Costing for Project Based Manufacturers: Is There a Right Answer?

COSTING FOR PROJECT BASED MANUFACTURERS: IS THERE A RIGHT ANSWER?

Editor’s Note: This is the first article in a two-part series on costing for project-based manufacturing.

Let’s face it; most people think manufacturing costing is boring. They also think that it’s a rudimentary exercise conducted by accountants pouring over piles of green bar paper reports in a back room.

But experienced manufacturing professionals recognize that cost accounting is often shrouded in mystery and confusion. They also likely know that this topic can be the cause of many arguments, and if not managed properly, the source of many issues and even disaster. Nowhere is this more evident than in a project-based manufacturing company.

In part, this controversy and confusion stems from the fact that there are no preset rules or guidelines that preside over how cost accounting is structured and utilized for most manufacturers. In the U.S., for instance, Generally Accepted Accounting Principles (GAAP) do not dictate how costing is done by a manufacturer. Its main aim is to stipulate that costing information, as applied to financial statements and related, is consistent and representative of reality versus revenues in a given accounting period.

Further, there are many schools of thought around costing and cost accounting. These include financial cost accounting, managerial cost accounting, throughput cost accounting, lean cost accounting and so on.

Last, but not least, there are many different cost accounting methodologies in use today, such as standard, FIFO actual, LIFO actual, average, weighted average, moving average and activity-based.

No wonder this is such a complex topic!

Project-based manufacturers are exposed to all of this complexity, but then add another dimension to the problem — they must go beyond costing for products and inventories and deal with costs as they are incurred and accrued to unique events called projects.

So back to the original question — is there a “right” answer concerning costing for project-based manufacturers? The simple answer to this question is no. There isn’t a silver bullet that can lay years of confusion and controversy to rest. Manufacturing in its many forms and variants is just too complex for a “one-size-fits-all” answer.

But there are some guidelines than can be applied to assist a project-centric manufacturer in determining a suitable path forward. Here are five questions project-based manufacturers need to ask as they determine their costing strategy:

1) Consider the purpose(s) for which the costing information is being generated.

Ask yourself if the information is being used:
•By the accounting department as they prepare financial statements and deal with auditors?
•For internal management purposes?
•For analyzing positioning amongst competitors?
•For determining cost-based pricing matrices?
•For contractual compliance with customer or governmental contracts?
•Or for other purposes?

You must define the audience or audiences for costing information prior to making any decisions so that you can select the right approach for their needs.

2) What type(s) of manufacturing is the organization involved with? Are the goods being manufactured highly standardized with limited variations in the material, labor and machine based inputs consumed in producing those goods or are goods and processes highly variable? Are goods made to stock in advance of demand based on stable and predictable forecasts or is production tailored for a given customer’s unique requirements? Are goods produced over very long time horizons where cost inputs to production may vary dramatically or is production done in very short lead-times where the chance for incurred variability among inputs is low? These factors also influence which approach is the best fit.

3) What is the burden that the organization as a whole must bear to generate, accumulate and analyze costs versus the benefits the organization derives from this information?

4) Just how accurate must the costing data be relative to some predetermined comparative yardstick such as a contract or reality in general? Are shortcuts permitted, such as compiling aggregated buckets of costs that can be applied across multiple inputs, outputs, inventories or project tasks based on a predefined formula?

5) What are current business systems capable of supporting?

For instance:
•What support is available within existing business systems (like ERP, MES and/or project management systems) for collecting costing data? Systems that support automated data collection tools such as bar coding, voice data collection, machine-based data collection or RFID usually have a lower cost per piece of information collected and used than manual systems do. This in turn lowers the break-even point between organizational burdens incurred to collect the data versus benefits to be derived from the same data.

•What types of costing methodologies do existing business systems utilize? For instance, choosing to pursue a FIFO actual costing methodology for goods and projects is not likely to be a good approach if the existing system(s) are only capable of handling standard cost calculations.

•Are the system elements supporting manufacturing integrated with the project management aspects of the systems environment? Are both of these integrated with the accounting system and the financial records? As with automatic data collection, systems that are fully integrated usually offer a lower break-even point between the burdens of managing costing data and the benefits to be derived from this information.

Look for the conclusion to this series, “4 Keys to Improving Your Costing for Project-Based Manufacturing,” coming soon…

Costing for Project Based Manufacturers: Is There a Right Answer?