What Are Non Controllable Costs?
Non controllable costs are expenses that a specific manager or department cannot directly influence or change within a given time frame. These costs are often fixed or allocated from a higher organizational level and are not subject to the immediate decision-making authority of a particular cost center manager. This concept is fundamental in managerial accounting, particularly for accurate performance evaluation and effective cost control.
The distinction between controllable and non controllable costs is crucial because it helps organizations assign accountability appropriately. While a division manager might be responsible for the labor and materials directly used in their production, they typically cannot control the rent for the corporate headquarters or the depreciation on machinery purchased by the central office. Understanding these costs allows management to focus their budgeting and decision making efforts on the expenses that can actually be influenced at each level of the organization.14
History and Origin
The concept of distinguishing between controllable and non-controllable costs is deeply rooted in the development of cost accounting and, more specifically, in the evolution of responsibility accounting. As businesses grew in complexity and decentralized their operations, it became necessary to create systems that could accurately measure the performance of individual segments and managers. Early accounting practices often lumped all expenses together, making it difficult to ascertain how well a particular manager was controlling the costs under their purview.
The formalization of "responsibility accounting" in the mid-20th century provided a framework for assigning revenues and costs to specific managers and departments based on their authority and influence. This system inherently requires the segregation of costs into those a manager can influence (controllable) and those they cannot (non-controllable). Professional bodies like the Institute of Management Accountants (IMA) have long emphasized the importance of this distinction for fair performance assessment within decentralized structures.13,12,11
Key Takeaways
- Non controllable costs are expenses that a manager or department cannot directly influence or alter.
- These costs are often allocated from higher levels of an organization or are fixed in the short term.
- Distinguishing non controllable costs is essential for fair performance evaluation and accountability in decentralized organizations.
- Examples include corporate overhead allocations, depreciation on centrally purchased assets, or long-term lease payments.
- Effective management focuses on influencing controllable costs while acknowledging non controllable ones for overall financial planning.
Interpreting Non Controllable Costs
Interpreting non controllable costs involves understanding their nature and impact within the broader financial context of an organization, even though they are not subject to immediate management influence at a specific level. For instance, while a cost center manager might not control the building's rent, knowing this non controllable fixed costs component is vital for overall departmental budgeting and for understanding the total expenses incurred.
These costs highlight the interconnectedness of different organizational units. Overhead costs allocated from a corporate headquarters to individual business units are typically non controllable at the unit level. However, they are a critical part of the total cost of operations for that unit. Effective interpretation means acknowledging these costs as part of the total economic reality of a division or project, even if they fall outside the immediate scope of a manager's direct influence. This awareness allows for more realistic financial planning and objective evaluation of a manager's true impact on the bottom line.
Hypothetical Example
Consider "TechInnovate," a decentralized company with various product divisions. Sarah manages the "Wearable Devices" division. Her division incurs direct costs like raw materials, direct labor, and specific marketing campaigns, which she can largely control. However, TechInnovate also has shared expenses.
One significant non controllable cost for Sarah's division is the allocated portion of the corporate research and development (R&D) department's budget. This R&D department develops core technologies used across all divisions, and its costs are distributed based on each division's revenue. For example, if the total corporate R&D budget is $5 million and Sarah's division generates 20% of the company's total revenue, her division will be allocated $1 million ($5 million * 20%) in R&D costs.
Sarah has no direct authority over the R&D department's staffing, projects, or overall spending. Therefore, this $1 million is a non controllable cost from her perspective. While it impacts her division's reported profitability, her performance evaluation would focus on how effectively she manages her controllable costs and generates revenue, not on the efficiency of the central R&D department. This distinction helps in assessing her true operational effectiveness within her responsibility center.
Practical Applications
Non controllable costs are critical in various practical financial and accounting scenarios. In internal reporting and managerial accounting, identifying these costs ensures that managers are held accountable only for expenses they can directly influence, fostering a fairer system of performance evaluation. For example, a plant manager might be responsible for production costs but not for the corporate tax department's salaries.
