Monthly Archives: February 2015

Making the Invisible Visible: Calculating the Total Costs of Occupational Accidents

With the publication of the 2014 report “Estimating the cost of accidents and ill-health at work: A review of methodologies” by the European Agency for Safety and Health at Work, there has been renewed interest in the effects of occupational accidents on company finances. But what is the bottom line effect of occupational accidents and why is it so difficult to measure?

In management accounting we talk about direct and indirect costs. Direct costs are costs that can be traced directly to a cost object (i.e. something we want to know the cost of) but indirect costs cannot be traced directly to a cost object. The ability of managers to discern between direct and indirect costs is dependent on the design of the accounting system where the focus is usually on tracing uses of hours and materials to the products and services, which the company trades.

If occupational accidents are seen as cost objects, managers cannot see how much they cost because most of the costs associated with occupational accidents are indirect costs. That is to say they can not be traced directly to occupational accidents because accounting systems are not set up to trace costs directly to occupational accidents. Nor should they. But this means that managers are often flying blind when it comes to the true cost of occupational accidents.

In a project involving nine companies in Denmark some years ago we developed a method for calculating the total costs of occupational accidents. This method – which we called the Systematic Accident Cost Analysis (SACA) method – is based on well-known management accounting method called Activity Based Costing. It focuses on identifying the activities that either emerge or are affected by the occupational accident. It then measures the use of resources and costs of these activities to get the total cost of the accident.

In the companies we analyzed with this method we found six types of costs associated with the consequences of occupational accidents.

  1. Costs due to the absence of the injured employee: Includes e.g. payment of sick pay and payment of supplementary sick pay.
  2. Communication costs: Includes e.g. formal communication to employees, staff, and general management as well as informal communication between employees.
  3. Administration costs: Includes payroll administration, administration regarding health and safety regulations and reporting requirements, follow-up activities and meetings.
  4. Costs of prevention initiatives: Includes e.g. purchase of machine components and training initiatives.
  5. Operation disturbance costs: Includes e.g. training of replacements, revenue loss, co-workers overtime, and production reductions.
  6. Other costs: Includes costs such as e.g. fines and gifts to injured employee.

The main conclusions were quite interesting and included:

  1. Indirect (i.e. hidden) costs of occupational accidents could vary from 2% – 98% depending on accident characteristics and the activities incurred as a consequence of the accident.
  2. Calculating occupational accident costs can illustrate and visualize the value created by the Occupational Health and Safety (OHS) department by preventing accidents and thus avoiding costs.
  3. Accident costs vary between companies and depend on accident type, wage structures and policies, OHS management system scope, and production process vulnerability.
  4. Smaller companies had on the average higher accident costs per accident than larger companies.

Preventing occupational accidents makes sense from a moral and legal perspective. But the project showed that prevention also makes sense from a company financial perspective. Lets say a mid sized production company has 5 occupational accidents a year showing a direct cost of 30.000 Euro on average per accident in the accounting system in sick pay and compensation. A SACA analysis showed that only 30% of the occupational costs are direct and thus visible in the accounting system. The total annual cost of occupational accidents is thus 500.000 Euro. This company in its most recent annual report disclosed a profit margin of 10% – i.e. how much of the revenue was left when all costs have been subtracted. This means that the company would have to sell for 5.000.000 Euros to generate enough profit to cover the costs of occupational accidents. In other words, if the accidents had been avoided, 5.000.000 Euros on the top line would have counted towards increasing the bottom line and the value increase of the company.

The SACA report (in Danish) is available by sending an e-mail to pallrik(at)ru.is and an English description of the method is available in this article.

Changes in internal controls in Icelandic companies 2008 – 2014

We are currently in the reporting phase for our research on changes in management accounting practices of Icelandic companies since 2008. A part of this research focuses on what characterizes the development of internal controls and weather the developments observed can be characterized as increasing or decreasing maturity of internal controls in Icelandic companies. This is currently being written for an academic publication, but here are a few highlights.

The data is based on two questionnaire surveys of internal control design and application carried out in 2008 and in 2014. The two surveys asked the same questions about internal controls in both years where we used the COSO framework as a guide for developing the questions as well as the ISACA internal control maturity framework. The population was in both years the 300 largest companies in Iceland and the response rates were 61 and 63 percent respectively.

The survey in 2008 was carried out months before the worst financial crisis in the history of Iceland hit the country. Although this was not the intention at the time, the 2008 survey documented management accounting practices – including internal control – in Icelandic companies at the end of the fastest expansion phase in Icelandic business history. The survey in 2014 was carried out after 6 years of financial restructuring, IMF interventions and general environmental turbulence and uncertainty. The comparison between these two data sets gives us some idea of what happens to management accounting practices when elements in the external environment suddenly change.

The below table gives an overview of some of the results from the internal control part of the survey.

Questions

Companies answering “Yes” in 2014

Companies answering “Yes” in 2008

Are internal controls of average or high importance?

92%

90%

Have internal controls been documented?

64%

36%

Has internal control processes been reviewed and approved by top management?

55%

41%

Is there in place a risk assessment and response plan for events that could threaten company objectives?

51%

20%

Have external auditors have advised on internal controls?

62%

47%

Are internal controls reviewed regularly to ensure alignment with risk and control conditions?

63%

36%

The results show that internal controls have developed significantly in the period after the crisis hit the companies in 2008. The management control literature concludes in general that behaviour orientated management controls become more flexible and result based with increasing levels of environmental turbulence. Our research  indicates however that accounting type, information focused controls seem to become stricter, more formalized and more activity centred. This tells us that management control system studies cannot  as such generalize findings for one part of a management control system to another. The study concludes that external disruptive events like a financial crisis spurs companies to increase the maturity of their internal controls.