Cause and Effect Profitability Solution
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Transcript of Cause and Effect Profitability Solution
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Cause and effect profitability solution
Yes, I have not written for a while, but one question was disturbing me for quite a long time
now. Especially after looking at few software solutions for Activity Based Costing. Some ofthem are now called Profitability and Cost Management solution. The question is, do we
need to have structural compartments (aka Modules) like resource, activity and cost
objects in those solutions? I understand that all those solutions have been designed quite a
few years back and they are mostly based on the CAM-I cross.
The CAM-I cross told us that the vertical flow is the cost flow and it flows from resources to
activities to cost objects. Cost objects are the final destination points for which we calculatecosts for. As such the Activity Based Costing requires three phases as resources, activities
and cost objects. All the software solutions based on this concept created in there solutions
three modules as the same. Also the diagram also shows that the cost flows from resource
to activity and activity to cost objects. Again the solutions had assignments that can have
cost flow like resource-activity, activity-cost object or resource-cost object. Some of the
solutions have resource-resource, activity-activity or cost object-cost object assignment
(intra-module) facility. Almost none (actually I wanted to write none here, but I cannot
claim that I have seen all the solutions) of the solutions have cost assignment possible
(directly) from activity-resource or cost object-activity or cost object-resource. Where ever it
is possible, one has to create some work around to handle this.
I certainly do not want to say all this is bad. But it was based on the concepts and
methodologies adopted at that time. It is more than 20 years that the concept has been
around. We have seen many changes in the Body of knowledge, implementation methods,
uses and software solutions in those years. Few things still remain as they were earlier like
1)The solutions are having resource, activity and cost object as structural divisions.
2)The follow up of this is, assignment are not possible in the reverse order (as directfunctionality)
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Scenario
Let us take one example of distributing the cost of shared service functions. These
functions like HR, Admin or IT provide services all other functions in the organization. Todistribute their cost based on the cause-and-effect relationship, we create following steps
a) Define the services provided by those function. For example recruit people, manage hotelbooking, manage software solutions.
b)Calculate the cost of each of these servicesc)Assign cost of those services based on the volume of the services consumed by each of the
other functionsd) This cost is as good as the other expenses (like employee cost, travel cost etc.) of the
functionsThis scenario cannot be created as it is defined here as a direct functionality.
Some of the software solutions where one can create intra module assignments, here is one
of the waysi)Enter cost of the shared services in the resource sectionii) Define the services of the shares service function in the resource section. Actually they are
processes or activities.iii)Calculate the unit cost of services. Resource-resource assignment.iv)Assign those services cost to other functions resource-resource assignment
Some solution that do not have resource-resource assignment facility, but activity-activity
assignment facilityi)Enter cost of shared service function in resource sectionii)Define services of shared service function in Activity section.iii)Calculate the cost of the servicesiv) Assign those services to the activities of other function that are consuming those services.
Activity-activity assignment
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Similarly the cost of Procurement department has to be calculated as vendor wise-material
wise and then takes as additional cost of the material. This scenario will also require a big
juggling in creating the model in the solutions.
The absence of the other functionality that of flowing cost in the reverse way i.e. cost-object-activity, activity-resource (as a direct functionality) is creating a challenge. This is
especially when one has to create the bottom-up model or Activity Based
Budgeting/Planning (ABB/P) model.
Activity based costing is based on the concept of cause -and-effect relationship. As such
there should not be any restriction on what is a source and destination. Actually I am
suggesting that there should not be a rigid concept of resource-activity-cost object.All
these sections should be logical. User should be able to create as many sections as she
wants and call them whatever she wants to. Once this restriction goes then we call the
solution as Cause and Effect Profitability Management Solution.This type solution can be used for single level assignment of costs or multilevel assignment
(2, 3 or even more). One need not worry about the concept of whether it is resource or
activity or cost object. Just select source and destination, link them, add driver and driver
quantities and calculate.I have called this solution as Profitability Management solution (not only cost) purposely.
Profit is a function of Revenue and Cost. Most of the solutions are built upon the concept of
cost assignment. What I mean is, those solutions allow us to create a flow of cost. Revenue
is directly entered against product-customer-channel combination and profitability is
calculated. This was based on the concept that is related to manufacturing industry In the
Telecom industry the revenue is bundled for many services that are used by the consumer it
is very difficult to create a profitability scenario. A lot of free services (completely or
partially) are also included. There is also volume based revenue for certain services. If we try
to use the usual functionality of the software solutions, it is very difficult to create this
scenario. So the solutions should have the functionality of calculating multiple measures
(cost, revenue, discount etc.) based on cause-and-effectrelationship to calculate
profitability at the end.
The flow of measures is based on cause-and-effectand it contains the functionality to flow
the information for all the measures that contribute to Profit. Hence the solution should be
Cause and Effect Profitability Management SolutionThe benefits this type of solution is full flexibility of modeling for profitability. It could be
single level or multi-level. We can calculate standard costs (multi-level calculation) and then
compare with actual. More than the usual variances of quantity, rate, mix etc. can be
available. We will be able to use the same solution for Revenue planning and it can become
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a real Profitability Management solution as it can plan and get actuals to analyze the
variances in Revenue, cost and hence, profit.Please provide your comments or suggestions on this concept of the solution. I have not
seen all the software solutions in their current forms, so some of the functionalities may be
already available. Is there a solution already in the market which can be called as Cause andEffect Profitability Solution?