the RCA model is the number of Services produced. 2.5 Hours of Work P.O. Qty: XX $: YY 10 P.O.s Actual Service Output: for 10 Clients 1 P.O. per Client 15 Min. per P.O. Service A Purchasing 12/31/2018 2:42 PM © RCA Institute 2009

The Bigger Picture Application Servers Helpdesk Utilities Password Output: 15,000 Capacity: 6,000 Capacity: 16,000 Output: 5,000 Utilities Password Resets Output: 50,000 Capacity: 60,000 Application Capacity: None Facilities Output: 2,000 Output: 5,000 Capacity: 6,000 Output: 2,000 Capacity: 2,500 Human Res Output: 1,400 Capacity: 1,600 12/31/2018 2:42 PM © RCA Institute 2009

Relationships - Assumptions Assume for the Moment that All Service Outputs Have to be Recorded. A Password Reset Requires 3 Minutes of Helpdesk time and 2 Application Transactions Human Resources Process Payroll is a Standard Based on Headcount per Pay Period. But, headcount is not an output on any of the receivers i.e., headcount does not feature in consumption relationships directly. All Utilities are Standard Consumptions, This Almost Always the Case. All Facilities Space are Standard Consumptions, this is also Almost Always True. 12/31/2018 2:42 PM © RCA Institute 2009

The Bigger Picture Application Servers Helpdesk Utilities Password Output: Output: Utilities Password Resets Output: Application Output: Facilities Output: Output: Human Res Legend: Recorded Imputed Output: 12/31/2018 2:42 PM © RCA Institute 2009

Target = Actual From the prior slide it is obvious that in imputing actual quantities in RCA some relationships will be simultaneous. This is a calculation similar to RCA’s price calculation. Resource Pool 2 Output: XX Hrs Step 2b Inputs Fix Prop RP1Hrs Y YY Step 1a Resource Pool 1 Output: YY Hrs Step 1b Step 2a Inputs Fix Prop RP2Hrs X XX Target = Actual Iteration Step 1: Sum all consumption quantities for each resource pool’s output. Step 2: Flex the inputs on each resource pool for its new actual output. Repeat… 12/31/2018 2:42 PM © RCA Institute 2009

Boolean Rules The ability to use If-then statements in your RCA model will depend on the software tool you have. In ERP systems there are naturally a large amount of transactional and features data available for these types of assignment rules. Similar to RCA’s modeling philosophy Boolean rules have nothing to do with money. The purpose of the rule is to determine the consumption quantity in the relationship.. 12/31/2018 2:42 PM © RCA Institute 2009

Boolean Rules Examples If the service order was created in the current month then post 1 planning and scheduling activity quantity to the order. If the Service category is ‘phone’ then post 1 VOIP quantity to the service order. If the receiving cost object on the P.O. master record is a cost center then post 1 P.O. quantity to that cost center. If the Service order status changed to ‘closed’ during the current month then post 1 invoice customer activity quantity to the order. If a cost center has active headcount assigned in the HR module, sum the headcount and then post a payroll process quantity of 1 for each person to the cost center. 12/31/2018 2:42 PM © RCA Institute 2009

The Final Model Application Servers Helpdesk Utilities Password Resets Output: Output: Utilities Password Resets Output: Application Output: Facilities Output: Payroll Processing Output: HR Module Human Res Legend: Recorded Imputed Output: 12/31/2018 2:42 PM © RCA Institute 2009

Characteristics of RCA RCA’s Cost Model: Is constructed based on fixed and proportional resource consumption quantities, which results in an accurate reflection of how resources are used in an organization. Is dynamic in that the model is able to adjust to changes in those consumption relations. Is flexible, the model does not become out of date due to rigid dollar based allocation relationships that is no longer valid when volumes and/or mix change. Requires very low maintenance to keep it current and able to provide managers with up to date information. Does all of the above while providing exceptional marginal information for decision analysis for all cost objects in the cost model.

Technology – Large ERP SAP Played A Major Role In The Research And Development Around RCA SAP Currently Has the Most Extensive RCA Functionality of Any of the IT Tools in the Market Large Install Base - Current SAP Users Can Adopt RCA Without Any Incremental Investment in Information Technology

Technology – Best of Breed macs Is A Best of Breed Management Accounting Suite of Products Typically Installed As A Bolt-on To Medium and Large ERPs that Lack Robust Management Accounting Capabilities System Has GPK Roots For More Information: http://www.macscontrolling.com/

Technology – Opens Source BI PALO An Open Source Business Intelligence Application - Runs on Excel Yes – The Basic Version Is Free (Under The GNU License), Download It At http://www.jedox.com Embedded In Excel, Does Not Need Special Programming Skills for Reporting or Maintenance Needs Business Content to Run An RCA Model – RCA Institute Will Make An Open Source RCA Database Available

Conclusion and Questions

The RCA Institute is… A Non-profit Entity Responsible for Training of Practitioners and Adopters Provides A Number of Products and Services to Mitigate Adopter Risk e.g., Certification, Assurance Services Sponsors Research into RCA Implementation and Long-term Use Serves to Raise RCA Awareness and Fulfill Advocacy and Outreach Roles

RCA Support & Quality Assurance Institute Membership Corporate & Individual Certification Specialist, Practitioner, Master Software Products Adopter Exploratory Workshops Customized Workshops applying RCA to an organization Implementation Review/Assurance Support Adopting Organizations & Practitioner Expertise Adopter Internal Use Reviews Evaluations of An Organization’s Effectiveness Using and Maintaining RCA

RCA Information Resource Consumption Accounting Institute – www.RCAInstitute.org Institute of Mangement Accountants Research Center of Excellence – www.imanet.org Strategic Finance –www.strategicfinancemag.com Management Accounting Quarterly –www.imanet.org/publications_maq_current.asp Cost Management Magazine Management Accounting Philosophy Series I-III Understanding Resource Consumption and Cost Behavior Series I & II Debating the Principles Series I-III Journal of Corporate Finance & Accounting, April 6, 2009. Resource Consumption Accounting: Manager Focused Management Accounting Management and Accounting Web – maaw.info (scroll down to Topic Block for Resource Consumption Accounting)

Questions??? Contact Information: www.RCAInstitute.org lwhite@rcainstitute.org 757.288.6082 Contact Information: www.altavia.com antonvdm@altavia.com