Controllable costs

Controllable costs are those costs over which a manager has control . In other words, they result from a specific decision or action undertaken by an executive . On the contrary, when a manager does not possess any control over costs, then such costs are called uncontrollable costs (or non-controllable costs).

The task of distinguishing and separating controllable and non-controllable costs falls mainly within the competence of management accountant .

Examples of controllable costs

Controllable costs include:

• raw materials,
• supplies (also office supplies),
• labour (salaries, wages, commissions),
• maintenance expenses,
• employee benefits,
• bonuses,
• donations,
• travel expenses,
• advertising,
• dues and subscriptions,
• staff trainings

Among controllable costs we would find variable direct costs. On the other side, the following costs usually can be defined as non-controllable costs: depreciation of machinery and equipment, insurance, utilities and overhead expenses. This group especially consists of fixed indirect costs . Other examples of uncontrollable costs are taxes (on buildings, premises) and rent (defined in advance by contract, lease or rental agreement) .

How to recognize the difference

Distinguishing controllable and non-controllable costs may cause some doubts and requires particular attention to details. Let's take depreciation as an example. In the case of a profit centre, the cost in question is not under the manager's control, thus, it is uncontrollable. On the other hand, depreciation in an investment centre belongs to controllable costs because the manager makes such investment decisions. As it turns out, the same cost can be classified into two different groups of costs depending on the chosen perspective (division, management level and so on) .

Another issue is that some costs can be partly controllable e.g. costs of raw materials are under the supervision of purchase and production departments. The purchase manager focuses on the price level control, while the production manager monitors the quantity of materials used. Consequently, those costs are assigned to both departments, but there should be only one person who is held accountable for them . What needs to be underlined here, from the purchasing manager's perspective, costs of direct materials depend also on market conditions so they cannot be fully controlled. The production manager will face a similar problem as the quantities used in the production process are determined by the quality of materials .

Costs of inventory are uncontrollable as a company cannot operate without acquiring and paying for it on time. Otherwise, the organization can lose strategic business relationships with partners or even go bankrupt. As opposite, marketing costs are those which might be altered in accordance with managers’ decisions on how to promote the firm .

Responsibility accounting and controllability concept

The business practice shows that every cost is, at least partially, a result of someone's decision or influence and therefore, in most cases, is assigned to a specific responsibility centre. Nevertheless, there might occur some situations when executives of such centres are supposed to clarify cost-variances that do not result from their own decisions .

A cost does not necessarily need to be in 100% under control of an executive to be categorized as a controllable one. That brings us to the issue of responsibility accounting which main aim is to assign specific costs to the managers that possess the most knowledge (or information) about them .

Properly defined costs and distinguished differences between controllable and uncontrollable costs, together with established budgets and standards, constitute a solid basis for fair evaluation of management's performance and efficiency measurement. The process of monitoring and evaluating managers becomes effective and meaningful only if they are directly liable for specific costs and can control them . Concerning the importance of controllable costs in management's performance, it should be noted that they also constitute a motivating element. The managers aware of the fact that they are liable for some costs will most likely tend to stick to the budgeted amounts and avoid undesirable variances in order to achieve planned goals .

Also, the time factor plays an important role in interpreting costs. If we assume a long enough period, costs become controllable and may be regulated at some organization's levels . Apart from that, performance evaluation usually takes place once a year or even more frequently. An important remark to be made here is that especially newly hired managers might be unfairly held responsible for their predecessors’ decisions (e.g. negotiated contracts or trade unions with a fixed price for a defined time span). Therefore, assuming the proper time perspective is crucial for further assessments .

The issue of controllable costs is directly connected to the whole controllability concept which also takes into account controllable investment. As already mentioned, the bottom line is that executives should be liable only for those costs and investment which are under their control. In reality, the concept is likely to be misinterpreted and problematic in terms of application. If we deduct controllable costs from the sales revenue, we receive the controllable contribution which is perceived as the most adequate measure while evaluating an executive's performance .

Generally, a person who is responsible for all costs that are incurred in a company is the managing director. In practice, though, the process of decentralization imposes delegating such responsibility to lower levels of the hierarchy. However, it is still worth mentioning that senior managers usually influence costs that low-level managers do not .

The whole issue of controllability is rather very ambiguous and might be tricky when it comes to interpretation and thorough understanding.

Advantages of Controllable costs

Controllable costs offer many advantages for managers. Specifically, these costs can be used to:

• Maximize profits: Controllable costs can be managed to reduce costs and increase profitability. This is especially useful in competitive market environments.
• Improve efficiency: Controlling costs can help managers make decisions that optimize the efficiency of the organization, allowing them to use resources more effectively.
• Increase flexibility: Controllable costs allow managers to adjust spending quickly and respond to changing market conditions.
• Provide data: Controlling costs provides data that can be used to measure and analyze the performance of the organization. This data can be used to make better decisions and improve operational efficiency.
• Increase accountability: Controlling costs creates an environment of accountability. Managers are held responsible for their decisions, and any mistakes are quickly identified and corrected.

Limitations of Controllable costs

Controllable costs are those costs over which a manager has control; however, there are some limitations to this. Below is a list of the main limitations:

• Controllable costs do not include fixed costs - these are costs that are not affected by the decisions of the manager and cannot be changed regardless of the level of output.
• It is difficult to accurately measure the exact impact of the decisions made by the manager on the costs, as they are influenced by many external factors.
• Controllable costs are often not considered in the decision-making process, as they are not seen as important as other costs.
• The costs may also be affected by factors outside the manager’s control, such as changes in the economy or raw material prices.
• Managers may not have the authority to make changes to the costs, as they may need to be approved by higher-level management.

Other approaches related to Controllable costs

Controllable costs are those costs over which a manager has control. Other approaches related to controllable costs include:

• Activity-based costing (ABC) - this approach involves allocating costs to activities that are the root cause of incurring the costs.
• Target costing - this is a process of setting a cost goal before product design begins and then working backward to design a product that can be sold at that price.
• Lean costing - this approach focuses on reducing waste and eliminating any activities that do not add value.
• Throughput accounting - this is an approach that focuses on managing the rate at which products are produced and sold.

In summary, controllable costs are those costs over which a manager has control, and there are various approaches that can be used to manage and reduce them, such as activity-based costing, target costing, lean costing, and throughput accounting.

Footnotes

Controllable costs — recommended articles

Differential costing — Step fixed cost — Principles of scientific management — Normal cost — Strategic cost management — ABC method — Step cost — Irrelevant cost — Allocated cost

References

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Author: Paulina Zachara