Cost management manual E-Book

Carmen Fullana Belda

• Herausgeber: Universidad Pontificia Comillas
• Kategorie: Fachliteratur
• Serie: Bibllioteca Comillas. Economía
• Sprache: Englisch

Seitenzahl: 655

Veröffentlichungsjahr: 2020

Beschreibung

This book presents a compendium of the current managerial accounting system, in its theoretical and methodological aspects. Internal accounting is used by companies to determine their costs and analytical results, which represent essential information for their management. As a professional reference book, oriented to educational purposes at University level, the authors hope that the text serves the purpose of being useful in terms of remembering concepts, reviewing procedures and solutions, and observing new approaches. Valid processes are addressed for all types of companies, not only industrial ones, but also commercial and service ones, with cases and solutions adapted to their characteristics. Detailed knowledge of cost formation inevitably reveals opportunities for improvement in working methods, in product design, in scheduling production operations and in the configuration of the organization itself. Nowadays, it is unquestionable that the analysis and interpretation of costs represents a powerful management tool to develop responsibility as professionals or company managers.

Leseprobe

COST MANAGEMENT MANUAL

Servicio de Biblioteca. Universidad Pontificia Comillas de Madrid

FULLANA BELDA, Carmen, autor

Cost management manual / Carmen Fullana & José Luis Paredes. -- Madrid : Universidad Pontificia Comillas, 2020.

469 p. -- (Biblioteca Comillas. Economía ; 9)

D.L. M 26690-2020. -- ISBN 978-84-8468-858-7

1. Contabilidad. 2. Control de costes. I. Paredes Ortega, José Luis, autor. II. Título

Esta editorial es miembro de la Unión de Editoriales Universitarias Españolas (UNE), lo que garantiza la difusión y comercialización de sus publicaciones a nivel nacional e internacional

© 2020 Carmen Fullana & José Luis Paredes

© 2020 Universidad Pontificia Comillas

Universidad Comillas, 3

28049 Madrid

Diseño de cubierta: Belén Recio Godoy

ISBN: 978-84-8468-858-7

Depósito Legal: M-26690-2020

Maquetación e impresíón: Imprenta Kadmos, s.c.l.

Reservados todos los derechos. Queda totalmente prohibida la reproducción total o parcial de este libro por cualquier procedimiento electrónico o mecánico, incluyendo fotocopia, grabación magnética o cualquier sistema de almacenamiento o recuperación de la información, sin permiso escrito de la UNIVERSIDAD PONTIFICIA COMILLAS.

Contents

CHAPTER 1

MANAGEMENT ACCOUNTING MAIN OBJECTIVES WITHIN A COMPANY

CHAPTER 2

PRODUCTION PROCESS AND COSTS

CHAPTER 3

COST ACCUMULATION BASIC MODEL (I)

CHAPTER 4

COST ACCUMULATION BASIC MODEL (II) (APPLICATION TO MULTIPRODUCTION, SERVICE AND RETAIL COMPANIES)

CHAPTER 5

INVENTORY MANAGEMENT

CHAPTER 6

COST ASSIGNMENT SECTION COSTING

CHAPTER 7

VALUATION OF WORK IN PROGRESS

CHAPTER 8

PROCESS COSTING: MULTIPHASE PRODUCTION

CHAPTER 9

COST BEHAVIOUR AND ABSORPTION COSTING MODEL

CHAPTER 10

VARIABLE COSTING MODEL AND COST-VOLUME-PROFIT ANALYSIS

CHAPTER 11

OTHER COSTING MODELS

CHAPTER 12

BUDGETS, STANDARD COSTS AND VARIANCES

CHAPTER 1

MANAGEMENT ACCOUNTING MAIN OBJECTIVES WITHIN A COMPANY

LEARNING OBJECTIVES

Review Financial Accounting, its mission as an external accounting system, its primary users, as well as the information it provides.Understand the limitations of the information provided by Financial Accounting and the consequent emergence of Management Accounting.Describe the concept of Costs Accounting as a part of Management Accounting specifically focused on calculating costs, listing its objectives and explaining its field of action as an internal accounting system.Give an overview of the major stages in the historical evolution of Management Accounting and present both the national and international organizations charged with the standardization of Management Accounting.

THE NEED FOR MANAGEMENT INFORMATION: A REAL CASE

Elevator Ltd. Company is a family business dedicated to the manufacture of components for elevators. Lately, due to mergers of companies in the sector, it has become the only company in the world that, as a manufacturer, offers the complete elevator. They produce practically all the components of the elevator, also customizing if needed the design for specific installations. Clients are small installer companies, whose customers are large construction companies and neighborhood associations. Elevator Ltd. owns a market share of 15% in the national market and 2% in the world market. The company has factories in Seville and Zaragoza, branches in the main cities of the country, and affiliated companies in many countries of the world (Austria, the Czech Republic, France, Greece, Italy, the Netherlands, Poland, Portugal, etc.).

A crisis in the real estate sector would put the company in a delicate situation, because although global earnings are positive, production processes are expensive, and Elevator lacks information on the profitability of each of its product lines.

The organization is aware of this lack of information on internal processes, costs and results. The company would like to have more data to be able to make decisions regarding the possibility of outsourcing the manufacturing of components, and thus be able to focus mainly on design tasks. This would allow Elevator to develop greater relationship with its customers, mainly the installers, who are not only responsible for the installation but also for the maintenance of the elevators. Furthermore, strengthening customers’ relationship would place the company in a more strategic position compared to its competitors, multinationals such as Otis, Schindler and Thyssen.

