Can you imagine accountants as American cowboys of the Wild, Wild West in the 1800s? I can. And they can be dangerous. Yeehaw! Yippee-i-o-i-a!

In place of guns in their belt holsters the cowboy accountant may be carrying a smartphone. Their rodeo rope that cowboys use to catch running steers may be their audit controls manual. The cowboy accountant would like to use a red hot branding iron to mark those managers who excessively sandbag their department’s annual budget amounts, but they will resort to just remembering who those budget busters are to pester later. Cowboy accountants also wear well-shined wing-tipped dress shoes as their cowboy boots.

Why am I making light humor of accountants with a metaphor of them as cowboys? It is because they operate today in a lawless frontier no different than the Wild West. To be clear, I am not referring to accountants performing external financial or tax accounting. For those two disciplines there are many regulatory laws to protect investors, bankers and government agencies. I am referring to the lawless frontier of internal managerial accounting used for internal analysis and decision making.

No laws. No jail.

When accountants get the financial accounting numbers wrong, then they might go to jail! Think Enron. However, if they get the internal managerial accounting numbers wrong, they don’t go to jail. So they can ease up and put only enough effort in to calculating and reporting costs and profit margins that they feel is worth their effort.

But therein is the problem. Some accountants are lazy. The laziness I am referring to is not about working long hours – most accountants do. The laziness I am referring to is where they do only enough work for what is convenient for themselves as opposed to what is good for who they serve – the users of the information.

It is typically the accountant who is in control of determining what constitutes good cost information. The users, for example in operations or marketing, usually have little say in the matter. Note that I wrote information, not just data. A simple definition is information is the conversion of raw transactional data (e.g., from a purchasing or payroll system) into something more meaningful. A product’s cost and gross profit margin would be an example of information. The input expenses, such as salaries and materials, are data converted by the accountant into output costs – the information.

Who is to Say What is Correct?

A complicating matter in our Wild West of managerial accounting is there are few if any standards to follow. On the financial accounting side of external compliance accounting there are many rules, including the USA’s standards established by the Financial Accounting Standards Board (FASB) or the emerging International Financial Reporting Standards (IFRS). And tax authorities have thousands of rules.

In contrast, managerial accountants are left to their own devices to define the managerial accounting practices to apply within their own organizations. If they want to allocate indirect and shared expenses (commonly called “overhead”) to product costs based on a single broadly averaged factor with no cause-and-effect relationships to the products (e.g., number of units produced, direct labor input hours), then they can. No one can stop them despite the fact that the result will be flawed and misleading over-costed and under-costed products. Of course, the users may complain. These are the type of user who recognizes that there are practical ways to trace and assign different portions of the indirect expense consumption using causally-based driver quantities. (That is, using activity-based costing [ABC] principles.)

 

Costing Methods Rivalries

If you believe there are heated differences in USA politics between the Republican and Democratic parties or among religious sects in the Middle East, you should read some of the vitriolic name-calling in Linkedin.com accounting discussion groups.

 

There are accounting camps that have almost come to blows if their fists could penetrate through an Internet conduit line. For example, some of the zealots from the lean accounting and theory-of-constraints throughput accounting communities, believe that any calculated cost is useless and a waste of time to calculate. They despise the activity-based costing community. And even in the ABC community there are rivalries between the consumption unit rate-based “push-method” ABC advocates and the “pull-method” time-driven activity-based costing (TDABC) advocates.

Want more accounting rivalries and confusion? Which of these managerial accounting methods should your organization use to provide the best information? Standard costing, project accounting, job order costing, economic value added (EVA), activity-based costing (ABC), supply chain costing, target costing, kaizen costing, lean accounting, life cycle costing, process costing, time-based activity-based costing (TDABC), resource consumption accounting (RCA), or throughput accounting?

Even many cost accountants are not sure of the answer!

Accounting institute task forces to the rescue.

Fortunately some of the professional accounting institutes are beginning to address this problem and fill the void of managerial accounting practices from prescribed principles.

In July 2009 The International Federation of Accountants’ Professional Accountants in Business Committee published “Evaluating and Improving Costing in Organizations.” A task force of The Institute of Management Accountants has recently published “The Conceptual Framework for Managerial Costing.” I was privileged to be a contributor to both documents. The latter document specifically identifies and defines 12 principles that if followed, an organization’s users will be more assured that they are receiving highly valid managerial accounting information.

So, for you cowboy accountants who are operating in the lawless frontier, you may discover there may be a new sheriff in town. You may no longer get away with reporting flawed and misleading information to your users and violating universal costing principles. (Now what the accounting industry needs is enforcement for managerial accounting, but that is an advanced topic for another article.)

Published with permission.