Tesco and its hello money.
Image from Tesco.ie
A few weeks ago, a news story broke about an accounting scandal at Tesco – see here for example.
So how can this happen? It’s very simple actually. Now, we don’t know if it’s an error or something deliberate, but from an accounting view the entries in the books are the same.
When I was in college 20 years ago, one of our accounting lecturers asked is how would we account for this “hello money” as he called it. Within a decade I was calculating and accounting for what were termed “long term agreements” in my role.
For the likes of Tesco, the amount involved are large and I would guess they account for hello money as a separate income stream – although it’s not shown in the published accounts. Another way would be to reduce purchase cost, but this would probably be for smaller amounts. But how can Tesco make such an error you ask? Simple, just ” over accrue”. This means recording future hello monies now. Of course, I have no idea this is what actually happened, but it does show how easy errors or manipulation can happen by using the good old accruals concept.
The cost of letting staff go……
As an accountant, when we think of the costs of letting staff go, we probably think redundancy costs and so on. These can be quite substantial. But maybe these short run costs are better than longer term damage costs. I know the example I give here may be less likely to work in Europe for employment law reasons, but I’m just trying to think about costs, not the HR side.
I read recently that Amazon (and others) are offerings employees a cash sum of up to $5000 if they wish to leave. Maybe this is a bit strange, but there may be an argument which suggests such a payment actually saves money longer term – employees who are not engaged with their company are probably less productive. I don’t know if companies like Amazon have done a cost analysis on this, but it seems to make sense.
To give another example, a few tears ago an employer told me that a substantial redundancy payment made to an employee probably was a good deal. The employee in question was creating a poor image with customers, which was starting to effect turnover. Again, maybe no cost analysis was done, but the short term cost of redundancy was compared with unknown longer term effects.
Does my milkman use Activity-Based Management ideas?
Not my milkman…
Ok, the title of this post is not really correct. It should be more like “does my milkman and his supplying dairy use activity-based management principles”? First, let me explain that where I live we still have milk delivered to our door twice per week. This is quite common in Ireland and has been happened for as long as I can remember. The only difference nowadays is that deliveries are no longer daily due to refrigeration technology improvements. Second, what is Activity-based Management (ABM)? In a co-authored text book (see burnsetal.com), ABM is defined as “The
use of ABC information to identify operational and strategic improvement possibilities”. We could extend this to say that ABM assumes a business manages itself based on activities (as in Activity-based Costing) rather than functions.
So what has this to do with my milkman? Well, despite its very traditional nature, technology has made its way into milk delivery. A new website (mymilkman.ie) has been set up by several dairies in Ireland to streamline milk delivery. Through the website, I can pay for my milk, change my order, pause my order if I go on holidays and so on. And when I signed up, I got €10 credit on my account.
I asked my milkman what he thought about the site. He told me that even if he gets only 50% of customers to sign-up, he will save 8 hours work per week. Why? Well he does not have to call to the door to collect money for one thing.
So what has this to do with ABM? Well the €10 credit on my account makes me think that someone is thinking that it costs less to manage a customer if online – and I would suggest this is a customer service activity. And if we think about it, how many businesses charge us more if we do things through call centres versus online for example. So there may be many businesses out there using the ideas of ABM – managing activities. But would they all use ABC? I doubt it. For example, the dairy industry probably used some form of process costing. Nevertheless, I think many businesses may use the basic idea of managing activities they perceive as costing more/less in different ways.
What is lean accounting?
Defining lean accounting is a bit odd to me, as I don’t really buy the idea that there is a technique called “lean accounting”. Having said that, there is definitely a concept called lean manufacturing. In a nutshell, lean manufacturing implies three concepts – pull, flow and waste reduction. Pull means product is produced (or pulled) according to customer demand. Flow means product moves through a facility as efficiently as possible and no delays. Both of these should imply waste reduction.
So what does this mean for accounting. Well one thing is inventory reduction. Another may be capital investment to get things working well. Both might put accountants off! But rather than me rattle on, here is a very nice article from Forbes which explains lean accounting and some issues.
Promotions on price
As a management accountant, when price is dropped we probably want to be sure that we still make a profit- or at least cover cost. An article I found on inc.com gives some very useful hints to ensure that price promotion is effective in the longer term. Your can read is at this link.
Stick to the cooking – restauranteurs and accounting knowledge?
Cuisine 3 etoiles de Jacques Lameloise (Photo credit: Wikipedia)
In October of this year, Michelin star chef Derry Clarke had a go at Dublin restaurants selling “cheap meals” – see here. I guess Clarke was thinking from his own view when he said “the number of restaurants offering meal deals at economically non-viable prices just isn’t sustainable, it’s the same cost in McDonalds, but we have all of the overheads”.
