Chapter #6: Understanding Key Cost
Relationships!
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To
be sustainable the value exchange between parties (being the business and the
customer) must both be beneficial. In my thoughts, this is a very fine line and
in a perfect world this may happen but the reality is not everyone is always
going to feel satisfied.
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Making Sense of Costs - It is of high importance for managers
to understand how costs behave in a firm. Absolutely!! This is something that
really interests me – linking the nasty figures, and other bits and pieces to
the realities of a business. As stated in chapter 6, understanding the
relationships of a firms cost to various aspects of a firm’s activities is
critical for managers – not optional, CRITICAL!
My thoughts – Definitely!! I mean if the manager doesn’t really have a
clue where the money is coming from, as well as being spent – then it is really
the blind leading the blind. This is where I stand firmly by accounting systems
helping businesses not hindering them. To run a successful business I believe
that costs should be delegated appropriately, giving a clearer breakdown of
what is going on! This way we can determine what is working and what isn’t
working, and in turn create new ideas, solutions that will improve business.
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Cost Objects – Engaging with the costs of a firm, I
feel ultimately allows us to see what is working and what isn’t (what is contributing to a company’s
profitability and what isn’t). I am familiar with different account numbers
as well as job numbers. The previous company that I worked for we really broke
down our costs. For Example when we had an event – one that sticks out to me
was the Cops and Robbers Bowls day we allocated the expenses as well as the
income to that job number (Cops and Robbers Bowls Day). So the expenses that we
incurred were costs such as the wages, food and alcohol supplied as well as
decorations etc). When entering these expenses they were allocated to this
event. The incomes (Daily Takings) were also allocated to this event. At the
end of that month when we looked at the profit and loss report – we could see
whether or not the function/event made a profit or a loss – Did the expenses
outweigh the income? Ok so from memory we made a loss, not by much but a loss
is a loss. The event is held annually and is a great community event that promotes
the club positively whilst showing our support for our local police team – so
we can’t can it! Instead we simply look at the expenses and determine what
costs were necessary and what were unnecessary. For example we can now
deconstruct the cost of wages. Was there too many staff on that day? Did we
have the staff on with the highest pay rate? Our company did not manufacture
products – it offered a service.
The service should ideally be beneficial for both parties and I believe
that understanding the costs of a firm enables us to do that by assisting
managers in recognizing costs and why they have incurred, and from this plan
and set a way forward. This process provides the managers to ask themselves so
many vital questions. Are these costs
necessary? Can we achieve the same result whilst spending less money? Will
these costs help or hinder my company’s profitability, or our company’s goals?
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How might numbers
create reality, rather than ‘merely’ reflect it? I am quite interested by this
question. So rather than just voice my thoughts I asked a few different people
what they thought of this question:
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My thoughts:
looking at numbers provides us with the opportunity to create reality – why,
well because we have the chance to make changes. We can choose to just ‘look’
at the numbers or use them to evaluate what is working and what isn’t and from
this move forward with a new action plan.
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Mikaela: She feels it “sets a numerical goal
that you can work towards, that leads you to produce results”.
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Jason: “Wow this made me think. I would
think numbers creating reality would be something like the certainty of numbers
in mathematical equations that we live by such as those in physics and those
that we know and use in everyday living”.
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Joanne: “Numbers are facts.
They do not lie. Therefore they have the potential to tell a story. How
successful or unsuccessful something is. Looking at the numbers can spark an
idea, a way to sustain or even improve what goes on in a business”.
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“Past
costs in a firm can be a starting point for managers to forecast expected
costs” – I would have to agree, and this brings me back to why I think it is
important to keep track of our finances. Past figures are really the foundation
for our company, providing us with what is working and what needs improvement.
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Chapter
#6 discusses (profit = revenue less expenses). So applying this to something I
know would be alcohol. Buying the product = expense incurred and then selling
it would be the revenue received? So when the alcohol doesn’t sell it becomes
inventory? I am a little confused but from my understanding this still equal’s
money on the bottom line and by not including this inventory of products we
will understate our firm’s bottom line (profit or loss)? What is this
inventory? Does this mean until a product is sold it is an asset?
