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Conceptual Framework for Managerial Costing: Report of the IMA Managerial Costing Conceptual Framework Task Force


Abstract and Figures

There is substantial confusion about what is the best or most appropriate approach for organizations to measure and report costs for managerial decisions. One would think that now in the 21st century this situation would be resolved, but debates continue, even among management accountants, about which approach to use. For example, some criticize standard costing as outdated; some advocates of lean accounting criticize activity-based costing; and some advocates of activity-based costing criticize a variation of it, time driven activity-based costing. What is needed to put an end to these rivalries is not a board of experts to choose the “best” approach, but instead a defined framework for costing that is independent of specific approaches, and enables organizations to determine for themselves what cost information best serves their needs. Then they can evaluate approaches using the independent framework and determine which costing approach will best model their organization and operations to measure costs. Facilitating this breakthrough in managerial costing is the purpose of this document. This Conceptual Framework for Managerial Costing defines the principles, concepts, and constraints that must be considered when designing or implementing a costing approach to support managerial decisions about the operations and economics of an organization’s activity. The focus of this framework is purely on cost modeling for decision support. The conceptual framework answers the question, “What principles and concepts best represent the behavior of resources and operations, and how are resources consumed by outputs for economic decision making by managers and employees inside the company?” It is important for an organization to learn from its past and current operating experience. However, the greater value is achieved when an organization can use its information to accurately project the impact of operating improvements and decisions on future results. This framework’s purpose is to place managerial costing on a clearly established and well-reasoned conceptual foundation of principles, concepts, and constraints....
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Conceptual Framework
Managerial Costing
Report of the
IMA Managerial Costing Conceptual
Framework Task Force
© 2013 IMA
Executive Summary
There is substantial confusion about what is the best or most appropriate
approach for organizations to measure and report costs for managerial decisions. One
would think that now in the 21st century this situation would be resolved, but debates
continue, even among management accountants, about which approach to use. For
example, some criticize standard costing as outdated; some advocates of lean
accounting criticize activity-based costing; and some advocates of activity-based costing
criticize a variation of it, time driven activity-based costing. What is needed to put an end
to these rivalries is not a board of experts to choose the “best” approach, but instead a
defined framework for costing that is independent of specific approaches, and enables
organizations to determine for themselves what cost information best serves their needs.
Then they can evaluate approaches using the independent framework and determine
which costing approach will best model their organization and operations to measure
costs. Facilitating this breakthrough in managerial costing is the purpose of this
This Conceptual Framework for Managerial Costing defines the principles,
concepts, and constraints that must be considered when designing or implementing a
costing approach to support managerial decisions about the operations and economics
of an organization’s activity. The focus of this framework is purely on cost modeling for
decision support. The conceptual framework answers the question, What principles
and concepts best represent the behavior of resources and operations, and how are
resources consumed by outputs for economic decision making by managers and
employees inside the company? It is important for an organization to learn from its past
and current operating experience. However, the greater value is achieved when an
organization can use its information to accurately project the impact of operating
improvements and decisions on future results.
This framework’s purpose is to place managerial costing on a clearly established
and well-reasoned conceptual foundation of principles, concepts, and constraints similar
to the conceptual frameworks drafted by accounting standards boards (for example, the
Financial Accounting Standards Board [FASB]) in the US and the International
Accounting Standards Board [IASB]). However, our goal is not to establish or suggest
standards, regulations, or rules of any kind for managerial costing. The Conceptual
Framework for Managerial Costing is not a costing solution, costing approach, or a cost
system design methodology. Rather, the framework provides a comprehensive, logical
baseline for designing and comparing costing approaches. Business examples are
provided throughout the framework to aid in understanding the concepts presented. The
framework also acknowledges the constraints or tradeoffs which must be considered in
designing managerial costing systems.
The need for and purpose of a conceptual framework results from two
problematic issues:
1. There is confusion in the marketplace among the multitude of costing
approaches and solutions. A basis for identifying the most appropriate
approach for organizations has not been articulated.
2. Cost information is useful for a variety of purposes for both external and
internal users. Financial accounting and reporting for external users is guided
by standards, regulations, and rules that impair the creation of cost
information needed for internal decision use. There is no clear reference
point for the creation of cost information for internal decision use; therefore, a
need exists for such a reference.
This conceptual framework presents principles and concepts that are universally
necessary to generate effective managerial cost information for internal use. By doing
this, the framework also allows costing approaches to be compared by means of the
following questions: What does an approach do well? What does an approach not do
well? Can two or more costing approaches coexist if they serve different and narrow
informational needs? Managers can use the framework to ensure the concepts they
need most are incorporated into the costing approach adopted.
It is important to emphasize that this Conceptual Framework for Managerial
Costing does not encompass any principles or requirements of International Financial
Reporting Standards (IFRS) or USA’s generally accepted accounting principles (US
GAAP) or external financial reporting required by government regulatory agencies,
investors, or other stakeholders. Though these compliance requirements are important,
their focus is the presentation of information for external use by the capital markets.
Managerial costing’s focus is internal. For the same reason, we have excluded
principles associated with taxation and regulatory reporting. All such forms of modeling
an organization’s economic activity can impact its long term sustainability and survival;
however, the Conceptual Framework for Managerial Costing is designed to focus on
internal decision support across operations, ideally for long-term value creation in an
optimal manner to maximize value for all stakeholders.
A few definitions are useful to clarify some common terms in the field of managerial
Managerial accounting is a profession that involves partnering in management
decision making, devising planning and performance management systems, and
providing expertise in financial reporting and control to assist management in the
formulation and implementation of an organization’s strategy. (Institute of Management
Accountants Statement of Management Accounting Number 1)
Cost accounting is measuring and reporting costs intended for external financial
reporting or regulatory purposes where guidelines and principles must be followed and
complied with to meet regulatory, legal, or other defined standards and requirements.
(Derived from International Federation of Accountants International Good Practice Guide
Evaluating and Improving Costing in Organizations, July 2009)
Managerial costing is costing done purely for the organization to use internally
to ensure that information for decisions reflects the characteristics of the organization’s
resources and operations.
Using the Framework
The Conceptual Framework for Managerial Costing will serve multiple purposes
for practitioners and academia by
1. Providing a conceptual framework for designing cost models that accurately
reflect operations and processes for the decisions organizations most
frequently need to make;
2. Providing a reliable reference for generating cost information for internal
management use that clarifies why this cost information is different from
external financial reporting, tax, and regulatory cost information;
3. Providing a framework for comparing the strengths and weaknesses for
decision support uses of existing and future approaches to generating cost
Overview of the Framework
The Conceptual Framework for Managerial Costing is composed of an objective,
principles, concepts, and constraints. The objective sets forth what managerial costing
should achieve and the principles and concepts to support its achievement.
The objective of managerial costing is to provide a monetary reflection of
the utilization of business resources and related cause and effect insights
into past, present, or future enterprise economic activities. Managerial
costing aids managers in their analysis and decision making and supports
optimizing the achievement of an enterprise’s strategic objectives.
The framework is represented by the following process diagram. Managerial
costing establishes a cost model, which provides a monetary representation of the
resources and processes of the organization. The guiding principle for operations
modeling (and hence cost modeling) is causality, reflecting cause-and-effect
relationships. A useful cost model must efficiently (1) take a manager from a monetary
effect to an operational cause, and (2) provide the manager with clear and direct insight
into the monetary effect of a particular operational action (cause) being considered.
Operational actions and their financial impacts should highly correlate with minimal
distortion. (Managerial costing’s goal is to have sufficiently high accuracy to satisfy a
decision’s information needs, not 100.00% accuracy. The topic of accuracy and the
effort-versus-benefit trade-off to increase accuracy are addressed in the framework.)
By applying the principle of causality and its associated concepts, we can create
an operational and financial model that represents the organization’s operations. This
establishes the baseline from which managers will seek to achieve strategy in an optimal
manner. Managers use cost information by applying the principle of analogy (defined in
Section III.A) to infer past or future causes or effects. The result will be learning from the
past, making plans for the future, and supporting decisions about the use of the
organization’s resources to achieve its strategic objectives.
Structure of the Framework Document
The Framework is comprised of Sections I, II, III, and Appendix A. Section III.A
defines managerial costing’s two guiding principles, Causality and Analogy, Section III.B
defines the Concepts, and Section III.C defines the Constraints. These sections present
the terms and concepts that are the foundation for managerial costing. Appendix B
focuses on practical application and uses illustrative examples of how to apply the
Globalization and volatility are raising the importance and criticality for better
internal decisions within organizations from daily operational decisions by employees to
strategic decisions by executive teams. The margin for error in decisions is getting
smaller. The impact of poor decisions is becoming more consequential. There is a need
to make decisions faster than before.
In this regard, technology is a valuable enabler for those organizations that
properly employ it. But technology for managerial costing is merely supportive. More
power and speed for poorly designed managerial costing methods and models yields
little value. However, technology will make sound cost model design (based on
managerial costing’s principles and concepts) imperative as software programs with
automated decision rules become commonplace. To complicate matters, managerial
accounting is shifting its emphasis from historical reporting (i.e., what happened?) to the
predictive view (i.e., what can or will happen?) Unless sound guiding principles, such as
described in this Framework, are adopted, historical information will be flawed and
misleading and projections will be derived from an imperfect cost base with imperfect
consumption rates. This will lead to poor decisions.
Managers and employees are in need of better cost information. The confusion
among the claims and capabilities of specific costing approaches must be given a
rational framework to allow them to be evaluated and used appropriately. The
principles, concepts, and constraints presented in the Conceptual Framework for
Managerial Costing will allow management accountants and managers throughout the
organization to make better use of cost information, relate it more clearly to operations
throughout the organization, and improve decisions in pursuit of the organization’s
strategic objectives.
In writing this Conceptual Framework for Managerial Costing, the members of the task
force recognized they were undertaking an audacious and arduous task. The subjects of
managerial costing and cost accounting research and writing touch three centuries.
While we were aware of some of this work, we were continually surprised as concepts
we thought original were found to have been written about beforesome in the
19thCentury. The task force recognizes that it stands on the shoulders of giants. The task
force also knows that it did not give the giants of the past and the present their full
measure of credit by meticulously researching their work and the derivation of the
concepts we present. However, this document is not a historical review. We thus have
no intention of offending; we simply werent seeking to document the history of the ideas
we present.
Instead, in writing this document, we sought to achieve a balance between
application to the practical world of the practitioner and providing enough theory to
provide a solid conceptual footing for application. We have referenced work that we used
directly but did not conduct exploratory research to determine the origin of concepts we
present or their histories in the management accounting and cost accounting literature.
The team members who comprised the task force are widely read, and some are widely
published, in the field of management accounting and costing. They are strongly
practitioner oriented. This Conceptual Framework contains the principles and concepts
the team members believe define the application of managerial costing and cost
modeling for the purpose of managerial decisions. While challenging in this type of
document, the task force sought to present an orientation toward practice and
We want to thank the Institute of Management Accountants, Inc. (IMA) for
sponsoring the work of this taskforce, particularly President and CEO Jeff Thompson
and VP of Research and Professor-in-Residence Raef Lawson. The members of the
Foundation for Applied Research provided review, feedback, and guidance on the
Framework; as did our special industry advisory review panel, which consisted of Dan
Hill, Consultant, CorePROFIT Solutions; J. Stephen McNally, Finance
Director/Controller, Campbell Soup Napoleon Operations; Robert Goldfarb, Controller,
Catalent; and Jerry Solomon, VP Baltimore OperationsMarquip Ward United.
As chair of the Managerial Costing Conceptual Framework task force, Id like to
thank the task force members. They wrote, reviewed, researched, debated, and
doggedly attended meetings for over two years to complete this document:
Anton van der Merwe
Principal, Alta Via Consulting
B. Douglas Clinton, CMA, CPA, Ph.D.
Professor, Northern Illinois University
Gary Cokins
Founder, Analytics-Based Performance Management LLC
Chuck Thomas, CMA, CPA, Ph.D.
Director, Financial Analysis/Operations Forecasting & Simulation, Southwest Airlines
Ken Templin, CMA
Retired Business Resource Manager, Caterpillar
Jim Huntzinger
President, Lean Accounting Summit
It is our hope that the profession of management accounting and the practice of
costing will be advanced by allowing organizationsprivate, public, not-for-profit,
governmentalto make better decisions and create greater value for stakeholders and
Larry R. White, CMA, CFM, CGFM, CPA
Chair, Managerial Costing Conceptual Framework Task Force
Chairman of the Board, IMA, 2004/5
Executive Director, Resource Consumption Accounting Institute or
Table of Contents
Executive Summary ........................................................................................................ 2
Preface............................................................................................................................ 7
List of Figures................................................................................................................ 10
List of Tables ................................................................................................................. 11
Introduction ................................................................................................................. 112
Section I: Objective of Managerial Costing .................................................................... 18
Section II: Scope of Managerial Costing ........................................................................ 22
Section III: The Characteristics of Managerial Costing .................................................. 28
Section III.A: Principles for Managerial Costing ......................................................... 33
First Principle: Causality ....................................................................................... 34
Second Principle: Analogy ................................................................................... 38
Section III.B: Concepts for Managerial Costing.......................................................... 41
Modeling Concepts .............................................................................................. 44
Information Use Concepts .................................................................................... 69
Section III.C: Constraints for Managerial Costing ...................................................... 77
Cost Modeling Constraints ................................................................................... 78
Information Use Constraints ................................................................................. 84
Section IV: Call to Action ............................................................................................... 88
Appendix A: Truth as a Foundation for Managerial Costing ........................................... 93
Appendix B: The Framework in Operation ................................................................... 101
Evaluating a Company’s Operations and Strategy for Modeling ......................... 102
Model Design & Construction ............................................................................. 106
Implementation Factors ...................................................................................... 121
An Organization’s Acceptance of Managerial Costing......................................... 128
Bibliography ................................................................................................................ 133
List of Figures
Figure 1: Realm of Managerial Accounting (IFAC) ........................................................ 14
Figure 2: Input Output Relationships of Resources ....................................................... 25
Figure 3: The Application of Principles, Constraints, and Concepts ............................... 31
Figure 4: The Principles, Constraints, and Concepts Selected ...................................... 32
Figure 5: The Application of the Principles .................................................................... 39
Figure 6: The Cost Modeling and Information Use Views .............................................. 43
Figure 7: Modeling Concepts ......................................................................................... 44
Figure 8: The Relation Between Total Cost and Total VolumeVariability ..................... 50
Figure 9: The Relation Between Resources and OutputResponsiveness .................... 51
Figure 10: Capacity Provision Costs and Planned Output ............................................. 57
Figure 11: Segregating Applied and Unapplied Capacity ............................................... 58
Figure 12: Illustration of the Concept of Work ................................................................ 61
Figure 13: Integrated Data Orientation. ......................................................................... 66
Figure 14: Information Use Concepts ............................................................................ 69
Figure 15: Constraints for Managerial Costing............................................................... 78
Figure 16: Summary--Principles, Concepts & Constraints ............................................. 87
Figure 17: The Four Optimization Areas and Optimization Scope ............................... 104
Figure 18: Inputs and Outputs Within a System ........................................................... 107
Figure 19: From Mission to Cost: Resources Are Consumed, and Costs Incurred, to
Achieve Managerial Objectives. .................................................................................. 110
Figure 20: Tiered Managerial Objectives for An Airline ................................................ 119
Figure 21: Common Applications of Cost Assessments .............................................. 131
List of Tables
Table 1: Scope of Managerial Costing ........................................................................... 27
Table 2: Modeling Concepts .......................................................................................... 68
Table 3: Information Use Concepts ............................................................................... 75
Table 4: Constraints for Managerial Costing .................................................................. 86
This conceptual framework has been written to fill a long-standing gap in the field
of management accounting. What is missing is a clear foundational set of principles for
costing that focuses on managers and employees, organizational insiders, as the
primary userswhom we frequently refer to as the customers of the information. The
framework defines the principles, concepts, and constraints that must be considered
when performing costing in order to fulfill the information needs of managers and
employees who require insights for making decisions about their operations. These
insights and decisions, made with detailed operational and financial information at all
levels of an organization, are what create sustainable economic value. Financial
statements, often for regulatory and compliance purposes, are produced in accordance
with generally accepted accounting principles (GAAP). These financial statements report
the results of decisions and actions to investors and creditors, who are the primary
customers of GAAP financial statements, in a structured model and format.
It is somewhat shocking to realize that no framework or guidance exists for
managerial costing, a critical area of management accounting. Arguably, the practitioner
can piece together such information from various textbooks, articles, and publications,
but who has the time to distill a concise set of principles and concepts from this wide and
often contradictory body of knowledge that touches three centuries, from the late 1800’s
through today? The tendency in recent decades has been to look for the best costing
method: traditional standard costing, activity-based costing, throughput costing, German
costing methods, resource consumption accounting, lean accounting, and many others.
However, a given method is not a panacea; it is an application of particular principles
and concepts, and it is limited by certain constraints. These characteristics are not
clearly listed, unlike the nutritional values on packaged foods, for each method. In most
cases, the specific characteristics of cost methods are not even clearly understood. The
present authors do not believe managerial costing methods can be labeled as precisely
as packaged food, even with the framework presented in this document. However, the
framework will dramatically improve current treatment by providing a set of principles,
concepts, and constraints that can be used to objectively evaluate approaches to costing
and the conditions for applying them for internal decision support.
The purpose of this framework is to help companies expand the use of
managerial costing in order to improve the decisions that managers and employees
make to optimize operations. The framework will create greater value by helping
managers achieve objectives as efficiently and effectively as possible at all levels of an
organization. Organizations will not invest in advanced costing approaches if they see
their acquisition and implementation as a high-risk venture with poorly quantified results
and questionable benefits. This framework seeks to provide clarity to the objectives an
organization seeks to achieve from the use of improved costing approaches and
systems. Practitioners can use the framework to define their costing needs and evaluate
costing solutions against objectively established criteria embodied in the principles,
concepts, and constraints described in the framework. Doing so will reduce the many
risks associated with implementation and use of poor costing methodology and inferior
system design.
What is Managerial Costing?
The term managerial costing was selected to identify the costing information
produced for internal use by the managers and employees of an organization. It is
information that need not, and in most cases should not, conform to the standards
established for financial accounting and financial reporting. The framework presented
here was created to provide structure to managerial costing, an area that has often been
considered the Wild West of the accounting profession because of adages such as
different costs for different purposes, different costs for different questions, relevancy
is all that matters, use what works for your company, and so on. Beliefs and pseudo-
truisms such as these are often used as an excuse or reason not to pursue a deeper
analysis of the foundational principles and concepts that underlie managerial costing
analyses and models.
It may come as a surprise to many accountants, and even more non-
accountants, that more than one financial model legitimately can be applied to describe
an organization and used to calculate valid financial information based on the modelers
assumptions. Furthermore, the models commonly used for external financial reporting
have very clear biases and limitations. These limitations are not secrets. They are clearly
acknowledged in the conceptual frameworks that have been written by all major
accounting standard-setting bodies, including the U.S. Financial Accounting Standards
Board, the International Accounting Standards Board, the U.S. Government Accounting
Standards Board, the U.S. Federal Accounting Standards Advisory Board, and the
International Public Sector Accounting Standards Board which include the most widely
recognized sources of GAAP for external financial reporting. Other financial models are
also quite common in business. For example, tax reporting requires a distinct financial
model; many regulated industries must submit financial and operational information that
differs significantly from GAAP financial statements; and governments establish statutory
cost reporting standards for a variety of social, contract management, and other
regulatory purposes. The managerial costing framework presented here will not
consider or address financial accounting, financial reporting, or other financial and cost
models, except where necessary to highlight some common errors encountered when
financial accounting information is used inappropriately with potentially misleading costs
for managerial costing and the associated management decision making.
The International Federation of Accountants International Good Practice
Guidance (IGPG) titled Evaluating and Improving Costing in Organizations (July 2009, uses the following diagram to define the realm of management
accounting’s costing functions in an organization:
Figure 1: Realm of Managerial Accounting (IFAC)
Managerial costing, as used in this conceptual framework, addresses creating the
information used for Performance Evaluation & Analysis and for Planning & Decision
Support in the above IFAC diagram. Managerial costing is meant to be a specific term
distinct from “cost accounting” and “management accounting.
The authors agree with IFACs definition of the term cost accounting in the IGPG
Evaluating and Improving Costing in Organization, paragraph 1.4:
Examples of cost uses for financial reporting include the valuation of inventories,
determination of transfer pricing amounts (for tax optimization purposes), and
segmental reporting. Such specific uses of cost assignment are usually
mandated by jurisdictions and regulatory authorities, especially where cost
assignment affects taxation or the determination of regulated pricing structures.
The discipline applied to produce this type of output is usually called cost
The Institute of Management Accountants (IMA) has established a clear
definition for management accounting in the Statement of Management Accounting #1:
Management accounting is a profession that involves partnering in management
decision making, devising planning and performance management systems, and
providing expertise in financial reporting and control to assist management in the
formulation and implementation of an organizations strategy.
