The old joke goes, two applicants for the job of cost accountant were asked the same question, “How much is two plus two?” The first applicant quickly answered, “Four!” while the second and successful applicant responded, “How much do you want it to be?”
My advanced degree is in managerial accounting, so please excuse my derisive joke on my profession. Unfortunately, we were all conditioned to accept the term “accounting accurate” as accurate when the goal of accounting is not accuracy, but stability and consistency. As supply and procurement professionals, we must know the difference between accuracy and consistency.
Take inventory as an example. Company A has 1000 kilos of copper in inventory; it uses the accounting convention of FIFO (first in, first out).That means the first price paid for that copper, €2.00 a kilo, is the value of the inventory regardless of future higher or lower purchase costs of the copper. Company B also has 1000 kilos of the same type of copper, but it uses the accounting convention of LIFO (last in, first out). That means the last price paid for that copper, €4.00 a kilo, is the value of the inventory regardless of future higher or lower purchase costs of the copper. Company A’s inventory value of the copper is €2,000.00, while Company B’s inventory value of the copper is €4,000.00. What is the real value of the copper inventory in Company A and B? Since our cost accountant was the successful candidate above, the answer is the same: “What do you want it to be?” These accounting conventions make it easy to report financials and stabilize cost accounting ledgers, but they are not accurate reflections of the true value. If you were deciding a cost plus contract with Company A or B, which value of inventory would you like to pay?
Another favorite of the financial community is general sales and administration (GS&A). In most commercial enterprises, it accounts for 15 to 20 percent of costs. The intent is to account for all of those expenditure activities, like sales, corporate HQ, central administration—even company planes and assets—that are shared by all of the various organizational entities in major corporations. If the total of GS&A is $20 million and we have 10 operating divisions, how should we allocate those costs to each division? How about a tenth each, or based on the percentage of sales, or people, or assets, or investment, or how about the number of bathrooms each division has? Did you forget our successful applicant? The answer is, “What do you want it to be?” Is that accurate? You are buying products from a division that does not use the corporate jets; should that division, by embedding those costs in their price, have you pay for those expenses? Another division from which you do not purchase products has embarked on a major sales campaign; should the other division from which you do purchase products, by embedding those costs in their price, have you pay for those expenses?
Caveat emptor. It is our responsibility to understand the accounting and financial information of our suppliers. That must be more than blindly accepting generally acceptable accounting principles (GAAP). The starting point is to read and understand the financial statement—especially the footnotes. The second source of knowledge is to understand the accounting conventions. The next time you are analyzing a supplier’s financials, include one of your cost accountants as part of your team. After all, many banks use ex-bank robbers to help with their security problems.