The Conceptual Framework for Managerial Costing

The Conceptual Framework for Managerial Costing Larry R. White, CMA, CFM, CGFM, CPA Former Global Chair, IMA 2004/5 Executive Director, Resource Consumption Accounting Institute

Outline Introduction What is managerial costing? Why a Framework for Managerial Costing? The objective of the Framework Using the Framework Principles for Managerial Costing Constraints for Managerial Costing Concepts for Managerial Costing 2

What is Managerial Costing? Cost Accounting Tool for Financial Reporting Management Accounting Activities of Professional Accountants in Business Managerial Costing Managerial Decision Support 3

Enterprise Financial Management Tax Accounting Financial Accounting Source data capture (transactions) Managerial Accounting Non-financial data capture Cost Measurement Cost Accounting External financial Reporting e.g. GAAP, IFRS Costs of goods sold Inventory valuation The Domain of Costing Performance Evaluation & Analysis For example: Assessment of current strategy & plans Integrated cost/operational performance measures (e.g. cost variance, capacity measurement, process efficiency etc) Profitability reporting Process analysis Learning & corrective actions Planning & Decision Support For example: Fully absorbed and incremental costing Adaptive operation & cost based planning, budgeting & forecasting What-if analysis & planning Product, process, channel, & customer strategic adaptations Enterprise optimization (e.g. make vs. buy, outsource etc) Lower Historical Value-added to managerial decisions Predictive Higher

Why a Conceptual Framework? All major Accounting Standards are built on a Conceptual Framework. Provides the theoretical underpinning and foundational logic Defines the customer and primary objective Where do accountants go for conceptual guidance for designing internal cost information models and systems? Who is the standard setter for internal cost information? Logic will prevail: The use of incorrect concepts to create information will create incorrect information!!!! 5

Costing Problems Distortion Transparency of Operations and Resources Modeling Money Nature of Cost Capacity Management and Identification of Idle Capacity 6

Statement of Objective Managerial Costing Conceptual Framework The objective of managerial costing is to Provide a monetary reflection of the utilization of business resources and Provide cause and effect insights into past, present, or future enterprise economic activities. Managerial costing aids managers In their analysis and decision making and Supports optimizing the achievement of an enterprise s strategic objectives. 7

Inputs: Resources, Operational Quantities, Costs CAUSALITY ANALOGY Output: Information For Decisions Concepts Resource Managerial Objective Cost Homogeneity Traceability Capacity Work Responsiveness Attributability Integrated Data Orientation Constraints Objectivity Accuracy Verifiability Measurability Materiality Modeling Concepts Operational Model Costed Information Use Concepts Baseline Optimization Information Concepts Avoidability Divisibility Interdependence Interchangeability Constraints Impartiality Congruence

Using the Framework Assessing and creating requirements For an internal costing approach based on an organization s strategic objectives. Evaluating costing methods or solutions. The Conceptual Framework is not a costing approach or method. It defines the key principles, concepts, and constraints to be considered in designing a costing approach. 9

Principles Causality (Cause & Effect) The relation between a managerial objective s quantitative output and the input quantities that must be, or must have been, consumed if the output is to be achieved. Analogy: (Information Use) The use of causal insights to infer past or future outcomes. 11

Inputs: Resources, Operational Quantities, Costs CAUSALITY ANALOGY Output: Information For Decisions Modeling Concepts Information Use Concepts Operational Model Costed Baseline Optimization Information

Foundation of Principles What must form the foundation for a set of principles? Truth What is True Cost? 13

Foundation of Principles Correspondence Definition of Truth Truth corresponds to facts. Resources in operation create a factual situation. 14

Example More Accounting Transactions 12,000/yr Accounting Operations Center: Personnel Cost $30,000,000 Operating Cost $15,000,000 Transactions/year: 3,000,000 Calculated Full Cost: $15/transaction X 12,000 = $180,000 Judgmental Marginal Cost: 1 Accounting Technician = $50,000 15

CAUSALITY ANALOGY Objectivity Accuracy Verifiability Measurability Materiality Modeling Constraints Information Use Constraints Impartiality Congruence

Modeling Constraints Objectivity Accuracy Verifiability Measurability Materiality A characteristic of a cost model that shows it to be free of any biases. The degree to which managerial costing information reflects the concepts you intended to model. A characteristic of modeling information that leads independent reviewers to arrive at similar conclusions. A characteristic of a causal relationship enabling it to be quantified with a reasonable amount of effort. A characteristic of cost modeling that would allow for simplification without compromising managers decision-making needs. 18

Information Use Constraints Impartiality Congruence The unbiased consideration of all resource application alternatives. The interdependence of individual managerial actions to attempt to achieve both individual and enterprise objectives in an optimal manner. 19

CAUSALITY ANALOGY Resource Managerial Objective Cost Homogeneity Traceability Capacity Work Responsiveness Attributability Integrated Data Orientation Modeling Concepts Information Use Concepts Avoidability Divisibility Interdependence Interchangeability

Overview of Modeling Concepts 1. Elements of an enterprise s operational model Resources and Managerial Objectives 2. Characteristics of resources and managerial objectives Cost, Homogeneity, Traceability, Capacity, and Work 3. Relationships between resources and managerial objectives Responsiveness and Attributability 4. The nature of the data needed for the model Integrated Data Orientation 22

Elements of an enterprise s operational model Resource Managerial Objective A definitive component of an enterprise acquired to generate future benefits. A specific result or outcome of the application or provision of resources that management chooses to monitor for the purpose of enabling one or more managerial activities. 23

Primarily relevant to characteristics Cost Homogeneity Traceability Capacity A monetary measure of (1) consuming a resource or its output to achieve a specific managerial objective, or (2) making a resource or its output available and not using it. A characteristic of one or more resources or inputs of similar technology or skill that allow for their costs to be governed by the same set of determinants and in an identical manner. A characteristic of an input unit that permits it to be identified in its entirety with a specific managerial objective on the basis of verifiable transaction records. The potential for a resource to do work. Work A measure of the specific nature of units of resource output. 24

Primarily relevant to relationships Responsiveness Attributability The correlation between a particular managerial objective s output quantity and the input quantities required to produce that output. The responsiveness of inputs to decisions that change the provision and/or consumption of resources. 25

Primarily relevant to the nature of the data needed Integrated Data Orientation Information about an organization s economic resources, events, and their corresponding monetary values, free from traditional accounting conventions, which allows for the aggregation of elementary data elements and their values for any purpose. 26

Overview of Analogy Concepts 1. Relevant to analysis avoidability and divisibility 2. Relevant to decision making interchangeability and interdependence 27

Primarily relevant to analysis: Avoidability Divisibility A characteristic of an input that allows for the input (and hence its costs) to be eliminated as a result of a decision. A characteristic of a resource that allows it to be associated in its entirety with the change in a managerial objective s output resulting from a decision. 29

Primarily relevant to decision making: Interdependence Interchangeability A relation between managerial objectives that occurs because of a decision to use resources to achieve one objective that affects the amount or quality of resources required to achieve other objectives. An attribute of any two or more resources or resource outputs that can be substituted for each other without affecting the costs of the other resources that are required to carry out the activities to which the interchangeable resources are devoted. 30

Thank You!! And Any Questions Larry R White, CMA, CFM, CPA, CGFM lwhite@rcainstitute.org 757 288 6082 31