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II. STRATEGIC ASSET MANAGEMENT PROCESS - CHAPTER 5 - STRATEGIC ASSET PERFORMANCE MEASUREMENT
5.1 Asset Cost Accounting
Asset cost accounting refers to the process of measuring and reporting the commitment and expenditure of money on the enterprises strategic assets such as products or equipment. The output of the process is cost data for assessing the asset portfolios performance relative to established business objectives and requirements. The inputs to the process include the basis against which asset portfolio performance is assessed (quantified requirements per Section 3.1 and cost budgets per Section 3.2) and expense data from ongoing asset operation during the asset life cycle. The TCM process map does not explicitly include the cost accounting process; it only addresses the strategic asset management interface with cost accounting.
The "accounting" process excludes the performance measurement process (Section 6.2) that covers the measurement of asset or process functional performance (e.g., operability, quality, achievement of schedule milestones, etc.). Together, accounting and performance measurement provide the information needed for business control and planning, just as project cost accounting and performance measurement provide the measures for project control (Sections 9.1 and 9.2). In terms of information technology (IT), the distinction between cost accounting and performance measurement is increasingly less distinct as materials or enterprise resource planning (MRP and ERP) systems increasingly encompass the measurement of all resource usage and performance data for both asset management and project control. However, disregarding IT integration, cost accounting practice remains a unique function in itself.
The most significant cost accounting technique of interest to cost engineering and strategic asset management is activity-based cost management (ABC/M) which improves upon traditional cost accounting by assigning costs to the work activities and then to the assets that drive the workload. This superior costing method based on cause-and-effect relationships is in contrast to simply capturing the spending expenses in cost centers and making somewhat arbitrary guesses or using broad averages (e.g., number of units produced) as to the relationship of the costs to the assets that are uniquely consuming the various types of costs. Traditional cost allocations leads to simultaneous over-costing and under-costing of outputs relative to their actual costs. As was mentioned in Section 3.2, ABC/M also supports asset planning. As asset design is elaborated, understanding the cost by work activity (by worker or by equipment) allows more effective assets to be developed.
.1 The Importance of Cost Measurements to Strategic Asset Management
As discussed in Section 3.1, requirements are a condition or capability that a problem solution must have to address their perceived problem or opportunity The first characteristic of a good requirement is that it defines what the asset will do. The next is that it be quantified to serve as a basis of performance measurement. For example, performance against a requirement such as "must have good reliability" cannot be measured; a statement such as "must have less than 1 percent downtime" is better.
As further discussed in Sections 2.3 and 3.3, the most important business requirement for most enterprises, and the basis for their asset investment decisions where applicable, is a measure of economic return on investment; a single measure that expresses in monetary terms the value of the investment over its life cycle to the enterprise. Allowing for the time value of money, return on investment improves with greater and/or sooner income and less and/or later costs incurred. In decision and investment analysis, income and costs may include non-monetary benefit and cost factors expressed in monetary terms.
An assets return on investment is determined through assessment (see Section 6.1); however, the financial view of assessment is based on measured income, benefits, and costs that comes from multi-period accounting (i.e., capital budgeting). The assessment is based on measured income, benefits, and costs. Revenue, the most common benefit, is usually unambiguous and easy to account for by asset. For example, when an enterprise sells a known number of products for a known price, it knows the origin, amount, and timing of income for each product. In other words, revenue measures (and many functional performance measures such as production rates) are inherently asset-based (i.e., unit or product price). Some costs are also unambiguous and easy to account for by asset. Typically, these costs include direct labor expenses for workers on the frontline who do repeated work directly on the asset, and the expense for material used directly in the asset.
However, many costs cannot be directly accounted for by asset because the resources (e.g., people, equipment, supplies) invested in it are also shared in work on other assets or they are invested indirectly in systems, processes, services, and so on that support other assets. An example of the former is a worker partly running a machine and partly sorting component parts. An example of the latter is maintenance workers repairing various machines or plant office personnel supporting the production of many products in a plant. The expense (e.g., their salary or wage) for their services cannot be directly traced and accounted to any particular product (i.e., their costs are typically accounted to a cost center such as plant management expense or "overhead"). However, the time period for their various types of work can be measured.
Therefore, the enterprises assessment of return on any given asset investment (and decisions regarding the investment) are significantly affected by which assets the indirect expenses are assigned to. If the assignment is arbitrary, without being based on causality, then success of the investment, and the enterprise, will be uncertain. Therefore, this section focuses on methods that result in asset-based cost accounting, specifically ABC/M.
