Managerial Accounting with David Burgstahler – Cost Allocation and Decisions

The phrase that defines this class and likely was used more times than anything else was ‘It depends’. While this phrase doesn’t help someone who is already confused and is trying to get a clarification, when everything truly depends on the underlying assumptions, ‘It depends’ becomes the logical answer. While the early part of the course consisted of simple accounting in terms of fixed and variable cost assumptions for a case called Ned’s Barber shop, it moved on to more complex cases that helped develop the understanding of fixed and flexible budgets, Managerial compensation based on Economic Value Added (EVA) and the utilization of a Balanced Scorecard which translates a high level strategy into divisional and mid level managerial goals.

Overall, I thought this was a wonderful course that demonstrated the importance of allocating costs correctly to prevent decision making that would harm the business. It made me realize that sometimes, it is a wise decision to operate certain sections of a business at a loss than to shut them down because they absorb certain fixed costs related to the business in turn keeping other sections profitable. This was demonstrated beautifully by the case on Oleo Software. They have 4 products out of which one product is losing money. They make the decision to shut down products that are losing money. As soon as they shut down the one product that was losing money, all of the fixed cost related to the business is now distributed into 3 products. Now even with the same amount of revenues for the other three products, one of them starts losing money because the allocation of fixed cost to that product has increased. When they shut down this product, the fixed cost is now allocated in two products equally and one of those two products start losing money. This continues until the business has no profits left. The moral of the case is that they should have never shut down the one product that was losing money when they had 4 products.

We also talked about looking at processes and figuring out the constrained resource. We did a case on Performance Motors where the garage would use a diagnostic tool to find the problem with the cars coming into the business. While I believe they had bandwidth on other stations to do more work, the constrained resource was the diagnostic tool. Without adding a diagnostic tool, they would not be able to complete the service within the prescribed time costing them more money than they would make by taking on more cars. This taught me to find the constrained resource in a flat process based business before trying to add more to the incoming business. It is also worth remembering that once you have added capacity to the constrained resource, it might not give you full utilization of this new resource due to the fact that now, another station might be at full capacity becoming the new constrained resource. Hence, the decision to add to the constrained resource should take into consideration how much capacity would be truly added before something else becomes a process constraint.

I will be writing more on Budgeting, EVA and Balanced Scorecard in a subsequent post