Managers often utilize information provided by their organizations’ accountants when making decisions. Yet frequently, this information is of poor quality or inappropriate to the decision being made. This can result in lost profits or, in the extreme, the failure of the organization.
Tremendous changes have taken place in the business environment during the past fifty years. Globalization, improved logistics, and technological advances have resulted in markets that are worldwide, the rise of global competition, and purchasing decisions based almost exclusively on data rather than personal and corporate relationships.
Despite these changes, the managerial costing practices followed by many organizations today are little different than they were fifty years ago. While the world around them changed and other parts of the organization reengineered themselves to meet the challenges of the new business environment, most companies – and their accountants – continued to follow managerial costing practices that reflected a world that no longer existed.
This does not mean, however, that many management accountants are unaware that a problem exists. The 2003 Survey of Best Accounting Practices,conducted by Ernst & Young and the Institute of Management Accountants (IMA), showed that 98% of the top financial executives surveyed believed that the cost information they supplied management to support their decisions was inaccurate. It further revealed that 80% of those financial executives do not plan on doing anything about it. A follow-up study conducted in 2012 indicated that the situation had, if anything, gotten worse over time.
A primary reason for this lack of accurate costing information is organizations’ reliance on their externally oriented financial accounting systems to provide the accounting information used to support internal business decision-making. Externally focused accounting systems, focused on regulatory compliance, cannot meet the information needs of managers tasked with creating value and contributing to the financial success of shareholders, owners, and stakeholders.
External financial accounting’s oversimplified methods of costing products and service misstate critical measures of performance. Few companies have the ability to report channel and customer profitability below the product/service gross profit margin line. Costs required to serve customers with radically different behavioral patterns are often ignored. As a result, companies are unable to correctly measure profitability by service channel or customer group. Similarly, the prices paid for goods and services from a supplier continue to be treated as their “cost,” despite the various expenses, activities and investment required to make those goods and services available when and where required. This results in poorly reasoned vendor selection, in-sourcing/out-sourcing and offshoring decisions.
Examples of the impact of using faulty accounting information for internal decision-making purposes abound. Use of financial accounting’s oversimplified product costing practices caused one profitable manufacturer of highly engineered products to lose its manufacturing business and force it to downsize and become an engineering services business. Failure to accurately measure channel maintenance and fulfillment costs led a restaurant equipment distributor’s profits to fall as it granted substantial discounts to high-volume customers with excessive channel maintenance and fulfillment costs. Offshoring enabled an auto supplier to reduce the price of a major component by $3 million annually. Unfortunately, the $3.5 million it spent each year to support that decision was lost in the financial accounting system. The examples are endless, yet organizations continue to rely on oversimplified financial accounting information to make critical business decisions.
Of course, the failure of the finance function to supply useful costing information to support operations is not news to the consumers of that information. A recent study of supply chain professionals conducted by the Association for Supply Chain Management (APICS) and IMA found that only one-third of respondents rely heavily on information provided by the finance staff when making business decisions.
How well does the accounting information you receive support your decision-making needs? If not well, the good news is that this need not be the case. There are accounting tools and techniques that can be used to generate the information you need. Companies can – and do – design effective managerial costing systems. By letting your finance function know you need better information, and by working together to produce that information, you will be able to avoid the perils of using faulty accounting information and start creating more value for your organization.