Erasmus Multilateral Projects – Virtual campuses
134350-LLP-1-2007-1-HU-ERASMUS-EVC
Virtual campus for SMEs in a multicultural milieu
Erasmus Multilateral Projects – Virtual
campuses
Reference Number of the Project: 134350LLP-1-2007-1-HU-ERASMUS-EVC
Title of the Project: Virtual campus for
SMEs in a multicultural milieu
(‘SMEdigcamp’)
This project was funded with support from the European Commission.
This publication reflects the views only of the author, and the
Commission cannot be held responsible for any use which may be made of the
information contained therein.
TEACHING MATERIAL OF THE MODULE
ADVANCED ACCOUNTING
Head of the quadrangle:
Imre SZTANÓ (HU)
Barbara KARDOS (HU)
Members of the quadrangle:
Svetlana WARHURST (UK)
Emmanuil NOIKOKYRIS (UK)
Liying MENG (UK)
Gunnar PRAUSE (DE)
Jean François TALBOUTIER (FR-ESCEM)
Frederique DEJEAN (FR-UPX)
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This project has been funded with support from the European Commission.
Erasmus Multilateral Projects – Virtual campuses
134350-LLP-1-2007-1-HU-ERASMUS-EVC
Virtual campus for SMEs in a multicultural milieu
TABLE OF CONTENTS
I. MODULE SPECIFICATION............................................................................................... 5
II. INDICATIVE CONTENT .................................................................................................. 8
CHAPTER 1: THE ROLE OF ACCOUNTING IN BUSINESSES...................................... 8
1.4. Training Material........................................................................................................ 8
1.4.1. Characteristics, and the correlation of financial accounting, and management
accounting ............................................................................................................................ 8
1.4.2. The concept, interpretation, function, and tasks of management accounting . 9
1.4.3. Regulating the accounting of businesses ............................................................... 9
1.4.4. The role of accounting policy in regulation......................................................... 10
1.4.5. The role of accounting policy decisions ............................................................... 10
1.4.6. Creating the data registers of businesses ............................................................. 11
1.5. Exercises................................................................................................................... 11
CHAPTER 2: DETERMINING THE RESULTS OF BUSINESSES .................................. 13
2.4.1. Compiling the P/L account ................................................................................ 13
2.4.2. P/L account based on the total costs method ..................................................... 13
2.4.3. P/L account based on the cost of sales method.................................................. 14
2.4.4. Comparing the determination of profit in accordance with P/L accounts
prepared by the total costs and cost of sales method................................................... 14
2.4.5. The result categories ............................................................................................... 14
2.4.6. The content of the items in the P/L account ....................................................... 14
2.4.6.1. Calculating operating revenue ....................................................................... 14
2.4.6.2. Determining operating expenses ................................................................... 15
2.4.6.3. Result of financial transactions....................................................................... 16
2.4.6.4. Extraordinary results ....................................................................................... 16
2.5. Exercises................................................................................................................... 16
CHAPTER 3: THE COSTS OF A BUSINESS ..................................................................... 19
3.4.1. The purpose and functions of cost calculation.................................................... 19
3.4.1.1. Cost-accounting ................................................................................................ 19
3.4.1.2. Decisions related to a business ....................................................................... 19
3.4.1.3. Planning and acting (decision making)......................................................... 19
3.4.2. The concept, interpretation, and methods of cost management ...................... 20
3.4.3. Interpreting costs (from a practical point of view)............................................. 20
3.4.3.1. The concept of expense.................................................................................... 20
3.4.3.2. The concept of cost ........................................................................................... 20
3.4.3.3. The concept of expenditure............................................................................. 20
3.4.4. Features of grouping costs ..................................................................................... 21
3.4.4.1. According to cost types ................................................................................... 21
3.4.4.2. According to deductibility .............................................................................. 21
3.4.4.3. Costs in accordance with location of emergence ......................................... 21
3.4.4.4. Costs based on their correlation to volume (cost characteristics) ............. 21
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3.4.4.5. Costs changing in accordance with decisions (controllable and
uncontrollable costs) ..................................................................................................... 22
3.4.4.6. Costs related to a change in the operation, differentiated costs
(incremental costs, marginal costs)............................................................................. 22
3.4.4.7. Costs in accordance with a given decision making level (controllable and
non-controllable costs).................................................................................................. 23
3.4.5. Functions of cost calculation, and the correlation of cost classification aspects
.............................................................................................................................................. 23
3.4.6. Calculations, net cost calculation .......................................................................... 23
3.4.6.1. Economic calculation ....................................................................................... 23
3.4.6.2. The object and functions of cost-accounting ................................................ 23
3.4.6.3. The basic principles of net cost calculation .................................................. 24
3.4.6.4. The types of net cost calculation .................................................................... 24
3.4.6.5. Methods of net cost calculation ...................................................................... 24
3.4.7. The practice of accouting for costs........................................................................ 25
3.4.7.1. The concept, purpose, and function of deducting costs ............................. 25
3.4.7.2. The possibilities of deducting costs ............................................................... 25
3.4.7.3. Features of input and output cost accounting ............................................. 26
3.4.7.4. Accounting for costs according to cost types ............................................... 26
3.4.7.5. Accounting for costs in accordance with cost centre and cost bearer ...... 26
3.4.7.6. Practical methods of cost accounting in businesses, the relation between
cost accounting, and profit calculation ...................................................................... 26
3.5.
Exercises.................................................................................................................. 26
CHAPTER 4: CONTROLLING COSTS.............................................................................. 29
4.4.1. Objectives of cost control........................................................................................ 29
4.4.2. Areas of cost control................................................................................................ 29
4.5. Exercises................................................................................................................... 29
CHAPTER 5: Analysing Costs............................................................................................. 31
5.4.1. Comparative index in cost analysis ...................................................................... 31
5.4.1.1. Allocating costs................................................................................................. 31
5.4.1.2. Cost ratio............................................................................................................ 31
5.4.1.3. Cost level ........................................................................................................... 31
5.4.2. Examining direct costs............................................................................................ 32
5.4.3. Examining direct costs............................................................................................ 32
5.5.
Exercises.................................................................................................................. 32
CHAPTER 6: ANALYZING THE COVERAGE SUM, AND REVENUE STATUS...... 34
6.4.1. The coverage sum and its analysis .................................................................... 34
6.4.1.1. Determining the coverage point.................................................................... 34
6.4.1.2. Determining the shut-down point ................................................................. 34
6.4.1.3. Analysing the coverage sum........................................................................... 35
6.4.2. Analysing revenue status....................................................................................... 36
6.4.2.1. The purpose and methods of analyzing revenue status............................. 36
6.4.2.2. Indicators of profit analysis ............................................................................ 36
6.4.3. Profit planning ......................................................................................................... 39
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6.4.3.1. Creating an optimum production plan ......................................................... 39
6.4.3.2. Factors affecting balance sheet profit ............................................................ 40
6.5. Exercises................................................................................................................... 42
CHAPTER 7: CASE STUDIES ............................................................................................. 44
C) NATIONAL SPECIFICATIONS .................................................................................... 45
1. HUNGARY......................................................................................................................... 45
2. GERMANY......................................................................................................................... 46
3. FRANCE ............................................................................................................................. 47
4. UNITED KINGDOM ........................................................................................................ 48
4
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Erasmus Multilateral Projects – Virtual campuses
134350-LLP-1-2007-1-HU-ERASMUS-EVC
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I. MODULE SPECIFICATION
a)
Description the module
The present teaching material aims to provide assistance in managing small and medium sized
enterprises, and in preparing their decisions. The module focuses primarily on the relationship
of costs/expenses, and performance, orienting the reader`s attention on factors affecting
revenue generation capacity.
Success with the module presupposes financial accounting knowledge, and especially skills
related to designing the content, and the structure of the profit and loss account.
The module contains, in addition to theoretical knowledge, also practical assignments to help
practice and apply the freshly learnt information.
b)
Module objectives
The module has been developed to help students understand and practice the following
concepts and skills:
(1) The role of accounting in businesses
(2) Determining the profits of a business
(3) Grouping the costs of businesses
(4) Interpreting cost management, and presenting its methods
(5) Methods and significance of net costing
(6) Controlling costs
(7) Analyzing costs
(8) Determining revenue status
c)
Prerequisites
Essential knowledge of accounting.
d)
Working method
Lectures
Seminars
15 hrs
15 hrs
The course material has been divided into lectures and seminars. It is recommended for
participating countries to use case studies that are typical for the given country and economic
environment. Chapter 7 of the Hungarian version contains a few case studies/examples
characteristic especially of the Hungarian economic climate.
