Squeeze Play

The management accounting profession is going through a major sea change as two opposing forces come into play. The first is the downsizing through reengineering of the financeand hence management accountingfunction; the second is the growing importance of cost management. (For more on these subjects, see A Smarter Way to Run a Business, by Eileen Morrissey and Gary Hudson. Also, refer to Getting Beyond Counting by William L. Reeb and Michaelle Cameron, JofA, Dec96, page 69.) As downsizing continues, many of the traditional accounting roles will be automated and the number of accountants required in the centralized finance department will fall dramaticallysome estimates suggest by as much as 70%. Only those CPAs willing and able to adapt to this new environment will have a chance to survive.

The growing importance of cost management is a result of increased competition. As the cost management graphic here shows, companies with low profit margins benefit more from cost reductions than companies with high profit margins. Therefore, as competition increases and profit margins fall, effective cost management becomes ever more important to the success of the company. The management accountant, as the companys measurement specialist, can play an essential role in the development and implementation of a broad array of cost management programs.

The advantages for CPAs who adopt this latter position lie in the interesting interaction between management accounting and cost management. It is this interaction that will play a major role in shaping the careers of many management accountants. Yet, considerable confusion exists about this interaction. For example, many people mistakenly believe the demand for management accountants will grow automatically with the demand for cost management, offsetting the downsizing effects. They foresee a bright future, with the management accountant emerging as a key player in the top management team.

THE FATAL FLAW
Unfortunately, at the heart of this vision is a critical misconceptionthat cost management is a subset of management accounting. Indeed, the two are closely related, but they are independent fields of knowledge. This separateness will shape the future of our profession because it allows cost management to be practiced with little or no formal exposure to accounting.

To justify this statement, it is necessary to illustrate how the two fields differ. First, there are cost management techniques that do not rely on accounting to any extent, such as just-in-time production and micro-profit centers. Second, there is no need for cost management systems and financial reporting systems to be able to reconcile in detail. Third, cost management data should be collected by the user, not the accountant. Finally, many management accounting techniques do not involve cost management.

ACCOUNTING-FREE COST MANAGEMENT
That cost management techniques require no accounting is captured in a statement by Kuniyasu Sakai, the founder of the Taiyo Group, a highly successful Japanese conglomerate: "It is the size of a company that matters. When a company gets too large, it cannot respond in time. You need small flexible companies to survive. Breaking large companies into smaller independent units is a powerful form of cost management."

When companies in the Taiyo Group split into smaller entities, no input from management accountants is involved in the splitting. The "child" starts as a division and is slowly weaned from its parent. It is the ability of the child to stand on its own, not some accounting analysis, that drives the process.

WHY THE TWAIN WILL NOT MEET
It is easy to muddle management accounting and cost management. Activity-based costing (ABC), the process of determining the accurate cost of products, looks like a management accounting technique, but it is not; it is a cost management technique. I learned this lesson in the first stages of developing ABC theory at a meeting of very early users of the ABC software I had developed to undertake my research. The members of the first group (primarily CPAs) spent considerable time describing their frustrations with the software and their efforts to reconcile it to their traditional mainframe cost accounting systems. They identified nine major failings of the software. The members of the next team (primarily non-CPAs) said they had spent no time reconciling the numbers; they were satisfied that the software was assigning the right amounts to the products, that it was superior to their mainframe systems and that the resulting product profitabilities were more informative. They then described the actions they had taken to increase the profitability of the company. The difference between the two approaches was significant. What I discovered from their two perspectives was that detailed reconciliation between the financial reporting and the ABC systems at the product level was impossible because of the complex set of rules imposed on the financial reporting systems. On top of that, the effort was unnecessary.

