It’s Better to be Approximately Right Than Precisely Wrong
Oct 17, 2013
This is a topic that we’ve written about several times in the past and it really is directed at cost managers who attempt to use an unreliable system to compute their product costs, and then compute those product costs out to the sixth decimal point. This gives the user of these types of costing systems an impression of great accuracy, when the reality is there are errors in the logic or methodology of constructing the system. That kind of precision gives a false sense of security, when in fact product costs can be off a huge percentage in either direction without the business managers having any idea that such errors exist.
It has been our experience that over and over again, properly constructed systems even though they may require estimates and approximations based on managements best guesses still tend to provide far more accurate results than those systems that rely on faulty methodology and attempt to achieve precision by a minute dissection of the product cost.
Our most recent costing assignment is exactly in this arena. The company has used a very simple but non-traditional method of valuing its products for many, many years. Now because of a changing marketplace, the owner is interested in rethinking the methodology and perhaps using a more robust system to help determine product costs.
During our first meeting, we were gathering data and quickly concluded that many of the objective resources that we would rely on to help construct a cost system were not available in this company’s accounting system. The reason is quite simple, they have not used this information in the past and therefore had no reason to keep track of it. As we’re moving into a new arena, much of the source data that would be necessary was not readily available in an objective fashion. However, the owner gathered a number of his management team memebers and we were quickly able to conclude reasonable estimates that the management team all had a chance to consider as the process moved forward. We determined being reasonably approximate would suffice for much of the source data that we needed to begin this conversion to a new system.
It would seem logical to me that this method would lead to some degree of inaccuracy related to the product costing. However, I believe we will find as this process moves along that our final end product cost will be materially correct with little risk of material error on the end cost.
That is not to say that there is not a risk of a small percentage error in one direction or the other on some of these individual product cost, there is likely going to be such errors. However, the accuracy of this system, based on reliable methodology, will produce results that will provide management insight into product costs that they didn’t previously have and lead to actionable steps to improve overall productivity and profitability. Future cost revisions will include the ability to get far more accurate information as its systems will be designed and put into place to gather these necessary input in a method that is objective, accurate, and timely. Our new system will have a complete review of the process by a number of different management members with differing responsibilities but with the general oversight of how the entire process works. This will give me comfort that although our estimates may be subjected to some revision in the future, the fundamental conclusions will be correct.
Categories: Cost Accounting