Controllable costs

Controllable costs
See also
Conditions of strategy implementation Master budget Resource plan Canvassing Entertainment allowance Functional budget Period of indemnity Management company Cost risk

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.

References

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Author: Paulina Zachara