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Profession versus Professionalism

Monday, June 30th, 2008

I was trying to analyze the definition of words Profession, Professional Body and Professionalism on www.reference.com. (These words are interchangeable used when the Accountants discuss among themselves.)

Profession:

A profession is an occupation, vocation or career where specialized knowledge of a subject, field, or science is applied. It is usually applied to occupations that involve prolonged academic training and a formal qualification. It is axiomatic that "professional activity involves systematic knowledge and proficiency." Professions are usually regulated by professional bodies that may set examinations of competence, act as a licensing authority for practitioners, and enforce adherence to an ethical code of practice.

Professional Body:

A professional body or professional organization, also known as a professional association or professional society, is an organization, usually non-profit, that exists to further a particular profession, to protect both the public interest and the interests of professionals. The balance between these two may be a matter of opinion. On the one hand, professional bodies may act to protect the public by maintaining and enforcing standards of training and ethics in their profession. On the other hand, they may also act like a cartel or a labor union (trade union) for the members of the profession, though this description is commonly rejected by the body concerned.

Many professional bodies perform professional certification to indicate a person possesses qualifications in the subject area, and sometimes membership in a professional body is synonymous with certification, but not always. Sometimes membership in a professional body is required for one to be legally able to practice the profession; see licensure.

Professionalism

Oxford Dictionary: the competence or skill expected of a professional.

Graham Ward in IFAC website: Professionalism, is about individual modes of behaviour that command respect and build trust. It is about excellence in service as measured by recognised standards.It is about delivering services or working to standards that meet the needs of and are expected by our clients.

Such behaviours are indeed a necessary part of belonging to a profession but almost any trade could be described as professional in these terms!

As any of us here knows, what separates the professionalism of members of a professional body from the behaviours of other types of so-named professionals, is the requirement to continually reinforce and demonstrate our professionalism, not merely assert it through a one-off qualification. And it is our membership of a professional body – one which embodies the distinguishing features I have defined – that confers on us the obligation to abide by professional standards and regulation.

It is therefore no longer enough for professions to say to the public ‘you must trust me’, today we must earn that trust and demonstrate: clearly, openly and often, why that trust should be given.

Source: Formula One Cars

Of the above three words, I had to search a lot on the word "Professionalism" to find a true meaning to suit accountancy profession. Members of accountancy profession will be normally be expected to take actions that contribute to the public interest.

The Principle of Professional Conduct on AICPA, US website summarizes Professionalism in a precise manner.

Section 51: These Principles of the Code of Professional Conduct of the American Institute of Certified Public Accountants express the profession’s recognition of its responsibilities to the public, to clients, and to colleagues. They guide members in the performance of their professional responsibilities and express the basic tenets of ethical and professional conduct. The Principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage.

Section 52: In carrying out their responsibilities as professionals, members should
exercise sensitive professional and moral judgments in all their activities.

Section 53: Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism.

Section 54: To maintain and broaden public confidence, members should perform
all professional responsibilities with the highest sense of integrity.

Section 55: A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

Section 56: A member should observe the profession’s technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member’s ability.

Section 57: A member in public practice should observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.

I would like to see your comments and views on this topic. Please feel free to comment on the blog post.

Regards,

Santosh Puthran

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Source: British Superbike Practice

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Ethical Decision Making

Saturday, June 28th, 2008

Recently BBC uncovered in the report on Child Labour practices in India where suppliers of the clothes of high street retailer Primark had used child labour to finish the goods. Primark fired all the three firms involved. The question is about Ethics and Ethical values.

What is Ethics ?

Business ethics is the broadest of the three terms. It addresses the morality of both economic systems (e.g., the free market, socialism, communism) and the conduct of the organizations found within these systems (e.g., corporations in a free market system).

Corporate ethics may be viewed as a subset of business ethics. Corporate ethics focuses specifically on issues of morality associated with business enterprises. These include relations internal to the organization (e.g., treatment of employees, dealings with shareholders, questions concerning product quality and customer service, etc.) as well as external relations (e.g., interactions with government, specific communities, society as a whole, the impact of corporate activities on the natural environment, etc.).

