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Johnson, H. T. 1990. Beyond product costing: A challenge to cost management's conventional wisdom. Journal of Cost Management (Fall): 15-21.

Summary by William Beck
Master of Accountancy Program
University of South Florida, Summer 2002

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In this article, Johnson explains how the “management by numbers” philosophy used following World War II in many American manufacturing companies caused their loss of competitiveness in the 1960s-1980s. While Johnson recognizes that financial accounting does have a place in management, he emphasizes the dangers of using this information to control operations

Loss of Relevance

Managerial accounting lost relevance following World War 2 because of the improper uses of financial information. Prior to World War 2, plant managers were expected to think in terms of product quality, customer satisfaction, employee moral, and other non-financial measures. Financial information was used simply for reporting purposes. During the 1960’s top managers of companies began to use financial information not only for reporting purposes, but also to control operations. This change in focus led to what Johnson calls “putting the cart before the horse”. In this illustration the cart represents the financial information and the horse represents the underlying force that produces financial results. Managers focused on accounting information (ROI, net income targets, etc.), in Johnson’s example the cart, and lost sight of the horse, what truly drives the financial results. The main cause in the loss of relevance in managerial accounting was not a failure of managerial accounting to provide information, but a misuse of the information provided. Had more accurate product costing information, such as activity-based costing, been available during the 1960s it would not have improved American companies ability to compete during this period or the decades that followed. While such techniques may have increased short-term profitability, it would not have prevented the loss of market share to competitors. The root cause of this decline in competitiveness was the “management by numbers” philosophy of the last 40 years.

Uses of Financial Accounting Information

Financial accounting information does have managerial uses. Financial accounting information allows managers to see the consequences of their intended action. This is the context - strategic planning - in which activity based costing was born (p. 17). However, Johnson explains that accounting information, including activity-based accounting information is not an appropriate object to manage for two reasons:

Accounting information does not identify what companies must do to be competitive.

Cost information does not identify the root cause of costs.

While activity-based costing does improve the quality of information used for strategic planning, it does nothing to change the way business is conducted or operations are organized.

Allegory from Plato's Republic

Johnson uses an allegory from Plato’s Republic to illustrate how managers can go from an unenlightened state in which they take appearance at face value to a state in which they understand reality. The allegory asks the reader to imagine a deep cavern with a person chained inside since childhood. The person in chained by the leg and neck so that the person can only see the wall in front of him. Behind the person is a fire with the person and the fire separated by a wall like that used as the screen to hide performers in a puppet show. Hidden from the person is a performer who cast shadows on the wall in front of the chained person with various objects that represent people, animals, and so on. The person chained in the cavern, having known nothing else, would believe the shadows of objects cast on the wall to be reality. If the person could free himself, he would pass by the puppet show, outside the cave, and achieve the highest enlightenment when he viewed the actual forms of people, animals, and other objects previously represented in the puppet show in the light of the sun.

Johnson explains how this allegory can be applied to the information that businesses use. The person chained in the cavern represents the finance oriented top managers and financial analysts who believe the accounting shadows passing before their eyes to be reality. The performer behind the wall casting the shadows is the management accountant. What lies outside the cave are the people doing the work that causes resources to be used and products to be created: the causes of the accounting shadows. To become enlightened, top managers must move outside the cave into the sunlight where they can see what justifies peoples activities. Ultimately, satisfaction of customers wants at a profit is the force that drives and justifies the work people do in business (p.18). The sunlight, therefore, is the knowledge of customers wants and how to satisfy those wants profitably (p.18).

Achieving Long-run Profitability

The goal of a company is to achieve long-run profitability. To gain the knowledge of what is needed to achieve this goal businesses over the past forty years have focused on accounting information. However this method of “manage by numbers” does not answer the crucial question to achieving long-run profitability: What do customers want and how do we satisfy that want profitably? Revenues and costs, delivered by accounting information, are simply monetary measures of products sold and of resources consumed: they provide no insight about customer needs or about the causes of profits (p.18). To determine what customers need and how to satisfy that need profitably, managers must look beyond information provided by accounting and look at information about customer needs and the activities of the business.