These costs also play a role in transfer pricing within large organizations, where goods or services are exchanged between divisions. The price set can include an allocation of corporate overhead costs that are non controllable to the receiving division, influencing its profitability. Furthermore, understanding non controllable costs is vital for strategic decision making. While a division might be performing well on controllable metrics, high allocated non controllable costs could signal an overall inefficiency at the corporate level, prompting a review of the entire organizational structure or allocation methods. Good corporate governance principles emphasize transparency and accountability in financial reporting, which includes a clear understanding of how costs, both controllable and non-controllable, are managed and allocated throughout an enterprise.10,9,8,7
Limitations and Criticisms
While the distinction between controllable and non controllable costs is crucial for responsibility center accounting, it is not without limitations and criticisms. One primary challenge lies in the arbitrary nature of allocation. Many non controllable costs, particularly corporate overhead, are allocated to departments or products using various bases (e.g., revenue, employee count, square footage). These allocation methods may not perfectly reflect the actual consumption of services or benefits, potentially distorting the reported profitability of divisions and leading to unfair performance evaluation.6,5,4 For instance, if a division that rarely uses IT support is still allocated a significant portion of IT department costs, its true performance might appear worse than it is.
Another limitation is that the classification of a cost as "non controllable" is often time-sensitive. A cost that is non controllable in the short term (e.g., a long-term lease agreement for premises) might become controllable in the long term (e.g., when the lease expires and renegotiation or relocation is possible). This dynamic nature can complicate consistent cost analysis over different periods.3 Additionally, over-reliance on this distinction can sometimes lead to a focus solely on minimizing controllable expenses, potentially neglecting broader strategic initiatives or long-term investments that might initially appear as non controllable but are vital for future growth. The challenge of classifying and allocating indirect costs is a perennial issue in cost accounting, where judgment and assumptions are often necessary.2
Non Controllable Costs vs. Controllable Costs
The fundamental difference between non controllable costs and controllable costs lies in the degree of influence a specific manager or department has over them.
| Feature | Non Controllable Costs | Controllable Costs |
|---|---|---|
| Definition | Expenses a manager or department cannot directly influence. | Expenses a manager or department can directly influence. |
| Accountability | Manager is not typically held accountable for these costs. | Manager is directly held accountable for these costs. |
| Time Horizon | Often fixed in the short to medium term. | Can often be changed or adjusted in the short term. |
| Source | Often allocated from higher organizational levels (e.g., corporate overhead, depreciation). | Direct costs related to operations (e.g., raw materials, direct labor). |
| Decision-Making | Less relevant for day-to-day operational decisions at that level. | Highly relevant for operational and tactical decision making. |
| Examples | Corporate headquarters rent, allocated IT support costs, central R&D expenses, property taxes. | Direct materials used in production, hourly wages of production staff, advertising budget for a specific product. |
The confusion between the two often arises when all costs affecting a department's profitability are simply viewed as "departmental costs" without distinguishing the level of control. However, for meaningful variance analysis and fair performance evaluation, it is essential to segregate expenses based on who has the authority and ability to manage them.
FAQs
What makes a cost non controllable?
A cost is considered non controllable if a specific manager or responsibility center does not have the authority or ability to influence or change the expense within a given time frame. These costs are often determined by higher management decisions or are fixed obligations that cannot be altered immediately.1
Why is it important to distinguish between controllable and non controllable costs?
Distinguishing these costs is crucial for effective managerial accounting and fair performance evaluation. It ensures that managers are held accountable only for the expenses they can realistically control, preventing them from being penalized for costs outside their influence. This also directs management's attention to areas where their actions can genuinely impact financial outcomes.
Are fixed costs always non controllable?
No, not necessarily. While many fixed costs, like long-term lease payments or depreciation on large assets, are often non controllable in the short term for a specific department, some fixed costs can be controllable by higher-level management. For example, the decision to invest in a new facility (which creates fixed depreciation costs) is a controllable decision at the corporate level. Conversely, some variable costs, like fluctuating utility rates, might be non controllable by an individual department, even though they vary with activity.
How do non controllable costs affect a company's financial statements?
Non controllable costs, along with controllable costs, are included in a company's overall financial statements, typically under operating expenses or overhead costs. While internal managerial reports segregate these costs for performance assessment, external financial statements (like the income statement) generally present aggregated cost categories without this distinction. They impact the company's overall profitability and asset valuation, just like any other expense.