Source: Hovefly

Ethical dilemmas

An ethical dilemma is a situation that will often involve an apparent conflict between moral imperatives, in which to obey one would result in transgressing another.

Eg.

Trading with rogue governments can be seen as either contribution to the continuation of the regime or supporting economic growth that benefits all concerned
If a foreign subsidiary of a company is operating in a country where it is legal to employ child labour, should the company take advantage of it ?
Should you bribe to get your work done ? In some countries it is a common practice where it is referred as Suvidha or Baksheesh.

An article on on Santa Clara University explains " A Framework on Ethical Decision Making"

Recognize an Ethical Issue

1. Is there something wrong personally, interpersonally, or socially? Could the conflict, the situation, or the decision be damaging to people or to the community?

2. Does the issue go beyond legal or institutional concerns? What does it do to people, who have dignity, rights, and hopes for a better life together?

Get the Facts

3. What are the relevant facts of the case? What facts are unknown?

4. What individuals and groups have an important stake in the outcome? Do some have a greater stake because they have a special need or because we have special obligations to them?

5. What are the options for acting? Have all the relevant persons and groups been consulted? If you showed your list of options to someone you respect, what would that person say?

Evaluate Alternative Actions From Various Ethical Perspectives

6. Which option will produce the most good and do the least harm?

Utilitarian Approach: The ethical action is the one that will produce the greatest balance of benefits over harms.

7. Even if not everyone gets all they want, will everyone’s rights and dignity still be respected?

Rights Approach: The ethical action is the one that most dutifully respects the rights of all affected.

8. Which option is fair to all stakeholders?

Fairness or Justice Approach: The ethical action is the one that treats people equally, or if unequally, that treats people proportionately and fairly.

9. Which option would help all participate more fully in the life we share as a family, community, society?

Common Good Approach: The ethical action is the one that contributes most to the achievement of a quality common life together.

10. Would you want to become the sort of person who acts this way (e.g., a person of courage or compassion)?

Virtue Approach: The ethical action is the one that embodies the habits and values of humans at their best.

Make a Decision and Test It

11. Considering all these perspectives, which of the options is the right or best thing to do?

12. If you told someone you respect why you chose this option, what would that person say? If you had to explain your decision on television, would you be comfortable doing so?

Act, Then Reflect on the Decision Later

13. Implement your decision. How did it turn out for all concerned? If you had it to do over again, what would you do differently?

If you as an Accountant are faced with Ethical dilemmas, apply the above principles. Further refer to your institute’s code of ethics. If you are still in doubt, then consult your Institute or Association.

I would like to hear your views on this subject for further discussion. You are welcome to comment on this blog post.

Regards,

Santosh Puthran

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Who will be a better Accountant - Shahrukh Khan or Aamir Khan ?

Wednesday, June 25th, 2008

Shahrukh Khan and Aamir Khan are two famous personalities in Bollywood. Both are equally successful and have a huge fan following. It depends upon what you consider success? Is it female fan following or fame or money. Never mind !!!

I am looking at the traits each one has. Then let you decide who will be a better accountant. Please use your imagination which one is more suitable to be a successful management accountant.

Shahrukh Khan

Mostly acts in movies that have contemporary themes.
Mostly works with a same set of people and makes movies with them and repeats the success.
He has a good PR and he tours around the world. All the tours are well publicized giving the details of what he eats, whom he meets and when he goes to sleep. This makes him known and people are interested in his next movie release.
He is approachable and gives frequent interview on TVs.
He started as a TV star. Sometimes he host TV quiz shows.
People know him very well since he acts in TV commercials. He makes good use of TV as a medium to maintain his popularity.
Sometimes experiments with movies with a different story and that gets him noticed.
Dances very well and challenges anyone to dance with him.

Aamir Khan

Some say he is a tough guy and he goes into minute details during movie making.
His movies are innovative, different, story oriented and at the same time convey social theme. More focused on reality.
He does not socialize and hates interviews.
He prefers that his work talks for himself rather than him.
He does not believe in awards like Filmfare but attempts for Oscars.
He can dance very well in movies but he does not tour or dance in shows. So general public do not know whether he is interesting or boring.
He makes few movies but they are blockbusters.
He always gives opportunities to new people in his movies and repeats his success with new set of people.

