Cost of all sorts have an essential “nature”. The “nature” is a consumption relationship between a resource and its direct output; the nature of a cost must reflect the the operational quantities that a resource provides to create an output. For example, 0.5 labor hours are required for each output unit. (Simple and obvious, but wait…) In RCA, this is often extended to resource groups that create a homogeneous output. Typically, the “nature” or relationship is defined by a fixed component and a proportional (or variable) component. In most cases, the relationship is linear; but inverse, exponential, and other relationships can certainly exist. Over broader ranges of output, steps in fixed costs can occur when you need to add larger quantities of resources.
Like most things in life, the “nature” of cost gets much more complex. Consider the 0.5 hour of labor which initially appears completely proportional. Is it? Labor is supported by a payroll infrastructure; a set of benefits – insurance, vacation, retirement, profit sharing, etc; a work group supervisor; and perhaps more. This support often adds a fixed cost component to what appears to be a purely proportional cost. Furthermore, the same direct labor hour may be regular time, overtime, or a holiday rate.
Additionally, the “nature” of a cost can change. The 0.5 labor hour and its fixed and proportional components may produce an output unit such as a required periodic maintenance procedure on a refrigeration unit. The cost of the refrigeration unit becomes a fixed cost of the product that is produced in the refrigerated facility. Such changes are always from proportional to fixed, never fixed to proportional.
This seems awfully detailed and complicated: Why is the “nature” of cost so important? A costing approach and supporting system that creates such information is the key to continuously knowing and using marginal and incremental cost information to maximize profit. Additionally, operational systems in manufacturing, logistics, retail, and high-volume services are becoming real time and “SMART” at a very granular level; a level of performance traditional financial accounting and cost systems cannot begin to support.
Resource Consumption Accounting is the only cost modeling approach that recognizes and supports tracking the nature of cost and a cost’s potential to change its nature as it is consumed by an organization and its processes. If you want to step up your game as a business partner, it’s time to create financial information that keeps pace with operations and their supporting systems.