ABC systems do not need to reconcile at the product level with a companys financial reporting systems. They should be stand-alone systems that are not subject to accounting rules. This lesson was learned by Hewlett-Packard, which originally had tied its cost driver accounting (CDA) systems (its version of ABC) to its financial reporting system. Only later did the company realize that problems, such as having to increase driver rates to avoid reporting large costs of underused capacity, were connected to this decision. The main problem was that the CDA system was designed to assist product engineers in designing new low-cost products. Unfortunately, the adjusted driver rates were inappropriate for this task. To avoid distorting the design process, Hewlett-Packard subsequently decoupled the two systems and now its CDA systems are independent of its financial reporting systems.

For inventory valuation (which is where product costing and financial reporting interface), Hewlett-Packard uses a simple material dollar allocation scheme. This system is not capable of reporting accurate product costs, but it is capable of reporting accurate inventory valuations. In fact, it cannot report the cost of individual products, only the value of inventory and cost of goods sold. For product costing, Hewlett-Packard uses CDA. This approach confirms that an ABC system should be separate from the financial reporting system. As long as the value of inventory reported by the ABC system (by summing up the reported costs) is in the same ballpark as that reported by the inventory valuation system, all is well.

Once the ABC system is decoupled from financial accounting, it can become a tool of pure cost management and be used to help the company increase profitability. For management accountants, this decoupling reduces the importance of their role in developing and implementing ABC and other cost management systems. Experience has taught us that users should have the dominant role in developing cost management systems because they are the individuals who use the data.

COST MANAGEMENT-FREE ACCOUNTING
The same lack of correspondence can be demonstated in the other direction. There are many management accounting techniques that do not involve cost management. The preparation of financial reports and budgets are good examples. These techniques require considerable management accounting skills but no cost management ones.

So it follows that if cost management techniques exist that require no accounting, cost management cannot be a subset of management accounting. Conversely, since management accounting includes preparing accounting reports, such as budgets, that require no active cost management (though they may reflect anticipated savings from the cost management programs), management accounting is not a subset of cost management. Therefore, increasing importance of cost management does not lead automatically to increasing importance of management accounting.

WHO COLLECTS THE DATA?
One critical difference between cost management and management accounting is who should collect the data. One of the important criticisms of accounting information is that it is too aggregate and too late. This criticism arises when individuals try to use accounting reports in ways for which they were not designed; for example, for real-time feedback. Many firms, including Sumitomo Electricwhich relies heavily on Kaizen (continuous improvement) costing to reduce costshave learned that for cost management purposes it is better to have the user collect the data, transform it and send it to the accounting department than it is to have accounting collect it. This shift reflects the proactive nature of cost management. In contrast, management accounting information typically has a monthly or longer period perspective and is used reactively to evaluate performance.

WHO HAS THE SKILLS SET?
Effective cost management requires in-depth knowledge of a companys strategy and production or service delivery systems. This knowledge is necessary if a cost management program is to add value as costs are reduced. For example, in hospitals it is typically a nurse with a masters degree, not a management accountant, who is the case manager responsible for developing cost management practices. Since it is easier to teach cost management to the functional specialist than it is to teach the job to the management accountant, the bulk of the growth in jobs created by the adoption of cost management will be among the functions, not the finance department. In other words, downsizing will result in fewer management accountants who, because they have become more highly skilled, have survived.

The management accountant can and should play a decisive role in the development of cost management programs. This role demands four sets of skills:

1. Expertise in systems design. The management accountant can become the person the functions specialist turns to for help when he or she is designing new cost management systems.
   
2. Expertise in change management. The management accountant can ensure that not only is a technically sound system installed but also that it is used.
   
3. The ability to relate strategy to cost management. The management accountant can help shape the companys strategic cost management programs.
   
4. Increased functional expertise. The management accountant can help the functions specialist take advantage of the information that is provided by the new cost management systems.

Many management accountants will react to the above advice by saying, "I already do all that," and in many cases they will be right. These are skills that all good management accountants should develop. The central message of this article to management accountants is that those skills are going to become even more essential and only individuals with such skills stand a chance of escaping the reengineers knife.

Robin Cooper is professor of management at the Peter F. Drucker Graduate Management Center, Claremont, California, and KPMG professor of strategic cost management at Manchester Business School, England.