Contents

1.ACCOUNTING SYSTEM

2.FINANCIAL ACCOUNTING. EXTERNAL ACCOUNTING SYSTEM

2.1.Usefullness of Financial Accounting

2.2.Information provided by Financial Accounting

2.3.Drawbacks of financial Accounting

3.COST ACCOUNTING. THE INTERNAL ACCOUNTING SYSTEM

3.1.Definition and objectives of cost accounting

3.2.Scope of cost accounting: value-creation within the company

3.3.Value-chain analysis

4.DIFFERENCES IN ACCOUNTING SYSTEMS

5.HISTORICAL EVOLUTION OF FINANCIAL ACCOUNTING SYSTEM

6.MANAGEMENT ACCOUNTING REGULATIONS

6.1.Official Spanish Regulations

6.2.Spanish Regulations in the professional field

7.PRACTICAL CASE STUDY

8.ACTIVITIES

9.REVIEW QUESTIONS

10. KEY TERMS AND CONCEPTS

1.ACCOUNTING SYSTEM

The first scientifically-based accounting system appeared towards the end of the 15th century1 with the specific purpose of recording the exchanges and trading balances between land and property owners.

However, during the course of the past two centuries accountancy has progressively turned into a formal and legally binding practice for businesses: on the one hand, because the Public Administration required the information provided by the so called Financial Statements in order to exercise fiscal control over corporations; and, on the other hand, because it provides a more complete system of information for managers to base their business decisions and for administrators and other interested parties to better understand the state of the business.

Overtime, with both scientific and technological development and with the transformation of business organizations, accounting has taken on an indisputable importance, to the point of becoming “the everyday language of business” and of being considered the primary source of information about a company.

The accounting system is constantly evolving: it adapts to new situations and offers increasingly broad and accurate information, driven by the integration of principles and rules coming from various private and public regulatory institutions, as a means of becoming of maximum usefulness to people inside and outside the company who are interested in the state of the business.

2.FINANCIAL ACCOUNTING. EXTERNAL ACCOUNTING SYSTEM

General Accounting, the application of which is mandatory in all companies, is known as Financial Accounting, because it provides data on the real asset value of the company, as well as on the origin of funds to finance the company.

Moreover, Financial Accounting is designed to keep the market informed about the company’s assets and records its dealings with the outside world, which is why it can be considered as an External Accounting System.

A substantial part of the data that Financial Accounting records is related to the world outside the company: sales and clients, purchases and suppliers, financing and financial institutions, relations with public bodies such as the Tax Authorities and the Social Security System, relations with shareholders, bondholders and all types of debtors and creditors; all of whom are considered as “external” parties to the company, but to whom access to accounting information must be guaranteed.

Furthermore, the legal basis of a company’s transactions operates through external documents: invoices, bills of exchange, financial promissory notes, contracts, title deeds etc.

In brief, both in the data that it records as well as in the users for whom the data is destined, Financial Accounting represents the external accounting system of a company.

2.1.Usefullness of Financial Accounting

The data provided by Financial Accounting is of interest not only to users outside the Company but also to its managers and directors, i.e. to internal users.

In summary, the users of Financial Accounting are the following:

–External users

Those who are economically or financially involved with the company, such as partners or shareholders, financing institutions, the Tax Authorities, as well as suppliers and clients.

The information provided by Financial Accountancy could also raise interest in other users: investors, financial market analysts, trade unions, private and public corporations, other companies and, society in general.

–Internal users

Primarily the management of the company; this is, either the owners or the managers, directors, executives, etc.

The remaining employees of the company due to their work connection.

2.2.Information provided by Financial Accounting

During the financial accounting fiscal year, which covers 12 consecutive months, all transactions that affect the business are recorded: all economic events and variations occurring from the beginning of the year. At the end of every fiscal year all the data gathered and appropriately presented and analysed is condensed into basic, legally required reports, such as Financial Statements which are composed of several documents.

The main objective of the Financial Statements is to present a faithful picture of the company’s financial situation, as well as the results of the fiscal year. The information provided enables the users of the accounts to analyse the state of the company’s business and to take consequent decisions.

In the area of finance, for example, one could decide whether it is better to depend on self-financing or external financing, or whether long- or short-term loans are appropriate; or to consider whether there are opportunities for taking on more debt and whether debts can be readily serviced; whether the assets are properly financed; or whether to take action on the principal elements of working capital, such as inventory, customers receivables and suppliers payables.

In the economic area, the data gives an overview of the process through which the business results have been achieved. This, in turn, facilitates decision-making in respect of the basic ingredients of these results, such as incomes and expenditures. Furthermore, it allows an analysis of the return on capital employed, both internal and external, and of the agreements on distribution of dividends to shareholders.

2.3.Drawbacks of financial Accounting

The management of a business is based fundamentally on decision-making. The information provided by financial accounting is insufficient to be able to make all these decisions. This inadequacy is mainly due to the important changes in business management models, which have increased substantially the demand for information needed for efficient and competitive management.

All levels of the business organization must make decisions and implement policies related exclusively to the internal sphere of management. Some of the most frequent can be:

–Product policy: Separate analysis on the profitability of each one of the products, and decisions on how to maintain and drive those which are most profitable, eliminating those that are not, or diversifying the range of products.

–Pricing and market policy: Setting the sales price based on production costs; possible lowering of prices in the face of competition; market research to determine which markets are most advantageous and which are most unfavourable to develop, as well as the viability of alternative markets.

–Process policy: choosing the most efficient production processes, reducing production costs, improving the different production methods, choosing the right suppliers and negotiating delivery deadlines to optimize the stock to be kept.

–Management policy: developing long-term strategic plans and short-term operating plans, through the implementation of budget systems and controls.

However, Financial Accounting has an essentially financial focus and is designed to generate the financial statements of a company, all in compliance with generally accepted accounting principles. But as a holistic system of information for managing a business it has its limitations.

If, specifically, we take a look at the Profit and Loss Account, the result is the difference between revenues and expenditures, with the data presented in a very aggregated way and providing only global information. Revenues and expenditures are classified only according to their nature and origin, but without any other kind of grouping specifying which of the various functional areas of the business they are destined to, or also without indicating how they have contributed to the final value of the products or services sold by the company.

