In the 1910's, H.L. Gnatt stated: “When times are good and there is plenty of business, this method of accounting indicates that our costs (per product) are low; but when times become bad and business is slack, it indicates high costs due to the increased proportion of burden each unit has to bear….Our cost systems, as generally operated at present, show us under such conditions our costs are high….far greater than the amount we can get for the goods. In other, words our present systems of cost accounting go to pieces when they are most needed.”
Sadly, what was true then, remains true for a shockingly large number of businesses who have not realized the need for managerial cost systems that are designed to provide information for internal decision support. The Institute of Management Accountants has created a Conceptual Framework for Managerial Costing (CFMC) that defines the principles and concepts that must be applied to create cost information for internal decision support. Resource Consumption Accounting is the most comprehensive way to implement those principles and concepts.
“Responsiveness” is one of the 10 concepts that support the principle of causality, or cause and effect, which is the fundamental principle for managerial cost modeling. Responsiveness means: The correlation between a particular managerial objective’s output quantity and the input quantities required to produce that output.
Practically, this means being aware of the nature of the resources consumed by each step in a process. For example, electricity (when purchased from a power company) is typically a completely proportional resource – it is consumed as it is needed. But if a particular material must be kept refrigerated to a particular temperature, the electricity associated with keeping the material cooled becomes a fixed resource quantity and, of course, cost unless the production using that material is halted and the inventory depleted. Tracing the use and nature of resources is critical to having responsive costs.
Traceability vs. Allocation
The difference between traceability and allocation is important because, while these terms are often used interchangeably, they are at opposite ends of a scale from a cost modeling perspective. Traceable means the ability to assign costs based on a clear and verifiable quantitative causal relationship. Thus, it becomes a direct cost relative to what can be traceable. In contrast, allocation is an arbitrary or generalized spreading of costs when the link between resource quantities and their dollars have been lost, no traceable causal relationship exists, or a causal relationship is ignored. Under the CFMC, allocations are always viewed as creating distorted information. Pooling and allocating traceable costs using a general metric provides less causal insight than tracing. Allocating costs with weak or non-causal relationships to a managerial objective also distorts the quality of decision-support information.
To have responsive cost information, the operational model must drive the cost model. And the cost model must be designed to collect and report information that reflects (like a mirror) the operational quantities used by resources and processes. Financial accounting and reporting information designed to support regulatory requirements don’t have any requirement to incorporate the principle of causality or the concept of responsiveness…..they aren’t even designed for internal decision support, they are designed for external investors and creditors. Get responsive for your internal decision support. Get RCA.