.2 Traditional and ABC/M Accounting
In cost accounting, actual monetary transactions are entered in a financial bookkeeping ledger per a chart of accounts that is generally organized by resource type. Resources are sources of work or expense such as labor salaries, electrical power, supplies, and so on. Accounting then translates the expenses (i.e., "what was spent") to costs for various cost centers (i.e., "what it was spent doing") so that the expenditures can be compared to the budgets established for the cost centers. An analogy to describe absorption costing is that the cost centers are sponges that absorb the work activities of the expenses captured in the ledgers spending buckets. Note that costs are calculated in absorption costing, not directly measured. In traditional accounting, the calculation assigns indirect expenses from the cost centers into the assets per established cost allocation methods such as proration in accordance with direct expenses, output volumes, or some other simple means with broad averages. In many cases, the cost centers and control budgets are established by organization (i.e., more "where" or "by whom," as opposed to "what" it was spent for). In that case, there is very little visibility as to the cost of assets, processes, or anything else that crosses organizational bounds.
As was mentioned, ABC/M improves upon traditional cost accounting by assigning or tracing indirect costs to the activities that drive them. These activities are work performed on or for a particular cost object or asset (e.g., products or standard service-lines). One way resource expenses are traced is to use the time that people or equipment spend performing certain activities. Figure 5.1-1 illustrates an ABC/M cost re-assignment network.
Figure 5.1-1. ABC/M Cost Re-Assignment Network
The activity tracing method is more complex than simple prorations, but it is the only accounting method that consistently and reliably supports the enterprise objective of improving the return on assets. ABC/M has increased the role of cost engineers in the asset cost accounting process because the method requires a greater knowledge of the work activities that belong to various processes than do traditional cost allocation accounting methods that conveniently use broad averages rather than reflect how the assets uniquely consume different work activities. The complexity of the process has been mitigated in recent years by integrated ABC/M software that allows enterprises to use the approach efficiently and consistently with automated data collection from transactional systems, such as an enterprise resource planning (ERP) system.
Most industry discussions of ABC/M methods, and software developed for the methods, center on cost management of recurring operational costs for non-capital assets such as products, process, and services (and in some cases also types of sales/distribution channels and types of customers). Industry discussions of project cost accounting, which usually center on the control of capital expenditures (CAPEX), do not often describe ABC/M accounting methods. However, if the methods used for project cost accounting are based on a work breakdown (i.e., activity-based), they inherently apply ABC/M principles. Indirect costs in a project environment where the direct costs are non-recurring, but the indirect costs are relatively more repetitive, can blend the ABC/M traced costs with the project accounting of the direct costs to view all of the enterprises costs.
.3 Accounting and CAPEX
The previous discussions focused on accounting for current expenses that are recorded in the general ledger and can be immediately deducted from income during the time period (e.g., month, quarter) when determining profit. However, CAPEX investments are amortized over time periods typically beyond a year. Before those expenses can be amortized, the absorption process first must assign the expenses to a work activity cost center, and then causally trace each activity cost to an asset cost object (i.e., an item in the asset ledger). Then, when the asset or some component of it is put in use (e.g., commonly at or near the end of a project), depreciation of these assigned costs begins (i.e., some portion of the cost is expensed each time period in accordance with established rules for that asset or industry class in that taxation jurisdiction).
ABC/M methods are applied at two phases for CAPEX. First, at the close of a project (see Section 9.1) ABC/M techniques help ensure that indirect project expenses are properly assigned to either the direct project work or to the appropriate capital asset, which is a cost object in its own right (i.e., capitalization). However, that asset (e.g., a factory) may be a resource in support of producing other assets (e.g., a product produced by that factory). In that case, ABC/M methods are used to help ensure that the depreciation expenses are properly assigned to the appropriate cost objects (e.g., products).
The first step (i.e., asset capitalization cost assignment) has been a traditional role of cost engineers because of their knowledge of asset and project costs. Cost engineers have long used ABC/M principles in capital cost assignment based on causal relationships, in part because ABC/M principles are inherent to activity-based project control, and projects are the process through which most CAPEX is expended.
As discussed in Section 9.1, it is common for the enterprise financial functions to be more concerned with capitalization (i.e., how they must deal with the expenses) than project control (where the resource expenses originated). The result is that enterprise accounting systems are often set up to support asset accounts, but not project control accounts. Therefore, cost engineers and project control practitioners often find themselves heavily involved in helping to change and improve accounting systems as more companies add ERP and project management capabilities.
5.1.2 Process Map for Asset Cost Accounting
The asset cost accounting process illustrated in Figure 5.1-2 includes not only the measurement of costs, but the review, classification, and accounting of them for asset management purposes. The process is integrated with performance measurement (see Section 5.2). The measured costs are inputs to the asset performance assessment process (Section 6.1)
Figure 5.1-2. Process Map for Asset Cost Accounting
The following sections briefly describe the steps in the asset cost accounting process.
