Dave Cain: Welcome to unsuitable on Rea Radio, the award-winning financial services and business advisory podcast that challenges your old school business practices and their traditional business suite culture. Our guests are industry professionals and experts who will challenge you to think beyond the suit and tie, while offering you meaningful, modern solutions to help enhance your company’s growth.
Dave: I’m your host, Dave Cain. In an effort to adopt new methods of automation, most manufacturers have embraced robotics as a cost effective and efficient solution, and the results have been great, but just as it takes time to get to know and use the new technology on the line or in the warehouse, it’s going to take some time to make the necessary adjustments in your accounting department as well.
Dave: Tom Scharf, a principal in our Cleveland, Ohio office and plays golf at a Canterbury Golf Club has worked with a lot of manufacturing companies over the years, and he’s seen a lot. Today he’s going to talk about the impact these technological advancements have made, or rather should make to your method of cost accounting. Welcome to unsuitable, Tom.
Tom Scharf: Let me tell you, cost accounting is exciting.
Dave: It is, okay, and we’re ready to go, and we want to talk about, first of all, being from Cleveland and obviously heavy, heavy manufacturing and also Browns country. Give us a Scharf-ism on the Browns for 2018.
Tom: Well the Browns are trying to … they’re going to try to manufacture three wins, last year they were the preseason champs at four and O in preseason, they just couldn’t manage to win a regular game, but we’re counting on three to four wins this year, I’m a happy camper.
Dave: Yeah, there you go. You know, I did a little research within our firm, and I believe we have in excess of 400 manufacturers, fabricators, all different sizes and shapes, and so we’re a heavy manufacturing service firm. And you’ve been doing this for over …
Dave: 40 years?
Dave: I do want to read some of your credentials, it’s pretty impressive.
Tom: We only have 20 minutes.
Dave: Yeah well, this will take 15 minutes. Obviously you’re a CPA, and you have you’re accredited in business valuation designation. You’re certified in financial forensics, that’s a CFF. And certified valuation analysis, CVA. And MAFF, master analyst in financial forensics. And this last one, you’re an SOB, and I’m not sure what that stands for. Is that anything?
Tom: Oh, that’s really special, I don’t want to put that on the radio here. But I will tell you, with all those degrees and all that forensic accounting and valuation degrees, 24 years ago I married a woman with four children, and I never looked at any of the unrecorded liabilities.
Dave: You never did, okay, there you go, that’s perfect. And I understand you’re a singer?
Tom: Yeah, I could do that.
Dave: What’s your genre, what do you like to sing?
Tom: Well, my favorite song in the world is Piano Man.
Tom: You know, I could do a-
Dave: A little Tonic and Gin.
Tom: American Pie, if you have eight minutes.
Dave: American Pie.
Tom: We could-
Dave: Yeah we do, we’ve got a little dead time, yeah. That’s a good one. Seriously, do you sing American Pie?
Dave: Do you? You want to give us a go here? Can you sing it?
Tom: A long, long time ago I could still remember how cost accounting used to make me smile. All right.
Tom: We should get down to business.
Dave: Bye bye, Miss American Pie.
Tom: You got it.
Dave: Okay. There we go, that starts off. So let’s talk about right away the robotics, and how things have changed in the manufacturing world, especially measuring your standard costs regarding labor.
Tom: Well yeah, and that’s interesting because cost accounting’s very complicated. You know, even us as CPAs, we get into a manufacturing company, we try to sit there and try to investigate their cost accounting, because how do they do know … how much does something cost them to make? Well, a lot of companies have been using the same cost system for 40 years. And manufacturing are certainly changed in the last three decades. But they’re using the same methodology to cost their product, at least from an accounting standpoint.
Tom: And so, as you look, the most common methodology of allocating overhead costs, for example, is direct labor. Well, 20 years ago, how many direct labor hours did it take to make an axle in a car, or a steering wheel, or any part of that? Okay, now today with robotics and such, you might have a guy that’s loading the machine, or a guy that’s unloading the machine, and half the time that’s going to be done with robotics, so when they’re looking at allocation of overhead, a lot of times you’re looking at allocations of overhead that might be 25, 30, 40 times labor. And those rates just … they don’t make sense.
Dave: Yeah, they’re outdated.