Aamir and Sharukh Khan are successful personalities in Bollywood. To summarise the traits above are leadership style, team management, self promotion, work and standards/ethics. Both the actors are successful using these traits to a different degree.

Please vote on who will be a successful accountant in a corporate environment depending on the traits they display.

I would like you to use your own imagination in making your choices and also add comments on the blog post. Looking forward to see your vote and comments.

Don’t forget Rate this Blog post.

Regards,

Santosh Puthran

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Knowledge Process Outsourcing (KPO)

Tuesday, June 24th, 2008

Knowledge process outsourcing (KPO) is a form of outsourcing, in which knowledge-related and information-related work is carried out by workers in a different company or by a subsidiary of the same organization, which may be in the same country or in an offshore location to save cost. Unlike the outsourcing of manufacturing, this typically involves high-value work carried out by highly skilled staff. KPO firms, in addition to providing expertise in the processes themselves, often make many low level business decisions—typically those that are easily undone if they conflict with higher-level business plans.

It is being claimed that KPO is one step extension of Business Processing Outsourcing (BPO) because BPO Industry is shaping into Knowledge Process Outsourcing because of its favorable advantageous and future scope. But, let us not treat it only a ‘B’ replaced by a ‘K’. In fact, Knowledge process can be defined as high added value processes chain where the achievement of objectives is highly dependent on the skills, domain knowledge and experience of the people carrying out the activity. And when this activity gets outsourced a new business activity emerges, which is generally known as Knowledge Process Outsourcing.

Source: NYCLONDON

What high-end services can be outsourced to the Indian KPO sector?

Here are some KPO services that can be outsourced to India :

Research & Development
Business and Technical Analysis
Learning Solutions
Animation & Design
Business & Market Research
Pharmaceuticals and Biotechnology
Medical Services
Writing & Content Development
Legal Services
Intellectual Property (IP) Research
Data Analytics
Network Management
Training & Consultancy

According to a report of National Association of Software and Services Companies (NASSCOM), the Indian chamber of commerce that serves as an interface to the Indian Software industry, Knowledge Process Outsourcing industry (KPO) is expected to reach USD 17 billion by 2010, of which USD 12 billion would be outsourced to India. Another report predicts that India will capture more than 70 percent of the KPO sector by 2010. Apart from India, countries such as Russia, China, the Czech Republic, Ireland, and Israel are also expected to join the KPO industry.

Challenges to providers

In addition to the challenges faced by clients, KPO companies themselves have challenges:

High staff turnover, especially where work is not challenging to the employee’s skills
High cost of training and tendency to lose the most experienced employees to the clients
Ensuring the security and confidentiality of information, especially when privacy laws vary from country to country

Source: NYCLONDON

Creating the climate for success in India

The responsibility of setting up successful KPOs in India ultimately belongs to the India-based business units that can effectively serve the global market. PricewaterhouseCoopers has identified four possible scenarios for the creation of KPO service providers:

The well-established IT and BPO companies will move up the value chain and diversify into KPO;
Companies currently serving specific vertical markets in India could choose to begin offering their services globally;
Multinational companies may form captive units in India whose staff belong to global teams within various functional units; and
New companies may be formed by Indians with very specialized skills and international work experience to provide services exclusively to the global market.

Irrespective of how they are formed, these business units should aspire to go all the way to create India-based expertise that produce tangible business benefits for the organizations they support within a short time frame.

They need to able to recruit, train and retain highly talented team members and be effective in moving them up the value chain.

Sources and References:

We like to invite you rate the post . You may also share it with your friends by clicking on the button ShareThis at the end of this post.

If you are working with a KPO, please let us know more about KPO by posting a comment on the blog.

