Income tax- House property- India simple guide

House Property -  Income Tax effects in India:

Self Occupied house  property:

If the house is self- occupied, then interest on housing loan taken from recognized financial institutions like bank etc. is eligible for deduction under Sec.24. The Annual Value of the property will be taken as nil and hence naturally there will be negative income i.e loss from house property which can be set off against any other income in the said financial year.

The interest allowed for the houses purchased prior to 1.4.1999 is only Rs.30000/- maximum and for subsequent period, the amount allowed is Rs. 150000/-. Only one house can be treated as self-occupied property if anyone owns more than one house and wants to claim self-occupied property either by himself or his relatives or even if it is locked.

House property given on rent:

For rented property, the annual value i.e. rent receivable is to be calculated first allowing deductions like municipal tax paid for the house property,  insurance paid for the house property. This is called net annual value. If it is not possible to calculate rentable value, then the annual value will be taken as ratable value as per municipal /city valuation.

From the Net  Annual value, the deductions are allowed for

1. Vacancy allowance ( house remained vacant)
2. Interest on house Bld loan without any limit
3. Repair allowance of 30% of net annual value.

The remaining amount , if it is negative, then this amount can be set off against other income like salaries and business income. Otherwise, it will be taxed at the appropriate rates  after adding this with other income. This type of calculation can be done for any number of houses owned by individual given on rent.

When you want to sell the house and have some capital gain:

Capital gain is divided into two categories:

1. Short term capital gain.
2. Long term capital gain.

Short Term Capital Gain:

If we sell the house property within 3 years from the date of purchase/ construction, it will be treated as short term capital gain and will be added to the income of that year and taxed according to the slab.  No indexation benefit will be given for the house property.

Long Term Capital Gain:

If we sell the house property after 3 years from the date of purchase/ construction, it will be treated as Long term capital gain. The tax rate applicable will be 20%  after application of indexation on the capital gain.

For example, X sold his property on Jan 1, 2006 for 80 lakhs. He bought it on 22.12.2002 for 35 lakhs. The capital gain will be

Sale price:   Rs. 80 lakhs

Index in 2002 was 447

Index in 2006 was 497.

Indexed cost of acquisition will be:  Rs. 35 lakhs * 497/447 = 39 lakhs(say)

So there is a long term capital gain of Rs. 41 lakhs. This is long term capital gain as there was 3 years gap and eligible for indexation and tax exemptions if capital gains are invested suitably.

There are tax exemptions available on the long term capital gains we make in selling house property.

1. If we invest in a plot, we need to purchase it within 2 years of sale of original property. We have to construct a house on the said plot within a year. In short, if we purchase a plot, within 3 years we have to completely constructed one house on it. Otherwise we will have to pay tax.  We have to invest minimum of Rs. 39 lakhs which is our capital gain. If we invest less than that, then the difference will be added to the income of the concerned financial year and taxed according to the tax slab.
2. If we purchase apartment, it should be done within 2 years from the date of original property sale. Tax conditions are same just like 1 above.
3. We can deposit the capital gains in a capital gains bank account with a nationalized bank within the date of filing returns in which the capital gains accrued. The amount along with the accumulated interest needs to be utilized for purchase of  a property within two years of sale date.
4. We can invest in Capital gains bonds also issued by NABARD ,HUDCO etc. if their bonds cover to give this benefit. But the interest rate will be nominal.

Caution:

When we construct/purchase a house  to avoid capital gains tax after sale of first house:

When we purchase a new house after selling our earlier one , ideally we should own it for a minimum of 3 years or else, the capital gains earlier exempt will be taxed and we will also have pay interest and penalties to income tax dept

C. R. Venkata Ramani

Green Trends: Green Healthcare

One of the new emerging sustainable initiatives is Green Healthcare. Leading healthcare organizations the world over are striving to create environments more conducive to healing, while also trying to eliminate barriers to patient safety and environment risks. While on one front these organizations want to be good stewards of the environment, on the other they are also striving to survive in the marketplace in these recessionary times.

Green Buildings form the basis of Green Healthcare

The first thought that comes to the mind when one says Green Healthcare is Green Buildings for hospitals i.e. buildings that are designed to be energy efficient while also eliminating pollutants. Green Guide for Healthcare, developed by green healthcare industry leaders, provides for Best Practices for creating high performance healing environments for healthcare organizations. This initiative provides a rating system based on credits for each initiative and helps hospitals benchmark themselves in this regard. Intuitive tools such as Energy Dashboard and Patient Room Touch Panels help in tracking and controlling the energy usage.

Equipment Efficiency

The next most important aspect of Green Healthcare is equipment efficiency. With more and more diagnostic imaging equipments and post-processing devices now available to a healthcare organization, it has become pertinent that the equipments are energy efficient. More and more organizations are looking for the availability of Energy Star qualified products for medical equipment purchases. Various innovations are ensuring that medical devices are most energy efficient, for e.g. Siemens SOMATOM Definition CT scanner claims energy savings of up to 30% and lead reduction of up to 83% over other products.