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e)
Evaluation
Evaluation methods
Presenting the case study (group work)
Simulation game
Semester-final examination (individual)
f)
Weighting %
30
20
50
Module structure
1. The role of accounting in businesses
1.1. Features, and the correlation of financial accounting, and management accounting
1.2. The concept, the interpretation, role, and the functions of management accounting
1.3. Controlling the accounting procedures of businesses
1.4. The role of accounting policy in legislation
1.5. The role of accounting policy decisions
1.6. Creating the data register of businesses
2. Determining the results of businesses
2.1. Compiling the P/L account
2.2. P/L accounts based on the total costs method
2.3. P/L account based on the cost of sales method
2.4. Comparing profits calculated using the two above methods: P/L accounts based on
total costs, and cost of sales
2.5. Categories of results
2.6. The content behind the items of the P/L account
3. The costs of businesses
3.1. The purposes and tasks of cost calculation
3.2. The concept and meaning of cost management, and its methods
3.3. Interpreting costs (from a practical point of view)
3.4. Principles of grouping costs
3.5. The functions of cost calculation, and the correlations of principles of cost grouping
3.6. Calculations, net cost calculation
3.7. The practice of deducting costs
4. Controlling costs
4.1. The purpose of controlling costs
4.2. Areas of controlling costs
5. Analysing costs
5.1. Benchmark indicators in cost analysis
5.2. Examining direct costs
5.3. Examining indirect costs
6. Examining the coverage sum and the revenue status
6.1. The concept and the analysis of the coverage amount
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6.2. Analysing the revenue status
6.3. Planning results
g)
Recommended Reading
Numerous very useful books have been published internationally on accounting. In what
follows, we list a few internationally noted publications. Each country is welcome to add their
own national favourites.
English language literature
Robert Kaplan, Anthony A. Atkinson: Advanced Management Accounting (3rd Edition)
Hungarian literature
A számvitel alapjai
Sztanó Imre, Perfekt, Budapest, 2006.
A vezetői számvitel alapjai
Kardos Barbara-Sztanó Imre-Veress Attila, Saldo, 2007.
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II. INDICATIVE CONTENT
CHAPTER 1: THE ROLE OF ACCOUNTING IN BUSINESSES
1.1.
Content Description
The chapter presents the role of accounting in the economy. Accounting is in fact a means of
communication among the actors of an economy. The branch of accounting that provides
information for external purposes is called financial accounting. If, however, such information
is required for making well-founded decisions by internal users, the relevant discipline is called
management accounting.
1.2.
Chapter Objectives
• To distinguish between financial accounting, and management accounting
• To familiarize with the regulation mechanisms of accounting
• To understand the significance of accounting policies
1.3.
Structure of the Chapter
•
•
•
•
•
•
•
The characteristics and the correlation of financial accounting and management
accounting
The concept, interpretation, role, and tasks of management accounting
Regulating the accounting of businesses
The statutory function of accounting policy
The role of accounting policy decisions
Creating the data registers of businesses
Exercises
1.4. Training Material
1.4.1. Characteristics, and the correlation of financial accounting, and management
accounting
Accounting is a practical activity that involves providing information. The function of
accounting is to specify, measure, and provide financial information of given economic
organisations, to ensure that users of such information can make well-founded decisions. Such
determination, measurement, and disclosure of facts may serve the communication of the
company with outside parties. That branch of accounting is called financial accounting. If
the information is needed to help internal users to make good decisions, it is called
management accounting.
It is useful to compare the features of financial and management accounting. The
following table presents the differences between the two areas.
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Financial accounting
Financial accounting is subject to
legislative control (principles, content)
Financial accounting focuses on past
economic events, and its reports presents
historic data.
Reports are subject to legislative control
named reporting obligation.
The report presents the entire business.
Management accounting
Management accounting is designed, and
regulated by the business owner.
Management accounting uses, in addition to
past data, also estimated future data/information
to help planning.
The business owner has no such obligation, it
operates the system at his own discretion.
Management accounting focuses on smaller
units incl. organisational units, products.
Information in the report is based on In addition to value based information it
values.
essentially provides quantity information.
1.4.2. The concept, interpretation, function, and tasks of management accounting
Management accounting provides information for management to help make good business
decisions.
Management accounting is the area of accounting that provides information to managers
whereby they can boost performance, and reduce costs, i.e. maximize results.
Management accounting is part of the company's management information system, and
helps business managers make well-founded decisions.
1.4.3. Regulating the accounting of businesses
As we review the international regulation of accounting, we need to highlight three systems
that have a decisive role in creating a standardised language in accounting. These are as
follows:
• Directives of the EU concerning accounting
• The International Accounting Standards (IAS) issued by the International
Accounting Standards Committee (IASC/IASB), and the International Financial
Reporting Standards (IFRS)
• The United States Generally Accepted Accounting Principles (US GAAP)
There are three EU Direcives setting out the general accounting rules of business entities:
• No 4 The Company law Directive – concerning the annual reports of economic
partnerships,
• No 7 Company law Directive – concerning consolidated – aggregate reports
• No 8 Company law Directive – concerning the licensing of the services of persons
assigned to review accounting reports
Hungarian accounting regulations may be regarded as having two tiers since 1 January
1992:
Tier 1
Statutory
regulations The Act specifies the reporting and book-keeping
(Act C of 2000 presently obligations, reporting, and book keeping principles of
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in force)
Tier 2
Government decrees
entities under the Act, the rules based on these
principles, and the requirements related to
publication, disclosure, and auditing.
Government regulations lay down the special
accounting obligations of specific economic entities,
various agencies of government finance, and other
organisations as empowered by the law. In addition,
government decrees provide the special rules of
liquidation, and business closures.
1.4.4. The role of accounting policy in regulation
The accounting policy most suitable to the specific features, circumstances of the business
owner must be selected and put down in writing based on the basic principles, and evaluation
tandards established in the Accounting Act specifying also the methods, and instruments
whereby the business plans to comply with the law. The accounting policy must specify the
• rules,
• requirements, and
• methods
characteristic of the business owner whereby he determines
• what he regards
o important, or
o significant
• from an accounting or evaluation point of view, and
o which ones, and
o under what circumstances he applies,
• from among the general options, and rating options offered in the accounting act, and
• why current practice must be changed.
1.4.5. The role of accounting policy decisions
Accounting policy is in fact a set of decisions. Therefore all decisions made, and regulations
created under the accounting policy are binding for the given business owner, and any
departure from them is only possible following amendment to or changes of the accounting
policy, and following the acceptance of the new, changed regulations, and only in compliance
with their provisions.
Accounting policy decisions may:
• be of a general application,
• refer to evaluation rules
• refer to stock taking
• refer to rules of cost-accounting
• refer to cash management rules
• refer to account categories, and
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•
refer to rules concerning records and documents
1.4.6. Creating the data registers of businesses
Businesses must prepare a statement supported by statutorily specified accounting
information concerning their assets, financial and revenue status following the closure of their
books for the given year. The statement must be in Hungarian. The purpose of the
statement is to provide information.
The format of the statement to be submitted depends on size of the annual net sales revenue,
the amount of the total assets, staff size, and the limit values of all these. For private
entrepreneurs the statement may be the following types:
• annual report,
• simplified annual report,
• consolidated annual report,
• simplified report.
Businesses must support their report by double entry book keeping. Book keeping must be
in Hungarian, either single or double entry. Book keeping is the activity whereby the
business owner maintains records of all events bearing on his assets, financials, and revenues
in the course of his operation in accordance with applicable legislation, on a continuous basis,
and closes these at the end of the financial year.
Double entry book keeping must be maintained with reference to any assets and liabilities
managed, used, or owned by the entrepreneur, and any economic transactions to reflect any
changes in assets and liabilities
• in a true and fair manner
• on a continuous basis
• in a closed system (sequentially)
• in a clear and transparent layout
Conclusion
Accounting means the observation, measurement, and recording of business processes; it
transforms the data recorded from the documents into information used as input to business
decisions.
1.5.
Exercises
Essay questions:
(1)
(2)
(3)
(4)
(5)
(6)
What is the difference between financial accounting and management accounting?
What is the role of management accounting?
At how many levels is accounting regulated in Hungary?
What types of accounting policy decisions do you know?
What is the significance of decisions concerning accounting policy?
What statements may businesses prepare?
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(7) What supports a statement?
Multiple choice questions:
(the correct answer is in bold type)
1. Outside users consist of the following:
A./ creditors, owners, management, employees` representative organisations
B./ investors, management, employees` representative organisations
C./ investors, creditors, tax authority, public organisations
2. The content of executive accounting is influenced by
A/. the nature, and the organisational structure of the business,
B./ the long-term objective of the business,
C./ the set of interests of the business
D./ A, B and C
3. The cost-awareness of the controlling approach means that
A./ everything is being done in the interest of future success,
B./ a cost may only emerge on the way to accomplishing a goal,
C./ it determines short and long term objectives in every area, and every area works to
achieve those objectives
D./ a cost may only emerge for a specific reason.
