Know “Unknown Costs” through Result-performance Costing

The article on February 8, 2007, said to charge performance costs to the results produced to manage value-added. There are two big questions concerning our 20^th century methods of costing, such as cost accounting and activity-based costing:

1. Are we gathering all of our costs?
2. Are we charging our costs to the right entity?

This article reviews what we are costing and why we cost what we are costing.

The fundamental thing we want to know is the cost of doing business against the value created by the business

When we ask what do we want to know the cost of? A common response is “We want to know the cost of doing business”. We define the business as the activity of providing goods and services. The cost of business is in business activity or performance. The value created by the business is in economic output results, like goods and services.

20^th century costing does not do this. We may get partial costs against contrived entities like center, activity, station, etc., which are overlays on the business and not the business. We account for some value as goods and services leave the enterprise in revenue.

We cannot know the cost of doing business and the value created by the business until we organize and manage the business!

The first thing we must do is to organize the actual business, so that we have one structure of results that define and organize all the things of value produced across the enterprise. To organize the business we also need one set of capital in specific performance solutions that can be deployed and utilized to produce results. The business is organized when specific performance solutions are deployed to incur costs and create value in the result produced. Then we can total the cost of every performance solution utilized against the value of the result produced to know a positive or negative result value-added.

Result-performance Management (R-pM) organizes and manages the business, so we now have the means to know all costs generated within the business and to charge the costs against the value created by the business. We can finally get rid of unknown costs and gather costs for the proper entity to know capital consumed in the business and charge our costs against the proper entity to know the value added by the business.

We can now use Result-performance Management (R-pM) to organize and manage the business by the capital consumed in performance solution costs to produce economic output in result value over planned time periods.

21^st Century Management includes accurate costing against the value created

Three of the Ten rules for 21^st Century Management cover knowing costs against the value created; Rule No 2: Generate profits from a chain of managed value and quality, Rule No 4: Keep records on the full cycle of cost and value in operations and development. and Rule No. 9: Collaborate to maximize shared value and minimize shared costs.

Costs arise from consumption of business, human, facility, or management capital in performance. Costs must be charged against the value created through the performance. Performance costs can only be charged against one entity; the result value produced. Charging performance costs to the result value produced enables a manageable result value-added along a result value chain, particularly the result value-quality chains that produce revenue results. This gives us Result-performance Costing to know the cost of performance against the value of the result produced. Business collaborators can employ Result-performance Costing to incur commonly-defined costs against the same result value for shared value-added.

20^th Century costing does not capture all costs

The first question explored in this article is; “Are we gathering all of our costs?” Here 20^th century management encounters two problems:

1. We are incurring many unknown costs, costs that we do not measure and capture
2. We do not have one entity that defines our costs, so we have to cost various entities that we can think of or “known costs”

Today, virtually every enterprise has “intangible assets” that really are unmanaged performance capital. Therefore, the enterprise can only capture known costs of known tangible asset entities like fixed assets, cash, and personnel. The enterprise ignores the even more important unknown costs of intangible assets. The costs are unknown because the enterprise lacks a structure to know the development costs and to document all capital developed. The enterprise also lacks a structure and one defined entity that enables all known costs to be managed.

Conventional costing charges costs to the wrong things

The second question is “Are we charging our costs to the right entity?” Here 20^th century management faces several more problems, since the enterprise does not:

1. Know what to charge the costs captured against
2. Know the extent of the performance capital it has
3. Know how capital is utilized in performance
4. Have a way to organize capital to be managed and to control costs
5. Have a way to organize capital for the purposes of utilizing the capital
6. Have a way to understand the true costs associated with each item of capital utilized.

Let us take these 20^th century management problems one at a time.

1. What do we charge our costs against?

We said when we consume capital in performance; we incur costs. We do not perform for the sake of performing; we perform to produce economic outputs in results. Therefore, we should charge our performance costs to the results we produce. We have many 20^th century methods of cost accounting. We cost processes, activities, stations, products, centers, and other entities.