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The difference between Direct and
Indirect Costs: This
really has and still is taking me a little to get my head wrapped around. So I
have been doing some research and I am trying to provide examples that I can
understand or have had experiences with and this is what I could find:
Direct costs: This makes a little sense to me.
Direct costs for an event would obviously be the materials/equipment
needed/used as well as the wages needs to pay for the staff required to run the
event.
Indirect costs: This confused me at first but from
what I can gather is that indirect costs can’t be directly linked to a certain
project as they benefit multiple ones. Examples would include electricity,
phone charges, office supplies etc. These are all necessary and contribute to
various different things however it can be very difficult to specifically say
how much electricity cost for that specific event.
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Process-costing: Allocating costs to products by
allocating them to a manufacturing process rather than a specific product/group
of products. So in my understanding this process is monitoring the costs,
making sure that possible implemented budgets are being followed and everything
is going according to plan. I am not too sure this is just my interpretation.
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Period and Product Costs: Period costs are costs of a business
not directly linked to our products and product costs are those that are
directly attached to products and are only seen as an expense once the products
they are attached to is sold.
My
thoughts/understanding – is that product costs are those that are
required/vital to making the product. Examples include direct labour and
material – very similar to direct costs. Period costs on the other hand are no
about of the ‘manufacturing’ process but are vital to perhaps the selling
process? Examples would possibly include advertising, shipping costs etc – very
similar to indirect costs.
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“Managers can decide to use whatever accounting approach they
wish to help them understand the key cost relationships in their firm”. I think
it is important for managers to use different approaches. Everyone is different
– and I think individuality enables a manager to understand properly and in
turn may find an easier way of doing things. Chapter #6 also mentions that they
must conform to certain rules and accounting standards when measuring,
allocating and apportioning costs. This intrigues me – I want to know what
rules and accounting standards must be followed and why? Is this just for the
final profit and loss statement? Or are the rules followed daily when entering
data into an accounting system?
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Overhead costs and overhead
absorption rates: THIS
CONFUSES ME!! From what I can gather it is a process designed for
companies/business owners to ‘forecast’ how much they need to put aside to
afford/pay for the production of a product or a particular service. I am
assuming this because later on in the chapter it says that the ‘actual’
overhead costs of production and ‘actual’ production volumes are properly known
at the end of the year. Due to this it makes sense to look at overhead costs
and absorption rates to predict how much something is going to cost. This may not
always go to plan as many assumptions have to be taken into consideration as
well as uncontrollable factors arising. This is a process I am thinking would
get better with practice and experience. What procedures could be put in place
or followed to make this process easier?
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Absorption and Variable Costing: I feel
comfortable with this concept – something I understand
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How Costs Change: This is something that managers would
have no choice but to constantly consider. They would have to ask themselves
several questions before making decisions as it is impossible to forecast the
future. How do managers make the right or most appropriate choices? Are there
any guidelines that they look at before making choices? Or is it all about the
‘risk’?
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Cost-Volume-Profit Analysis: Understanding
the costs and level of activity in a firm is vital for managers. However in
saying this it can be extremely difficult as it is all about assumptions. When
organising an event there are obviously expenses that will have to be paid
regardless of how many people show up, how many people don’t and how
successful/unsuccessful the event was. As said in chapter #6 this is critical
information that no one can know for sure in advance. This ultimately means the
manager must take a RISK – ‘you have to
risk it to get the biscuit’. Having previous experience in organising
events it is a real shame when things don’t go to plan particularly when a loss
is made. My thoughts on breaking-even in an event are good. When you break even
and no loss is made, although it is not an ideal outcome you are still
providing a service that could further promote your company/business for future
events. And sometimes it is all about putting a smile on a customer’s face.
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After
reading this chapter, not once, not twice but about three times, I finally feel
a little more at ease with the concepts discussed. Some of the content I felt
was too overwhelming and I felt I had to research more into the topics and look
at examples that made sense to me.
