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.

• Generally accepted accounting principles (GAAP) require that you allocate variances if those variances are material in relationship to the amount of inventory being held at the end of the year.
• The Internal Revenue Service (IRS)  has rules related to allocating variances and those rules are that if the variances are material in relationship to the total cost capitalized than they must be allocated to inventory.  Further, the IRS requires that there be special allocations of overhead to inventory as part of code section 263A.
• Additionally good costing techniques have their own guidelines as to when overhead should be allocated to inventory. As a costing manager you need to consider all three of these alternatives and apply overhead to inventory in a way that is the most efficient and suitable for your own needs.

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.

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.

The general organization of a cost accounting department that is categorized by accounting function often will look something like this:

1. The first process to be segregated is the general reporting.  This process is part of thecost department that makes periodic calculations. Very often, and no less frequently than monthly, the variances created in the manufacturing operations should be reported in a variety of forms to the management groups that are responsible for such variances.
2. The second process that will likely be segregated is the special sales and order analysis.  This department is primarily focused on cost versus sales price, margin analysis, and relationships between product cost and selling price. The department is typically associated with the pricing department due to its relationship to setting selling prices and maintaining margins.
3. The third function is special cost analysis or variance analysis. This department is primarily responsible for intensive variance analysis.  Meaning they are reviewing the reports done by the general reporting process, analyzing the variances, and then working with the industrial and operating engineers and the department managers to reduce costs and improve company profitability.  The department works to establish controls mostly as a result of analyzing variances and reviewing budget differences.  Part of their responsibilities is to work with engineering to establish and maintain the standards.  Another part of their job is to report on results of the variance analysis projects so that actual benefits derived from cost analysis can be shown to senior management.  Further, their responsibilities are to closely follow up and do the necessary studies on unfavorable variances to improve those operations. Finally, they are responsible for reporting any deviations uncovered during their variance analysis from established accounting procedures or cost principles that were set by the company.

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.

1. There were no accounting or operations budget to manage by.
2. The general ledger package had some sophisticated ability to track inventory items and job cost, but it was not being utilized.
3. Inventory and costing were being done via a combination of taking physical inventories using manual count sheets and extending them utilizing excel spreadsheets.
4. The process was done MONTHLY for all raw materials, work in process, and finished goods inventory items.
5. According to the Controller, her time doing this process each month (not to mention those individuals counting and a few of her subordinate’s time involved) was a MINIMUM of 3-4 entire days.
6. Based on conversations with the Controller, she did not truly understand what she is doing. So it stands to reason when the financials “did not make sense,” she did not know how to “fix”them.
7. The plant was a machining plant, with over 40 CNC’s, and they were applying overhead based on direct labor hours.
8. The application rate was determined in 2007, and had not been updated since.

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.

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?

The presentation was high energy (at times he spoke 200 words per minute!), thought provoking, and emotional.  If you do not know of him, or have not heard him speak, put it on your to do list.  It was well worth my time! During his presentation, he used a phrase that we have covered many different times since we started the blog. “If you keep doing what you’ve always done, you’ll keep getting what you’ve always got.” I think this originally came from Mark Twain.

My reference here is to the overall process of effectively planning for the management accounting of your business. The planning includes budgeting, cost modeling, and in depth analysis of the link between operations and the finance department. All too often this link between finance and operations does not exist. The entire process is interdependent, and those who are in charge need to understand the relationships.

The problem that I see consistently is that these components while all interdependent, need to EACH be executed in order for the Company to be successful at managing the product cost and to be able to quickly and effectively make decisions.

1. Building the budget – Many companies are stuck in the 3% rut. The current year’s budget is last year’s actual multiplied by a cost of living adjustment. That just does not make sense! I am working on a budget right now where the majority of the assumptions provided by the OWNER cannot be proven through historical data analysis. Preparing an accurate budget is about analyzing what has happened (history), using your knowledge of what you expect to happen (the crystal ball) and merging those into a living template that can be updated as needed.  The budget needs to be realistic, and malleable.
2. The Cost Model – The budget should be part of this process, as should standards, reporting, metrics, and the complete understanding of operations. Many companies don’t even have a cost model, and are not sure where to begin. START SOMEWHERE!!!
3. Integration with Operations – While at leadership Toledo last night, one of my classmates looked at me and said “You are NOT the typical accountant!” I asked him to expand on that, and he said, “you are not the type to sit behind your desk and crunch numbers all day.” That is very true! So, you need someone in charge of your management accounting with that same quality. They have to be willing to know more than just the numbers. They have to be willing to open that feed that allows a deep understanding of the business processes and the resources that are consumed during those processes.