Managerial costing plays a critical role in the broad field of management accounting. The
managerial costing conceptual framework presented in this document contains carefully
defined principles and concepts designed to rectify many of the current weaknesses of
internal costing practices. It is intended to guide the management accountant in the
creation of superior cost and decision-support information free from the constraints of
financial accounting conventions and standards. The frameworks sole objective is to
satisfy the needs of managers and employees who seek to understand the interaction of
operational resources and their monetary values in order to select optimal decision
alternatives and create long-term sustainable value for their organization and the
economy as a whole.
Benefits of a Conceptual Framework for Managerial Costing
A clear framework with a set of principles and concepts can logically model and
value an organization’s operations to generate high quality information for analysis,
insights, and decision making. Management accountants will be able to more efficiently
and effectively provide managers and employees with managerial costings unique
insights into the operations and economics of organizations. The benefits of the
framework are numerous and include the following:
A framework and principles for developing cost and decision-support
information for internal use will allow companies, including midsize and
smaller organizations, to more consistently enhance their operational
modeling and decision-support information, thus improving their
competitiveness and sustained profitability.
Expanding the effective use of cost information among nonfinancial
managers who use or would like to use cost information will improve the
effectiveness and efficiency of their operations.
Insight into the limitations of external financial reporting models will have
beneficial effects on evaluating risk in the economy because it will highlight
the limitations of these models to predict the long-term value creation of
Investment in managerial costing expertise and systems should expand when
decision makers see a clearer, more accepted, and less risky path to creating
the effective operational models that provide the cost and decision-support
information they need.
Understanding of the limitations of transparency in external financial
reporting will improve as businesses and the public become more aware of
the differences between financial information for internal decision making and
external financial reporting.
Consistent use of similar cost and decision support concepts and principles
across organizations and industries will improve the general understanding of
decision-support information and clarify why it is not the same as that used
for external financial reporting.
A conceptual framework for managerial costing assists in differentiating and
defining management accounting expertise and its unique knowledge, skills,
and value propositions within the broader accounting profession.
Structure of the Framework
This document is structured in a manner similar to the conceptual framework
documents that have long existed for external financial reporting standard-setting bodies
(and that form the foundation of GAAP). This was done for two reasons:
1. To ensure clarity of intent.
The needs of managers and employees for detailed monetary information on
operations must be as critically important to CEOs, CFOs, Controllers, and
their staffs as is their providing required information to capital markets,
investors, taxing authorities, and regulators. The stock market clearly does
not value a company for excellently prepared financial statements if
operational excellence is lacking. This managerial costing framework is
meant to serve as a basis for creating the cost and decision-support
information that managers and employees need to be optimally effective in
managing an organizations operations, a fundamental element in improving
an organizations value.
2. To enhance understandability.
It is important to provide a contrast to the much more widely known and
widely taught concepts of financial accounting. Therefore, the conceptual
framework for managerial costing was structured with the same first three
sections as most conceptual frameworks for external financial reporting in
order to provide that contrast. This framework addresses:
Section I: The Objective of Managerial Costing
Section II: The Scope of Managerial Costing
Section III: Characteristics of Managerial Costing
This framework also includes an appendix on the practical application of the
Appendix B: The Framework in Operation
Reading the Conceptual Framework for Managerial Costing
Sections I through III provide the backbone of the conceptual framework, and the
management accountant leading a costing initiative or responsible for providing cost
information to his or her organization should take the time necessary to understand the
principles, concepts, and constraints that define effective managerial costing. Section III
is the heart of the conceptual framework and necessarily contains a substantial amount
of theory, though we have worked to provide illustrative examples throughout the
For those with a less intense interest in the theory, it may be best to read Section
I and II, then skip to Appendix B, which focuses more directly on applying the conceptual
framework. However, before reading Appendix B, the reader should scan the names and
definitions of the principles, concepts, and constraints, and examine the summary
diagrams at the end of each part of Section III. These terms are used with precise
definitions as explained in Section III and will not be correctly understood if read with a
common use definition in mind.
The most controversial section of this framework is Appendix A, which argues
that the ultimate foundation of managerial costing is that it pursues truth as opposed to a
standard of informational relevance based on a consensus process that sets rules and
standards. While you may or may not agree, you should find it thought-provokingand
the authors hopeinsightful.
Section I: Objective of Managerial Costing
Objective of Managerial Costing
Defining the objective of managerial costing guides the selection of principles,
concepts, and constraints in the framework. The objective defines the purpose and the
desired outcome of engaging in the effort to design and create the systems and
processes that support managerial costing and the information managerial costing must
The objective of managerial costing is to provide a monetary reflection of the
utilization of business resources and related cause and effect insights into past,
present, or future enterprise economic activities. Managerial costing aids
managers in their analysis and decision making and supports optimizing the
achievement of an enterprises strategic objectives.
The paragraphs below explain the significant phrases and terms used in this
statement of the objective of managerial costing. The terms are presented in the order
they are used in the objective statement above. Readers are strongly encouraged to
study these explanations, because they define fundamental ideas that will be used
throughout this conceptual framework.
Managerial Costing: Managerial costing entails linking an organizations
resources, activities, products, and services to an economic impact expressed in
monetary terms. The focus is on internal operations and meeting the needs of
managerial costings customers: internal management. Managerial costing differs from
cost accounting, which is for inventory valuation and product/service costs in accordance
with external financial reporting conventions for stakeholders such as investors,
creditors, and regulators. Managerial costing is relevant to the financial planning and
analysis (FP&A) functions most larger companies are establishing as distinct
organizational elements.
Monetary Reflection: Accounting, in all its forms, expresses enterprise
operations in monetary terms, in many cases using substantial estimates. Managerial
costing, however, must support detailed economic decision making and must accurately
reflect the actual resources and processes it intends to represent in monetary terms. The
term reflection emphasizes the need for a faithful representation of both operational
quantities and related monetary values for use in analysis and decision making. The
monetary view (and any estimates) cannot obscure business operations in any way that
would impede or distort managements predictive tasks, analysis, and decision making.
Resources: To achieve strategic objectives, organizations acquire and deploy
resources such as people, machinery, buildings, capital. The acquisition and deployment
of resources also comprises the source of all the costs of an organization. Managerial
cost measurement and cost modeling present unique and insightful information by
providing an accurate reflection of an organization’s resources, their usage, and related
costs. Cost modeling cannot fully capture many intangible resources, such as the value
of a brand or reputation, exceptional teamwork, great leadership, or exceptional
creativity or skill. Such characteristics will always require judgment in the use of
managerial costing information.
Cause and Effect Insights: To be useful, monetary measures and value must
be clearly tied to what an organization does. Internal management makes rational
inferences about resource application when making decisions concerning process
design, improving operational efficiency and effectiveness, and strategy execution. Much
of this logic is based upon insights about cause and effect relationships. Effective
managerial costing aids in determining the operational causes of positive and negative
monetary outcomes so that they can be replicated or improved, respectively. Cost
models must also aid internal management when inferring the monetary impact of
possible future changes in production and support operations.
Past: Managerial costing has an important role in organizational learning,
including evaluating past results for insights against plans and expectations, and
extrapolating from trends and process variation to select appropriate corrective actions.
Root causes are not always obvious, and examining historical data to gain insights is
often helpful.
Present: Managerial costing must provide a clear model of existing operations.
This accurate and timely reflection helps internal management understand how
effectively they are currently meeting an organizations objectives. Such monetary
insights also add extra significance to nonfinancial measures. Managerial costing should
provide insights into the economic effects of tactical decisions with present or very near-
term impacts.
Future: Continuous change prevails in business. Managerial costing models
reflect the present state, which provides the starting point for projecting, analyzing, and
evaluating future actions, options, opportunities, and risks. Internal managements
forward-looking entrepreneurial activities are the most influential actions in creating and
sustaining value. They can be reflected in monetary terms by adapting the managerial
costing model with scenarios and assumptions.
Enterprise Economic Activity: Managerial costing is focused on the entire
enterprise or organization, all of its functions and processes (product/service
development, production, support, distribution/supply chain, sales/marketing,
administration, and management), and the resources the enterprise uses to carry out
those operations. Enterprise economic activity refers to operations beyond just
production or service operations; it includes all resources used by an enterprise to
achieve its strategic objectives.
Aids: Cost information is only one consideration in analysis and decision making.
Political considerations, customer critical needs, ethical and equitable considerations,
and a wide range of other factors are impossible to represent in monetary terms. A cost
models expression of past, present, and future events in monetary terms is highly useful
but should not limit the range of causes and their effects that must be considered.
Managers: Managerial costing focuses on the needs of managers and
employees making decisions inside an organization. Cost information informs their
predictive activities, analysis, and decisions, which will sustain and create long-term
value consistent with enterprise strategic objectives. For these purposes, managers and
employees require information that presents the economic impact of an organizations
operations free from distortions and the restricted insight associated with any external
reporting conventions for financial accounting, taxes, regulatory bodies, and so on.
Analysis and Decision Making: Analysis focuses on facilitating learning and
gaining knowledge about the enterprises economic activity, specifically its resources
and their capabilities, with a view toward achieving strategic objectives. Analysis
requires accurate, representative data that will facilitate inductive and deductive logic
through cause and effect insights that produce useful information, such as a range of
viable decision alternatives. Decision making builds on analysis and requires considering
qualitative and other relationships and factors that may not be adequately represented in
managerial costing information.
Optimizing: Internal management is tasked with achieving enterprise strategic
objectives in an effective and efficient manner. They have the resources the organization
has invested in at their disposal, and in every decision they are expected to apply them
to realize maximum benefit while consuming the least amount of resources. Optimization
should occur with each decision, but it is in a larger perspective a continuous effort to
improve and learn.
Enterprise Strategic Objectives: Enterprises have a variety of reasons for
existence. Strategic objectives and strategic value need not be expressed solely in
monetary terms. Many public sector and not-for-profit organizations focus on
nonfinancial objectives; however, they have strong needs for cost measurement and
modeling to evaluate their efficiency and effectiveness in meeting those nonfinancial
objectives. Managerial costing is most useful to enterprises that seek to increase their
value (financial or nonfinancial) over the long term.
Section II: Scope of Managerial Costing
Scope of Managerial Costing
The scope of managerial costing entails providing internal information to support
the decisions of managers and employees who seek to optimize business operations.
Managerial costing information may be useful externally but will need to be evaluated
against external reporting principles, standards, and laws that govern such uses. The
following eight tenets capture the scope of managerial costing for internal use.
A. Provide managers and employees with an accurate, objective cost model of
the organization and cost information that reflects the use of the
organizations resources.
Managerial costing focuses on providing managers with accurate, objective
information. Every decision management makes is a resource application decision. For
example, the decision to let an employee go due to substance abuse has eliminated that
resource from the available pool. Managerial costing information should therefore be as
reflective of the businesss resources and processes as practical.
Models that have any other objective than the accurate, objective representation
of the organizations resources and processes fall outside this conceptual framework.
Examples of such models include those related to compliance tasks such as financial
reporting to meet tax needs and regulatory requirements. These costing applications fall
outside the scope of this framework because the information generated may distort
managers understanding of costs when making decisions about the best economic use
of resources.
The scope of managerial costing caters to the information needs of internal
management in an organization.
B. Present decision-support information in a flexible manner that caters to the
timeline for insights needed by internal decision makers.
Managerial cost models are not restricted to arbitrary reporting time-period
cutoffs for models or information (e.g., end of month, quarter, or year). The appropriate
time frame for managerial costing information varies based on the time impact of a
decision, the plan or forecast horizon, and the implementation of the associated
changes. The focus is on representing the organizations use of resources and the
resources operational and economic characteristics as they exist today or might exist in
relevant time periods in the future.
The scope of managerial costing caters to the timelines of internal management
in an organization.
C. Provide decision makers insight into the marginal/incremental aspects of the
alternatives they are considering.
The bulk of decisions in an enterprise consider current resources, capabilities,
and outputs in order to achieve strategic objectives. Most decisions consequently are
incremental in nature and use existing operations as a baseline. An accurate rendering
of the current application of resources is therefore the logical and appropriate starting
point for effective incremental analysis.
When managers are provided with (1) a clear picture of current resource
application, (2) a mechanism for assessing proposed changes in resource application,
and (3) the marginal/incremental costs of the actions being considered, they are
equipped to properly evaluate the alternatives for achieving stated objectives.
The scope of managerial costing includes providing managers with clear
marginal/incremental insights into the resource application alternatives they are
D. Model quantitative cause and effect linkages between outputs and the inputs
required to produce and deliver final outputs.
One key to effective decision making is the ability to make two kinds of causal
linkages. The first link is from a cause to its effect, such as a drop in sales (the cause)
that results in excess/idle capacity (the effect).The second link is from an effect to its
cause, such as an unprofitable product (the effect) caused by significant reworks (the
cause). Effective managerial costing models must make these kinds of links visible,
reflecting the use of resources as they are consumed by the series of input and output
relationships as shown in Figure 2 and continuing along the value chain that leads to
final outputs. Depending on a particular organizations decision support needs, the
managerial costing model is often required to provide a deep level of cause and effect
Figure 2: Input Output Relationships of Resources
When weak cause and effect linkages exist, associated costs must be modeled
in a manner that best reflects the economic impact of related resources for the
appropriate segment level in the organization. For example, the excess/idle capacity for
a machine dedicated to a particular product must be assigned to that products gross
The scope of managerial costing entails an accurate reflection of an
organizations cause and effect relationships.
E. Accurately value all operations (support and production) of an organization
(i.e., the supply and consumption of resources) in monetary terms.
The unique quality that managerial costing brings to a nonfinancial model of an
organizations operations is the application of monetary estimates to represent the
combination of resource quantities that eventually create final outputs. This application
of monetary value and the subsequent analysis must not distort the representation of the
resources and processes used throughout the organization. The dependency between
resource consumption and costs means that managerial costing begins with an accurate
reflection of the nonfinancial quantitative flows of resources.
The scope of managerial costing entails the accurate valuation of all quantitative
cause and effect relationships.
F. Provide information that aids in both immediate and forward-looking decision
making for optimization, growth, and attainment of enterprise strategic
Managerial costing models must support economic decision making in the
present and the future. Models must facilitate the accurate determination of avoidable
and unavoidable costs and support the calculation of opportunity costs for a range of
decision scenarios.
The scope of managerial costing includes consideration of the types of decisions
and the strategic objectives of a particular organization.
G. Provide information to evaluate performance and learn from results.
Managerial costing provides feedback on the quality of decisions, the use of
resources, and the effectiveness of processes in attaining desired results. Managerial
costing information can be used for accountability and learning by providing not only
results but insight into the causes of those results.
The scope of managerial costing includes providing historical information for
evaluation, learning, and identifying corrective actions.
H. Provide the basis and baseline factors for exploratory and predictive
managerial activities.
Managerial costing includes using cost models to project and plan supplementing
of historical results and existing resource capabilities for making comparisons and
projections. When used for planning and forecasting, a managerial costing model is
adapted to allow users to explore cause and effect relationships resulting from new or
changed processes and from the resource application alternatives being considered.
The scope of managerial costing involves model adaptation to support
simulation, forecasting, and planning.
Table 1: Scope of Managerial Costing
Scope of Managerial Costing
A. Provide managers and employees with an accurate, objective cost
model of the organization and cost information that reflects the use of
the organizations resources.
B. Present decision-support information in a flexible manner that caters to
the timeline for insights needed by internal decision makers.
C. Provide decision makers insight into the marginal/incremental aspects
of the alternatives they are considering.
D. Model quantitative cause and effect linkages between outputs and the
inputs required to produce and deliver final outputs.
E. Accurately values all operations (support and production) of an
organization (i.e., the supply and consumption of resources) in
monetary terms.
F. Provides information that aids in immediate and future economic
decision making for optimization, growth, and/or attainment of
enterprise strategic objectives.
G. Provides information to evaluate performance and learn from results
H. Provides the basis and baseline factors for exploratory and predictive
managerial activities
Section III: The Characteristics of Managerial Costing
A Framework for the Qualitative Characteristics of Managerial Costing
The literature of managerial costing over the last century includes a number of
articles and a few books that have been labeled as frameworks. For example, the
Management and Accounting Web ( has a category titled Framework
for Management Accounting, but the subject matter is extremely broad. This framework
is unique because its focus is neither cost accounting nor management accounting. Cost
accounting-oriented frameworks, at least those since the 1930s, are inevitably
constrained by cost accountings contribution to external financial reporting, where it is
viewed as a servant of financial accounting and reporting (example: George Staubus,
Activity Costing and Input-Output Accounting, 1971). Frameworks focusing on
management accounting also tend to retain financial accounting and reporting as a key
customer of cost accounting, but they also bring in decision making, organizational, and
behavioral theories to shore up the management focus (examples: A. R. Belkaoui,
Conceptual Foundations of Management Accounting, 1980, and The New Foundations
of Management Accounting,1992; C. J. McNair, Form Over Function: Toward an
Architecture of Costs,” 1993).
None of these efforts achieved wide acceptance as a management accounting
framework. Nevertheless, these historical structures were examined for insights into
creating and structuring the current framework. These prior attempts were not focused
solely on the two critical elements that underlie the current framework: (1) creating
internal management information for managers and employees based on the two unique
managerial costing principles of causality and analogy, and (2) incorporating these
principles into a conceptual framework. These principles will be discussed in detail in
Section III.A.
The framework presented here is focused, as defined in the Introduction,
squarely on building a model of the organization to support managerial decision making
without any compromises to other uses of cost information. To achieve this result in a
structured manner, much has been drawn from the work of Gordon Shillinglaw,
particularly the article, Cost Accounting Principles for External Reporting: A Conceptual
Framework, which appeared in 1979 in Essays to William A. Paton: Pioneer Accounting
Theorist. The Shillinglaw framework proved to be a particularly useful baseline to
demonstrate the integration of causality and analogy into the existing body of
management accounting knowledge. While Shillinglaws framework was intended to
guide the selection of measurement principles for establishing a management
accounting system with a focus on cost accounting for external reporting, he made wide
use of decision support applications in his framework discussion. Shillinglaws approach
and the basic building blocks of his framework facilitated the current pursuit of
integrating causality and analogy into a management accounting framework focused
purely on internal management needs. The essential building blocks for a managerial
costing framework drawn from Shillinglaws framework comprise the following three
Principles are the gatekeepers of the framework. As principles, causality and
analogy wield their influence over the framework as criteria by defining the
underlying purpose of the framework as (1) cause and effect operational
modeling, and (2) the consistent application of the resultant information in
managers inferences. Causality and analogy serve as the litmus test for
incorporating concepts into the managerial costing system. Since they
embody the purposes of the system, they also serve to guard and preserve
those purposes once the system is operational.
Concepts are defined by Shillinglaw as understood abstractions of a class of
relationships, a trait, or a characteristic (1979, 159). The framework
presented here uses concepts in the same way. They constitute
relationships, traits, or characteristics that need to exist for effective cost
measurement, modeling, and use of the information. Examples of concepts
include cost, capacity, and managerial objective. In the discussion that
follows, concepts are divided into two groups: (1) those related to the
principle of causality (or model construction), and (2) those related to the
principle of analogy (or information use).
Constraints function as filters in selecting concepts and also provide
boundaries for the application of the selected concepts. They contribute to
the system of checks and balances in the overall framework. Examples of
constraints include objectivity, accuracy, and materiality.
These three elements and their values are graphically depicted in Figure 3.
Shillinglaw’s framework suggested three additional elements that progressed
from relevant concepts to principles and on to standards and methods. This
conceptual framework for managerial costing uses on the three primary elements
listed above which were essential to selecting principles. As explained in the
Introduction, this conceptual framework is not addressing codification and
standard setting.
Figure 3: The Application of Principles, Constraints, and Concepts
This framework provides a principles-based approach to defining and evaluating
an organizations cost model. Not every organization will come to the same
implementation solution. As discussed in the Introduction, the nature and complexity of
an organizations business will drive different needs for effective internal decision
support from its cost model. A thorough understanding of the framework and its
principles, concepts, and constraints will enhance an organizations insight into its
options for designing, developing, and using internal management information to enable
achievement of its strategic objectives in an optimal manner.
The integration of causality and analogy and the expansion of the framework into
a full-blown managerial costing framework are discussed in the next three subsections of
the framework. The selected principles, constraints, and concepts are identified in
Figure 4.
Figure 4: The Principles, Constraints, and Concepts Selected
Section III.A: Principles for Managerial Costing
First Principle: Causality
Principles can be thought of as innate laws for which proof is not necessary
because they are self-evident. Causality, the recognition of the relation between a cause
and its effect, is such a principle. Causality is the basis for all inferences in the scientific
method. It is appropriate, and in fact essential, to apply causality to managerial costing,
and as a principle it is the basis for discerning truth in cost modeling and its decision-
support information.
The term truth is not used here in terms of achieving an absolutely precise
numerical answer. It is instead a direction that guides one toward better, more correct
information. Without a definition of truth for managerial costing, all assumptions and any
outcomes are valid. The consequence of not pursuing truth is the creation of misleading
decision-support information that does not reflect reality accurately. Defining truth
provides a benchmark against which one can measure the quality of a model and its
assumptions. Truth in cost modeling means reflecting the reality of the operations being
modeled. The field of philosophy has many theories of truth. For managerial costing
applications, the Correspondence Theory of Truth is most applicable. A simple definition
is, A statement or opinion is true if what it corresponds to is a fact. (For a more
comprehensive explanation of how truth serves as the foundation for managerial costing
principles, see Appendix A.)