Regards,

Santosh Puthran

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Cultural Web - A big challenge

Sunday, June 22nd, 2008

A big challenge in most organizations is whether they know what their culture is - and whether it is the right culture to support their strategy!! Organizational analysis aims to generate an understanding of the organizational structure and culture of the system the project is looking at. This can help in understanding the ease or difficulty with which new strategies can be adopted.

Check these for your own organisation:

How would you describe your organisational culture?
How would the workforce describe it?
Would this be the same as the directors and top management think?
How would your clients, customers, users and suppliers describe it?
What is the does this mean about the way the organisation operates?
Does this culture support or sabotage your strategy?
What are the clues which tell people about your strategy?

Source: Flickr

The Cultural Web, developed by Gerry Johnson and Kevan Scholes in 1992, provides one such approach for looking at and changing your organization’s culture. Using it, you can expose cultural assumptions and practices, and set to work aligning organizational elements with one another, and with your strategy.

Elements of the Cultural Web

The Cultural Web identifies six interrelated elements that help to make up what Johnson and Scholes call the “paradigm” – the pattern or model – of the work environment. By analyzing the factors in each, you can begin to see the bigger picture of your culture: what is working, what isn’t working, and what needs to be changed. The six elements are:

Stories – The past events and people talked about inside and outside the company. Who and what the company chooses to immortalize says a great deal about what it values, and perceives as great behavior.
Rituals and Routines – The daily behavior and actions of people that signal acceptable behavior. This determines what is expected to happen in given situations, and what is valued by management.
Symbols – The visual representations of the company including logos, how plush the offices are, and the formal or informal dress codes.
Organizational Structure – This includes both the structure defined by the organization chart, and the unwritten lines of power and influence that indicate whose contributions are most valued.
Control Systems – The ways that the organization is controlled. These include financial systems, quality systems, and rewards (including the way they are measured and distributed within the organization.)
Power Structures – The pockets of real power in the company. This may involve one or two key senior executives, a whole group of executives, or even a department. The key is that these people have the greatest amount of influence on decisions, operations, and strategic direction.

Source: Little Boy with a Bat

These elements are represented graphically as six semi-overlapping circles (see Figure 1 below), which together influence the cultural paradigm.

Source: Mind Tools. Click here to read more

If you like the article, please rate, comment and share.

Regards,

Santosh Puthran

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Business, Customer Value, Cost and Management Accounting

Friday, June 20th, 2008

This is a guest post by CMA Devarajan Swaminathan. He has over 10 years post qualification experience in Accounting, Auditing, Finance as well as Management Accounting. He is the proprietor of Devarajan Swaminathan & Co - Cost Accountants.

View CMA.Devarajan Swaminathan’s profile

My understanding of a BUSINESS: Back to basics

There is a customer: He has money

I am the supplier: I have the product.

The aim is to sell him my product in return for his money.

A business is not and cannot be more complicated than this. Everything revolves around this.

To do the above I have spent resources like financial, technical, physical, human to bring the product first at my doorstep and then to the customers doorstep. My aim is to sell my product and in turn take his money. The difference what we call PROFIT, is actually my earnings for (a) the efforts I have put (b) the risk I have taken.

How well I do the above is what holds the key to the success or failure of a business ?

The above is true when my product will sell. How about a scenario where my product does not sell? Not because there is no demand but because some one else sells the same or better product better than me and at a better price. I stand to loose the customer. This brings out the question what is the true value of my product and what is the true value of my customer.

PROFIT: Determined by the complex interplay of value, price and cost and its maximization are what every business tries to achieve. In other words maximization of the shareholders wealth, ROI and so on and so forth. The issue how does one go about doing this?

Source: Humming Bird

The reason for so much importance to the compliance is because of more and more weightage given to enhancing shareholder value rather than enhancing customer value. Although the irony its customer value that’s creating shareholder value. The sales value declared in the financial are taken for granted without any thought on how and why the sales value has been arrived at.

What is driving the sales?
We have a measurement of the shareholder value with all those EBIDTA, EPS, PV, ROI ratios. All these are meaningless unless we measure customer.
Do we have a measurement of CUSTOMER VALUE?
Cost based pricing and price based costing in my opinion are both insufficient.It should be customer value based costing and pricing.

