ARTICLES WERE MADE POSSIBLE BY A FAR GRANT.

Comparing U.S. and German Cost Accounting Methods B Y K IP K RUMWIEDE, CMA, CPA, PH.D., AND A UGUSTIN S UESSMAIR THIS ARTICLE EXPANDS ON THE AUTHORS ARTICLE, GETTING DOWN TO SPECIFICS ON RCA, WHICH APPEARED IN THE JUNE 2007 ISSUE OF STRATEGIC FINANCE. BOTH ARTICLES WERE MADE POSSIBLE BY A FAR GRANT. EXECUTIVE SUMMARY During our in-depth study of German and U.S. costing systems, we found that German companies emphasize management accounting more, and U.S. companies place their accounting emphasis on financial reporting. In addition, more German companies than U.S. companies are satisfied with their costing systems. We recently completed an in-depth study of German and U.S. costing systems, which included site visits to several firms in both countries and a detailed survey asking many of the same questions to make head-to-head comparisons. We came away from our German site visits quite impressed with not only the amount of detail but also the level of commitment these firms place on management accounting (i.e., controlling ) information. This large emphasis placed on management accounting is rarely seen in U.S. firms, which tend to place their accounting emphasis on financial reporting. Any proposed management accounting initiative has to overcome strict cost-versus-benefit hurdles to be approved. We will provide details of our survey results and site visits (see Table 1 for a summary of the respondents by industry). The results are based on 148 surveys from German companies and 130 from U.S. companies in a cross section of industries during January through June 2006. The German response rate was 36% of the companies contacted, and the U.S. response rate was 27%. Overall, the U.S. respondent firms were somewhat larger than the German firms in terms of sales revenue ($201 million $250 million versus $151 million $200 million, respectively). The two countries also varied somewhat in terms of industries represented with more U.S. responders than German responders (72% versus 58%, respectively) from manufacturing firms. We also report industry differences when applicable. We found that the Germans focus more on certain advanced costing practices often associated with what has become known as resource consumption accounting (RCA). Firms in the United States tend to focus on different practices. Many of these differences are driven by culture and more advanced implementations of MANAGEMENT ACCOUNTING QUARTERLY 1 SPRING 2007, VOL. 8, NO. 3

Table 1: RESPONDENTS BY INDUSTRY INDUSTRY GERMAN FIRMS U.S. FIRMS Construction 5 (3%) 3 (2%) Food & Textiles (including consumer goods) 8 (5%) 18 (14%) Chemicals (including paper & printing) 19 (13%) 11 (8%) Metals (including rubber & plastics) 24 (16%) 24 (18%) Machinery (including electronics) 30 (20%) 35 (27%) Other Manufacturing firms 0 (0%) 2 (2%) Total Manufacturing Industries 86 (58%) 93 (72%) Transportation (incl. communication & utilities) 19 (13%) 7 (5%) Wholesale Trade (incl. Retail trade) 6 (4%) 5 (4%) Finance (incl. Insurance & Real Estate) 9 (6%) 5 (4%) Consulting (incl. software & other business services) 22 (15%) 7 (5%) Health (incl. other public services) 5 (3%) 12 (9%) Other Service firms 1 (1%) 1 (1%) Total Nonmanufacturing Industries 62 (42%) 37 (28%) Total 148 (100%) 130 (100%) enterprise resource planning (ERP) systems. We will discuss the differences and similarities in order to help non-german companies determine whether advanced costing practices such as RCA will add strategic value for their firms. GENERAL DIFFERENCES D IFFERENT C ULTURES The culture in most U.S. firms is that costing practices are just not important enough to invest heavy resources in more detailed methods. Convincing upper management to invest in more advanced methods usually requires a strong quantification of the expected benefits of those methods. Because those benefits are usually hard to quantify, the investments rarely get made. Even when firms spend millions on a new ERP system, much effort is made to minimize the expense and just try to get the new system to do essentially what the old system did. As one director of worldwide manufacturing finance responded about the possibility of implementing RCA, It could work if operations management would agree to adopt. Cultural change is the biggest issue, and it would be a major effort to change the metrics being used today. The Germans take a very different approach. Table 2 illustrates the strong emphasis Germans tend to place on management accounting, which is known as controlling. Their answers show consistently stronger topmanagement support for managerial accounting, pursuit of advanced cost accounting methods, and importance placed on internal decision support, planning, and control. On average, more than 40% of their accounting employees perform controlling functions compared to about 35% in the United States. German and Japanese companies are also known for having a longer-term planning horizon than U.S. firms. This characteristic was supported by our survey of German firms, which were less likely to take a short-term view in meeting profit goals and somewhat more likely to continue offering an unprofitable product or service MANAGEMENT ACCOUNTING QUARTERLY 2 SPRING 2007, VOL. 8, NO. 3