3.COST ACCOUNTING. THE INTERNAL ACCOUNTING SYSTEM

Based on what has been presented above, it is clear that financial accounting has limitations for managerial decision taking. Due to this fact, management accounting emerged as a new system of accounting that would facilitate strategic decision making.

The expansion in accounting began with a new branch of accounting, namely cost accounting, whose original objective was to calculate the cost of products and services as a means of determining their profitability. Cost accounting was initially intended as an expansion of financial accounting and not as a distinct system of financial information.

With the development of corporations and the establishment of new forms of management, cost accounting split off from financial accounting, into the form of management accounting, expanding its scope to include the planning and control functions of corporate management, in addition to the calculation of costs and analytical results of a company.

THE ACCOUNTING SYSTEMS IN THE COMPANY

Cost accounting is also often referred to as analytical accounting because it delivers data through a process of detailed analysis of generated costs and results; specifically, it aims to deal with the data that does not appear in the profit and loss account.

3.1.Definition and objectives of cost accounting

Analytical cost accounting can be defined as a branch of management accounting which analyses, appraises and records internal company transactions, calculating the costs of its products, services and functions and providing information that is useful for the control of costs and results, such as for decisions on cost and management control.

The most pertinent objectives generally assigned to cost accounting are, in brief, the following:

Evaluation of goods and services produced by the company, based on the resources used to that end. This includes the costs of the products and services sold (cost of goods/services sold) and the cost of inventory (stocks). So it provides the inventory value for financial accounting.

Analysis and evaluation of the activities undertaken for the production of goods and services, by assigning costs to the specific areas, departments and functions used in their production.

Drawing up of an analytical income statement in which the process of generating the result is presented in a more detailed form than in the profit and loss account. On the one hand, vertical data which show the gross margin, the operating income and the net margin; on the other, horizontal data with a break-down of results per products sold and services rendered.

TABLE OF ANALYTICAL INCOME STATEMENT

Product 1

Product 2

…

Product n

Total

Revenue

–Cost of goods/services sold

Gross/industrial margin

–Sales and distribution costs

Commercial margin

–General and administration costs

Operating income

3.2.Scope of cost accounting: value-creation within the company

When dealing with the scope of analytical cost accounting it is essential to introduce the study of the internal processes of value transformation within the company and the concept of value-chain.

The ultimate goal of any company is to obtain and sell products or to develop and offer services. To succeed in this, productive inputs are available and used:

–INFRASTRUCTURE: buildings, factories, machinery, tools, furniture, IT equipment etc.

–MATERIALS: for production, for selling and consuming.

–PERSONNEL: input of know-how and labour.

–EXTERNAL INPUTS: supplies and services required from outside parties

All the inputs used have a value: the purchase price, salaries or depreciation costs, which are turned into products or services of greater value. Within a company an internal movement of value creation is continuously produced.

VALUE CREATION WITHIN A COMPANY

INPUTS

MOVEMENT OF INPUTS VALUES

ACCUMULATED VALUES

INFRASTRUCTURE

MATERIALS

PERSONNEL

EXTERNALSERVICES

Wear & Tear/Depreciation

Consumption

Labour

Expenses

Products

and

services

3.3.Value-chain analysis

The value chain, popularized by Professor Michael Porter of the Harvard Business School, is considered a strategic planning tool aimed at identifying value-generating activities and analyzing the competitive advantages and benefits they bring to the company.

At this point in the chapter, it is a matter of looking exclusively at the creation of value. The areas creating value transform the consumption of available resources, with the collaboration of the support areas, into added value products or services for the market. Value creation activities are carried out in a series of successive stages or processes that suggest the idea of a “chain” in which each link represents one of these stages of the process that incorporates and accumulates value until the end of the chain. It is known as the value chain and its graphic representation is shown in the following scheme:

Analytical cost accounting produces an analysis of the movement of value within a company, which leads to a measurement and evaluation of the resources employed and of the goods and services obtained.

At first one might think that analytical accounting is applicable only in industrial or manufacturing companies, and that is how it was initially; but nowadays the process of calculating and controlling costs is used also in service and retail companies. All companies, whatever their nature, are similar in their operating processes and the way in which they create value.

4.DIFFERENCES IN ACCOUNTING SYSTEMS

a. Differences related to the application within the company and the regulations:

FINANCIAL ACCOUNTING

COST ACCOUNTING

Obligatory in all companies, whatever their legal status.

Application is voluntary for companies

Governed by legal requirements and universally accepted accounting principles.

Does not adhere to any legal requirements and is governed by principles suitable to the specific needs of a company’s management.

b. Differences with regard to the scope, primary users and objectives of the reports.

FINANCIAL ACCOUNTING

COST ACCOUNTING

Scope

Owner’s equity

Transactions recorded with third parties.

Internal process of value creation.

Objective

Financial Statements elaboration

Analytical Profit and Loss Account

Cost reporting

Primary users

Outside/third parties.

For internal use for decisions relating to the outside world.

Only for internal use

c. Other important differences.

Period covered

Maximum one year, required by law

Short periods, normally for one month

Measurement unit

Expressed only in local currency

Expressed in physical units of whatever nature and converted into monetary terms

Type of Information

Historical data

Historical and forecasted data

Although both accounting systems operate independently from one another since their reports have different objectives and primary users, they do complement one another in various aspects. On the one hand, financial accounting obtains data from cost accounting, the most important example of this being the valuation of final inventories in order to determine the variation in stock and the closing of the fiscal year.

On the other hand, cost accounting uses information available in the company’s financial accounting system for making calculations as, for example, for purchases, expenses, sales and revenues, avoiding duplication in this process.

