1. Effective Marginal Costing: Know Your Resource Needs Larry R. White, CGFM, CMA, CFM, CPA Executive Director, Resource Consumption Accounting Institute CAPT, USCG (Retired)

2. Agenda What exactly is Marginal Costing? Why is Marginal Costing important? How is Marginal Costing done?

3. Quiz What is Marginal Costing? Does it have any other names? Where or When do you use it? What do you remember about it from Cost Accounting or Microeconomics?

4. What is Marginal Costing? Wikipedia: –Marginal Cost is the change in total cost that arises when the quantity produced changes by one unit.total cost –Marginal Costing (under Cost Accounting): This method is used particularly for short-term decision- making. Its principal tenets are: –Revenue (per product) - variable costs (per product) = contribution (per product)contribution –Total contribution - total fixed costs = total profit or total loss) Thus, it does not attempt to allocate fixed costs in an arbitrary manner to different products.

5. A Closer Look What resource use (and costs) will change if output changes? What you need to know: –Relationships within a process: What resources in the value chain contribute to creating the output? –Characteristics of the resources used: Which resources will need beefed up or reduced? What resource quantities have fixed and proportional relationships with the change in output? –Costs associated with the resource changes.

6. What we need to know: Final Output 1 Final Output 2 Final Output 3 Final Output 4 Resource Pool A Resource Pool E Resource Pool H Resource Pool F Resource Pool G Resource Pool B Resource Pool C Resource Pool D

7. 9/19/2015RCA Institute All Rights Reserved7 Product AProduct B Service 1Service 2Service 3 Total Volume $’s Change in Total $’s Due to a Change in Total Volume Fixed Cost Variable Cost Cost-Volume-Profit Analysis

8. 9/19/2015RCA Institute All Rights Reserved8 Product AProduct B Service 1 Service 2Service 3 An Output Inputs & their $’s Fixed Inputs Proportional Inputs An Output Inputs & their $’s Fixed Inputs Proportional Inputs An Output Inputs & their $’s Fixed Inputs Proportional Inputs An Output Inputs & their $’s Fixed Inputs Proportional Inputs An Output Inputs & their $’s Fixed Inputs Proportional Inputs Responsiveness

9. Marginal Costing vs. Unit Costing More Accounting Transactions – 12,000/yr Finance Center: –Personnel Cost $30,000,000 –Operating Cost $15,000,000 –Transactions/year: 3,000,000 –Unit Full Cost Cost: $15/transaction X 12,000 = $180,000 –Judgmental Marginal Cost: 1 GS-7 = $65,000

10. Agenda What exactly is Marginal Costing? Why is Marginal Costing important? How is Marginal Costing done?

11. Importance of Marginal Costing Budgets are incremental or decremental. Full Cost is nearly always a gross overstatement. Only way to achieve transparency and internal management alignment around financial impacts.

12. Full Cost Full Cost is the correct figure for very few actions Worse you can calculate full cost easily And……know next to nothing about your processes or resources. –Finance Center Transaction Example.

13. Example Fact set: City Council is requiring fire inspections every 18 mths rather than every 3 years. Current Fire Inspection Staff: 1 Supervisor, 3 Inspectors, 1 Clerk,.75 FTE Hearing Officer/Judge, 1 FTE Billing and Collection at City Treasurer What else do you need to know? –Space, Current Capacity (including non fire inspection work), equipment (computers, vehicles), training, hearing workload………

14. Agenda What exactly is Marginal Costing? Why is Marginal Costing important? How is Marginal Costing done?

15. Calculating Marginal Costs How are marginal costs calculated? Ad hoc Analysis –Advantages/Disadvantages Policy Based Formulas –Advantages/Disadvantages Directly fm Management Accounting Information –Advantages/Disadvantages

16. Calculating Marginal Costs What you need to know: –Process Flow –Resources in the process –How resources interact/support each other Characteristics of the resource Fixed and proportional relationship to outputs (intermediate and/or final) –Costs to overlay the resource flows.

17. Information Elements for Marginal Costing Organizational components Resource Pools in the Process RP output & ouput consumers Output Capacity Resource Relationships to Output –Fixed & Proportional Cost of Resource Pools –Primary (inherent) & Secondary (support) Based on Cause and Effect Relationships

18. Creating Accurate Marginal Costs Requirement 1: Accurately render the enterprise’s flow of economic goods and services with causal relationships Fire Inspection Resource Pool Inspections - Clean Inspections – Fines & Penalty Re-Inspections - Clean Output: Inspector Labor Hrs Bldg Space IT Support Motor Pool HR & Pay Procurement SQFT # WS # Cars # Miles HR Events # PO’s Hearings/Court Appearances Re-Inspections – Fines & Penalty FD Internal Affairs Bldg Space IT Support Motor Pool HR & Pay # Man hrs

19. Causal Relationships Strong Form - Consumption relationship can be quantified Weak Form – Consumption relationship exists, but cannot be quantified –Examples: Excess Capacity, Fire Chief & personal staff Attributable Cost – Costs of an output that could be eliminated if that output were discontinued and resources were reduced accordingly.

