The Bottom Line; Victim of Cost Accounting

By Emig, James M.; Mazeffa, Matthew | The National Public Accountant, April 1990 | Go to article overview

The Bottom Line; Victim of Cost Accounting


Emig, James M., Mazeffa, Matthew, The National Public Accountant


The Bottom Line Victim of Cost Accounting

Product design, new product introduction decisions and the amount of effort expended on trying to market a given product or product line are influenced by the anticipated cost and profitability of the specific product. Accurate cost accounting data are necessary in order to determine accurate product figures. If the accounting data upon which the decisions are based are not relevant, then the outcome of these decisions cannot be relied upon to achieve the desired results.

The cost accounting system is the driving force behind product related decisions. Decisions which are critical to a firm's existence are based upon the outputs of this cost system, which requires the firm to spend a great deal of resources in establishing the system. In the development of this accounting system a little common sense can be much more beneficial than merely following the "traditional" cost accounting formats and formulas.

In their 1987 article "Is Management Accounting Irrelevant?" Johnson and Kaplan indicated that rather than attempt to revise all of the historical cost accounting groundwork, most firms should merely attempt to modify their current cost accounting systems. By simplifying and streamlining their existing systems, most firms would be able to determine exactly what information was necessary to make decisions. By using a more basic approach, most firms would be able to solve many of their planning and control problems. This simple adjustment should allow many firms to improve their "bottom line" problems.

Form Over Substance

In order for product costs to have relevance, they must be properly allocated. The review of 13 studies by many of the top researchers in the managerial accounting field was conducted by the Harvard Business School in 1986. This review showed that the most common characteristic among all companies in the field was that they employed a two-step cost allocation system. In the first step, costs are assigned to cost pools, and in the second step these costs are allocated from the cost pools to the products. The companies studied used a variety of methods to allocate these costs in the first step, but all companies then used direct labor hours to allocate overhead from the cost pools to the products in the second step. All of the costs allocated into overhead were then assigned to individual products on the basis of a single factor.

In practice, most firms will generally use only one system of cost allocation. Problems that arise with this fact may show that not only is the system outdated, but that a particular cost accounting system which is concerned with maximizing external reporting results could, in fact, be detrimental to product costing. Companies will occasionally be more concerned with form rather than substance when collecting and evaluating cost accounting information. This point was emphasized by Ford Worthy when he stated that the typical cost accounting system is designed more as a means of valuing inventory than as a measuring tool for product costs and product cost assignment. While this approach may benefit the balance sheet, it will ultimately be detrimental to the decision making process.

Traditional Cost

Accounting

The biggest problem with traditional cost accounting could very well be the fact that it is too traditional. Virtually all management accounting practices in use today were developed before 1925.

The cost systems in place today were more than adequate at the time of their development; most likely in the early 1900s. At that time the factors that created the cost were easily identifiable. In many instances a firm had only one product line. Therefore it was known who worked where and for how long. Raw materials were traceable through the production process and their costs were allocated properly. Because of this limited product diversity, material and labor costs, costs which could be easily calculated, provided the bulk of the product costs for which a firm had to account. …

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