A few weeks ago, I was discussing a paradox with Doug Hicks, president of D.T. Hicks & Co., a performance-improvement consulting firm in Farmington Hills, Michigan. The paradox, which continues to puzzle me, is how chief financial officers (CFOs) and controllers can be aware that their managerial accounting data is flawed and misleading, yet not take action to do anything about it.
Now, I'm not referring to the financial accounting data used for external reporting; that information passes strict audits. I'm referring to the managerial accounting used internally for analysis and decisions. For this data, there is no governmental regulatory agency enforcing rules, so the CFO can apply any accounting practice he or she likes. For example, the CFO may choose to allocate substantial indirect expenses for product and standard service-line costs based on broadly averaged allocation factors, such as number of employees or sales dollars. The vast differences among products mean each product is unique in its consumption of expenses throughout various business processes and departments, with no relation to the arbitrary cost factor chosen by the CFO. By not tracing those indirect costs to outputs based on true cause and effect relationships - called drivers - some product costs become undervalued and others overvalued. It is a zero-sum error situation.
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