Summary
Management accounting provides information for internal actors to help them make their
decisions by processing past data.
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CHAPTER 2: DETERMINING THE RESULTS OF BUSINESSES
2.1.
Content Description
The result of a business is determined through an indirect method, the creation of the P/L
account. The P/L account is the presentation of the background of the business owner`s
balance sheet profit for the year that he is entitled to keep, and presents the main factors
influencing the generation of, and changes to the results, and the structure of the balance sheet
profit.
2.2.
Chapter Objectives
• We will learn the methods of determining results
• We will to familiarize with the types, and profit categories of P/L accounts.
• We will learn how to determine the result of the business, and quantify the
components that influence it
2.3.
Structure of the Chapter
•
•
•
•
•
•
2.4.
Compiling the P/L account
P/L accounts based on the total costs method
P/L account based on the cost of sales method
Comparing results determined through total costs and cost of sales
Result categories
The content of the items of P/L accounts
Training Material
2.4.1.
Compiling the P/L account
The Accounting Act ensures businesses the freedom of making their choice concerning the
structure, and segmentation of the P/L account.
The balance sheet profit must be determined on the basis of operating results, taking account
of the results of financial transactions, and extraordinary results.
Operating results may be stated in either of two ways:
• Total costs,
• Cost of sales.
2.4.2. P/L account based on the total costs method
A difference of revenues and expenses with reference to the given period, and emerging
during the same, which is the difference of the aggregate sum of the net sales revenue posted
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in the financial year, the capitalised value of self-manufactured assets, other revenues on the
one hand, and material type expenses posted in the given financial year, personnel-type
expenses, depreciation, and other expenses on the other.
2.4.3. P/L account based on the cost of sales method
The net value of the difference of the revenues and costs of sales with reference to the given
period, and emerging in the same period, expressed as a differential of the net sales revenue
posted in the business year and the direct and indirect costs of sales, and the differential of
other revenues and other expenditure.
2.4.4. Comparing the determination of profit in accordance with P/L accounts prepared by
the total costs and cost of sales method
In the case of P/L accounts based on both total costs, and cost of sales the result of the
business is identical; the only difference is in the way factors are grouped in list down to the
result category called ‘A) Result of operations (business)’.
There are identical yield and expense elements even within the result categories of operations
(business), namely:
Net revenue of sales
Other revenues
Purchase price of goods sold
Price of services sold (mediated)
Other expenses
The P/L account groups and lines (items) listed appear with identical content in both types of
P/L accounts.
2.4.5. The result categories
Regarding its structure, the P/L account contains the following result categories in both
methods:
A. Result of operations (business)
B. Result of financial transactions
C. Usual business result (A+B)
D. Extraordinary result
E. Pre-tax profit (C+D)
F. Taxed profit
G. Balance sheet profit
2.4.6. The content of the items in the P/L account
2.4.6.1. Calculating operating revenue
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Operating revenue in the P/L account prepared using the total costs method:
Net sales revenue
Capitalized value of self-manufactured assets
Other revenues
Net sales revenue must contains the countervalue of inventories sold during the contractual
delivery period in the financial year previously purchased or produced by the business, and
services provided increased by price subsidy or mark-ups, or reduced by discounts, not
including value added tax.
Value of capitalized own performance must refer to
the value of assets produced by the business during the financial year (capitalized
among assets), and
total (aggregate) sum of changes in the amount of self-produced assets.
Other revenues are revenues that do not form part of net sales revenues generated in the
course of regular business, and that do not qualify either as revenue of financial transactions,
or as extraordinary revenue.
2.4.6.2. Determining operating expenses
Operating expenses in the P/L account prepared by the total costs method:
material type expenses
personnel type expenses
depreciation
other expenses
The following must be listed under material type expenses
• price of materials purchased and used,
• price of services used (purchased) including non-deductable value added tax
• price of other services
• purchase price of goods sold
• price of services sold (mediated)
Personnel type expenses must include
• wages of employees, and the fees paid for the work of members of a cooperative
• the sum collected by a natural person owner (member) as payment for his personal
contribution
• other personnel type payments, and
• sum of contributions payable on the basis of wages
Depreciation must include the sum whereby intangible assets, and tangible assets are planned to
depreciate
Other expenses include items not related to net sales revenue neither directly nor indirectly, and
other loss-type items that have emerged in the course of regular business, and do not qualify either
as expenses of financial transactions, or as extraordinary expenses.
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2.4.6.3. Result of financial transactions
The result of financial transactions is the difference of revenues and expenses of financial
transactions. It is important to separate revenues and expenses of financial transactions because this
is how their effect on the balance sheet profit may be accurately determined.
2.4.6.4. Extraordinary results
Extraordinary results are the difference of extraordinary revenues and extraordinary expenses.
Extraordinary revenues and expenses are independent from the regular operations, and are outside
of the usual business of the business owner. It is necessary to separate extraordinary revenues and
expenses because this is how their effect on the balance sheet profit may be accurately determined.
Conclusions
The P/L account reflects the origin of the balance sheet profit, and the main factors
influencing it, thus providing input to profitability calculations.
2.5.
Exercises
Essay questions:
(1) What does the P/L account reflect?
(2) What methods may be used to prepare a P/L account?
(3) What are the characteristics of the P/L account prepared by the total costs method?
(4) What are the characteristics of the P/L account prepared by the cost of sales method?
(5) What are result categories?
(6) What are operating yields?
(7) What are operating expenses?
Multiple choice questions:
(the correct answer is in bold type)
1. Which items influence the result of operating (business) results?
A./ revenue from selling intangible assets
B./ book value of bonds sold
C./ purchase value of materials sold
D./ wages paid to employees
E./ higher than planned depreciation of physical assets scrapped due to fire
2. Which of the following items belong among results of financial transactions?
A./ realized interest on bill of exchange claims,
B./ costs of discounting bills of exchange,
C./ exchange rate differential arising upon settling bills of exchange denominated
in a foreign exchange,
D./ costs of printing bills of exchange,
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E./ interest paid
3. Which statement is true?
A./ The price of goods sold forms part of material costs.
B./ The purchase value of goods sold reduces the value of material type expenses.
C./ The purchase value of goods sold forms part of direct costs of sales.
D./ The price of goods sold increases the cost of sales.
4. Which of the following must NOT be accounted for among other revenues?
A./ Revenues received in conjunction with insurance events.
B./ The sum of fines, non-delivery penalties, delay penalties, and damage
compensations.
C./ Revenues received for the direct sale of intangible assets upon selling them.
D./ The value of assets taken over without compensation as registered with the
transferring party (no higher than valid market price).
5. Which of the following must be listed under net sales revenue?
A./ Revenue derived from the sale of tangible assets,
B./ Revenue derived from the sale of finished products,
C./ Countervalue of goods sold to a foreign country,
D./ The value of packaging material invoiced at purchase price.
6. Which of the following must be posted with personnel expenses?
A./ wage contributions,
B./ the countervalue of services used (purchased) including undeductable value added
tax
C./ employee’s contribution,
D./ the book value of material inventory missing, de-registered from the books
7. Which of the following must be posted as the value of the services used?
A./ banking costs,
B./ the value of accounting services as per the relevant invoice excluding value
added tax,
C./ the value of rental services as per the relevant invoice excluding value added
tax
D./ employer’s contribution
8. Which of the following must be posted among other expenses:
A./ the deducted impairment of claims,
B./ the sum of uncollectible claims written off in the relevant financial year,
C./ the planned depreciation of intellectual property posted in the relevant financial
year,
D./ interest payable on loans.
True-false questions:
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1. The balance sheet and the P/L account relate to each other in the balance sheet profit of the
given period. (T)
2. The results of a business may be determined by a direct as well as an indirect method. (T)
3. The Accounting Act requires all businesses using double-entry book keeping to indicate the
costs of their operations by cost type. (T)
4. The P/L account contains the origin of the after tax balance sheet profit of the business
remaining with the owner as per the relevant year, and indicates the major factors with regard
to the generation, and modification of the result, the composition, and the generation of the
balance sheet profit. (T)
Summary
The P/L account provides a background to the balance sheet profit regardless of the method
selected, it presents the division of results, i.e. the part of the results of the business
transferred to the state (in the form of taxes), to the owners (dividend), or what sum remains
with the business as balance sheet earnings.
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CHAPTER 3: THE COSTS OF A BUSINESS
3.1.
Content Description
Businesses use a variety of resources in the course of their operation, and their yields are
generated as they use these resources. Distinguishing among the concepts of costs, expenses,
expenditure, grouping costs, the basic elements of economic calculation required for
appropriately accounting for costs.
3.2.
Chapter Objectives
• Familiarizing with the grouping options of costs
• Learning the methods of inventory management
• Learning the methods of economic calculation and cost-accounting
3.3.
