Costing: a warning for the unwary

A widely used text book, Jones's 'Accounting' says

... costing concerns (1) setting a price for a product or service so that a profit is made and (2) arriving at a correct valuation for stock. (p379)

This is seriously in error and we shouldn't be teaching it to vulnerable young minds. Using costs to set prices is a way of going bankrupt quickly. Prices need to be set at the price that will optimise profits, which is largely determined by the market. Using costs to set prices is likely either to set prices too cheap, in which case profit opportunities are lost, or too expensive, in which case volumes will be too low earn the best profit.

Valuation of stock is a relatively minor function of costing, since it is only about finding a number to attach to stock in the financial statements and should have no substantial economic consequences. The notion that there is a 'correct' value is something beginners in management accounting should be warned about. All management accounting valuations are essentially arbitrary to some degree. What is important is to know how the application of the arbitrary rules is likely to affect decision taking and distribution of wealth.

In my view, management accounting is firstly about maintenance of control within organisations. Costing is a process of accumulating costs so that someone is made responsible for keeping them under control.

The second purpose of management accounting is to provide information for taking decisions - but the people taking the decisions really ought to understand where the numbers come from so they can work out what is going on. Sadly, that is often not the case.

The third thing that management accounting does is to consolidate the position of those in power in the organisation, for good or ill. Not only are they provided with information that others don't have, but they also get to decide on resource allocation through the budgeting system. By labelling your group or department as being in deficit (for example by allocation of central overheads) the people in power get the chance to intervene, demand cuts, veto appointments and do all sorts of other damage. Again, sadly, people often believe deficits have more substance than they do. Management accountants like deficits. Deficits give them power. They get asked to write reports and join task forces looking for cost savings and all kinds of other exciting stuff. People defer to them and ask their opinion. When everyone is making a profit, accountants don't have much to contribute. Their role is not to comment on strategy and they don't know about marketing or product development issues so they tend to be ignored or reduced to number-crunchers.