As businesses attempt to improve the usefulness of their cost accounting process they consider changes to their existing system or purchasing a comprehensive new system. Regardless of what path you choose, when you are done, the system must have the basic safeguards to be reliable.
Many companies do not realize the impact an effective implementation of an ERP system can have on their inventory procedures. The opposite is also true. If you have a poor implementation of an ERP system, it can have an equally devastating impact on inventory procedures.
I don’t know exact statistics, but I do know that all too often companies implement an expensive ERP package and within the first year decide that the package was not worth the time or the money. Generally speaking, the packages ARE worth the money, but the implementation process typically is lacking. The Company ends up with detailed inventory reports that do not reflect accurate balances and do not reconcile to general ledger balances on a consistent basis.
It is so important during the implementation process to identify someone to lead this part of the project, and who has the time to identify and correct the issues. One common error that causes major problems with inventory is that the bills of material (BOM) are incorrect for single or multiple products. If you have not identified correct part numbers, quantities of ingredients, weights, etc. in your BOM, there will clearly be issues with the reported consumption of raw materials.
Similar to this, if your raw materials have not been set up in equivalent units to that which you are issuing to inventory, not only can the potential impact on inventory be significant, it might also be very difficult to discover! One of my clients had this issue about three months ago when they recognized a million dollar adjustment floating through their variance accounts.
Another common factor that could cause inventory inaccuracy is that materials are not being moved to proper locations based on procedures. If the system allows a “location” to go negative, it’s time to check a negative report and get to root cause of what may have cause this. It can come down to material not being moved or inaccurate BOMs. I have also frequently seen transfers of finished goods between Company locations being handled as additions to or decreases of inventory. If your company does large volume intersite transfers, this can have a major impact on inventory valuations if not set up correctly.
These are just a SMALL sampling of some of the issues that can cause inventory balances to be skewed when implementing an ERP system. More importantly, if your inventory balances are inaccurate, what are the consequences?
Operationally, the system might not generate work orders if it thinks you already have the finished good items in stock. If your system is incorrect and you truly do not have the inventory you will likely miss shipments which will potentially cause loss of customers or future orders. In addition, if the work orders are not generated the system will not tell you to purchase material. It is all a downhill spiral from here.
If the system does not tell you to purchase material and your purchased on-hand balances are lacking, you will not have product to produce your manufactured parts. You will possibly be expediting material in and finished goods back out which can become very costly to your company. On top of that, it can wreak havoc on the production floor. A scheduler has to decide which jobs are priorities sometimes on an hourly basis.
Add to these costs other factors such as the cost to deal with machines that need to be changed over quickly to fill an order because your finished goods on-hand counts were inaccurate. How much does it cost your company when you have to switch over jobs that you were not thinking you had to run? What is the time it takes to switch over jobs? The list of issues can continue to go on from here.
Many of you live this in your organizations every day. You’ve bought a system, it is not “automating” your process as you had hoped, and you spend just as much time manually scheduling, editing inventory counts and balances, tracking cycle counts, and PUTTING OUT FIRES. If this is you, it is time to revisit the ERP system and implementation process. It is NOT the software; it is the lack of training, procedures, and accountability. It is time to revisit the implementation process with someone who can help facilitate the desired end result.
For those manufacturing companies that are operating with a costing system that creates variances on a periodic basis, one of the questions we frequently hear has to do with when and how do I allocate variances to inventory.
Good costing techniques are generally those that require the variance to be expensed and not allocated to inventory. This is only if the variance is a result of a preventable action that has created an inefficiency which is generally temporary in nature. Furthermore, a variance that is created from a temporary reduction in volume (in either production or sales) and then affects production should not be capitalized. However, variances that are caused as a result of say for example: rapidly changing material prices either up or down, changing wage rates generally on the upside that have not been built into the standard, or insufficient unavoidable variances as result of planned burden versus actual burden as part of the overhead allocation, should be charged to inventory on a reasonable basis.
How to allocate those variances between inventory and cost of goods sold is best left to the discretion of the cost manager who is most familiar with the entire operation. The method that I see used occasionally is to add the beginning inventory to the cost of goods sold for the period, and then subtract from that the ending inventory to get to the amount of goods produced for the period. For example, if you are trying to allocate material variances you would compare the material variance to the dollar value of material in beginning inventory plus the value of material in cost of goods sold minus the value of material in ending inventory. This will then allow you to allocate the material variance to ending inventory and cost of goods sold. You can of course substitute labor and overhead for material and do this exercise with each of them.
Because of unique circumstances due to the product or production methods, this formula may not always be the most suitable way to allocate variances to inventory. The in-depth knowledge of the process and the cost manager’s judgment on the best way to properly identify overhead or other direct costs that need to be allocated to inventory is generally preferable and necessary. If you are unsure as to the best method to identify costs and inventory then use the basic formula, which is identify what is most reasonable and prudent and results in the most accurate representation of the costs.
I cannot tell you how many times over the last few years I have heard that comment as a justification for not addressing a company’s cost ailments. Most Companies continue to live with systems and costing models that are marginally functional and materially inaccurate because they don’t see an immediate need to address them. How long can you really live with what you have?
Las week, I had the opportunity to have lunch with the CFO of a very successful local Company who made this exact statement several times during the course of our conversation until he realized it would no longer work. My goal during the lunch was to identify WHAT made him ultimately realize that it was no longer acceptable.
