Decision Making
Does Accounting Undermine Manager's Ability to Make Good Decisions?
The Profitability Analytics Center of Excellence (PACE) aspires to help management accountants and the broader business community recognize and understand the need, the benefits, and a path forward for improving cost and revenue information for internal decision support.
An important component of Profitability Analytics is employing an effective managerial costing system, based on distinctly different principles and requirements from GAAP and external financial accounting. This website provides resources for the many diverse stakeholder groups affected by the quality of their organization’s managerial costing practices. We encourage you to use the resources available here learn more about how this issue affects the performance of your organization and what you need to do.
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There is a misconception that costs are accurate. Information generated by financial accounting-focused systems is limited to organization-wide measurements and often fails at even basic levels of granularity. As a result, profitability by product, service-line, channel and customer is misstated. Cross-subsidized costs are rampant with misallocations—making profitable business divisions or products look bad while unprofitable business lines look good. Effective business portfolio management is difficult in these circumstances.
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Further, the usefulness of information is severely limited. Financial accounting-focused systems fail to measure costs of core aspects of the business. By failing to link costs with causes, the unavoidable results are misleading profit margins, unrealistic budgets and forecasts, as well as ill-informed insourcing, outsourcing, offshoring, capital spending and other critical management decisions.
The persistence of 20th Century management accounting practices and systems into the 21st Century is not due to the absence of better, more relevant accounting models. For several decades, management accounting thought leaders have been developing new, more effective models to meet the needs of organizations competing in a worldwide and highly-competitive marketplace. However, the majority of practicing accountants are unaware of, or are ignoring, these superior methods and concepts. As a result, decision making is weakened.
Management accounting practices need to advance. Accounting systems can and should reflect underlying managerial economics that are essential to guiding an organization to higher levels of success. For too long the accounting profession has fallen behind other business disciplines in its commitment to building and sustaining value. It must now move into catch-up mode to provide managers with accurate and useful information based on cause and effect relationships.
Decision makers should demand better managerial costing from their accountants to manage performance and profitability of products, service-lines, channels, customers and their supporting processes. Simply “adjusting” compliance-focused financial accounting systems and traditional costing practices won’t work. It’s an ineffective solution to the larger problem. Better and more robust information is required to make decisions and take action that builds value in an organization. That information is available, but accountants must be committed to, and managers must demand, 21st Century managerial costing solutions.
What Does Causality Mean?
The goal of Profitability Analytics is to provide a high-level framework that can be used to provide decision makers with comprehensive and accurate decision-support information. To meet that objective, the decision support information must be a fair reflection of the realities that surround a decision.
But the realities that surround us are complex. To survive in such a complex world, we create models that we use to guide our actions and our decisions. The guiding principle for determining how the elements of a model related to one another is causality.
To access a webinar discussing what is meant by the causality principle, its application to operational and financial modeling, and examples of the application of the principle, click on a link below.