Dave: And the accounting system has not kept up to date, so it could be it’s throwing off bad information to the decision makers.
Tom: Yeah. I mean, the guy on the line goes and takes a bathroom break and all the sudden you’ve got an overhead allocation of 2500 bucks.
Dave: You know, when we start talking about cost accounting, immediately for my thought is that’s reserved for very large, very complicated manufacturers. What do you think about that? Is there room for it in the one million, two million, 10 million dollar company?
Tom: Absolutely. In fact, sometimes it’s more important for the smaller companies than it is for the larger companies. Obviously larger companies have more people, they have more accounting data, they have more ability to analyze, they have more engineers on staff. They have much better methodology, and they’re competing in a much larger environment than a lot of the smaller companies. The smaller companies on the other side of the coin might be more short run processors. They’re not dealing with a part that’s going to last two months on a machine, they might be running it for a week, they might be running it for two weeks. And when it comes to cost accounting, you’ve got to get in the cost of tooling, and the cost of reset up your machine and how much down time you’re going to have, what your production time is, and your run rates.
Dave: Is this going to help my bottom line if I switch? Or pay more attention?
Tom: Well, what it might do is help you make decisions on which parts you want to make, and which ones you might not want. A lot of times if you look at it, people have been running the same parts for years. And all the sudden they look, and everybody knows what the material cost is, they weigh it, they know what their scrap rate is. They kind of look at it and try to figure out how much machine time it runs on, because most manufacturers look at machine time and try to figure out about how much it’s going to take, and they use a rate, and then they calculate it out, they throw their price out there, and all of the sudden they find out that you know what, they’ve got to cut their price a third to get the job.
Tom: Well they do, because they need the job, or it’s a great customer, they’re running other parts of pieces with it, and lo and behold, they start running the job and all of the sudden they look, they’re not even covering their overhead on the job.
Dave: Their cost, right. Right. Right, so you could have a situation where you’re running a specific part of piece at a loss, and not knowing.
Dave: Or making a decision to pass along a discount to a good customer, and you probably couldn’t afford to do that.
Tom: Yes. In fact, we’re recently, I mean the manufacturing industry, really nationally, in Ohio is doing very well right now. You know, machine time is actually at a premium. So I think it’s important that clients and customers that are manufacturers are looking at their jobs to see what jobs should we really be doing? Because in all honesty, you’ve got machine time, you’ve got wear and tear, you’ve got overhead that’s going to be allocated to each of these jobs, and if you’re turning down work, you should be making sure to hang on to the more profitable pieces.
Dave: Right, and so that leads into the next question, with your experience in the manufacturing area, and I know you study manufacturing on an ongoing basis, making strides, manufacturing on the increase in the state of Ohio?
Tom: I don’t have a manufacturing client right now that isn’t making money. So I mean, manufacturing’s doing very well. Government’s been very helpful with adding additional depreciation deductions, encouraging people to go out and buy equipment. They’re upgrading their equipment, better equipment. Unfortunately, the jobs where a guy could come out of high school and just work on a shop floor and just do a manual job, loading machine, those jobs are no longer in existence, but the job for the young man or the young lady that could come in and learn how to program a CNC machine, that could lay out a machine, and teach the machine how it’s supposed to work are really where the manufacturing jobs are today.
Tom: And understanding, not only how the part’s made, but the most efficient way to make a part. If you could cut time, machine time, off the production of a part, you’re going to save money because you could run more parts through that particular machine. And a lot of that’s run in most companies by engineers, but I could tell you my father was a tool and die man, and he was a self taught engineer. And I know my way around the shop, I’ve been around, I love manufacturing clients, and it’s always interesting, these people are constantly doing research and development. There’s research and development tax credits that are very applicable to the manufacturers, and it all revolves, again, on understanding your costs.
Dave: You know, I’d love to follow you around as you take a tour of a manufacturing plant, and I bet with your experience and background, you can spot a couple things within an hour or less.
Tom: You can. I think with-
Dave: Brag a little bit, I know you can.