In my opinion Customer value comes into play not when they are there but when they are not there. Most of the time the customer is taken for granted. Ask Dunlop tyres where they goofed up? Ask Mukand Steel where they goofed up? In fact we need to ask all those companies that were either closed down or are in the verge of closing down and the reason for the same. As the scale of operations increase the customer value increases significantly. E.g. I put a plant and mobilize resources to take my product to my customer for Rs. 10 billion. Tomorrow another player enters the market with a better product and better delivery capability due to which I loose my customers and my business, what is my loss, is my customer value.

Customer value is not the PROFIT per customer that I WOULD have earned but the LOSS per customer that I WILL incur if they are not there/ i loose them. How do I come down to a unit value is based on the capacity built up to serve customers. How well (efficiently and effectively) I either structure the Rs.10 billion or the customer base or both is what determines the cost, the premium that the customer is willing to pay for my product (which is based on his perception of the product value i.e. brand, quality, service, performance, resale value etc) is what sets my premium / margin and the addition of the two is my Price. This significantly varies between market segments. The day the business goofs up on cost structuring (which is a good quality product taken to the customer in the best possible manner and quickest possible time) and customer perception it’s got to loose both the customer and value.

The shareholders expectations is taken care by the generalists and compliance oriented accounting. In terms of money received, deployed and returns generated and reported. We as management accountants need to shift our focus from shareholders and bring it to customers for the sake of shareholders because business revolves around customers and not shareholders. Interests of shareholders are taken care automatically when the interests of the customers are taken care of. Vice versa is not true.

Management accountants as bean growers need to be customer/ business centric and focused. Strategy is how best I can add and create value to my customers and thereby my shareholders using management accounting tools and techniques. To do all that I have said above one needs to focus on management accounting, customer measurement, cost measurement, cost management and cost control. Once the focus shifts to customer value and cost, other things revolving what determines cost (i.e. financial, physical, technical and human resources) are automatically addressed to, managed and maximized. It thus adds value to the needs of the customer which in turn adds value to the shareholders.

Just a thought.

Your value additional thoughts, opinions, perspective solicited.

Regards,

CMA.Devarajan Swaminathan
Devarajan Swaminathan & Co.
Cost and Management Accountants

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Firefox - How do they make money ?

Thursday, June 19th, 2008

I downloaded Firefox 3 yesterday . I and am very happy with the improvements Mozilla has made to the browser (more than 15000 to be precise). Over 8 million downloads has been made in 24 hours. Let’s see whether it becomes a world record.

Yesterday, I downloaded the add-on Feedly and it provides a wonderful browsing experience to read all my RSS feeds in one window like a magazine. You should have a iGoogle account. to use Feedly since it gets data from your igoogle settings.

I wondered how free software like Firefox, Digg, Snurl make money or fund their projects ?

I searched on google and found answers:

Firefox

Mozilla Corporation makes all that money because of the Google Search box on the top right. If you search with that box (which I do all day long) and you click on the Google ads on the results page Firefox gets ~80% of that. They also have Amazon in the search box, and other services that I’m sure kick them back some affiliate fees. Brilliant.

Source: Calacanis.com

Digg.com

It’s speculative math, to be sure, but let’s take a whack at it. The CPM (cost per thousand displays) rates for Digg’s new design are $16 for 728×90 leaderboards, $14 for 120×600 skyscraper positions, and $9 for 125×125 blocks. The 125×125 slots often seem to be filled by Google AdSense ads, which will probably monetize at a slightly lower rate than $9 per thousand displays - but not much lower, given Digg’s tech-related topics. So let’s say $6 CPM for the 125×125 spots. Simple maths is $ 800k a month.

Source: Blogprofit.net

Google has been the main driver to the development of the open source software. You may also see that most of the websites running google adsense.

You will also notice that free software vendors have their own stores … mainly selling T-shirts, caps or cups with logo printed on it. The cost of the T-shirt with $ 15 which is equivalent to one year subscription of any anti-virus software. So you buy it, you are funding the software !!! Visit some of the stores.

