Decisions are made constantly at all levels of an organization. External reporting that provides a highly aggregated view infrequently is seldom of use in the vast majority of these decisions. Smart management decisions seldom occur without knowledge and managerial costing provides the essential elements of information.
Cost intelligence is needed to help make sound decisions and drive continuous improvement in operations. Let’s consider the reasons why management needs for actionable intelligence is not satisfied its external reporting. Managerial costing differs in purpose, goal, methodology, test, and dynamics.
How does Managerial Costing Differ in Purpose?
I’d bet that almost all of the readers of this piece do some personal external reporting. It’s due to the tax authorities every year! Now consider why you do this external reporting every time you send your tax returns. Do you do it because you enjoy it or get something out of the process? Or do you do it because it is required and there are penalties for not doing it? Just ask yourself if you would continue next year if it were suddenly not required.
On the other hand, consider your checkbook balancing or household budgeting. This is not a requirement of the tax authorities but millions of people do it. Why? There must be a personal benefit and those people must be learning something of value from the process. External reporting is done because it is required and managerial costing is done because it is needed.
How is Managerial Costing’s Goal Different?
Consider your goal in doing your tax return. It is not optional and done simply for compliance with the requirement. Managerial costing, on the other hand, is optional. You do it because the benefit or value of doing it exceeds the cost or time of the effort. In other words you learn something of value that justifies the effort. There is no IRS requirement that you balance your checkbook!
What is different about Managerial Costing’s Methodology?
External reporting generally comes with strict methodology requirements or standards. For example, you are expected to comply with definitions of what is tax deductible and what is not. More complex issues like depreciation have methodology expressed in tables for various asset classes. Moreover, you are subject to audits to insure that you are complying with the methodology imposed.
On the other hand, balancing your checkbook comes with no auditable methodology. Some people balance monthly to the penny and others look for major issues infrequently. Some check their balances daily or before a purchase and others don’t balance at all.
The same analogy applies to other personal managerial efforts like maintaining a household budget process. The point is that the method is up to you: not an external authority. You determine your managerial costing methodology.
What Different about the Test of Success?
The test of external reporting is done by the external entity that required you to do the reporting. Third party auditors are often employed to provide “assurance” of compliance. We are happy to pass an audit without issue. The purpose of the audit is to discourage misstatement or cheating.
But why would you cheat or deliberately misstate your checkbook balance? If it made you feel better you are free to add a million dollars to your checkbook balance. And who would care if you did. You are making the effort, if you do so, to learn something so you have an incentive to report the truth.
(Now, I must admit I had a student who did deliberately misstate his checkbook entries because he “didn’t want his wife to know” his spending. However, I’d rebut that his was an external reporting rather than managerial costing process!)
How is Dynamics Different?
Because of the complexity in defining its methodology, external reporting requirements are relatively slow to change. Consider a change in tax law. It could take years to make changes.
On the other hand, managerial costing is user defined to serve the user. The user can change methodology anytime the user wishes. Your checkbook and household budget process are yours and you can change how you do them without anybody else’s approval.
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