.1 Planning for Strategic Asset Cost Accounting
The process for asset cost accounting starts with planning for cost accounting. Initial planning starts during the requirements elicitation and analysis process (see Section 3.1) and continues through development of cost budgets in support of investment decision making (see Section 3.3). Business control is facilitated when the cost accounting process reports costs using the same coding structure or chart of accounts as the control or budget accounts. However, general ledger accounting systems were never designed to support cost allocations, including ABC/M (i.e., they lack cost assignment network capabilities). Therefore, the interface (i.e., cost assignment) between cost accounting and asset-based business control systems must be designed and planned. As was mentioned, ABC/M methods also apply to asset planning (see Section 3.2), so planning must begin early.
Planning ensures that the managerial accounting system cost accounts are either consistent with the control accounts, or that processes and procedures are in place to assign the accounting system cost data to the control accounts in the cost control system. The cost assignment network (i.e., cost absorption mapping) may be automated or facilitated by commercial software or it may involve manual translation and reentry of data (e.g., spreadsheets). In addition, the interaction/interface of owner, supplier, and contractor accounting systems, if any, must be considered and addressed in cost accounting plans.
.2 Initiate Cost Accounts
After cost accounting has been planned, cost accounts are opened or initiated in the cost accounting system or ledgers in accordance with the applicable chart of accounts. If ABC/M is used, the accounts for ABC/M purposes will be based on activity-based principles of cause-and-effect with an action verb-adjective-noun naming convention for the work activities (e.g., process customer orders) that are consumed by the cost objects. For recurring expenses, the cost accounts may always be open. However, accounts in the asset ledger, in which CAPEX will be assigned at project closeout, are opened as projects are implemented and closed out upon completion. The accounting plan will establish who may enter, change, delete, view, or otherwise use data and information in or from the system. To avoid mischarges, cost accounts are generally opened only as needed, not all at once.
.3 Measure, Review, Classify and Account Costs
Once accounts are opened, payments made by the enterprise for resource expenses (e.g., payroll, suppliers, contractors, etc.) are recorded by the accounting process against the appropriate resource cost account. Payments may also be made from one internal cost account to another within an enterprise. In any case, the cost account ledgers are charged (debited) to reflect the dispersal of funds.
The accounting function regularly checks that the costs recorded by the accounting process are appropriate. Cost data are commonly miscoded, misfiled, improperly invoiced, or otherwise mischarged. In addition, work may have been completed or materials received, but not yet invoiced; accounting must review progress measurements (Section 5.2) to determine if a commitment has been made.
As was discussed, indirect or overhead costs are assigned by the accounting process to other cost centers. Indirect or overhead costs may be apportioned using a percentage markup on the direct costs method ignoring causality and introducing some cost inaccuracy or the ABC/M method may be used to assure higher accuracy and visibility to individual indirect cost elements and their drivers. The accounting process periodically evaluates the cost assignment method used to ensure that the costs incurred are in balance with allocations. Cost engineers may be involved with establishing or reviewing the basis of assigning expenses to cost centers and how each cost center is consumed by its activity driver into the enterprises cost objects.
The accounting process may charge to a cost account (i.e., book a debit to the ledger) on a cash or accrual basis. Cost accounting is on a cash basis when a check is cut and the expense is recorded as expended during the same time period, such as the month recorded. In accrual accounting, the payment may occur in a different time period than the period when the profit and loss expense is recognized. For example, costs may be booked before the check is cut in recognition that while an actual payment has not been made, a commitment or liability to make that payment has been incurred. It may also be booked after the check is cut in recognition that while an actual payment has been made, the work or resource for which payment has been made has not yet occurred or been received. Cost accounting reports both accrued (i.e., committed) and cash (i.e., actual) expenditures. This helps business understand the enterprises liabilities and supports forecasts of remaining costs.
.4 Report Project Costs
The cost accounting system reports expenses as they are debited and credited to the various expense accounts in the ledgers. As was discussed, if the accounting system cost accounts are inconsistent with the control accounts, the accounting process must transfer the expenses to the cost control system.
.5 Close Cost Accounts
Cost accounts are closed to accepting charges when no longer needed. For recurring expenses, the cost accounts may always be open. However, accounts in the asset ledger, in which CAPEX has been assigned at project closeout, are closed after the asset is fully depreciated.
5.1.3 Inputs to Asset Cost Accounting
.1 Requirements. (see Section 3.1) Establishes the conditions or capabilities that must be met or possessed by an asset (i.e., system, product, service, result, or component). Requirements often include cost targets. The methods to be used to measure and account for costs and performance are often established as requirements.