Structure of the Chapter
•
•
•
•
•
•
•
3.4.
The purpose and functions of cost calculation
The concept, interpretation, and the methods of cost calculation
The meaning of costs from a practical point of view
The principles of grouping costs
The functions of cost calculation and the correlation of aspects of cost grouping
Calculations, net cost calculation
The practice of accounting for costs
Training Material
3.4.1. The purpose and functions of cost calculation
3.4.1.1. Cost-accounting
Cost-accounting is a type of calculation focusing always on determining the financial
equivalent of resources used to create goods.
3.4.1.2. Decisions related to a business
Determining the net cost of self-produced inventories, and services rendered may be
important e.g. when specifying sales prices, prior to beginning a new activity, or when
decicing to discontinue an on-going activity.
3.4.1.3. Planning and acting (decision making)
Determining the net cost of the product or service may take place prior to, during, or after
commencing the actual activity. If the preliminary calculation suggests that the market price
covers the planned net cost, it means that the business is worth launching. The interim
calculations are typically used by businesses comparing plan and fact, and if the two reflect a
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discrepancy larger than normal, they analyse and act upon required measures. Follow-up
calculations are meant to prepare decisions for the future, i.e. whether the activity is worth
continuing.
3.4.2. The concept, interpretation, and methods of cost management
Costs management is an activity that has costs as its central concept, and contains its
• planning,
• assignation,
• analytic recording,
• posting in the general ledger,
• calculation,
• control,
• analyis, and
• the creation of its information system.
Methods of costs management:
• applying standards of use in costs management
• applying the factor of cost change
• the purpose and application of coverage cost calculation
• marginal costing
• standard cost calculation
• value analysis
• applying other methods
3.4.3. Interpreting costs (from a practical point of view)
3.4.3.1. The concept of expense
From an operational point of view an expense may be interpreted as a reduction of assets.
However, we tend to refer to expenses more often as a financial concept in the sense of
reduction of financial assets.
3.4.3.2. The concept of cost
Cost is the financial equivalent of using resources.
3.4.3.3. The concept of expenditure
Expenditure is a concept related to production, and the generation of results.
A part of expenditure is generated by first deducting costs – required to produce the goods –
which becomes an expenditure following the sale.
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3.4.4. Features of grouping costs
3.4.4.1. According to cost types
Cost types are the following:
• material costs
• costs of services taken advantage of
• costs of other services
• wage costs
• other personnel type costs
• wage contributions, and
• depreciation.
3.4.4.2. According to deductibility
Based on their planning, assignation, and deduction, costs may be direct and indirect costs.
Direct costs are those about which it is clear upon their emergence which product or service
they relate to, i.e. which part of such costs are borne by whom. With indirect costs it is not
possible to name who bears the costs, i.e. only the location is known where the costs emerge
(cost centre).
3.4.4.3. Costs in accordance with location of emergence
Grouping costs in accordance with the location of their emergence means classification by
cost centres. We know already that the cost centre principle means that when the cost is
incurred, only its location is known. Indirect costs are typically deducted at the cost
centres, and part of the costs thus deducted will be allocated to the cost bearers with the help
of projection bases. In this particular case we calculate the absorption costing rate (index):
sum of costs to be allocated
sum of projection base
Projection bases may be many types. Thus a value data or some natural unit of measurement
may be used. The absorption costing rate may be used to determine how much of the divided
costs are borne by any one of the cost bearers.
Grouping according to cost bearers means the total amount of costs allocated to the various
activities (production, or service provision) out of all deducted cost.
The cost bearers are appointed by the business. Cost bearer is a product, or service in the
interest of which the cost has arisen, and with reference to which the costs are deducted.
3.4.4.4. Costs based on their correlation to volume (cost characteristics)
3.4.4.4.1. Standard (fixed) costs
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Part of the production costs – regardless of production volume – arises in a relatively constant
amount, i.e. standard costs – without a significant change of business volume – are
unchanged in the period under review.
3.4.4.4.2. Variable costs
Variable costs are the ones that change to some degree with the change of business volumes.
Four groups (cost types) may be distinguished among variable costs based on their rate of
response.
3.4.4.4.2.1. Linearly changing costs (proportionate costs)
Proportionate (or linearly changing) costs change proportionately to the change of
production volume, i.e. cost increase by one unit with each unit of volume growth.
3.4.4.4.2.2. Progressively changing costs
Costs changing in excess of the linear rate – i.e. progressive costs – include those that
increase in a proportion higher than production volume, which means e.g. that if production
rises by 1%, costs rise by more than 1%. The cost variation factor of progressively changing
costs is above 1 as the costs growth index exceeds the volume growht index.
3.4.4.4.2.3. Degressively changing costs
Degressively changing cost increase with the increase of production, but to a lower rate than
production volumes. Degressively changing costs have a cost change factor of 0-1 as costs
change with production volume (i.e. they reflect a rate higher than 0), but the rate of change is
not proportionate to the change of production volumes (they are lower).
3.4.4.4.2.4. Regressively changing costs
Regressively changing costs are characterized by the fact that with the increase of business
volume they decrease. In reality it is hard to find examples for this, but it happens that
production volumes cause still utilizable heat energy to increase, which reduces heating costs.
The unit costs of degressively changing costs drop degressively as business volumes rise.
3.4.4.5. Costs changing in accordance with decisions (controllable and uncontrollable
costs)
Controllable costs include costs that (may) change following a particular decision. At the
same time there are costs that the decision does not change, i.e. the decision does not affect
them.
3.4.4.6. Costs related to a change in the operation, differentiated costs (incremental
costs, marginal costs)
The supplementary amount created by increasing production is called incremental
production. The cost of the production increment, i.e. the excess is the incremental cost. We
can of course calculate unit cost even in incremental production which we call differential
(incremental) costs.
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3.4.4.7. Costs in accordance with a given decision making level (controllable and noncontrollable costs)
If changes of costs, i.e. the decision concerning use of resources are delegated to various
levels of management, it is possible that a manager at a lower level has no authority to control
the use of a particular resource, and thus the related costs.
3.4.5. Functions of cost calculation, and the correlation of cost classification aspects
Costs express the financial equivalent of resource use, which may be a multitude of types, and
lend themselves to categorization along a variety of principles. Costs incurred, and deducted
in the course of the business may be grouped according to different aspects, and therefore
several types of cost analyses may be created.
Net costs must be determined by means of retroactive calculation or based on a relevant
standard in order to specify the balance-sheet value of self-produced inventories, and
uninvoiced services in accordance with the Accounting Act; the statement must contain all
costs broken down by type either in the P/L account or in the notes to the report. In addition,
the business owner must follow procedures designed to fit his own business profile when
calculating, and grouping costs.
3.4.6. Calculations, net cost calculation
3.4.6.1. Economic calculation
A calculation is a technical, economic activity/calculation that takes into account,
summarises, and, occasionally, measures the effectiveness of the performance of some
activity.
The purpose of a calculaton is always to determine – in advance or retroactively – some
parameter related to some activity or to production.
Economic calculation means calculations to prepare executive decisions, to control and
analyse the implementation of decisions made.
3.4.6.2. The object and functions of cost-accounting
Net cost calculation also means calculation targeted at determining the financial equivalent of
resources used to create goods.
Net cost calculation is based on the unit of calculation with reference to which the financial
equivalent of the resources used to create goods is determined.
The following may be units of calculation:
• a given product, individual calculation, (in the event of small amounts, and long
processing time)
• series, series calculation (in the event serial production)
• group of products, the equivalent distributive method (products differing in size,
design, or shape)
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• order
One of the functions of net cost calculation is compliance with applicable legislation,
determining the balance sheet value of self-produced inventories, and uninvoiced services; its
other function is to prepare management decision making, and verify the implementation of
the decisions retroactively.
3.4.6.3. The basic principles of net cost calculation
The names of the priciples of net cost calculation faithfully reflect their content:
cost-accounting based of the utilization of resources
the principle of genuinits of cost
the principle of completeness of costs
consistency in determining net cost
accrual of sudden costs
the principle of cost-bearing capacity
3.4.6.4. The types of net cost calculation
3.4.6.4.1. Pre-calculation
Pre-calculation (plan calculation) is the economic/technical activity whereby the entrepreneur
determines the expected net cost of the product (service) prior to the inception of operation
(the activity) in accordance with technical and technological standards.
Precalculation may be based on either of the following:
• technical standards,
• comparative calculations.
3.4.6.4.2. Interim calculation
During the calculation period, while interim calculation is taking place (prior to the
completion of the production process) we determine the net cost of one calculation unit for
controlling and intervention purposes.
3.4.6.4.3. Post calculation
Post calculation is the technical/economic exercise whereby the entrepreneur calculates the
actual direct net cost of one calculation unit based on costs actually incurred, collected from
his records after the operation has closed, and/or at the end of the financial year.