5.HISTORICAL EVOLUTION OF FINANCIAL ACCOUNTING SYSTEM

The intention in this section is not to analyze in detail each and every of the different phases into which the historical evolution of this subject is normally divided, but rather to limit our study to a summary of the overall history of the discipline, highlighting its most important stages.

The development of financial information system, has followed a sequence which can be summarized in three stages, as follows:

1st STAGE: Cost Accounting as a complement to Financial Accounting

Cost Accounting began with the Industrial Revolution of the 19th century, when production systems evolved from hand-crafting to more complex processes which made it more difficult for management to distinguish between the cost of production and other intermediate costs. This is due to the fact that the increasing complexity prevented Financial Accounting, used until then, from offering sufficient information with the mere record of external data.

Accordingly, accounting was required, at minimum, to provide the calculation of the cost of products, transactions and of stock remaining in the company’s inventory. It was more of an expansion of the scope of Financial Accounting than a different and new system of financial information.

2nd STAGE: Evolution towards Management Accounting

During the first half of the 20th century, mass production became the norm with the creation of large corporations and the diversification in the manufacture of many products. At the same time, corporations expanded the location of the production facilities to more distant geographical areas and markets, favoured by the development of new communication means.

Corporate activities began to organize themselves in hierarchical specialized departments and functions, led by functional managers who were assigned objectives in harmony with the overall objectives of the corporation. These changes, in turn, called for new styles of management and organization, which were supported by engineers and analysts at the launch of so called “Scientific Management”, as a way of delivering better management and better productivity. The big challenge of this period was to control and manage these organizations efficiently and profitably.

From the beginning of this stage, the necessity arose for Cost Accounting to provide more and more appropriate financial information, to stay within the new styles of management via delegation. It could no longer be an integral part of Financial Accounting. Then, Cost Accounting had to acquire its autonomy, and a new branch of accounting i.e. Management Accounting was created. Cost Accounting remained an integral part of Management Accounting.

3rd STAGE: Incorporation of new accounting techniques

This third phase covers a long period, between the first half of the 20th century until today, during which internal accounting needed to develop and improve.

The characteristics of the evolution of Management Accounting and of Cost Accounting as an integral part thereof, were associated with the evolution of the economical, technological and social environment, which had taken place during the second half of the 20th century and with a concurrent transformation undergone by corporations.

It is sufficient to list a few of the scientific methods applied by accounting, as by many other sciences, for a better understanding of the improvements introduced into the systems of financial information: statistical and quantitative methods, linear programming, decision-making theories, etc.

Regarding the technological advances, it is undeniable that the development undergone by information technology has enabled the systems of accounting information to provide its reports in a more appropriate and timely manner.

The corporations and models of management have experienced transformations in parallel to the economic and social changes created by uncertainty, risk and competition in the business environment, forcing management strategies to be increasingly risky and innovative: strategic planning, flexible production, total quality, individual product accounting, mass media advertising, standardization certifications, cost reductions, process-engineering, etc. At the same time, new forms of corporations have emerged which have transcended local and national boundaries and become multinational corporations with very decentralized activities and responsibilities.

All the changes noted above meant that all the systems of traditional accounting had to be improved in order to adapt to these changes. Accordingly, accounting has incorporated new techniques capable of complying with today’s financial information requirements.

6.MANAGEMENT ACCOUNTING REGULATIONS

Accounting standardization is understood as the set of rules and criteria to which accounting must comply in order to present homogeneous information that allows its understanding and comparison.

The huge efforts dedicated to the development of regulations in Financial Accounting by different organizations and institutions, both national and international, are well known. In the majority of cases, these regulations are more than simple recommendations: they are legally binding regulations, backed-up by national and international legislation.

In the field of Financial Accounting, this effort is clearly necessary, given the absolute necessity to provide information that is understandable, uniform, comparable and relevant to outside users.

Management Accounting is a financial information system for internal users in which the latter can decide, at their discretion, what type of information they require for decision-making, and what format, composition and structure their reports should take. Accordingly, not only the existence of norms and directions for presenting the financial information provided by Management Accounting, but also the mere existence of a generalized model valid for all organizations (given the enormous possible variety of internal value transformation processes within corporations) might seem impossible or inappropriate.

Notwithstanding the above, guidelines for the presentation of internal accounting data have been published by various renowned private institutions in this professional field. Clearly, these are recommendations of an indicative, advisory nature and not legally binding regulations, and generally with only national application. Moreover, in a few countries accounting regulations which govern certain aspects of internal accounting have been published by public authorities.

The answer to the question why it is necessary to publish regulations for the presentation of internal accounting information? can be found in the need to establish some basic guidelines for the calculation of costs which serve as an orientation to corporations for the most rational and useful calculation of costs, for the valuation of goods and services obtained and for obtaining internal analytical results.

Below are listed the organizations which have published recommendations for Management Accounting and which have had a major influence in the international field.

COUNTRY

ORGANIZATION

INTERNATIONAL

FINANCIAL AND MANAGEMENT ACCOUNTING COMMITTEE (FMAC) FROM INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC)

U.S.A

INSTITUTE OF MANAGEMENTS ACCOUNTANTS (IMA)

AMERICAN ACCOUNTING ASSOCIATION (AAA)

NATIONAL ASSOCIATION OF ACCOUNTANTS (NAA)

COST ACCOUNTING STANDARDS SUBCOMMITTEE (CASS) Y COST ACCOUNTING STANDARDS BOARD (CASB)

UNITED KINGDOM

CHARTERED INSTITUTE OF MANAGEMENT ACCOUNTANTS (CIMA)

INSTITUTE OF COST AND MANAGEMENT ACCOUNTANTS (ICMA)

FRANCE

CONSEIL NATIONAL DE LA COMPTABILITÉ - CHAPTER III (ANALYTICAL ACCOUNTING) OF FRENCH FINANCIAL ACCOUNTING PLAN (27th of April 1982).

