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TrueValueMetrics
ACTION INFORMATION FOR ALL OF SOCIETY Metrics about the State, Progress and Performance of the Economy and Society Metrics about Impact on People, Place, Planet and Profit Chapter 5 - ACCOUNTING'S KEY CONCEPTS 5-4 COST ACCOUNTING | |||||||||
WHAT IS COSTING FOR? Understanding costs The purpose of cost accounting is to understand costs and thus be in a position to manage costs. There are many different techniques that can be used, but the overriding goal is to have a useful understanding of costs, for better decisions to be made and for progress to be accelerated. The goal is not only to understand what costs are and what progress is being made ... but to understand also how this progress relates to the progress that should have been made. Cost accounting provides the data foundation in the corporate setting so that management need not use anecdotes, journalism and publicity brochures for decision making ... and TVM Value Accountancy takes these same ideas and applies them in the broader community setting. Moving data from neutral The purpose of cost analysis is to improve understanding. Good accounting data are neutral, and merely reflect some underlying reality. Cost analysis takes data and puts it in a form that augments understanding. It really does not matter what analysis is done as long as the result is better understanding and improved decision making. It does matter that the analysis is done on top of neutral data. It does matter that data are reliable and reflect an underlying reality.
Cost centers Cost centers, profit centers, investment centers, departments, etc are all rather similar. The key is to understand what they are doing and what they are costing. If what they are doing does not seem to have any value ... then some further questions need to be asked and decisions made. Corporate accounting systems usually have very effective cost accounting capability, but getting useful information from these systems is not always obvious. Value chain The value chain has been a critical factor in organizing development, production and marketing around the globe. The value chain has been structured to maximize profit for the involved organizations with little regard to the optimization of community value. The results have been predictable with favorable profit optimization largely offset by value destruction for society. Transfer prices Prices are critical in economic analysis and the determination of profit and value to any entity. Transfer pricing is used to put a value on goods and services as they move from one sub-entity to another within an organization, or between controlled entities. They are a tool that can be used to move profit between entities and may have inappropriate consequences. Management accounting Management accounting is a subset of accounting that helps to get relevant analysis into the hands of decision makers. I see management information as the least amount of information that is needed to make good decisions reliably. Department costs and the variants A cost center is one way in which costs can be organized to help understand and control costs. By pulling costs together within a unit called a cost center, it is possible to get information about a company's activities in a simple way. Responsibility accounting Responsibility accounting is the name given to accounting where the reports specifically identify the responsible managers. This is a useful technique for getting clarity about who is responsible for what ... and there is rarely much agreement. Elements of cost Materials, labor and equipment are the main elements of cost that go into most production activities ... and determine costs. Fixed and Variable Costs But these items also determine the behavior of costs and how costs can be improved. Breakeven When costs are thought of as being fixed and variable, and revenues are thought of as being directly related to quantities, in a profitable activity, there is a mathematical point where revenues equal the sum of fixed and variable costs. This is known as the breakeven point. Standards The techniques of standard costing can be used in TVM Value Accountancy as they are in corporate cost accountancy. A standard is what might be expected based on technical assessment ... compared to an actual which is what actually happened. There are many ways in which the comparison between actual and standard can be made ... the aim of analytical accountancy is for this comparison to improve understanding the most and cost the least. Useless ... or valuable Standards my be thought of as being fixed and arbitrary and useless ... or they may be used as a very powerful tool for understanding a lot of complex material in an efficient way. In this latter mode standards come alive. They start off being the best that can be ... best in the sense of reflecting the best data that are accessible ... and then they improve as better data becomes available and is made accessible. Standard cost Standard cost accounting helps cost accountants measure cost performance without getting deeply buried in detail. Standard costs are the theoretical cost of an item or service Standard, actual, variance The comparison of standard with actual alerts a cost accountant to something that is different and helps put the focus of effort onto something that is out of the ordinary. If actual costs are different from standard costs, then it is time to find out why. Standard values The same approach is used for value as for cost. Every activity produces something ... what is the standard value of this output? This can be determined in an arbitrary manner, and then it can be used in an analytical framework, and compared to alternative values that are justified from different other perspectives. Analysis ... a step to creating value from data Data are nothing without analysis. The effective use of the product of analysis for decision making and holding people and organizations accountable is what makes TVM Value Accountancy valuable. Experience has shown that performance improves when there is active feedback and there are the data that enables people and organizations to be held to account. People may not like it ... but their performance improves. The purpose of analysis is to get a better understanding. The data are neutral ... the analysis then produces results that might suggest some conclusions. It really does not matter what analysis is done as long as the result is better understanding and improved decision making. One value step is moving from data through analysis to understanding ... another is to move from understanding to effective action. In some situations this has been done with wonderful results, but mostly there have been interventions that were more expensive than effective. Comparative analysis Comparative analysis has many forms ... including
Time series Time series are very powerful ... the corporate world uses them all the time. Capital markets use time series ... the public needs to have time series that show what is going on that specifically impacts their community. Historic cost accounting A valid criticism of accounting is that it is all about history ... and this also applies to cost accountancy. But it is also a fact that if you know something about the past, it is possible better to understand today and the future.
Clearly knowing everything about the past is going to be costly, consume time and therefore be counterproductive ... but having knowledge about the behavior of costs, prices and values ... and about productivity, profits and value adding are valuable. In fact, there is no high performing corporate organization that does not understand these things.