3.4.6.5. Methods of net cost calculation
3.4.6.5.1. Distributive costing (distributive method (simple method, equivalent method))
In the course of distributive costing the net cost of the product must be expressed as the
quotient of completed production value, and the amount produced.
Simple distributive costing may be applied in the event of a homogeneous product mix;
equivalent distributive costing, however, is used with products of a product family. In the
latter case the equivalence numbers express the proportion of the resources used for the
various products to the lead/main product.
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One-tier and multi-tier sub-methods may be distinguished within both types of distributive
costing, and the number of tiers are determined – in the case of simple distributive costing –
by the net cost of the category to be determined, while in the case of equivalent method, the
amount of figures in the sytem determined on the basis of calculation items.
3.4.6.5.2. Index calculation method
In the course of absorption costing, indirect from an accounting point of view, are divided
with the help of appropriately selected projection bases.
A projection base is the production factor that may be determined in a natural measurement
unit or value whose amount and changes influence the evolution of the sum and amount of
indirect costs per product.
The absorption costing rate (index) is the quotient of the cost to be divided and the projection
base.
When applying one type of projection base we use simple or global absorption costing; when
applying different projection bases for individual cost groups we apply selective absorption
costing.
In the course of the absorption costing process we may apply dictated (internally established)
and/or actual absorption costing rate.
3.4.7. The practice of accouting for costs
3.4.7.1. The concept, purpose, and function of deducting costs
The purpose of deducting costs is providing information concerning trends of costs
Preparing decisions requires the following information:
• total production cost of the given period,
• the size and composition of costs per cost types
• the size and composition of costs per cost centres and cost bearers
• the size and composition of costs per fixed and variable cost-parts
• total costs of individual products/activities,
• total costs of the product/service created/rendered,
• the way in which costs changed compared to the plan or the base,
• the reasons of changes of costs (excess costs and cost savings)
Cost accounting is broken down to synthetic and analytic cost recording systems
3.4.7.2. The possibilities of deducting costs
Cost accounts serve the purpose of posting costs in the general ledger.
Costs may be accounted for in accordance with:
• cost types, and/or
• locations of cost, or cost bearers.
Accouting for costs incurred in the interest of the business may be through:
• primary cost type accounting, or
• primary cost location-cost bearer accounting
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3.4.7.3. Features of input and output cost accounting
Input cost accounting means the filing of costs related to the use of resources, while output
cost accounting involves accounting for creating products, and providing services.
3.4.7.4. Accounting for costs according to cost types
When accounting for costs by cost types the costs must be posted on the general ledger
accounts in accordance with the grouping into cost types. In other words one concentrates on
what resource use caused the increase of costs.
3.4.7.5. Accounting for costs in accordance with cost centre and cost bearer
The cost accounts are used to account for direct costs, while cost centre accounts serve the
purpose of accounting for indirect costs.
In the course of primary cost centre - cost bearer accounting the costs are recorded in the
books in accordance with their posting method, i.e. one must distinguish them into direct and
indirect cost accounting.
3.4.7.6. Practical methods of cost accounting in businesses, the relation between cost
accounting, and profit calculation
Accounting for costs in accordance with cost type is a statutory requirement provided by the
Accounting Act, thus all costs incurred in the interest of the activity may be done in either of
two ways:
• by primary cost type accounting,
• by primary cost centre-cost bearer accounting.
The business owner may decide to prepare his P/L account by the total costs method, in which
case the compulsory posting of costs by cost type will support the preparation of the P/L
account.
If the business prepares its P/L account in accordance with cost of sales, the costs must be
broken down to direct and indirect costs, i.e. costs of cost centres and cost bearers must be
maintained (in the general ledger or on an analytical basis), and the costs must be presented
by cost type along with the capitalized value of self-manufactured assets.
Conclusion
Cost management and cost accounting are closely related issues, and their methods and
implementation is influenced by numerous accounting policy decisions. That means that when
building a management information system, it must be taken into account what information is
required at what level of decision making to have an optimal activity.
3.5.
Exercises
(1) What are the purposes and functions of cost accounting?
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(2) What is meant by cost management?
(3) How can the concepts of expense, cost, and expenditure be distinguished, and how do
they interrelate?
(4) List principles of grouping costs.
(5) What is meant by ‘rate of response’?
(6) Give the broad definition of economic calculation.
(7) What are the basic principles of net cost calculation?
(8) When and for what purpose can calculations be made?
(9) Please describe the methods of net cost calculation.
(10) Distinguish between input and output cost accounting.
(11) Which are the practical methods of cost accounting, and what type of P/L account
can be associated with them?
Multiple choice questions
(the correct answer is printed in bold)
1. Based on the time (frequency) of cost management, control may be a(n) … activity.
A./ preliminary
B./ retroactive
C./ continuous and retroactive
D./ occasional
2. Based on the time of cost management, planning may be a(n) … activity.
A./ preliminary
B./ retroactive
C./ continuous and retroactive
D./ occasional
3. Material standards may be standards based on … .
A./ technical calculations and statistical averages
B./ estimates and practical experience
C./ both A and B
D./ technical calculations only
4. The unit cost of supplementary production is the …
A./ average incremental cost
B./ incremental cost
C./ marginal cost
True-false questions:
1. The activity meant by cost management has cost in its focus, and includes its planning,
assignation, accounting, controlling, analysis, and the creation of its IT system. (T)
2. Value analysis constructively analyses the function (F) and cost (C) correlations of a
product in order to approach as much as possible the technical-economic optimum, and
thereby creates a more modern product. (T)
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3. Account group 5 must contain costs by cost categories. (T)
4. Business owners preparing their P/L account by the total costs method must, within account
group 5, indicate separately the changes of capitalized value of self-manufactured assets in the
year in question (as the coverage of direct costs of equal size), and the value of unsold assets
equal to net cost. (T)
5. Business owners preparing their P/L account by total costs must, within account group 6-7,
indicate separately the changes of capitalized value of self-manufactured assets in the year in
question (as the coverage of direct costs of equal size), and the value of unsold assets equal to
net cost. (F)
6. Account group 8 contains, for P/L accounts being prepared by cost of sales, all material
type expenses, personnel type expenses, and depreciation. (F)
7. Account group 6-7 may be used for management information purposes in accordance with
the relevant decision by the business owner. The application of the account group enables
requiring various units of the business to account for their operation, and the creation of cost
management, and net cost calculation. (T)
8. The only function of net cost calculation is providing data to evaluate self-produced
inventories. (F)
9. Production costs include expenses emerging directly in the course of producing, installing,
extending, redesigning (to fit a different purpose), transforming, or restoring the asset or
product. (T)
10. The direct net costs may contain sales costs, and management, and other general costs not
directly associated to production. (F)
Summary
The present chapter has discussed cost management providing details of is fundamental
concepts, methods, net cost calculation, and options of accounting for costs. It is advisable to
do the exercises offered to better familiarize with the methods described.
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CHAPTER 4: CONTROLLING COSTS
4.1.
Content Description
The present chapter offers a brief discussion of the purposes and areas of methods of cost
control. Controlling costs may become necessary for a number of reasons, and several
organisations, or in-house units may equally perform cost controls.
4.2.
Chapter Objectives
• Describing the objectives of cost control
• Learning the possible areas of cost control
4.3.
Structure of the Chapter
Objectives of controlling costs
Areas of controlling costs
4.4.
Training Material
4.4.1. Objectives of cost control
The objectives of cost control, then, is determined by who conducts it and for what purpose.
4.4.2. Areas of cost control
Cost controls conducted within the organisation by management members is the most
frequent. The amount of resources actually used, i.e. the costs incurred may be
influenced/reduced on the basis of the findings of the audit, by making the appropriate
decisions, taking the necessary measures, and by introducing the required procedures.
A tax audit is typically targeted at whether the resources have been used for a legitimate
purpose.
An audit consists of reviewing the net cost calculation system used to determine the balance
sheet value of self-produced inventories, and self-produced assets.
The Office of Fair Trade, the consumer protection bodies, and other supervisory
organisations most typically control the principles of price setting, and examine the elements
of net costs as part of the same exercise.
Conclusion
The objective of cost control is determined by the area in question.
4.5.
Exercises
Essay questions:
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(1) What is the purpose of cost control?
(2) What are the areas of cost control?
(3) What cost reduction methods/practices can you list?
True-false questions:
1. Costs must be controlled for a purpose provided by, and methods laid down in legislation.
(F)
2. A tax audit is the sum of investigations into the legitimacy of resource use by management.
(F)
3. The Office of Fair Trade, consumer protection bodies, and other supervisory agencies
control mostly the system of price setting, and investigate elements of net cost in conjunction
with the same. (T)
Summary
The control of costs may be carried out by the business, which is one element of rational
business management, but an outside provider may also be hired, or it may be carried out by a
supervisory agency to gain assurance if the use of resources complies with applicable
legislation.