Fig 1: Siemens SOMATOM Definition CT Scanner

Electronic Storage

Another significant development has been the creation of central electronic storage repositories. The continued use of PACS systems and the move towards networked hospitals means a huge reduction in the requirement to film the patient images. It also eliminates the need to purchase envelopes to store them and the expense to courier those to remotely located PACS stations.

Recycling of Medical Waste & Equipments

One of the key concerns with the healthcare industry has been the toxic nature of the medical waste and the effect of the same on the environment. More and more healthcare organizations are rolling out initiatives to recycle the waste. Some hospitals reported savings of $1 million or more by recycling paper, cardboard, metal, batteries, lamps and printer toner cartridges.

Suppliers these days are also offering more programs for the take-back and recycling of used products. Siemens Medical Solutions offers take-back of its used systems for recycling and proper treatment. No substances that are banned for use are included. The take-back program is part of Siemens’ product sustainability program, entitled product-related environmental protection (PREP).

The PREP process is used to improve environmental performance of its products across all product life cycle phases. The PREP process includes:

• Inventorying the environmental aspects of products and packaging
• Selecting environmental improvement targets for significant product revisions and new products across all product life cycle phases
• Refurbishing of used systems
• Offering take-back of used systems
• Providing product environmental data.

Conclusion

Green Hospitals is a trend that is taking hold in hospitals across the world.       It is counter-intuitive for hospitals to offer anything other than the most healthful environments. This provides the solution providers in the field of healthcare with a wonderful opportunity to participate in this drive to provide the Green Healthcare solutions of tomorrow.

References

http://www.rt-image.com/Green_Purchasing_Trends_in_Imaging_Recycling_education_and_more/content=9804J05E48B6A69440969872448090441

http://www.alternativehealthjournal.com/article/healthcare_s_green_initiative_the_healthy_hospital_movement/3744

http://www.canadafreepress.com/index.php/articles-health/8044

http://www.gghc.org/

http://www.buildingtechnologies.siemens.com/bt/us/SiteCollectionDocuments/sbt_internet_us/solutions-services/industry/Steps_Toward_Sustainability.pdf

Indian income tax- Part II

How to file the Income tax return?

Filing of returns can be done in two ways;

Offline

Returns are prepared manually using traditional paper form. There are two ways in offline:

1. We can submit the filled ITR form at the nearest income tax office where we want to submit our return or
2. We can use the services of Chartered Accountant or any tax return preparer (TRP) who are certified ones by IT dept.  We may have to shell out some money for their services which range from Rs.200 to 2000. We should not attach any documents or any proofs. These are needed when you are called for assessment by ITO by lottery as most of the cases are settled by summary assessment. Refunds if any will be credited automatically for the most of the cases on summary assessments.

Online

1. Electronically we can file the return using internet. This is called e-filing. Nowadays many employers are using digitally signed Form no.16 and issues to employees. If this is available, then the filing agencies will do the rest for employees by way of filling and filing without presence of employee and their signature.
2. Filing of returns by companies is compulsory but it is optional for salaried class.

There are several of websites are available for input for online filing. Simply we have to enter the details of form no.16 in the software of the website. It will automatically generate an electronic return in XML format. This can be saved in desktop and then it needs to be uploaded on www.incometaxindiafiling.gov.in which is a Govt site for income tax filing. The major web sites which offer this facility are www.taxspanner com, www.taxsmile.com etc. Even Govt own site is there called www.incometaxindiaefiling.gov.in/portal/index.jsp. In this, we have to use our PAN as the user name for registering in the site. This site is offering free service. Many of the web-sites take some fee for uploading the files in income tax site. For complicated returns like business income etc, taxspanner.com site is generally preferred. The person who upload the file will get acknowledgement ITR-V from IT dept by email. Keeping a photocopy of this acknowledgement, the original need to be submitted or couriered to a specific IT office in Bangalore within 30 days. The address of the IT office in Bangalore is as follows:

Income tax dept CPC,

Post Box no.1,

Electronic City post office,

Bangalore-560100.

Then this e-filing of return will be treated as E-filing with signature. Suppose if any one is having Digital signature (DS), then there is no need to send the above to Bangalore.

What is DS

Digital Signature is nothing but authenticated signature of any particular person. This is similar to handwritten signature on any documents.  Websites are charging some amount for DS and it is valid normally for 2 years. Govt has authorized many websites /agencies to do this job. To get DS from a tax site, we have to download the relevant form, then fill it up and attach the required documents like address and identity proof. This packet needs to be sent to the specified address in the website by post or courier mode. Within 15 days to one month, we can get our authorized DS. This DS will be useful for big business houses etc. for many deals including income tax matters.

C. R. Venkataramani

Indian income tax – Part I

Filing of Indian income tax  form for assesses in India

Forms to be used:

ITR-1 form is to be used by individuals having income from salary, pension and interest earned in the financial year.

ITR-2 is to be used when income from capital gains, income from house property and income from any other source is there apart from the details for ITR-1.

ITR-4  is to be used for all individuals having income from business or profession.

Only concerned form is to be used as per the earning details.

The above forms can be downloaded from website of income tax i.e. www.incometaxindia.gov.in/download_all.asp .

