Can you imagine accountants as American cowboys of the Wild, Wild West in the 1800s? I can. And they can be dangerous. Yeehaw! Yippee-i-o-i-a!
In place of guns in their belt holsters the cowboy accountant may be carrying a smartphone. Their rodeo rope that cowboys use to catch running steers may be their audit controls manual. Cowboy accountants also wear well-shined wing-tipped dress shoes as their cowboy boots.
Why am I making light humor of accountants with a metaphor of them as cowboys? It is because they operate today in a lawless frontier no different than the Wild West. To be clear, I am not referring to external financial accounting for government regulatory and statutory reporting but rather to the lawless frontier of internal managerial accounting used by managers for insights, analysis, and decision making.
No laws. No jail.
When accountants get the external financial accounting numbers wrong, then they might go to jail! Think Enron. However, if they get the internal management accounting numbers wrong, they don’t go to jail. So, they can ease up and report what they falsely believe is reasonably accurate information.
But therein is the problem. Some accountants are lazy. The laziness I am referring to is not about working long hours – most accountants do. The laziness I am referring to is where they do only enough work for what is convenient for themselves as opposed to what is good for who they serve – the users of the information who perform analysis and make decisions. So, the accountants typically slack off by applying simplistic cost allocations.
Who is to say what is correct?
A complicating matter in our Wild West of management accounting is there are few if any standards to follow. On the external financial accounting side of compliance and statutory accounting there are many rules, including Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). And tax authorities have thousands of rules.
In contrast, management accountants are left to their own devices to define the internal management accounting practices to apply within their own organizations. If they want to allocate indirect and shared expenses (commonly called “overhead”) to product costs like spreading butter across bread based on a single broadly averaged factor with no cause-and-effect relationship to the products (e.g., number of units produced, direct labor input hours), then they can. No one can stop them despite the fact that the result will be flawed and misleading with simultaneous over-costed and under-costed products. There is zero-sum error. It perfectly reconciles but is wrong in the parts. And typically substantially wrong with over +30% and -30% error from the actual costs. One solution to this problem is to adopt activity-based costing [ABC] principles.
Accounting institute task forces to the rescue.
Fortunately, some of the professional accounting institutes are beginning to address this problem. The task force of The Institute of Management Accountants (www.imanet.org) that created this website has published “The Conceptual Framework for Managerial Costing.”I was privileged to be a contributor to this document. This report specifically defines 12 principles that if followed, an organization’s users will be more assured that they are receiving highly valid and accurate management accounting information.
So, for you cowboy accountants who are operating in the lawless frontier, you may discover there may be a new sheriff in town. You may no longer get away with reporting flawed and misleading information to your users, who are likely making poor decisions with it, and violating cost accounting’s universal principles – especially its causality principle.