Table 2: FOCUS ON MANAGEMENT ACCOUNTING QUESTION 1 GERMAN FIRMS U.S. FIRMS Managerial accounting receives strong, active support from top management. 5.79 4.76 Our company pursues advanced cost accounting methods. 4.56 3.52 We have a strong internal decision support, planning, and control focus in our firm. 4.81 4.28 Internal decision support, planning, and control are as important as financial 5.65 4.93 reporting in our firm. Approx. what % of accounting employees perform primarily internal decision 40.30 35.30 support-related functions? 1 Except for the last question, responses based on a 7-point scale with 7=strongly agree and 1=strongly disagree. Bolded numbers are statistically different at 95% confidence level (two-tailed). Table 3: LONG-TERM EMPHASIS QUESTION 1 GERMAN FIRMS U.S. FIRMS We strive to maximize profits primarily in the short term. [REVERSE SCORED] 4.40 3.50 Management will continue offering an unprofitable product or service if it has 5.25 4.88 a promising future. Current profit is the only real goal at our company. [REVERSE SCORED] 5.16 3.89 Our firm faces a lot of pressure to meet short-term profit goals. [REVERSE SCORED] 3.78 2.97 1 Responses based on a 7-point scale with 7=strongly agree and 1=strongly disagree. Bolded numbers are statistically different at 95% confidence level (two-tailed). Table 4: IMPORTANCE OF PRECISION QUESTION 1 GERMAN FIRMS U.S. FIRMS There is strong attention to precision in our company. 5.36 4.92 We are careful to be exact in our analyses. 5.41 4.84 It is very important for managers to have precise answers to most questions. 5.66 4.91 Our management information must be highly accurate in most cases. 5.13 5.24 1 Responses based on a 7-point scale with 7=strongly agree and 1=strongly disagree. Bolded numbers are statistically different at 95% confidence level (two-tailed). as long as it had a promising future (see Table 3). Germans are also known for their precision engineering, and this emphasis on precision carries over into their cost analysis as well. As Table 4 shows, German firms exceeded the U.S. firms in attention to precision and exactness in analysis. This tendency is apparent in the firms cost accounting practices that we will discuss later. One German controller, whose firm uses thousands of cost centers, commented, How can you not have this level of detail? MANAGEMENT ACCOUNTING QUARTERLY 3 SPRING 2007, VOL. 8, NO. 3

STRONGER I NFORMATION SYSTEMS Across the board, no matter how we asked it, we found German firms almost always have much stronger information systems (IS) than firms in the United States. Perhaps it is the longer-term outlook, or the emphasis on precision, or a little of both. Table 5 shows that their responses to various questions regarding the quality of their IS were consistently far and away higher than the U.S. firms responses. Their processes are more fully mapped out, more integrated, and more user-friendly. There is a wider array of data available, and it is more accurate. One reason for these results is that they are more likely to have implemented ERP systems (81% versus 65% for the U.S. firms). Implementing an ERP system alone, however, is not enough to achieve the systems quality the German firms exhibit. Many U.S. firms implemented ERP systems in the late 1990s, primarily to address Y2K concerns. Often one key goal of these implementations was to be able to do the same things (e.g., reports) as before with minimal disruption to operations. It is no wonder that many U.S. firms have been disappointed with the lackluster returns on their huge ERP investments. Table 5 also shows far more variation in ERP vendors in the United States compared to Germany, where SAP dominates the field. SATISFACTION WITH E XISTING COST ACCOUNTING SYSTEM We asked respondents to rate their cost accounting system in several areas on a scale of 1 to 7. Table 6 reports the percentage of respondents answering a 6 or 7. German firms rated their system the overall right tool 77% to 78% of the time compared to 23% to 26% of the time for U.S. firms. German manufacturing firms gave their systems highest marks for budgeting, planning, and evaluation, as well as for product decisions, but they were also significantly higher than U.S. firms on process improvement and customer profitability analysis. For nonmanufacturing firms, German firms are still far more satisfied overall and rate their system superior for budgeting, planning, and evaluation. In the other categories, however, the two groups had similar and much lower satisfaction rates. S IMPLER, MORE COMPLEX, OR ABOUT THE SAME? We asked survey respondents whether they expected Table 5: INFORMATION SYSTEM QUALITY QUESTION 1 GERMAN FIRMS U.S. FIRMS All processes in our organization are fully described and mapped out. 4.91 3.66 Our IS across functions (sales, operations, etc.) are highly integrated. 