Tom: Now we’ve got to brag, but no differently than … you know, you can probably walk an inventory and you could look at it and you could see approximately what a few different pieces parts …, and you walk around and you could pretty well approximate in your head how much money in inventory they have. You could see what’s moving, what’s not moving, and how efficient they are. What do they store their product? Do they have to store their product inside, or do they have to store their product outside? Do they have to code it? Do they have to put rust prohibitives on it? Do they have to send it out, are there other … do they got to anodize it, do they have to do other processes? Heat treat. You know, some of those things could be done in house, some of those things could be done internally, but when you start looking at it, and if you get enough production, you could bring some of those kind of processes inside your plant.
Tom: Not only do you save the cost of what you would pay a heat treater, but you also save the transportation charge of sending it out, coming it back in, and with all the quality standards that are out there right now, you’ve got to be responsible to maintain those quality standards. You have a better control on it, you have a better control on your scrap, and over all, the timing, you could save a week or so in the production cost.
Dave: Sure. Tom, I want to follow up on something you said a few minutes ago about tax credits, and tax attributes that are available for manufacturers. Under the new tax changes that are in place, or going to be in place in the next few years, manufacturing industry’s a winner?
Tom: Absolutely, absolutely.
Dave: And where do you attribute that to? Is that the equipment write offs and the like?
Tom: Yeah, especially in the last tax act that was just recently enacted, you can have an increase in Section 179, immediate write offs, the bonus depreciation. Boy, you know, if you go out and buy a machine for half a million dollars, you can take it right off your income as a tax bill. That’s significant tax saving. But even more-
Dave: You’re giving away free advise here now, come on there.
Tom: Okay, I’ll pull it back.
Dave: Pull it back.
Dave: No, but that’s a good point. I mean, there’s-
Tom: Speak to your Rea tax professionals, especially our tax department.
Dave: There you go.
Tom: They specialize in RND credits.
Dave: There’s a good commercial. But let’s jump in the weeds a little bit, get a little technical. I’ll try to go to your side of the aisle here, but let’s talk about fixed and variable overhead. And again, just give us a quick overview, what’s the difference between fixed and variable overhead, and how is it allocated?
Tom: Thanks, Dave. And nothing really excites me more than fixed and variable overhead.
Dave: I can tell you’re excited.
Tom: I have to tell you.
Dave: You’re on your feet.
Tom: Fixed overhead, okay, is your house. Okay, it’s the facility, your car, the golf cart you have in the back yard, your riding lawn mower. Variable is what it costs you to have somebody cut your grass, what it’s going to cost you to pay your wife to go out and get grocery stores, and how much you use … the gasoline used in the car. So fixed costs are generally costs that are spent off the bat, whether you’re running or not running, there’s not going to be any variance in it. Your rent, rent is the easiest example of it. But in manufacturing there’s a lot of those.
Tom: Variable costs, variable costs are easy to explain to. Is that if you’re driving a car, your variable cost is your gasoline. Gasoline’s going to be directly proportional to the amount that you’re driving your car. The question is, is that you can’t put things in just buckets of fixed and variable. Because there are things … there are variable costs that have some portion of it fixed. For example, okay, we’re getting paid today, whether we’re out playing golf, or whether we’re doing this, or whether we’re working for a client, okay, those are three different areas of levels of productivity. Okay. Our salaries, or our wages, or the wages that are paid to individuals, generally speaking are variable costs. But if you’ve got John who’s working on the shop floor, and John is working on two machines, or working on four machines, some portion of John’s compensation could be considered to be a fixed cost. So there is some variation.
Tom: That’s why when we talked a little earlier is that a very common practice in allocation of overhead is direct labor. Direct labor, I could tell you the majority of my manufacturing clients still use direct labor. They don’t want to change it to machine hours, to any other forms, because A, they have to start rethinking. And it forces them to step back and try to look at and say, “Wow, why do I want to do that?” The accounting department, accountants love to change so much all the time, so trying to get somebody to reallocate their methodology of costing things, it’s like moving a building.
Tom: But, on the other side of the coin is that things have changed, we’re going to continue to advance, and the technology that’s out there internally in the accounting department, and even just with simple Excel worksheets can enable you to do it with a little bit more ease.
Dave: What year did American Pie come out?
Tom: Boy, Don McClain, one hit wonder, 1974?
Dave: Bixler will check that out, our staff will fix that out.
Tom: I’m guessing.
Dave: Drove the Chevy to the levy, he’ll get back to us here shortly. Check out that, get back to us Bixler.
