The question here is: Are costs aligned with cash flowing away from your company, and if not, why not? Costs should, by their very nature, be aligned to cash leaving, but they are not in all cases. Costing and cost accounting are based on false ideas, false relationships, and on the inappropriate use of math. These issues will be discussed in detail throughout the rest of the book. The purpose of this chapter is only to demonstrate that costs, themselves, do not align with cash.
Pick an arbitrary time period. It begins on the first day of the analysis period—a month, a year—and ends on the last day of that period. During that time, you spend money buying things, consuming things, and doing work. Let’s think about the scenario. At the end of the analysis, what you spent, how much you spent, what you bought, and how you used it have been determined. Every action and transaction is now set in stone. There is only one description; one representation of what happened. When you look back, you didn’t hire one or two people. You hired two. You didn’t have 200 or 300 meetings. You had 273 meetings. You didn’t create 75 or 80 products to sell. You created 76. Everything that happened during that period can be documented in retrospect. Then comes costing.
If we agree on the idea that there is one and only one description of the past, let’s think about the costing aspect. There are many different approaches to costing products, services, processes, and activities. Each one emphasizes something different. Standard costing may emphasize different aspects of cost assignments and relationships than activity-based costing. Lean accounting is different from throughput accounting. Yet, the fact remains that each approach is attempting to assign the cost of what was purchased either before or during the analysis period, to what you did and created, all in the name of determining the cost of a product, service, process, or activity.
The result is a puzzling scenario. When trying to cost a product, service, or activity in an analysis period, since each approach available to use assigns costs differently, you can create different values for the cost. The cost of a pen you manufacture, for example, may be calculated to be $1.12 with standard costing, $1.27 with activity-based costing, and $1.35 with overhead costs spread equally. This can be disturbing but understandable because each approach emphasizes different things. However, even if you talk to three people about using one approach such as activity-based costing, you will likely receive three different costs as well.1 What is even more puzzling is that if you use a fairly standard procedure, the approach will pass an audit performed by your CPA (certified public accounting) firm. Had you used another standard approach and calculated a different number, it, too, would pass the audit. So, what is the right answer?
Let’s recap. During an analysis period, one set of spending transactions and one set of activities occurred, and the result was the creation of a unique description of work and output. Yet different costs for the exact same thing can be created. The difference can be due to the approach used, but even using the same approach, one can calculate different values. One must ask: If the desire to describe one thing results in multiple answers, how effective is any one of the answers at explaining what happened? If you walk into a physician’s office not knowing how tall you are and they tell you that you’re 5ft 9inches, you can feel good about that number. But if they tell you that you’re 5ft 9inches, 6ft 4inches, or 5ft 3inches depending on the technique they used, you will question the results. And if using the same approach, say a yardstick, and the answer is that you’re either 5ft 9inches or 6ft 1inch, again, you’ll question results. Segal’s law suggests a man with a watch knows what time it is. A man with two watches has no idea.2
If cash were spent one way, one set of activities occurred, and you are trying to determine the cost of these activities, logically, there would be one and only one cost. If there can be many costs coming from one set of data describing what happened, how can they all be aligned to cash flow?
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1Often, the differences are tied to the scope of activities being considered and choices about how to interpret and assign costs.
2“When Can Segal’s Law Be Applied?” - Quora. Web. 22 Nov. 2015.