In my last blog we saw that the law of non-contradiction makes it impossible to deny the existence of truth, and, absolute truth in particular. We also saw that this insight is important to management accounting. It finds application in management accounting because operational truths (how real resources are actually used) must form the basis for costing information used in decision making. Where did this epiphany lead us? For the most part, not very far from where we started. It is more like a massive anchor has been driven into solid rock right where we were. Thus we have a starting point to build on. At this point we are still left with the question: how do I get to a cost number I can trust?
To answer this question we must turn to one of the other laws of logic, namely, the law of rational inference. In this regard, philosophy recognizes first principles i.e., principles for which no proof is necessary because they are self-evident. Causality, the recognition of the relation between a cause and its effect is such a principle. Causality comes with some serious clout. It is the cornerstone of the scientific method, something our post-modern culture has elevated to the status of religion when it comes to knowing the truth (at least for truths about the material world, of course…).
In management accounting causality as the guiding principle finds a similar application because it expresses the relationship between an output (a flight hour) and a required input (the jet fuel burned during one hour of flight time). All resource application in the manufacturing conversion process and in the service provision process can be explained—and crucial for management accounting—be modeled in this way. At this juncture it is important to point out that our desire to satisfy the principle of causality in cost modeling has nothing to do with cost/money—at least not in establishing the relationships! We are dealing with operational resources (liters of water, KwH’s of electricity, kilograms of melted aluminum out of a furnace, hours in an operating room, etc.) The causal relationships are therefore expressed in resource or input quantities in relation to the output quantity generated or desired. For example, I need three eggs to make one omelet and two pilots for the flight from Dallas to New York City. Each causal relationship is expressed in the quantity of the resource or input consumed and characterized by its particular unit of measure such as cubic feet, kilograms, hours, etc.
Once these quantity-based resource consumption relationships have been defined they are modeled and provide an entirely quantity-based model of the company’s operations. It is only at this point that value/cost comes into play. A value layer is then added to the quantity-based model. Whenever a resource or an input is consumed in production or service provision its value/cost follows the causal consumption. In this way money/cost becomes a ubiquitous unit of measure for all causal relationships. Thus we arrive at a cost number we can truly trust!