He may have a point about the number of restaurants being sustainable, but Derry, stick to the cooking. Any management accountant could figure out that even if meals are sold cheap (and I doubt they are below cost as Clarke suggests), they still make a contribution towards overhead costs. It would be better to have 50 guests in a restaurant earning a contribution of €5 a head (€250 in total) than having an empty restaurant. In the latter case, costs such as labour, heating, rent and so on are still incurred.
What cost can you sell at?
Factory (Photo credit: howzey)
In this post, I recount a conversation I had with a great mentor some years ago. It questioned my notion of what costs are relevant and how to set prices once a plant/factory is not at full capacity.
In a factory ( or any business perhaps ) when there is free capacity we can start to look at the make up of costs a little closer. Traditionally, management accounting would suggest we should at least cover all variable costs in the selling price. But think about it like this – if we have spare capacity, then perhaps the only additional cost is the material cost. Let’s assume we have a machine with a full crew, but not at full capacity. The fixed costs of the machine are just that – fixed, and we cannot avoid them. The labour costs are in effect fixed too, as workers will be paid. So, in this case, only the material costs are relevant. And this, any selling price above the material cost contributes to profit.
Yes, there may be many simplistic assumptions in the above. However, it made me think back then and I always give this example to my students. It is of course an example of throughput accounting, which I will mention next week.
Related articles
Hidden costs – what are they?
Opportunity Cost (Photo credit: maxymedia)
The term “hidden cost” is one which we are probably quite familiar – the media like to use if a lot. But what is a hidden cost? Where do these costs hide? Can we avoid them in decision-making? Too many questions to answer in a single post, but let’s start with the term itself.
If you do a google search, you will get many definitions which define hidden costs as a similar concept to opportunity costs. I disagree with such definitions as if you have identified an opportunity cost, then it is not hidden is it? Ok, perhaps I am being a bit unfair here, but to me hidden costs are those which you may not foresee when making a decision. Of course, it’s never possible to foresee all costs when making a decision, but perhaps the hidden costs might emerge if more time is given to the decision – easier said than done in a business scenario.
Take the example of a house purchase decision. This is a big decision in anyone’s life, and we normally take the time to make the right decision on location, size, internal layout, price, amount to borrow and so on. After a few years in the house we might discover we are far from schools or work, or that it is hard to heat the house – these would be hidden costs of our house purchase as we probably did not factor them into our initial decision. There’s a good chance though that we would include such things in a second house purchase decision.
Product development and advertising costs
It’s probably fairly obvious that product development costs affect the overall profitability of any product. Some products like drugs and new technology incur huge development costs. New technology, at least at the consumer end, often incurs huge advertising and promotion costs too. And simply, if sales are not sufficient, then losses occur.
As an example, consider a report from the Irish Times on Microsoft’s efforts in the tablet market.
“Microsoft’s Surface tablets have yet to make any profit as sputtering sales have been eclipsed by advertising costs and an accounting charge, according to the software company’s annual report.
The two tablet models, introduced in October and February to challenge Apple’s popular iPad, have so far brought in revenue of $853 million, Microsoft revealed for the first time in its annual report filed with regulators yesterday.
That is less than the $900 million charge Microsoft announced earlier this month to write down the value of unsold Surface RT – the first model – still on its hands.
On top of that, Microsoft said its sales and marketing expenses increased $1.4 billion, or 10 per cent, because of the huge advertising campaigns for Windows 8 and Surface. It also identified Surface as one of the reasons its overall production costs rose.
The Surface is Microsoft’s first foray into making its own computers after years of focusing on software, but its first attempts have not won over consumers. By comparison, Apple sold almost $24 billion worth of iPads over the last three quarters.”
(Above is copyright of Irish Times/Reuters)
An effective internal auditor: key attributes
An internal auditor is someone who checks the internal control systems in an organisation – usually larger organisations. Staff typically fear the arrival of an external auditor, but at least they go away in a few weeks. The internal auditor is not only ever present, but knows a lot more about a business than any external person. Thus, in my own experience, internal auditors are perhaps less liked than external auditors. However, perhaps my experience was just a bad one. This articles from CGMA at least suggests that an internal auditor needs some decent communication and social skills to0.
(Image from CGMA)
The effective internal auditor: 7 key attributes.
