Lies, damn lies and cost accounting

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By Reginald Tomas Lee, Sr. Business Expert Press, 2016, ISBN 978-1631570650, $ 34.95 (paperback) reviewed by Ronald J. Baker

One of the most influential accounting academics of the 20th century was William Paton, who in a 1922 treatise described what he believed to be the core business of the cost accountant:

The essential basis of the work of the cost accountant – without it there could be no costing – is the assumption that the value of any good, service or condition, used in production, pass in the object or product for which the original item was spent and attaches to the result, giving it its value.

Fortunately, Paton later repudiated this notion in a speech he gave at a conference in 1970:

The fundamental difficulty with the idea that cost dollars, as incurred, attach like barnacles to the physical flow of materials and to the flow of mining activities, is that it is at odds. with the actual process of valuation in a free competitive market. The customer doesn’t buy a handful of classified and traced cost dollars; he buys a product at the current market price. And the market price can be higher or lower than any calculated cost.

The simple truth is that depending on the cost accounting method used, radically different cost allocations can be calculated.

In 1987, H. Thomas Johnson and Robert S. Kaplan published Loss of relevance: the rise and fall of management accounting, which spawned the activity-based cost (ABC) revolution. But ABC is just a new way to go wrong, which Johnson has proven in his next book, Profit beyond measure, a study on how Toyota does not use standard cost accounting.

Between Reginald Tomas Lee, author of Lies, Bloody Lies, and Cost Accounting: How Capacity Management Improves Cost and Cash Flow Management. Lee gives three reasons why cost accounting is a bad practice:

  • Getting a cost requires creating and forcing numbers and relationships that don’t exist.
  • Doing this leads to losing touch with operations.
  • It also creates meaningless numbers that people think of as a gospel (a unique representation of an artificial reality).

The simple truth is that depending on the cost accounting method used, radically different cost allocations can be calculated. There are many approved cost accounting methods (standard cost, total absorption cost, average cost, lean cost, marginal cost, activity-based cost), all of which will result in a wide range of costs per unit that do not exist. have nothing to do with cash. . For example, using the above methods, let’s say Apple has calculated its cost of manufacturing the Apple Pencil for its iPad Pro to be between $ 10 and $ 40. Does that mean that if he doesn’t make an Apple Pencil, he’ll save $ 10-40 in cash?

This is why Lee argues that cost accounting imposes mathematical relationships that do not make sense, which is confusing. metric with measurements. Walking outside with two thermometers will likely give a relatively accurate temperature reading of each, that’s a the measure. Cost accounting, depending on the method used, gives a wide range of possible numbers – these are metric. This explains the old joke about the accountant who, when asked what 2 + 2 is, replies, “What would you like it to be?” “

In addition, Segall’s law applies to cost accounting: “A man with a watch knows what time it is; a man with two watches is never quite sure. Yet cost accounting data is treated like gospel, giving a false sense of accuracy. Accountants would rather be precisely wrong than approximately right.

The important point is that the costs should be known before building the product or doing the job, not after. There is no point in knowing the cost breakdown by the penny if the customer does not agree with the value or the price. Additionally, most costs, especially in a professional business, relate to capacity: labor, rent, equipment, and technology. These costs do not vary depending on how this capacity is used; that’s why airlines, hotels, and cruise ships also don’t use standard cost accounting, but instead focus on pricing, cash flow, and capacity modeling. Watch how Uber, for example, uses pricing to match capacity with demand, rolling out peak prices in high-demand areas to entice more drivers into the region. Managers should never confuse being busy, or being at full capacity, with being profitable.

To add insult to injury, cost accounting does not help companies price better, generate more profits, lead project management more efficiently, better qualify clients, predict performance. team members, manage capacity, model cash flow or measure what matters to customers. in fact, it is a lagging indicator. This is exactly what Johnson meant when he wrote that “quantitative measures can only describe [relationships], they can’t explain them.

One of Peter’s tenets is that the bureaucracy defends the status quo long after the point in time when the status quo has lost its status. Cost accounting does not deserve to be the apotheosis of pricing or operations; it focuses the limited attention of the rulers on the absolutely wrong things. The professional accountants collectively plunge a ruler into an oven to determine its temperature: it is the wrong measuring device.

It may sound like the ultimate apostasy, but like the mythological Cassandra, Reginald Lee has been speaking the truth, even though no one is ready to believe it. Read his book.

Ronald J. Baker is the founder of the VeraSage Institute, Petaluma, California.

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