Tom: It was a long, long time ago.
Dave: So in your consultation that you do with clients, do you work with them to format or set up their financial statements, or flash reports, and specialized reports to begin to capture some of the fixed, and the variable, and the direct labor?
Tom: Yeah, we do. But the first thing you need to do is you need to make sure that your accountants have a good understanding of what the company does. You have to understand the manufacturing process, because you don’t take a cost accounting system and try to overlay your manufacturing system on it. Our clients have a manufacturing system, okay, we’re CPAs, not manufacturers. They are going to manufacture their product, trust me, so as efficiently as you can what we need to do as CPAs is understand how they manufacture their product, and then we need to look at our cost accounting system to make sure that our cost accounting system is capturing the costs that might be most effective to them.
Dave: Right. So it goes well and beyond just the external financial reporting. So are you an auditor by trade? I see you’ve got business valuation, you’ve got forensics, but you’ve got that look of an auditor in your eye, like, “Man, I can break that down, I can find anything in your system.”
Tom: Well, you’re not looking in my eyes.
Dave: I normally don’t look in your eyes.
Tom: Yeah, that’s right.
Dave: But just for information.
Tom: No, I mean audits don’t excite me. I love the tax aspect of it, I do a lot of consulting, a lot of management planning, I like being able to do things for our clients that actually can move the needle. I think our best return for a client is to be able to find them a methodology to save cash. And have a better operation of production. If you can look at somebody’s cost accounting system and you realize where they’re … you know, maybe they have an over abundance of inventory sitting on the floor. If you could take $15,000.00 of cash out of somebody’s inventory, that excites a client.
Dave: You know, and you realize in less than 15 minutes you’ve given six tremendous tips to improve the bottom line and efficiencies of your business.
Tom: Was American Pie one of them?
Dave: No, that’s the fun part-
Dave: Of the equation that … but anyway, you’ve had several things that you’ve brought up today that I think are truly planting ideas that puts more cash into the bucket. That allows for benefits and etc. so well done on that front.
Dave: You know, you’d mentioned job costing is maybe not for everyone. Specific job costing is maybe not right for all businesses, let’s dive into that. Talk about specific job costing, if you can, for a minute.
Tom: Job costing, well, the most common area you’re going to see job costing, honestly, is going to be on a construction job.
Tom: The simplest way to explain it. A gentleman’s building a house, or lady, they’re building a house, they have a job cost jacket for everything that they do as far as to construct the house. And they have their way of costing that, and manufacturing, if you’re a manufacturer that does a lot of custom manufactured work, you need to track your costs specifically to the job that you’re … Because at the beginning of the job, you’re going to go out and you’re going to estimate the job. You’re going to estimate how many hours it’s going to be, how many machine hours, how much you think it’s going to cost. Wouldn’t it be nice at the end of the job to know whether you made any money or not? And if you don’t have a good cost accounting system you don’t know that.
Tom: And if you don’t pay attention to it, you did it the first time, the guy needs another one a year and a half from now so what do you think you’re going to do? What did I charge you last year? You’re going to go back, you’re going to look at that jacket, and you say, “Okay, you know, prices went up maybe five, 10%.” Give him the price, five, 10%. What if you lost money on that job? And you didn’t know it? You might’ve just taken on another job that maybe you’re going to lose money again.
Tom: So if you don’t know what your costs are it could actually turn out to hurt you. And then the other side of the coin is it might be that you came up with some hugely efficient way to make the product, or where there’s some cost efficiency in the savings, and maybe you know what, you could give it to the guy from the same price, and keep him happy, and still make a lot of money.
Dave: You know, I think you just challenged our listeners to find out what products, how they’re making money on each product. Sounds simple, but it’s not that simple. And if I were going to ask you, look, I want to overhaul or analyze my accounting system to try to begin to capture all that stuff, that’s not an easy process. What would you recommend if I ask you that question, how long would that take?
Tom: It depends based on the size. What I would tell you this, contact us this time of year, this time of year our business is a little slower than it normally is even though we’re always busy throughout the year, but this is a good time, summer time, fall, it’s a great time to step back and do a project like that. At Rea we can work with you on pricing, because it’s not our prime time. If you come and you ask us in the middle of February to do it, you know-
Dave: It’s pretty tough.