Product costing is the closest that we come, since products are one example of a result. All the others are contrived entities that we have laid over the business and do not define the business. (What do the partial costs of a process, activity, station, or center tell us?) Even when we cost products, we still only capture our known costs, and we try to associate these costs with an eventual product instead of costing each result directly produced by the cost, in the chain of results producing the product.

2. How do we know the extent of enterprise performance capital?

We need to define performance capital as anything utilized in performance that helps the enterprise produce a result. In essence, capital is everything around us; the building space and physical things we use, the processes and procedures we follow, the management guidance we receive, our own capabilities, information we access, and those who help us produce a result. We need a performance structure to define the extent of our performance capital, and one entity “Performance Solution” that breaks capital down to solutions that incur knowable costs, so that we can document and manage all performance capital.

3. How do we use capital in performance?

Capital is utilized as performance solutions to produce a “result”. A result is the desired or undesired output from performance, that is a definable entity, and that can be counted. There can be only one objective of all performance: to produce an economic output result of value that exceeds the total cost of performance. In order to understand how we use capital we need to define the results produced. Once we define results produced, we must think of value as another definable entity on order to know the value created from performance costs. Result valuation is the subject of other articles.

4. How do we organize capital in order to be managed and to control costs?

Capital is managed by producing capital results. The primary capital that determines whether we produce a good result or a defective result is the human capability solution deployed to produce the result. Therefore, in order to properly manage capital and control costs, we must organize capital for support by the human capabilities required to manage and support the capital. 20^th century management administers known tangible capital and does not manage all capital to produce results. Most enterprises mix together capital and have problems administering certain capital, because the proper human capability is not assigned.

5. How do we organize capital for purposes of utilizing the capital?

We utilize capital to produce results. In order to produce results, we have to organize the capital that must be in place before we can produce the first result in the set of results we must produce. Once we begin to produce results, we need the capital that is only utilized or consumed when we are actually producing a specific result. We also need information to guide us in producing the result and we need to produce information to document the result produced. In this way, we integrate similarly-utilized performance solutions together to produce results and can control similar performance costs.

6. How do we understand the true costs associated with each item of capital utilized?

Capital must be defined as a specific performance solution to be utilized and incur costs. 20^th century management records and manages fixed asset performance solutions as assets. Every performance solution must be costed over its full life-cycle, similar to a fixed asset. The costs of acquisition, development, improvement, should be captured to understand the investment in a solution. Operation and support costs are captured to understand on-going costs. Once we capture true costs against a solution, we have flexibility in how we actually manage costs of utilizing the solution and derive meaning from the universe of known costs.

We need to use R-pM to define “Performance Solutions” to account for all costs and then charge costs to the “Result” produced

Costs are an attribute of the performance solution utilized be it a business process, human personnel, facility equipment or supplies, facility records, management tactics guidance, human knowledge, etc. Costing performance solutions is up to the management tactics policy solution. Performance solution costs could be development amortization, operation support, a standard utilization charge, etc.

R-pM provides the means to define our performance solutions properly and measure the costs of developing, operating, supporting, and utilizing our solutions, to establish a basis for all of our costs through Result-performance Costing. R-pM takes advantage of modern information technology to capture costs and value as the enterprise routine. Most costs become routine and can by automatically generated. This reduces cost entry to the changes and exceptions. Costs charged to a set-result can be automatically allocated to lower level results in the set. We can then manage the actual costs incurred in the utilization of every solution in producing identified and managed results.

Result-performance Management provides the method to know all costs against result value” to manage “Result Value-added”

Result-performance Management is a breakthrough method to manage performance costs against result value. To learn more about Result-performance Costing, Join the worldwide R-pM Community and download the R-pM Toolkit, which is continually be updated with more information on Result-performance Costing, result valuation, and result value-added management.