20. Attributable Cost Example Fire Inspectors Fire Investigators Fire Stations Training Center Internal Affairs Fire Chief/Staff Bldg Space IT Support Motor Pool HR & Pay Procurement Inspections Investigations Readiness Fire Safety Mission Man-Hrs Product/Services Results Segment Weak Causal Relation

21. Creating Accurate Marginal Costs Requirement 2: Link the quantitative flow of goods and services to their monetary implications.

22. Example Primary Costs:Fixed $Prop $ Supervisor2,000 hrs75,000 Inspectors6,000hrs180,000 Clerk2,000 hrs30,000 Operating Budget100,00025,000 Secondary Costs:OutputFixed Qty Prop Qty Fixed $Prop $ Bldg SpaceSQFT1,200120,000 IT SupportWk St8024,000 Motor PoolF:Cars P:Miles 330,0009,00018,000 HR& PayHR Events130152,050 ProcurementPO’s60243,0002,400 FD Internal AffMan Hrs1206,000

23. Example (Continued) Output Capacity: 6,000 Inspection Hours Planned Output: 4,500 Inspection Hours Restricted/Idle Capacity: 1,500 Hours Fixed Cost: $339,050 Rate: $56.50 Proportional Cost: $255,400 Rate: $42.60 – 6,000 hrs Rate: $56.80 – 4,500 hrs

24. Creating Accurate Marginal Costs Requirement 3: Provide Insight into input- output behaviors and their respective costs –Changing Nature of Costs – Become more Fixed Electricity Janitorial HVAC Maint Bldg Security Building 6 Space Resource Pool Proportional Fixed

25. Creating Accurate Marginal Costs Requirement 4: Segment the cost model for only that portion of economic goods and services relevant to the decision at hand. –Ex: Levels of decisions Resource Level: Fire Inspection Dept Costs & Resources Value Chain/Process Level: Improve Fire Inspection Violation Enforcement. Inspection to Hearing to Collection. Product/Service Line Level: Fire Prevention Activities Organizational Profitability/Performance: Reduce Number of Fires in City – Incidents, Property/Lives Lost

26. Creating Accurate Marginal Costs Requirement 5: Reflect all causal relationships and their characteristics relevant to the decision at hand –What costs are relevent? Hire 3 new inspectors Contract for 4500 hrs of Inspector Expertise. Buy new Inspection Documentation software and equipment. Revise inspection schedule to permit geographic sequencing. Increase fines for Fire Inspection violations.

27. Creating Accurate Marginal Costs Requirement 6: Provide accurate monetary information for all relevant cost categories appropriate to the decision. Relevance = – For Strong Causal Relationship A clear Cause and Effect Relationship Proportional or Fixed –For Weak Causal Relationship Cost Assignment to the responsibility level that can eliminate the resource and its cost.

28. Cost of Fire Code Enforcement MarginalAttributable FID Primary Proportional Costxxx FID Secondary Proportional Costxxx FID Primary Fixed Costxxx FID Secondary Fixed Costxxx FID Excess Capacityxxx Hearing Officer Primary Proportional Costxxx Hearing Officer Secondary Proportional Costxxx Hearing Officer Primary Fixed Costxxx Hearing Officer Secondary Fixed Costxxx Billing/Collection Primary Proportional Costxxx Billing/Collection Secondary Proportional Costxxx Billing/Collection Primary Fixed Costxxx Billing/Collection Secondary Fixed Costxxx

29. Marginal Costing Requirements Incorporate Foundational Economic Principles 1.Provide an accurate rendering of an enterprise’s flow of economic goods and services. Accommodate the strong form of causality. Accommodate the weak form of causality 2.Link the quantitative flow of goods and services to their monetary implications. 3.Provide insight into input- output behaviors - and their respective costs Segment Information to Enhance Its Relevance to Decision Makers 4.Segment the cost model for only that portion of economic goods and services relevant to the decision at hand. 5.Reflect all causal relationships and their characteristics relevant to the decision 6.Provide accurate monetary information for all relevant cost categories appropriate to the decision.

30. RCA Structure for Marginal Costing

31. RCA Recognition

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

33. RCA Institute Objectives Improve Management Accounting Knowledge and Practice –Focus on Decision Support for Enterprise Optimization Build A Highly Structured and Disciplined RCA Community –Create Standard Body of Knowledge and Standards of Practice –Initial Objective is 150-200 Highly Skilled Practitioners (The Tipping Point) –Provide A Professional Structure that Minimizes Risk to RCA Adopters

34. 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

35. www.RCAInstitute.org lwhite@rcainstitute.org 757 288 6082