How Good or Bad Are Your Organization’s Costing Practices?

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Performance & Financial Management

How Good or Bad Are Your Organization’s Costing Practices?

by Gary Cokins, CPIM, Analytics-Based Performance Management | January 27, 2014 | 2

Since the 1980s, spurred by the publication of the book Relevance Lost: The Rise and Fall of Managerial Accounting by Professors Robert S. Kaplan and H. Thomas Johnson, managerial accounting practices have made significant strides forward. This has been especially true in terms of improving costing using techniques such as activity-based costing. But many organizations have not reformed their costing methods and remain decades behind.

How can these organizations know if their costing practices have become stale and out-of-date and if, consequently, these practices no longer adequately meet the informational needs of managers and employee teams, allowing them to gain insights and make better decisions?

To help organizations to understand how progressive and effective their costing practices are, I developed a Costing Levels Continuum Maturity Framework (the Framework), available on the IFAC website. It can be a useful tool for both professional accountancy organizations and individual accountants who work in in the public/government and private sectors.

The Framework’s purpose is a) to highlight gaps between an organization’s existing and potential data, information, processes, procedures, and practices; and b) to potentially provide prescriptive advice to mitigate deficiencies and close those gaps.

The Framework can be especially useful for boards of directors to execute their governance responsibilities, particularly where they require greater assurance that the organization has sufficiently effective internal managerial accounting information to support analysis and make sound decisions. Board members inherently have a fiduciary responsibility and, therefore, rely on their audit committee to assure that the financial controls prevent fraud and ensure high-quality financial and corporate reporting—ultimately ensuring that stakeholder value isn’t destroyed. But there are very few standards or regulations for internal management accounting practices to mirror operating processes (cost accounting standards exist in India, set by the Cost Accounting Standards Board).

Managers too often hope that internal management information systems are good enough for decision making. The design of these systems is controllable by a management team that obviously needs the internal information; managers typically assume that useful and relevant data is being provided. But who is to say that their operational and cost measurement data and information is good enough for critical decisions, such as reporting and analyzing customer and product profitability?

A self-assessment tool can lead to prescriptive improvements

The Framework was initially intended to be used as a self-assessment tool to help an organization a) determine and evaluate its current capability; and b) decide what maturity level in the Framework it might justify aspiring to, given organizational requirements and the decision needs of employees. It is likely that managers and front-line staff need actions for improving performance evaluation and analysis (i.e., interpretative and diagnostic capability) and for planning and decision support (i.e., analytical and predictive capability).

A key challenge is the confusion that managerial accounting for internal purposes can and likely will report different costs (e.g., product costs) compared to costs reported in its external financial reporting. Experienced organizations understand that this will always be the case because various incurred expenses will very likely be treated or allocated using different assumptions than those imposed by reporting requirements, such as from the US Financial Accounting Standards Board or International Financial Reporting Standards (IFRS).

The Framework also highlights the importance of implementing costing systems that are “fit for purpose,” as described in IFAC’s International Good Practice Guidance, Evaluating and Improving Costing in Organizations, where Principle D states that:

The design, implementation, and continuous improvement of costing methods, data collection, and systems should reflect a balance between the required level of accuracy and cost of measurement (i.e., cost-benefit tradeoff) based on the competitive situation of the organization.

The maturity approach usefully recognizes that there will be a maturity level in the Framework for any organization beyond which additional analysis will fail to improve decision making enough to justify the incremental effort and associated cost to improve cost management. In making this judgment call, the same principles apply as when making business decisions that an improvement to costing is intended to support. The resources that need to be devoted to the improvement and its maintenance (e.g., data collection) need to be identified and evaluated. An apparent gain in system sophistication can easily be negated by a later inability to maintain, update, and operate the system effectively.

A future vision—certification of an organization’s managerial accounting practices

It is possible that in the future an audit-like assessment can be performed by management accountants using the Framework. This assessment could initially be similar to the role performed by, for example, examiners for the quality certifications of the International Organization for Standardization (ISO)’s standard on quality management, ISO-9000 Quality Management. Its purpose would be to evaluate the quality of an organization’s management accounting practices, treatments, and systems. The assessment isn’t designed to be a report card to punish organizations that may receive a low assessment score. It is intended to foster improved managerial accounting and improve the quality of decisions.

Eventually, there could be formal certification administered by professional accountancy organizations or regulatory bodies. Today, accounting firms attest to the compliance and accuracy of an organization’s financial reporting for regulatory agencies and the investment community. Why should there not also be a certification audit for processes, procedures, and practices that produce internal managerial information used for decision making?

The margin for error in decisions continually gets slimmer as most industries become increasingly competitive. Transactional data is not information—it is only the starting point to transform data into information. And if the transformation doesn’t occur or is flawed, then poor decisions are inevitable, and the enterprise performance management won’t achieve its full potential, which leads to managers, employee teams, and shareholders being shortchanged. Organizations that have not progressed and improved their managerial accounting practices will be at competitive disadvantage.

 

Gary Cokins is an internationally recognized expert, speaker, and author in business analytics and enterprise performance management systems. He is the founder of Analytics-Based Performance Management LLC, an advisory firm.

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Gary Cokins
May 28, 2014

Nick ... Thanks for your comment to my article. I agree with your point that one issue accountants have with managerial accounting is their concern with excessively high precision in cost accuracy. As a result they (and sometimes their consultants) over-design their cost system well beyond diminishing returns on extra accuracy for extra administrative effort to collect, validate, and report the data. The rule should be, "Is the extra higher climb worth the view?" The costing models should be designed up to the point that the information is "good enough." Gary ... Gary Cokins

Nick Shepherd
March 20, 2014

Great article Gary - especially interesting the idea of a "health check" on the level of costing maturity; one issue that always arises is how to balance quality and simplicity in costing approaches in SME's who often have limited resources to set up and use effective costing analytics.


 

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