Filling of ITR -1:

This is mainly used for salaried employees and is simple. Every salaried employee will be given form no.16 in the month of May every year about the salary earned during the year with Tax deducted at source by employer. Only the details of form no.16 have to be incorporated in ITR -1. This form is to be deposited in the concerned income tax circle of income tax dept of the place where the salaried employee will be assessed. There is no need of any expert in filling the form as it is easy and simple.

Filling of ITR -2:

In this form, in addition to the details in form no.16, the salaried person has to add up capital gains/loss and also the income/loss from house properties and income from other sources like securities etc. This form is slightly complicated and may need the help of experts if numerous properties are there.

Filling of ITR -4:

If the assessee is from a business or profession, he has to use ITR-4. This form is more complicated and needs the assistance of experts like Chartered Accountant or income tax consultant.

Before Filing the ITR form:

a) Check whether any amount is payable to Income tax:

You have to check whether you have to pay any amount to income tax dept though your employer or any other tax deducting agencies missed it or you have any additional income which was not covered by any one. In this case you have to subtract your Tax deducted at source from the total tax liability as per return and arrange to pay the difference to income tax dept through form no.280. This can be paid in any bank and you will get a receipt number which has to be quoted  in the ITR form.

b) Check whether any amount is refundable by IT dept:

If you have paid excess tax to IT dept  as per the IT form, then you are entitled to a tax refund. In this case, you have to mention your bank details in the form in addition to contact details. It is also important to mention the MICR number of your bank branch. It is a 9 digit number mentioned next to your cheque number . Interest will be paid by Income tax dept for any delayed refund taking some grace time.

CR Venkata Ramani

Software Development in a Recession – II

Introduction

As a global recession looms large over the sunshine industry of the last decade, there is a big question mark on where Software Development is headed in the midst of all these gloom. Cost Cutting and Increased Productivity have emerged as the two favorite mantras of the IT corporate, so what does all this mean to the software development industry. The current article is the second part in a series that looks at this aspect. Part 1 of the series dealt with an insight into the design/architecture costs. The second part takes a look at Standards and Processes in the industry.

 

Standards/Processes – Why?

Given the fact that IT has shaped itself into a reasonable industry only for around 2 decades or so, the number of Quality systems, processes and procedures that have been implemented, discussed and scratched are amazingly high. Standards such as ISO9000 series, CMMi, Six Sigma, TQM, Lean, TPM, JIT have all been lapped up by the software industry at an amazing speed. On the one hand while this is a good thing from the standardization and quality perspective, it poses the question of cost incurred in these processes and the benefit derived there-of.

The simplest way to start is to ask the basic question: “Why do I want to implement a Quality System?” If you are using the standard as a marketing gimmick (a plaque on the wall; a logo on a website), or just because a customer requires it, then the standard will be a burden, not a benefit. If the honest reason for implementing the standard is improvement, then it can truly help your organization become better. Again, if certification is the only goal then you may gain certification but miss the benefit of the standard. An organization can employ the standard, and benefit from it, without ever seeking certification.

The purpose of a Quality System is to create an internal control system through defining and documenting processes with well-written procedures so that a company can address a few key areas such as Compliance, Operational Needs, Manage Risks, Knowledge Sharing and Continuous Improvements. For e.g. complying with the law of the land is a basic function of an organization and so is ensuring that the activities fundamental to the organization’s success are properly guided by the management and are performed in a consistent way that meets the organization’s need. While processes and procedures themselves may not demonstrate compliance, well-defined and documented processes (i.e. procedures, training materials) along with records that demonstrate process capability can make evident an effective internal control system and compliance to regulations and standards.

 

Standards/Processes – How many?

The question that pops up is whether to adopt any specific Quality Standard or whether to adopt multiple standards. This is interesting as in the past decade companies have adopted more than one standard and have got themselves certified for these standards. Companies first comply themselves with one standard, then come up with a mapping strategy between this standard and the next standard that they want to get certified on and add more processes / procedures to fill the gaps. This mapping leads to making things a bit bulky for both standards. Things become even bulkier when the company tries to add another standard.

Creating dozens and dozens of procedures is usually not helpful.  In fact, such an approach can create more problems than it resolves.  They can’t be found, they aren’t used, they aren’t updated, and a glut of uncontrolled copies are scattered throughout the organization. This is exactly what happens when Quality Standards are imposed on businesses without due deligence.

The basic reasons for which Standards and Processes are defined are actually lost and questions like “What processes are required, which of these require high control and where is the improvement required?” are often lost in the rat race to acquire certifications. The futility of this whole cycle has been aptly demostrated by the Satyam fraud, where despite all the processes in place, the basic underlying deficiency could not be tracked, that too by highly experienced auditors.

On the other end of the spectrum are a set of companies, that have not gone for certifications, but instead have chosen to pick and choose the best of the processes from various standards based on their applicability to their businesses. E.g. of such companies are Oracle Corporation and Microsoft Corporation, both of which have stayed away from formal CMMi certification but do get an external auditor to benchmark once in a while how they are placed viz-a-viz the industry. Of course, such a strategy works well for product based companies rather than services company which needs to assure clients that it has the process to handle their requirements, but what this shows is that Quality Standards are not required for certification alone, but for a specific benefit. So what is the benefits that the organization plans to derive decides what Quality Standards are to be followed.

