Product Costing Systems: Finding the Right Approach

• Published date: 01 May 2015
• DOI: http://doi.org/10.1002/jcaf.22045
• Author: Joseph G. Fisher,Kip Krumwiede
• Date: 01 May 2015

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© 2015 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI 10.1002/jcaf.22045

This article was originally published in Volume 23, Number 3 of The Journal of Corporate Accounting and Finance.

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Joseph G. Fisher and Kip Krumwiede

Many firms use

product cost-

ing informa-

tion to value inven-

tory for financial

reporting purposes.

However, having

timely, relevant cost

information is essen-

tial for profitability

analysis and strategic

planning. Consider

the following story. A

few years ago, after

implementing a more

detailed costing sys-

tem, Nestlé SA Chief Executive

Peter Brabeck made an unex-

pected and alarming discovery:

His company was produc-

ing 130,000 variations of its

various brands, and 30 percent

weren’t making money.1 Exces-

sive focus on variable costs and

spare capacity led to the con-

clusion that many new products

were “profitable” and long-

term winners. Nestlé’s margins

were lower than competitors,

however, which strongly sug-

gested that these seemingly

“profitable” products were

actually decreasing firm profit.

Careful consideration of the

cost and profitability analysis

provided by its new sophis-

ticated Enterprise Resource

Planning (ERP) system led

Nestlé to jettison weaker

brands, consolidate product

offerings, and make significant

adjustments in strategic direc-

tion. As Nestlé discovered,

selecting the correct product

costing system for strategic

decisions can be challenging

but is essential in guiding firm

strategy. The wrong system can

lead to faulty strategic deci-

sions with disastrous results.

We have found that many

firms underinvest in their

product costing systems. But

if improvements in product

cost accuracy would lead to

different decision out-

comes, then the cost

of improving the cost

system becomes a stra-

tegic investment rather

than an unfavorable

spending variance.

While managers realize

the problems caused

by relying on flawed

cost information, it is

challenging to identify

the appropriate cost

system. Complicating

the task is the fact that

different strategic deci-

sions call for different product

costs. The purpose of this article

is to help companies determine

the right product cost system

approach. First, we discuss

why choosing the right costing

approach is important. Second,

we discuss four key questions

that must be answered when

selecting a costing approach and

the associated options. Lastly,

we describe actions to take to

achieve a proper fit.

WHY PRODUCT COST SYSTEMS

MATTER

So why do companies need a

costing system? First, generally

Product Costing Systems: Finding

the Right Approach

Many product costing methods and systems exist,

but having the right costing system for a given

situation can be difficult. This article identifies four

key questions to answer and points out the advan-

tages and disadvantages of various cost systems

to find the right balance of convenience, correct-

ness, and implementation costs in a product cost-

ing system. Nestlé, for example, discovered that

good product management, aided by better cost

systems, can pay major dividends.

© 2015 Wiley Periodicals, Inc.