Tom: We’ll do it, we’ll carve out the time because we’ll do whatever we need to do to complete our cars, but it’s really not efficient for our clients and us.
Dave: Yeah. You know, maybe this is an unfair question, but we’ve known to ask unfair questions on unsuitable from time to time, but we have a lot of clients, and it’s industry wide, that use QuickBooks as their accounting system, and they try to do some inventory, and they try to do some things. As we get a little more complex with our cost and allocation of cost, is that the right platform?
Tom: Well …
Dave: Again, unfair question, but-
Tom: Right, unfair.
Dave: This is … you know, that’s one we get.
Tom: The problem with QuickBooks is it’s not in how QuickBooks works as an accounting system, it’s how it’s set up. As a cost accountant, you need to spend the time to figure out what buckets do you want to capture in your expense account. If everything just goes into cost of good sole, then you’re going to sort out a mess. But if you know what are the key factors, or the key items, that are most important to your business, those are the costs that you need to segregate. No differently than time.
Tom: Payroll is a significant cost of any particular job. Do you just put everything into direct payroll? Or do you take your payroll and you try to break it out into various levels of processing?
Tom: Do you care if the shipping guy, his wages goes in the same wages as the guy that’s running the CNC machine? If that doesn’t mean anything to you, a lot of times QuickBooks users are going to sit there and they’re just going to put it all in because it’s simple.
Dave: So the answer to that, and I like the direction you went with that, is QuickBooks may be the right platform, but you’ve got to set it up correctly, just like any other piece of software. And sometimes, with QuickBooks, you’re rushing to get that in and it’s not set up properly.
Tom: Yeah, it’s the last thing that happens. You get your business going, they get moving on a thing, and then they come to you, Dave, and sit there and says, “You know, what’s this chart of accounts?” Well, QuickBooks has one, and that’s the one they use.
Dave: Go for it.
Dave: So in the few minutes we have left, Tom, can you close with one of your famous Scharf-isms? You have one for us? Or do we just want to sing all the way out?
Tom: No, I have plenty of Scharf-isms, now, there’s a couple things, first of all, for all us tax preparers, I just want to let you know that pigs squeak by, and hogs get slaughtered.
Dave: There you go.
Tom: To that extent, when you start looking at expenses and everything, okay, we don’t want to screw flies. So you need to make sure, you don’t want to sort fly shit from pepper. So too many times as accountants we love detail, we want to make sure everything balances. Look at the things that are important, okay. Some of the things that are not so important, as my dad told me once ago, he says, “You know what, you’ve got to let it go, son.”
Dave: Yeah. You know, I think I’d like to hire you as my CPA. I get singing, I get expert advice on manufacturing and cost control, and get these Scharf-isms.
Tom: Maybe even golf.
Dave: And golf. You’re plug and play. You’re on my list to call. Our guest today has been Tom Scharf from Rea & Associates in Cleveland, Ohio. Thanks for joining us, Tom. Wonderful presentation. We’re still waiting on Bixler on the date of American Pie. 1971. Yes, 1971, so you were-
Tom: Plus or minus three years.
Dave: You’re rounding, you were good. We’ll give it to you.
Tom: Don’t want to screw flies.
Dave: I think the primary take away from our conversation today is that if you haven’t had to take a look at the way you’re costing your labor lately, or your accounting system, now is the time. Give Tom a buzz.
Dave: Listeners, speaking of time, thanks for putting aside your time to listen to today’s episode. Very much appreciated.
Dave: If you want to learn more about cost accounting you can reach out to Tom, or your Rea advisor. Or you can email us at ReaCPA.com, or give us a buzz and we’ll connect you with someone in your area.
Dave: In the meantime, if you enjoyed today’s episode, let us know. Like it, comment, or share it. And don’t forget to check out videos of our podcast on YouTube.
Dave: Until next time, I’m Dave Cain, encouraging you to loosen up your tie and think outside the box, and drive the Chevy to the levy.
Disclaimer: The views expressed on unsuitable on Rea Radio are our own, and do not necessarily reflect the views of Rea & Associates. The podcast is for informational and educational purposes only, and is not intended to replace the professional advice you would receive elsewhere. Consult with a trusted advisor about your unique situation so they can expertly guide you to the best solution for your specific circumstance.