Manufacturing companies struggle to effectively and efficiently design a cost accounting system to properly value inventory, provide data for profitable and competitive product pricing, and enable operational control of costs. As such, these companies find themselves unable to explain root causes of variances, lose business to competitors because of overpricing, lose money on sales due to underpricing, and fail to accurately value inventory because of woefully inaccurate standards.
However, we have found many companies in this position are unwilling to modify their costing system. After wrapping up a recent assessment of a manufacturing company’s financial systems and processes, it finally struck me there was one common message received from the client after this assessment and the dozen I have done before it, and I’m paraphrasing: “Don’t touch my costing system.”
Regardless of the talk of change and blowing up the status quo, the costing system of yesteryear seems to always be off-limits even though it fails to meet its primary objectives. Why is this the case?
Let’s attempt to answer the question by acknowledging the primary objectives of any costing system:
1. Produce financial and tax statements: Properly state inventory values and recognize costs of goods sold (at actuals) per GAAP at the end of a reporting period (may require manual allocations depending on costing approach used).
2. Control costs: Enable cost visibility at the cost center and/or activity level to promote operational control of production-related expenses.
3. Capture product costs for pricing: Capture all relevant product costs throughout the value stream (e.g. design, manufacturing, marketing, back office support, etc.).
The vast majority of costing systems being utilized address one, maybe two, of the primary objectives, but rarely all three.
The most common mistake companies make is to accept the inefficiencies within the costing system to get the costing information required by the business. Therefore, the assumption is the cost accounting system is functioning as designed. This is false.
Instead, companies need to delve a level deeper to understand the true accuracies (or inaccuracies) of the system and resources (time and money) required to maintain the system. To do so, we ask our clients to complete a survey on how well the costing system meets needs within the organization.
The output of this survey sheds light on where deficiencies might exist within the cost accounting system and creates the start of a business case for challenging the entire process.
Performing an adequate assessment of the costing system will pinpoint weaknesses to be addressed. At times, a tweak here and there can address the gaps, however, a complete overhaul of the system is often required.
Where to begin? Start by following these four steps:
1. Gather requirements: Invest time to inventory and document the requirements for stakeholders and internal customers of the costing system. Take advantage of this opportunity to also standardize metrics used across the functions.
2. Design from scratch: Design the costing process from scratch, assuming no constraints (e.g. technology), taking into account the requirements obtained from step one. Determining the right costing methods (standard, actual, average, activity based, etc.) should be evaluated during this step. Note: More than one process or system may be required to fulfill all primary objectives.
3. Align roles and responsibilities: Identify the roles within the organization who will be supporting the costing process and delivering information, and communicate appropriately. Expected services to be delivered by the costing system should also be clearly defined and communicated.
4. Create an implementation roadmap: The suggested approach for implementing a new costing system is to identify and prioritize all initiatives required to address existing gaps and meet the future state requirements. Breaking the implementation into smaller, more manageable projects allows the organization to attain benefits along the way. And it's often easier for the business to absorb the changes.
It’s time to let go of the costing processes providing little to no value. An effective costing process can provide a significant competitive advantage for the business. Furthermore, the right costing process can act as a catalyst to break down organizational silos between the accounting, operations, and commercial teams.
Trenegy has assisted many companies with implementing an effective and efficient costing system. For additional information, please contact us at info@trenegy.com.