 

Standards/Processes – Lean Methodology

Lean thinking is an emerging methodology to reduce wasteful processes. It is more a mindset of viewing things in the right light, focussing, removing waste, and increasing customer value. It is predominantly another manufacturing concept that is slowly beginning to make an entry into the IT industry.

Lean processes tend to retain the processes that add value to the customer while cutting out those processes that do not. The simple fact is that if a process does not add value or generate revenue then it simply adds cost!! Lean Processes follow 5 basic steps:

1. Identify activities that create value.
2. Determine the sequence of activities.
3. Eliminate activities that do not add value.
4. Ensure that products/projects are available when the consumers want them.
5. Continuously improve processes.

So for e.g. suppose a company is providing an IT support to a customer and bills the company for the time and material spent on providing the support, then it might not require the overhead of a completly bulky project planning and tracking mechanism. Instead they might want to have a task tracking and issue tracking mechanism with minimal project planning aspects involved on a day-to-day basis.

Six Sigma on the other hand states:

1. Define
2. Measure
3. Analyze
4. Improve
5. Control

So while the former considers non-value addition as a waste, the later considers non-conformance to defined standards as a waste. Lean Operations redefines waste as anything the customer won’t pay for—everything from clerical errors to idle machine operators.

The process identifies seven types of waste:

1. Waiting—for products, personnel, parts, the availability of machines;
2. Transportation time—for equipment and parts needed for repairs;
3. Processes—duplicate data entry, inefficient stocking;
4. Excessive inventory;
5. Unnecessary motion by people and machines;
6. Overproduction;
7. Correction of defects or service errors.

Given this, it might be worthwhile to revisit the Quality Standards and apply Lean processes on them to prune out all those non-value adding activities. Note that not all of Lean processes might be applicable per se to the Software Industry, but those that do could result in significant benefits.

 

Standards/Processes – Documentation

The common belief seems to be that implementing Quality Standards can create a bureaucratic documentation nightmare with volumes of complicated procedures that require heavy oversight and manpower to create and maintain. That is not really the case. In fact, implementing Quality Standards can actually streamline and simplify your documentation/record creation and management. For e.g. suppose we consider ISO:9001, there are only 6 mandatory procedures for the same namely:

1. Record Control (per ISO 9001 clause 4.2.4)
2. Internal Audit (per ISO 9001 clause 8.2.2)
3. Control of Non-Conformities (per ISO 9001 clause 8.3)
4. Corrective Action (per ISO 9001 clause 8.5.2)
5. Preventive Action (per ISO 9001 clause 8.5.3)

As it is difficult for most organizations to get by with these six procedures alone, they add more procedures over and above these. But, the fact that these are the only required procedures should send a message that, despite the perception of the opposite, ISO 9001 is not about tons of procedures. The same generally holds good for other Quality Standards.

What actually creates the bulk is usually the records. For e.g. ISO 9001 has 21 mandatory records to go with the 6 procedures. All organizations going for the certification either have these records in place or are in the process of getting them in place. But, the key fact here is not having the records, but what is done with these records? The ultimate goal of a Quality Standard is improvement and one key to improvement is record keeping that captures important data related to performance metrics. So a simple question that any organization needs to ask is “What do we do with the records? What are the improvements that have been triggered by the metrics captured in these records?” If there is no visible or quantifiable improvement in the metrics, then these records and the process associated with these records need to be re-looked at both from their usability aspects as well as their capturing aspects.

 

Standards/Processes – Other Areas of Improvements

There are other problems that usually bloat up standards and processes. Simply put, they are hard to find, hard to read, not used, not followed, too long, poorly written, poorly formatted, out of date, and not accurate. Wow!! That’s a lot of baggage, but the truth is not all of the above said are simple ramblings or cribbings, but some of these are facts. Let’s examine some of the stark realities that lead to some of these.

 

Horses for Courses

Who would you get to frame the processes? Too often the task of developing and writing important organizational documentation falls to those who have little experience or training in this area. They may have extensive process and organizational knowledge, but without proper experience or training, this expertise gets translated very poorly into a document.

The end result is something that is hard to understand and implement and in some cases leading to the actual reason of the process being lost in translation. Identifying key resources like the Process Owner, the Technical Writer, Process User is the first step in ensuring to avoid thne same. You can not realistically expect the process expert or process owner to magically transform into a technical writer and expect positive results. It also results in reducing the cost incurred in maintaining of these processes, time spent on training and getting a buy-in on these procedures.

 

Proper Training

Most of the quality trainings are done in bulk and are more used by people for dozing off rather than to actually inculcate the processes mentioned. Usually hands-on training and training on the relevant pieces at appropriate times ensure that the processes are better understood. Guides and mentors to explain the usability and the benefit of the processes great enhance the valueadded by the processes.

