Establishing a Cost System

We held an interview with Dr. Raef Lawson, Vice President-Research & Policy and Professor-in-Residence, IMA – The Institute of Management Accountants. Dr. Raef Lawson will give a lecture on topic Regaining Relevance – The Path Forward for Cost Management on

12th Controlling Conference, May 26th 2021.

1. Can you briefly explain the importance of establishing a cost accounting system based on the principle of causality?

The guiding principle for building a managerial costing model of an organization’s operations—and hence its costs—should be causality, the relationship between a cause and its effect. The model designer must start with the resources required for performing operations and how those resources drive the incurrence of costs through the cause-and-effect relationships that exist within the business. Managers in an organization make decisions about the resources (for example, the uses of existing or new machines or people), which subsequently create a monetary impact, or they seek to adjust the level or type of resources to create a particular monetary outcome (for example, less resource use and lower costs for a process). Therefore, for internal decision making, costs must reflect the resources that cause those costs to be incurred.

2. What is the starting point for defining a costing system?

To improve its managerial costing model, an organization should do an initial assessment of its managerial costing system, develop a costing model that’s appropriate for its needs, and then implement a system tailored to its strategic and operational goals and decision-making needs. We suggest a six steps process described in our Developing an Effective Managerial Costing Model monograph.

3. Can you explain the impact of customer needs on the cost management system?

Based on a strategic analysis and an understanding of current operations, organizations need to identify the types of strategic and operational decisions they need make in the future. An organization’s costing model should help answer key questions that are essential to these decisions. These include questions such as:

• Which customers are profitable and how can they be retained?
• Which customers are not profitable and how can they be converted to be profitable (or passed on to a competitor)?
• Which market territories and business segments are the most profitable? Which ones are most worthy of more investment?

A costing system that does not provide the information needed to answer these questions is not adequately supporting the organization’s decision-makers.

4. Which types of costs below the gross profit line are most significantly affected by customers and need the most attention?

Over the last few decades, many organizations have been offering an increasing variety of products and services and using more types of distribution and sales channels. Additionally, they are servicing more and different types of customers. Introducing this greater variation and diversity creates complexity and increasing complexity results in greater overhead expenses.

The cost of customer activities include costs such as processing sales orders, call center assistance, handling returned items, and the sales force’s making sales calls. The extent to which a given customer causes these costs to be incurred can vary greatly and that can substantially affect the profitability of that customer.

5. What important message/recommendation would you give to companies that want to optimize their cost structure in times of reduced business activity and reduced revenue?

Optimizing cost structure does not necessarily mean minimizing costs. This needs to be done in the context of an holistically framework that considers revenue, cost and investment management together (such as the Profitability Analytics Framework).  Organizations should evaluate the quality of information produced by their managerial costing systems and ensure that the information they produce supports the organization’s strategy (which may have changed due to the pandemic) and the decisions that are made to support implementation of that strategy.

If you want to learn more about Establishing a Cost System, join us on 12th Controlling Conference on 26th May, online.