The following article is from guest blogger, Gary Cokins.

Please forgive me for my persistent rant and criticism against accountants who continue to calculate the substantial and growing high indirect and shared costs originating from resource expenses such as salaries, supplies, power, information technologies, and travel. I cannot seem to hold back my frustration.

When I observe managerial accounting practices and methods that simply allocate indirect and shared expenses typically as a large combined “pool” using a single broad-brushed cost allocation base (e.g., number of units produced, sales amounts, direct labor input hours, head count, square feet/meters), I do not know if I should laugh or cry!

Accountants as pirates

These cost allocation methods just described violate what should now be well known by accountants as the “causality principle.” Expenses should not be “allocated” implying using any convenient base denominator in the calculation that converts 100% of the expenses into 100% of costs. Expenses should be “assigned and traced” in proportion to how the expenses are consumed by outputs. This means that the various work activity costs that belong to the end-to-end and cross-department processes should be disaggregated and re-assigned using a quantity or volume metric that reflects the consumption rate.

Now at this point some readers of this article have stopped reading and gone off to do other things like process journal entries and admire how elegant their debit and credit T-accounts look. Many of them suspect they are going to hear another heralding of the virtues of activity-based costing (ABC). That’s fine. Let me continue writing to the rest of you.

First, what were pirates and what is piracy? A definition for piracy is an act of robbery typically at sea but also applicable on land. It refers to raids across land borders. Can I use a pirate analogy for misguided accountants? I believe I can if you allow me to use some imagination.

When accountants misallocate calculating past period historical costs (e.g. product costing), the result is simultaneously over- and under-costing compared to the economic reality because re-assigning expenses and costs is a zero-sum-error calculation. Are the accountants “robbing” anyone? Yes. At one level they are acting like Robin Hood taking from some (i.e., product costs) to give to others. At a more personal level they are “robbing” managers and employee teams from having reasonable cost accuracy from which to draw insights for decisions such as:

• Product
• Service-line
• Channel
• Customer rationalization

Accurate reported output costs and profit margins lead to a better understanding for determining how much and what types of resources to use to maximize the organization’s mission to stockholders (commercial companies) and stakeholders (in the government public sector).

What about “raids across land borders?” If you continue with this piracy analogy, one can substitute the borders of the organization chart for land borders. We all acknowledge that organizational silos exist at some level despite the lean and Six Sigma quality management community’s pursuit to eradicate the self-serving behavior of an organization’s departments. When accountants focus on departmental cost center reporting of actual versus budget spending, they make managers either happy or sad, but rarely any smarter. Managers rarely see or sufficiently understand the cross-departmental costs of activities. And the reported costs of the products and service-lines that consume these expenses will be flawed and misleading due to non-causal broad-brushed averaging earlier described.

Unethical or irresponsible? Shame on versus shaming accountants

I recently posted a question on the website discussion group of one of the professional accounting institutes. Based on this institute’s definition for the code of ethics, which now has higher interest based on financial scandals like Enron, I asked if accountants are behaving unethically or just irresponsibly when they basically, and most likely knowingly, miscalculate output costs. There were a range of responses including several who defended accountants as simply just “doing their job” and that the total costs do perfectly reconcile without error. (Now there is an auditor’s mentality. Correct in the whole, and everywhere incorrect in the parts.)

What about my personal behavior in writing this article? Am I placing shame on accountants or shaming them. There is a difference. Shame exists when one admits they have a committed act and therefore are dishonorable. Shaming is an assault on the worth of an individual. Shame results in the accused having diminished self-esteem and at the extreme to be dismissed and banished from the organization they were a member of — a harsh penalty.

If I am shaming an accountant for their lack of caring to provide their managers and workforce with reliably valid information for decision making, and if they already have low self-esteem, then I might cause them to have an irreversible downward spiral. I certainly do not want that to happen. But I will maintain my position and assign shame to those accountants who themselves know who they are. They know they are admittedly using misallocating cost calculations that violate costing’s causality principle. It is a principle. The causality principle is not a law like they can be handed a traffic ticket from a policeman.

Why does any of this matter?

Why am I standing my ground and persistent? Management accounting has an imminent important task ahead. Most commercial companies are shifting from being product-centric to customer-centric for a whole host of reasons including that customers now view most suppliers as selling commodities. This means a supplier’s competitive edge will come from offering differentiated services to increasingly granular and different micro-segmented types of customers. It is no longer about just increasing market share and growing sales. It is about growing profitable sales. If accountants do not have mastery on tracing expenses to channels and customers they place their company at peril and risk.

ABOUT THE AUTHOR

Gary Cokins, CPIM

http://www.garycokins.com

Gary Cokins (Cornell University BS IE/OR, 1971; Northwestern University Kellogg MBA 1974) is an internationally recognized expert, speaker, and author in enterprise and corporate performance management (EPM/CPM) systems. He is the founder of Analytics-Based Performance Management LLC www.garycokins.com . He began his career in industry with a Fortune 100 company in CFO and operations roles. Then 15 years in consulting with Deloitte, KPMG, and EDS. From 1997 until 2013 Gary was a Principal Consultant with SAS, a business analytics software vendor. His most recent books are Performance Management: Integrating Strategy Execution, Methodologies, Risk, and Analytics and Predictive Business Analytics.

If you and your team are having trouble coming up with reliably valid information for decision making, then consider investing in a corporate performance management (CPM) solution like True Sky.

Learn more about a Planning, Budgeting & Forecasting solution.