Modern Cost Accounting Systems Failing U.S. Businesses

By Peters, Tom | THE JOURNAL RECORD, May 2, 1987 | Go to article overview

Modern Cost Accounting Systems Failing U.S. Businesses


Peters, Tom, THE JOURNAL RECORD


As if we didn't have enough industrial challenges - such as inflexibility and poor product quality - even our basic systems are crippling us.

For example, cost accounting systems routinely allocate overhead costs, such as the accounting department, engineering, utilities, machinery and management, to direct labor. In fact, each typical ``direct-labor hour'' may carry an overhead ``burden,'' as the accountants call it, of 1,000 percent. That's why, when a manager is pushed by higher-ups to cut costs, there is but one sensible target under this accounting regimen - direct labor, which, on the books, includes that huge burden charge.

Here's what can happen. Suppose the manager decides to subcontract production of a labor-intense part. He saves 100 hours of direct labor at $20 per hour ($2,000 in all). But on the books, the actual direct-labor savings plus the 1,000 percent burden (worth 10 times the labor), adds up to credited savings of $22,000.

The subcontract to a smaller, low overhead, perhaps offshore operation costs, say, $5,000. The net savings, then, is $17,000. Much applause goes to the plant manager.

Unfortunately, the real story is different from the accounting story. The actual factory overhead is not reduced at all by the act of subcontracting (you can't shut the lights out over one idle machine).

In fact, overhead is increased, because the plant manager has to negotiate and administer a contract with the new supplier and handle the incoming components, not to mention the increased initial uncertainty of delivery and quality with any supplier.

So the real net savings is the $2,000 in direct labor minus the $5,000 subcontract cost minus, say, $1,000 in real, added overhead - or a loss of $4,000! Nonetheless, thanks to the miracle of traditional accounting, the plant manager takes a bow.

Such perverse outcomes are commonplace, say professors H. Thomas Johnson and Robert S. Kaplan in their new book, ``Relevance Lost: The Rise and Fall of Management Accounting.'' In fact the authors report that some experts claim that ``cost accounting is the number one enemy of productivity.''

Industrialists trained in engineering, such as Andrew Carnegie, perfected modern accounting to assist managerial decision-making needs concerning the production process. But slowly, as professionally-trained accountants began to take control of the systems, accounting's emphasis shifted from management tool to financial reporting. …

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