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Performance46

In thebusinessworld, therearviewmirror is

always clearerthan thewindshield

Warren Buffett,

American investor,

businessman and philanthropist

Cost management system at JSC Russian Railways

IntroductionRecently, corporations have been applying

end-product management and supply chain

management to increase the protability

of each product, which enables prices

to be kept low while raising prots.

An activity-based costing method is the key

to success in these critical management

strategies. ABC is a costing model that

identies the cost pools and activity

centers in an organization. It assigns

costs to products and services (cost

drivers) based on the number of eventsor transactions involved in the process

of providing a product or a service. As

a result, ABC management can support

managers to see how shareholder value

can be maximized and how corporate

performance can be improved. Specically

for monopolies it is greatly important to

pursue a price policy based on product

costs, while for other corporations

it is imposed by market prices.

In addition, cost management systems

in large state-owned holdings have theirown special features, including a very

high share of indirect expenses in the

consolidated corporate expenses. The

process of cost allocation with respect to

different business units (BU) and subunits

usually has high potential for improvement.

Based on the situation described above

plus a framework of reform, the national

railway monopoly, JSC Russian Railways,

started a process to restructure the

management accounting system by

implementing an activity-based costingmethod in order to increase efciency

and reduce costs without sacricing

the value for the customers.

The companyJSC Russian Railways (hereinafter RZD)

is one of the biggest railway companies

in the world. RZD has a complicated

multi-level structure that includes

company branches and representation

ofces, subsidiaries and associates. As

of December 2006, the company had a

total of 120 subsidiaries and associates.

Some of the elds in which RZD

operates are:

Freight trafc

Long-distance passenger trafc

Suburban passenger trafc

Infrastructure services

Locomotive power services

Rolling stock repair services

Capital construction

Research and development

Maintenance of public property

Large-scale production, functional

diversication and the complicated

organizational structure of RZD result in

differences between the units reporting

standards, use of the wrong consolidation

principles and the undened corporate

policies, which entail misleading decision-

making processes for management.

These imperfections in the management

reporting can damage corporate

strategy. Therefore, we were engaged

in the project of reengineering RZDs

management accounting system.

The improvement project for the

cost management system of RZD

was implemented in three phases.

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Performance 47

Phase 2

To increase the accuracy of cost allocation

and create an effective management

system, an activity-based costing analysis

of the types of activities was carried out.

The development of a new accounting

methodology requested improvements

and adjustments to the previous format,

providing detailed data gathering for

more accurate cost allocation using

the activity-based costing analysis.

The challenge was to create separate

cost accounting frameworks for the

different types of activities. The detailed

analysis of the activities of every

business unit and their inclusion in the

strategic corporate scheme allowed them

to derive the new accounting format

showing costs of single business units.

As the new accounting format is more

exible, it enables the conduction

of cost structure operating analysisand operating budget planning

based on cost groups; including a

breakdown of costs to cost items.

Phase 1A specic characteristic of RZD is that

general indirect expenses and overheads

are rather high as a percentage of total

expenses. Indirect expenses, related

to the maintenance of the railways

infrastructure, account for 40% of the total

general costs and 30% of handling costs.

Overhead costs, which are proportional

to the labor compensation fund in recent

years, also accounted for approximately

30% of total handling costs. Consequently,

some 60% of the total expenses of railway

transportation are distributable, and

the structure of trafc handling costs

depends sharply on the accuracy level of

allocation of these distributable expenses.

Therefore, in order to dene prot- and

loss-making activities facilitating the

development and maintenance of an

effective cost management system and

increasing protability of the whole

company, an activity-based analysis of

expenses and functions (marketing,

legal services, human resources, nance

and accounting, etc.) was carried out.

The analysis conducted during the

diagnostic phase of the project allowed

the identication of existing accounting

methodology and cost allocation

methodology deciencies. They could

be classied into two main areas: data

gathering and cost allocation method.

Regarding the data gathering

process for costs, the following

problems were identied:

Incorrect consolidation structure

Failure to break down expenses

on cost accounts and cost items

by lling out the form

Incorrect cost allocation to general

and administration expenses inthe consolidated balance sheet

In the area of cost allocation method,

the following problems were identied:

Application of outdated

coefcients for distribution

Application of labor compensation

fund as a basis for cost allocation

Allocation of overhead expenses on

the upper level (some expenses,

e.g., general and administration

expenses could be allocated at

the level of business units)

Overheads

Products/

servicesAllocation

coefficients

BU 1

Expenses

con

solidated

BU n

Direct

costs

Cost data

Figure 1: Cost allocation

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The main advantages of the new

accounting format were as follows:

Structuring costs by types of activity

Indication of physical measures and

number of employees by cost items

Specication of company expenses

and all physical measures enabling

planning and cost items accounting

The new cost allocation methodology

involved the implementation of an

activity-based costing model. As a

result of the implementation of thenew cost allocation methodology, it

was possible to carry out a structural

analysis of costs by type of activity.

Some characteristics of the new method

of cost allocation were as follows:

Adding denition of function as

an object of cost accounting

Allocation of production costs

and general and administration

costs to production function

Function 1

Function n

Function 2

Product 1

Product 2

Product nAdditional

function n

Additional

function n

Direct

allocation

BU 1

BU 2

BU 3

BU n

Cost data

gure : ost account ng o d erent types o act v t es

In proportion to

the statistics

coefficents

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Performance 49

Allocation of general and administration

costs and costs of service departments

to production functions of production

departments, and not to types

of activities, which increased the

accuracy of cost allocation

Allocation of general and

administration costs at lower levels

Implementation of a new cost

allocation scheme for selected items

Implementation of a

cross-costing method

Phase 3

During this phase, a pilot project to make

the cost management system more

effective was executed in the Moscow

section of RZD. An electronic model,

which enables separate accounting

by type of activity and type of rail

transportation, was created. The high

level of satisfaction with the results of

the pilot made the management decide to

develop the activity-based costing model

and apply it to the whole company.

Conclusions

The rst benets of implementing

the activity-based costing

method were realized in the

management reporting system.

Data gathering systems are the basis for

management reporting. Improvement

of the formats and processes of data

gathering lead to successful optimization

of the management reporting system,

avoiding the creation and implementation

of additional systems for similar

purposes. Critical redesign of the

formats and standards of data gathering

brings a higher level of efciency

and even motivates employees.

Beyond that, implementing activity-

based management makes prot- and

loss-making activities more visible to

RZD, facilitating the elimination of loss

or taking reform measures to promote

protability. It enables an increase in the

effectiveness of budgeting by identifying

a cost/performance relationship in the

different elds of activities of the Russian

railways, links corporate strategy to

operational decision-making and helps

improve decisions about tariffs that are

based on the cost of activities. It also

encourages continuous improvement and

total quality control because planning and

control are directed at the process level.

Therefore, the ABC method is the key

to the improved performance of the

Russian railway in several respects and

supports taking measures to promote

protable business development.

Authors

Sergey Zaborov is a Senior Manager in the

Advisory Practice, Ernst & Young, Russia.

Liani Asatiani is a Senior Consultant in the

Advisory Practice, Ernst & Young, Russia.