Part V: Groves and Shinn: The Debate Over Costing
(published on EFA® every year since 2012, previously titled “The Debate Over Costing”; incorporated and republished every year, here as the last in a five-part series)
On the BUILDER discussion group on LinkedIn, I had this exchange with Shinn Consulting’s Emma Shinn, on whether costs on the NAHB Chart of Accounts Income Statement should be allocated according to the rules of absorption costing or the rules of variable costing.
The matter of how the NAHB Income Statement Income Statement allocates costs was the subject of an April 2009 post on Escape from Averageness®. It was also the subject of a series of posts in January 2012, summarizing the results of a CFO survey we conducted on the NAHB Income Statement, preceding the 2012 International Builders Show (IBS).
Here is the exchange, in its entirety:
Emma: “I do respectfully disagree with your assessment of the NAHB Chart of Accounts – the purpose of the [Chart of Accounts] is to provide a structure for collecting financial information in an organized and meaningful way. It provides builders the capabilities to produce reports that are meaningful and that will guide them in their decision-making process.
“In no way does it deter or hinder the contribution margin analysis you talk about. In fact, it facilitates such analysis as it provides the classification of cost and expenses in a way that facilitates the identification of the variable and fixed components.
“The contribution margin analysis does not deter from the analysis of the traditional income statement and the valuable information it provides to the builders. The contribution margin analysis does provide an expanded view and I agree with you in that builders can benefit from also looking at the income statement from this point of view as it refines further the behavior of fixed vs. variable cost and expenses.
“However, your assessment of the NAHB Chart of Account is unfounded and could not be farther away from the reality of what the purpose of the [Chart of Accounts] is set up to be.”
Fletcher: “Emma, you don’t have to take my word for it. As part of the survey, we asked CFOs for their insight related to the structure of the NAHB Income Statement (i.e., line item accounts in series 300-900), as it relates to cost allocation (variable v. absorption) and management tools (breakeven, CVP, etc.).
“This an excerpt from one CFO:
“’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.’
“The thoughtful examination of any managerial accounting or cost accounting textbook validates this CFO’s statements.”
Emma: “Once again, I respectfully disagree with that assessment. There is nothing in the Chart of Accounts that prevents a company from preparing a statement utilizing other analytical tools. The income statement you call the ‘NAHB Income Statement’ is the standard income statement presented in any accounting principles class.
“If you want to do further analysis for specific managerial considerations, that is always highly encouraged. However, I again say the NAHB Chart of Accounts vs. the charts of accounts I normally encounter in my reviews of builders’ operations facilitates further analysis; it does not preclude the analysis.
“Accounting, in my view, is primarily a management tool and we continue to encourage builders to view it as a very powerful means to help direct their management decisions. That is not to take away the role accounting also plays in reporting results to third parties, such as lenders and investors.”
Fletcher: “Emma, the NAHB COA Income Statement has a lot of attributes. However, there is a difference between what something ‘does not deter or hinder’ or ‘does not preclude’, on the one hand, and what it positively, proactively enables, on the other.
“That may be all our differing views are about. However, here are two of the specific points made on the matter, posted on SAI’s Escape from Averageness® weblog in April 2009:
“’The NAHB COA Income Statement treats Indirect Construction Cost as one of the costs that is deducted from Revenue to determine Gross Profit (the only difference between Gross Margin and Gross Profit is the inclusion of Indirect Construction Cost). But – do Indirect Construction Costs vary according to Revenue? Probably not. For the most part, they are non-variable costs that will most likely be incurred regardless of the Revenue produced.
‘The NAHB COA Income Statement treats Selling Expenses (including Real Estate Commissions) as an Operating Expense, as a part of overhead. Anything allocated to Selling Expense, therefore, should be a non-variable cost. Is that the case? No. The bulk of Selling Expense is a variable cost.’
“Emma – some of the CFOs in the survey were very out-spoken on this issue, and the shortcomings of absorption costing are well-documented.”
(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/)