CONSEIL SUPÉRIEUR DE L´ORDRE DES EXPERTS COMPABLES ET DES COMPTABLES AGRÉÉS (CEREDE)

6.1.Official Spanish Regulations

In Spain efforts to standardize management accounting have been made at two levels: official and unofficial.

At an official level the first proposal can be found in the work of Group 9 of the “Plan General de Contabilidad” of 1973 (O.M. of August 1st, 1978 – BOE of September 1978, number 2270). It proposes a dual system, independent of financial accounting, for recording the internal transactions of the corporation’s accounts using the double entry system.

In the “Plan General Contable” of 1990 (R.D. 1643/1990 of December 20th), which replaced that of 1973 and was prompted by the need to assimilate the EU Community Directives applicable to Accounting, the work of the Group 9 was not yet reflected, nor were defined rules foreseen for cost accounting; however, there was also no explicit repeal of the Group 9’s previous proposals.

However, in the final “Plan General Contable” of 2008 (R.D. 1514/2007 of November 16th), groups 8 and 9, which were left free under the previous Plan, were taken over by expenditures and revenues which are attributable to the net assets. And within the scope of standardization there is no express reference to management accounting.

The second proposal comes from the resolution of the Institute of Accounting and Account Auditing (ICAC) “Criteria for Determining Costs of Production” (May 9th, 2000 – BOE of June 13th, 2000, number 141). It establishes a number of rules and specific criteria for corporations to calculate their costs. These rules build on the general regulations contained in the “Plan General de Contabilidad” relating to the valuation of inventories (and to fixed assets) which are produced or manufactured by corporation.

6.2.Spanish Regulations in the professional field

In the profesional field, it is important to point out the standardization made by the “Asociación Española de Contabilidad Directiva (ACODI)” as well as the “Asociación Española de Contabilidad y Administración de Empresas (AECA)”. Last of which has done so by emitting documents through its Management Accounting Comission since 1988.

You can consult these documents by accessing the following link: http/www.aeca.es

8.ACTIVITIES

From annual financial statements of real companies with which the student has worked in previous financial accounting courses, describe the external users who would be interested in these reports. Likewise, the students must try to describe what they consider the internal users of these companies to be and what type of information they would need to be able to manage the specific company that is being analyzed.

9.REVIEW QUESTIONS

Discuss the determining aspects to consider financial accounting as an external accounting system. Illustrate it with some examples.

Indicate two groups of external users of financial accounting indicating the interests of each of them with logical examples.

Indicate two groups of internal users of financial accounting indicating the interests of each of them with logical examples.

Describe the possibilities of analysis that the information provided by financial accounting allows from and economic and financial point of view.

List the main aspects for which the financial accounting information is considered insufficient. Indicate those that are considered as more determining.

Explain the reasons why management accounting is considered as the internal accounting system.

Indicate the fundamental objectives of analytical cost accounting and comment on the usefulness of each of them for the company.

Describe the internal creation of value in the company with an indication of the most common elements involved in the process.

Explain the value creation chain in the company. As an example, apply the explanation to the production of jeans and draw a scheme of the value chain.

Highlight and explain four essential differences between financial accounting and cost accounting.

Discuss whether or not it is convenient to standardize cost accounting and justify your answer.

10.KEY TERMS AND CONCEPTS

General accounting: mandatory accounting required by all companies.

Financial accounting: name with which general accounting is also known for its characteristic of showing equity from a financial perspective.

External accounting system: financial accounting is considered an external accounting system because it records external transactions and is intended for external users.

External users: those stakeholders who do not belong to the company but maintain a relationship with it or have an interest in its situation, such as shareholders, management, banks, suppliers and customers, trade unions, etc.

Internal users: those agents who belong to the company, whether they are the owners, administrators, managers or other staff.

Financial statements: mandatory final reports required from financial accounting in each financial year that reflect the true image of the company’s assets and results.

Management accounting: non-mandatory accounting oriented towards the preparation and communication of information that the managers of the company need for decision-making.

Cost accounting: the part of management accounting that deals with the calculation of the costs of the processes, products and services performed by the company.

Analytical accounting: name with which cost accounting is also known, focus on analytical processes to determine costs and generate results.

Internal accounting system: management accounting, and its branch of cost accounting, is considered an internal accounting system because it prepares information on internal process and is aimed at internal users.

Analytical income statement: income statement that presents cost accounting or analytical accounting broken down by product or service.

Internal movement of values: transformation of some values into other superior values throughout the production process.

Value chain: representation of each of the stages of the process in which value is created within the company.

Autonomy of cost accounting: aspect for which cost accounting does not act on the basis of legal rules and principles but on its own criteria adapted to the information needs for management.

Interrelationships between accounting: exchange of data recorded by financial accounting and data calculated by cost accounting to avoid duplication in its preparation.

Accounting standardization: set of rules and principles that govern accounting systems to present homogeneous, understandable and comparable information.

1Treaty published in 1494 by Luca Paccioli in Venice.

CHAPTER 2

PRODUCTION PROCESS AND COSTS

LEARNING OBJECTIVES

Distinguish the concepts of expense and payment.Look at the differences between expense and investment.Know the productive process of the companies and describe it from both the physical and the economic point of view, considered as a management movement of value creation.Understand the concept of cost, its magnitudes and cost objects.Study the correspondence between expenses and costs, determining valuation differences.Determine incorporable, non-incorporable and additional charges that are included or not in the costs and conciliation of the results of management and financial systems.

THE PROBLEM OF DEFINING THE CONCEPT OF COST

Javier González is a freelance transporter working for the “MUCHOPAN” food group that produces fresh bakery products. Javier’s activity consists of carrying out a standard route every day, distributing MUCHOPAN products to around forty establishments, normally neighborhood supermarkets. For this work, Javier invoices about 20,000€ net euros per year, but he is not sure that in this amount he is correctly considering the costs, since, after talking about it with Pedro Crespo, another autonomous worker who belongs to the network of transporters of MUCHOPAN, there are items that create confusion with respect to their treatment.

