Costing Menu or Recipe Ingredients?

Resource Consumption Accounting, Lean Accounting, Activity-Based Costing, Life-Cycle Costing, Throughput Accounting, Grenzplankostenrechnung, Time-Driven Activity-Based Costing, Economic Value Added…the concepts and methodologies being promoted in management accounting circles are endless. When you read the arguments put forth by advocates for each idea, you’d think that their methodology is superior to all the rest and the only one you’ll need to solve all your company’s costing problems. When you see the manner in which they are presented, you’d think these methods were mutually exclusive options. Management accountants are presented with a menu of options with the expectation that they will pick the method most appropriate for their organization from the menu.

But should that be the case? Should these concepts be considered options on a menu, or would it be better to view them as an inventory of ingredients that can be combined into a recipe that accurately reflects the unique economic cost structure of a business and meets that business’ decision costing needs?

On the door of Thomas Edison’s laboratory was a sign that read, “A man will resort to almost any expedient to avoid the real labor of thinking.” I fear the menu approach to costing concepts is a prime example of this adage. The ability to select a pre-packaged, paint-by-the-numbers solution from a menu eliminates “the real labor of thinking” when a company must develop a costing system. Whoever has the most influence over the decision selects the concept that best addressed his or her needs and that concept is implemented (too often it’s the accountant who opts for the simplest method that will support inventory valuation).

Unfortunately, none of the “costing methods with a name” included on the menu is complete. They were all designed to solve selected costing deficiencies – those considered important from a limited perspective – and then either ignore the others or consider them unimportant. When one methodology is adopted, a few of the company’s costing problems are solved while many other problems go unaddressed. Each menu item does, however, have an important economic truth at its core that may be critical to the creation of a valid cost model for an organization.

For example: Activity-Based Costing emphasizes the need for costs to flow logically from their incurrence through activities to products or services following cause-and-effect relationships, Economic Value Added addresses the failure of accounting costs to reflect true economic costs and the absence of cost of capital from traditional cost measurements, Lean Accounting highlights the importance of value streams, throughput time, and non-value adding activities, and Resource Consumption Accounting emphasizes the measurement and management of capacity utilization.

If cost information is to be accurate and relevant to decision makers, why wouldn’t an organization want the economic truth that can only be gained by applying the individual truths at the core of each of these critical concepts? Why pick one method from the menu and ignore the problems left unsolved?

Wouldn’t it be preferable for organizations to view the myriad of available costing methodologies as ingredients to include in a recipe that results in a valid economic cost model of its business? One that can be used to accurately measure the relevant cost for each type of decision faced by management. Each concept has something to offer, but none of them offers a complete solution. I know it would require overcoming human nature - an individual’s inclination to avoid “the real labor of thinking” – but wouldn’t the economic rewards from decisions based on cost information from an accurate and relevant, causality-based cost model be worth the effort?

The Profitability Analytics Framework encourages the development of causality-based models for managing revenues, costs, and investments. An effective cost model will incorporate the key features underlying each of the costing methodologies on the menu and provide decision makers with the fact-based cost information they need to make quality business decisions.