Clearly this is the satellite view. Each of these three components encompasses many more facts and details that need to be understood and implemented for success in the management accounting function. While I don’t have any statistics to quote, based on my experience, a good percentage of you reading this post are definitely lacking in at least one, if not all of the above areas. The time has come, even if you only change one part of the equation. Isn’t it time you achieved different, better results?

This principle is one of the foundations of standard cost systems, but that still does not answer what should be measured. There are three general guidelines that may be used to determine what to measure:

1. The first is the amount and relative importance of a cost variance that arises from a specific cause.  The basic concept here is materiality; meaning, is the variance likely to be large and is the cost important to control? If so, it should be computed and reported regularly.
2. The next guideline relates to the underlying cause of the variance and how often it occurs.  If the variance is an isolated, one time occurrence which is not likely to happen again, then the cost manager must question the expenditure of resources to analyze and report on that variance.  On the other hand, if its reoccurrence is almost certain, it would warrant periodic analysis and reporting.
3. The final guideline that I see used frequently has to do with determining which variances point out opportunities for cost reduction and which show little or no direct action can be taken.  Common sense would indicate that a cost that meets guideline one and two and is subject to substantial control by management certainly comes to the top of the list of relative analysis and reporting.  However, the opposite is true. A variance that can be slightly influenced by management in the short term is only worth a limited analysis and a very infrequent reporting cycle.

As you reflect on the reporting in your own company, you may discover reporting processes that are antiquated and yet still continued to be implemented.  Take time to analyze how you determine what to measure; then ask yourself, “does it make sense and does it follow the basic guidelines?”

The post lunch speaker was Lynn Ritter, Education Coordinator for the Alzheimer’s Association here in Northwest Ohio.  As you might imagine, based on her title, she was there to educate us about what Alzheimer’s truly is (as compared to dementia) and to give us some valuable information on how to deal with it should we ever encounter it firsthand.   Unfortunately, I have already faced that as many others have.  My maternal grandfather had Alzheimer’s for many years before he passed, and it is difficult no matter what role you play – the victim or the caregiver’s.

Lynn started the presentation with some pictures of the human brain.  The pictures showed the difference between a healthy brain and someone who had advanced Alzheimer’s.  Notice the difference- the healthy brain is much larger, more tissue.  The Alzheimer’s brain is smaller and the cross section pictures that Lynn showed us contained a great deal of “empty space.”  Once the cells were covered in plaque, they could not function, and simply die.   Someone with Alzheimer’s cannot process the information that they are receiving because they simply don’t have the tools   (cells, neurons and dendrites!) to do so.

As weird as it sounds, this reminded me of a conversation I had with a potential new client just the day before.  This individual was the Vice-President of a Company that processes revenues over $500 million and telling me that he was struggling on a daily basis to make decisions for his Company.  Again, this is THE MOST common theme that brings me around initially.  Trying to assess the roadblock I kept pushing to find out why he was unable to make these decisions.   His answer?  He had not seen a set of financial statements since August, 2011.  WOW.  The numbers that he is able to extract from his team do not reconcile to anything, and his biggest concern?  The cost of the jobs that he is performing.  It appears from the initial assessment that no one  is even reviewing the costs on a daily, or even weekly basis.

I walked away from this meeting wondering just how long this type of situation can go on without catastrophic effects for the Company.  The most interesting part, of course, is the correlation with my education on Health Day.

This Vice President (and the rest of his management team) will never be able to effectively make decisions with confidence because the tools to do so are not there.  Whether the cause is inherent in the system (software), the accounting team, the leaders, the processes- the correct information is not being processed and forwarded on as it should be for this business to be AS successful as it could be.

Look at your team.   Look at your processes.  Look at your system, operations, metrics…… Where is the link that could be causing the death of your decision making ability?