Is your organization’s costing system failing to provide the information you need to make informed decisions? Read on to learn how to do a quick assessment of the adequacy of your organization’s system.
Most of us are familiar with the accounting systems our organizations use for external financial reporting. These systems prepare reports for a specific purpose, and in conformance with specific reporting standards (U.S. GAAP or IFRS, for example).
Many organizations fail to realize the information these systems produce is generally inadequate for internal decision-making. There is a large difference between costing done for external financial reporting and managerial costing – costing done purely for an organization’s internal use. The goal of managerial costing is to ensure information for decisions reflects the characteristics of the organization’s resources and operations. Yet most companies have inadequate managerial costing systems, relying on systems designed primarily to meet external financial reporting standards. As I noted in my previous blog, this can result in issues such as companies being unable to correctly measure profitability by service channel or customer group, and the inability to measure the “total cost of ownership” for goods and services purchased from suppliers, resulting in poorly reasoned vendor selection and sourcing decisions, and more.
How can you determine the adequacy of your organization’s costing system? An initial quick assessment can be made by answering the eight questions below. (These questions were developed by the Center for Managerial Costing Quality.) Answer “yes” or “no” to these questions, then add up the number of questions with “yes.”
Quick Assessment of Costing System Effectiveness
- Question 1: Do your organization’s managers spend an inordinate amount of time debating the accuracy of cost information being provided to support their decisions?
- Question 2 : Is the primary purpose of costing in your organization to support the reporting of financial results to owners, lenders and other outside parties?
- Question 3: Can some of your customers, or customer groups, be labeled as “high-maintenance” while the maintenance levels for other customers are much lower?
- Question 4: Are you much more price-competitive on some of your service/product lines than you are on others?
- Question 5 : Do your customers demand more “add-on” services or customizations be incorporated into your organization’s basic services or products today than they did in the past?
- Question 6: Have labor-intensive services or operations been replaced with technology-intensive activities since your organization’s cost model was last updated?
- Question 7: Since your organization’s cost model was last updated, have indirect costs become a much larger percentage of total costs, or have “overhead/burden” rates increased significantly?
- Question 8: Is only one basis used to apply all indirect costs to your organization’s services or products? (Note: A single basis might be labor hours, labor dollars, material cost and so forth.)
While situations vary, a rule of thumb is that organizations answering “yes” to four or more of these questions may be relying on a cost system that is dangerously inadequate for its management needs. However, regardless of the score, most companies can benefit by improving their cost system. I’ll discuss how to do that in a future blog.