The revenue model for the business has changed. No direct selling of software. More the number of users for the product, more the advertisers and sponsors.

Imagine if put this as a case study to Accountants whether this model is ethical or not, the arguments would swing both ways !!!

I feel that any business to be successful has to have a good revenue model. A good stream of funding will make the entrepreneur direct his time and energies for the business to be successful.

Regards,

Santosh Puthran

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Activity Based Management - Dispelling the myths - Part II

Monday, June 16th, 2008

This is a Guest Post by Rajendra Patil, Pune, India

Profile: A technocrat with 17 years of proven success in ERP Implementation, Business Analysis, Consultancy Assignments in Strategic Cost Management, Profitability Analytics, Performance Management and Business Process Management in conjunction with the enterprise wide BI solutions. Currently working as an independent consultant in the area of Performance Management and Profitability.

This is the concluding part of earlier post Activity Based Management - Dispelling the Myths - Part I

Myth: Cost systems play a limited role

Fact:

Traditionally this has been true and it has its own reasons. The calculations were not accurate. As it was based on putting overheads as ‘peanut butter’, it did not reflect the changes in the business scenario into the costs.

ABM benefits the organization in various ways like

Information for effective decision-making
Information to continuously improve processes and reduce costs
A focus on significant costs
A relationship between organizational cost and organizational value
Methods to measure performance with accountability
ABM can be used strategically to understand and improve profitability of the organization, operational performance and resource planning.

Myth: We cannot do anything about fixed costs;

Fact:

We can look at fixed costs in couple of ways

Fixed costs are fixed eternally. If we take into consideration a longer time horizon, then we can see the fixed costs are also changing. In that case we have to understand the reasons that are changing the ‘Fixed’ costs.
Fixed costs are generally attached with corresponding capacities. The investment should match with the required capacity. Alternatively the organization should look for the business that uses maximum if the installed capacity.
These fixed costs have to be taken to the products, customers or channels according to the ‘Cause-and-Effect’ relationship.

Myth: Only manufacturing costs are product costs; and Product costs are not useful for managing overhead activities.

Fact:

ABC is based on the ‘Cause-and-Effect’ relationship. The costs can be caused by product, customer, vendor, channel etc. We have to trace the expenses to the proper origin. This helps us to understand the relationship of the costs with the business scenario. With the help of this information we can take current business decisions as well as plan our costs in the future.

The companies that have implemented SAS Activity Based Management Solution

Lakshmi Machine Works
ING Vysya Life Insurance

On MS Excel

Kirlosakar Brothers
Thermax
Suzlon Energy
NCDEX
Wockhardt Hospitals
Kores
Syngenta
Merck
Crompton Greeves

If you have any questions on Activity Based Management and its implementation, you may post your comments on this blog post or write to Rajendra Patil on rajendra@appsconsulting.in on specific issues or concerns.

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Job Rotation - A Donkey Story

Monday, June 16th, 2008

Have you heard the story of "The Washer man and the Foolish Donkey"?

To refresh your memory, and for the benefit of those who have not grown up listening to this moral story, it goes like this…

There was once a washer man who had a donkey and a dog. One night when the whole world was sleeping, a thief broke into the house, the washer man was fast asleep but the donkey and the dog were awake. The dog decided not to bark since the master did not take good care of him and wanted to teach him a lesson. The donkey got worried and said to the dog that if he doesn’t bark, the donkey will have to do something himself. The dog did not change his mind and the donkey started braying loudly. Hearing the donkey bray, the thief ran away, the master woke up and started beating the donkey for braying in the middle of the night for no reason.