5.31 4.50 Overall, the IS offer user-friendly query capability to various users. 4.50 3.91 Our IS within operations or manufacturing are highly integrated. 5.10 4.56 A wide array of cost and performance data is available in the IS. 5.25 4.40 The IS generally provide data that are accurate and up to date. 5.54 4.59 Do you use an enterprise resource planning (ERP) information system? 81% 65% If yes, who s the vendor: SAP 61% 18% Oracle 2% 11% JD Edwards 1% 11% NAVISION 8% 0% Other 28% 60% 1 Responses based on a 7-point scale with 7=strongly agree and 1=strongly disagree. Bolded numbers are statistically different at 95% confidence level (two-tailed). MANAGEMENT ACCOUNTING QUARTERLY 4 SPRING 2007, VOL. 8, NO. 3

Table 6: SATISFACTION WITH COST ACCOUNTING SYSTEM MANUFACTURING FIRMS NONMANUFACURING FIRMS PERSPECTIVE GERMAN U.S. GERMAN U.S. Overall right tool 78% 23% 77% 26% Budgeting, planning, and evaluation 52% 20% 56% 30% Product decisions (e.g., pricing, design, outsourcing) 53% 29% 28% 35% Process improvement 44% 16% 33% 28% Customer profitability analysis 48% 29% 28% 34% 1 Percentages represent number of respondents answering 6 or 7 on a 7-point scale with 7=strongly agree and 1=strongly disagree. Note: Bolded numbers are statistically different at 95% confidence level (two-tailed). their cost accounting system to be simpler, more complex, or about the same in the next five years. On our German site visits, we found a common trend to simplify the sophisticated systems to make them more understandable to management. Among U.S. firms we visited, we also found a desire to increase the complexity and accuracy of their systems. The overall survey results, however, were just the opposite. Fifty-eight percent of the German firms responded more complex (35% about the same) compared to 50% of the U.S. firms (29% about the same). There were some industry differences in the results. The nonmanufacturing firms in both countries were much more likely to say more complex (65% to 68%). Differences between the two countries tended to be among the manufacturing groups. For instance, 58% of the German chemical, paper, and printing industry group expected their cost system to stay about the same, and none said simpler. In the Unites States, 18% said about the same, and 27% expected it to get simpler. Overall, 20% of the U.S. manufacturing firms responded about the same compared to only 7% of the German firms. STRATEGIC F OCUS We asked participants to rank their strategic priorities from a list of eight possibilities. Both U.S. and German firms ranked providing high-quality products or services as their number one priority, although U.S. firms ranked it even higher than German firms did (1.76 versus 2.52, where 1 equals most important and 8 equals least important). U.S. firms were also more likely to indicate fast/dependable deliveries and new product introductions. German firms were more likely to identify cost leadership, excellent after-sale service, and customization strategies. There was virtually no difference between the two countries in how they rated customer market pressure, potential for cost distortions, and the importance of cost information, but there were big differences in the two countries costing methods and practices. OVERALL COSTING M ETHODS AND R EPETITIVENESS OF P ROCESSES We asked respondents which label best described their costing system and compared the labels chosen for different levels of process repetitiveness. Batch and continuous process producers in Germany are most likely to use direct costing (72% and 56%, respectively), and job shops tend to use departmental allocation methods (56%). In the United States, departmental allocation methods are the dominant costing method among batch (50%), continuous process (47%), and job shops (43%). Regarding GPK, batch and continuous process producers most often use GPK (38% and 30%, respectively), while only 21% of the job shops reported using it. COSTING P RACTICES Table 7 compares the costing practices of the two countries segmented by manufacturing and nonmanufacturing firms. U.S. firms are far more likely than German firms to use plantwide or departmental overhead rates. The limitations of these traditional overhead allocation MANAGEMENT ACCOUNTING QUARTERLY 5 SPRING 2007, VOL. 8, NO. 3