In the corporate world, there is a good foundation of knowledge about cost, prices and profits. Not much of this is available to the public, but it is an integral part of decision making in the corporate setting. The situation about cost knowledge in the public sector as a whole and the relief and development sector in particular is remarkably limited. As a result it is fair to say that society gets a lot less from its government than it should ... even at the best of times. Cost accounting ... two settings Cost accounting ... and thinking about cost, price and profit are central to management information in the corporate setting. But this is not the case for society as a whole. Cost accounting is weak in most public sector organizations ... and there is no history of cost accounting about society and socio-economic progress. But what works to help understand the behavior of cost in the corporate sector can be modified for use within the TVM Value Accountancy setting. Almost all the tips and tricks that may be used for corporate understanding can also be used to understand how to make better progress in the societal setting. Corporate accounting systems usually have very effective cost accounting capability, but getting useful information from these systems is not always obvious.
Cost accounting is a management tool. The purpose of cost accounting is not to merely exist, but to provide actionable information for managers and the organization's decision makers. Accuracy is not as important as relevance.
The purpose of cost accounting is to build the foundation for the understanding of cost behavior. Today's costs are a combination of both history and today ... and ultimately so also are profits. When applied to TVM Value Accountancy understanding the behavior of cost helps to make socio-economic progress more than a zero-sum game ... or worse, a real world application of “Heads I win ... tails you lose”. It is helpful to understand not only the behavior of cost ... but also the behavior of productivity. Edward Deming ... one of the history's experts on systems and quality ... would have understood the idea. Cost and productivity are different manifestations of the same system. But cost also has an effect throughout the value chain ... and different parts of the value chain have a whole range of behaviors that impact on both corporate profits and on society. All of the many different cost elements behave in different ways ... the aggregate cost depends on all of the pieces ... and the unit cost depends on all of the pieces as well ... but not always in ways that are immediately obvious. At the same time the value elements also behave in complex ways ... sometimes a function of a cost change, sometimes for unrelated reasons.
Clearly knowing everything about the past is counterproductive ... but knowing about the behavior of costs is very useful. More and more detail may not be the best answer ... ability to look at data in different ways may be more useful. Cost accounting is a powerful tool ... but it needs to be in the hands of people who have an understanding of accounting and the sectors involved. Cost accounting is a part of accounting that informs about how much things cost. In the corporate enterprise the cost systems are well developed and our used extensively. In the not for profit organization, cost systems are much less developed and analysis of costs is rarely integrated into the accounting systems, but done rather as ad hoc studies or as part of monitoring and evaluation exercises. How much did it cost ... how much should it have cost. The question “How much did it cost ... how much should it have cost?” is fundamental to managing performance. It is not a question that the relief and development industry wants to answer, nor to get answered. Many ways to do cost analysis There are many ways to do analytical accounting. Rather than simply summarizing the accounts for the period based on the organization as a whole, the accounts can be summarized in more detail, as, for example:
Departmental accounting
Almost all companies will have department accounting so that the costs of a department can be understood and controlled. A department may have multiple cost centers. Department accounting is widespread because it informs about the costs of a department. Sometimes the costs are linked to revenues or activity levels. In Community Accounting applications, analysis of costs between activities in the community provides useful additional understanding. Departmental accounting and cost center accounting are similar, with cost centers often more detailed than the department.
Cost center
Profit center A profit center is a version of a cost center ... in this case not only costs are associated with the unit, but also the revenues of the unit. This may or may not be useful depending on the structure of the company and the internal value chains. The profit center is similar to a cost center except that the profit center also brings in the revenue side as well as the costs. Variants include using contribution instead of revenues. In Community Accountancy applications the goal is to link costs and value adding. The same concepts that link cost and revenue works also for cost and value. Where there is activity, it is possible to go to the activity value analysis using standard costs and values.
Investment center
Product costs
Process costs
For each step of the process all the costs ... by element of cost ... are known and the actual and standard are easily compared. When costs vary from standard, the cause can be easily identified and taken into consideration. Activity costs Many products are produced using an end to end process. This is the case in, for example: chemical factories, steel mills, refineries, and pulp and paper plants. In all of these cases it is possible to cost the product because the cost behavior of each step of the process is well understood.
For each step of the process all the costs ... by element of cost ... are known and the
actual and standard are easily compared. When costs vary from standard, the cause
can be easily identified and taken into consideration.
Project costs
Project costs – World Bank project ManyContract costing Too many contracts are strong in legal language, but weak with reference to costs and expectations. This need not be ... and should not be. But it does require some level of understanding of costs and the impact on contract performance. Value chain costing One of the most useful tools for the business analysis is value chain costing ... how much of the cost is added at each stage ... from farm to consumer ... from mine to a consumer or industrial good.... etc. It is helpful to know how much profit is added at each stage, and what investment is required for each stage. The transfer price from stage to stage in the value chain can be the difference between a value chain that works and one that does not. A value chain price at one stage becomes a value chain cost at the next stage ... but this cost contains an element of profit as well as just costs. There is little public easily accessible information about value chain costing, but it is a critical piece of information for the understanding of progress. Progress drives itself when the incentives are right ... where the reward for investment and effort is adequate. Progress stops when the incentive is not there ... and inn a long and complex value chain it only takes one piece of the chain to be devoid of incentive for the whole value chain to crumble. Note: A number of different value chains are described in the Value Chain chapter.
Regulation ... the enabling environment The regulatory environment has costs .. and benefits ... and changes the economics of a product, service or business.
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