Thursday, February 25, 2016


In the recent budget Indian railways have highlighted on adoption of Activity base costing in Indian railways. Its nice to find that Indian railways are adopting and changing’s its mindsets and policy towards cost optimization and to recover from losses despite of higher revenues. We all know that Indian railways earns a lot through advance ticket booking but it has loses on its books. This is very reason that after independence Indian government is aggressive looking ahead for adoption of costing methods in its railways operating process. Before I move ahead I would like to inform my readers that I will cut down on words and would give images to portray the concepts of  Cost Management in Indian Railways. Now this activity based costing adoption in Indian railways is going to be wider scope since it has many functions and many departments linked under several segments. If we make a quick look towards the several areas where activity based costing can be implemented:

·         Freight traffic
·         Passenger Traffic

These two segments are further divided and in to several part where in order to design a cost model we need to identify the various parts of the cost drivers. A question might come up that what type of cost information is required and which areas to be focused to plugging the gaps. Well cost information and understanding is needed so that our results to could identify the final objective. Cost Optimization is a broader term hence we drill it further and we conclude are as follows:
ü  Identify money makers or money losers
ü  Take resource allocation decisions
ü  plan and control operations and activities
ü  Find economic break-even points
ü  Compare different options
ü  Discover opportunities for cost improvement
ü  Prepare and actualize business plans
ü  Improve strategic decisions making
Now moving ahead we find that Indian railways needs pricing decision of its Freight Tariffs and also about its investments decisions so that movement of goods and services brings more trade and investment opportunities. We are all demanding GST but once it’s come the biggest requirement over the years will be logistics and Indian railways demand will go up. Hence pricing become more important so as neither the customer neither the government burns a hole in its pocket. So my activity based costing should be linked not only with cost optimization but with identification of pricing of its services.
In railways we can derive the Activity based costing either by Top down Approach or By Bottom up approach.
To clarify these terms two examples may be given:
Example I: When using the top-down approach to calculate the staff costs for the traction, they would be calculated by dividing the total costs for driver wages in a railway company by the number of driving hours of all drivers in that company.
A bottom-up approach would be to multiply the number of driver working-hours for a certain activity by the gross salary per driver-hour.
Example II: When using the top-down approach to calculate the energy costs for a certain activity, the total traction-related energy costs in a railway company would be divided by the total train-kilometres (or gross ton-kilometres or whatever unit of measurement is considered suitable) this railway company produces during a given period, giving the energy cost per train-kilometre.
A bottom-up approach would be to calculate the energy consumption for that activity using a suitable formula which takes into account running resistance, air resistance, losses, etc. and then multiplying the calculated energy consumption, suitably expressed in kWh, by the actual working price per kWh.
Which of the approaches is used in the model depends partly on what data are available. Generally a bottom-up approach is preferable for the following reason:
In the top-down approach, there is no longer any direct connection to the factors causing and determining the costs; instead, the total costs are simply distributed over some measurement units (train-kilometres, working hours, tons, etc), although no linear connection necessarily exists at all.
For example, when calculating infrastructure charges for a train, these can of course, easily be calculated by dividing a railway company’s total annual infrastructure charges by the total train-kilometres, although in reality they might be charged per gross-ton-kilometre or vice versa.
A bottom-up approach makes it easier to take into consideration specific characteristics of a  transport, as well as changes in the relevant cost determining factors, as the following examples illustrate:

When calculating energy costs for example, a bottom-up approach makes it possible to take into account the weight of the train and if it is running at high or low speed, while the top-down approach normally only calculates the costs on the basis of the average energy consumption per train-kilometre, irrespective of the speed and weight. Another example would be infrastructure charges.

Please do remember they have common cost and joint cost in many departments hence you need to design the costing models and also the cost drivers accordingly. The below picture will elaborate about the flow chart:

At the same time there is incremental cost of operating which also needs to be taken into account. Hence I have included one format for the incremental costing of the Railways based on the departments and segments. The below flow helps me cut my words and complexity in explanation: 

Now lets come to the model of Activity Base costing where cost drivers are segmented: I have given the format for making its much easier to understand.

Hence In my 1st series i give an idea about the steps and the process to be taken while designing the activity based costing models for railway segment. In my next series I will come up with more valuable insights of other segments raised in the Indian Railway Budget 2016-17 related to cost management profession.


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