.2 Cost Budget Accounts. The investment decision making process (see Section 3.3) establishes cost budgets for the selected asset solutions. The budgets should follow a chart of accounts that aligns with the way costs will be measured and assessed; plans must address how expenses will be assigned to the appropriate cost accounts (e.g., ABC/M).
.3 Performance Measurement Plans. Plans for measuring asset performance (Section 5.2) should be aligned with cost accounting plans as appropriate. Alignment may consider the frequency of measurements, alignment with control accounts, etc.
.4 Asset Performance. (Section 5.2) The time of initiation and closing of cost accounts is partly dependent on activity start and completion dates. Also, activity performance is compared to payments made to identify committed costs.
.5 Changes. During project execution, changes to requirements and asset planning are identified in the change management process (Section 6.2). Change may result in changes to asset cost accounting.
.6 Charges to Cost Accounts. In the accounting process (steps of which are not part of the TCM process map), the disbursal of funds is recorded by the accounting process against the appropriate cost account.
.7 Historical Accounting Information. Successful past asset cost accounting approaches are commonly used as future planning references.
5.1.4 Outputs from Asset Cost Accounting
.1 Cost Budget Accounts. Asset cost accounting planning may identify improvements to the basis of investment decision making (Section 3.3).
.2 Performance Measurement Plans. Asset cost accounting planning may identify improvements in plans for measuring performance (Section 5.2).
.3 Cost Information for Assessment. Cost information is used in asset performance assessment (Section 6.1).
.4 Historical Accounting Information. The enterprise cost accounting approaches are captured for use as a future planning reference. Asset cost data are also captured in the project historical database (Section 6.3).
5.1.5 Key Concepts for Asset Cost Accounting
The following concepts and terminology described in this and other chapters are particularly important to understanding the asset cost accounting process of TCM:
.1 Cost Accounts. Charts of accounts for capturing expenditure and cost information.
.2 Expenditures/Expenses. An expense that is charged to a ledger account when a payment or disbursement is made. Expenses differ from reported costs because costs (e.g., a process cost, activity cost, product cost, or customer cost) are always calculated.
.3 Commitments. The sum of all financial obligations made, including expenditures as well as obligations, which will not be performed or received until later. May also be referred to as an "accrued expenditure."
.4 Cost Allocation or Assignment (overhead, markups, etc.). The process of representing and reflecting how outputs of work (or the work itself) consumes and draws on resources by transferring costs from one account to another so that calculated and reported costs are consistent with the basis for the cost included in the cost control budget.
.5 Cash and Accrual Accounting. In cash accounting, costs are accounted for when expended (i.e., payments are made or cash disbursed). In accrual accounting, costs are accounted for when an obligation to make an expenditure is incurred, even if cash will not be expended or disbursed until a later time.
.6 Capitalization and Depreciation. Some costs are charged (i.e., expensed) as immediate or current expenses. However, capital expenses (CAPEX) are held in suspense as work-in-progress (i.e., a suspense account), until the capital asset is put in service. Prior to being put in service, the capital project costs are assigned to items in the capital asset ledger and balance sheet (i.e., capitalized), and these costs are then charged or recognized over time in the profit statement as a depreciation expense. Capital and expense designations and depreciation rules are usually defined by government tax authorities. Cost engineers often assist the finance function in making the cost allocations.
.7 Activity-Based Costing/Management (ABC/M). A superior method to causally trace and assign resource expenses into costs (rather than allocate costs) in a way that the costs budgeted and charged to an account truly represent all the resources consumed by the activity or item represented in the account (i.e., the allocation is not arbitrarily based on broad averages without causality, but reflects what events drive the cost).
Further Readings and Sources
The interface of asset management with cost accounting is generally covered in business management and accounting texts. The following references provide basic information and will lead to more detailed treatments.
AACE International. Skills and Knowledge of Cost Engineering, 5th ed. (chapter on Activity-Based Cost Management). Morgantown, WV: AACE International, 2004.
Cokins, Gary. Activity Based Cost Management: An Executive Guide. New York: John Wiley & Sons, 2001.
Humphreys, Kenneth, Editor. Project and Cost Engineers Handbook, 4th ed. New York: Marcel Dekker, Inc., 2005.
Klammer, Thomas P. Managing Strategic and Capital Investment Decisions. Burr Ridge, IL: Irwin Professional Publishing, 1993.
Ostrenga, M., M. Harwood, R. McIlhatten, and T. Ozan, Editors. Ernst & Youngs Guide to Total Cost Management. New York: John Wiley & Sons, 1992.
Piekarski, Julian A. "Advanced Managerial Costing in Industry," AACE International Transactions. Morgantown, WV: AACE International, 1994.
Player, Steve and David E. Keys. Activity-Based Management. New York: MasterMedia Limited, 1995.
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