The truth requirement in managerial costing is simply that a cost model must
correspond to the operational facts into which it strives to provide management insights.
Models are more correct and assumptions are more valid the closer they are to the
observable reality, or truth. For example, suppose an organization uses a bottling
machine with the capacity to fill 5,000 bottles per hour. Any corresponding cost model
should reflect that capability.
The Roles of Money and Resource Quantities
The accounting profession has historically used causality exclusively in the
context of value (i.e., as a characteristic of cost). Such a monetary view assumes a
direct causal link between an output and its costs. Defining causality this way would be
adequate if cost information was limited to cost accounting for external reporting.
When managerial costing is used for analysis and decisions to optimize an
enterprises performance, however, this monetary view falls short because it lacks
insight into the more foundational data: the quantities of an organizations resources. For
example, number of people, number of units of production/output, quantity of scrap, and
so on provide understandable and tangible measures of resources and their application.
Money can be thought of as a proxy for these underlying quantitative realities. Money is
not the lever that results in actual changes on the groundit is the managers ability to
understand and adjust the acquisition, use, and consumption of resources that affects
change. That is, a monetary view alone provides inadequate insight into the real facts:
the resources, business processes, and goods and services affected by decisions and
Money, nevertheless, plays an important role in characterizing diverse economic
resources acquisition, consumption, and trading as a common denominator. You cannot
hold a cost cupped in your handsit is not tangible. Similar to an imaging system on a
radar or sonar screen, the monetary view in accounting reflects something else: costs
are merely the imaging of economic resources and can be thought of as the meta-
language of these quantitative economic entities. Managers will be most effective when
their decision-support information provides them with insight directly into the quantities of
resources and goods and services they are attempting to optimize. Therefore, for
optimization purposes and to effectively manage an enterprise, quantitative information
about resources and their consumption form the basis for managerial costings monetary
This quantitative view of causality casts a different light on the traditional view of
management accounting as primarily a financial costing method (i.e., concerned with
allocating expenses collected in the general ledger to cost object buckets, such as a
products cost). Instead of a primary focus on parsing the general ledger’s monetary
units (e.g., dollars, euros) into operational metrics, quantity-based causality means
managerial costings backbone is an operational model comprised of outputs and their
required input (resource) quantities. This allows the managerial costing model to directly
connect to the quantitative data of the logistics/operations systems. Operational
quantities and their costs––available from source documents (e.g., a goods receipt)––
are therefore kept closely coupled throughout an organizations internal value chain.
Defining Causality for Managerial Costing
To support managers pursuit of optimal resource usage, managerial costing is
first and foremost concerned with the quantitative representation of resources, goods,
and services. With this objective and the Correspondence Theory of Truth in mind, the
definition of causality in management costing is formulated as follows:
Causality: The relation between a managerial objectives quantitative output and the
input quantities consumed if the output is to be achieved.1
To distinguish this definition from other definitions, it will be referred to as the
correspondence definition of causality. As an example of how the correspondence
definition of causality is applied, consider a jet airplane flight simulators electricity
consumption that is measured and determined to be 200 kilowatts of electricity for every
hour of operation. Managements objective is to sell 250 simulator training hours per
month. Based on that objective, the causal relationship is therefore defined as Output =
250 simulator hours, Quantity of Electric Power Input Required = 50,000 (250x200)
Adapted from G. Shillinglaw, Cost Accounting Principles,” 162.
kilowatt-hours. (Note: At this point, the quantitative causal relationship has been defined
without any consideration of costs.)
The following two primary issues arise in applying the principle of causality as
defined for managerial costing:
1. The strength of causal relationships can vary from strong to weak. Both types
of relationships must be modeled in a manner that supports managerial
insight and decision making in order to aid achieving the organizations
strategic objectives in an optimal manner.
2. The collection of operational and financial data to provide a monetary view of
the causal relationships is required.
Strong and Weak Forms of Causality
An accurate model of enterprise economic activity is only possible if the causality
principle is consistently satisfied in quantitative modeling. The proper modeling of
causality in managerial costing necessitates a distinction between the strong and weak
forms of applying the principle.
Strong Form of Causality: The strong form refers to instances where a
consumption relationship can be explicitly quantified. That is, a requisite dependency
exists between an output (e.g., 250 simulator hours) and an input (e.g., 50,000 kilowatt-
hours (kWh) required to run the simulator for 250 hours).
Weak Form of Causality: The weak form exists when the inputoutput
relationship cannot be quantified in this manner but an association nevertheless clearly
exists. For example, a machine is dedicated to making products A and B (two products
comprising a product group). What is the relationship of the machines excess/idle
capacity costs to products A and B? The cost for the machine had to be incurred to
make products A and B, but the relationship between the products produced and the
machines idle time cannot be quantified. To illustrate, consider the addition of product C
to the product group, which consumes some of the machines excess/idle time. Although
the machines idle time decreases with the introduction of product C, there is no effect
on the units of products A and B produced or the machine hours they consume (that is,
the causal relationship). With the weak form of causality there is not a requisite
dependency between the output (units of products A and B produced) and an apparent
input (the machines excess/idle hours). Nevertheless, an association exists in these
instances that is important to enterprise optimization (i.e., in a decision to discontinue the
product group, the machines excess/idle capacity cost is clearly an avoidable cost).
The proper treatment of the principle of causality––in both its strong and weak
forms––is important to enterprise optimization and managers use of decision support
information. Section III.B of this framework will introduce concepts for achieving the
proper treatment of the two forms of causality.
Creating an Effective Monetary View
It is essential that quantitative resource data clearly support any representation of
cause and effect relationships that is made in monetary terms.
Managerial costing must provide a monetary view of economic activity, which
implies a duality of information. Money serves as a common denominator to weigh and
evaluate otherwise incomparable alternatives in decision analysis. Its use in optimization
is essential. Managers information needs are therefore of a dual nature: (1) a
quantitative (non-monetary) representation of relevant cause and effect relationships,
and (2) the valuation (monetary representation) of those relationships. For example,
assume that electricity costs $0.10/kWh for the simulator training company. This would
mean the strong causal relationship defined above can be expanded to reflect both a
monetary and a non-monetary view. For example, Output = 250 simulator hours;
Electrical Input = 200 kWh/simulator hours; Total Electrical Inputs = 50,000 kWh; and
Input Costs = $5,000.
The concept of Integrated Data Orientation explained in Section III.B. defines
how this integration of monetary and operational data is achieved in practice.
Enhanced Cost Modeling
The correspondence definition of causality and its practical application lead to the
following advantages for cost modeling:
Information usefulness is significantly enhanced as managers gain insight
directly into the resource quantities they strive to influence/adjust.
In producing cost information, managerial cost models can be separated from
financial accountings reporting structures and conventions defined for
compliance with regulatory agencies.
Basing the cost model on operational structures and data reduces the
administrative effort of collecting and maintaining cost information, since
normal operational data maintenance activities double as cost model
An improved approach to modeling weak causal relationships to avoid
distortions to causal information.
Applying the correspondence definition of causality also eliminates a criticism of
causality as purely historically oriented (i.e., descriptive) and not suitable for forward-
looking optimization decisions and actions (i.e., predictive). Quantity-based causality
supports both. The descriptive view reports what happened, while the predictive view
applies the quantity-based method and reflects current resource capabilitythe very
resources management is tasked to use and adjust in order to achieve enterprise
strategic objectives in an optimal manner.
In the quest for principles to anchor managerial costing to the bedrock of truth,
the principle of causality is key. As defined, causality embodies the Correspondence
Theory of Truth and, as such, serves as the starting point to transform managerial
costing into a customer-focused (i.e., manager-focused) and enterprise optimization-
centric discipline.
Second Principle: Analogy
The second principle for managerial costing is analogy. Analogy applies when
insights are used and inferences are made about known cause and effect relationships.
The simulator example can be used to illustrate the application of this principle. The
causal relationship is known (the simulator consumes 200 kW per training hour). A
managerapplying the principle of analogycan infer that electricity consumption was
200 kWh/hour a month ago and will also be that amount in the future. Thus, a manager
uses known cause and effect insights to make inferences (that is, analogous application
of the information) about past or future outcomes.
Analogy: The use of causal insights to infer past or future causes or effects.
Analogy serves as a principle for managerial costing because it
1. Governs the way in which cost information is used;
2. Lies at the center of enterprise optimization;
3. Is inherent in all (rational) managerial actions;
4. Is indispensible for organizational learning;
5. Unequivocally focuses managerial costing on its primary users: managers.
The two principles for managerial costing therefore apply as follows: (1) causality
deals with understanding and capturing enterprise quantitative cause and effect
relationships, and (2) analogy is concerned with applying causal information in
optimization actions. In using managerial costing information, the principle of analogy
finds application in two ways, as illustrated in Figure 5:
1. By using the relationships embedded in the cost model to reflect recurring
events (e.g., operating the simulator for 200 hours in the last measurement
period). This is useful for understanding and analyzing financial results, for
performance measurement, and control. Most importantly, analogy forms the
basis for organizational learning when financial results can be logically and
efficiently traced to operational causes.
2. When using causal insights to infer outcomes of potential future events (e.g.,
the avoidable costs when considering replacing the current simulator with a
new one). Predictive managerial activities that support change and
improvement such as planning, simulation, what-if analysis, and evaluating
decision alternatives comprise such forward-looking inferences governed by
the principle of analogy.
Figure 5: The Application of the Principles
In business, the use of analogy goes beyond its application in using managerial
cost information. In fact, its use is pervasive in enterprise optimization in general
because it applies even if managers base their decisions on cause and effect relations
not considered by cost models. For example, when a managers primary consideration in
making a product continuation decision is the fact that the last time a complementary
product was discontinued the company lost an important customer, the manager is
projecting a known cause and effect relationship. The principle of analogy fundamentally
underlies nearly all managerial decisions and actions and is the basis upon which
valuable business experience is developed. A cost model built on cause and effect
relationships facilitates learning and decision making by providing clear, logical insights
into the operational and financial relationships of an organization for all managers. Such
a model can substantially shorten the experiential learning curve.
Analogy is most important in its strategic application because this is where
direction setting from the executive team occurs. In this regard, the aim of an
optimization action must be distinguished from the actions outcome. Aim refers to a
managerial actions strategic intentin particular, whether it changes strategy (that is,
an adaptive action) or whether it reinforces the current strategy (that is, a corrective
action).See Part IV.A for further discussion on the role of analogy in managerial cost
model design.
The principles of causality and analogy are not unique to managerial costing. A
strong argument could be made that they are fundamental principles for many
professional disciplines. For example, they govern the scientific method. They must,
however, be emphasized for managerial costing.
The core of organizational success is understanding customer needs and
designing and executing productive operations that meet those needs. Managerial
costing applies causality and analogy as a bridge to model and apply monetary
measurements to operations. The framework presented here does not address the
essential issue of understanding customer needs, but it does assume a thorough
understanding of the operations modeled and measured.
Once a manager understands an operation, cost information compiled based on
the principles of causality and analogy will provide a truthful representation of the
operation in monetary terms in order to assist decision making. The concepts in the next
section define the elements needed to build an effective cost model based on a thorough
understanding of operations.
Section III.B: Concepts for Managerial Costing
Concepts for Managerial Costing
The concepts for managerial costing are framed by two fundamental and
connected views: (1) the measurement and capture of an organizations resources and
costs referred to as modeling, and (2) the use of that information for decision making.
Figure 6 illustrates the relationship between these views with a U shape and their
common ground, the generation of information for business optimization decisions.
The objective of the cost modeling view is to provide measurements and
calculations (including rates) that reflect the consumption of the organizations resources
in support, administrative, and product- or service-producing operations. Resources
include the labor, equipment, supplies, materials, external services, and so on that are
acquired by an organization in order to pursue its objectives. Building a highly effective
model is important since it forms the baseline information for a large variety of internal
management activities, such as planning and improving operations and evaluating
performance. Causality is the principle that governs constructing managerial costing’s
operational model and the information the model provides. The result from calculating
monetary values for the models consumption relationships is attributable cost,
defined as costs of an output that can be eliminated in time if that output were
discontinued and resource consumption and/or provision were reduced accordingly. It is
as close as one can get to full cost while adhering to the principle of causality.
The intent of the information use view is to provide a basis for how decision
makers (at any level, including managers, supervisors, or employees) should apply the
results of the cost model to gain insights and make inferences in order to make
decisions and take action. Decision makers apply insights gained from the models
information to infer the use of existing resources for new purposes or new resources for
existing purposes (i.e., in an analogous manner). Analogy is, therefore, the principle that
users of the information adhere to in applying the model information in analysis in
making cause and effect inferences (i.e., managers analogous activities), in selecting an
optimal decision alternative, and taking adaptive and corrective actions.
G. Shillinglaw, “The Concept of Attributable Cost,” 7385.
Figure 6: The Cost Modeling and Information Use Views
The concepts related to cost and operational modeling are discussed before
introducing the concepts relevant to the principle of analogy and the use of information
generated by the model.
Modeling Concepts
The concepts related to constructing managerial costing’s operational and cost
model are the focus of Figure 7.
Figure 7: Modeling Concepts
Overview of Modeling Concepts
These concepts serve as the building blocks for a reflective, cause and effect-
based model of an organizations operations. They cover (1) the entities that make up an
enterprises operational model (resources and managerial objectives); (2) characteristics
of those entities (homogeneity, capacity, work, traceability, and cost); (3) the
relationships between the entities in the model (responsiveness and attributability); and
(4) the relationships between the data needed for the model (integrated data
Resource: A definitive component of an enterprise acquired to generate future benefits.
The framework requires the inclusion of the resource concept for at least four
1. Resources are the source of all costs and demand explicit modeling.
2. Resources are the entities that have productive capacity.
3. Resources are the quantitative entities decision makers must adjust or
influence to effect change.
4. Resources are the final determinant in any optimization activity of the
magnitude of incremental gain and are the basic building blocks in
optimization (refer to the discussion in Section III.B on the concept of
This definition of a resource is intentionally broad and includes people, machines,
information technology, raw materials, and cash as well as resources developed
internally (e.g., a hospitals billing software developed in-house).
Managerial Objective: A specific result or outcome of the application or provision of
resources that management chooses to monitor for the purpose of enabling one or more
managerial activities.
The framework requires the inclusion of managerial objective because
1. Achieving managerial objectives is the reason for employing resources to
produce output;
2. Establishing and managing discrete managerial objectives is necessary in
order to achieve an enterprises strategic objectives;
3. Managerial objectives align with managers responsibilities, the need for
measurement, accountability, and ultimately incentives (e.g., bonuses).
Managerial objectives can be the final outputs of an organization or any
intermediate outputs. They can serve any measurement, analytical, or predictive
purposes for whatever timeframe managers deem appropriate. Examples of managerial
objectives include production activities and support activities provided by the enterprises
resources (and consumed internally), activities of external or contracted services,
saleable products and services, target markets and market segments, and projects to
build or acquire resources and infrastructure.
Managerial objectives consume resources, and most contribute to another
downstream or higher-level managerial objective. For example, providing machine
maintenance is a managerial objective of a Plant Maintenance Team. The machine
maintenance output is consumed in part by the machines that make up Production Line
101. The managerial objective for Production Line 10 is the production of Component X
which is used in a final, saleable product, Product XYZ. The managerial objective for
Product XYZ is a defined level of market penetration and profitability in specified market
segments and target markets.
An accurate reflection of consumption relationshipscharacterized in
nonfinancial and financial termsbetween managerial objectives is important for four
1. To comply with the principle of causality;
2. To provide cause and effect insights for analysis and decision support;
3. To accumulate all of an objectives attributable costs, which serve as the
baseline for determining the relevant costs for a particular decision;
4. To ensure all resources consumed in achieving a managerial objective can
be identified for decision making and optimization.
Cost: A monetary measure of (1) consuming a resource or its output to achieve a
specific managerial objective, or (2) making a resource or its output available and not
using it.
Cost is included in the framework because
1. Determining the cost of resource use and managerial objectives is the
purpose of managerial costing;
2. Including costs presents resource consumption in a general monetary form
that allows comparability between diverse alternatives.
In line with the quantitative understanding of causality (Section III.A), the
traditional view of cost as a direct relation between money and a cost objectives output
must be redefined because it does not support the creation of quantitative causal
relationships. The cost associated with a managerial objective results from the relation
between its output (production man-hours, production machine hours, product, and so
on) and the inputs (labor, equipment, raw material, operating budget, floor space,
utilities, and so on) required to produce the objectives output.
In the framework, the definition of cost portrays the understanding that the flow of
money in a managerial costing model merely reflects the underlying operational
consumption of goods and services; money is only the meta-language of economic
activity and not the activity itself. Thus, the cost of an input is assigned to a managerial
objective because that input quantity is required to achieve the objective in the first
place. The definition reflects a consumption viewpoint: money reflects resource
consumption. In a consumption view, money is not allocated or assigned in the absence
of a causal quantitatively defined consumption relationship.
The definition of cost includes the costs of wasted or inactive resources, that is,
resource capacity available for the achievement of managerial objectives but not used.
From an optimization perspective, excess/idle capacity always has a cost impactat the
very least, an opportunity cost.
Responsiveness: The correlation between a particular managerial objectives output
quantity and the input quantities required to produce that output.
Responsiveness is included in the framework because
1. It facilitates accurate marginal cost information;
2. It provides insights into the nature of cause and effect relationships;
3. It enables the costing of managerial objectives at all levels throughout the
Responsiveness and Variability
Responsiveness replaces the conventional concept of variability. Variability is
defined in terms of the relation between total volume and total cost (Shillinglaw, 1979,
162). Variability implies a linear relationship between total final product output for a
company and its total cost. As illustrated in Figure 8, variability assumes that a change in
total output from point A to point B will always result in a change in total cost from point
X to point Y or vice versa.
Figure 8: The Relation Between Total Cost and Total VolumeVariability
However, toward the latter part of the 20thCentury the emergence of multipurpose
production facilities and an increase in product customization led to complexity in
business and resulted in increased indirect and shared costs. This has unmasked the
concept of variability as an overly simplistic view of consumption and cost behavior. For
example, when producing fewer, relatively more complex products, total output volume
will decrease but can still result in higher total cost due to an increased number of more
specialized direct and indirect activities needed to produce these complex products.
Additionally, variabilitys focus on final output provides little insight into the consumption
and cost relationships between resources that interact in a process. Because causality is
concerned with the relationship between a specific output and the inputs required to
produce it, causality demands more specificity in cause and effect expressions than
variabilitys aggregate level assumption is able to provide. The concept of variability is
therefore replaced by the more robust concept of responsiveness.
Responsiveness reflects the nature of quantitative consumption at the individual
managerial objective levels (i.e., for each managerial objective the consumption
relationships of inputs are defined in relation to the objectives output). An example is
electricity. It can be consumed proportionally in any quantity. However, when electricity
becomes an input to a building which provides the output of space (square or cubic feet),
the electricity associated with heating or cooling and lighting the space acquires a fixed
consumption relationship with the output of space. Electricity consumed by an operating
machine would remain proportional to the output of machine hours since that
consumption would stop or diminish substantially (in most cases) when the machine was
Modeling Responsiveness
Consistent with the frameworks objective of providing managers with cause and
effect insights and enabling related inferences, responsiveness is not concerned with the
relationship between total volume and total cost as in Figure 7, at least not directly.
Instead, it focuses on reflecting the nature of cause and effect relationships at the point
within a process where managers must influence the behavior and consumption of
resources as shown in Figure 9.
Figure 9: The Relation Between Resources and Output Responsiveness
Causal relationships can be static, dynamic, or a combination of both in relation
to output. These responsiveness characteristics are defined as follows:
A fixed responsiveness relationship indicates that an input will be consumed
regardless of changes in the level of output of the consuming managerial
objective. Typical examples of a fixed relationship are regular preventative
maintenance hours for a flight simulator, the supervisor of the simulator
operators, and the floor space for the simulator.
A proportional responsiveness relationship indicates that demand for an input
will change as the consuming objectives output level changes, typically in a
linear manner. Examples of proportional responsiveness relationships are the
electricity (kWh) the simulator consumes during operation and the simulator
operators hours.
In contrast to the concept of variability, responsiveness does not concern itself
primarily with cost behaviorresponsiveness deals only with the consumption of input
quantities. This is consistent with the quantitative definition of causality and with the
recognition that value (money) is the meta-language of economic activity (i.e., money
merely inherits the behavioral characteristic of its associated input quantity). For
example, a flight simulator with an output of 250 hours consumes 50,000 kWh of
electricity proportionate to output. The associated electricity cost of $5,000 (assume
$0.10 per kWh) is classified as a proportional cost for the simulator. Conversely, the cost
of an input quantity consumed in a fixed manner, such as regular preventative
maintenance, results in a fixed cost.