One of the major irritants that I have faced with Quality Processes is when I am told to follow a process without knowing how it benefits me. It makes it all so easy when I know the value I get from following a process. Improper or Inadequate training has other drawbacks, as people in order to ensure that they are not flagged off for following processes tend to create records without following or understanding the actual process. This most of the times results in additional non-required records and documentation and again adds no real value at all.

 

Improper Generalization

Usually best practices from one area are tried to be generalized and pushed into other areas. While in some cases it is good, in most cases it just is there an overhead adding little if any value. For e.g. RCA is a great tool for finding long term solutions to recurring issues and issues which arise late in the product lifecycle. But then process organizations tend to push RCA into all stages including the design stage. Imagine in the design stage when teams are trying out the feasibility and benefits of different solutions and the process asks them to do an RCA to find out why the best design was not the first design to be tried out!!

 

Knee Jerk Reactions

Sometimes some gap in the process when highlighted as an audit finding or when is criticized by observers or stakeholders leads to knee jerk reactions from the organizations. They tend to have more processes in place to avoid this situation without completely weighing in the pros and cons of the same. Over a period of time such processes not only add costs to the organizations, they also tend to provide little or no value.

 

Audit Processes

With the advent of internal audits, the frequencies of these audits has been increased highly. Most organizations have quarterly audits and the emphasis of these audits has moved over from the actual improvement due to the process to the simple verification of records.

Part of the problem is due to the fact that the increased frequency means that more auditors have to be identified with little or no training which means that all they can do is follow instructions for verfication of records. Even for competent auditors the load of auditing projects frequently means that unless something is overtly out of place, they tend to just verify the existing records. Funnily enough, when it comes to verification of the records, the auditors approach it in a very hawkish manner as well. It must be understood that auditors have to perform serveral duties and have to act as “Watch Dogs” but not as “Blood Hounds”. Several enlightened firms of auditors have readily agreed to adopt ideas of process simplification, but some conservative members do not show the same willingness and need to be persuaded.

 

Summary

The Standards and Processes are the basic building blocks of the performance of an organization. Over a period of time, they tend to clutter and grow in size and actually become an overhead instead of a value-addition. Companies need to constantly prune and re-define them to be of maximum value and a recession gives an added incentive to cut through all the redundant and non-value adding processes and emerge out as a lean and mean organization ready to face the competition.

 

References

http://www.bain.com/management_tools/tools_lean_operations.asp?groupCode=2

http://www.bizmanualz.com/information/2007/11/05/policies-and-procedures-can-help-your-organization.html

http://www.bizmanualz.com/information/2008/05/05/why-implement-an-iso-9001-quality-management-system.html

http://www.bizmanualz.com/information/2008/08/29/avoid-poorly-written-procedures.html

http://www.bizmanualz.com/information/2005/07/14/lean-thinking-for-process-improvement.html

http://www.bizmanualz.com/information/2005/03/17/does-solving-problems-improve-the-process.html

The Paperwork Jungle – C. N. Parkinson/M.K. Rustomji/ A.V. Deshmane

Activity based costing in Service Sector – Part III

The mapping is self-explanatory. Using this method of ABC, we can identify costs per activity whether it is inside branch of a bank or in virtual bank like internet banking or in insurance company etc. When customer using these activities can be analyzed for costs and these costs can be compared with the revenues they give to the service sector thus profitability per consumer can be worked out. Product profitability is also easy to calculate. The only major problem is to identify the activities properly using cost and activity drivers and assign to products / customers / channel etc. Direct costs can be assigned directly. Only indirect costs can be identified with activities using resource drivers and cost objects like customers, products, channel etc. can be identified with activity drivers.

What happens when ABC is done in service sector:

When Activity based Costing is implemented, then every department head will be required to oversee activity costs and he will be on tenterhook to reduce the costs. He will voluntarily surrender idle assets to improve his bottom-line. He will say “I have space which I do not need and use, please use it for some other activity.”

Someone will say “I have surplus people, so take them away. I am having machines, I am   not like to use it most of the time, it is inherited, take them away or allow it to share with others. ”

If we see the substitute in banking, it is electronic payments which cost very meagure amount per transaction. It is swift and smart. It is extremely customer centric without seeing the customer in the bank. Customer stay at home and we will look after his interests. At a negligible cost, great personal relationship gained. But of course, chances of cross selling the products are lost. Any this can be managed with frequent visit by officers to the residence of good customers. Because at branch if valued customer comes, tea or coke offered, bank time was spent for transactions and it all cost bank Rs.80/-.Activity base has converted a deliverable to the bottom-line. If deliverables go to bottom-line which is the least incidence of costs, bank can maximize those transactions with least incidence of cost.

If the electronic data processing’s are cheaper for most of the activities with less manpower, it is better to go for software .The  banks can seek system administrator rather than clerks as customers have to pay high for clerks for improving their competitiveness and cost reduction. ABC helps to identify the areas. Live contacts with customers are also a must as cross selling is catching up to prop up the revenues of the service sectors. So Marketing dept of service sector should be geared to analyze the customer trends based on ABC and identify the existing good customers where there is chance to cross sell more products. It’ll cost you 5 times more to attract a new customer than it is to bring one of your past customers back to you. It is still cheaper to cross sell to your existing customers. If you’re a smart business owner, you’ll understand that every cent you invest in advertising is going towards acquiring new customers. You’ll also realize that once you’ve acquired the customers, you just can’t afford to let them go.

