The purpose of this article is to provide a historical explanation of why manufacturers began using cost accounting information as a substitute for cost management information. Johnson believes that defenders of, as well as critics of cost accounting do not understand its purpose. The article begins by explaining the difference between cost management and cost accounting. Cost management is used to assign costs to products and to use the information gained to control costs and to make management decisions about production. Cost accounting is used to allocate costs to products and to use the information to determine inventory valuation and net income.

Cost management has been used since the early 1800s. In the 1800s, most manufacturers produced only a few similar products, and they relied on economies of scale and efficiency to make a profit.  Because product lines were homogeneous, gathering cost data was relatively simple, and the benefits outweighed the costs.

In the 1880s, many manufacturers began to broaden their product lines. Because different products used resources at different rates, accurate cost information became more difficult to gather. It was during this time period that Alexander Church advocated tracing all costs, including indirect costs such as selling and administrative costs, to individual products so that the profitability of each individual product could be determined.

Around 1900, cost accounting was developed by auditors as a way to value inventory on audited financial statements. It was a way to assign value to inventory and determine income without introducing any numbers that were “outside the stream of original transactions.” Cost accounting is adequate for financial reporting, because the overall results are relatively accurate even if cost information for individual products is inaccurate. It also is the least costly way to allocate indirect costs to products.

In the early 1900s, managers and authors understood the differences between cost management and cost accounting. So Johnson questions how cost accounting information has become commonly used for making management decisions. Some believe that public accountants convinced management accountants to make the change. But auditors have not historically, nor do they now have a significant influence on management behavior. There also was a large time gap between the disappearance of cost management and management’s adoption of cost accounting.

Johnson believes that manufacturers stopped gathering cost management information early in the 1900s because the costs to gather and process the information outweighed the benefits that it provided. Manufacturers found other ways to maintain profitability and did not focus on cost management from the 1920s to the 1950s.

In the 1960s, foreign competition increased, and manufacturers were forced to look at ways to cut costs in order to remain competitive. At the same time, technology made gathering and processing cost information less expensive. But rather than gathering cost management information, most manufacturers used cost accounting information to evaluate their product lines. Johnson believes that the reason for this is that the only costing methods that managers had been exposed to were those presented in university cost accounting courses focused on training students for careers in public accounting.

Peter Drucker wrote an article in the 1960s that pointed out the problem of inaccurate product costing¹. He claimed that the main products of most American manufacturers were profitable, but that a manufacturer’s competitiveness disappeared because of the presence of “specialties” whose true costs were significantly higher than those calculated by cost accounting methods. The method that Drucker advocated for tracing product costs produces misleading results², but his emphasis on cost drivers is important for manufacturers to consider. Johnson also mentions an article by Miller and Vollman³, Cooper's Schrader Bellows case⁴, and his Weyerhaeuser field study⁵ as indications that ideas similar to those of Church and Drucker are reemerging in practice.

Johnson concludes by pointing out that cost management information needs to benefit managers, not accountants. Cost management systems should produce information that will help management “identify and evaluate the resources needed to deliver value to the customer.” Cost accounting information is not relevant to management decision-making.

___________________________________________

¹ Drucker, P. F. 1963. Managing for business effectiveness. Harvard Business Review (May-June): 59-62. 

² Although Johnson does not explain why Drucker's method would produce misleading results, consider Drucker's statement (p. 11) to see if you can discover the problem.

According to Drucker, ..."economic results are, by and large, directly proportionate to revenue, while cost (other than direct materials and purchased parts) are directly proportionate to number of transactions."

³ Miller, J. G. and T. E. Vollmann. 1985. The hidden factory. Harvard Business Review (September-October): 142-150. (Summary).

⁴ Cooper, R. 1985. Schrader Bellows. HBS Case Services.

⁵ Johnson, H. T. 1987. Managing diversity and strategic overhead cost: Weyerhaeuser Company, 1972-1986. Field Research in Management Accounting and Control. Edited by W. J. Bruns, Jr. and R. S. Kaplan. Harvard Business School Press.

	Web maaw.info