Note that the cumulative effect of responsiveness overcomes the flaw identified
with variability (i.e., responsiveness is able to reflect an inverse relationship between
total volume and total cost). To illustrate, consider a situation in which fewer, more
complex products are manufactured in a larger number of smaller batches, resulting in
higher total costs due to the increased number of batches and inspections along with
additional planning and scheduling costs. Since responsiveness defines more specific
causal relationships for each of these work areas, higher inputs and costs (e.g.,
overtime) will be reflected in line with each work areas higher output levels even though
total product volume will be less.
(Please note this paragraph defines a specific example
and is not a general statement on the merits of small versus large batch production.)
Understanding the differences between the concepts of proportional costas
used in this frameworkand traditional variable cost is important. Due to variabilitys
aggregate assumptionit functions at the total cost levelsome circumspection is
therefore required when attempting to compare the two cost concepts. Responsiveness,
with its proportional cost, can provide a total cost number, but variability cannot be
reliably disaggregated to the level of responsiveness (i.e., to individual managerial
objectives). Therefore, proportional cost is similar to traditional variable costs since it can
express total cost linearly with changes in total volume if individual responsiveness
relations so dictate. However, in certain casesas described abovetotal proportional
cost can and willwhen appropriatebehave inversely to total volume.
Responsiveness also enables the following two modeling practices, which are
crucial to managers cause and effect insights:
1. Responsiveness allows for the ability to define some of a particular inputs
quantities as fixed in nature and some as proportional. For example, a
simulator consumes preventative maintenance hours regardless of its level of
output (i.e., a fixed consumption). It also consumes maintenance hours from
the same department for repairs (i.e., a proportional consumption). In a
decision to satisfy additional output demand using existing capacity, only the
cost related to proportional maintenance hours are potentially relevant.
2. Responsiveness recognizes that a resource normally acquired
proportionately can be consumed in a fixed manner. For example, a simulator
It is essential that the term “output” here be understood as reflecting specific resource outputs
(e.g., inspection outputs, scheduling outputs, and planning outputs) and not finished goods or
consumes 5 kW of electricity per hour when it is idle to keep hydraulics
primed, key components and instruments heated, and diagnostics active.
This input quantity (43,800 kWh per year, 5 kWh/hr x 24 hr/day x 356 day/yr)
is a fixed consumption for the simulator and results in fixed costs of $4,380
(43,800 kWh x $0.10) for the year regardless of the level of output toward the
managerial objective of providing simulator training. Thus, responsiveness
allows for changing the nature of an inputfrom proportional to fixedwhen
the change is reflective of the nature of a particular causal relationship.
Moreover, once a cost is fixed within a process, it cannot become
proportional. This means that under responsiveness costs will become
increasingly fixed as resources are consumed through consecutive causal
relationships in a productive process.
Establishing the concept of responsiveness in the managerial costing framework
is critical in striving for a reliable representation of operational cause and effect insights.
Responsiveness and the manner in which it accommodates causal relationships and
their characteristics provides managers with a superior operational foundation to base
inferences in their analogous or information use activities, such as analysis, decision
making, and planning. Responsiveness is the cornerstone of the marginal/incremental
information that the managerial costing model will provide.
Traceability: A characteristic of an input unit that permits it to be identified in its entirety
with a specific managerial objective on the basis of verifiable transaction records.
Traceability is included in the framework for the following reasons:
1. Cause and effect relationships between inputs and outputs of managerial
objectives must be identified. Traceability is defined to align with the
quantitative nature of causality (i.e., a certain quantity of resources is needed
to produce a certain level of output). Traceability must be viewed in
quantitative resource terms.
2. Resource consumption must be connected with specific managerial
objectives when a causal relationship exists.
Examples of verifiable transaction records that allow for the tracing of resource
quantities are bills of materials, product routing steps, material requisitions, time cards,
invoices, transaction execution records in software applications, and machine design
specifications and ratings. During the conceptual design of a cost model, traceability
should at face value be considered evidence for causality. The absence of traceability
indicates the lack of a strong causal relationship, the lack of a quantitative consumption
relationship, and hence a relationship must then be modeled using the concept of
attributability discussed on page 62.
Capacity: The potential for a resource to do work.
Capacity must be included in the framework for the following reasons:
1. It provides the limits of a resources capability to contribute to achieving
managerial objectives.
2. Using resource capacity effectively in achieving a managerial objective is the
key to optimization.
3. Excess or idle capacity represents a major optimization opportunity.
Types of Capacity
Capacity is a key characteristic of all resources; therefore, capacity-related
resource inputs and their costs should be treated with care. The principle of causality
and the various analogous uses of capacity-related information necessitate a distinction
between two types of capacity inputs: (1) those required for capacity provision, and (2)
those related to capacity usage. Capacity provision inputs and the associated costs must
be incurred before the first unit of output can be generated and until the decision is made
to eliminate the particular capacity. Capacity usage inputs and their associated cost are
incremental and required for each unit of output generated. These types of inputs as
they relate to capacity are defined as follows:
1. A resources capacity provision inputs are those required to enable its output
commitment even if no output is generated in the end. The anticipated level
of output to be generated is determined by the planned demands of the
internal and external consumers of the resource’s output. A resources
capacity provision costs are the costs of the fixed input quantities it must
consume to meet its committed capacity. For the flight simulator example,
such capacity provision inputs would include capital represented by
depreciation, preventive maintenance, and costs for the building space the
simulator occupies. Resource capacity provision costs for a human resource
may include recruitment, relocation, and training. Once a resource has been
committed to provide a certain level of output, the associated capacity
provision costs cannot be avoided until a decision is made and action taken
to eliminate the capacity.
2. A resources capacity usage inputs are those additional inputsover and
above capacity provision inputsincurred to provide the output actually
produced and consumed by other managerial objectives. Capacity usage
costs are the costs of proportional inputs consumed in producing output.
Examples for equipment resources may include consumables, lubricants, and
electricity consumed during productive output. The primary example for
human resources is the labor wage rate.
Modeling Capacity
The assignment of all capacity costs, from both the provision and usage inputs, is
a function of the denominator volume used to calculate the capacity resources output
cost rates. Capacity usage inputs and their costs are incurred causally as demanded by
the consumers of capacity, and the appropriate denominator for calculating the capacity
usage cost rate is planned output. A resources actual capacity usage costs will reflect
its actual output generated.
The assignment of capacity provision inputs (and their costs) is more challenging
because the causal relationship is not typically as strong. What is an appropriate
denominator level for calculating an output rate to assign capacity provision costs? The
answer to this question requires a denominator volume that will appropriately reflect both
the strong and the weak forms of causality with regard to capacity provision inputs. For
example, consider using planned output for this purpose, as illustrated in Figure 10.
Figure 10: Capacity Provision Costs and Planned Output
As illustrated in Figure 10, if planned output is used as the denominator for rate
determination, all capacity provision costs are assigned to products (though assignment
could be to activities, resources, managerial objectives, and so on) consuming that
resource capacity. In this case, common fixed costs (costs that have a very weak or no
consumption relationship with a specific output, such as excess/idle capacity) are
assigned to products A, B, and C in a manner inconsistent with the principle of causality.
This arbitrarily spreads some capacity provision costs to the consumers (products A, B,
and C in this case) and compromises managers cause and effect insights. In short, the
products will be over-costed.
Therefore, the denominator used to assign capacity provision costs must reflect
the following:
When resource capacity is applied to produce a product/service as well as
when the resource remains unapplied.
Capacity provision inputs and their costs as relating to both applied and
unapplied capacity. This is illustrated in Figure 11.
Note: Applied capacity is defined as productive capacity (time spent making product)
and nonproductive capacity (time for setups, planned and unplanned maintenance,
rework, and so on) that can be causally related to a specific output with a consumption
relationship. Unapplied capacity includes all idle/excess time as well as nonproductive
capacity that does not have a strong causal relationship to a specific output.
Figure 11: Segregating Applied and Unapplied Capacity
As illustrated in Figure 11, if theoretical capacity (see definition below) is used as
the denominator, only the capacity provision costs related to the capacity actually
applied are assigned to the products and services produced. Common fixed costs, the
lightly textured (non-product) areas in Figure 11, are not assigned to the products and
services produced. In this instance, only the capacity provision costs represented by the
darker, shaded, capacity applied areas (product) will be assigned to products A, B, and
C, respectively.
Since the objective is to assign a capacity resources costs in a causal manner
for the purposes of managers analogous use, it is clear that capacity provision costs
should be assigned to a resources entire period of availability. Therefore, capacity
provision costs for idle/excess resource time should not be assigned to productive output
but should instead be handled in accordance with the concept of attributability (page 62).
For optimization purposes, theoretical capacity is the appropriate denominator for
assigning capacity provision costs to the consumers of capacity. Any other denominator,
including practical capacity, will assign some unapplied capacity and its provision costs
arbitrarily to the products produced.
Note on Capacity Definitions:
Idle/Excess Capacity: Capacity not currently scheduled for use. The Consortium for
Advanced Manufacturing International (CAM-I) Capacity Model breaks idle capacity
into three specific classes: not marketable (no market exists or management made a
strategic decision to exit the market), off limits (capacity unavailable for use), and
marketable (a market exists but capacity is idle).
Nonproductive Capacity: Capacity not in a productive state or not in one of the defined
idle states. Nonproductive capacity includes setups, maintenance standby, scheduled
downtime, unscheduled downtime, rework, and scrap. Variation is the primary cause of
nonproductive capacity.
Productive Capacity: Capacity that provides value to the customer. Productive capacity
is used to change a product or provide a service. Productive capacity results in the
delivery of good products or services. It may also represent the use of capacity for
process or product development.
Theoretical Capacity: The full period a resource is available based on ownership rights
or contract agreements. Buildings and equipment are typically available 7 x 24 x 365.
Human resources are typically available for an agreed upon number of hours per week.
Overtime is an additional resource when used.
Source: Thomas Klammer, ed., Capacity Measurement and Improvement: A Manager’s
Guide to Evaluating and Optimizing Capacity Productivity, 1996.
Work: A measure of the specific nature of units of resource output.
Work is included in the framework for the following reasons:
1. Resources engage in specific work activities or business processes to
accomplish managerial objectives.
2. The ability to model work provides decision makers with information that is
often important to optimization efforts.
3. The work concept is also useful for analogous purposes when insight into the
nature of work is beneficial to managers optimization endeavors (e.g., for
process improvement).
The concept of work is the foundation of activity-based costing and is
incorporated into the framework with its application subject to the quantity-based
definition of causality. An illustration of the consumption of resource quantities with and
without the concept of work is provided in Figure 12. Work is used in modeling when it
provides important decision-support information, enhances accuracy, reduces the level
of administrative effort in modeling, or is cost-beneficial in expressing a causal
relationship. A common example is an organization’s purchasing function where
resource time recording is administratively prohibitive and the work output (the number
of purchase orders or contracts) provides an easily accessible and traceable output
measure to consumers.
To effectively model the concept of work requires the use of resource quantities
to maintain traceability of the resource capacities throughout an enterprise model. Work
activities do not have capacity themselves; they merely transmit capacity usage.
Figure 12: Illustration of the Concept of Work
Without Work
Pool A
Planned Output: 1,000 Hrs
Actual Output: 900 Hrs
Using Work
Pool A
Planned Output: 1,000 Hrs
Actual Output: 900 Hrs
Pool A 900 Hrs
Setups (Qty 10) 200 Hrs
Run Machine 700 Hrs
Attributability: The responsiveness of inputs to decisions that change the provision
and/or consumption of resources.
Attributability is included in the framework for the following reasons:
1. Not all resources have strong cause and effect relationships with a
managerial objective.
2. Costs with a weak causal relationship to a managerial objective are often
relevant costs in decision making.
3. The costs associated with a resource with a weak causal relationship to an
output can distort decision-support information if not modeled and used
Attributability governs the application of the weak form of causality. Causality was
discussed in Section III.A. Principles for Managerial Costing; however, its relation to
attributability needs elaboration.
In particular, common fixed costs and other costs, which cannot be quantitatively
associated with specific outputs in a causal manner, fall within the sphere of influence of
the concept of attributability. Another term often used in association with this category of
costs is business sustaining costs. For optimization purposes, these costs need to be
assigned to business levels (e.g., product, product group, a plant, a region, a distribution
channel, or the entire organization), where they are relevant in decision making. The
common practice of allocating these costs to outputs arbitrarily, or with the same effect,
based on a highly generalized driver, distorts decision-making information at many levels
of an organization.
Attributable Cost
As previously defined, attributable costs are the costs of an output that could be
eliminated in time, if that output were discontinued and resource consumption and/or
provision were reduced accordingly. Therefore, a managerial objectives attributable
costs may include the following when they exist and apply: (1) all direct costs, (2) causal
support costs, including a proportionate share of capacity provision costs, and (3)
attributable common fixed costs.
The attributable cost concept is the most complete cost concept based on the
principle of causalityit effectively incorporates both the strong and weak forms of the
principle. For this reason, the attributable costs of a managerial objective serve as the
baseline information for managers analogous needs (refer to Figure 1).
Modeling Weak Causal Relationships
It is important to note that quantitative causal relationships in the managerial costing
framework relate to specific outputs, while costs assigned based on the concept of
attributability are generally assigned to business levels. The term business level refers
to a combination of related managerial objectives for which specific optimization
activities are undertaken. Excess/idle capacity cost for a product group is an example of
attributable fixed cost. Another example would be an airline that assigns business class
lounge costs in Paris to the product group Destination Paris. If the airline decides
discontinue flights to Paris, the lounge costs are clearly avoidable, and hence they are
attributable to that business level. At more aggregate levels, more costs will be
attributable until at the highest level (i.e., the operating result for the enterprise)
company-wide common costs are attributable. Examples of such entity-level attributable
costs are the Office of the President and the Public Relations Department. It is only at
this highest level of an organization that attributable costs will equal full costs.
Homogeneity: A characteristic of one or more resources or inputs of similar technology
or skill that allow for their costs to be governed by the same set of determinants and in an
identical manner.
Homogeneity is included in the framework for the following reasons:
1. Resources need to be grouped around similar capabilities and outputs for
managerial purposes.
2. Organizational elements (e.g., departments and cost centers) must often be
divided into homogeneous groupings of resources to be modeled effectively.
Homogeneity is a long-recognized concept that plays a key role in cost
measurement and modeling. It allows for the grouping of like resources into a single
managerial objective in order to manage, optimize, and charge for the use of those
resources in a cost-effective manner. To illustrate, the homogeneity concept leads to the
conclusion that equipment from two production lines that always make the same product
should be modeled in different resource pools if one production line and its equipment
had significantly different technical and cost characteristics. This should occur even if the
two production lines had the same supervisor. Similarly, highly qualified technicians and
trainee technicians with significantly different wages but who often work together on the
same job orders require separate resource pools (based on the concept of homogeneity)
in order to accurately reflect their respective consumption rates and costs.
Integrated Data Orientation: Information about an organizations economic resources,
events, and their corresponding monetary values, free from traditional accounting
conventions, which allows for the aggregation of elementary data elements and their values
for any purpose.
Managerial costing requires a consistent set of source data with the following
1. Not restricted to traditional financial accounting defined conventions
2. Consistently stored for access and retrieval throughout the organization
rather than by financial users only
3. Integrates operational and financial data
Traditional accounting systems are restricted to information that is provided
through the use of traditional accounting artifacts such as debits and credits, journal
entries, the chart of accounts, the general ledger, and various sub-ledgers. The concept
of integrated data orientation prevents managerial costing from being dependent on the
general ledger and allows for a clean separation of financial accounting and managerial
Using integrated data is also a primary enabler of operational modeling and
provides the quantitative nonfinancial information needs of enterprise optimization. The
ability to apply more than one valuation layer to the quantitative operational model
solves the issue of cost information that must be compiled based on different principles,
such as financial accountings matching and periodic principles and managerial costings
need for causal information.
In traditional management accounting practice, monetary units captured from
source documents are recorded in the general ledger and the quantities are recorded in
operational systems. As illustrated in Figure13, with the concept of integrated data
orientation, the cost modeling system comprises a valuation layer on top of the
operational quantity-based model guaranteeing direct linkage and integrity of
optimization information. The inherent integrity of operational quantities (which are
physically observable) coupled with their values in the different valuation layers allows
an alternative to the general ledger’s summarized data. The appropriate information will
be generated from source transactions for the different uses of cost information, such as
inventory valuation for external reporting using traditional monetary focused cost
accounting techniques, and enterprise optimization using monetary valuation tied to
cause and effect based operational resource flows.
Figure 13: Integrated Data Orientation.
Two key weaknesses of the traditional accounting model are the following:
1. Its dimensions are limited. Most accounting measurements are expressed in
monetary terms, a practice that precludes maintenance and use of
productivity, performance, reliability, and other multidimensional data.
2. Its degree of integration (with functional areas of an enterprise other than
finance) is too restricted. Information concerning the same set of phenomena
will often be maintained separately by accountants and non-accountants,
thus leading to inconsistency plus information gaps and overlaps (McCarthy,
McCarthy (1982) also noted that in the traditional accounting model, the
aggregation level for stored information is too high. Accounting data is used by a wide
variety of decision makers, each needing differing amounts of quantity, aggregation, and
focus depending upon their personalities, decision styles, and conceptual structures.
Therefore, information concerning economic events and objects should be kept in as
elementary a form as possible in order to be aggregated by the eventual user.
Enterprise resource planning (ERP) software systems are well suited to
implementing the integrative data concept within a cost model. ERP systems provide
integration through the implementation of an enterprise database that spans the range of
enterprise activities and locations (OLeary, 65).
Relating the Integrated Data Orientation Concept to Other Concepts
Integrated data supports the concept of verifiability of a cost model. Using data
prepared for other purposes allows managers to verify with little effort the source data of
a costing model. One can readily confirm that figures used in a cost model match figures
used in operational reports. The use of integrated data also reduces the amount of
resources required to maintain and use a costing model. When data are used in
operations, they are already validated for that use. Confirming data validity reduces or
eliminates the need for validation prior to use in a costing model.
Table 2: Modeling Concepts
Modeling Concepts
A definitive component of an enterprise acquired to generate
future benefits.
A specific result or outcome of the application or provision of
resources that management chooses to monitor for the
purpose of enabling one or more managerial activities.
A monetary measure of (1) consuming a resource or its output
to achieve a specific managerial objective, or (2) making a
resource or its output available and not using it.
The correlation between a particular managerial objectives
output quantity and the input quantities required to produce
that output.
A characteristic of an input unit that permits it to be identified
in its entirety with a specific managerial objective on the basis
of verifiable transaction records.
The potential for a resource to do work.
A measure of the specific nature of units of resource output.
The responsiveness of inputs to decisions that change the
provision and/or consumption of resources.
A characteristic of one or more resources or inputs of similar
technology or skill that allow for their costs to be governed by
the same set of determinants and in an identical manner.
Integrated Data
Information about an organizations economic resources,
events, and their corresponding monetary values, free from
traditional accounting conventions, which allows for the
aggregation of elementary data elements and their values for
any purpose.
Information Use Concepts
The concepts applicable to the principle of analogy, the use of managerial
costing information, are illustrated in Figure 15:
Figure 14: Information Use Concepts
Overview of Information Use Concepts
The cost model generates information about the consumption of resources and
their costs; however, decision makers must be knowledgeable about concepts that apply
when using the model information. Resources and managerial objectives are highly
interdependent in a model, and countless qualitative factors can change and have an
impact on their costs. The concepts governing information use comprise the following
two groups:
1. Those primarily relevant to analysis (i.e., avoidability and divisibility).
Resources are employed to achieve managerial objectives, but the
consumption characteristics associated with those managerial objectives may
not be divisible in the same way. For example, a process may require 1,000
hours of skilled labor, but such skilled labor is only readily available on a full-
time basis. As decisions are made to improve or change the achievement of
managerial objectives, resource consumption and resultant costs may or may
not be avoidable. Thorough analysis is often required to determine resource
divisibility and the costs that will become avoidable.
2. Those primarily relevant to decision making (that is, interchangeability and
interdependence). Resources of similar types may be interchangeable, and
changes can be accomplished much more rapidly than the model can be
updated. Interdependencies also often exist. For example, a plating company
adopts a new electroplating process for a key product. If by adopting the new
process the plating company adds additional work steps to its changeovers,
then the productivity rate of its plating process will diminish. Information use
concepts in this category highlight the need to consider qualitative aspects in
decision making.
. .
Avoidability: A characteristic of an input that allows for the input (and hence its costs) to
be eliminated as a result of a decision.
Avoidability is included in the framework because:
1. It is a pivotal concept in analysis because for every decision scenario an
enterprise faces, understanding the avoidable and unavoidable costs is
2. Decision makers need to evaluate whether changes in resource consumption
will result in the ability to avoid the costs of affected resources.
Avoidability is well known in the management accounting profession, but in the
context of the framework it is important to understand that it is applied with a focus on
input units rather than costs. Avoidability is not a characteristic of costs but of input
quantities. This is consistent with the earlier characterization of money as the meta-
language of economic activity, and also applies to the use of monetary cost information
in decision analysis. The application of the concept of avoidability in decision analysis
leads to determining a decision alternatives avoidable costs. Avoidable cost is defined
as cost incurred for a managerial objective that willimmediately or in time in some
instancesno longer be incurred if the need for that objective is eliminated.
