INTERNAL REPORTING‹HELP OR FRUSTRATION?

By Richard V. Calvasina, O. Ronald Gray, Eugene J. Calvasina, and Gerald E. Calvasina

Many companies have internal reports that are unique and peculiar to their circumstance, situations, and prejudices. Too frequently, internal reports are the result of an evolutionary process where bells and whistles are added to existing reports, and rarely is irrelevant or little used information deleted. Often, internal reports "grow like topsy" with no underlying plan, reason, or rationale. Sometimes, inertia may be the explanation for the format and continued existence of some internal reports, e.g., an ad hoc/specific purpose report may become a tradition after the original purpose lapsed. Learning how to prepare or use existing internal reports can be one of the most vexing tasks confronted by a new hire.

Why are internal reports such a problem? One explanation is the lack of emphasis placed on internal financial reporting in accounting curricula. Generally accepted accounting principles governing financial reporting are drummed into the minds of students. Internal reporting for planning and control is, if not neglected, not nearly emphasized to the same extent. When it comes to internal reporting or managerial accounting, students are often told, "while we have rules for external reporting that are essentially legislated, there are no rules for internal reporting or managerial accounting." The result is, graduates may be inadequately prepared to cope with the complexity and variety of internal reports in their new work environments. New hires frequently become emulators of bad reports.

While there are no governing bodies legislating rules for internal reporting, management and other internal reports cannot be prepared in an anything-goes manner and be effective communicators. Exhibit 1 is a composite of common deficiencies found in internal reports that could cause a user significant frustration and anxiety. Chief among these defects are‹

* multiple units of measure,

* more than one category analyzed,

* use of title over/under budget for variances' column,

* multiple or combined variances on one line,

* responsibility not properly identified, and

* insufficient detail.

Deficiencies and inadequacies in reports often result in users losing confidence in the accounting system's ability to respond to information needs. Users simply look elsewhere for more relevant management decision-making information. From the perspective of report preparers, this tacit no confidence vote can have broad adverse repercussions‹the worst case scenario being deemphasis or elimination of the accounting function as part of the management team.

None of the deficiencies in Exhibit 1 relate to accuracy of substantive content. However, it takes more than accurate numbers to have a well prepared, informative report. Improper presentation may render information inaccessible or discourage its proper and effective use.

Internal reports must be easy to read and comprehend. While not always possible to make a report so user friendly that its purpose and use is intuitive, it is, nevertheless, a goal to strive for. At a minimum, a successful report should allow the user to find information without protracted analysis, recompilation, or recalculation. And, complex reports should be accompanied by written discussion and analysis to facilitate their use.

Improving Internal Reports

Suggestions for preparing user-friendly reports follow:

Proper Title. A proper title should quickly resolve uncertainties about report content. The title of any report depends on its objective, what it intends to communicate. It should be self-explanatory, descriptive, and specific. The basics of a proper title include‹

* identification of the reporting entity,

* the character of the report,

* what is being evaluated,

* how it is being evaluated, and

* the time period covered

The report in Exhibit 1, is a performance report for cutting department number 12, dated September 30, 199X and the manager is R. Calvin. While the term performance report indicates that this department is being evaluated, it is ambiguous and conveys nothing specific as to report content or how performance is being evaluated. Knowing what is being evaluated (labor usage), and the types of evaluation (costs and efficiency), are important.

The Exhibit 1 report title is further flawed because there is no proper time period specified. There should be no ambiguity or uncertainty about the time period covered by the report. The term monthly is used in the body of the report, and a careful reader would understand that this report is for the month of September, not some other period of time ended September 30, 199X, or not just for September 30, 199X. With a proper title, report period ambiguities are easily resolved.

A revised title for the Exhibit 1 report appears in Exhibit 2. The new title lists all the items included in the report. The revised title highlights a major problem with the report, a lack of focus; too many items are addressed to be an effective reporting vehicle.