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CHAPTER 5: Analysing Costs
5.1.
Content Description
In this chapter we provide an overview of the possible ways and methods of cost analysis.
Analyzing costs is an examination of the factors bearing on cost structure, cost changes, and
the evolution of costs from a given point of view.
5.2.
Chapter Objectives
• Calculating and interpreting benchmark indicators
• Understanding the correlation between cost level and cost ratio
• Familiarizing with the methods used to analyse direct and indirect costs
5.3.
Structure of the Chapter
•
•
•
5.4.
Benchmark ratios in cost analysis
Allocating costs
Cost ratio
Cost level
Analyzing direct costs
Analyzing indirect costs
Training Material
5.4.1. Comparative index in cost analysis
5.4.1.1. Allocating costs
The cost allocation index shows the ratio of a set of costs grouped according to any principle
to the full set of costs.
costs belonging to a certain group
* 100%
total costs
5.4.1.2. Cost ratio
The cost ratio expresses the relation of individual cost types and production value.
cost type
* 100%
production value
5.4.1.3. Cost level
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Cost level is the quotient of a given partial cost, and production value. The meaning of the
index depends on what cost items appear in the numerator, e.g. deducted direct cost,
calculated direct costs, full costs.
partial costs
* 100%
production value
Note: when calculating the cost ratio, and the cost level, sales may come in the nominator, i.e.
the nominator is determined on the basis of the amount sold.
5.4.2. Examining direct costs
Several methods are available to analyse direct costs:
• Cost structure analysis
• Cost evolution analysis
• Analyzing the effect of relevant factors on costs
Cost structure analysis means the examination of the distribution of individual direct cost
groups.
Analyzing the evolution of costs means examining the changes, and the dynamics of the
entirety and/or components of direct costs.
Examining the effect of relevant factors on costs may take place through the chain method, by
standardization, and by partial divergence analysis.
5.4.3. Examining direct costs
Examining indirect costs may take place by flexible cost analysis, and that method may be
used to examine both operating and central general costs.
The following are the steps of flexible cost analysis:
1. cost grouping by function
2. determining the indices at typical work load
3. calculating the rate of response (variable costs / total costs)
4. determining justified costs
5. interpreting absolute (fact-plan) and relative (fact-justified) divergences, identifying
causes
Conclusion
Analyzing costs, i.e. the financial equivalents of resource use is aimed at promoting the
effectiveness of the business, and the required control points may be identified by analysis.
5.5.
Exercises
Essay questions:
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(1) What methods do you know for analyzing costs?
(2) What are comparative indices?
(3) How can the allocation of costs be quantified?
(4) What is cost ratio?
(5) What is meant by cost level?
(6) How can direct costs be analysed?
(7) How are indirect costs analysed?
True-false questions:
1. Cost structure analysis is not suitable for examining direct costs. (F)
2. The cost ratio expresses the relationship of the individual cost types and production value.
(T)
3. The examination of indirect costs may be done through flexible cost analysis. (T)
Summary
Cost analysis is an activity whereby control points are identified with reference to resource
use. The type of costs analysed, and the purpose of the analysis determine the analytic method
to be employed.
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CHAPTER 6: ANALYZING THE COVERAGE SUM, AND REVENUE STATUS
6.1.
Content Description
In the present chapter we identify, and analyse the coverage sum, analyse revenue status, and
present the steps of profit planning. Analyzing costs, cost structure, changing of costs, and
examining the factors affecting costs from various points of view.
6.2.
Chapter Objectives
• Defining coverage point, and operation suspension point
• Familiarizing with the steps of revenue status analysis
• Learning the methods of profit planning
6.3.
Structure of the Chapter
•
•
•
The coverage sum and its analysis
Identifying the coverage point
Determining the point of termination of operations
Analyzing revenue status
The purposes and methods of revenue status
Indices of profit planning
Profit planning
Designing the optimal production plan
Factors influencing the balance sheet profit
6.4.
Training Material
6.4.1.
The coverage sum and its analysis
6.4.1.1. Determining the coverage point
From an economic point of view the coverage point is the amount of production at which the
total cos ts
average cost of the product, i.e.
equals market price, i.e. total costs and sales
amount.produced
are equal. In that case the costs of the business will return, but no profit is generated.
The coverage point is at the minimum of the average curve. AC=P
At that point marginal cost and marginal revenue are equal, i.e. the cost of one additional unit
produced equals the revenue derived from its sale.
6.4.1.2. Determining the shut-down point
all var iable cos t
, that is
amount.produced
average variable cost, and if prices fall below that value, production must be suspended. At
The point of suspension of operations is at the minimum value of
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that point, the average variable cost of an additionally produced unit equals market
price, and production below that point would cause losses to the business as the direct cost of
one item exceeds market price.
6.4.1.3. Analysing the coverage sum
Findings:
• Production above the coverage point results in a profit, i.e. the business generates profit on
top of covering the variable and standard costs
• Production at the coverage point does not generate profit, but variable and standard cost
return
• Production between the coverage and the suspension of operations point losses are
minimal, and at that point all variable cost are covered, along with part of variable costs
• At the point of suspension of operations variable costs are covered, and the sum of losses
equal the sum of standard costs
• Production below the point of suspending operations production cannot be regarded
economically rational as losses begin to build up.
The coverage sum is determined by revenue and the size of proportional type costs as it is
legible from the template. Revenue can be described as the product of net sales price, and
amount of sales; meanwhile proportional type costs may be defined as the product of the
amount produced, and unit cost.
1.
2.
3.
4.
5.
sales (p*q)
Proportional type costs (c*q)
Coverage sum (1-2) (f*q)
Fixed type costs
Profit (3-4)
We must apply some simplifying suppositions for the purposes of our analyses in order to
model the realistic economic situation
• The amount of production and sales equal
• Proportional costs are the indirect costs, i.e. unit proportional costs, and net costs
• Fixed costs are the undivided costs
• The coverage sum – based on the above – comes in row III. Gross profit of sales in the
P/L account prepared by the cost of sales method
• Profit comes in row A. Operating (business) profit of the P/L account
The following symbols are used in the course of the analysis:
p = sales price
q = production and sales volume
c = net cost
f = specific coverage (p-c)
The analysis of the coverage sum may take place through
• The comparison method
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• The method of segmentation into factors,
• Mathematical and statistical methods
6.4.2. Analysing revenue status
6.4.2.1. The purpose and methods of analyzing revenue status
An essential condition to running a business is a profitable operation. A business may be
regarded profitable if all its revenues exceed all its expenses, and thus its pre-tax profits are
positive.
The basis of determining if a business is profitable is the profit achieved by that business.
An analysis may take place with the aim of
• justifying and preparing a decision
• measuring performance
• identifying the causes of discrepancies
• creating, and using a system of interests
Analyzing results
o is a periodical activity (frequency)
o is comprehensive (scope)
o describes and projects operations, and prepares decisions (character)
o is an economic (value) analysis (approach);
The phases of result analysis
Profit forecast (budget): there are several methods to carry out analyses, which we will
discuss in more detail in the next sub-chapter
Interim result analysis: activity performed continuously on an on-going basis the
operation of the business, consisting of matching plan and fact figures during a given
period of time, and analysing possible discrepancies; updating of plans may become
necessary if new information so requires.
Retroactive profit analysis: it may be prepared following the period forming the basis of the
planning period; it offers an opportunity for the company to match its statistics to the data of a
period selected to be the base, and/or to plan data.
6.4.2.2. Indicators of profit analysis
The aim of analyzing profitability is to provide a comprehensive picture concerning the profit
generated by the business during a given period.
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The basic formula of determining profitability:
profit
projection.base
Profit in the basic formula may take the following forms:
• Gross results of sales (P/L account prepared using the cost of sales method)
• Operating (business) profit
• Usual business profit
• Pre-tax profit
• Taxed profit
• balance sheet profit
Profit may be determined using several projection bases
• Net revenue of sales
• Total revenue
(sales revenue + other revenues + revenue on financial operations + extraordinary
revenue)
• Value of owner’s equity (tied-up capital)
• Total assets
• Invested assets
• Invested assets + inventories
• Personnel expenses
• Wage costs
• Average staff size
The definition of profit to be applied is essentially determined by the purpose of the analysis,
the specific features of the business, and market conditions. The definition of profit and the
projection base must match.
Indices of profitability analysis:
If the projection base selected is the owner’s equity or tied-up capital in a broad sense,
then the return on equity must be determined
If the projection base selected is the profit component, then the profitability index
will be determined
If the projection base selected is on the asset side of the balance sheet, then it is an
efficiency index.
