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Your product costing may not be relevant for decision-making

The purpose of traditional product costing is to value inventory for the balance sheet and calculate the cost of goods sold for the income statement. This external financial reporting need is driving current costing practices and is distorting your management accounting and hence also decision making.

External accounting standards state that the product cost shall cover all manufacturing cost and forces us to mix:

  • volume based cost with time-based cost

  • material cost with labuor cost

  • direct with indirect cost (overheads)

This mix of differently behaving cost elements distorts our capability to understand our underlying reality for managing and driving profitability on product, customer and product line level. We are often convinced to believe that more allocations and preciseness in the product cost will help us make better decisions. However, key analysis and decisions like margin times volume sensitivity become useless. The understandingof the bottom-line effect of a decision, when there are multiple changes in price, volume or product mix, is totally lost. Making profitabilitycomparisons on product level is out of context and it becomes impossible to control or reduce cost with this set of "mathematically correct looking set of spaghetti".

Decisions based on traditional product costing might harm your money-making capability instead of improving your performance. Savings in a bottleneck will reduce output and investing in a non-bottleneck is a waste of money. You can work on your allocation methods and allocation keys but always ask yourself will this help you make better decisions? Are cost allocations really adding value to your money-making capabilities or are they preventing transparency on how money is actually generated?

At Nobsh, we always start our analysis by de-mixing cost elements, and we sure get out a lot of useful information by doing so. The purpose of management accounting is to support the management to make decisions that drive real profitability and cash flow. Focus should be on relevance, not on rules and regulations.

How relevant is your management accounting, do you see the problem?

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