Excessive Precision. Too Much or Is It?

Sep 12, 2013

One of the ten things that cost accountants typically do wrong is worrying about excessive precision in the calculation of product costs all while they miss huge common sense and logical issues. As a result, huge mistakes are made in the calculation of product costs. The error that I am referencing is that it is better to be approximately right than it is to be precisely wrong. Some cost accountants like to take product costs out to the fourth decimal place while making such huge errors in their calculations that the dollars are grossly off. However, I believe one of our most recent assignments will contradict that concept. In this case, the client has long made their calculations in ounces, which is the smallest unit of measure available in their industry. This means that all their product costs are computed for all bands of cost on the per ounce basis. They do their quoting on a per ounce basis and they compute profitability by the various product types on a per ounce basis. It appears to us that although they have room for improvement in a couple of areas, overall their job costing appears to be relatively accurate.

However, as I was thinking about this further it occurred to me that in many cases their single orders are listed in tons. That is, one customer may order many tons of a given material at the same time. I presume then that their largest customers are ordering thousands of tons of a material at the end of the year. If that is true, then it would seem to me that in order to actually determine overall profitability by customer, or even by order, we should be extending our product cost out beyond the fourth decimal point.

In this particular case, there is a relatively small number of products the company produces and sells. Actually under a hundred or so. I believe the re-costing and the expansion of the accuracy of the costing will not be a burdensome task. However, I am concerned that if we have dropped fractions of cents on a per ounce basis that by the time we make those overall calculations on the thousands of tons, that we may come up with a different result.

The industry that this client works in is very price competitive and they are constantly searching for ways to remove even fractions of a cent from their product cost to stay as competitive as they can. I believe this more precise costing calculations will be suitable for their needs.

You may question why they are making these calculations in such small quantities when their orders are in such large quantities and I believe it is because the smallest unit of measure that likely will be needed would be this smaller ounce measure and simply having a few customers that placed huge orders does not change the overall approach to the costing, but rather creates a overall need for more precision.

Categories: Cost Accounting