More Banks are now opting for ABC due to its utility in complex product mixing as in banks products are sold as bundles from different segments.

C.R. Venkata Ramani

(AICWA)

(This article by Mr. C.R. Venkata Ramani is extracted from his article published earlier in “The Chartered Accountant” magazine.)

Activity based costing in Service Sector – Part II

Activity Based Costing (ABC) is a technique for calculating the expenditure associated with the performance of group of tasks within an organization.

• Cost objects consume activities.
• Activities consume resources.
• This consumption of resources is what drives costs.

Activity Based Costing

Activities know no boundaries of dept or division as some activities like loans depending on values go to higher levels for sanction. Costs increases or decreases as there are changes in the work load that affect the activity costs via their cost drivers. Work activities are triggered by events and the costs react as the effect.

Some definitions related with ABC

An Activity is defined as “a value adding process which consumes resources.

Cost driver is “an activity or factor which generates cost”, for example, a cost driver could be no. of material receipts in the stores dept which is measurable or it can be a natural disaster like earth quake or electrical short-circuit fire which cannot be expected or measurable in advance. We are concerned with measurable drivers.

Resource drivers:  Trace expenditures to work activities.

Activity drivers: trace work activity to cost objects.

An activity driver may be the number of times an activity is performed—transaction driver—or the length of time an activity is performed-duration driver or deep intensive operation -intensity driver.

The traditional report and activity based report are shown below(Table A & B). The General Ledger uses a chart of account whereas ABC uses a chart of activities as its language. When you translate those “chart of accounts” expenses into the “chart of activities” that consume the  financial general ledger’s expenses, a manager’s insights from viewing the activity costs begin to increase. His responsibility is defined and he will take interest in showing performance.

ABC is very work-centric whereas the General Ledger is transaction-centric. The General ledger view on the traditional view describes “what was spent” whereas the activity-based view describes “what for it was spent?”

Traditional Presentation of Costs (Table A)

Dept: X

Expense Head	Amt in Rs.
Direct Labour cost	2600
Direct material	100
Direct expenses	100
Indirect expenses	500
Total costs:	3300

ABC Method of presentation of costs  (Table –B)

Dept: X

Departmental activities	Cost	No. of transactions	Cost/Trans (actual Rs)
Sanctioning and opening loan a/cs – term loans	1000	10	100
Sanctioning and opening loan a/cs – project loans	1500	10	150
Follow up of term loans	50	10	5
Follow up of project loans	50	10	5
Transactions in term loans	300	15	20
Transactions in project loans	400	20	20
Total activity costs:	3300

The Six General Steps to Activity-Based Costing Implementation:

1. Identify Cost Centers or Strategic Business units: First identify the cost centers or SBU of the banks or service units.

2. Identify Activities: Next we should conduct an in-depth analysis of the operating processes. Each process may consist of one or more activities required by outputs. Activities may be subdivided into tasks if need be.

Some of the activities in a savings section of a bank which is a service sector are

• Opening savings account
• Cash collection
• Cheque collection
• Cheque payment
• Electronic payment
• Setting up internet account access
• Cheque issue,
• Customer complaint/enquiry processing
• Pass book updating

Activity Dictionary is to be made department wise or cost centre wise which will help mapping up all activities and to avoid any overlapping of activities. If this is supported by codes will help to prepare a software wherein all costs/revenues can be captured as a routine and for identification activity wise.

3. Assign resource costs to activities: This is also referred to as “tracing,” assigning costs to cost objects determines why costs were incurred.

4. Identify outputs: Then we have to identify all of the outputs for which activities are performed and resources are consumed. Outputs can be products, services, or customers-persons or entities to which a bank is required to provide goods or services.

5. Assign activity costs to outputs: We can use activity drivers to assign activity costs to outputs based on individual outputs’ consumption of or demand for activities. For example, a driver may be the number of times an activity is performed—transaction driver—or the length of time an activity is performed-duration driver or intensity driver which emphasize about intensity or quality of the product.

6. Note and report un-necessary activities and unused capacity: We can note down and report un-necessary activities which consume resources but not benefit to customers and growth of bank and also report any underutilized capacity. These can be identified when we look into facets of activities and its importance in value chain of the bank.

For activities, there is one unwritten rule i.e.  “It is wise to pay heed to the “5% rule” which states that if any activity which does not account for 5% or more of the depts’s time, then it should probably be aggregated with another activity “. So in a department, there can be maximum of 20 activities.

C.R. Venkata Ramani

(AICWA)

(This article by Mr. C.R. Venkata Ramani is extracted from his article published earlier in “The Chartered Accountant” magazine.)