The definition of the indices themselves does not carry information; the analysis is only useful
as soon as there is a benchmark. Benchmarking may be to a previous period, or to the
performance of another company, but in each case ‘noise’ must be eliminated from the
analysis. The firs step in doing so is the appropriate selection of the indices to be used.
A purpose of the analysis may be the pro-rata performance of the business. For dynamic
analyses it is practical to use a profit category that best characterizes the business.
The following are some key profitability indicators and their interpretation:
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Gross profitability (coverage ratio) =
gross profit of sales
net sales revenue
Gross profitability (coverage ratio) may be calculated from the data of the P/L account
prepared by the cost of sales method. The gross profit of sales is the difference of net sales
revenue of sales and direct costs of sales. The direct net cost of self-produced inventories
sold, the purchase price of goods sold, and the value of services sold (mediated) appear
among direct costs of sales. Positive gross profitability does not always mean positive pre-tax
profit as the size, and the proportion of indirect costs greatly affect the profits of the business.
Return on sales (ROS) =
pre - tax profit
total revenues
What ratio of revenues remain as profit is indicative of the profitability of all the revenue of
the business.
taxed profit
owner' s equity
The profits made available by the owners, and/or accumulated over past years serves to
measure the profitability of the owner’s equity in both domestic, and international practice.
Return on equity (ROE)
Return on Assets (ROA); Return on Investment (ROI)
ROA =
pre - tax profit
total assets
pre - tax profit
investment *
It reflects the profit generation potential of assets. The profit category to be examined must be
selected in accordance with the asset group selected as projection base.
Return on equity and return on assets will equal if the business finances its own assets purely
from its own equity, and if total assets are interpreted as investment required for the business
(investment* = total assets), and suppose that the investment was carried out purely from their
own equity, in which case ROE=ROA=ROI
ROA expresses that the assets of a business are capable of generating a certain amount of
profit, and ROI measures the efficiency of the business as an investment.
ROI =
Profitability per work done
Profitability per wage costs
pre - tax profit
wage costs
Profitability per personnel type expenses =
pre - tax profit
personnel type expenses
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Examining profitability per work done is usually justified in businesses where personnel type
expenses represent a significant ratio of total costs, i.e. in the case of activities that are more
labour than raw material intensive. It is more reasonable to select personnel type expenses as
the projection base than wage costs regarding the major proportion of costs incurred by other
personnel type expenses in domestic practice.
6.4.3. Profit planning
Revenue expected by the owners is one of the possible starting points for profit planning.
The equity made available by the owners i.e. the subscribed capital is the initial step in setting
a specific revenue requirement. Revenue is always determined with reference to face value.
The rate of the yield set of course greatly depends on the business’ yield policy, and on the
price of the shares in the owners’ hands.
In addition to expected revenue, owners may also determine the expected rate of growth of
the business, the ratio of profit to be retained to cater for such growth.
The ratio of dividend paid is determined by the business’ dividend policy (as accepted by the
owners at the general meeting).
6.4.3.1. Creating an optimum production plan
Creating an optimum production plan makes sense for both manufacturing, and service
providing businesses as long as the services provided may form the basis of net cost
calculation, and can therefore be regarded units of calculation. It means that the resources
required for providing the service must be determined along with their capacities, and the
expected solvent demand. Of course with service provider firms a more suitable term is
‘optimum service portfolio’.
In commerce, optimum production plan corresponds to designing an optimum product
structure, which may require similar steps.
To determine the way in which a business may achieve the highest coverage sum, one must
take into account the bottle necks of the business one by one. A bottleneck in a business
(keeping it from growing) may be either an outside or an inside factor such as:
1. with production firms e.g. it could be machine capacity, or – on a short term – labour
shortage
2. with service providers: typically the amount and the quality (qualification) of the
labour force
3. in commerce: e.g. the floor area of the shop
4. and with any activity: the level of solvent demand
The first three items in the list may be influenced by the business, i.e. when creating the plan,
efforts must be made to minimize internal bottlenecks in order to maximize profits. It is
therefore justified to increase machine capacity, train the work force, or extend the floor area
of the shop to a size sufficient to prevent solvent demand from being a bottleneck.
The net costs of individual units of calculation (product, activity, goods) must be determined,
and the amount of effort required to produce it must be identified (standard units of time,
which could be machine time or working time)
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The profitability of units of calculation is indicated by the specific coverage sum, defined as
the difference of net sales price and direct net cost. Producing various products (or providing
various services) is done by using various amounts of resources, therefore they must be
brought to a common denominator in order to compare them. Different products may be
matched, and their profitability ranking determined on the basis of the specific coverage sum
per one unit of the resource used. Naturally, the activity to be pursued, and the product to be
manufactured first is, considering sales potential, the one with the highest specific coverage
per one unit of resource. When production and sales plans are created, the valid supply
contracts for the reference period must be taken into account.
6.4.3.2. Factors affecting balance sheet profit
Profit planning may take place through quantifying the factors that determine profit. The
grouping of the main factors to determine profits may be in accordance with the format of the
P/L account selected, and established in the business’ accounting policy.
6.4.3.2.1 In the event of a P/L account prepared by the cost of sales method:
⇒ Factors influencing sales revenue:
Evolution of sales prices of products sold
Evolution of the volume of products sold
Evolution of the composition of sales
⇒ Factors determining the capitalized value of self-manufactured assets:
Increase or decrease of self-produced inventories
Value of self-produced assets (value of investment made by the business);
establishment/reorganisation, direct costs of experimental development depend on the
decision of the business, if it is capitalised,)
⇒ Factors determining other revenues
Positive influence on profits of economic events occurring in the course of usual
operation, but not part of the core business
⇒ Factors determining the value of material type expenses
The size and internal structure of material type expenses are determined by the core
activity of the business
In the case of an essentially trading business there will always be a particularly high
ratio of the purchase price of goods sold among material type expenses, while in
service providers that item will be absent altogether from the P/L account.
At the same time, material costs from material use is not only relevant to
manufacturing and production firms as even a business providing a service uses e.g.
office supplies or purchases fuel to operate its vehicles.
⇒ Factors determining the size of personnel type expenses
It is true also for personnel type expenses that their size and internal structure is
typically determined by the core activity of the business.
The ratio of personnel type expenses is high in the relatively labour intensive service
industry compared to both profit, and the other cost types. Analytical possibilities are
limited by the fact that part of the work is carried out by occasionally hired workforce,
and suppliers, which is posted among material type expenses as services used.
⇒ Factors determining the value of depreciation
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⇒
⇒
⇒
⇒
⇒
The sum of depreciation is significantly affected by the full stock of intangible and
tangible assets, their age composition, and the level of technological development.
Factors determining the other expenses
The negative effect on profit of economic events occurring in the course of usual
operations, but not part of the core activity of the business.
Factors determining profits of financial transactions
The types of investments (business stakes, shares, bonds, bank deposits) of a
company, and whether it is engaged in foreign trade, more particularly, if it primarily
trades domestically or internationally essentially affects the profits from financial
transactions.
Factors determining the size of extraordinary profit
The size of extraordinary profit is influenced by economic events other than usual
business (contribution in kind, uncompensated transfer of assets)
Factors determining the degree of tax liability
The base and the rate of tax liability is laid down in law. Businesses pay 16%
corporate tax and 4% special tax on their positive tax base. The tax base may be
reduced by various items or increased taking into account the special features of the
business.
Factors influencing the size of the dividend
The amount of the dividend is determined by the business’ dividend policy, the profit
on the activity (taxed profit), the profits of previous years (retained earnings), statutory
limits to dividend payment, and ultimately the general meeting accepting the annual
report.
6.4.3.2.2 P/L account prepared by the cost of sales method (operating profit):
⇒ Factors influencing sales revenue:
Trends in sales prices of goods sold
Trends in the volume of goods sold
Trends in the composition of sales
⇒ Factors influencing the direct cost of sales
Trends in sales prices of goods sold
Trends in the volume of goods sold
Trends in the composition of sales
Purchase price of goods sold, and/or the value of services sold (mediated)
⇒ Factors determining the indirect cost of sales
Indirect costs arising in the reference period, or sales, administrative, and other
general costs are indirect cost of sales; these are typically standard costs, i.e.
independent from the volume of production.
⇒ Other factors determining revenues
Economic events of positive effect occurring in the course of usual operation, but not
part of the core business.
⇒ Factors determining other expenses
Economic events of negative effect occurring in the course of usual operation, but not
part of the core business.
Conclusion
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The primary and short-term objective of a business is profitable operation, which, over time,
enables accumulation of assets, and the rate of realization of that objective must be
continuously monitored.
6.5.
Exercises
Essay questions:
(1) What is the meaning of coverage point, and how can it be determined?
(2) What is the meaning of the point of suspension of operations, and how can it be
determined?
(3) What are the indicators of profit analysis?