Until now, Javier obtained his net invoicing by subtracting from the income obtained from delivery services provided to MUCHOPAN, the totality of the payments done for, the fuel, the maintenance of his van, the taxes, the receipt of the loan he contracted to buy it and the rest of the items that he receives every month from the bank. But Pedro has made him notice that he is not taking into account the value of the 7 hours he spends each day on the steering wheel, nor the use of the van, which he drives and uses every day and will have to be renewed within five years. In addition, the loan receipt paid includes interest expenses, but should the rest of the amount be considered as an expense?

Within this situation, Javier is not able to evaluate the profitability of the transport activity, he cannot even ensure that it is profitable for him, and he would like to to clearly delimit the costs of his activity.

Contents

1.CLARIFICATION ON EXPENDITURE, PAYMENTS AND INVESTMENTS

1.1.Concept of expense

1.1.1.Expenses and the accrual principle

1.2.The financial flows of payments

1.3.Differences between expenses and payments

1.4.Concept of investment

1.5.Purchases and expenses

1.6.Financial accounting: Expenditure by the nature

2.PRODUCTION PROCESS

2.1.The production process from a physical point of view

2.2.The production process from an economic point of view

3.PRODUCTION PROCESS IN SERVICES COMPANIES

4.INTRODUCTION TO THE CONCEPT OF COST

4.1.Technical and economic magnitude of the cost

4.2.Cost objects

4.3.Cost drivers

5.BASIC COST CLASSIFICATION

5.1.Based on cost object

5.2.Based on cost behaviour

6.THE RELATIONSHIP BETWEEN EXPENSES AND COSTS. VALUATION DIFFERENCES

6.1.Types of charges and valuation differences

6.2.Classification of charges

6.3.Reconciliation of results due to valuation differences

7.SETTING OBJECTIVES IN COSTING: INFORMATION REQUIREMENTS

8.PRACTICAL CASE STUDY

9.REVIEW QUESTIONS

10. ACTIVITIES

11. KEY TERMS AND CONCEPTS

1.CLARIFICATION ON EXPENDITURE, PAYMENTS AND INVESTMENTS

The terms expense, payment and investment are sometimes mistakenly identified as similar concepts. This confusion arises when the key characteristic that differentiate them are not taken into account.

The difference between expenses and payments is based on distinguishing between the actual flows of goods and services consumed and the financial flows or cash movement they generate. Expenses correspond to actual flows of goods or services, while payments constitute financial flows. Thus, an electricity expense is generated when the electricity supply is received, and the payment associated with is done when the invoice of the supplying company is paid. Both concepts, payment and expense, do not necessarily coincide in time.

In order to differentiate between expenses and investments, it is necessary to analyze the perishable or durable nature of the goods object of the transaction. Perishable or consumer goods are expenses. Durable or non-current assets represent investments.

With these characteristics in mind, these concepts are defined and described below.

1.1.Concept of expense

The concept of expense can be examined from two perspectives: according to its equity impact on the equity of the company’s balance sheet and according to the economic meaning of the transaction.

The first definition of expenditure is a technical-accounting concept linked to financial accounting:

An expense is the reduction in value of an asset, due to its use, consumption or impairment, without an increase in another asset or a decrease in a liability, thus resulting in a decrease in the net worth of the company.

Examples: the payment of the payroll to the personnel supposes an exit of the bank account, decrease of an asset, without any increase of another asset in the balance sheet as counterpart. Consumption of office supplies, which results in a decrease in inventories, without an increase in another asset. Deterioration of an installation, which causes a decrease in the asset value without any counterpart.

The second definition, derived from the previous one, considers expenditure as an economic concept related to consumption:

An expense is the value of services received and goods consumed by the company in an economic period, regardless of the time of payment.

Therefore, expenses are originated when the actual flow of goods or services is produced, that is, when they are acquired and consumed, and not necessarily with the financial flow of the payments they generate.

Other examples: fuels for vehicles consumed during the period, repair of a machine, electricity consumption for the month even if paid later in a bimonthly accrued receipt, rental price for the current month even if paid in advance for the whole quarter, etc.

1.1.1.Expenses and the accrual principle

In accounting expenses are recorded following the accrual principle, whereby expenses are accrued when they arise, when they are incurred, irrespective of when they are paid. The accrual principle is by definition the one that clearly identifies expenses with the actual flow of goods and services, separating it from the cash outflow when the two do not coincide in time.

But outside the sphere of business and in common language, it is common to use the term “expense” to express a disbursement of money, whatever its nature. This use of the term expense is inappropriate, since it makes the concepts of payment and expense equivalent, while two different aspects of the transactions are involved: the moment in which the expense is recorded and the moment in which it is paid,

1.2.The financial flows of payments

The concept of payment corresponds to the cash flows out of the company.

A payment is an outflow of money from the company’s treasury, whatever its destination or motivation.

This means that outgoing cash can refer to expenses payments, and can also be associated to other transactions that are not expenses.

Some examples of payments related to expenses: payment of salaries, payment to a transport agency, payment of a telephone bill, payment of bank interest, etc.

Examples referring to other concepts that are not expenses: an initial payment for the purchase of a vehicle, the payment of a term to cancel a debt, the delivery of an advance to a supplier, the payment of dividends to shareholders, etc.

1.3.Differences between expenses and payments

Some conclusions can be drawn from the definitions of expense and payment:

Payments do not have to coincide with the accrual of expenses, and although they may occur at the same time, expense and payment remain different concepts.

It is not always the case that a payment is made because an expense is being faced, in other words, payments also arise for reasons other than consumption.

Example: Cash outflow due to the repayment of a bank loan.