For example: If a maintenance procedure is improved, saving 1,000 hours of
technician resource time, the cost is avoidable only if one can reduce the number of
technician hours supplied. (See the next concept for more discussion.)
Divisibility: A characteristic of a resource that allows it to be associated in its entirety
with the change in a managerial objectives output resulting from a decision.
Divisibility is included in the framework for the following reasons:
1. It is a characteristic of resources that is critical to decision making.
2. It is a key factor in determining whether costs are avoidable.
In decision analysis, the magnitude of any incremental gain that a particular cost
reduction decision will yield depends entirely on whether resources affected by the
decision can be eliminated or sold (i.e., if the resource is divisible, its cost can be
avoided). Similarly, resources needed for any increase in output can only be acquired in
certain divisible units. Thus, resource divisibility is one of the primary determinants of
For example: Consider a team of highly trained maintenance technicians whose
skills are in high demand in numerous industries. A low-cost equipment monitoring
system could save 1,000 hours of technician time per year. The maintenance technician
time is only divisible if one of the technicians is willing to work part-time or if the
company is willing to risk a lower level of maintenance coverage by eliminating a full-
time technician (assume 1,600 productive hours per technician per year).
Interdependence: A relation between managerial objectives that occurs because of a
decision to use resources to achieve one objective that affects the amount or quality of
resources required to achieve other objectives.
Interdependence is included in the framework because:
1. Interdependence has many qualitative dimensions that must be considered
when using information from a cost model.
2. It is a key causal factor (often qualitative) to be considered together with the
causal information the cost model provides.
3. It is a causal factor that can outweigh quantitative consumption relationships
and may therefore dictate selecting a decision alternative that might
otherwise be considered suboptimal.
Interdependence highlights the need in analysis and decision making to consider
cause and effect relationships other than pure consumption causal relationships. Such
interdependencies are typically decision-specific and are difficult to model ex ante in the
cost model. Nevertheless, it is often possible to infer interdependence when considering
the operational cause and effect relations incorporated in the cost model. For example,
opening a new plant, Plant B, may require that talented people from an existing Plant A
be transferred to the new plant to help train the new workforce and establish operations
quicker. This will have a direct impact on the productivity and costs of Plant A that will be
apparent to managers but may be difficult to quantify.
The concept of interdependence highlights the criticality of understanding the
operations of an organization holistically. No model, whether cost-oriented or purely
operational, can substitute for a functional understanding of the physical operations
performed to create value in an organization. Without this understanding, the risk that
even high-quality data and carefully constructed information will lead to less than optimal
decisions remains great.
Interchangeability: An attribute of any two or more resources or resource outputs that
can be substituted for each other without affecting the costs of the other resources that
are required to carry out the activities to which the interchangeable resources are
Interchangeability is included in the framework for the following reasons:
1. The wide range of resources that can be substituted and the speed with
which they can be substituted will exceed the ability of a model to adapt.
2. Resource fungibility (i.e., a resource with the capability to be used in various
productive processes), not necessarily currently modeled and could be a
viable alternative in many decision scenarios.
3. Managers need to consider all options for achieving managerial objectives in
a timely manner.
The effects of interchangeability or a lack thereof can often also be gleaned after
the fact from the cause and effect insights incorporated in the cost model. For example,
two workers do the same type of work, but one is less skilled and requires more
inspection and rework. These workers are interchangeable but will change the cost
structure of the resource pool. The cost impact of interchangeability is normally apparent
in a historical analysis but is difficult to model since it is often unknown beforehand
whether the substitution will be feasible or acceptable (e.g., to the customer).
Table 3: Information Use Concepts
Information Use Concepts
Primarily relevant to analysis:
A characteristic of an input that allows for the input (and
hence its costs) to be eliminated as a result of a decision.
A characteristic of a resource that allows it to be associated
in its entirety with the change in a managerial objectives
output resulting from a decision.
Primarily relevant to decision making:
A relation between managerial objectives that occurs
because of a decision to use resources to achieve one
objective that affects the amount or quality of resources
required to achieve other objectives.
An attribute of any two or more resources or resource
outputs that can be substituted for each other without
affecting the costs of the other resources that are required
to carry out the activities to which the interchangeable
resources are devoted.
Section III.C: Constraints for Managerial Costing
Constraints for Managerial Costing
Within this framework, we started with principles and then defined supporting
concepts. In turn, constraints are a boundary of the zone in which principles and
concepts are allowed to govern. For this document, constraints are the implicit
requirements that qualify applying modeling and information concepts. Concepts that
meet the qualifying boundary requirements are included; other concepts are irrelevant.
Most of the constraints identified are not absolute but operate within a range. If a
concept is applied with integrity to its definition and within the boundaries of the
framework constraints, a higher-quality cost model and better decision-support
information will result.
This section will first discuss constraints applicable to modeling, the left side of
Figure 15, and then those that apply when cost information is used, the right side of
Figure 15.
Figure 15: Constraints for Managerial Costing
Cost Modeling Constraints
Five constraints are applied to the concepts associated with managerial cost
modeling: objectivity, accuracy, verifiability, measurability, and materiality.
Objectivity: A characteristic of a cost model that shows it to be free of any biases.
A cost model should be free from intentional bias. This is a fundamental goal, a
basic requirement, and hence it is a constraint. Modeling with the intention of producing
a biased result falls outside the scope of this framework.
Objectivity is established during cost model construction when decisions are
made about which organizational resources and outputs to include in the model and how
they should be modeled. Thus, managerial costing information can only be objective if
the model that produces that information is constructed in an unbiased manner.
Objectivity reinforces the application of the Correspondence Definition of Truth, which
stresses that truth is based on observable facts.
This framework seeks to establish the principles, concepts, and constraints for
modeling an organizations operations and resources as they can be verified. The
model serves as the baseline for a wide variety of planning and analysis activities. When
planning and analysis are performed, a range of assumptions with varying probabilities
of success will be examined. Objectivity, as framed here, applies to the baseline model.
Failure to apply objectivity when constructing the model will invalidate planning
assumptions and skew planning, analysis efforts, and results.
Consider the following example. When considering a change to a process, one is
interested in possible unintended consequences. Therefore, it is common for a decision
maker to desire to know the maximum amount of costs that could result from remotely
possible, but damaging, unintended consequences from a process change. This type of
analysis can be useful and is not meant to be discouraged by the operation of the
objectivity constraint.
Accuracy: The degree to which managerial costing information reflects the concepts you
intended to model.
A cost model should reflect the concepts and principles explained in this
framework; that is, a managerial costing model should reflect essential and important
relationships and their cumulative effects (i.e., costs). Cost modeling not intended to do
so lies outside of the scope of this documentfor example, costing for tax or external
financial reporting must subordinate the principles and concepts in this framework to
generally accepted accounting principles or tax laws.
It is important to recognize that accuracy in reference to cost is normally
associated with a numerical output; that is not the case in this framework. This constraint
focuses on the accuracy of the relationships between resources and managerial
objectives. Even with this nonfinancial focus, accuracy is conditional to the context for
which cost information is to be used. That is, an organization with razor-thin margins
requires more accuracy in modeling the relationships generating their cost information
than a company with 80% or 90% margins.
Verifiability: A characteristic of modeling information that leads independent reviewers to
arrive at similar conclusions.
An objective of a modeler is to create a model that could be reviewed by an
independent person who would arrive at similar conclusions about the models design.
Cost models should be designed and developed in such a way that a user should at all
times be able to determine or test the accuracy or correctness of the assumptions
represented. Verifiability of cost information is crucial to users trusting what the model
In this framework, information refers foremost to quantitative, nonfinancial
operations information reflecting the flow of economic goods and services. These
quantities are subject to the verifiability constraint since they serve as the foundation for
modeling and valuation. Cost model information should be verifiable as a feature of each
quantitative input unit.
In scientific research, scientists often attempt to verify the findings of research
published by other scientists. To accomplish this, they must be provided the same
starting information and test procedures to conduct their experiments and verify the
published results. This context applies to verifiability in cost modeling.
Measurability: A characteristic of a causal relationship enabling it to be quantified with a
reasonable amount of effort.
The measurability constraint requires a cost modeler to create a model with
relationships that are quantifiable with a reasonable amount of effort. In the past, prior to
the easy availability of data provided by integrated enterprise-wide data warehouses,
this measurability constraint was very restrictive. In most cases, it limited cost modelers
to financial transactions and account balances available in general ledgers and
subledgers. However, the German Grenzplankostenrechnung (GPK) approach has
shown that integrated data orientation allows for far more detail in management
accounting with less effort (Friedl, 2006). Moreover, due to the real-time nature of
operational controls, the typical shop floor collects data in excess of that needed to meet
the demands of managerial costings measurability constraint. This data can be used to
model far more detail and accuracy, if warranted. For example, checkouts of jigs and
dies from the tool crib in a machine shop are tracked by job and employee in a log; most
cost models would be satisfied with knowing only which jigs and dies of significant cost
(i.e., the material ones) were used on a job.
Measurability is a constraint that is also applied by production/operations in
determining the quantitative information they use. Cost modeling that uses integrated
data orientation is, in many cases, in a position to accept production/operations
application of the measurability constraint. The Managerial Costing Frameworks focus
on operational quantities (instead of modeling abstract dollar amounts alone) provides a
clear option to achieve better measurability and organizational linkage when
production/operations has already made judgments about the appropriate levels of
tracking for resources, managerial objectives, and relationships. It is unlikely a cost
model will need the same, much less a greater, level of detail.
Materiality: A characteristic of cost modeling that would allow for simplification without
compromising managers decision-making needs.
An objective of a modeler is to create a model that is parsimonious in the sense
that it includes no unnecessary details. The materiality constraint requires that cost
modelers simplify without compromising the information needs of managers.
Measurability and materiality function as counterweights to each other. As mentioned
earlier, the level of detail and accuracy required depends on the uses of the information,
but the incremental benefits of the greater visibility that results from the additional effort
to attain it must exceed the incremental administrative effort to collect the data.
Materiality has traditionally been defined in terms of the error that results
because significant information has been omitted. Frequently, information is lost as a
result of aggregating, which reduces effort but causes a loss of information that a finer
level of detail would provide.
Such aggregation reduces the time and effort required to store and use data that
was appropriate in the past. Today, though, with integrated data, the need to
compromise using aggregation has been reduced because the effort required to
measure has been reduced. The measurability constraint is now less restrictive. Fewer
inputs need to be excluded from cost models because of the effort to measure them. In
fact, managerial costings issue is no longer the effort of collecting an appropriate level
of detail but that of weeding out unnecessary operational detail. The application of the
materiality constraint has changed from minimizing the error in cost measurement
information due to compromises in implementation (i.e., aggregation) to that of
appropriately reducing unnecessary detail in order to satisfy managers analogous
Information Use Constraints
As previously illustrated in Figure 15, two constraints are applied to the concepts
associated with the use of cost model information: Impartiality and Congruence.
Impartiality: The unbiased consideration of all resource application alternatives.
Impartiality is an important component of any optimization activity in that it
recognizes the need for (1) a lack of prejudice on the part of managers, and (2)
consideration of all options for applying resources.
In one sense, this constraint is similar to the objectivity constraint in modeling.
However, in using managerial costing information, the added requirement is that
managers should not limit themselves to merely those opportunities that are obvious and
conventional. Creative, entrepreneurial evaluations of the situation are required;
managers must assess a wide range of alternatives.
Managerial costing analysis needs to present the facts and data associated with
all alternatives from the cost model for use in decision making in a professional and
impartial manner. The recommendations of management accountants and decisions
made by managers seldom rest solely on the results of cost modeling but are affected by
qualitative managerial and behavioral factors as well.
Congruence: The interdependence of individual managerial actions to attempt to achieve
both individual and enterprise objectives in an optimal manner.
Congruence requires that managers recognize the dependence of overall
enterprise optimization on their individual actions. Enterprise strategy expresses
enterprise objectives and the path to achieving them with actions, projects, and changes.
Cost information plays an important role in supporting managers in achieving these
objectives in an optimal manner. The selection of the most congruent alternative is
informed by a managers evaluation of the incremental gain of all related resource
application alternatives as well as all relevant qualitative causal aspects, such as
customers likely reaction to a price increase on a product that can easily be substituted
or the impact on an organizations reputation. All other things being equal, the alternative
with the largest incremental overall gain over the status quo, despite potential localized
suboptimal outcomes, is the optimal solution and the one that satisfies the congruence
This constraint recognizes that cost information is not the only factor in decision
making; however, cost information and the supporting cost model should facilitate
congruent action from an objective, quantitative perspective.
Table 4: Constraints for Managerial Costing
Constraints for Managerial Costing
Modeling Constraints
A characteristic of a cost model that shows it to be free of any
The degree to which managerial costing information reflects
the concepts you intended to model.
A characteristic of modeling information that leads
independent reviewers to arrive at similar conclusions.
A characteristic of a causal relationship enabling it to be
quantified with a reasonable amount of effort.
A characteristic of cost modeling that would allow for
simplification without compromising managers decision-
making needs.
Information Use Constraints
The unbiased consideration of all resource application
The interdependence of individual managerial actions to
attempt to achieve both individual and enterprise objectives in
an optimal manner.
Figure 16: Summary Principles, Concepts & Constraints
Section IV: Call to Action
Call to Action for Improving Managerial Costing
This managerial costing conceptual framework presents principles, concepts,
and constraints to guide the profession in providing managers with the cost model and
decision-support information they need to be effective. As the authors conclude this
document, a valid question is, “Why should management accountants adopt, foster, and
promote the framework?” In this section, key aspects of the framework are summarized
to show why the framework is important, not just to the profession and its customers
(i.e., managers) but to the larger business community and beyond.
Managerial Costing and Customer Focus
Over the last three decades, management accounting’s costing practices have
seen a number of innovations. These included activity-based costing (ABC), resource
consumption accounting (RCA), and extensions of either operational scheduling (e.g.,
theory of constraints [TOC]) or manufacturing strategies (e.g., lean accounting [LA]). In
retrospect, these advances now seem to have been inevitable as the profession came to
terms with its stagnation, confined as it was to the narrow area of cost accounting. That
is, product costing, transfer pricing, and inventory valuation that marked more than half a
century (before the late 1970s and early 1980s) of domination by financial accounting
and its focus on external reporting for regulatory compliance.
However, upsetting the traditional standard costing apple cart, in the United
States at least, brought new opportunities to the profession. Where there once was a
dominant way of doing things, the managerial costing landscape was suddenly in
turmoil. This is nowhere more evident than in management accounting’s discourse
during this time, which became at times less than civil as proponents of now-competing
approaches jockeyed for position; competing approaches often contradicted each other.
Small wonder that research reveals the real casualty of the profession’s foray into an
“anything goes” landscape was its customers.
Purely from an internal perspective, the profession has a compelling need for a
framework to consolidate the experience and learning that now touches three centuries,
and, in particular, to consolidate the expansion in developments in recent decades. Such
a framework has never been successfully deployed, and at this point there is an obvious
need for management accounting to get its costing house in order. Management
accountants need to provide their customers a logical, structured, and orderly way to go
about managerial costing or the profession will find its customers indifferent. The result
will be that managerial costing is viewed as a minefield where the narrow needs for cost
accounting to support financial reporting is the only safe path. Other approaches to
costing will be viewed as high-risk endeavors. Managers need what managerial costing
can provide. This is clearly illustrated by the stand-alone manufacturing initiatives (e.g.,
TOC and LA) where production and operations managers have sought to generate the
A. Garg et al., “Roles and Practices”; Ernst and Young, “2003 Survey of Mangagement.”
B. D. Clinton and L. R. White, “Roles and Practices in Management Accounting.”
information they needed largely on their own. If the profession fails them, managers will
find alternative sources for solutions.
Notwithstanding this compelling case for the framework from within the
profession, the authors see far greater and wider-ranging benefits when adopting a
customer focus with the managerial costing framework as the foundation. Using the
framework with primarily an inward focus will solve the problems created by a process of
innovation that was improperly managed in the first place. But overt introspection,
whether to come to terms with infighting or to clean up after the brawl, loses sight of the
profession’s primary purpose. The profession has not been adding value to its
customers as it should have. Asking for a time-out to fix what the profession had
managed poorly will just further delay real and tangible contributions to our customers.
The authors explore below the case for adding more substantive value to our
customers starting now. The motivation for applying the framework is discussed from the
perspective of managerial costing’s scope and the need for optimization in business and
the larger community.
What Managerial Costing Can Achieve
The Introduction, Sections I, and Section II described the benefits, objective, and
scope of managerial costing as all those areas of business activity and managerial
processes in which costing and operations play a key role. In the principles section and
the Appendix on truth, the foundation for managerial costing, the authors spotlighted the
pivotal role of managerial cost information in all managerial actions.
Without relevant and useful operational and corresponding cost information,
managers at best fly blind and at worst are misled. If managers have good operational
information but lack corresponding cost insights, they can only guess the net impact on
the bottom line of alternative courses of action. High-quality managerial cost information
is vital to managers’ predictive needs—from strategic envisioning and organizational
planning to simulation, profitability analysis, setting cost and performance standards, and
making cost estimates. Additionally, tactical and operational decisions such as
controlling cost and performance, evaluating opportunities, making investments, and
supporting continuous improvement and organizational learning require a clear causal
relationship between cost and operations, which is the purpose of managerial costing.
Management accounting’s sphere of influence is undeniably extensive, and the
managerial costing framework, solidly grounded in the laws of logic and principles of
decision science, can yield significant improvements in supporting analysis and decision
making. But these benefits for the profession’s customers reveal only part of what stands
to be gained. The authors propose that more significant benefits can be realized.
Optimization refers to the need to do more with less or, ideally, do the most with
the least. This process starts with applying optimization thinking to every decision made.
Managerial costing’s role in this regard is unique because money serves as a common
denominator allowing for the evaluation of incomparable alternatives in decision making.
Management accounting is the only discipline with the explicit objective, know-how, and
experienceas reflected in the managerial costing frameworkthat can provide such
comparative information at the point of decision making. Managerial costing stands
alone in its ability to enable optimization from the bottom up (one decision at a time) in
all the areas of its scope.
When the need arises to make trade-offs between conflicting locally optimal
outcomes, managerial costing’s unique strength comes to the fore yet again. On the
topic of optimization, managerial costing has no peer, and it is here where the much
broader and more significant benefits of the managerial costing framework can be found
for the management accounting profession.
Consider the need for optimization not merely at the operating division or
company level but also at the national or even global level. Resources are always limited
and clear signs are even more evident, such as upward trends in major commodity
prices, that natural resource scarcity will become a major twenty-first century challenge.
The magnitude of this challenge becomes evident when considering that both the
Chinese and Indian economies have the potential to each be three times the size of the
U.S. economy. Just by considering energy resources alone, the twenty-first century
clearly will require not only prudent but also optimal use of natural resources.
Is There a Quantitative Justification for Better Costing?
Consider how you would measure the impact of better decisions resulting from
having more accurate and explanative information from a good managerial costing
system. You might eventually conclude that the many improvement and change
initiatives organizations pursue (e.g., total quality management, lean management,
process reengineering) are occurring simultaneously. As a result, it is nearly impossible
to trace benefits, such as cost savings or cost avoidance, directly to an individual change
One step removed from this quantitative measurement challenge is the
measurement of qualitative effects that better information from improved costing can
have. Improved costing serves to enable all improvement programs and the operational
decisions managers make with those programs in place. Continuous improvement is
now part of most companies’ DNA, and providing appropriate cost measurements is vital
to a company’s success. Adapting a common set of costing principles and criteria with a
strong focus on truth as outlined in the framework is key to providing the needed cost
measurement support.
The Call to Action
A house is built from the bottom upbrick by brick, frame by frame, whether that
house is your career, the company you work for that you and other stakeholders are
vested in, or your nation’s economic well-being. No profession rivals management
accounting in determining how efficiently and effectively that house is built and
As manifested in the principles anchoring the managerial costing framework, the
accounting profession holds one of the keys to enable better decision making. Every
decision that managers, companies, and governments make is a resource application
decision. Will the management accounting profession rise to the challenge to have a real
and substantive impact on cost methodology in an environment in dire need of sound
guidance? To rewrite a quotation from Albert Einstein that expresses the profession’s
challenge appropriately, The management accountant must not merely wait and
criticize, he must embrace, defend and promote the cause the best he can. The fate of
the profession will be such as the profession deserves.
Adapted from Albert Einstein: The individual must not merely wait and criticize, he must defend
the cause the best he can. The fate of the world will be such as the world deserves.
Appendix A: Truth as a Foundation for Managerial Costing
The Foundation of Truth for Managerial Costing
The concept of truth is something every management accountant is familiar with,
not only at a personal level, but also as far as our discipline is concerned. We can all
spot a wayward allocation from a mile away; in fact every manager can, particularly
when it looms large on a cost report with no clear causal relationship to the outputs. The
statement that the managerial costing framework is based on a foundation of truth
captures this reality. That is, there are wrong ways to do costing and therefore there
must be better ways to provide decision-support information. It is this foundation of truth
that will be the focus of this appendix.