Table 7: COMPARISON OF COSTING PRACTICES MANUFACTURING FIRMS NONMANUFACURING FIRMS ITEM GERMAN U.S. GERMAN U.S. Plantwide/departmental overhead rates 55% 78% 53% 66% Target costing 1 29% 17% 16% 30% RCA PRACTICES 1. Contribution margin accounting 1 79% 47% 60% 51% 2. Variable costing (fixed costs not allocated to cost objects) 27% 21% 21% 28% 3. Higher number of resource cost centers 175.0 16.9 207.2 2 44.1 2 4. Identify at least one output measure per resource cost center 31% 46% 26% 39% 5. Variances are reported by resource cost center 83% 53% 71% 64% 6. Fixed and variable costs separated for each resource cost 40% 50% 32% 48% center 7. Costs from support cost centers are transferred to primary cost 47% 43% 29% 37% centers while maintaining the distinction between fixed and variable costs 8. Activity- or process-based cost drivers 20% 31% 23% 69% 9. Idle capacity is identified, computed, and not allocated to 35% 21% 19% 14% products 10. Use available capacity when computing internal cost center 53% 21% 47% 20% rates 11. Use replacement cost depreciation 34% 9% 26% 7% 12. Consumption (total demand) is estimated for each resource 49% 39% 39% 25% cost center 13. Standard costs are used for most costing purposes 64% 73% 53% 54% Average no. of RCA practices ( RCA Score ) 6.0 4.6 4.7 4.3 1 Percentages represent number of respondents answering 5 or higher on a 7-point scale with 7=strongly agree and 1=strongly disagree. Note: Bolded numbers are statistically different at 95% confidence level (two-tailed). 2 After removal of two German firms and one U.S. firm that reported very high numbers of cost centers: 4,000, 4,400, and 2,045 cost centers, respectively. These firms are not considered representative of the rest of the firms and appear to have misinterpreted the question. methods are well known, yet the methods continue to dominate in this country. It is no wonder why satisfaction with costing systems is so low in the United States! The use of target costing is fairly low in both countries, despite its great success in Japan. It is somewhat more common among German manufacturing firms and U.S. nonmanufacturing firms. RCA PRACTICES In this study, we also asked companies in both countries specific questions to determine their use of costing practices commonly associated with resource consumption accounting. Table 7 shows these practices broken out by country and by manufacturing and nonmanufacturing firms. CONTRIBUTION M ARGIN ACCOUNTING On the manufacturing side, the Germans are quite likely to use contribution margin (CM) accounting. Most of our German site visit firms showed us their detailed contribution margin (Deckungsbeitragsrechnung (DB)) income statement they use for most decisions. The MANAGEMENT ACCOUNTING QUARTERLY 6 SPRING 2007, VOL. 8, NO. 3

survey results showed that 79% of the German manufacturing firms (and 60% of nonmanufacturing firms) use DB compared to 47% to 51% of U.S. firms. Several of the manufacturing industries had 100% use of CM in Germany, while in the United States only the consulting, etc., and wholesale/retail nonmanufacturing industries had 100% usage. VARIABLE COSTING Closely related to contribution margin accounting is variable costing, where fixed costs are not allocated to cost objects (e.g., products, services, customers, etc.). The low percentages for German firms are surprising given the high percentage that use contribution accounting. Our site visits, however, showed that even though firms prepare detailed CM statements, certain fixed costs also are subtracted at lower levels of the statement to provide more complete segment or product margins. These fixed costs are used for some decision making as well. So it is not that German firms ignore fixed costs, but they use them only when they are relevant to the decision at hand. N UMBER OF COST C ENTERS We found generally higher numbers of cost centers, cost pools, and cost drivers for German firms than for U.S. firms. U.S. manufacturing firms use an average of about 17 cost centers compared to 175 for German firms. Nonmanufacturing firms in both countries also tend to have more cost centers than manufacturing firms do. U.S. nonmanufacturing firms reported an average of about 44 cost centers compared to about 207 for the Germans. Not only are the number of cost centers much higher for German firms, but these firms also tend to track more cost attributes separately within each cost center. Examples include cost behavior (fixed or variable), decision relevance, cash flow relevance, allocation level (e.g., primary or secondary cost), production cost category (e.g., strategic, idle capacity, etc.), absorbability, and production cost type (e.g., material handling, process labor, etc.). Also, the great majority of German manufacturing firms report variances for each cost center (83% versus 53% in the United States). One way in which U.S. manufacturing firms excel in cost-center accounting is that they are more likely to identify at least one output