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Session Two Topics

2. Session Two Topics. Revenues Management accounting Relevant costs Cost allocation under full absorption. Financial vs Managerial Accounting. Financial Accounting: highly regulated independent check of statements accuracy oriented backward perspective generally external use.

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Session Two Topics

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  2. Session Two Topics • Revenues • Management accounting • Relevant costs • Cost allocation under full absorption

  3. Financial vs Managerial Accounting • Financial Accounting: • highly regulated • independent check of statements • accuracy oriented • backward perspective • generally external use • Managerial Accounting • company dependent • no direct independent control • speed oriented • onward perspective • generally internal use

  4. A concept of revenue – definition and traps • Revenue defined as an increase in assets or decrease in liabilities that is caused by the provision of services or products to customers. • Under the accrual basis of accounting, revenue is usually recognized when goods are shipped or services delivered to the customer. Under the cash basis of accounting, revenue is usually recognized when cash is received from the customer following its receipt of goods or services. • Revenue vs cash inflow • Revenue vs price (rebates, discounts other provisions)

  5. A concept of cost – definition and use • Cost defined 1 = monetary value of economic resources used in performing an activity • Cost defined (measured) 2 = the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition (IAS 16) • Cost vs expense (very close to the second definition of a cost) • Cost vs price (quantity of payment or compensation given by one party to another in return for goods or services) • Cost vs investment (money committed or property acquired for future income)

  6. Financial vs Managerial AccountingFAQ • Financial Accounting: • what was the A’s equity at the date of? • What was the profit made over a period of? • Was the Company solvent at the closing date? • Managerial Accounting • shall we buy/sell a business segment? • shall we launch a new product line? • shall we increase/decrease prices? • is our cost level still competitive?

  7. Financial vs Managerial Accountingrelevant costs (items) • Financial Accounting: • only costs incurred matter • almost no estimates allowed • full absorption approach • no scenario analyses • Managerial Accounting • only future costs matter (sunk costs!!!) • estimates widely used • marginal costs approach • scenario analysis and hybrids (opportunity costs)

  8. Typical costs items by origin • Remuneration (salaries, wages, fringe benefits) • Raw materials • Energy • External services • Taxes and duties allocated to costs (real estates tax, stamp duties but neither VAT nor excise tax • Depreciation, Depletion & Amortisation

  9. Cost absorption • Cost of goods sold • General costs (period costs) • Logically there should be no costs left after allocation (orphan costs) since ultimately every dollar spent has to be covered • The problem is that share of direct costs (naturally allocated) decreases while the one of general costs growths rapidly and in some most advanced and valuable businesses gets dominance

  10. Cost absorption • Profit = Revenues – costs • Revenues (excl. bounded sales) are always direct and objective • Costs must be fully allocated to products & services sold • Cost allocation is always to some extend subjective • According to various studies indirect costs account between 30-42 % of the total costs (Laney, Atrill, p. 316)

  11. Use of the full absorption approach • Long -term pricing • Long-term resource allocation • Financial accounting

  12. Cost allocation – types of costs • Direct vs indirect costs • Direct vs variable costs • raw material • wages • Indirect vs fixed costs • office rent

  13. Cost allocation – targets • Products (individual, group) • Business segments • Customers (individual, segments, markets)

  14. Typical manufacturing processes • Job order • order • batch • assembly • Process • process (often with joint products issue)

  15. Cost allocation – job order • Cost pools • Overheads • For one-factory firm: typically two levels: factory shared services + supporting activities • For international corporations: multilayer structure

  16. Cost allocation – job order • Cost drivers: • Typically related to the time used • e.g. machine hours (production lines) • e.g. employees’ working hours (services) • A need for standardized (normative) costing: otherwise forecasting ability non-existent • Process costing skipped as too complicated atthis level

  17. Cost allocation – exercises • Atrill Activity 10.5 • Atrill Exercise 10.6 (Homework)

  18. Cost allocation – Critique of conventional costing • Not a tool to analyse overheads: a growing portion of total costs • Inability to provide analytical background in responding key strategic and operational questions: • shall we enter a new market (say Ukraine)? • shall we keep servicing this very group of customers (say students?)

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