(4) How can an optimum production plan be designed?
(5) What factors must be taken into account in designing the optimum production plan.
(6) What factors influence?
True-false questions:
1. From an economic point of view the coverage point is the amount of production at which
the average price of the product equals the market price. (T)
2. The business suspension point is at the minimum of the average variable cost, and if prices
move any lower, production must be suspended. (T)
3. The average variable cost of one additionally produced unit at the coverage point equals the
market price, and producing below that point would cause losses to the company as the direct
price of one product exceeds the market price. (F)
Multiple choice questions:
(the correct answer is printed in bold type)
1. The ROA index is
A./ the quotient of the pre-tax profit, and total revenues
B./ the quotient of taxed profit, and owner’s equity
C./ the quotient of taxed profit and total assets
2. The ROE index is
A./ the quotient of pre-tax profit, and total revenues
B./ the quotient of taxed profit and owner’s equity
C./ the quotient of taxed profit and total assets
3. From among the factors influencing balance sheet profit the following affect sales
revenue:
A./ trends in sales price of goods sold
B./ Change of volume of goods sold
C./ Change of the composition of goods sold
D./ All of the above
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Summary
Profit analysis is an activity in the course of which the business determines its coverage point
and/or operation suspension point per activity, per organisational unit or for the business as a
whole; it calculates the various indicators that reflect profit trends, and determines, with
reference to competitors, to the reference period or to the plan if it is necessary to make
decisions that affect the performance of the activity.
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CHAPTER 7: CASE STUDIES
When preparing case studies, the countries should take into account their national
characteristics, thus we recommend adding country specific examples to help students absorb
the material appearing in the theoretical part of the given chapter.
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C) NATIONAL SPECIFICATIONS
In this chapter the cost-accounting system typically used by Hungarian businesses is
presented through practical examples, building on the knowledge in sub-chapter 3.7 The
practice of accounting for costs.
1. HUNGARY
Options of accounting for costs on the basis of the Hungarian Accounting Act
The Accounting Act leaves it for the business owner to design a reasonable system to account
for their costs. Businesses can select from many methods, but naturally, the specific features
of the operation must be taken into account along with the type of inventory accounting the
business owner uses, and how they wish to prepare their P/L account. The method selected
must be established in the accounting policy. In what follows we summarise the most typical
practices that are in compliance with applicable accounting legislation. They are as follows:
The business owner posts his costs exclusively on the accounts of account group 5 Cost
categories
The business is not involved in manufacturing (it does not have inventories of its
own)
The business engages in manufacturing, and has inventories of its own
It does not maintain continuous records of its self-produced inventories
It maintains continuous records of the amount and value of its self-produced
inventories, but does not distinguish between direct and indirect costs
It maintains continuous records of the amount and value of its self-produced
inventories, and distinguishes between direct and indirect costs
It maintains continuous records of the amount and value of its self-produced
inventories, in which it posts changes mainly at a unit clearing price,
distinguishes between direct and indirect costs, and modifies value data to
actual direct net costs
It maintains continuous records of the amount and value of its self-produced
inventories, in which it posts changes mainly at a unit clearing price,
distinguishes between direct and indirect costs, and modifies value data to
actual direct net costs only at the end of the year.
the business owner posts his costs primarily in account group 5 Cost types and secondly in
categories 6 Cost centres, general costs, and 7 Costs of activities, and records the changes
of self-produced inventories in the course of the year at a unit clearing price, and modifies
value data to direct net cost at the end of the year latest.
the business owner posts his costs primarily in account groups 6 (Cost centres), and 7
(Costs of activities), and secondly in category 5 (Cost types), and records the changes of
self-produced inventories in the course of the year at unit clearing price, and modifies
value data to direct net cost at the end of the year latest.
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2. GERMANY
Registration, German Accounting and Publication Requirements
All business vehicles are subject to a registration requirement with the commercial register at
the district court (Amtsgericht), where the business is operated. The commercial register
contains all basic information about the business and its owners. All information is public
domain and accessible for creditors and public authorities.
All commercial businesses are subject to a bookkeeping requirement and are obliged to keep
accounts. They also have to prepare financial statements as of the end of each fiscal year in
accordance with German GAAP.
The affairs and financial position of the business must be documented in accordance with
good accounting practice. The basis for the book-keeping and the original or a copy of all
business correspondence must be saved. At the commencement of business, an opening
balance sheet must be prepared, and every year a balance sheet must be drawn up.
The financial year can be chosen to begin at the commencement of business, but it must never
(not even in connection with setting it up) span more than 12 months. Changes in the financial
year require approval from the local tax office (Finanzamt).
In principle, accounts should be kept in German. If another language is used, the tax
authorities may request a translation. The profit and loss account and the balance sheet must
be in German and numbers should be stated in Euro.
Account books, inventories, balance sheets and other important documents are to be kept for
10 years. Business correspondence and vouchers must be kept for 6 years.
The rules on book-keeping and annual accounts are widely based on EU directives. Stock
companies must publish their annual accounts.
Distinction is made between large, medium-sized and small companies. Small companies are
those that do not meet at least two of the three following conditions over a 2-year period:
•
balance sheet total of € 4,015,000
•
turnover of € 8,030,000 in the last accounting year
•
average of 50 employees annually
Below we disregard medium-sized and large companies, as they are not particularly relevant
with regards to the establishment of a new business. Small companies must prepare simplified
annual accounts. There is no audit requirement and only limited duty of disclosure.
The annual accounts must be prepared no later than 6 months after the end of the financial
year. No later than 12 months after the end of the financial year a balance sheet with notes but not a comprehensive annual report - must be submitted to the trade register. Proposals for
the distribution of profits or losses must be included, however.
For corporations and commercial partnerships with no individuals as general partner (i.e.
GmbH & Co. KG), the following special provisions apply: There are special provisions
regarding the format of the balance sheet and the evaluation of assets and liabilities.
Additionally, a management report is mandatory. Financial statements and the management
report need to be audited by a certified accountant (Wirtschaftsprüfer), unless the company or
partnership does not exceed special thresholds pertaining to its balance sheet total, turnover
and number of employees (kleine Kapitalgesellschaft). A brief note is placed in the German
Federal Gazette (Bundesanzeiger), stating that the balance sheet has been submitted.
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3. FRANCE
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4. UNITED KINGDOM
A brief overview of the accounting system regulation in the UK:
The accounting and disclosure requirements for financial statements in the UK (UK Generally
Accepted Accounting Practise of UK GAAP) are a mixture of accounting standards and
company law requirements.
The Accounting Standards Board (ASB) issues the UK accounting standards. The Accounting
Standards are also known as Financial Reporting Standards (FRSs). Accounting Standards
also include the Statements of Standard Accounting Practise (SSAPs) issued by the
Accounting Standards Committee (ASC), an ancestor of ASB. The ASB has adopted all
remaining in force SSAPs as at 1990. Finally, accounting standards also include the Abstracts
issued by the Urgent Issues task Force (UITF). The issues addressed by the UITF are usually
specific aspects of an existing standard or company law.
The Companies Act 2006 defines the disclosure requirements for companies adopting UK
GAAP. These requirements do not apply to the companies which use International Financial
Reporting Standards (IFRSs), unless otherwise stated in the Companies Act. Companies that
are listed in the London Stock Exchange and the Alternative Investment Market should follow
IFRSs, and are required to follow additional rules set out by the Financial Services Authority
(FSA).
The accounting and disclosure requiremens of Small and Medium-sized entities (SMEs):
A small company (as defined in the Companies Act 1985):
1. Turnover must not exceed £5.6 millions.
2. The total of fixed and current assets must not exceed £2.8 millions.
3. It should not employ more than 50 employees.
A company is not a “small” one if one of the following holds;
1. It is (or was at any time during the year) a plc.
2. Its operations include one or more of the excluded business categories relating to financial
services and insurance.
3. It was a subsidiary of a group that contains a plc or insurance or financial services
company.
If the company qualifies to be recognized an SME it is entitled to the following concessions:
a. It can use the Financial Reporting Standards for Smaller Entities (FRSSEs), which
constitute a simplified version of FRSs and have less disclosure requirements.
b. It is not required to prepare a cash flow statement.
c. It is allowed to offer a reduced level of disclosure to its shareholders.
d. It is allowed to file abbreviated accounts with the Registar of Companies. (Turnover, cost
of sales and other operating income can be omitted as well as the obligation of reporting
turnover and profit by type of operation and geographical segment)
e. Many (but not all) small companies are exempt from the requirement of a statutory audit.
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[The material in this section (“A brief overview of the accounting system regulation in the
UK”) has used information from the following sources:
Holmes, G. Sugden, A. and Gee, P. (2008) Interpreting Company Reports and Accounts.
Harlow: Prentice Hall.
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This project has been funded with support from the European Commission.