Integration of ABC costing with PCM models

SAP Profitability and Performance Management (PaPM) comes with a set of predefined sample contents specifically designed for profitability and cost management, including both industry specific and cross industry contents. The heart of these contents is the PCM (Profitability and Cost Management) contents, and it is also the earliest and most popular business case developed in PaPM. PCM contents pertaining to various industries have been developed and is available with the package of contents. My name is Elizabeth Mathews, I have been a part of SAP Profitability and Performance Management Content Development and Advanced Analytics team for over three years and I work on creating and enhancing sample contents. In this article I would like to introduce you to ABC costing methodology that is implemented within the PCM models.

Managing profits and costs is an important task for every enterprise. Regular analysis of relevant KPIs allow the business to be agile, able to react quickly and decisively in multiple scenarios. Our PCM contents cover an end-to-end example of an Activity-Based Costing Model and are configured to facilitate granular analysis on revenue and cost information to obtain deeper insights at multiple levels such as product, sales channel and customer.

Activity-based costing is an allocation strategy which overcomes the limitations of traditional cost allocation methodologies where the overhead costs are more arbitrarily assigned to products and services. The activity-based approach assumes that all resources are used on corresponding activities that then generate the product and service. Hence using this approach, the overhead cost of a product is calculated based on the activity consumption on creating the product which results in a realistic estimate of the costs of manufacturing for specific products. It comes with further advantage such as identification of processes which are inefficient or unnecessary so that they can be improved or removed accordingly which leads to less cost wastage. It also provides a better understanding and control of overhead cost involved in manufacturing.

Furthermore, activity-based costing approach has grown in popularity in recent times due to various reasons such as increase in manufacturing overhead costs, the lack of correlation between manufacturing overhead costs and machine/labor hours, the increase in diversity of product and services offered by companies and differences in the amounts of different products manufactured.
ABC also comes with certain drawbacks as it is time consuming and expensive to prepare, gather and analyze data. The utility of the methodology is also limited in the cases where overhead cost is negligible compared to total operating cost.

In a traditional costing method, all of the overhead costs are assumed to be equally allocated to all products and services. However, the ABC methodology, first identifies the cost for each overhead activity and then allocates it to product and services based on what activities are associated with the production of corresponding product and service. Once the data is available in model table, PaPM facilitates the ABC methodology by providing powerful and efficient allocation functions to allocate direct and indirect costs including both on actual and plan data. Further, the reporting capabilities can be used to visualize the costs at most granular level. The implementation of the methodology in PaPM is detailed in the next section.

Activity-Based Costing structure in PCM content

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Fig 1: Activity Based Costing flow chart

The figure represented here provides the structure of the ABC implementation within the contents. The data is organized in multiple model tables for GL Accounts, Resources, Activities and Product & Service. Some contents also include information regarding Sales Channel, Region of Sales or Customer information. The organization of data into such categories reduces dependency and facilitates seamless incorporation of changes within each category without affecting the whole model. The amount from GL account is first split across various resources based on certain driver values, from where it is next allocated to activities and finally to the products and services. Separate driver values are maintained for each of the allocation steps which can also be easily updated.

The implementation of an activity-based costing model usually involves a series of steps. At first is the identification of resources, which are in effect the costs represented in general ledger. These are the costs that are then linked to products, services or customer using ABC method. The next step involves identification of activities which are the actual tasks performed in the organization. Using Activity-based costing, the costs are allocated based on what activity caused the expenditure. Next step is to determine the cost objects for which finally the costs will be measured. Final step is to have the drivers ready for both resource allocation as well as allocation of activities. Resource drivers provides a link between the expenditures of the company with the activities performed in the company. Activity driver links cost of performing activities to cost objects such as products and services.

We explain the configuration used in our system with an example from the sample content ‘Profitability and Cost Management’ (Environment: SXP, Version:14) from the cross-industry category. At first, tables are maintained to store relevant resource and activity information along with the driver values used for allocation. The Resource Driver table shows the correlation between Resource and Activity, and can be used to maintain information regarding which resources are used for each activity along with the driver information which can be maintained to store the proportions to be used for allocation.

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Fig 2: Resource Driver table

The activity driver table stores the information which connects Activities to end Products associated with this business process. The relation between product and the activities associated with its production is maintained here. Activity Driver field maintains information regarding what kind of driver value is used to measure the activity such as working hours, number of pieces or percentage depending on the activity and Activity Value field stores the quantity of each Activity Driver.

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Fig 3: Activity Drivers table

In the processing part, two functions are then maintained to perform the allocation in two steps: from resource to activities and from activities to products.

Allocate Resource to Activities, use Resource Driver as sender data and the Activity Driver as receiver data. The Resource Value field is used as the distribution base, which is the proportions used for allocation of resources.

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Fig 4: Processing function for Allocating Resources to Activities

Allocate Activities to Products and Services, use Activity Driver as sender data and the Customer and Channel Positions as receiver data. The Activity Value field is used as the distribution base, which is the proportions used for allocation of activities.

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Fig 5: Processing function for Allocating Activities to Products and Services

The sample contents included within PaPM framework comes with preconfigured report queries with comprehensive and meaningful visualization capabilities. One such chart is the Sankey diagram and is shown in the Fig 6. It clearly displays the interconnection between each level of allocation right from GL Account through Resources, Activities and finally to Products. Hovering over each connection provides information on the exact amount allocated.

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Fig 6: Sankey Diagram

It is also possible to view the results in tabular form by adjusting configurations according to the user’s requirements. Fields can be added to rows or columns to fine tune the display. One such arrangement in displayed in Fig 7, which displays the cost by resource, activity and product for each posting date.

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Fig 7: Tabular display of Final Results

ABC methodology is also extended to all of the industry specific sample contents for profitability and cost management. The modeling of these sample contents is similar to the Profitability and Cost Management sample content but includes specific data and reports pertaining to the industry. For example, in sample content Healthcare Profitability and Management, after the activity-based costing on services, the costs of services can be further allocated to procedures, physicians, facilities, diagnoses and patients. This enables users to drill down to the most granular level using the reporting queries.

To conclude, Activity-based costing is a useful costing alternative to the traditional costing methodologies. The popularity of this method is growing as it provides significant advantages with regard to process improvement, efficiency of operations, pricing decisions of the product and overall, a better profitability performance. Since the implementation of ABC methodology is quite challenging, it often requires new technology and skills. This is where PaPM provides significant advantage as it facilitates the whole process by providing powerful allocation functions and reporting capabilities.

We hope this blog post has provided enough insights into Activity Based Costing approach and how it is implemented in SAP Profitability and Performance Management contents. Please feel free to share your thoughts and comments or if you require any further clarifications on the topics discussed here. Thank you for reading.