On the contrary, some expenses accrued are not paid in the same period of time. In some cases, because it has already been paid before the expense has taken place (advance payments) in others because the subsequent payment to the expense has been agreed (deferred payments).

Example of advanced payments for insurance premiums which are usually paid at the beginning of the year

Example of deferred payments: advertising campaigns paid at the end of the project.

It must also be considered that there are expenses that are not associated with payments, because their existence does not imply cash outflows, as it is the case of amortization expenses, impairment and losses in general.

In the following table, payments and expenses are placed over a period of time:

PAYMENTS OF THE PERIOD

NOT PAYMENTS

Payments of assets, cancellation of debts and other miscellaneous payments

Payments of prior-period expenses

Period Expense Payments

Prepaid expenses for the period

Expenses of the period with deferred payment

Amortisation expenses, impairments and losses

NOT EXPENSES

EXPENSES OF THE PERIOD

1.4.Concept of investment

Investment is a concept related to long-lasting goods to be used by the company in the long term (non-current assets)

An investment is a fixed assets acquired by the company to establish or expand a productive structure in order to perform its operating activities.

The distinguishing feature of investments is that they are goods that are intended to remain in the company for more than one financial year, a few or even many years. This is the case of all the property elements that make up the non-current, material and intangible assets of the company. These are: land, buildings, transport elements, furniture, IT equipment, technical installations, computer applications, patents, trademarks, etc.

Therefore, an investment is not an expense at the time it is made. However, all these elements lose value irreversibly when they are used in the company’s activity. This depreciation is systematically recorded each period through the accounting amortization process. Depreciation represents the write-off of an asset value over a period of time, commonly the useful life. Assets such as machinery and equipment are expensive, instead of realizing the entire cost of the assets in year one, depreciation of the assets allows company to spread out that cost over time.

1.5.Purchases and expenses

Finally, it should be added that there are acquisitions of certain assets that are neither investments nor expenses, as is the case of purchases of inventories of any kind. These are storable goods, and as such, the moment of their acquisition does not coincide with that of their consumption, so technically they do not represent an expense at the time of purchase, but neither an investment, since they are destined for consumption in the most immediate possible way. Purchases of these goods become an expense when they are applied to their purpose, either for their sale (cost of sales of goods) or for their management consumption in the production process (raw materials and consumables, which are dealt with in later points and topics).

In financial accounting, purchases of inventories are recorded in expense accounts at the time of purchase, but this is due to the fact that financial accounting systems do not normally follow a permanent inventory control system, but rather a periodic one. Management accounting, on the other hand, faithfully follows the concept of expense, and will only consider that there is an expense when what has been purchased has been consumed.

In any case, even if the entry of purchases into the warehouse is not considered an expense in management accounting, it must be accrued at its net value, which is calculated in this way:

Gross purchases (provider price plus associated charges)

–Commercial discounts

–Volume discounts on purchase

–Prompt pay discounts

–Returns of purchases

=Net purchases

The treatment of inventories, purchases and consumptions will be discussed in detail in the following chapters.

1.6.Financial accounting: Expenditure by the nature

The general accounting system classifies expenditure by type, by origin or reason for expenditure, grouped into these categories:

a)Purchases of storable goods

Acquisition of materials and other storable goods (inventories) that will be consumed over time in the production process.

Purchases of goods and raw materials.

Other supplies: auxiliary materials and consumables, office supplies, packaging, tools, spare parts, fuels, etc.

Hiring of external services.

Purchases adjustments: commercial discounts, volume discounts, discounts for prompt payment and returns of purchases.

b)Services received from abroad

All those services received during the period.

Personnel expenses: salaries and wages, social security contributions and other staff-related costs.

Transport, travel and communications.

Insurance and tax premiums.

Supplies of gas, electricity and others.

Advertising and representation expenses.

Banking services and commissions.

Leases and royalties.

Repairs and maintenance.

Independent professional services.

c)Depreciation and losses on assets

Reduction in the value of long-lasting assets to be recorded within the financial year. It includes losses or impairment of assets for other causes than common use.

Depreciation of fixed assets.

Losses on fixed assets.

Losses due to depreciation or deterioration of fixed assets.

Losses due to depreciation or deterioration of inventories.

Losses due to depreciation or impairment of investments and loans.

d)Miscellaneous expenses

Atypical expenses not derived from the company’s normal operating activity, as well as other expenses related to future risks.

Exceptional expenses.

Losses on unpaid trade receivables.

Allocations to commercial provisions, liabilities and risks

e)Financial expenses

Interest earned on loans obtained from credit institutions, on the issuance of debt instruments or on the deferral of disbursements for acquisitions of fixed assets.

Interest on obligations and bonds.

Interest on debts with credit institutions.

Interest on discounted bills of exchange and factoring operations.

Losses from participations and credits.

Exchange losses.

2.PRODUCTION PROCESS

Before starting the study of the concept of cost, it is essential to analyse what the production process consists of, which will serve as a basis for learning how to calculate costs. The fact of beginning this analysis in industrial companies is for didactic reasons, since it is in this sector where a more complete operation appears and the generation of costs is better appreciated in its totality.

Production processes can be simple or very complex, both in terms of the operations to be carried out and the resources used. Obviously, making clay pots or bottling water is not the same as making a computer or a microscope, but in all cases there is an operating procedure. Whatever the complexity of it, it can be described in the following elementary way:

The productive process consists of transforming some acquired goods known as “raw materials” into other different goods called “finished goods”.

The scheme of an industrial production process represents the value creation chain of the company in the strictly productive area, also known as the “supply chain”: buying raw materials (RM) and storing them, transforming them into products and storing them, selling the finished products (FG).

The production process flow chart usually covers the following stages:

It begins with the acquisition of the necessary raw materials, other materials and production factors. The procurement activity connects with agents from the outside world who are the suppliers and constitutes the starting point or gateway into the management sphere of the company.