measure per resource cost center than German firms (46% versus 31%, respectively). ACTIVITY-BASED COSTING We did not find much difference in the percentage of firms describing their costing system as activity-based costing (ABC): 19% for the Germans and 21% for the Americans. The highest percentages came from nonmanufacturing firms: 38% in the United States and 27% in Germany. The industry groups with the highest ABC usage were finance (50%), wholesale/retail trade (36%), and healthcare (35%). The highest manufacturing group was chemicals (23%). Although most firms don t call their costing systems ABC, many others use activity- or process-based cost drivers. As shown in Table 7, the U.S. nonmanufacturing firms (69%) and manufacturing firms (31%) tend to use ABC drivers more than German firms do (23% and 20%, respectively). COMPUTING COST OF I DLE CAPACITY Computing the cost of idle capacity is rare in the United States. As shown in Table 7, only about 14% to 21% of the firms do so, and about the same percentage use available capacity to compute internal cost rates. Using capacity as the denominator in determining overhead rates is required to get the cost of unused capacity. Some U.S. companies have used activity-based costing for this purpose and subtract the cost of used capacity from the total cost for each activity to get the cost of unused capacity. Fifty-three percent of German manufacturing firms, however, use available capacity at the cost-center level to compute rates, and 35% said they not only identify and compute the cost of unused capacity but also do not allocate that cost to products. By performing this computation at the cost-center level, these firms get a much more accurate picture of the available capacity that is not being used. U SE OF R EPLACEMENT COST D EPRECIATION One key practice of RCA is replacement cost depreciation. Advantages of using replacement cost instead of historical-based depreciation include a more current cost of production, less incentive to hold on to outdated equipment, and better equalizing of plants for sourcing MANAGEMENT ACCOUNTING QUARTERLY 7 SPRING 2007, VOL. 8, NO. 3

decisions. Thirty-four percent of German manufacturing firms and 26% of nonmanufacturing firms reported using replacement cost depreciation for internal cost analysis. In the United States, where the use of EBITDA (earnings before interest, taxes, depreciation, and amortization) is an increasingly important performance measure, only 7% to 9% of the firms reported using replacement cost depreciation. A U.S. vice president of finance commented, We exclude depreciation from product cost. We are more cash-based cost accounting. I see depreciation as a sunk cost or cost of a prior capital decision. THE RCA SCORE The results of our study show promise for RCA in the United States. We computed an RCA score for both German and U.S. firms measured by how many of the 13 possible RCA practices are being used. As Table 7 shows, the overall average scores for nonmanufacturing firms are 4.7 for German firms and 4.3 for U.S. firms. There is more disparity among the manufacturing firms with 6.0 for the Germans and 4.6 for U.S. firms. The fact that the average RCA scores are somewhat close in the two countries is partially due to similarities in the percentage use of several costing practices between the two countries. These include using variable costing, separating variable and fixed costs for each cost center, transferring costs from support cost centers to primary cost centers while maintaining the distinction between fixed and variable costs, estimating consumption for each resource cost center, and using planned or standard costs for most costing purposes. Although the average number of practices in the two countries is in the same ballpark, the degree of using each practice is usually higher for German firms. U.S. SITE VISITS To learn more about what it would take for U.S. firms to implement more RCA practices and to a deeper level, we visited some U.S. plants to talk to them about it. One plant, which asked to remain anonymous, already uses many RCA practices. It separates fixed and variable costs, uses standard costs, and estimates demand by cost center for about 23 cost centers. It also has an ERP system by SAP. Adding other RCA practices would be desirable but would have to overcome some resistance in the organization. The plant controller, Tim Winkler, said that not allocating fixed costs to products in the standards would be a tough sell to management. As the firm uses full-absorption cost as required by GAAP, any alternative analysis such as contribution margin or direct costing, which might be used for sourcing or investment decisions, must be done offline. The company may still be a good candidate for RCA, however. It is a continuous batch processor, producing many different products with