The framework anchors this pursuit of truth by using the principles of the
scientific method as the principles for managerial costing. The principles, causality and
analogy, enable scientists to deal with causes and their effects in different time frames
such as in forensics that seeks to understand events in the past. Though managerial
costing may not be a science, it nonetheless is informed by science. But decision
sciencewhich managerial costing supports with the information it providesis a
science. Managers make inferences about future outcomes of decision alternatives they
are considering based on cause and effect insights. The information managerial costing
provides therefore needs to be compiled using principles that support managers’
application of decision-science practices.
However, a healthy dose of caution should accompany any insistence on
absolute truth in managerial costing. This is because you can be off by mere pennies
and reflect a profitable customer or product as unprofitable; the world is just not that
simple and practice defies such outright idealism. Therefore, the first order of business is
to define what is meant by the following statement: Truth is the foundation for
managerial costing. This will be done by pointing out what the statement does not mean,
and then by a more in-depth discussion of what it does mean.
The Ultimate Objective is Not Precision
In line with the need for caution noted above, the first objection one commonly
encounters on the topic of truth in managerial costing is the following: consistently
obtaining an absolutely truthful number in managerial costing is cost-prohibitive, if not
impossible. And without any fear of contradicting our assertion of the existence of an
underlying truth in managerial costing, we agree: an absolutely precise cost number is
often an unrealistic objective.
First, a customer who is only marginally profitable or marginally unprofitable is
almost always unwanted. Neither the capital markets nor the entrepreneur seeking
ample reward for the risk taken tolerates a business that squeezes out a return
measured at the second decimal. The reality is that managers do not need an absolutely
precise number to select the optimal outcome from among the alternatives under
Second, the objection mischaracterizes the statement concerning truth in
managerial costing. Truth is the foundation for managerial costing and not an idealistic
and precise number that must be achieved at all cost and at all times. In the framework,
accuracy is a constraint of managerial information and not the overarching objective. As
discussed, the degree to which this attribute should approach the absolutely accurate
cost number will vary based on a variety of factors for each company. For example, for a
company with very thin margins, a highly competitive environment, and a diverse
product portfolio, accuracy will be more important than it would be to a company with
80% gross margins and very little competition. Materiality and measurability constraints
discussed in the framework allow ample room to evaluate degrees of accuracy, and the
principle of analogy guides the management accountant toward management’s decision
support needs.
In considering the need for truth, the reality of imprecision or the degree of
accuracy achieved in managerial costing is not an argument against it. Using the
framework to guide managerial cost model design will result in information that is more
representative of the underlying absolutely accurate cost number. This is due to the
framework’s inherent recognition of truth as the foundation for managerial costing, and
not as the explicit objective of the framework or the proposed truth statement. When it
comes to accuracy, it is better to be approximately right than completely wrong in a very
precise manner.
The Meaning of Truth as the Foundation of Managerial Costing
Having identified what is not meant by truth as a foundation for managerial
costing, it is important to define what is meant by truth as a foundation for managerial
Tying Truth to the Essence of Managerial Costing
Understanding what truth means as the foundation of managerial costing starts
with recognizing the essence of what managerial costing sets out to achieve. That is, it is
a discipline that provides managers with insight into their organization’s operational
resources, their consumption, and their outputs in monetary terms. As reflected in IMA’s
definition of management accounting, this information is essential for various managerial
and organizational processes.
Managerial costing is tasked with providing a monetary reflection of the
resources and their application that managers use to achieve strategic objectives. The
reflective nature of managerial costing information is paramount for two reasons: (1) it
highlights how managers use managerial costing information, and (2) it points to an
appropriate definition for truth in managerial costing. These two aspects are discussed in
the next two sections.
The Laws of Logic
Managerial costing communicates to managers the state, capabilities,
application, and outputs of an organization’s resources in monetary terms. As with all
communications, certain ground rules apply. These rules ensure the information
communicated is logical and well understood. For example, consider the statement, “We
are going out of business because of a superseding technology; therefore, we will be
investing $5 million in the old technology.” Also consider the following: “We sold zero of
Product 123 last month but our gross sales for Product 123 last month was $1 million.”
These examples each violate one of the two laws of logic that underlie managerial
costing’s ability to provide accurate reflective insights to managers. The first example
violates the law of rational inference: that is, the reasoning is simply irrational. The
second example violates the law of non-contradiction: that is, the first part of the
statement is contradicted by the second part).
The need for the managerial cost model to be a logical representation of the
enterprise’s operations is obvious; managers cannot and should not be misled or
misguided in their attempts to understand the financial implications of a particular
decision alternative or operational outcome. Managerial costing is a crucial tool in the
manager’s toolbox that aids in optimization endeavors. For example, managers often
observe a result, such as an unprofitable product, and attempt to understand the reason
or cause behind it (i.e., managers reason inductively from an effect to its cause). Or in
decision making, managers evaluate a number of alternatives and select the one with
the optimal outcome (i.e., managers reason deductively from the cause (decision) to its
effect). This understanding of how managers use managerial costing information
crystallizes what it means for the cost model to be reflective of operations. Managerial
costing must reflect operational cause and effect relationships and value them with
money in order to support managers’ inductive and deductive thinking processes. These
processes include all aspects of planning, simulation, analysis, control activities, and
decision making. The law of rational inference (i.e., the relation between a cause and its
effect) determines the structure of managerial costing information, and in the framework,
it is embodied in the principle of causality.
This is the limit of how far the law of rational inference will take us in
demonstrating managerial costing’s foundation of truth. It falls to the law of non-
contradiction to anchor managerial costing to the bedrock of truth.
The Foundation for Managerial Costing
In presenting managers with cause and effect insights, managerial costing
should provide financial information that accurately reflects the reality (the operational
facts) that managers seek to understand. The requirement is simply this: Managerial
costing information must be a true reflection of the underlying operational facts it
represents. In epistemology, the branch of philosophy that deals with the theory of
knowledge, such a definition of truth has existed for more than two millenniums. Aristotle
(384322 BC) is credited with the correspondence definition of truth: “To say of what is
that it is not, or of what is not that it is, is false; while to say of what is that it is, and what
is not that it is not, is true” (Morris, 46).
This definition comes across as verbose, but it can be more succinctly
expressed as: telling it like it is. A modern version of the correspondence definition of
truth is the following: a statement or opinion is true if what it corresponds to is a fact
(Angeles, 317). For managerial costing, this means corresponding to the facts of the
operations that it strives to provide insights into. The law of non-contradiction,
epitomized in the correspondence definition of truth serves to bridge the gap and anchor
managerial costing to a bedrock of truth.
The recognition of the need for truth is so fundamental that it often goes without
saying. Above, we have used a philosophical basis (the laws of logic) to show that truth
in managerial costing is indispensable. But one finds truth permeating the profession
throughout its history. For example, Church in the early 1900s said the following
concerning managerial costing: It is very important that costs should not be regarded as
something that may be manipulated, nor should they be thought of as representing
anything but the cold truth, however unwelcome that may be (Church, 37, emphasis in
the original).
A concerted effort in the 1940s and 1950s by the Committee on Cost Accounting
Concepts and Standards (CACS) to define principles for management accounting
culminated in a number of principled statements. A foundational aspect recognized by
CACS was that the cost accountant was concerned not merely with the presentation of
facts, but his objective was, in so far as possible, a presentation of the truth of the facts
(Benninger, 35).
In the current business environment, truth finds even more forceful application in
accounting generally. For example, when CEOs and CFOs certify a company’s financial
statementsfor which managerial costing provides key inputswith the declaration that
the information “does not contain any untrue statement and is “not misleading and
“fairly represents … the financial position, truth can hardly be more in the forefront.
The law also ties clear punitive consequences to any misstatements (untruths) in
accounting information. The basis of truth upon which C-level executives are prosecuted
and imprisoned (as has happened) is in plain view and recognized by all.
Objections to Truth in Managerial Costing
As fundamental and necessary as truth is to managerial costing, it could be
argued that objections border on the bizarre and should be summarily dismissed.
However, answering a number of common objections to truth as managerial costing’s
foundation serves three purposes: (1) to better understand truth in managerial costing,
(2) to clarify truth’s application in managerial costing, and (3) to preemptively defend the
managerial costing framework by pointing out weaknesses and fallacies in common
objections to truth as its foundation. For these reasons, this section will address a
number of commonly encountered objections.
The objections to truth as the foundation of managerial costing span the gambit.
They include a highbrow disdain for truth in general, confusing the subjective nature of
The Sarbanes-Oxley Act, 2002, Section 302-2.
the agent in managerial costing (i.e., the management accountant) with the profession’s
overarching objective, and perpetuating cultural relativism. The latter refers to the denial
that absolute truths exist at all. We will address all of these.
The Highbrow Objection: Insisting on truth as the bedrock of managerial
costing is pious, arrogant, and hypocritical.” The framework, of course, is none of these
things. On the contrary, acknowledgingas the bedrock of truth doesthat there is
something bigger to managerial costing than each of us, or even all of us, is humbling. It
is the exact opposite of arrogance, highbrow piety, and hypocrisy to admit that the best
we can do is to strive to attain a completely accurate cost. In this regard, the framework
acknowledges the many compromises that must be made in applying its concepts and
The Subjective Agent Objection: “Accountants are subjective ‘constructors of
reality’ presenting and representing the situations in limited and one-sided ways
(Morgan, 478). In other words, the notion of truth in managerial costing is indefensible
since each management accountant brings his own biases, preferences, and
motivations to the cost model constructed. The subjective nature of the agent in
managerial costing is no doubt the case, and this is one of the aspects that the
managerial costing framework seeks to address. The subjective agent aspect inherent in
managerial costing is a prime reason for having a framework with a clear foundation
based on truth and corresponding principles, not an objection!
The Ruse Objection: Truth in managerial costing is a ruse since everything is
based on assumptions. This objection usually surfaces with cost estimates or other
predictive uses of managerial costing information. The objection is, of course, itself a
ruse because much concrete, factual information is known about the organization: its
resources, their capabilities, the company’s products and services, and related strategic
objectives. Such known facts form the basis upon which assumptions in managerial
costing are logically formed; no manager will be tolerated for assuming they were in the
bread business, and purchased tons of flour, when the company has been solely
focused on making computer chips right under his nose for fifteen years. Assumptions
require a basis of truth, and a structure within which to be accommodated to produce
useful predictive information. Like the previous objection, the ruse objection is an
argument in favor of the need for a managerial costing framework based on truth and
logic. The Dumbing Down Objection: “Truth cannot be absolute because knowledge
is ever growing and expanding. Or, what is true today may be false tomorrow. For
example, activity based costing (ABC) broke the standard costing truth-mold and
revealed the pitfalls of assigning indirect costs based on volume. This objection fails to
note that it is not the truth that changed, but management accountants’ understanding of
it. ABC’s insight was not a case of moving from an old truth to a new one; it was instead
forsaking an old error for a more complete insight into an existing truth.
The Stifling Objection: Adopting an absolute truth perspective stifles progress
and innovation.” But knowledge expands on the back of truth. As indicated above by the
ABC example, this objection has no leg to stand on. Adopting an absolute truth view
does not prevent new facts from being uncovered nor more complete insight into the
truth. On the contrary, truth provides a foundation for critical evaluation and real
The Progression Objection: Approaches in managerial costing are not equals,
but merely stages in the development to a mature/ultimate solution.” The fact that
pundits do not readily admit the inferiority of their respective approaches in a
comparative discussion should not be lost on the reader. Moreover, when it comes to
managerial costing solutions, managers, the consumers of solutions, seem to have lost
interest as they have grown confused. The many methods and claims concerning
managerial costing solutions must appear to them not as progress but as endless spin.
Nevertheless, this objection has merit insofar as a mature/ultimate solution can be
known. The framework is meant to provide the foundation and structure for
understanding the path toward a mature/ultimate solution and the compromises in
striving for such a managerial costing solution.
The What Works Objection: “You take what works for you and I will take what
works for me.”
This is an objection predicated on relativism in which people attempt to
come to terms with the anomalies in a relativist environment by adopting the pragmatic
view of truth. The problem with this view is that dishonesty has been known to work at
times; for those who don’t get caught it even works to fudge the numbers for the
company’s financial statements. Obviously what works is not the same as what is true or
right. The Feel Good Objection: Just do what you feel is right, or just do what makes
you feel good.” This is another relativist reduction of truth. However, the consequences
of such a subjective view in a discipline like managerial costing (where objectivity is
essential) should be sufficient to severely discount this approach. Even the term
“discipline” seems to imply a contradiction here. The complete disconnect between “what
feels good” and truth is illustrated by the fact that bad financial results do not make the
executive or the management accountant feel good, but are nevertheless true.
Disadvantages of the Relativist View in Managerial Costing
As stated above, relativism is the opposite of acknowledging the existence of
truth. At a very fundamental level, relativism’s claim that there are no absolute truths
also precludes its own claim from being true. The relativist’s claim needs itself to be true
to refute the existence of truth (that is, it violates the law of non-contradiction). Therefore,
relativism is self-defeating and as an alternative to the bedrock of truth generally it is
scoffed at in epistemology.
In its managerial costing disguise, relativism fails for the
same reason; one cannot claim that there is no single right approach while in the same
breath establishing an approachthat considers all views validas the one approach.
Going beyond the pure philosophical argument against relativism, the following
are undesirable consequences that result from applying the relativist view in managerial
Morris, 103: “Truth is the raw material for creativity.”
P. A. Angeles, HarperCollins Dictionary of Philosophy, 317.
Morris, 47.
1. Ambiguity, confusion, and frustration are the order of the day. If anything
goes, a statement such as “My company is a going concern and making money
but we are out of business now” has to stand. Of course, this is an absurd
statement; only one of the claims can be true. There is an obvious need to stifle
certain views and assertions.
2. If there is no standard or truth, on what basis are rogue theories challenged?
Therefore, not only does relativism allow for a cacophony of contradicting
theories and practices but there is no way to right the ship as long as relativism is
deemed a viable view.
3. The frequent bias resulting from those protecting vested interests causes the
discourse within the profession to swing wildly from factual statements to
character assassination.
4. If there is no truth, there is also no lieno error. A manager can commit the
blended cost concept error (that is, confuse operational costs of fixed/variable
with the decision concepts of unavoidable/avoidable) all day long and be none
the wiser for itever.
5. Real progress is stifled under relativism; practitioners cannot see the forest
from the trees to identify causes worthy of further pursuit. Moreover, critical
thinkinga key ingredient to progressis diminished in a relativist-oriented
discussion. Who is to say that any one approach is better than any other?
6. The lack of a recognized common frame of reference makes it difficult for the
profession to effectively communicate with those looking in from the outside (that
is, managers).
7. Management accountants are not able to make a convincing case for and
demonstrate how they add value to the enterprise beyond the limited application
established in standards for financial reporting.
The foundation of truth for managerial costing is absolutely essential, and its
essence must guide every aspect of managerial cost modeling. This is the premise upon
which the managerial costing framework is based as it strives to provide the structure
and the guidance to create information that will better support managers.
Appendix B: The Framework in Operation
Evaluating a Company’s Operations and Strategy for Modeling
Managerial costing is always accomplished in the context of supporting the
achievement of an organizations strategic objectives and optimizing its operations
toward that end. The managerial costing practitioner must evaluate, understand, and
incorporate the organizations strategy and operations into the design and construction
of an effective managerial cost model and apply the resulting decision-support
information effectively.
Where to Start
Current operations serve as the foundation for optimization information for the
following three reasons. First, at any point in time the organizations current investments
(resources deployed), its value chain, its products/services, and its market segments
and customers equate to the status quo, and collectively they are what managers are
tasked to use to achieve strategic objectives. Second, whenever change is to be
introduced, managers begin with the status quo as the baseline in their decision making
(i.e., any change must demonstrate a net incremental gain). Third, in evaluating decision
alternatives, managers best guidance as to future outcomes is often provided by their
understanding the cause and effect relationships inherent in the conversion process they
are attempting to influence and improve.
Enterprise Optimization Context, Aim and Scope
Managerial decisions that select optimal outcomes are the primary drivers for
best achieving strategic objectives. In turn, decision making is influenced by three
characteristics of a companys optimization environment that must be considered in
managerial costing conceptual design: context, aim, and scope.
The Context of Optimization Decisions
All optimization decisions occur within an industry environment, a competitive
situation, and the companys own current conditions and disposition. This is the
companys optimization context, and it determines the nature and frequency of the types
of decisions its managers will make. For example, within its context, selecting a new
facility location could be strategic to one company (e.g., Toyota opening a new truck
plant in Texas) and tactical to another (e.g., Starbucks opening another store on a
corner one block away). Similarly, one more unit of output will be an operational decision
for one company (e.g., an additional batch of dough for the local bakery) but a strategic
decision to another (e.g., Boeing considering whether to make a B737 or divert the
resources to B787 Dreamliner production to regain its competitive momentum vis-a-vis
Optimization context provides managerial costing with a frame of reference and
dictates the focus for supporting managers. For example, in a distribution business,
operational insights are critical to achieving internal efficiency (e.g., receiving, picking,
packing, and shipping) and to understand what a profitable minimum order size is. On
the other hand, in an outsourcing business, the mix of products and services (e.g.,
application hosting, infrastructure, and business processes) structured and priced for a
particular deal is often critical. These examples reveal the importance for decision
makers of understanding what it entails to arrive at an optimum outcome in different
contexts, insight for which managerial costing should be the primary contributor.
The Aim of an Optimization Decision
The aim of optimization decisions should not be confused with the decisions
outcome. Aim refers to a managerial actions strategic intentmore specifically, to
change strategy (an adaptive action) or to reinforce existing strategy (a corrective
Adaptive actions alter the companys existing strategy/plan because changes
in the internal or external environments nullified prior assumptions. An example is an
airline deciding on an earlier implementation of a fleet replacement program due to the
effects of global energy demand on crude oil prices. In contrast, corrective actions are
steps taken to bring an organization back on track with its existing objectives. For
example, a competitor introduced a new product, so corrective actions are required to
realize the planned market share target, which has fallen short.
The distinction between adaptive and corrective actions is important for
managerial costing because of different information requirements for each. Adaptive
actions are dependent on information that will assist managers in making extrapolations
and projections as to future outcomes. Managers are best served by cause and effect
information with appropriate structure and detail to facilitate their forward-looking
activities. In contrast, corrective actions are triggered by information providing insights
into the deviation of actual results from the plan or target. Here, the information focuses
on actual results and their causes and effects in order to help managers understand
what transpired and to guide appropriate corrective actions. The aims of optimization
decisions require managerial costing to support planning,
simulation, measurement,
and analysis through cause and effect insights. The principle of causality is therefore
essential to the effective support of managers optimization actions.
The historical data
is less important than the relationships. Relationships are essential for modeling the
future and understanding the past.
G. Shillinglaw, Managerial Cost Accounting, 8.
Budgeting is a form of planning. So are rolling financial forecasts. This article does not explicitly
discuss them, but they are implicit in the discussion. They are also only one type of decision of
the many that management accounting should support.
A. Van der Merwe, “Management Accounting Philosophy: Cornerstones for Restoration.”
Optimization Decisions and Their Scope
Optimization scope is comprised of two dimensions: (1) breadth, the value chain
areas targeted by a decision, and (2) depth, the extent of cost insights required to fully
understand a decisions impact/effects. Figure 17 demonstrates how these two
dimensions relate to the conversion process.
Figure 17: The Four Optimization Areas and Optimization Scope
Breadth consists of the four value chain optimization areas:
1. Sourcing resource/input markets. Here, decisions consider new technologies,
methods, and worker/equipment resources, and strive to maximize limited
capital resources through asset replacement, investment, sourcing, and
2. Applying resource/inputs in conversion. Efficiency is emphasizeddoing
things rightand decisions address resource application, utilization,
realignment or redeployment, process improvements, eliminating waste, and
capacity management.
3. Producing outputs. Effectiveness is the focus (doing the right things
producing the right outputs). Examples include decisions that deal with
product make-or-buy, supporting new product introduction, process
improvements, reengineering, and eliminating waste.
4. Realizing gain from enterprise outputs. This involves creating the desired
outcomes in product/service markets. Decisions cover target markets and
market segments, costs-to-serve these, product/service mix, product
discontinuance, entering new markets, creating new products/services for
existing markets, and market mining.
More incisive decisions typically span more than one value chain area. An
example is the introduction of the iPod, a new product creating a new market and
A. Van der Merwe, “Management Accounting Philosophy: Filling Up the Moat.”
requiring new technologies and inputs to produce. For managerial costing, the breadth of
optimization decisions dictates the types of managerial objectives
to use and calculate
values for in a model.
Depth is concerned with the information needs related to the magnitude of
change that result from optimization decisions. Incisive decisions require deeper insight
into causal relationships and the effects they are likely to have. To this end, decision-
support information must comprise a range of cost concepts that provides insight into the
level of optimization influence. The cost concepts include the following:
Throughput costs (when deciding to produce one additional unit within the
relevant range
Incremental costs (the difference in total costs between two alternatives in a
Short-term proportional costs (when considering the opportunity cost of
mutually exclusive uses of resources).
Attributable costs (for divestment decisions such as a bank outsourcing its
information technology function).
Full costs
(for strategic decisions, such as a tool manufacturer entering the
South American market by establishing a plant in the region).