It continues with the factory operations needed to transform the materials acquired into finished goods.

It ends with the sale and commercialization of the finished goods. The distribution activity is the last of the company’s internal scope and represents the connection with the external parties, represented by the customers.

This process can be described in more detail by considering it from the perspective of two distinct points of view: the physical and the economic.

2.1.The production process from a physical point of view

From this point of view, the production process consists of a series of physical operations carried out in an established order, in which all the available resources (buildings, installations, equipment and people) are used, with the aim of transforming raw materials or other elements into valuable finished goods.

Observe the following examples:

Raw Materials

Transformation operation

Finished goods

Wooden planks

Cutting, polishing, assembling, varnishing

Furniture

Fabric rolls

Marking, cutting, sewing, ironing

Clothing

Flour

Kneading, moulding, fermenting, cooking

Bread bars

2.2.The production process from an economic point of view

From this other perspective, the production process is a set of activities that add value to raw materials through the absorption costing of productive resources. Values of production resources consumed in the process are added to initial values, represented by the acquisition of raw materials, obtaining afterwards a higher final value, which is the value of finished goods.

The process explained before, can be considered as an internal movement of value transformation, called “value chain”.

To explain the example mentioned before:

+ INITIAL VALUES

Wood, cloth, flour

(at acquisition value)

+ ADDED VALUES

Consumption of productive resouces: Work, energy, insurance, financial services, amortizations, etc.

(at factor acquisition prices)

3.PRODUCTION PROCESS IN SERVICES COMPANIES

Although what has been described above refers to companies in the industrial field, what has been said regarding the process of management transformation of values is applicable to all types of companies, being industrial, commercial or service companies.

The production process in service companies differs from that of the industrial company only from the physical point of view: raw materials are not transformed but rather they are processed or services provided. From the economic point of view, however, the process also consists of the incorporation of values, since knowledge and labour, supplies and other resources are used to be transformed into services for clients.

As an example, see the following figure referring to service companies:

SERVICE COMPANY

RESOURCES INVOLVED

SERVICES PROVIDED

Transport Agency

–Trucks

–Drivers

–Fuel

–Spare parts, etc.

Transport of goods

Repairs Workshop

–Technicias

–Tools

–Energy

–Travels, etc.

Repaired equipments

Consulting and advising

–Lawers

–Economists

–Administratives

–Information equipment

–Office materials, etc.

Expedited equipments

In the following chapter, the specificities of service companies are detailed in more depth and completed with a case study.

4.INTRODUCTION TO THE CONCEPT OF COST

It is normal to have an intuitive concept of the term “cost”, since it is used continuously in everyday life to describe the value of all that is acquired.

The meaning of the term “cost” is a sacrifice of something; normally, the sacrifice of money that is given or will have to be given in exchange for what one wants to achieve.

Perhaps this general idea is not enough to define the concept of cost in the company, but it does contain the central essence of the concept: sacrifice of something.

In the description of the productive process it has been indicated that it consists of the rational and necessary application and consumption of production resources, which is, the sacrifice of resources to obtain the finished goods or services provided. The goods consumed and production resources used (inputs) are called factors and the goods obtained (outputs) are the products or services.

Attending to the previous references, the term of cost can be defined as follows:

A cost is the value of the factors consumed throughout the management transformation process that takes place in the company to carry out activities, obtain products or provide services.

If expenditure (expense) is a concept of general accounting, cost is a concept of analytical accounting.

4.1.Technical and economic magnitude of the cost

The technical magnitude of cost is the consumption of the factors expressed in physical units: kilograms, meters, liters, units, working hours, machine hours, kilowatts, and so on. It is also known as the physical magnitude of the cost, that is to say the “quantity” of factor that is represented by (Q).

The economic magnitude of the cost is the value of each unit of the factor consumed, generally referred to as the “price” of the factor and represented by (P).

The monetary expression of the cost is obtained by applying to each technical magnitude, the price of each factor or economic magnitude.

Thus, the cost of a factor is calculated as follows:

The cost of an activity, a product or a service is the sum of the costs of the factors consumed for its realization.

Example: in order to calculate the cost of manufacturing a wooden shelf, the factors consumed in the production process must be valued by quantifying each factor consumed (technical magnitude) and applying the corresponding price of the factor (economic magnitude).

Technical Magnitude

Economic Magnitude

↓

↓

CONSUMED FACTOR

QUANTITY CONSUMED

PRICE PER UNIT

FACTOR COST

RM: wood

3 m.

5€/m.

15€

Auxiliar material: glue and paint

1 pot

4€/u.

4€

Work: Direct Labour

2 h.

10€/h.

20€

Energy strengh: high voltage

10 kw.h.

0.30€/kw.h.

3€

Equipment depreciation

1 machine hour

8€/m.h.

8€

TOTAL COST PER UNIT (wooden shelf)

50€

4.2.Cost objects

From the definition of cost, as the value of the factors consumed to obtain “something”, it can be deduced that cost is not an indeterminate concept but that it has to be the cost of something concrete, the cost of a process, of a department, of a product, etc.

Cost objects are all the elements that are involved in the internal process of value transformation and for which you want to obtain the cost. To value them is the objective.

The cost objects in the enterprise are multiple, as they serve to fulfil the cost information needs of companies throughout the value creation process. They fall into two broad categories:

Intermediate cost objects: the different departments that make up the company’s organizational and productive structure, as well as the activities carried out in them. These elements can be called functions, cost centers, processes, activities, etc. They are generally known as cost centres. They are cost objects because it is important to quantify the costs that are consumed in each of them.

Final cost objects or cost bearers: these are the products and services obtained by the company as the culmination of the production process. The costs of intermediate cost objects are added successively to the finished goods and services. They are considered the cost bearers since they are the ones that carry the final value of the consumptions made.