When Worlds Collide: Operations vs. Accounting

…in 2007 I witnessed a classic debate between operations and accounting:

Ops: Why is this standard unit cost so high [$1.25]? It used to cost 50 cents and we used to sell this for a buck!
Acc: The material price went up and the labor/overhead rate went up.
Ops: But that doesn’t make sense! What overhead rate?
Acc: $80 per hour of direct labor
Ops: What? What’s in there??
Acc: It’s labor + the overhead derived from spreading it over total labor hours
Ops: Is it $80 everywhere?
Acc: No, this is for the molding department. Every department has a different rate.
Ops: Molding? But this product isn’t molded!! There’s only a little glue sprayer that they use to apply the Velcro to the foam.
Acc: But the people in the molding department produce it so that’s the rate we use in the routing and it went up from last year’s $45 because you didn't utilize the equipment well enough.
Ops: But that doesn’t make sense! This product doesn’t USE molding equipment!!!

I hear and see this kind of interchange quite a bit. The numbers, products, and processes change, but the underlying disconnect is the same. Standard cost is inadequate for today's management and operations strategies. Hence the importance of Activity-Based Costing and other Strategic Costing methods. Standard cost is fine for the finance/accounting side of things. It is necessary to value inventory (until lean thinking can reduce it) and create monthly financials.

Finance and accounting folks are entrenched with standard cost methodologies, which is good for regulatory requirements sake. There are only a few who possess the right lens to see things different. But it is very important for management to see true costs, and make their strategic and operational decisions based on that.

"Traditional managerial accounting is at best useless, and at worst dysfunctional and misleading.“

John K. Shank

Noble Professor of Managerial Accounting and Management Control

Tuck School of Business - Dartmouth College

“[Traditional standard cost systems] are inadequate for managers and employees in today’s competitive environment.”

Robert S. Kaplan

Baker Foundation Professor at Harvard Business School