The Second Worst Cost Accounting System I Ever Saw

Nov 14, 2013

A year or so ago I wrote an article about the worst cost accounting system I ever saw. I came across this system years ago when I was first beginning my career in public accounting. It was related to a manufacturing business that was family owned that the son had taken over from his father a few years before I became affiliated with them. He was attempting to operate the company in the same fashion that his father had for years. The company was reasonably profitable particularly in times of high volume but controls were loose and the son didn’t seem to know or place value in improving controls at any level. The cost system was equally undocumented and lacked necessary controls. In fact the assumptions that were used to build the cost system were unrelated to manufacturing as it currently existed. Even more distributing was that the cost information being used to value products was equally as unrelated to current financial information produced by the company. No one understood how the cost was being developed, which was done automatically by the computer system, nor could they explain what the output meant or how it should be best used.

Although I recommended repeatedly to spend some time to first understand and then correct any shortcomings in the system, the owner was disinterested and used the analogy that since they were making money it was not necessary to more fully understand the cost. 

Within a few years of my beginning to work with this client, the industry they were working in experienced a severe downturn which eliminated 30% – 40% of the volume in the company. This huge reduction in volume translated into monthly losses that the owner could not understand or even form a plan to counteract. By now the company was in bad shape, the cost model although broken was unable to be fixed due to lack of time and resources and the fundamental information that the management team needed to fix the problem was unavailable. Shortly thereafter the company went out of existence and all of the employees were let go.

I’ve recently run across a similar fact pattern with one of our most recent cost clients.

At the initial meeting the client was unable to tell me when the last time the system had been updated; where the information came from to develop unit cost; what assumptions were built-in to the development of those costs; and how to best use the information the system was providing.

In this case, the system was completely automated and was drawing cost information from the general ledger side, and the operational information was being periodically updated by the accounting staff. Or at least in theory, that’s how the system was supposed to work. Since no one could explain or understand where the numbers were coming from nor could they show a trail of how the calculations were made based on operational information, the entire cost model came into question related to the overall validity and reliability of this system.

The owner clearly recognized that there was a problem but I don’t believe he fully grasped the magnitude of what there was to do.

I proposed a few simple tests to be run to determine the overall level of accuracy and reliability in the model simply as a quick and dirty check to see how broken this cost system really was.

We have embarked on the task of making these checks and I am fearful that our initial concerns about the unreliable misleading information the system is producing will be confirmed. Although we are in the initial stages of this testing we can’t prove that yet, but soon we will be in a position to draw conclusions that may lead to a course of corrective action for this business and this system before it does any more serious damage to this company or its financial future. The positive I see here is that this owner understands there is a problem and it needs to be fixed.

Categories: Cost Accounting