For managerial costing, optimization context, aim, and scope, therefore, dictate
the level of detail for various cost concepts and the level of resource consumption and
cost modeling insight that must be provided. Moreover, the principle of causality is
essential as the basis for cost information; managerial activities are heavily dependent
on causal insights, and the accompanying monetary information managers rely on must
naturally be based on the same principle. In the outsourcing business example above,
insights key to success are resources (servers and network infrastructure) attributable
costs and the demand patterns for resource outputs (e.g., processing power and
bandwidth) and their incremental costs.
A cost model must generate decision-support information that appropriately
addresses the context, aim, and scope associated with an organization and its strategy.
The application of the managerial costing framework principlescausality and
analogyare universal. However, the management accountant will need to make
appropriate choices and trade-offs among the frameworks concepts and constraints in
order to find the correct balance and focus for any particular organization.
In managerial costing, the types of managerial objectives can include those related to
resources, work activities, products, service lines, distribution channels, and customers.
The relevant range is an economic term typically meaning a range where changes in demand
levels require proportional changes in consumed material but not in the worker or equipment
Often referred to as fully absorbed or fully loaded costs.
Model Design & Construction
Cost modeling entails the following six steps:
A. Identify the resources (and their costs) the organization retains for its use.
B. Identify the managerial objectives the resources support.
C. Develop an understanding of the cause and effect relations between
managerial objectives.
D. Design a model that captures the managerial objectives and their causal
E. Provide a description of the model to include its scope, intended uses,
required inputs, outputs, and underlying assumptions and limitations.
F. Apply and maintain the cost model.
A. Identify the resources (and their costs) the organization retains for its use.
In cases where integrated data orientation is lacking, an organizations general
ledger is a good starting point, usually adequate for identifying the costs of resources it
procures and the expenses for them.
Additionally, an understanding of each type of
resources inherent characteristics is needed, which starts with an understanding of the
physical entities that managers oversee and about which they make application
decisions. Specifically, a modeler needs to understand each resources output,
storability, and cost behavior characteristics. The latter refers to how the resources
various cost components behave in relation to its output (i.e., whether the cost change is
proportionate to output or remains fixedthe concept of responsiveness).
B. Identify the managerial objectives the resources support.
A cost model reflects the reality of an organizations resources, the work and
outputs of the resources, and how the work and output are consumed in producing
intermediate and final outputs. One must understand an organization in all these
respects in order to establish managerial objectives that are representative and will
provide useful causal insights and related cost information.
Managerial objectives can be grouped into three tiers:
Tier 1 is for resources and their outputs, which comprise resource pools and
Tier 2 is for products and services, including production orders, service
orders, and projects.
Tier 3 is for result segments, including entity level (e.g., plant, business unit,
or legal entity), market segment, and target market cost objects. In for profit
However, the general ledger is inadequate for many other cost modeling needs.
entities, these managerial objectives also generate revenue to enable
profitability management.
As discussed in Part IV.A of the framework, the particular managerial objectives a
modeler will employ are determined by managers analogous needs. That is, managers
planning, analytical, decision-making, and optimization needs determine which of the
above managerial objectives are used and at what level of granularity they are
established. At the very least, they should correspond to individual managers areas of
C. Develop an understanding of the cause and effect relations between
managerial objectives.
Resources, captured in first-tier managerial objectives, are used to provide
outputs that represent ultimate managerial objectives as well as outputs that become
inputs used in achieving intermediate managerial objectives. In managerial costing, this
system of inputs, intermediate outputs, and ultimate outputs must be understood and
modeled. The model captures an organizations cause and effect relationships, which (in
turn) serve as the basis for assigning resource costs through the model. Figure 18 is an
example of input and output causal relations within such a system.
Figure 18: Inputs and Outputs Within a System
D. Design a model that captures the managerial objectives and their causal
Adapted from G. Mobus, “Question Everything”although there is nothing particularly novel
about Mobus’ graphic.
Causal Relation
Equipped with an understanding of the organization, its objectives, managers
needs, its resources, their activities, and outputs, a management accountant can begin
the tasks of designing an adequate representation of the relationships between
resources and their consumers, expressed in quantitative inputoutput relationships.
Once this quantitative model is established, resource costs serve to value the model in
decision-appropriate monetary terms.
A set of illustrations is provided in the section (below) Illustrated Scenarios for
Designing a Cost Model. The scenarios will shed more light on this step in the
conceptual design. The scenarios presented discuss some of the most common cost-
determination challenges, relating them to the concepts presented in the framework.
E. Provide a description of the model to include its scope, intended uses,
required inputs, outputs, and underlying assumptions and limitations.
It is crucial that users of cost information understand not only the principles
inherent in their cost models conceptual design but also what the underlying
assumptions are that went into constructing the model and the models limitations. For
example, if financial depreciation is used, users must recognize the limitations of the
model in providing insight into product life-cycle profitability and the compromises in
product/service gross margins due to the forced and often much shorter asset life used
in financial depreciation compared to the actual economic life of the asset. That is, while
the asset is being depreciated, products/services will be over-costed, and once the asset
is fully depreciated, products/services will be under-costed.
F. Apply and maintain the cost model.
By feeding resource costs and output quantities into a completed model, one can
calculate costs for the various managerial objectives specified. These costs, then, are
available for use in monitoring and decision-making activities. Keeping the model
current, including adapting it to managers changing analogous needs, is a vital part of
consistently providing managers with relevant information. In model conceptual design,
the constraints in the framework related to modeling (e.g., measurability and materiality)
and to managers analogous needs play an important role in curbing the size and
complexity of the model. Countless managerial costing initiatives have failed because
modelers were oblivious to what it would take to maintain their unrestrained conceptual
design effort.
Illustrative Scenarios for Designing a Cost Model
In order to illustrate applying the conceptual framework in designing a cost
model, we will use the simplified setting of an airline as an example. We will work only
with a subset of the airlines resources and managerial objectivesjust those necessary
to illustrate some key points.
For these purposes we will consider only three resources:
Aircraft fuel
An Aircraft
Only four managerial objectives will be considered in the illustrative example:
Operate Flight 123.
Provide a trip for a coach class passenger to Destination X.
Operate a daily flight to Destination X.
Serve Destination X with a daily frequency of flights and two passenger
Our discussion here will follow a progression intended to be easily followed that
addresses the managerial costing concepts identified in the two categories used in the
framework, namely, Modeling Concepts and Information Use Concepts. Although this
part of Appendix B is primarily concerned with model design and construction, we are
including a limited application of information use concepts to clearly delineate concepts
that can be confusing, in particular, causality (a modeling concept) and avoidability (an
information use concept).
The concepts that will be illustrated are the following:
Modeling Concepts
Managerial Objective
Integrated data
Information Use Concepts
This subsection begins by introducing a resource required to achieve a particular
managerial objective: aircraft fuel to provide a specific flight. From there we alter the
example by changing the assumption about how the airline acquires fuel. In order to
cover other concepts, the discussion proceeds to add an additional resource, pilots, and
an additional managerial objective, which will bring the airlines customers into focus.
That is, this discussion starts with product-costing before extending to result segments.
These scenarios will allow us to touch upon all the concepts in the framework.
In the fuel resource discussion, we will address characteristics inherent in the
resource itself and in the manner in which it is consumed by the airline. This will facilitate
a discussion on types of resources and their characteristics that are important to
optimization. With the discussion of airline pilots, in addition to introducing the need to
provide cost information about a second managerial objective, we will address some
common capacity issues.
Scenario 1. Fuel for Flights with Fuel Purchased for Each Flight.
Lets assume that an airline purchases fuel for each flight in exactly the quantity
required to perform the flight; that is, prior to each flight, the airline purchases from the
outside supplier the fuel required to fly to its next airport directly. Lets further assume
that the fuel provider invoices the airline for each flights fuel.
In order to produce a flight, the airline consumes fuel, a resource. The economic
value sacrificed by the airline to acquire the fuel is represented by cost. The path to
costs in this scenario of necessity leads from the airlines mission through one of its
managerial objectives. Figure 19 depicts a path from the airlines mission to its fuel
Figure 19: From Mission to Cost: Resources Are Consumed, and Costs Incurred,
to Achieve Managerial Objectives.
Part of the mission of the airline is to provide air transportation services to travelers. So a
primary managerial objective is to provide trips to passenger-customers. In order to
provide trips to passenger-customers, the airline produces flights, flying airplanes
between airports. In order to produce flights, the airline consumes fuel. In order to
acquire fuel to produce flights, the airline incurs costs.
Applying Modeling Concepts in Scenario 1
Managerial Objective. An airline manager would be interested in knowing, How
much does it cost to produce Flight 123? and, more specifically, How much is the cost
of fuel required for Flight 123? The managerial objective of interest in this scenario is,
therefore, Flight 123. Notice how the managers analogical needs feature in
establishing the managerial objective for Flight 123. For him to make a profit on Flight
123 or forecast future fuel costs, he needs this information.
Resource. A serviceable aircraft is the first resource the manager needs. In our
scenario, the second is fuel. These two resources are examples of the two categories of
resources the management accountant has to model. The first category is those with
capacity and highly perishable outputs (e.g., the aircraft with flight hours as its output).
This type of resource will be discussed in more detail in Scenario 2 when we introduce
the pilots. The second category is resources that can be stored and used when required.
Resources of this class are typically direct materialsjet fuel in our scenario. It is
important to note that because fuel is a direct product cost in Scenario 1, the modeler
does not have to establish a managerial objective for fuel.
Cost. The fuel resource is consumed to meet the managerial objective of
operating Flight 123 and has a monetary measure.
Traceability. In Scenario 1, the airline receives a separate invoice for the fuel
provided for (and consumed during) Flight 123, and the fuel costs are traceable to Flight
123. In situations like this, a cost modeler seldom needs to consider any cost
determination method beyond simple tracing. In order to determine the fuel cost of each
flight, the airline merely needs to identify the fuel providers invoice for each flight and
post the invoiced cost accordingly.
Responsiveness. In this scenario, the responsiveness of the quantity of fuel
consumed to flight output is not a complicated factor in cost modeling. Nonetheless, note
that the relationship between fuel costs and flights is highly responsive. Each additional
flight hour results in the consumption of additional fuel. Fuel consumption, and therefore
fuel costs, have a proportionate responsiveness relationship to Flight 123s output, as
opposed to a fixed relationship.
Applying Information Use Concepts in Scenario 1
Divisibility. Aircraft fuel is a highly divisible resource; it can be divided into very
small quantities. In Scenario 1, high divisibility creates the opportunity for the airline to
avoid much of the cost of Flight 123 should the airline decide to not produce the flight.
Avoidability. Fuel costs, in Scenario 1, are easily avoided by the airline by
choosing not to produce Flight 123. That is, if the airline chooses to operate Flight 123, it
will consume fuel for which it will need to expend other resources. If the airline were to
choose not to operate Flight 123, it would avoid the cost of fuel.
Scenario 2. Fuel for Flights with Fuel Purchased in Bulk Quantities.
Now, lets modify the assumption about the manner in which the airline acquires
fuel. Instead of acquiring fuel flight-by-flight, assume that the airline purchases fuel in
large shipments (at least larger than the quantity required for a single flight). The airline
stores the fuel and loads the required quantities for each flight.
Further assume that the airlines fuel provider invoices for each bulk shipment
and that the airlines enterprise resource planning (ERP) system captures and stores the
quantities of fuel loaded prior to each flight. As with Scenario 1, assume that the amount
of fuel remaining onboard after each flight is either insignificant or a constant amount.
Applying Modeling Concepts in Scenario 2
Managerial Objective. In this scenario, fuel is a resource that justifies having one
or more dedicated managerial objectives. This is because a variety of additional
resources now need to be acquired, planned, managed, and paid to get the fuel on
board the aircraft. These other resources include storage facilities, refueling trucks,
personnel to operate equipment and comply with environmental and safety regulations,
and so on The bulk acquisition and storage of fuel, the distribution to flights, and the
airline potentially getting involved in hedging to shield itself from fluctuating crude oil
prices create a complex optimization challenge that justifies dedicated managerial
Responsiveness. In Scenario 2, the responsiveness relationships of fuel costs
will now include some fixed-cost responsiveness relationships. This is because the
storage facilities and the distribution equipment in the airlines fuel infrastructure add a
component of fixed costs to Flight 123s fuel cost.
Integrated Data. A conventional accounting system comprised of general ledger,
accounts payable, accounts receivable, and so on would not store the quantities of fuel
on hand and loaded prior to each flight. An ERP system, though, typically would and
makes these quantities available for costing flights.
Traceability. To trace fuel cost to specific flights, internal records of transfers from
the airline bulk fuel facility to specific flights must be maintained. Additionally, the
inventory of fuel must be continuously valued as fuel is purchased at different prices.
Applying Information Use Concepts in Scenario 2
Divisibility. Fuel is as divisible as it was in Scenario 1. As defined in the
framework, a resources divisibility is an inherent trait of the resource and not something
affected by the quantities in which the resource is acquired.
Avoidability.The change in how the airline purchases fuel in Scenario 2 highlights
an interesting aspect of avoidability, namely, that there is often a time dimension to the
ability to avoid a cost. In this instance, because of how the airline purchases fuel, it will
only see the cash benefit of the cancelled flights fuel the next time it buysa little less
bulk fuel. In contrast, in Scenario 1 the fuel cost was avoidable and the cash benefit was
realized at the time the flight was scheduled or very soon thereafter.
Scenario 3. Pilots for Flights.
Now, we introduce a second resource, pilots. Assume the airline acquires pilot
time by employing fulltime employeespilots. Further, assume the airline produces
flights that exactly occupy all pilot time acquired and that all pilots possess the same
technical qualifications and receive the same pay.
Applying Modeling Concepts in Scenario 3
Managerial Objective. Similar to fuel in Scenario 2, modeling pilot costs requires
specifying at least one managerial objective. This resource pool will have the output of
block hours. Block hours start from push back at the departure gate and end when
parking at the arrival gate (that is, the time a pilot is occupied producing a flight).
Assume the FAA limits pilots to 60 block hours per month. If the airline has 10 pilot-
employees, the annual capacity of the pilot resource pool will be 7,200 (60 * 12 *10)
block hours. All the inputs (and their costs) required to produce block hours will be
accumulated in the pilot resource pool, including pilot salaries, fringe benefits,
certification allowances, uniforms, training, facilities, transportation, lodging and meals
away from home base, and the costs of other internal support resources such as Human
Resources and Purchasing.
Responsiveness. The responsiveness of pilot costs will have both fixed and
proportionate relationships to their block-hour output. For example, required simulator
training time results in fixed pilot salary costs, while salaries paid for block hours flown
are proportionate to the pilot resource pool output. This means that a pilot block hour will
have a fixed component and a proportional component to its rate.
Traceability. Airlines must keep meticulous records about pilot block hours flown,
pilot assignment, and pilot utilization to ensure compliance with FAA regulations. Pilot
block hours are, therefore, traceable to specific flights and serve as the basis for
assigning block-hour costs to flights.
Homogeneity. In this scenario, because the technical qualifications and salaries
of pilots are all the same, the same block-hour rate applies for all pilots.
However, if pilots were not homogeneous, for example, some pilots had a much
higher pay rate, then a cost modeler should consider pooling the higher-paid pilots into
their own resource pool based on the concept of homogeneity. With two or more such
homogeneous sets, pilot costs per block hour would differ. Individual flights are then
assigned pilot costs using the appropriate pools block-hour rate. This distinction adds
value if there is a real difference in how the different pilots block hours are consumed by
Applying Information Use Concepts in Scenario 3
Divisibility. The resource is only divisible if a change in output is large enough to
make the resource as a whole surplus to requirements. Cancelling a single flight that
would have consumed eight block hours means the pilot will sit idle. A pilot resource is
only divisible if long-term flight schedule changes result in the demand for block hours
decreasing by at least 720 block hours (that is, the annual capacity of a pilot).
Avoidability. Since the pilot resource is not divisible, any reduction in block-hour
demand will result in both the fixed and proportional cost per block hour being
unavoidable to the airline. Conversely, a divisible pilot resource would mean that the
proportional costs, as well as some of the fixed costs, for 720 block hours become
avoidable. An example of block-hour fixed costs that will be unavoidable are the costs of
pilot facility space (e.g., the pre-flight briefing room space costs), which will be
unaffected by one less flight.
Scenario 4. Pilots for Flights, with Unused Pilot Time Each Day.
Lets modify the assumption that the airline uses exactly all of each pilots
available block hours. Assume that the airline uses two aircraft types for two distinct
business segments: (1) short-range aircraft for domestic flights managed by a domestic
business unit, and (2) long-range aircraft for international flights managed by the
international business unit. This requires two different sets of pilots based on aircraft
certification. That is, for Scenario 4, assume that the airline uses some, but not all, of the
available pilot block hours for each set of pilots. This might happen because of the
airlines choices about what flights to operate or as a result of adverse impacts on the
planned flight schedule such as poor weather conditions.
In this scenario, not all block hours available are consumed. Some pilot block-
hour costs will be left unassigned; these represent hours of excess or idle time not
assigned to any specific flight, such as Flight 123. Based on the principle of causality,
only the block hours required to produce Flight 123 were assigned to that specific flight
cost object.
Applying Modeling Concepts in Scenario 4
Capacity. The demand for pilot capacity imposed by the airlines flight schedule is
less than the available pilot capacity. As alluded to under Scenario 3s Managerial
Objective discussion, the pilot resource pool must be managed and optimized for the
available capacity and the costs of pilot block hours. The cost determination challenge
here is what to do with the cost of the pilot capacity that is unused.
Attributability. Applying the principle of causality, the pilot time acquired in excess
of that needed to operate flights cannot be assigned to individual flights produced.
Instead, in accordance with framework principles, the cost of excess block hours is
accounted for using the concept of attributability.
In Scenario 4, pilots are interchangeable across all flights of their business unit
short-range pilots for the domestic business units flight schedule and long-range pilots
for the international business units flight schedule. The appropriate level of attributability
for excess/idle pilot block hours for each of the pilot resource pools is, therefore, the
respective business units gross margins. If certain aircraft types were dedicated to
specific routes, it would be possible to assign excess/idle pilot block-hour costs to a
lower-level managerial objective and manage block-hour capacity and utilization at, for
example, the route profit-and-loss level. In contrast to the common practice of spreading
excess/idle capacity costs to lowest-level products (e.g., Flight 123s block-hour cost)
and hiding itthe concept of attributability applied in the manner described ensures that
key optimization metrics are visible and highlighted at the level where they are managed.
To demonstrate the flexibility a modeler sometimes has in cost model design
when applying framework concepts, consider how pilot standby capacity should be
included in the airline cost model. Is standby time, which incurs a separate standby
allowance cost, part of idle time? Should standby costs be assigned to flights based on
the principle of causality (that is, flights that draw on the standby pool are documented
and can be charged accordingly), or should standby costs be assigned, using the
concept of attributability, to a specific result segment similar to excess/idle capacity? The
modeler likely has at least the following three options to incorporate standby capacity
into the airlines cost model:
1. Treat standby capacity and related costs similar to excess/idle costs and
highlight it as a separate line item in the business unit profit and loss
statement. In this way, standby capacity is managed on an exception basis,
such as when its costs exceed a certain threshold number (e.g., a percentage
of productive block hours flown).
2. Collect the standby hours and related costs in a dedicated managerial
objective for managing standby capacity. If this method is selected, a
procedure for costing is needed, such as charging flights that draw on the
standby pool.
3. Treat standby capacity costs as a cost of doing business. That is, calamity
can befall any pilot on his way to work or any flight schedule, and having
pilots on standby to prevent an escalating ripple effect from such events
throughout the network necessitates having standby capacity. As a cost of
doing business, standby capacity costs can be included in the pilot block-hour
resource pool and included as part of the fixed-cost component for each
block hour charged to flights.
Which alternative is the most appropriate? The cost modeler should not make
this decision on his or her own. Instead, as will be discussed Appendix B, Part C, to
facilitate manager acceptance of a cost model and ensure that their analogous needs
are met, managers should be consulted in determining model outputs.
Work. Scenario 4 also lends itself to demonstrating the application of the concept
of work. Assume that the airline is operating significantly below the industry standard for
pilot block hours flown per year but does not have much excess/idle capacity. The
manager would like more analytical insight into how much time pilots spend on various
activities. In this case, the modeler might employ the activity-based costing concept of
work and define the types of activities pilots spend their time on, such as executing a
flight, training, dead heading (i.e., repositioning between airports to start a new flight),
laying over away from home base, and standing by. With this additional analytical
insight, managers could assess factors related to pilot work efficiency. For example, the
effectiveness of flight crew schedulers in assigning pilots to service slots could be
This additional analytical insight would come at an increased cost and result in a
more complex model. A cost modeler must weigh the added benefits and costs of the
additional model detail, complexity, and maintenance.