Adapt to Principal User. Reports should be tailored to the information needs of the primary users. Some managers want to know all there is to know about everything in their particular department. Other managers rely on a few important facts to judge the overall performance of their operations. It does no good to prepare a report providing all the information about a responsibility center if the manager is not going to use it. Conversely, it is a mistake to provide a report that contains only a few facts when the manager wants everything.

Only relevant information used by the reader should be presented. Superfluous information is not only expensive to produce and distribute, but it obscures or clouds pertinent information. In Exhibit 1, if R. Calvin, the department head, has no control over material purchases, the material purchase price variance should not be on any report presented to him. Direct material usage by different cutting crews, type of material, and utilization of material by product would be relevant data for the cutting department manager.

A manager's position in the company is prime in determining the level of report detail to be presented. While a department manager would need detailed information, the CEO would not need to know the material utilization by individual cutting crew or job lot being processed through the cutting department. As managers assume wider areas of responsibility, the level of detail diminishes and scope of presentation increases.

Simple. Internal reports should be simple and straightforward. Ideally, they should have a single central theme; combining different issues in a single report causes confusion.

In Exhibit 1, different units of measure are represented--number of employees, labor hours, dollars, number of cuts, and machine hours--embodying most of the production factors in the cutting department. This approach places a burden on the user, who must constantly remember the changing units of measure on each line, to arrive at proper conclusions.

The all-inclusive approach in Exhibit 1 creates the need to use a descriptive title in the variance column consistent with expense, revenue, and production activity categories. The over or under budget label used for the variance column does not communicate; favorable or unfavorable would be more appropriate. If only one category of items in a report is being evaluated, over or under budget is not a problem.

The Exhibit 1 report should be simplified, separated into several reports, each with a central theme (e.g., the spending evaluations separate from efficiency evaluations and the production activity, and factory overhead volume variances in individual reports).

Communicate Significant Distinctions. Only essential information should be presented, and arranged so that the important values are readily discernible. The user should be able to look at the report and identify the important points of information. If the user must spend time differentiating the significant from the insignificant, the report is inefficient.

One significant distinction relates to responsibility or controllability. If the internal report is to assess the cost control abilities of the manager, it should contain only those items that the manager can control. The Exhibit 1 report is deficient in this respect; only in the area of overhead expense is some attempt made to identify controllability.

When an internal report contains the cost factors for a department, the items controllable by the department head should be clearly delineated. Vague terms, such as semicontrollable in Exhibit 1, should never be used. Because the cutting department manager does not have complete control, a classification, such as, "Not Controlled by Department Manager," should have been utilized.

Another problem with the Exhibit 1 report is labor and material variances in single line presentations. Direct labor and direct material costs are impacted by both changes in prices and efficiency. Commingling two sources of variance in one line of data may seriously mislead the user. In Exhibit 1, the direct labor variance could be caused by both a labor rate change and efficiency. Small total variances may be the result of two large offsetting variances.

Consistency. Report format and content should be consistent from period to period. Changes should be infrequent. Reports should also be consistent as to time intervals. Specific reports should not alternate among daily, weekly, biweekly, and monthly time intervals. The identification of developing trends is enhanced by maintaining a consistent time interval.

Timeliness. Internal reports must arrive in time to be useful. Reporting frequency should be dictated by operating needs and not the timetable required for most financial accounting reporting. A lower level manager who is involved in the everyday activities of a business will need information on a much more frequent basis than a top level manager, perhaps on a daily or even shorter interval.

Accuracy. Absolute precision is no prerequisite for usefulness. An internal accounting report must be reasonably accurate, and sometimes there has to be a trade-off between accuracy and timeliness. Often, the short periods covered by internal reports and the speed with which they are compiled preclude the ultimate in accuracy.

Achievement Based. The evaluation of performance in internal reports must be based on achievement. The benchmarks contained in them should represent past actual accomplishment. For a manufacturing firm, this is best measured by first quality equivalent units of production by manufacturing category.

