There is a growing desire among organizations to understand their costs and the behavior of factors that drive their costs. However, there is also confusion over how to understand costs and how to distinguish competing cost measurement methodologies (e.g., activity-based costing, standard costing, throughput ac- counting, project accounting, target costing). The result is that managers and em- ployees are confused by mixed messages about which costs are the correct costs.
Upon closer inspection, various costing methods do not necessarily compete;
they can be reconciled and combined. They are all cut from the same cloth: They measure the consumption of economic resources.
There is a need for an overarching framework to describe how expenses are measured as costs and used in decision making. An understandable frame- work is not rocket science; it can be simply constructed and articulated. A candidate framework is presented here. Figure 11.1 displays an overarching framework for the world of accounting with a tree, branch, and leaf structure.
The figure is similar to taxonomies that biologists use to understand plant and animal kingdoms. A taxonomy defines the components that make up of a body of knowledge.
Note that at the top part of the figure the broad discipline of accounting imme- diately branches into managerial accounting and financial accounting. Make no mistake about the focus of this book—it is on managerial accounting, not finan- cial accounting. Financial accounting addresses external reporting used as com-
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pliance reporting for banks, owners, publicly owned companies, and government regulators. In contrast, managerial accounting is used internally by managers and employee teams for decision making. If you violate financial accounting laws, you may go to jail. However, you don’t risk going to jail if you have poor man- agerial accounting, but you run the risk of making bad decisions. And, as fre- quently noted in this book, the margin for error is getting slimmer as the pressure grows for better organizational performance.
At the highest level of managerial accounting in Figure 11.1 are two broad el- ements:measuring the costs and usingthe cost data. In this framework, each branch can be further separated into the following key components:
Cost Measurement.Measuring costs comprises two functions—collecting data and assigning the source expenses—in a way that is meaningful for the organization.
1. Collecting data.These procedures are mature, dating back centuries.
2. Assigning expenses into costs.This is an important branch because it displays the alternative methods, usually blended, for translating an organization’s spending into its calculated costs. What the meth- 86 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS
Managerial
Accounting Financial Accounting
(External Reporting)
Cost Measurement Cost Uses
(Decision Support)
Collecting cost data Assigning expense data into costs
Concepts, assumptions
& issues
Methods
Control (Feedback)
Assessment (Insights & Learning)
Planning (Predictive)
Budgeting Accountability
Financial Operational
SCORECARDS, PERFORMANCE MEASURES
Managing capacity
Managing demand
QUOTATIONS (PRICING), WHAT-IF ANALYSIS Financial Operational
SYSTEMS INTEGRATION
ACCOUNTING
Variance analysis
Segmented cost analysis Operational,
quality Financial
Figure 11.1 Accounting Taxonomy ccc_cokins_11_85-97.qxd 1/14/04 10:27 AM Page 86
ods have in common is that they start with the cash outlay source ex- pensesthat were captured in the transaction-based systems, such as payroll and purchasing systems. The expenses are then causally traced and converted into the cost objects. Activity-based manage- ment (ABM) has emerged as the accepted costing method that as- sures accuracy.1
Cost Uses.The first chapter of many managerial accounting textbooks usu- ally states that there are three broad uses for cost data: operational control, assessment and evaluation, and predictive planning.
1. Operational control.There is a growing belief that the emphasis in collecting and assigning cost data should shift away from control and toward the other two uses of cost data, assessment (learning) and predictive planning. The reasoning for this shift is that it is usually too late to control a process after the fact with historical expense and cost data. Furthermore, cost variances do not reflect quality or ser- vice levels—they are an incomplete message.
2. Assessment and evaluation.The second purpose for cost data is to assess what is happening and evaluate why. This answers the question, “What does something cost now?” The emphasis here is on gaining insights and learning to better achieve the organiza- tion’s goals.
3. Predictive planning.Predictive planning, budgeting, and forecast- ing are increasingly becoming of great interest as ways of using cost data. This branch involves marginal expense analysis, often called incremental costing or relevant costing. Examples include what-if analysis, trade-off analysis, outsourcing decisions, invest- ment decisions, and, more fundamentally, determining the costs as- sociated with a customer quote to estimate the profit margin if that price quote were to be accepted. This branch of the managerial ac- counting framework can be described as expense forecasting. Some might argue that this does not qualify as cost accounting but rather is about economic analysis. This is in part due to its inclusion of ca- pacity requirement analysis and adjustments to an organization’s existing capacity.
In Part One, when I introduced the performance management (PM) wheel, I mentioned that ABM can generate important performance management data, IF ACTIVITY-BASED MANAGEMENT IS THE ANSWER . . . 87 ccc_cokins_11_85-97.qxd 1/14/04 10:27 AM Page 87
some of which can serve as a source of inputs to the PM process wheel. Let’s now understand what ABM is.