various package types and processing machines used for multiple products. Winkler liked the idea of using replacement cost depreciation because it would eliminate distortions in overhead variances. Organizational resistance to implementing RCA also could be an issue. A few years ago, Winkler made a change to how overhead costs were charged to more accurately reflect how costs were incurred by various processing lines. This resulted in wide margin swings for certain specialty products, which not unexpectedly caused some heartburn for the brand managers. To use more of an RCA approach, he said, We would need to demonstrate solid evidence of the benefit to the company. Another challenge would be making the needed changes to the company s ERP system. Because the company is growing, its ERP professionals are almost entirely dedicated to site/business implementations. Given the nature of finite resources, changing the ERP configuration for RCA would require an extraordinarily high rate of return. C LIFFSTAR CORPORATION We also visited with Winston Woody Woodard, Jr., director of cost accounting and internal audit at juice producer Cliffstar Corporation in Dunkirk, N.Y. This company is a strong candidate for ABC or RCA. The costs of setting up machines are significant, and the company has a diversity of product, process, packaging, and storage costs. It already uses SAP, splits variable/fixed costs, uses variable costing, and could really use more detailed cost reports for more cost control and better decision making. It also has some customers who are more demanding than others. For MANAGEMENT ACCOUNTING QUARTERLY 8 SPRING 2007, VOL. 8, NO. 3

example, Wal-Mart requires that products be shipped with substantial remaining shelf life. Cliffstar produces more than 100 different brands and has to separate kosher from nonkosher juices. Woodard said that highvolume products subsidize low-volume products, so we tend to overrun high-volume product and underrun low-volume product to hit targets. On the downside for RCA, Cliffstar currently defines very few cost centers. It uses the same cost centers for budgetary responsibility. To break the operations down further, it would need to assign each production line as a work center. The operations managers, however, do not feel that level of complexity is worth the trouble. On the other hand, they often want more detailed cost and efficiency reports, Woodard laments. Also, computing the cost of capacity is not a big issue because the company is running close to capacity right now and back-charges vendors for any materials-related downtime. Using replacement cost depreciation would not be so important because the company relies on low bookvalue assets in its production costs. Woodard added: We spend capital dollars sparingly, and since depreciation is a fixed cost it is not in our operating margins. We rely on assets with little or no net book value in production. Also, our banks are focused on EBITDA, so depreciation is not as important. RCA also will be a tough sell to management at Cliffstar, who tends to have more of a short-term focus and probably would not support more detailed costing. Instead, according to Woodard, Budget for the year is king. important factor that should make U.S. firms consider implementing more RCA practices is still the exceptionally low satisfaction U.S. firms have with their current costing systems. As we mentioned earlier, close to 80% of all German firms rated their system the overall right tool compared to less than 30% of all U.S. firms. Also, the satisfaction ratings are higher for the Germans on almost all aspects of the costing systems we asked about. Why not consider something that works so well in Europe? The benefits of these systems are not fully appreciated until they are experienced firsthand. Kip Krumwiede, Ph.D., CMA, CPA, is an associate professor of accounting at Boise State University in Boise, Idaho. You can reach Kip at (208) 426-2288 or kipkrumwiede@boisestate.edu. Prof. Dr. Augustin Suessmair is a professor of strategic management and control at the University of Lueneburg. You can reach Augustin at (+49) 4131-677-743 or suessmair@uni-lueneburg.de. ON THE PLUS SIDE Finally, we asked U.S. respondents their opinion about whether the benefits would exceed the costs of using RCA in their firm. About 13% said, yes; about 15% said, no; and the rest were not sure. Only 41% overall said they had even heard of RCA. There is clearly a need for more information and training on RCA practices as well as U.S. firms willing to try it and step out from the organizational resistance and traditions that hold them back. On the plus side for RCA, U.S. firms commonly use several RCA practices, albeit frequently to a lesser degree than their German counterparts. But the most MANAGEMENT ACCOUNTING QUARTERLY 9 SPRING 2007, VOL. 8, NO. 3