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4.6. Total cost – concept and information

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Core Concepts of Accounting – Numbers and People

Instituto de Física e Tecnologia de Moscou

4.9 (12 classificações) | 1.1K alunos inscritos

Curso 3 de 5 no Understanding Modern Finance Programa de cursos integrados

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

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4.9 (12 classificações)

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Na lição

Managerial Accounting – Core Ideas. Cost Behavior. Direct and Indirect Costs. Indirect Cost Allocation

Weeks 4 through 6 of the Course are devoted to the issues of managerial accounting. First, we introduce the key ideas of managerial accounting, and compare it to the financial accounting. We focus on the much closer link of managerial accounting to people. Then the core idea of managerial accounting – cost – is introduced and discussed. You will learn why it is so important to identify the total cost of any product, project, or division. We will study cost behavior, fixed and variable costs, and break-even point. The last part of Week 3 discusses cost tracing and allocation as a major task of any in-depth cost analysis. We study an example and come up with the tracing and allocation roadmap.

4.1. What is managerial accounting? Key ideas11:42

4.2. Managerial vs. financial accounting – a comparison11:21

4.3. Systems of managerial accounting13:42

4.4. Introduction to costs – major terms12:49

4.5. Cost behavior12:02

4.6. Total cost – concept and information12:55

4.7. Direct and indirect costs14:08

4.8. Indirect cost allocation11:04

4.9. Cost allocation example (1) – initial cost allocation13:30

4.10. Cost allocation example (2) – cost re-allocation11:17

4.11. Cost allocation example (3) – cost allocation rates10:50

4.12. The tracing and allocation roadmap9:49

Ministrado por

Konstantin Kontor
Director and Professor of Finance and Strategy

Transcrição

Well, now we're moving to another very important idea about total cost,

and I will emphasize this word total.

So, we would like to really see how these total cost charges

against certain objects are being accumulated, assigned, and studied.

Because basically, oftentimes, and this is the story at many companies,

and we have many projects that people sort of forget some of these components,

and all of you know this.

Let's say, if you make a forecast really on your own you curve and then you say, well,

if I engage in this project,

it will cost me that and that much,

and then that never happens.

That the result is a smaller amount.

It's always something more.

And for us, it's important to see how we can

make sure that we do not missed out on anything.

So let's talk about total costs,

and this will be the idea and information.

So, basically, if we do know what the total cost is,

how we can use this information.

Now, first of all,

we start with the idea.

And again, what I will say right now is kind of trivial.

So total cost is the sum of all resources used for a specific object.

Now, the key story is this all.

When I said that oftentimes people miss some of,

and they just forget about some of, these components,

that is not because they would like to sort of hide something,

this is rather because they oftentimes

overlook some of the resources that are not on the surface.

And we will talk about that in greater detail in the whole fabric of this course,

but that must be kept in mind right now.

Now, and then, the next idea that the total cost is,

this is the sum of direct costs for this object plus

the proportional share of indirect costs for this object.

And this is the key story,

because the question is, first of all,

what this share is,

and what does it mean proportional,

and why it charged against this object,

and so on and so forth?

So, the key issue is finding this,

because you can say,

well, with respect to the direct costs, it's also important.

But strictly speaking, with respect to direct costs,

we talk about identifying and measuring them.

With respect to indirect costs,

it's not enough to identify and measure them.

You have to properly assign,

or as oftentimes is said here, allocate them.

So this allocation is finding this proportional and a right share.

And again, you can ask the question,

why is that so important?

Because you can see right now that if we have the pool of all indirect costs,

then regardless of how you allocate that,

regardless how you assign or reassigned that,

the total sum doesn't change.

Indeed, it doesn't. But what does change?

This is these shares that they're charged against certain objects.

So if you had the total object,

the total company, the total project, nothing changes,

and all this fight and all these procedures,

they are redundant or they are just meaningless.

However, if we would like to know what this part of this project of this company cost,

in this case, that becomes the crucial question.

Now, let's proceed. And here,

I would provide a very simplistic diagram that will be components of total cost,

and that will be sort of for a manufacturing company.

Again, this diagram is not comprehensive,

but it does include most important components.

First of all, direct labor cost.

Well, that we measure,

and to that, we add indirect manufacturing costs.

The sum of these two has a special name.

It's called conversion cost.

So, basically, this is the total cost

used for converting raw materials into finished goods products.

Now, then we add here direct material cost.

So, basically, we take some raw materials,

and if we do not add this,

then nothing happens to them.

But if we do something with them with the use of,

so for example, here, direct labor,

so here, there are a lot of other things, for example,

depreciation, and that was the outcome here of the equipment that you use.

And then, all that taken together,

that has another name.

So this is going to

be total manufacturing cost.

That's not yet though.

So, you add to that things like sales and distribution costs,

because when you produce that,

then you have to sell them.

Because when you produce something, you put it in

your warehouse for finished goods inventory, then unfortunately,

you have not yet generated a penny of cash

or even a penny of sales if these are on credit.

Then, here comes general administrative,

here come R and D,

here comes interest on your loans, and so on,

and all that taken together, that gives you,

I will use a red marker, total cost.

So that's basically a diagram that shows to you how,

it's not exactly cost rather that we're studying financial accounting.

It's something else, but that is a simple diagram that allows you to keep that in mind.

And then, the next important thing here is cost assignment.

So we try to be more specific.

They're basically two major approaches.

One is to a product,

and that is called job costing.

And then, another, this is to a process,

and that is called process costing.

Well, we'll study both.

But for now, the important thing is to keep in

mind how we can properly use the information about total cost.

Let's say that we've successfully completed this goal.

So we've identified the total costs for all cost objects that we are interested in.

So, how then we can use

the information on the total cost?

Well, this information, and I'll put in the red,

it helps in, first of all,

creating financial statements, and this is for reporting.

Well, even if we put together our financial statements for external users,

we take this into account.

Then, the next, even more important thing,

this is profitability analysis.

What do I mean here?

Well, let's say, if we identified that the total cost of this product is this,

then we see at what the price we are selling that.

And maybe, we're doing that at a loss.

You can say, how come?

But the thing is that even for direct costs,

it's sort of stupid to charge less than the total amount of direct cost,

but it does depend upon how much of these indirect costs we charge against this object.

So you can say, well,

overall, your profitability doesn't change.

Indeed, it doesn't, but,

object by object, product by product,

process by process, it does change.

And, for example, if you charge too high

a part of a direct costs on this process, for example,

then this process becomes money losing,

and that's extremely demotivating for all the people involved in this process.

So, if you're interested in the fact that this process successfully develops,

you probably wouldn't do that or you would make some changes.

Now, again, like I said,

the overall idea, this is profitability by,

let's say, product, process, customer, division, whatever.

And then, the next thing is that

we can use this information in answering the big question,

how much does this,

whatever this is, cost?

Now we can answer this question.

And clearly, we deal with pricing here.

If we know what's the total cost,

then we can use that cost plus approach or whatever.

So at least in our pricing decisions,

we will keep in mind that we will have at least to cover this total cost or otherwise,

we will be running losses.

So you can see that here we can easily say that total cost is key

in strategic

and planning decisions.

And so to me, remember,

we said that the major difference between

financial gain imagery accounting is the fact that now we deal with the future,

we deal with uncertainty,

and we deal with planning and strategy.

Now, we can see why so often it's called cost accounting.

Because it is the idea of total cost that is key in making these decisions.

I'm not saying correctly,

but making the better decisions in this area.

So, in what follows,

we will keep studying the total cost.

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