Please forgive me for my persistent rant and criticism against accountants who process annual budgets that are of questionable value or continue to misallocate 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.
Many accountants use practices from the 1960s. If accountants were scientists, the world would still be viewed as flat. If accountants were doctors, they would still be using leaches and blood-letting.
When I observe managerial accounting practices and methods that ignore capacity-sensitive driver-based budgeting principles or simply allocate indirect and shared expenses typically as 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, or square feet/meters), I do not know if I should laugh or cry!
Accountants as pirates
The cost allocation methods just described violate what should now be well known by accountants as the “causality principle.” Expenses should not be “allocated” implying the use of 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. This means that the various work activity costs, which belong to end-to-end and cross-department processes, should be disaggregated and re-assigned to product, channel, and customer costs using a quantity or volume metric that reflects the consumption rate of the activity cost.
Now at this point some accountant readers of this article may 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 write to the rest of you who care about better decision making in your organization (or for your client).
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 mis-allocate calculating past period historical costs (e.g., product costing), the result is simultaneously over- and under-costing compared to the economic reality. This is because re-assigning expenses and costs is a zero-sum-error calculation. Are the accountants “robbing” anyone when they mis-allocate costs? 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 and visibility from which to draw insights for decisions such as product, service-line, channel, and customer rationalization. Accurate reported output costs and profit margins lead to generating needed questions among line managers and a better understanding for determining how much and what types of resources to use to maximize the organization’s mission to its stockholders (commercial companies) and its 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 with 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 and 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 that belong to end-to-end business processes. And the reported costs of the products and service-lines that consume these expenses are flawed and misleading due to non-causal broad-brushed cost allocation averaging that I earlier described.
Unethical or irresponsible? Shame on versus shaming accountants
I recently posted a question in the website discussion group of one of the professional accounting institutes. Based on this institute’s definition of 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 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 committed an inappropriate act and therefore are dishonorable. Shaming is an assault on the worth of an individual. Shame results in the accused diminished self-esteem and at the extreme where the individual is dismissed and banished from the organization they were a member of – a harsh penalty.
If I am shaming an accountant who already has low personal self-esteem for their lack of caring to provide their line managers, executives, and workforce with reliably valid information for decision making, 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 are guilty. They know they are admittedly using misallocating cost calculations that violate costing’s causality principle. It is a principle. Rules are many, but principles are few like gravity and the speed of light. The causality principle is not a law such as giving accountants 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 micro-segmented types of customers.
It is no longer about just increasing market share and growing sales. It is about growing profitable sales. Managers need to know where they make and lose money. They need t know which types of customers to retain, grow, win-back, and acquire; and how much to optimally spend with those actions. 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 is the founder of Analytics-Based Performance Management LLC, an advisory firm. He is an internationally recognized expert, speaker and author in advanced cost management and performance improvement systems; previously a principal consultant with SAS. You can contact him at firstname.lastname@example.org. For more of Cokins' unique look at the world, visit his website at www.garycokins.com .)
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