Viewpoint - September 2006

Viewpoint - November 2005

Strategic Cost Management
B. Douglas Clinton, CPA, Ph.D.
Department of Accountancy, Northern Illinois University
November 2006

Since this portion of the Research Center of Excellence is devoted to strategic cost management, it seems we should, at a minimum, be able to come to some agreement on the nature of costs (i.e. how costs behave). Indeed, it seems we have done that with our operational cost concepts (fixed and variable) and relevant decision cost concepts (avoidable and unavoidable). Unfortunately, the degree to which practitioners and academics have used these concepts appropriately is deplorable. This is perhaps the most significant costing error in both academia and practice today.

In our textbooks, the formal definition of relevant costs for decision purposes is accurately rendered as ‘future costs that differ (i.e. are avoidable) between decision alternatives.’ But this definition is soon forgotten. The conversation quickly turns to using fixed or variable cost characteristics in decision analysis. But operational cost concepts (defined as costs that do/do not change with changes in output) is of little help to us with this task.

An artifact of this error is in choosing a costing method to use in tackling a decision based on the decision’s time-frame (i.e. short-term, intermediate, long-term). This is also inappropriate. We should seek to understand and model applicable cost behavior regardless of the costing method we choose. This is because costing methods are only able to describe operational cost concepts, not decision cost concepts. A case in point is the existence of opportunity costs. These are not included in any costing method and cannot be known in advance of a decision scenario. Even the costs that are recorded by costing methods cannot be predetermined as relevant (or not relevant) until we know the details of the decision.

Accounting’s error of fixation on operating cost concepts for decision making is likely rooted in traditional microeconomic concepts (fixed and variable) of price theory. However, economics is not designed to support the broad range of decision making tasks of managers—that is management accounting’s job! We must not fail in that mission. This requires us to practice what we preach, increasing the degree of care that we use in determining and using relevant cost concepts appropriately. We likewise need to give up on the idea that we choose a new or different costing tool based on the decision time-frame.

Am I suggesting that operational cost concepts are unimportant? Not at all. Operational cost concepts are intended to reflect the inherent and potentially changing behavior of resource consumption within an organization. These costs will also provide the substance of which many decision-relevant costs are quantified. Thus, operational costs must be accurate and properly modeled to ensure their usefulness. But operational costs cannot assume the role of being decision relevant without ultimately passing through the filter of avoidability with the decision at hand. Until we understand this, we will be unable to provide relevant decision support information.

I suggest readers join the debate by subscribing to the IMA’s “New Costing” Listserv E-mail exchange. I also encourage you to share your thoughts, articles, research studies, and helpful links on strategic cost management with me directly at clinton@niu.edu.