Applying Information Use Concepts in Scenario 4
Interdependence. To illustrate the difference between causality (the principle in
model construction) and interdependence (a key concept in decision making and
information use), assume that the manager gets the information on all the activities pilots
are involved in and how much time they spend on each activity. The manager concludes
that flight crew scheduling is the likely source of the problem. Upon further investigation,
the manager determines that an antiquated scheduling software application prevents
flight crew schedulers from responding in an optimum manner to sudden changes in the
flight schedule. In the event of one or more disruptions, such as weather delays,
unscheduled aircraft changes, or delays due to an air traffic control override, the
scheduling software invariably causes an inordinate amount of pilot dead-heading and
layovers. Layovers result because pilots reach their short-term on-duty limits while out
on a route and must be taken off duty away from home base. This, in turn, increases
meal and lodging costs and has even resulted in aircraft changes because only pilots
certified on a different aircraft were available to take over. Thus, a snowball effect often
wreaks havoc in crew scheduling.
When the manager raises the issue with the scheduling supervisor, she reminds
him that she had requested a new flight crew scheduling software application two years
ago, but the airlines capital investment board had given the project low priority. It was
not funded. The decision to not invest in a new software application was taken without
insight into all of the interdependencies that exist in the airlines flight network. With the
insights from a new managerial costing system, the manager will now be able to
demonstrate the interdependencies related to the decision and the need to replace the
existing scheduling application. Interdependencies are reflected in cause and effect
relationships, but these differ from normal operational causal relationships that are
explicitly modeled in the cost model because interdependencies often relate to abnormal
operational circumstances or suboptimal operations, as in the scheduling example. In
using managerial cost information, managers should consider interdependence, whether
evident implicitly in cost information (but still requiring interpretation as in the scheduling
example) or not evident at all, such as for qualitative cause and effect relationships (low
pilot morale due to continued suboptimal scheduling).
Scenario 5. Pilots for One More Flight.
Assume that the airline has upgraded its flight crew scheduling application and
now makes much better use of its pilots. This has resulted in more excess/idle pilot block
hours. Further assume that an airline manager is considering the possibility of producing
one more flight on the Destination X route utilizing some of the unused block hours.
Applying Modeling Concepts in Scenario 5
None. The decision in Scenario 5 can be evaluated with the model as
Applying Information Use Concepts in Scenario 5
Avoidability. The cost of fuel required to operate the additional flight can easily be
avoided by not operating the additional flight. As far as pilot costs are concerned, the
flight can be produced using pilot block hours that would otherwise go unused (that is,
the related block-hour costs are unavoidable). Since the pilots required to operate the
additional flight are already employed and will obtain no more pay as a result of
operating the additional flight, the pilot compensation associated with the additional flight
are sunk costs and not relevant to a decision about whether one more flight is
economical to operate. In fact, the lucrative nature of decisions that can use existing idle
capacity (and its sunk costs) is highlighted by the contribution to profit compared to a
scenario where two new pilots would have to be employed to produce the additional
flight; in the excess/idle scenario the contribution to profit is significantly higher by at
least the amount of two pilots total compensation.
Interchangeability. Note that an assumption of resource interchangeability
underlies the decision in Scenario 5. In part, the lucrative nature of the opportunity exists
because pilots are interchangeable. That is, pilots can be assigned to the new flight
without any cost impact on other flights. In the case that pilots were not interchangeable,
the cost effects on other flights would have to be included in the analysis of the new
flight opportunity.
Scenario 6. Adding the Customer Dimension.
The airline provides each flight with the intention of providing airport-to-airport
trips for several customers simultaneously, including business class customers, coach
class customers, and freight customers. Further assume that the airline provides only
nonstop, single-flight trips to its customers. And for this scenario, let us follow the
original, simple fueling assumptions for other flight costs: (1) the airline purchases fuel
and pays for navigation and landing for each flight, and (2) the respective providers
invoice the airline for each flights fuel and services.
Applying Modeling Concepts in Scenario 6
Managerial Objective. As illustrated in Figure 20, managerial objectives are
established for each of the three types of customers the airline serves. These cost
objects reflect the revenue from these customers and the respective causal costs that
can be assigned to each managerial objective. A higher-level managerial objective for
Flight 123 is also established and contains all the flights causal costs. As indicated by
the arrows, the contribution margin and gross margin for the flight are obtained by
subtracting flight costs from the sum of margins of the three customer cost objects. This
tiered or cascading view of managerial objectives is typical of result segments and is
easily accommodated by multi-dimensional slice-and-dice OLAP tools when a cost
model is designed to collect the information.
Consider that the cost objects for each day of the week can be summarized into
a route cost object, and in turn all routes to Destination X can be summarized into a
destination cost object. In this way, various attributable costs can be incorporated into
margins at each level: for example, the costs of the business class lounge at Destination
X, which will be attributed for inclusion in the Destination X attributable margin.
Moreover, the airline can compare the profitability of Flight 123 on Mondays with other
days of the week or the profitability of customer types (e.g., coach class) for different
days of the week or even different months (i.e., seasonally).
Figure 20: Tiered Managerial Objectives for An Airline
Traceability. Fuel costs and other flight costs are not directly traceable to a
specific customer. Attempting to allocate flight costs to the customer-level cost objects
would result in an arbitrary allocation that seriously compromises managers causal
insights. Clearly, landing fees, navigation costs, and so on are flight costs and relate to
operating the flight and not whether one more customer is served.
Applying Information Use Concepts in Scenario 6
Avoidability. Using a cascading set of managerial objectives as in Scenario 6,
managers are provided clear insight into inputs (and their costs) that are potentially
avoidable at each level of causal assignment; that is, for each managerial objective. Of
course, such strict adherence to the principle of causality means that a full cost view
(arbitrary as it would be) is not available at the customer level.
Given the traditional use of managerial costing to generate final product or
service costs for financial reporting based on full absorption of cost, many managers
might not be comfortable with cascading margins and a strict adherence to the principle
of causality. In this regard, there are a few things to note:
1. Arbitrary full absorption to the customer level for the airline creates the
illusion of causal insight. In reality, arbitrary cost allocations leave managers
with no clear cause and effect insights and compromise the use of real causal
inputs and their costs if they are mixed with non-causal allocations.
2. Using cascading margins, managers are equipped to use relative margin
analyses to identify business segments, at any level, for rationalization or
profitable exploitation. For example, in a cost-cutting initiative the manager
might compare Destination X with Destination Y. Managerial costing
information compiled based on the framework principles and concepts will
clearly highlight the avoidable costs for eachfor example, the respective
business-class lounge costs. Had the modeler resorted to traditional full-
absorption costing he or she would have, at best, spread all business-class
lounges costs to business class passengers, obscuring this crucial insight.
Often the method employed to spread costs determines which product or
segment will be a candidate for elimination. The selection of method can hide
the real operational characteristics that ultimately drive profitability.
3. All avoidable costs for a particular decision alternative are also always causal
costs on the managerial objective under consideration. Stated differently,
non-causal cost allocations are arbitrary and defeat proper analysis to
determine their behavior as it relates to a particular decision alternative.
Arbitrary full absorption to the customer level for the airline creates not only
the illusion of causal costs but also the illusion of potential avoidability. As
pointed out, flight costs are simply not avoidable at the customer level, so
what purpose does it serve to allocate flight costs in this way? From a
managerial costing perspective, none. Departing from the framework
principles compromises managers decision-support information and their
ability to optimize enterprise operations.
Implementation Factors
Implementing a managerial costing approach requires much more than
understanding and applying the principles, concepts, and constraints articulated in this
framework. The management accountant will need to lead or serve as part of a cross-
functional team to address a wide variety of technical, managerial, and social/cultural
issues that can impact the effectiveness of an organization in using managerial costing
to improve its information for decision making. Cost information is a critical component of
an organizations performance information and the decisions made with improved cost
information will have an impact on everyone and every aspect of the organization.
A comprehensive discussion of all the implementation factors is beyond the
scope of this section; however, a brief overview of some key factors is provided as a
guide toward planning an effective project and building an implementation team. Further
research and the acquisition of greater expertise in each of these areas are
recommended for any organization planning a managerial costing initiative. As will be
obvious by the breadth and diversity of issues, the introduction and implementation of a
managerial costing approach in an organization requires expertise that is normally only
available from a team effort.
Conceptual Design of the Managerial Costing Model and Solution
While managerial costing ultimately requires a software solution, it cannot be
emphasized strongly enough that software selection is not the way to start implementing
a managerial costing project. As discussed in Appendix B, Part A, the first step is to
understand the types of decisions the managers in your organization need to make in
order to optimize their operations and achieve the organizations strategic objectives.
This requires gaining a deep understanding of your organizations operations and
helping managers and organizational leadership look beyond the financial information
they currently use. What cost information is needed to drive the organizations
Conceptual design for managerial costing models must recognize that
managerial costing is fundamentally different from its cousin, financial accounting.
Managerial costing is an analytic application, while financial accounting is transaction-
and regulatory standards-driven. This means managerial costing must adapt to an
organizations decision needs, its processes, and its resource composition rather than a
specific prescriptive external reporting standard. As mentioned earlier, financial
accounting is about valuation, and in contrast managerial costing is about creating
economic value. The principles, concepts, and constraints identified in this framework
are reference points to consider when designing a managerial cost model for an
The basic approach to conceptual design is as described in Section IV, Parts A
and B:
Gain an understanding of your organizations strategy and operations.
Identify the optimization decisions that are regularly made at the various
managerial levels throughout the organization.
Identify the resources and their application to be optimized in the key
productive processes in your organization related to those core decisions.
Identify the support resources that interact with and enable the productive
Group resources into homogeneous resource pools, define their output
quantities, and if required based on managers analytical and decision
support needs, express some of these resource outputs using activities.
Map resource costs to each resource pool and capture the resources cost
characteristics in cost classifications.
Use the concepts in this framework to streamline the model of the resources
used and the monetary values that flow from them through the various
consumption relationships to outputs.
Managing the Introduction of a Costing Approach
Project management is rapidly achieving a level of professionalism thanks to its
growing importance in todays complex and competitive business environment.
Implementation of a managerial costing approach is complex and touches most
components of the organization in a significant way. Without constant pressure on a
managerial costing projects balance between cost, schedule, and performance, the
project runs the risk of getting swamped by requirements growth, scope creep, or
Managerial costing initiatives, like most well-designed projects, should be
segmented into smaller phased deliverables that can be assessed and approved by
senior management on a regular basis. This keeps both the project staff and the rest of
the organization focused on completing segments of the project. It is easy for managerial
costing efforts to become trapped by escalating requirements and complexity or
idealistic demands of managers who do not appreciate the cost of information. The
improved information from more incisive managerial costing will lead to more
sophisticated questions and demands for more in-depth modeling efforts. The project
team and organizational leadership need to be prepared for this and focus on ensuring
that the entire organization gets the benefit of the improved information before the
project gets stuck in any one area.
Management is a process of continual change and improvement, and the cost
system will also need to change over time. The objective of project management is to
ensure improvement efforts are achieved, implemented, and become part of new
business practices.
As mentioned earlier, it is extremely important that the initial step in a managerial
costing project should not be the selection of software; neither should the softwares
capability dictate the conceptual design. The development of a conceptual design for an
organizations managerial costing must always precede an evaluation of software
alternatives. This is true even if you already have an enterprise resource planning (ERP)
suite in place. Managerial costing has historically suffered from two substantial
1. It has been implemented primarily to support external financial reporting
costing requirements, what the framework defines as cost accounting. The
problems associated with the differing principles, objectives, and audiences
for external financial reporting were discussed in the Introduction to the
framework. Managerial costing is focused on providing information for use
inside the company to create competitive advantages in the marketplace.
This requires significantly more granular and analytically supportive
2. Managerial costing solutions have been software-driven. This has inhibited
the conceptual design phase of managerial costing because the tendency
has been to move toward software implementation and making the
organizations needs fit the selected software capability.
Software will be needed for managerial costing, but it is critically important to first
examine your organizations use of the principles, concepts, and constraints outlined in
this framework. Evaluate and consider how they may apply to your organizations
strategy and for your optimization needs, build a conceptual design, and then start to
examine software alternatives to support your conceptual design, whether you own
software or must acquire it.
Managerial costing is typically done using three general types of software:
1. Enterprise Resource Planning (ERP) Software: Large-scale software with
integrated modules. For managerial costing, an ERP system used in both
logistics and finance may serve as an effective foundation for cost
information. An ERP system used only for financial accounting and reporting
may not have the resource and logistical information this framework
considers a necessary foundation for managerial costing. However,
operational systems such as manufacturing enterprise solutions in the
manufacturing industry may be a rich source of the necessary operational
2. Best-of-Breed Managerial Costing Software: A number of specialized
software solutions exist for specific managerial costing approaches. Most
integrate with ERP, financial, logistics, and operational systems. Over the
years, many of the large ERP software vendors have purchased one or more
of these solutions and they may be usable as independent modules.
3. Business Intelligence Software: This software focuses on integrating data
across the enterprise and typically requires creating calculation engines to
support managerial costing. This class of software works well for
organizations that are small with simple needs or are large with unique needs
and the expertise to develop solutions.
Whichever path is chosen, software will likely constrain the management
accountants conceptual design and model for a costing solution. It is important to
understand your requirements so that you can assess the constraints and benefits of the
software tool you select.
This framework places a great deal of emphasis on operational data about the
processes and resources within your organization. Implementing a managerial costing
approach based on this framework requires gaining familiarity with the operational and
logistics data and supporting systems in your organization. Such an effort has a
significant benefit because it demonstrates for the operational and logistics areas that
your approach is to listen and learn about their work environments and challenges.
The types of systems and data vary widely depending on the nature, size, and
sophistication of the organization. You may be dealing with highly sophisticated
manufacturing enterprise solutions, customer management solutions, or logistics
management solutions, or with locally created databases and spreadsheets. The
challenge is to apply the principles, concepts, and constraints in this framework to create
decision-support information that will be used to improve optimization and performance.
This means the implementation team must discover what data is being used as
managers at all levels make decisions.
Source data quality is often an issue in managerial costing implementations. The
inherent challenge for managerial costing and its extensive use of operational data is
that financial accounting information is subjected to an audit in public companies and
many other organizations. Logistics and operational data simply are not subjected to an
audit. However, the financial data needed to reflect an organizations operations at the
level of detail required to achieve causal relationships may need to be more discrete
than what is typically available in the general ledger. The implementation team and its
sponsor need to understand the different focus of managerial costing as described in
Sections I and II, Objective and Scope of Managerial Costing, of this framework. The
real test is for the model to build its own credibility by providing information that
accurately reflects operational resources and their monetary value and that allows for
quicker, more accurate, and more profitable decisions throughout the organization.
Major ERP and business intelligence software vendors with strong integrated
data orientation capabilities will make this easier by creating different views of the
organization: a financial reporting view, a logistics/supply chain view, an operations
control view, and a managerial costing view. These views allow different types of costs
to support the different views; for example, different depreciation approaches could be
used. The views will clearly identify the differences and allow reconciliation for the
differences between them. No matter what your level of sophistication, it is a good idea
to document the different assumptions between your managerial costing approach and
other financial views of the organization. The differences will become an issue for which
a confident and concise explanation should be readily available whenever senior
financial or organizational leadership changes.
There is often concern that a cost system that isnt closely tied to the financial
accounting system will require a great deal of labor-intensive maintenance. On the
contrary, given the importance of operational information, the concern should be with a
lack of operational information generally available to financial personnel. However, the
maintenance concern can be overcome by the extensive use of operational and logistics
data and tight integration with those systems, a trait inherent in most ERP systems.
When operational personnel trust and use the cost information, they will provide more
complete and accurate data to keep relevant operational information up-to-date in stand-
alone systems. The use of standard cost rates that are regularly reviewed and updated
will allow operations to achieve near real-time data at very discrete levels. Most financial
processes are relatively slow compared to the real-time nature of operational data that
must detect problems before they multiply and create waste and lost customers.
Leadership and Change Management.
The first step in a successful managerial costing implementation effort is to
recognize it is not a technical accounting exercise. You are undertaking to change the
decision-supportand to a great extentthe performance information throughout the
organization. Well over 50%, possibly as much as 90%, of the effort will involve making
people feel comfortable and confident about the changing information and the practices
to produce the information.
This management of change requires a strong leadership commitment from an
executive sponsor in the organizations senior management and also requires the
implementation team to think and act like leaders in everything they do. Leaders
communicate a vision of a better futureand with inspiration. The first step in
communication is to listen to the organization, from top management to first-line
supervisors, and understand how the vision of a better future you present can support
their vision of a better future. People are normally easier to convince of needed change
when they are confident they are understood by someone with (1) the organizations
best interest at heart, and (2) clarity about their contribution to the organizations
Technical prowess in managerial costing will defeat the team if it is lacking, but it
will not ensure success by itself. This framework was written to provide the managerial
costing practitioner with a range of options and explanations about how managerial
costing principles and concepts can improve decision making in an organization.
Creatively applied, these explanations should be useful in explaining the range of
choices to users of decision-support information and should allow you to lead them to
the choices that make sense for your organization. But again, this can only be done
when they have confidence that you understand their needs and objectives.
The topic of leadership and change is obviously far too broad and complex to be
covered in a brief overview such as this; however, the topic of overcoming resistance to
change faces nearly every managerial costing initiative. Resistance to change is
particularly acute for managerial costing because many people in the company,
including accountants, simply arent aware of the problems poor managerial costing is
creating. Users and accountants tend to think only about cost accounting, and hence
they view what costing they do as a necessary compliance activity. Often, even
accountants dont have the experience or knowledge to generate alternative solutions
and improve managerial costing beyond the minimum cost accounting requirements.
One often overlooked but effective approach to addressing and overcoming the
natural human tendency resistance to change is to focus on creating discomfort with the
status quo. A simple formula to overcome resistance to change is
(D x V x F) > R, where R stands for Resistance
Do not underestimate how large the R is; it can be enormous, even if it is
relatively passive. Change is hard to get started. Therefore, if any of D, V or F in the
equation is zero or small, then their combination will not exceed R. You will need all
three factors in great abundance:
D is dissatisfaction with the current state. Unless people have discomfort,
they will rarely be interested in changing anything. People like the status quo.
V is a vision of what better looks like. When people see a different view of
their circumstances or a solution that can lead to an improved condition, they
will consider changing.
F is often neglected: it stands for first practical steps. Some may think that
having a lot of dissatisfaction (D) with a solid vision (V) is sufficient to
overcome that large resistance (R) variable. But large amounts of D and V
are not enough. If people think the vision is overly theoretical, complicated,
costly or impractical, they will not pursue changes to realize that vision. You
need F to make the vision attainable.
So how do D, V, and F apply to gain buy-in for costing reforms? This Conceptual
Framework enthusiastically promotes the vision of robust costing methodsthe V in the
equation. The authors advice is to also place emphasis on the D. Here is why.
Change will only result when people feel compelled to change. Having high
levels of dissatisfaction and discomfort, the D, may likely be the best lever to use to
influence your organization. But dissatisfaction is often latent, not overt. It may not be
obvious to many in your organization that traditional costing methods are flawed. They
presume that since external CPA auditors attested that financial reports are in
compliance with regulatory laws, nothing is wrong. But that audit is of the financial
accounting system, and we are addressing the managerial costing system. You will need
to create discomfort by explaining that there can be cost inaccuracy and lack of visibility
of the individual products, services, channels, and customers even though the total costs
are accounted for with financial accounting. Again as mentioned, financial accounting is
for valuation (e.g., inventory costs). It is ruled by GAAP. In contrast, managerial costing
is about creating economic value with better analysis, insights, decisions, and actions.
Our suggestion is to create discomfortthe D. We suggest applying the Socratic
method of questioning, named after the classical Greek philosopher Socrates who
stimulated rational thinking and illuminated ideas by posing questions to his students,
such as Plato. Imagine asking your executive team and colleagues questions like these:
Are our more complex products with high technical support being subsidized by our
costing method by the simple products that use relatively little indirect and shared
expenses? Are our largest customers presumably our most profitable ones? Are any of
them so demanding of us that the extra effort erodes our profitsbut we do not measure
those costs? How do we know? How do we know which types of customers to retain, to
grow, to acquire as new or to win back? How much is optimal to spend on each
customer type with deals, offers, and promotions to retain, grow, acquire, and win back
those customers? Wont any spending amount above or below the optimal for each
customer type lead to destroying shareholder wealth?
In many cases, the executives and colleagues will not have good answers. That
is when you can hit them with the knockout-punch questions. When they respond that
they do not know the answers, ask them, Is that a good thing? How long can we keep
making decisions without knowing these answers? If you ask these types of thought-
provoking and deliberately disturbing questions in the right way, you will not need to
spend much time on promoting your vision (V) of the equation, the variable that many
project champions typically prefer to begin with. By converting and exposing latent
problems into ones that are evident to your executives and colleagues, the solutions
become more obvious and understandable.
And what about the F in the equationthe first practical steps? Many
organizations embarking on the journey to reform their managerial costing struggle with
how to get started. Consider pilots and rapid prototyping with iterative re-modeling
techniques to demonstrate value and prove concepts. Pilots and prototypes should
produce directionally correct results. What they accomplish is accelerated learning and
buy-in. They are engaging because the models are of your organization and not of a
fictitious one from a training course.
Always remember that in the absence of facts, anybodys opinion is a good one.
And usually the biggest opinion winswhich is likely to be that of your boss or your