Activity based costing in Service Sector – Part I

For service companies, customer profitability is far more important than product profitability because the costs of providing a service product are usually determined by customer behavior. Take the example of a standard product like a Savings/current account. One customer may make very few deposits, withdrawals or balanced and service requests, and use only electronic channels – ATM and internet. Such a customer imposes low demands on the bank’s resources. A second customer, however, may manage her Savings/current account balance very closely, keeping only the minimum amount on hand, and make many in-person branch withdrawals and deposits. This customer’s account may be highly unprofitable under current pricing arrangements.

Service companies need to identify the differential profitability of individual customers, even those using standard products. The customer almost completely determines the quantity of demands for the organization’s operating activities so, unlike manufacturing companies, the variation in demand for organizational resources is much more customer-driven than product-driven. Customer balances or sales volume are poor proxies for profitability. Small-balance customers can be quite profitable and large-balance customers can be highly unprofitable. And to complete the picture, financial service companies need to integrate information about the transfer price of funds and the cost of risk (e.g., loan loss provisions and reserves, and risk-adjusted cost of equity) when calculating individual customer profitability.

Activity based costing (ABC) helps to find out customer profitability as well as product profitability. Before going deep into it, we must know when to go in for ABC as it is slightly costly affair as compared to other traditional costing methods.

The use of volume-based allocations which is traditional one will provide fairly accurate calculated costs when the following conditions exist.

• Few and very similar products and service lines
• Low overhead expenses
• Homogeneous processes, channels, customer demands and customers.
• Very very high margins.

How many banks posses those characteristics today? Hardly any.

Five people go to a restaurant. One of them does not want to eat, he orders one cool drink. The others order cocktail drinks, a full meal and a desert. The total bill comes to Rs.5000. Whether this amount will be shared by all? If it is to be shared, then this is the surest way of losing friends. In a sense, ABC is like this. You have to put the resources in the right activity, right pocket. Otherwise, you lose customers.

In Traditional accounting, no. of transactions or volume forms the base for apportioning the total expenses among products. Transaction for a particular activity may be sizable and for another, it may not be so, for e.g., for opening a cash credit account process, activities are more but for opening one simple savings account, it is simpler on KYC basis.  One activity takes much more time and effort as compared to another. So there is differential cost impact.

In another example, a machine manufactures two products. Assuming that the production volume of the two products is the same, using traditional costing methods, the cost of using the costly machine will be factored by two and assigned to the two products. However this might not be correct as one product might require more processing time in the machine than the other. Traditional costing methods always assume a relation between overhead and the production volume. It always fails to take into account the size or complexity of the product. In reality, it is not safe to assume that the manufacture volume of the finalized product is directly proportionate to the product cost as not all overheads vary with the number of units produced. With traditional costing methods, there is always a danger of one product subsidizing another.

In one more case, a company was having ten products and the advertisement and selling costs are apportioned based on volume of sales. When concerned Sales Manager was interviewed, he gave the view that he did not labour much for nearly seven products and orders were automatically coming. Out of the advertisement and selling costs budget, hardly 20% is spent on seven fast moving products. Only for three products, he was compelled to do lot of canvassing by way of advertisements, personal persuasions, and visuals etc.by spending 80% of budget for pushing up sales. In fact seven products cross-subsidizes the three products.

Another good example, we all know that most customers have a better payment history than others. Let’s say ABC assessed cost to chase customer payments is Rs.10, 00,000 a year and concerned bank have 10000 customers. On traditional cost basis, the cost per customer will be Rs.100. ABC dictates that only customers who pay late cause the costs of “chasing customers for late payment”. If 90% of bank customers pay on time, then the remaining 10% alone should receive this cost, i.e.  Rs.1000 per customer. Further when we go deep into the details, some customers had to be reminded many times about late payments and hence their share should have been more than Rs.1000 as compared to others. So application of traditional method which is based total number of customers and total cost of chasing the customers for payment affects customer relationship i.e. 9000 customers who do not want to pay for this activity for which they are not responsible. They will be dissatisfied with this levy though they are right in time for payment. This type of  view could not be obtained through traditional costing methods.

Any sensible marketing man will not sell his product unless he recovers men, material and overhead costs along with some profit. Only in exceptional cases and market catching activities, compromise may be made temporarily on pricing. In the same way, each activity enjoyed by the customer of any firm or bank should pay for the services. Otherwise, in the long run, the firm/bank may incur losses. At least a total income from bundle or complex activities should exceed the cost of the activities though some plus and minuses are there among the activities. Hence ABC is the remedy for this complex business where overhead plays major part and customers in service sectors are demanding only complex or bundle of products  nowadays.

ABC stands out from traditional costing methods especially when:

• Overhead is high,
• Products are complex
• Competition is stiff

C.R. Venkata Ramani

(AICWA)

(This article by Mr. C.R. Venkata Ramani is extracted from his article published earlier in “The Chartered Accountant” magazine.)

Phases of Optimization – III (Post-Optimization Phase)

In this article, we take a look at Post-Optimization phase in a detailed manner.

The Post-Optimization phase evaluates the optimizations done in terms of improvements and benchmarks. It is also the phase where in the lessons learnt from the current optimization process can be built into the know how for subsequent projects.