Moral of the story "One must not engage in duties other than his own"

Source: Dog Newton

Now take a new look at the same story…

The washer man (J) was a well educated man from a premier management institute. He had the fundas of looking at the bigger picture and thinking out of the box. He was convinced that there must be some reason for the donkey to bray in the night. He walked outside a little and did some fact finding, applied a bottom up approach, figured out from the ground realities that there was a thief who broke in and the donkey only wanted to alert him about it. Looking at the donkey’s extra initiative and going beyond the call of the duty, he rewarded him with lot of hay and other perks and became his favorite pet. The dog’s life didn’t change much, except that now the donkey was more motivated in doing the dogs duties as well. In the annual appraisal the dog managed a "meets requirement" …

Soon the dog realized that the donkey is taking care of his duties and he can enjoy his life sleeping and lazing around. The donkey was rated as "star performer". The donkey had to live up to his already high performance standards. Soon he was over burdened with work and always under pressure and now is looking for a job rotation…

Regards,

Santosh Puthran

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Activity Based Management - Dispelling the myths - Part I

Friday, June 13th, 2008

This is a Guest Post by Rajendra Patil, Pune, India

Profile: A technocrat with 17 years of proven success in ERP Implementation, Business Analysis, Consultancy Assignments in Strategic Cost Management, Profitability Analytics, Performance Management and Business Process Management in conjunction with the enterprise wide BI solutions. Currently working as an independent consultant in the area of Performance Management and Profitability.

The list of myths on Activity Based Costing for discussion was posted by CMA.Siva Rama Krishna Srirangam. Rajendra Patil of AppsConsulting dispels the myths in two part series on the Management Accountant Blog and companies in India that have implemented ABM.

We have to understand the characteristics of the customers in each quadrant. We have to try to bring them in the ‘Top-Right’ quadrant.

Myth : All that we need are more cost centers;

Fact :

More cost centers would help you to get more accurate ‘Cost center accounting’. ABC is based on the ‘Cause-and-effect’ relationship. This causal relationship is lost when we try to relate the costs at various cost centers directly to the products.
When we use the ‘Cause-and-effect’ relationship, we understand that, the products are not the only entities that are causing the costs. With this reasoning we can segregate the costs as Product Costs, Customer Costs, Business sustaining Costs and Available to use Costs. Use this information to improve the performance of the organization.

Myth: Machine-hour systems save the time; and

Fact:

Machine hour system is related to the calculation of cost of production only. The experience has shown that we can take the cost of production from the conventional costing system. The accuracy is enough for the ABC models used for strategic decisions purpose. The accuracy of the production cost can also be improved, if needed using ABC. ABC is actually for assigning the ‘overheads’ with a causal relationship.

Myth: A cost system should be kept simple.

Fact:

This is true. It is actually true for any system. As it has been earlier explained, it is the skill of the implementation team to keep the model simple. At the same time is has to be seen that the results expected are not be compromised.
Alternatively, the complexity of the model in the conventional terms can be kept with the analysts and the business users are not exposed to it. The business users can use the various reports in different formats.

Myth: We do not need more accurate product costs:

Fact:

Yes, this true in case if the complexity of design to delivery of the products does not vary largely. If it is not so, then the typical revelation is that the products with higher volume get higher costs and those with lower volume (may be with higher complexity) get lower costs.

Myth: We know what our products cost; and

Fact:

It is not only the products that cause overheads. The complexity of the business causes overheads in the organization. This complexity is brought by the multiple products, customers, channels, regions etc. We should be able to segregate the costs that caused by the reasons other than the products only. Once we are able to do that, then we can understand the reasons for the same and business decisions can be taken. There is more to understand than only the product costs in ABM.

Myth: The market sets prices, so we do not need product costs.

Fact:

Let me take this statement as understanding or managing profitability of the organization. Firstly to understand the profit, one has to understand the proper costs. ABC helps to calculate cost more accurately. We have to also understand that the product profitability is different from customer profitability. The same product sold to different customers can bring different level of profit.
All customers are not equal. Generally the customers that bring more revenue are taken as most profitable customers. This may not be true, as various customers ask different prices, discounts, make changes in the schedule, ask non-standard products, order small quantities large number of times etc. This changes the profitability of the customers.
It has been observed typically that the top 15 percent of the customers bring the current level of profit. Top 45 percent of the customers bring 450 percent of the profit and last 20 percent of the customers take away the 350 percent of the profit away from the organization.
The best information for an organization is to understand whether their best customers are buying their best products.

Continued… in Part II

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