by Don Kennedy, Ph.D., P.Eng., IntPE, CPEM, FASEM
The concept I am talking about today is sometimes called the “more is better” fallacy, and I will pick accruals as an example of this.
You may have been in meetings discussing alternatives to address some hazard. One is simple and cheap - the other is complex and expensive. The top manager might say “you cannot put a price on safety.” The fallacy here is that the more expensive alternative is the better one. We know this is not necessarily true. Many times things are cheaper because they are better and the option most often chosen. The expensive option is expensive because it is unique and requires more custom labor.
Accruals, for those that do not know, are accounting entries used to cover expenses that are incurred but will not be paid for before the end of the current fiscal period. Accountants typically ask the managers for their estimates for these accruals. I call accruals “imaginary numbers that we make up and they go away at the first day of the next period.” I give them effort warranted by that view. I have provided accruals totaling more than $50 million for which I spent around 4 hours compiling. The company audited my numbers and found no irregularities.
Another manager spent a whole week (40 hours) on his numbers that totaled around $10 million. He was very thorough trying to identify every potential cost that could be incurred before the end of the year. He was very happy with his result and the effort expended to come up with those accruals.
Now for the difference between the two approaches. I knew how much my department was spending every month. Christmas and New Years Eve fall before the end of the year and spending is typically lower in December than other months as a result. Construction companies often take 2 weeks off at the end of the year in my area. I identified all activities I knew would happen and assumed things that might happen would not. Invoices often come in more than a month after the expense was incurred so there is a lag, especially at year end. I made sure my $50 million was not going to be more than the realized amount.
By trying to include as much as possible, the other manager produced a number higher than the normal monthly rate of spending of $6 million. Managers might be optimistic about all the work that might get done, especially if there is pressure to get things finished by the year end deadline. But things happen.
As I flippantly alluded to, accruals are reversed on the first day of the new accounting period. So my department had a -$50 million entry and the other had a -$10 million entry on January 1. My true numbers were $55 million in December but only $45 million in January, so the $50 million in January looked very normal. The other department had only $4 million actuals in December and $5 million in January. The total expenses in January for that department after the reversal entry was minus $1 million. This raised a lot of red flags for that manager to explain how there could be negative expenses. Trying to be very thorough and list every possible event, created a problematic number. Doing less was a better approach.
Less is often more.
About the Author
Dr. Don Kennedy, a fellow of ASEM, has been a regular attendee of the ASEM conference since 1999, with particularly good participation at the informal late evening "discussions" (sometimes making it difficult to get to the morning plenaries). “Improving Your Life at Work” is Don Kennedy's ebook which includes a lengthy bibliography for people looking for references on management theory.