We spent a great deal of time discussing how companies are able to hide their costing flaws because of successful years. About twelve years ago, he was the CFO for such a company. The systems and cost methods being utilized at the Company were much like last week’s blog described, and the management team had set a goal for growth. They went through the proper process of employing an educated CIO who guided them down the right path: putting all of the inventory items into the system, setting up routings, identifying accurate bills of material. It did make a considerable difference. Over the last ten years, the Company had grown from $10 million in revenue to over $65 million in revenue.
He indicated that without that process, “growth simply would not have been possible.” As the economy started to tank a few years ago, profit margins started to slip. Because this Company was proactive in reviewing their systems and assignment of costs, they were able to maintain a comfortable profit, and make decisions quickly about what to produce, where to focus their production and cost cutting efforts, and if expansion truly makes sense.
I somewhat equate this theory to my home life. As I have said before, working opposite shifts from my husband essentially places me in the position of trying to have four children in four different places (often different cities) at the same time. Without a significant amount of planning (sometimes weeks ahead) to enlist the help of others, I am predisposed to miss my goal of getting them where they need to be. With my system (ME) I simply cannot do it sometimes.
The whole point of this blog is to provide you with the benefit of this CFO’s direct experience. If you are in the position described last week and BUSINESS IS GOING WELL, now is the time to visit what you are doing relative to systems and costing. If you know that your systems are just making it and not adding any value to your process, NOW is the time. Waiting until you are knee deep in inventory valuation issues, declining profits, consistently late delivery dates, then it just might be too late.
As I think about the organization of a cost accounting department in a current manufacturing environment, it is sometimes difficult to sort out what functions each person in the department should be doing. I recall from earlier experiences with large manufacturing companies that many times the cost accounting function was organized by department or process. Meaning there would be one cost accountant responsible for one area of the plant where one process or manufacturing operation was taking place. However, I also have experienced others where the cost accounting department was organized by function within that department. In many cases that is the most efficient way to organize a cost accounting department.
The general organization of a cost accounting department that is categorized by accounting function often will look something like this:
Often times departments arranged in this fashion have high levels of efficiency because of the specialized nature of each of these assignments. This is also possible in companies that are too small to have separate cost departments. I have seen a single cost accountant able to arrange their work schedule to include focus on each of these issues at different times of the week or the month so as to create special focus on each of these points of importance.
I spent a day last week meeting with a potential new client. I had received the all too familiar phone call a week prior. The owner of the Company said to me, “I simply don’t trust the financial statements that I get each month because the changes in inventory are too erratic.” Knowing full well what I thought I might find, I agreed to come out for a few hours and take a brief overview of their inventory and costing system. I am happy to say that the problems I encountered at this manufacturing facility were not ANY DIFFERENT than any other client or potential client I have visited. Let me summarize:
I could keep going, but I think you get the picture. It makes perfect sense that the financial statements could be trusted. I would say based on the above facts, they were not even materially correct for GAAP purposes, let alone being able to provide any relevant information for management decisions.
In a situation like this, where do you start? The owner agreed that perhaps the system should be updated, but did not think it made sense to complete “standards” for more than 5000 SKU’s. As I dug deeper, it was apparent to me that all of these standards were in excel spreadsheets, HUNDREDS of them.
My personal opinion is that they can keep going like this for a while, but not realizing how much time is being wasted EVERY day completing the excel spreadsheets, extending physical inventory numbers, looking up unit costs, trying to figure out why the numbers don’t make sense and manually tracking inventory throughout the process. I cannot even begin to predict how much time could be saved by fully implementing the system and costing methodology, but I know the results would be SIGNIFICANT.
I would start with a full analysis of the types of jobs being done. I gleaned a general overview, however there are many variations going on out there. Once the types of jobs have been determined, we need to see if our current software will support the inputs needed for these types of jobs. The time consuming part is ensuring that software is correctly installed and all applicable materials and routings are identified for each process.
My mantra from last week: “If you keep doing what you’ve always done, you’ll keep getting what you’ve always got.” You have to be willing to face the music, commit the time, make the financial investment and CHANGE what you have always done.
If you are a member of the IMA or the AICPA or perhaps a comparable entity, then you have no doubt heard about the new AICPA credential CGMA – Chartered Global Management Accountant. If you are a member of the IMA then you received communications on “what does it mean to be a management accountant,” where the IMA insists that just allowing members to use the CGMA designation is not enough. The AICPA has established criteria along with being a voting member of the AICPA that would allow you to have the right to use this certification. The IMA then applauds its 40 years of existence and its rigorous testing methods for certification. I am an active member, in fact the secretary of my local chapter of the IMA and I hold my CMA certification. I must say I am proud that I took and passed the exam and maybe that does mean more to me than just getting to use the GCMA credentials. Although it sure is nice for being rewarded for also having my CPA and for having the necessary consulting experience, I am now able to use the CGMA credentials. I am personally not a huge fan of taking exams, and I am not sure they are always a true judge of an individual’s knowledge. I would love to hear your opinions!
At any rate, the entire buzz about the new CGMA credential and the arguments as to why it is such a great thing and then the opposing arguments as to why it is not got me thinking. So often we want to make sure we have the right person for the job and that everything is done the best way possible and that we have all the information we need. Is that really reality? We get the person that we feel is the best and the truth is no one is ever perfect. The important thing is that the books and records are materially accurate and that we are getting useful information in a timely manner.
So yes, I would love to hear your opinions on the CGMA and the CMA and any other letters you have behind your names, but I also want to hear about how your day to day is going. Are you getting the information you need? Is it timely? Is it accurate? Sure having a controller who is a CMA or a CGMA, or a CPA, or whatever is great, but if you are answering no to those questions, does it matter?