Doing the Wrong Thing Efficiently

One problem that arises from the use of costing methods, such as activity-based costing, to control operations is that it often leads management to doing the wrong thing efficiently. Often companies act to increase short term profitability to the detriment of the long-run. Johnson sights some examples such as attempting to reduce setup costs by decreasing the number and increasing the run time of setups, or decreasing purchasing costs by increasing order size and decreasing the frequency of orders (Both moves are contrary to modern philosophies such as just-in-time). Using activity-based costing as a method for reaching such decisions does nothing to improve the company’s competitiveness in the global economy and often can be detrimental to long run profitability.

Vision for the Future

Johnson notes the following key elements to returning manufacturing companies to long-run profitability and restoring the relevance of management accounting:

Always keep information that is used to control operating activities separate from the financial information used for planning and budgeting. [Johnson’s Law: If you think your management accounting system incorporates an integrated feedback loop that ties day-to-day operating activities with the bottom-line financial information, you are probably lost in the woods with a pocketful of wet matches.]

Don’t try to eliminate “non-value” adding activities. No one consciously pursues work that has no value. Instead, manage activities to move work-causing constraints- make work unnecessary.

Know within reason the probable long-term financial consequences of planned activities, but don’t try to manage the costs of activities. Manage the work activities entail.

Know the most important information any company can have: what it takes to create and keep satisfied customers. Almost no company today has that information. Activity-based costs do not qualify. (p. 20).

While financial accounting information, such as that provided by activity-based costing, does offer quality information that can be useful for strategic planning, it is necessary for companies to recognize the dangers of its misuse. Managers must have other sources of information that will show them what customers need and how to satisfy that need profitably.

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Related summaries:

Johnson, H. T. 1983. The search for gain in markets and firms: A review of the historical emergence of management accounting systems. Accounting, Organizations and Society 8(2-3): 139-146. (Summary).

Johnson, H. T. 1987. The decline of cost management: A reinterpretation of 20th-century cost accounting. Journal of Cost Management (Spring): 5-12. (Summary).

Johnson, H. T. 1988. Activity based information: A blueprint for world class management accounting. Management Accounting (June): 23-30. (Summary).

Johnson, H. T. 1989. Professors, customers, and value: bringing a global perspective to management accounting education. Proceedings of the Third Annual Management Accounting Symposium. Sarasota: American Accounting Association: 7-20. (Summary).

Johnson, H. T. 1992. It's time to stop overselling activity-based concepts. Management Accounting (September): 26-35. (Summary).

Johnson, H. T. 1992. Relevance Regained: From Top-Down Control to Bottom-up Empowerment. The Free Press. (Summary).

Johnson, H. T. 1995. Management accounting in the 21st century. Journal of Cost Management (Fall): 15-20. (Summary).

Johnson, H. T. 2006. Lean accounting: To become lean, shed accounting. Cost Management (January/February): 6-17. (Summary).

Johnson, H. T. 2006. Sustainability and "Lean Operations". Cost Management (March/April): 40-45. (Summary).

Johnson, H. T. and A. Broms. 2000. Profit Beyond Measure: Extraordinary Results through Attention to Work and People. The Free Press. (Summary).

Johnson, H. T. and R. S. Kaplan. 1987. Relevance Lost: The Rise and Fall of Management Accounting. Boston: Harvard Business School Press. (Summaries and additional information).

Kaplan, R. S. 1983. Measuring manufacturing performance: A new challenge for managerial accounting research. The Accounting Review (October): 686-705. (JSTOR link). (Summary).

Kaplan, R. S. 1984. The evolution of management accounting. The Accounting Review (July): 390-418. (JSTOR link). (Summary).