Post Optimization Activities

i) Benchmarking: Benchmarking provides a snapshot of the system performance and allows comparisons with others / standards. This is also a method of evaluation of the success of the performance optimizations being done in the project.

Benchmarking is usually done on the following aspects:

1. Industry Standards: This helps evaluate how the product performs in comparison with the Industry Standards after optimization.
2. Competition: This helps evaluate how the product performs in comparison with the competition.
3. Hardware: This activity helps evaluate the performance of the product on different hardware. Using this information the optimal hardware recommendations for the product can be arrived at.
4. Software: This activity evaluates the performance of the product with different software such as Operating Systems, Databases etc. Based on this the performance expectations on different software platforms can be established.
5. Versions: Benchmarking can also be used between different versions of the product to showcase the improvements that have gone in with each version. Refer to the below graph as an example.

Benchmarking between different versions

ii)            Knowledge Sharing: At the end of any Optimization process it is important to consolidate the learning and ensure that these are made part of the next iteration of development. It is also pertinent to share the experiences to other teams doing similar development. Knowledge sharing is important especially if there are some neat tricks or logic that has been implemented to achieve the same.

For consolidating the findings one way of doing it could be to enhance the best practices with the learning from the current cycle. Another option is to enhance the code review checklist to involve more points from the current cycle for optimization.

Morals of the Story

1)     Benchmarking gives a perspective on the success of the optimization process vis-à-vis the industry standards and previous versions.

2)     Benchmarking in terms of hardware and software gives a perspective on what is the best fit combination for the software.

Cheers!

Ram

Phases of Optimization – II (Optimization Phase)

In this article, we take a look at Optimization phase in a detailed manner.

The Optimization phase builds on the inputs received from the Pre-Optimization phase and looks at ways and means of implementing the optimization steps to increase performance.

There are two distinct parts to the Optimization phase, the first part is the initial implementation with respect to coding and code reviews. The second part is aimed at identifying trends and looking at specific instances to improve.

Implementation Level Activities

i)                APIs: At this stage decisions are made with respect to the actual APIs or libraries to be used. For e.g. whether to go for IPP library and the specific Windows APIs to use. The idea here is to look at it in terms of performance and not in terms of functionality alone.

ii)            Evaluation of Loops: This activity looks at the various loops and tries to reduce the level of looping involved. Can a three level nested loop be reduced to two-level of nesting? Can loops be combined together? Can we replace recursion with loops?

iii)        Exception Handling: Exception Handling is a useful mechanism which comes with an overhead in terms of performance. At this stage it can be verified whether exception handling is really required in certain APIs or not. Especially APIs invoked recursively or in a loop need to be visited during this activity.

iv)            Evaluation of the Data Variables: In this activity the idea is to look at data variables in terms of whether it is the right data variable for the activity. This is especially important for STL classes such as vectors, lists, maps etc. where selection of the right variable can impact the performance significantly. The other point to consider might be whether the data variable is required or whether it can be moved to a better location.

v)                Reuse Opportunities: One of the essentials for optimization both code as well as performance is to ensure that there are not multiple ways of doing the same thing and the most optimal way is used always. So this step is to evaluate the code and product from that aspect.

All the activities listed in this part can be efficiently implemented in a project using code review checklists specifically designed for performance tuning.

Trend and Outlier Analysis

Trends depict a pattern within an application that is not obvious on a case by case basis. For e.g. if there is a deterioration of the performance with time, that cannot be visualized by looking at a single run of the software.

Outliers depict specific instances which do not conform to the performance requirements for the software. For e.g. if the processing of a single image takes more time compared to other datasets, then this image represents an outlier.

The key to doing Trend and Outlier Analysis is often the first step of identifying the Trends and Outlier. For this purpose graphs are perfect tools which help identifying these.

Other interesting graphs for performance optimization are Resource Utilization Graphs, Breakup Analysis Graphs & Relational Graphs.

Fig 1: Resource Utilization Graph

Resource Utilization Graph

Using the above Resource Utilization Graph, it is clear that the system performs in a linear manner till around 800 to 900 users, and then there is an exponential increase in the processor usage. This might be a good indicator to go define the performance parameters of the system. This is a good example of a trend analysis based on the Resource Utilization Graph. The other benefit of this graph is it helps define the threshold limits like the max number of users the system can support.

Fig 2: Outlier Analysis

Outlier Analysis

The above graph depicts the memory usage per number of images. Four of these instances indicate sudden increased memory requirement. These are nothing but outliers. In this particular case, this occurred as there were gaps in these datasets leading to internal interpolation leading to additional number of images and hence the increased size. This is an example of outlier analysis.

Artifacts from Optimization Phase

Some sample artifacts from the Optimization Phase are:

1)    Regular performance reports.

2)    Focused Code Review Reports and Checklists.

3)    Performance Graphs

4)    Identification of Trends and Outliers.

5)    Interdependence between components in terms of performance.

Morals of the Story

1)     Trend Analysis helps in identifying non-obvious patterns within the software system.

2)     Outlier Analysis helps in identifying peaks and troughs in the system.

3)     Graphs are a very handy tool for performance optimization.

Cheers!

Ram