Currency devaluations – the effects on assets
Devaluation (Photo credit: ervega)
It is not that often that we as accountants face the problem of currency devaluations. We would have to be an accountant in a large global firm who has assets denominated in a foreign currency that is devalued. You know I am a management accountant, so I will leave the complex accounting standards up to the experts. In other words, I avoid the complex issues here.
Last February, the Venezuelan Bolivar was devalued by about 30%. The exchange rate was moved from 4.3 bolivars to one US dollar to 6.3 bolivars. So for example, if a company had assets worth 430,000 bolivars or $100,000, the value of these in $ terms is now $68,253 (4.3/6.3 x 100,000). As Venezuela has many foreign investing companies, the balance sheet of these have been hit a little. For example, Irish paper and packaging company Smurfit Kappa saw its asset values fall by €142m – see here
Fraud at Olympus
Internal controls and fraud are not really an area that I write a lot on. Just before Christmas I read this article from CIMA about fraud at Japanese firm Olympus. It includes interviews with Michael Woodward, who was at the heart of putting things right. The are a lot of issues in the article and it is worth a read.
Sustainability – an accountant’s brief thoughts
Sustainability is a huge issue for us all, not just for accountants. It is not my specific area of expertise, so over the next few weeks Dr Stephen Jollands, University of Exeter, will be writing a few guest posts on my blog. He will give you much more on sustainability actually means, but let me tell you what inspired me to ask Dr Jollands to write some stuff.
I was travelling back to Ireland on an Aer Lingus flight recently. It was an early flight, so I ordered a breakfast, some muffins and drinks for my kids and a tea and cake for my wife. So we started to eat. As I was eating my breakfast I realised I had a portion or marmalade I did not want to eat just then, and portions of salt/pepper I did not use, and some plastic cutlery and some milk. So I thought why not bring some of it home and use it for lunch – which I duly did. Then I started to think about how many similar items would be simply waste on the flight. And, thinking further, the effort (and cost) that goes into produced all these portions is simply wasted too. This, I thought is completely daft, and here it come, not sustainable. All sorts of questions came into my mind – why do we waste so much, why do the flight attendants not ask if you want certain portions, how much money is wasted in this one flight, what natural resources are wasted etc.
This simple everyday experience of mine shows the kind of issues that might be part of the broader sustainability field. I’ll leave it up to Dr Jollands to give you some more insights over the coming weeks.
Business recovery plans – a must, but a cost?
This summer, customers of the Irish based Ulster Bank faced 3-4 weeks of problems getting paid and paying bills as the banks payment system failed. Customers had to queue to get cash from their accounts and go to other banks to pay bills- see my post 2 weeks ago about how some countries are limiting the amount that can be paid in cash; these limits would be too low to pay a mortgage in Ireland for most.
When I worked in a paper firm, I was involved in the decision to set up a simple business recovery plan. At the time, I was IT manager at a plant with about €30m turnover and 150 staff. The whole place was more or less run by a single system which managed sales orders, production planning and invoicing. We had a server onsite which done all this. This was not always so, so once I realised we were so dependent on a single piece of hardware/software I initiated a discussion with the plant management board to get a recovery plan in place. To keep it brief the cost of having a server available to us at any location within 4 hours was €7000 per annum. As part of the contract we could also do a free trial run once a year to test how long it would take to recover our systems. I always remember the production manager saying this was a cheap deal as if we had no systems we would basically loose wall customers within a week. And all we did was made cardboard boxes. Surely a bank should have a much better system in place. The cost does not really matter in the decision, it’s much more about the list revenue and lost customers.
The photo by the way comes from a friends Facebook page .
Another cost-volume-profit example – supersize portions
In June this year, I was watching a programme called “The men who made us eat more” on BBC. It told the story of how super-size portions and combo-meals came about in fast-food chains like McDonalds, Burger King and other similar ones. One of the participants mentioned how the profit margin on the extra portion (or the additional products in a combo-meal) is huge. He explained why, and the explanation is again an application of understanding costs and volumes (or CVP).
Let’s take the example of a portion of french fries. If we think about the cost of a regular size portion first. The variable cost would be mainly the ingredients, i.e. potato, packaging cost and maybe energy costs. There would be quite a few fixed costs – all the costs associated with the running of the restaurant, including staff costs (they need to be paid even if there are no food orders). Now if we make the portion size larger, the additional cost will be very small – some extra ingredients, a slightly bigger package and that’s about it. But, the price increase is proportionately much higher than the cost increase usually. Thus, by encouraging a customer to super-size or buy a combo-deal, profits can rise at a much faster rate than the corresponding increase in costs.
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