[原创]Limitations to Cost Management Based on the Accounting Standard

1.1 Nature of Accounting Standard

As the foundation of Accounting, the Acounting Standard defines the items of expense and cost object, as well as their costing relationships for the financial reporting purpose. In a word, they can be summaried through the activity-based costing model as shown in Exhibit 1-1.

Exhibit 1-1 Activity-Based Costing Model Integrated with Accounting Standard

 Although activity-based costing model makes the improvement with activity costs for the traditional costing method, it is still in compliance with the Accounting Standard. That is, there is only one cost object - product cost. Therefore, the activity-based costing model in Exhibit 1-1 implies such common assumption that all the resource input leads to nothing but one output – product, no matter whether the indirect expense (overhead) is allocated to product through activity cost or not. However, the actual relationships among resource, activity and cost object are based on the multi-input and multi-output (MI&MO) process as shown in Exhibit 1-2. This means that the resource input not only has the output of product but also has other different output such as quality, efficiency, customer, and so on, which are ruled out by the Accounting Standard and thus ignored in practice.

In nature, the Accounting Standard that is only for regulatory reports required by external users is not just for the actual needs of cost control. The external users normally pay attention to the information of profit, liability and asset instead of the detailed cost information although it has impact on the profit and asset, but the management accountants specifically focus on the latter. Therefore, in order to drive more effective and efficient business performance, management accountants should adopt such a new costing model that is consistent with the MI&MO process.

In the following parts, the activity-based costing model shown in Exhibit 1-1 is called ‘Multi-Input and Single-Output Costing Model’ (MI&SO Costing Model).

Exhibit 1-2 Multi-Input and Multi-Output Process (MI&MO Process)

1.2 Limitation to Classification of Cost Object

       Exhibit 1-1 also shows that there is only one classification of cost object – product cost, while Exhibit 1-2 indicates totally nine types of cost objects existing in the operational management. Each cost object represents the cost of fruit in the corresponding management fields. For example, quality level is the fruit of quality management. Its cost is the consumption of those resources particular to the quality management.

       Generally, the categories of cost object should be included efficiency, customer, risk, capital, safety, human resource, and environment. This is because each cost object is related closely to its management systems on which management accountants have to make business decisions and to facilitate responsible, excellent business performance:

        Product cost is related to production management in the aspects of bills of materials (BOM), procurement, manufacturing and etc.

        Quality cost is related to quality management such as the operation of ISO 9000 quality system, total-quality management (TQM) and 6 sigma quality control;

        Efficiency cost is related to efficiency management such as business process reengineering (BPR) and just-in-time (JIT) production;

        Customer cost is related to sales management such as the operation of customer relationship management (CRM);

        Risk cost is related to risk management such as the operation of enterprise risk management (ERM) system;

        Capital cost is related to capital management such as the financial operations;

        Safety cost is related to safety management such as the operation of safety management system (SMS);

        Human resource cost is related to human resource management;

        Environment cost is related to environment protection management such as the operation of ISO 14000 environmental management system.

Thus, the exclusive output limitation of the Accounting Standard is not appropriate for the business entity to make its total cost management so as to form the competitive advantage of lower cost in its supply chain.

1.3 Limitation to Activity-Based Cost

       Although ABC improves the cost accounting in the allocation of indirect expense (overhead) to product through the activity cost, Exhibit 1-1 still has the limitation as follows:

        Activities exclusively contributed to product cost

As shown in Exhibit 1-2, each cost object is independent of others or at the equal position with others. Thus these cost objects should have their direct material, direct and indirect expense, activity cost like the composition expenses of product cost.

For example, activity costs of quality management should be contributed to quality cost; activity costs of efficiency management should be contributed to efficiency cost; activity costs of customer management should be contributed to customer cost. Therefore, the attribute of each activity should be its cost objects instead of product cost only.

