Theory of Constraints Handbook - James Cox Iii [241]
Business Environment, Second Half of the 20th Century
During the 30 years following World War II, U.S. companies basically followed the same strategy of cost-conscious mass production. In addition, the premier department in schools of business, those drawing the most intelligent students and wielding the most political power, slowly switched from accounting to finance.
During the 1960s and probably much earlier, Harvard Business School began teaching MBA students how to manage by the numbers, meaning using a company’s financial records and other formulas and models developed in finance (Peters and Waterman, 1982, 30) to manage the company. While there were cautions published about the formulas’ complex and fragile treatment of uncertainty in the development of financial models and the overreliance on the skills of MBAs (Hayes and Abernathy, 1980, 67; Peters and Waterman, 1982, 31–33; Johnson and Kaplan, 1987, 15, 125–126), the predominance of finance departments over accounting departments in both academia and industry gradually spread across the United States and throughout the world during almost the next two decades.3 The focus of the 1980s on behavioral consequences of the formulistic approach to business decisions lasted about a decade; by the 1990s, though, business was back to using formulas and models, along with new continuous improvement methodologies (Dearlove and Crainer) in order to regain ground lost to international competitors.4 This movement no doubt was inspired and certainly facilitated by consulting firms who found ingenious ways to convince management that their assistance was required (Stewart, 2009).
Accounting’s Response to a 20th Century Changing Environment
Management accounting, for most companies, barely noticed the changes occurring in business due to their general absorption with other accounting areas (e.g., financial, tax, auditing) and most especially GAAP accounting for external reporting (Johnson and Kaplan, 1987, 2–14, 125). However, it became obvious during the 1980s that traditional accounting and accounting reports had lost their relevance for internal decisions (Johnson and Kaplan, 1987).5Fully absorbed manufacturing costs, including variable and fixed costs of production (whether actual or standard costs), accumulated for external reporting purposes typically do not provide information needed by managers for operating decisions.
Some solutions to the irrelevance of management accounting information have been known for a number of years, but have not been widely accepted and practiced. In addition, newer solutions recently have been proposed (Kaplan and Norton, 1992; Johnson and Broms, 2000; Smith, 2000; Cunningham and Fiume, 2003; Oliver, 2004; Van Veen-Dirks and Molenaar, 2009). The most well-known proposed accounting solutions are discussed in the following sections.
Direct or Variable Costing Income Statement
Direct or variable costing6 (where all costs are divided into fixed and variable components that are then recorded in separate accounts), however, has been included in textbooks since at least the 1960s (Dopuch and Birnberg, 1969, Chapter 15) and has been covered in virtually every cost and management accounting textbook since that time (Hilton, 2009, Chapter 8; Garrison, Noreen, and Brewer, 2010, Chapter 7). The basic format begins with revenues earned, then subtracts all variable costs to provide contribution margin (sometimes called gross margin). From contribution margin, all fixed costs (both manufacturing and general, selling, and administrative) are deducted to arrive at operating income. This method is not acceptable for external financial statements, however, and has not been broadly accepted.
Direct or variable costing is presented in all cost and managerial accounting textbooks as a method of periodic reporting and for providing information for decision makers. The basic idea is that revenue, minus all variable costs (basically equivalent to out-of-pocket costs), is subtotaled as contribution margin. Fixed costs,