Costing can be confusing. This is true for accountants as well as manufacturing managers.
First, there are conflicting terms such as management accounting, cost accounting, product costing, managerial costing, and more. Second, there are numerous methodologies such as standard costing, activity-based costing, variable costing, process costing, throughput costing, resource consumption accounting, target costing, and many more. Third, it is difficult to find comprehensive costing education. College courses focus on costing for financial reporting, standard costing, tested on the CPA exam. Accounting academia trails practice by a decade or more in costing. Fourth, executive salaries are often tied to financial statement results, which incorporate a very high-level form of costing limited to product costing and not reflective of operations.
So how do you sort the costing clutter? There are two basic costing needs in organizations: internal decision-making and external financial reporting. Manufacturing personnel want costing that reflects operations, so they can communicate needs and improvements effectively and efficiently. Accountants focus on costing for external financial statements. These two needs are driven by different principles.
Costing for internal decision-making is driven by the need for cause-and-effect insights between resources and the activities and outputs that consume them in the business process. Costing for external financial reporting is driven by generally accepted accounting principles codified by the Financial Accounting Standards Board. This last point is the crux of the problem, because principles for external costing are codified, and the principles for internal decision support have long been uncodified. This is changing, but the accounting profession is still catching up—remember that 10-year lag for developments to reach accounting academia and textbooks.
The change began in 2009, with the publication of the International Good Practice Guide: Evaluating and Improving Costing in Organizations, in which the International Federation of Accountants (IFAC) defined cost accounting as costing methods to support external financial reporting. They emphasized that cost accounting practices often deviated from cause-and-effect relationships and would not produce information appropriate for many types of decisions.
Concurrently, IFAC also published a Costing Continuum Maturity Framework that identified the capabilities and limitations of many costing methodologies. In 2013 and 2014, the Institute of Management Accountants (IMA) expanded on IFAC’s work with the Conceptual Framework for Managerial Costing, which created a comprehensive set of principles, concepts and constraints supporting the creation of internal decision support information. The term, managerial costing, was defined as costing for internal uses.
Is there a definitive way to do effective costing for internal decision support? The answer is no, but neither is there a definitive way to do costing for external financial reporting. However, principles and concepts for managerial costing exist that define a comprehensive solution for internal use. One of the problems with costing was the clutter of methodologies that promised “the” solution. For example, throughput costing or the costing of Theory of Constraints was often presented to manufacturers as “the” solution. It is a very useful tool and connects resources, processes and costs for some categories of internal cost-based decisions. When reviewed in light of a comprehensive conceptual framework, throughput accounting has clear limitations: for example, the way it presents the resource capacities in what it calls “operating expense” and its narrow categorization of fixed and variable costs.
The good news is that a structure is forming around managerial costing that will allow for substantial improvements in the ability of both accountants and manufacturing managers to present both the internal and external cost views based on established principles and guidance. For example, the Manufacturing Enterprise Solutions Association (MESA) includes some of the techniques, such as resource consumption accounting, in its Metrics Framework and Guidebook.
>>Larry White, CMA, CFM, CPA, CGFM, lwhite@rcainstitute.org, is Executive Director of theResource Consumption Accounting Institute, which trains and advocates for improved cost information connecting operations to business performance.
