Part IV: Academic Insight into the Problems with the NAHB Chart of Accounts Income Statement

(published every year on EFA® since 2012;  updated, incorporated, and republished here, as the fourth in a five-part series)

“The NAHB Chart of Accounts is designed for historical financial reporting.  It is not a managerial accounting tool.  NAHB would do its members a great service by developing guidance on cost and managerial accounting.

“In my roles as both a CFO and a President of a homebuilding company, I am intimately familiar with both the strengths and weaknesses of the NAHB Chart of Accounts.  It was a great tool for benchmarking our performance with other builders and to industry standards.  It was interesting to benchmark our company, but the statements produced utilizing the NAHB Chart of Accounts were of no use when it came to making pricing decisions.”

So said, in part, one of the CFOs participating in SAI’s survey regarding the format and the utilization of their company’s particular Income Statement in relation to the NAHB Chart of Accounts Income Statement.

The thoughtful examination of any managerial accounting or cost accounting textbook validates this CFO’s statements.

To cite one:

“Financial accounting is mainly concerned with the historical aspects of external reporting . . . governed by generally-accepted accounting principles (GAAP).  Management accounting, on the other hand, is concerned primarily with providing information to internal managers . . . charged with planning and controlling the operations of the firm . . . not subject to GAAP . . . one thing is clear from the NAA definition of management accounting:

“The major function of cost accounting is cost accumulation for inventory valuation and income determination.  Management accounting, however, emphasizes the use of the cost data for planning, control, and decision-making purposes.”

Accounting Handbook, Barron’s, J. Siegel and J. Shim, 1990.

 

To cite another:

“Although an Income Statement prepared in the functional format may be useful for external reporting purposes, it has serious limitations when used for internal purposes . . . the Contribution Income Statement emphasizes the behavior of costs, and therefore, is extremely helpful to a manager in judging the impact on profits, of changes in price, cost, or volume.”

Managerial Accounting, 10th Ed., McGraw-Hill Irwin, R. Garrison and E. Noreen, 2003.

 

To cite yet another, directed towards resolving the need for a company to prepare multiple sets of financial information:

“For companies committed to maintaining variable contribution information, there are two choices available . . . 1. maintain their accounting system on a full-absorption GAAP basis, with separate calculations and analysis of variable contribution information [or] 2. maintain their accounting systems on a variable contribution basis with a monthly reconciliation to GAAP . . . if the only real reason for maintaining full-absorption accounting is to satisfy external requirements, doesn’t it make more sense to use option 2 and perform simple month-end reconciliation to GAAP?”

The Measurement Nightmare: How the Theory of Constraints Can Resolve Conflicting Strategies, Policies, and Measures, APICS series, The St. Lucie Press, D. Smith, 2000.

 

The last of the preceding excerpts is consistent with the others;  in fairness, it comes from Throughput Accounting (the emergent cost accounting methodology supporting Theory of Constraints), which places it outside the mainstream.  Throughput Accounting uses a profit and loss statement that is an outlier to even a Contribution Margin P&L, by refusing to assign costs to inventory, and expensing product costs immediately;  literally, it has no internal use for GAAP compliance.

In the similarly nascent and outlying world of cost accounting methods that aim to support Lean Production, in its broadest sense, as a management system – as a business strategy, as an operating philosophy – the advice is more obtuse;  Lean Accounting sees no conflict with GAAP, uses an operating statement that clearly mixes variable and non-variable costs, but nevertheless states these among its Lean Accounting Concepts and Principles:

“2. Do not confuse a fixed cost for a variable cost” and “3. Eliminate absorption accounting for manufacturing transactions.”

The Real Numbers: Management Accounting in a Lean Organization, Managing Times Press, J. E. Cunningham, O. J. Fiume, E. Adams, 2003.

 

At best, comparison with “industry best practices” promotes a satisfaction with some sort of competitive equality, a settling for the expediency of the ideas of someone else.  The real problem with best practices is that it stifles creativity and innovation, works against creating competitive advantage, and creates the illusion of continuous improvement.

GAAP-for-the-sake-of-GAAP?  Compliance-for-the-sake-of-compliance?  If you are a builder, you manage every day;  you only report periodically.  You are not in the business of complying with generally-accepted accounting principles;  you are in the business of making money.  Emphasizing compliance is a case of the tail wagging the dog.

Bottom-line:  the two arguable attributes of the NAHB Chart of Accounts Income Statement – comparativeness-driven conformity and reporting-driven compliance – might be desirable, and to a degree necessary, but they are not a justification to sacrifice sound managerial accounting.  You cannot properly and effectively manage a homebuilding operation using the cost allocations recommended in the NAHB Chart of Accounts Income Statement.

Next:  Part V:  Groves and Shinn:  The Debate Over Costing

 

(variable costing and the Contribution Income Statement format are addressed at every Pipeline workshop™;  learn more here:  http://buildervelocity.com or http://saiconsulting.com/buildervelocity-pipeline-workshops/)