Sunday, 20 May 2007

Accounting vs. Operations

Accounting versus Operations? Shouldn't the Accounting Department support Operations?


But sometimes, accounting results can lead to the wrong operational decisions. Let me give you a couple of examples:

  • A client of mine sold high grade tool steel in pre-cut sizes. If a customer ordered an eight inch round (for example) and they didn't have any in stock, they would take the next higher size (e.g. nine inch) and cut it down. All of the profit for that sale ended up as scrap on the floor, but at least the customer relationship was preserved. The problem came when they ordered more steel because the accounting system recorded it as a sale of the nine inch size which meant that nine inch would be reordered instead of what the customer wanted.

  • Another major issue is sales between divisions. The easiest way to track these sales is to sell at cost. That way there is no profit recognized on what is really an internal transfer. But how does that effect the profit shown by the two divisions? If the bonuses of the division managers are based on division profit, selling at cost may not reflect the economic results of the two. Selling at cost also removes any incentive to the producing division to be efficient. The correct response: let the two division managers negotiate a fair price. Additional entries may be necessary at year end, but the operational results will be much better.
Accounting must serve Operations, not the other way around!