Robert Page is a Cost Accounting Professional in the Rochester, New York area.
For any readers not familiar with the nautical use of the noun “fantail,” Merriam-Webster’s fourth definition describes it as the “after overhang of a ship, shaped like a duck’s bill.” (For those with a land-locked vocabulary, “after” as used in this definition is a directional reference going toward the back end of a ship, in the case of the fantail it is at the tail end.)
The fantail offers enough deck space for a number of people. It has been a lucky spot for me, and I don’t mind if some of you want to join me there. Feel free to bring your fishing gear, nets and so on. They might come in handy.
Standing at the rail, the wake churns below and dissipates toward the horizon. There is no better place from which to catch, clean and see the real effects of our ships passage.
As a rule, management has a recurring desire to know how the figurative ship of the organization is doing. With universal recognition of the accuracy of hindsight, we are blessed with an affinity for… feedback! So a wealth of business data is captured and retained, for an array of periodic management reporting demands.
The other side of the management information coin is the curse, the necessary evil of prediction. Planning and budgeting processes are welcomed like root canal surgery. The term “inaccurate forecast” contains an adjective that is quite redundant in relation to the noun, but this is not news. Certainly, none of this is criticism, only recognition of the nature of forecasts, plans and budgets. They are, of necessity, built from recipes formulated with layers of assumptions. The compounding net effects of such are often difficult to trace, let alone explain. In all of this, the art of prediction is focused first on estimating the results of a set of speculated events and conditions. Hence, any detailing of causes and effects tends to be far less granular than that supported by historic data streams.
So, why would one prefer to build standard product costs from budgetary information, when 20/20 historic materials are at hand? This goes to the question of intended uses of the standard cost tool. Some may want to tie product cost to budget, so explanations of variances from budget tend to serve double duty in reviewing variances to standard product cost. The biggest tradeoff in taking this option, simply put, is standard product cost accuracy.
I suspect that a few of the criticisms leveled at standard cost come from situations where the need for accurate cost performance information is not well met by this approach. I submit that the practice of selecting budget over historic data results in lower product cost accuracy and usefulness.
Consider standard cost use options that are better served when built from an historic basis:
- First up is inventory valuation. Management is curious to know what it cost to buy or make inventory; historic basis is your richest data source, and can be screened for significant, one-time event variations.
- Our second use is to calculate gross profitability, by product. At market prices, how are we doing?
- Let’s assume that Management likes to see cost shrink as a percentage of revenue, and have visibility and control of that relationship by product. Let’s also bet that they will want this information on a periodic, recurring basis. Therefore, it’s important that the materials we select to construct the standard cost tool can be retrieved, and our chosen methods repeated year after year. These are subject naturally to method and material improvements, addressing changes in the business model, et cetera. But in brief, the characteristics of repeatability and sustainability matter. Use of historic basis wins again.
- What about costs for product pricing? Whether we are reviewing a current product or considering something new, pricing questions typically demand future cost thinking. Beginning with a standard cost that is historically accurate, and addressing known or expected changes to that known past, is my recommended approach, especially when the alternative is a struggle to deduce what has changed relative to the combined effects of layered speculations played out in a budget-based standard.
That’s it for today. If you need me, I’ll be back aft.