When the all-inclusive approach to reporting, as in Exhibit 1, is used, identification and calculation of appropriate benchmarks is frustrated. The likelihood for the preparer to fail to properly identify or calculate benchmark figures is significantly increased. Even if valid benchmarks can be prepared, the user may be so confused by the message presented in the report that it may be worthless.

Constructive in Tone. Internal reports should be constructive in tone. Too often, they are used as justification for inflicting punishment on managers for not achieving budget goals. They should be used to identify areas where corrective actions need to be taken and to identify managers who are performing capably.

Revised Report

An internal performance report should facilitate the communication of important information. For the manager of the cutting department, a disaggregated report presenting detailed information by production line, material used, or product produced would be much more valuable than a single summary total. If the cutting department had three different cutting tables, the information on material usage should be presented so that each individual cost center's performance can be identified.

In Exhibit 3, a report analyzing direct material usage by cutting table is presented. This report is based on a central theme, direct material usage. Material price variances do not appear in this report. If different fabrics were being cut at each table and the manager needed this detail, the report could be further refined to show the material usage by individual fabric for each of the three tables.

If this information were being provided to the plant manager, a one line presentation for material usage for each cutting department would suffice. While a cutting department manager would need the detail by table and/or fabric, the plant manager would need the information by department manager. *

Richard V. Calvasina and O. Ronald Gray are associate professors at the University of West Florida, Eugene J. Calvasina is a professor at Southern University in Baton Rouge, and Gerald E. Calvasina is an associate professor at the University of North Carolina at Charlotte.

Editor:
Michael Goldstein, CPA
The CPA Journal

NOVEMBER 1995 / THE CPA JOURNAL

Cost Center: Cutting Date: September 30, 199X

Cost Center: #12 Manager: R. Calvin

(Over) or

Monthly Under

Actual Budget Budget

Workers 12.0 11.0 1

Direct labor hours 1,700 1,728 28

Direct labor cost $17,300 $17,280 $(20)

Direct materials used 7,000 7,120 120

Overhead expense:

Controllable:

Machine setup 733 824 91

Down time 538 640 102

Maintenance 430 269 (161)

Overtime premium 384 ­ (384)

Rework 81 31 (50)

Scrap 851 750 (101)

Total controllable expense 3,017 2,514 (503)

Semicontrollable:

Indirect labor 2,109 2,000 (109)

Salaries 2,600 2,500 (100)

Repairs 800 750 (50)

Utilities 340 200 (140)

Total semicontrollable
expense 5,849 5,450 (399)

Allocated:

Depreciation-building 400 250 (150)

Depreciation-equipment 3,600 3,700 100

Property taxes 1,500 1,500 0

General reallocations 35,000 28,000 (7,000)

Total allocated 40,500 33,450 (7,050)

Cost center overhead 49,366 41,414 (7,952)

Total center costs $73,666 $65,814 $(7,852)

Activity measures

Number of cuts 180 175 (5)

Operating machine hours 1,170 1,250 80

Evaluation of direct material price and usage, direct labor rate and efficiency, factory overhead spending and volume, workers, number of cuts, and operating machine hours

Cost Center: Cutting Period: Month Ended Sept. 30, 199X
Cost Center: #12 Manager: R. Calvin

70

Cutting Department, R. Calvin, Manager

Direct Material Usage Report (in Yards)

For the Week Ended September 30, 1994

(Figures in Yards)

Variance

Description Actual Allowed* Fav. (Unfav.)

Table 1 2,300 2,450 150

Table 2 3,600 3,300 (300)

Table 3 7,800 7,750 ( 50)

Total 13,700 13,500 (200)

* Allowed usage based on first quality equivalent units of production and standard (budgeted) quantity of material per unit.

GEAR-UP

1/4 SQ

BW