As discussed in previous writing, managerial costing can be distinguished from external reporting on dimensions of purpose, goal, methodology, test, and dynamics. The purpose of this piece is to provide a framework to visualize a wide scope of cost accounting uses. To restate the fundamental difference this framework starts by defining Financial Costing as cost accounting done to support the external reporting requirement. Managerial Costing is then the cost accounting done to support internal needs.
The internal needs for managerial costing can be broken down into two major categories. Some costing’s goal is to support ongoing operations in a way that improves the cost effectiveness of operations. The second major use of managerial costing is designed to improve the cost effectiveness of major decisions of an infrequent nature.
How Can Managerial Costing Support Operational Improvement?
Let’s discuss the operational control area first. I’ve seen three distinctly different types work very effectively. These differ primarily in the focused area of what is being managed or controlled.
Organization Based Control is useful in managing cost centers. Cost centers have no revenue and therefore no bottom line profit or loss. They exist for various purposes but all incur cost for salaries and wages, supplies, travel, etc. They are often hierarchical: which is to say the cost centers can be managed individually and as groups by higher reporting level.
Role Based Control is useful in managing support costs. In addition to support organizations being cost centers they have an added level of complexity in that support cost centers exist to support other organizations or operations and costs can be allocated to those areas. While organization based control supports the management chain of command, role based costing supports the consumers of the support.
Output Based Control is useful in managing the performance of those responsible for products or services. This is the most complex type of managerial costing in that it aggregates cost from operational cost centers and support areas by each product or service being managed. Output based control can work with profit centers since products or services often have revenue.
How Can Managerial Costing Support Decision Making?
Decision making differs from ongoing operations in that a decision is a one-time event rather than an ongoing process. Some, but not all, decisions are important enough that an ad hoc managerial costing effort is helpful in improving cost effectiveness.
Price setting is one such decision. It is something considered periodically: perhaps annually. It might be very wise to look at the profit margins, return on investment, competitor pricing, backlogs, inventory levels and other information elements on a product by product basis. While there is value is looking at this periodically, it is not needed continuously in most cases.
Cost benefit analysis is a classic use of managerial costing for decision making. We use it all the time in our personal lives too. It could be said that every non emotional or reactive decision we make uses some level of cost benefit analysis.
Consider your choice of route on your last drive. Did you take a route that was shortest or fastest or just drive in the general direction? You implicitly considered some elements of cost and weighed them against your assessment of benefit.
Note that there is not one correct answer. I might put more weight on the cost of gas and you might value your time more than I do. This is often the case in cost benefit analysis. It is a decision tool: not a substitute for judgement
In the car route decision you didn’t have to make an elaborate accounting. However, major decisions such as building a new facility, buying a piece of equipment, moving operations to a different state are important enough to dedicate considerable effort to evaluating the costs and benefits of various alternative solutions to the issue.
Strategic questions frequently arise that also need an answer. For example, management might want to know the cost of training or the cost of employee turnover. Answering questions like these is often best handled by a one-time cost based analysis.
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