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An Operations-Focused Framework for Costing

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FILED IN:  Finance
     
The Institute of Management Accountants (IMA) has released a Conceptual Framework for Managerial Costing that is purely focused on costing for internal decision support. The real benefit for manufacturing managers is that you now have a solid reference to discuss improvements that link operational and financial information.
Everyone in manufacturing agrees that knowing the costs associated with operations improves decision-making. However, for nearly a century, costing has been dominated by accounting standards that are designed to present information to external stakeholders—investors and creditors. The methods that attempt to link these externally focused accounting standards to internal operations are so complex and produce so little useful information that even accountants hate to deal with them, and others just shakes their heads.

Relief is in sight. The Institute of Management Accountants (IMA) has released a Conceptual Framework for Managerial Costing that is purely focused on costing for internal decision support. The framework’s objective is “to provide a monetary reflection of the utilization of business resources and related cause and effect insights into past, present or future enterprise economic activities.” The framework ignores generally accepted accounting standards for external reporting and addresses the question: How should costing be done to optimize operations and long-term value creation?

The core principles of the new framework are causality (cause and effect) and analogy (use of information and logical inference). The causality principle guides the construction of a model that must reflect resource and process causal relationships. In fact, the framework promotes modeling resources and processes before applying monetary values. The analogy principle emphasizes that the impact of decisions must be compared logically using cause-and-effect inferences to the current state to comprehensively assess impact.

>> Beyond the Factory Floor: Manufacturing managers have a superior position creating information for the organization of the cost of products and operations. Click http://bit.ly/15T5cvk

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The new costing framework expands on the two core principles of causality and analogy by identifying and explaining a number of key concepts that define and support each principle. Here again manufacturers will be encouraged to see the focus is physical resources, not just money. The framework recommends that all resources be tied clearly to managerial objectives. For example, the objective of a machine maintenance team is to produce maintenance hours that are consumed by particular machines: their costs should not be aggregated or pooled and allocated to a product cost in a pool with other support/overhead activities. The framework defines a concept known as attributability, which acknowledges that causal relationships vary from very strong to weak to nonexistent.

The concept of attributability clearly states that distortion will be created if weak causal relationships are allocated. It advocates the best practice is to attribute such costs to the level of the organization that the costs are causally related to or that has management authority to eliminate the costs. The concept of capacity defines the importance of knowing capacities, correctly identifying capacity use, and accurately modeling them—for example, avoiding the distortions that can occur if excess or idle capacity is allocated into product cost and not identified clearly for active management attention. Hopefully, these examples give you a sense that the framework’s focus is much different from traditional cost accounting.

The real benefit of the Conceptual Framework for Managerial Costing for manufacturing managers is that you now have a solid reference to discuss improvements that link operational and financial information. Narrowly focused accountants take the perspective that the only number that can be considered is the number on the financial statement. Though that number is important for many purposes, the external GAAP reporting model is based on a conceptual framework that puts the needs of investors and creditors front and center—and does not regard the managers’ needs to make decisions as important. The framework will also be useful for evaluating an organization’s costing requirements and in guiding implementation options.

>> Larry White, CMA, CPA, CGFM,  [email protected], is the Executive Director of the Resource Consumption Accounting Institute (www.rcainstitute.org). which trains and advocates for improved cost information connected to operational business performance.

FILED IN: Finance
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