How many times, as a management accountant, have you been asked for a “True” cost? Have you ever thought about what this means? What cost did you provide that was not “true”? And did you lie when you provided it?
“True” cost usually means a cost other than the cost calculated by the cost accounting system that generates information for regulatory financial reporting. Sometimes the inquiry is more tactfully addressed by asking for a “relevant” cost. Relevant meaning pertinent to the decision that an individual is trying to find information to help them make. In both cases, the information you provided (probably from the cost accounting module of your financial reporting system) isn’t true or relevant, but you didn’t lie or intend to mislead or confuse. What’s going on? Apparently, this is why you often hear people asking for ONE version of the financial truth.
The problem is the accounting profession has not been very clear on the term “Truth”. Regulatory financial reporting has a standard of “truth” set forth in generally accepted accounting principles created by FASB, IASB, or another national standard setting body. These rules are the result of a social consensus by many stakeholders. They create “general purpose financial statements” that are meant to provide information to investors and creditors that is fairly standard and can be audited to provide confidence in public capital markets. I refer to this type of truth as the “Laws of Men”.
Truth for financial information for internal decision making is less clearly defined by the accounting profession. Logically, it should reflect reality and follow the same rules as science – truth must correspond to facts. The IMA Conceptual Framework for Managerial Costing focuses only on internal decision making. It defines the key principle for creating internal information as Causality, or accurately reflecting operational cause and effect relationships with monetary models. I refer to this type of truth as the “Laws of Nature”. Neither is superior or inferior, but they are very different and financial personnel must be clear about what perspective they are presenting…….And stop the myth that ONE version of the financial truth can be created or ever exist.
If you are interested in reading more on financial or monetary truth from an internal decision support perspective, a good article is The Foundation of Truth in Managerial Costing.
Larry R. White, CMA, CSCA, CPA, CGFM
Executive Director, Resource Consumption Accounting Institute
John Maurice Clark highlighted the fact that the is no ONE version of the truth in his groundbreaking 1923 book "Studies in the Economics of Overhead Costs" where he explained:
“Most of this controversy will disappear if we carry our study far enough to recognize that there are different kinds of problems for which we need information about costs, and that the particular information we need differs from one problem to another." “As a result, if cost accounting set out, determined to discover what the cost of everything is and convinced in advance that there is one figure which can be found and which will furnish exactly the information which is desired for every possible purpose, it will necessarily fail, because there is no such figure.”
It's sad to think of how many misinformed, value-sapping decisions have been made because those individuals advising decision makers have failed to recognize this economic fact that was brought to their attention almost a century ago.
Larry .... Your post is well written. There will always be a debate with semantics of the terms "true", "real", "accurate", "actual" and similar terms. Regardless of what they mean, what is more important is for an organization's CFO and their accountants to provide its managers and executives with flawed and misleading cost information. That reported information is the opposite of the terms I mentioned. One of the culprits? Allocating indirect expenses (commonly referred to as "overhead") to product and service line costs like spreading butter across bread. This violates the "causality principle" that you mention. It is borderline irresponsible for CFOs and accountants to do this when there are progressive management accounting practices and methods that resolve this.