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Changing the rules of cost analysis

Dallon Christensen | March 11, 2011
I am a regular reader of, and contributor to, LinkedIn groups focused on the finance profession. Two recent LinkedIn discussions have provided excellent evidence that we need to examine how we analyze cost information.

I am a regular reader of, and contributor to, LinkedIn groups focused on the finance profession. Two recent LinkedIn discussions have provided excellent evidence that we need to examine how we analyze cost information.

The first discussion, in the Institute of Management Accountants group, asked a very provocative question: "Were accoutants responsible for the recent economic crisis?" Having worked for a media relations group in college, I immediately smelled a discussion starter! The exchanges are very lively, and focused on the role of accountants in reporting facts to management vs. examining the reasoning behind the numbers. The second discussion, in the Cost Accounting for Process Manufacturers group, asked whether standard costing was obsolete in today's manufacturing environment. Again, the animated discussion raised many good points.

I have spent the majority of my finance career focusing on cost management and analysis. And I really did not consider myself a true finance professional until I understood product costs. I believe finance professionals with a good cost background add tremendous value to organizations. However, we must change our focus from recording current costs to planning the future of our product costs. The speed of new product introductions and the severe profitability impact of incorrect decisions requires us to change how we view costs.

To be truly valued business partners we will need to focus on three forward-looking aspects of cost.

* Quality of costs must be considered. By "quality of costs", I mean what percentage of your costs are at risk of changing. Signed long-term agreements with suppliers indicate high quality of cost. How quickly can your organization improve its cost quality?

* We cannot forecast a single value for product costs. When social unrest in Libya can cause gasoline prices to spike 35 cents in 15 days, the static models of yesterday will not work. We must anticipate several scenarios and identify drivers in those scenarios.

Find the right cost drivers, not just all the cost drivers. The biggest drawback of activity-based costing is that we try to identify every single cost driver. We value precision over accuracy, and the result is inaccurate cost data.

Any organization looking for accurate and meaningful information for investment and management decisions must trust its cost information. However, the new face of finance is understanding how costs will behave in the future. Our present way of understanding product and service costs simply will not work in an environment of fair value accounting and valuations of future activity.

 

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