RCA Discussion: Is Your Costing System Putting Your Business in Danger?

Larry R. White, CMA, CSCA, CFM, CPA, CGFM Executive Director, Resource Consumption Institute Former Global Chair, IMA Member, IFAC Professional in Business Committee

1 What Didn’t Change?

Measurement?

Perception?

Decisions?

Reality?

Outcomes?

2 What is Accounting?

Law of Nature Reflection of Reality

Law of Man Social Consensus 3 Definitions

• Accounting • Tool for /Reporting • • Activities of Professional Accountants in Business • Managerial Costing • Internal Decision Support for Managers • An Operational Model Costed • Financial Accounting/Reporting • Principles established to inform Investors & Creditors in Public Capital Markets without the power to demand more information • Generally Accepted Accounting Principles are a social consensus – Standard Setting Bodies

4 Truth: Definition for Accounting

Substantive Theories of Truth • Correspondence theory Reality/Science Truth corresponds to facts • Coherence theory Proper fit of elements within a whole system • Constructivist theory Constructed by social processes Human/ • Consensus theory Social Whatever is agreed upon • Pragmatic theory Putting concepts into practice

5 Costing “Quick Assessment”

• Nine Questions • If you answer “Yes” to 6 or more, your organization may be relying on a cost model that puts its future at “serious risk”. • Center for Managerial Costing Quality, Sponsored by IMA • www.thecmcq.org

6 Assessment

1. Do your organization’s managers spend an inordinate amount of time debating the accuracy of cost information being provided to support their decisions?

7 Assessment

2. Is the primary purpose of costing in your organization to support the reporting of financial results to owners, lenders and other outside parties?

8 Assessment

3. Can some of your customers, or customer groups, be labeled as “high-maintenance” while the maintenance levels for other customers are much lower?

9 Assessment

4. Are you much more competitive on some of your service/product lines than you are on others?

10 Assessment

5. Do your customers demand that more “add on” services or customizations be incorporated into your organization’s basic services or products today than they did in the past?

11 Assessment

6. Can some of your organization’s business activities be described as “people aided by technology” while others can be more accurately described “technology aided by people?”

12 Assessment

7. Have labor-intensive services or operations been replaced with automated or computer-controlled activities since your organization’s cost model was last updated?

13 Assessment

8. Since your organization’s cost model was last updated, have indirect become a much larger percentage of total costs or have “overhead/burden” rates increased significantly?

14 Assessment

9. Is only one basis used to apply all indirect costs to your organization’s services or products? (Note: a single basis might be labor hours, labor dollars, material cost, etc.)

15 Quick Assessment

• Where is your organization?

16 Management Accounting Myth 3 3. Decision makers want you to measure costs accurately Decisions can be made without Facts, but they cannot be made without Emotion. 17 Management Accounting Myth 2

• The “material, direct labor, burden and SG&A” model is appropriate for costing or decisions in the 21st Century

18 Management Accounting Myth 1

• Financial accounting measures are appropriate for use in internal decision making

External Audience: Investors and Creditors Internal Managers and Employees19 Enterprise Financial Management

Tax Financial Source data Managerial capture Non-financial Accounting Accounting (transactions) Accounting data capture

Cost Measurement

Cost Accounting Performance Evaluation Planning & Decision External financial Reporting & Analysis e.g. GAAP, IFRS Support For example: For example: • Assessment of current strategy • Fully absorbed and incremental costing •Costs of goods sold & plans • Adaptive operation & cost based •Inventory valuation • Integrated cost/operational planning, budgeting & forecasting performance measures (e.g. cost • What-if analysis & planning variance, capacity measurement, • Product, process, channel, & customer process efficiency etc) strategic adaptations • Profitability reporting • Enterprise optimization (e.g. make vs. • Process analysis buy, outsource etc) The Domain of Costing • Learning & corrective actions

Historical Predictive Lower Value-added to managerial decisions Higher Here is Part of the Problem. Which managerial accounting/costing method?

Standard Costing, Project Accounting, Job Order Costing, Economic Value Added TM, Balanced Scorecard, Activity Based Costing, Intellectual Capital, Performance Pyramid, Business Excellence Model, Customer Profitability, Strategic Management Accounting, Strategic Cost Management, Supply Chain Costing, Flow Return on Investment, Business Models, Target Costing, Kaizen Costing, Lean Accounting, Life Cycle Costing, Value Added Analysis, Process Costing, Time-based Activity Based Costing, Value engineering, Stock Options, Micro Profit Centres, Quality Costing, Non-value Added Cost, Human capital, Resource Consumption Accounting, Structural Capital, Relationship Capital, Brand Value, Total Cost of Ownership, Throughput Accounting, Triple Bottom Line, Beyond Budgeting, Risk- adjusted Return on Capital at Risk ……

21 Inputs: Output: Information Resources CAUSALITY ANALOGY For Decisions

Concepts • Resource • Managerial Information Objective Modeling Concepts • Cost Use Concepts • • Homogeniety Concepts Avoidability • Traceability • Divisibility • Capacity • Interdependence • Work Operational Baseline • Interchangeability • Attributability Model Optimization • Responsiveness Constraints • Integrated Data Costed Information Orientation • Impartiality • Congruence Constraints • Objectivity • Accuracy • Verifiability • Measurability • IMA Conceptual Framework for Managerial Costing IMA Conceptual Framework for Managerial Costing

www.Imanet.org Research & Publications Statements on Management Accounting

23 13 Excuses for Bad Costing

1. We’re making money, why does it matter? 2. I’ll just by new software to fix my costing. Courtesy of William Vaughn Company, Ohio 3. I already know my “true” cost. 4. We’ve done it this way forever. 5. I don’t have sophisticated software, so I can’t have a costing system. 6. I know it all, it’s all in my head. 7. We are small, we’ll worry about it if we get bigger. 8. That’s just made up stuff consultants do, no one worries about costing. 9. No one looks at the reports I generate, so there is no point in doing them better. 10. I cannot afford to fix my costing system. 11. I don’t have any support for fixing the system, so its not worth it. 12. I am way too busy to spend time worrying about costing.

13. I do not even know where to start. 24 www.RCAInstitute.org

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