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The Shift to Predictive Accounting – Part II

After having analyzed the broad landscape of accounting, we move forward in what the decision makers need in order to create value.

Read the previous blog

The Shift to Predictive Accounting

What? So what? Then what?

The value, utility, and usefulness of this information increases at an exponential rate from the shift in emphasis from cost accounting to cost analysis to decision-based costing.

The cost reporting for analysis information converts cost measurement data into a context. It is useful for managers and employee teams to clearly observe outcomes with transparency that may have never been seen before, or is dramatically different from their existing beliefs derived from their firm’s less mature cost allocation methods. Cost reporting displays the reality of what has happened, and provides answers to “What?” That is, what did things cost last period?

However, an obvious follow-up question should be “So what?” That is, based on any questionable or bothersome observations from historical costs, is there merit to making changes and interventions? How relevant to improving performance is the outcome we are seeing?

This leads to the more critical, and relatively higher value-added need to propose actions – to make and take decisions – surfaced from cost planning. This is the “Then what?” question. This is what managers want to know. For example, what change can be made or action taken (such as a distributor altering its distribution routes), and what is the ultimate impact? Of course, changes will lead to multiple effects on service levels, quality and delivery times, but the economic effect of profits and costs should also be considered. And this gets to the heart of the widening gap between accountants and decision makers who use accounting data. To close the gap, accountants must change their mindset from managerial accounting to managerial economics.

The need for managerial economics

There is a catch. When the Cost Reporting and Analysis element shifts to become the Decision Support with Cost Planning, then analysis shifts to the realm of decision support via economic analysis. For example, one needs to understand the impact that changes have on future expenses. Therefore, the focus now shifts to resources and their capacities. This involves classifying the behavior of resource expenses as fixed, step-fixed, or variable related to changes in service offerings, volumes, mix, processes and the like. This gets tricky. A key concept is this: The “adjustability of capacity” of any individual resource expense depends on both the planning horizon and the ease or difficulty of adjusting the individual resource’s capacity. This wanders into the messy area of marginal cost analysis that textbooks oversimplify, but is complicated to accurately calculate in the real world.

In the predictive view of costs, changes in demand – such as the volume and mix of products and services ordered from customers – will drive the consumption of processes (and the work activities that belong to them). In turn, this will determine what level of both fixed and variable resource expenses are needed to supply capacity for future use.

Since decisions only affect the future, the predictive view of accounting is the basis for planning, analysis and evaluation. This view is what managers are increasingly seeking, and accountants are lagging at providing. The predictive view involves forecasts and cost consumption rates to determine more valid budgets and rolling financial forecast revisions of the budget.

Closing the accounting gap

Cost accounting system data is not the same thing as cost information that should be used for decision making. The majority of value from cost information for decision making does not reside in historical reports – the descriptive view. Its primary value comes from planning the future including driver-based budgeting and rolling financial forecasts. This requires the predictive view of accounting. There is a gap between what managers need and what accountants provide. Closing the gap should be a high priority for every CFO.

Read the previous blog

Performance Management processes

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