        Activities unrelated to product cost

Although the traditional ABC is useful in modern cost and process management, some companies may complain about the extra spendings incurred by numerous activity numbers. As a matter of fact, the indirect expense shown in Exhibit 1-1 is defined from the view of product, but if from the view of quality or others, it may be direct expense. For instance, the inspection expense is indirect for the product cost, but it is direct for the inspection cost of quality. If so, the number of quality inspection activity as well as its cost driver can be reduced to zero.

1.4 Limitation to Master Budget

       The master budget is a vital tool that translates the enterprise strategic plan into short-term and long-term budgets for implementation. The results of master budget are mainly three pro forma statements: cash budget, budgeted income statement, and budgeted balance sheet.

       Most companies wish to control their costs through the functions of annual master budget, but the actual effects at the end of year normally disappoint them. One of reasons is that multipe cost objects except product cost are out of consideration in the master budget. No budget no control. In the daily operational management, each entity unavoidably has its own poor managerial costs in the aspects of quality, efficiency, risk and etc. Due to the fact that the pro forma statements are prepared based on the Accounting Standard, the master budget is unable to take multiple cost objects into consideration. In this case, management accountants may be free of controlling those costs incurred by the poor management such as defects, rework, overproduction and overprocessing, accident, environmental pollution, and etc.

1.5 Limitation to Cost Management Performance Measurement

       Generally, the key purpose of cost management performance measurement is to assess the performance of each operational system in accordance with the cost-benefit principle. To do this, the performance indexes of cost management should include the cost indexes and their combinations with non cost indexes.

       As a matter of fact, the operational systems of business entity normally are those related to the procurement, production, quality, sales, risk, human resource, capital, safety, environment, and etc. Thus, the scope of cost indexes firstly includes the costs of product, purchase, quality, efficiency, customer, capital, risk, human resource, safety, environment, activity, and etc. And then, these cost indexes are combined with the non cost indexes such as production volume, setup time, machine hour, labor hour, inspection hour, batch of production, number of purchase orders, and etc. But whatever the actual management requirements are, the limitation of Exhibit 1-1 is not able to provide such diversified cost information to the management accountants for their cost performance measurement.

1.6 Limitation to Quality Cost Management

       The costs of quality consist of prevention, appraisal, internal failure, and external failure costs. The objective of quality cost management is to minimize and eliminate the failure costs and manage the prevention and appraisal costs to an appropriate level. Quality costs can be substantial. But, in most companies, they are buried in cost of goods manufactured and sold, salaries, travel expenses, insurance, technical services, and so forth. They remain unknown and therefore unmanaged.

As mentioned in 1.2, the measurement of quality cost is required under the ISO 9004:2000 to evaluate the performance of quality system. The reason for this is to prevent the products in poor or extra quality from being manufactured in the first place that leads to the high quality cost. Normally, the relationship between prevention cost and total quality cost is described as a curve of parabola shown in Exhibit 1-3. In this case, quality cost should be controlled under a reasonable level (e.g., y≤y1) in an appropriate range (e.g., x∈[x1, x2]) as descrided in the following situations:

        where x≤x1, y>y1, quality is poor;

        where x1≤x≤x2, y≤y1, quality is controlled in an appropriate level;

        where x≥x2, y>y1, quality is extra superior.

Exhibit 1-3 Relationship between Prevention Cost and Total Quality Cost

       The Acounting Standard makes no implication on the definition of costing model of quality relative to the following questions:

        Is quality cost as a cost object indepent with product cost?

        Does quality cost have its own direct material, direct expense, and indirect expense as well as activity cost like product cost?

1.7 Summary

       The fundamental limitation to the cost management based on the Accounting Standard is the MI&SO costing model in which only product cost is defined and other cost objects like quality are omitted. The emergence of CSS is to solve this limitation by guiding the entities in a supply chain to establish an ordering and improvable cost management system so as to continuously eliminate its poor management cost and to upgrade the staff quality as well as to form the cost competitive advantage eventually.