On July 14th last, it was reported on the BBC website that the total cost to BP of the Deepwater Horizon oil spill back in 2010 was totalling $61.6 billion – quite an amount. If you look back at the media websites/newspapers over the years you will see the amount rising over time.
Just out of curiosity, I had a look at the most recent financial statements of BP to see what they include on this. Two things came to mind before I looked at the accounts 1) the amounts involved here are material and 2) it spans many reporting periods, so IAS 10 Events after the Reporting Period would probably kick in. Looking at the accounts to 31.12.2015, they contain a separate note which itemises the events of the event on each of the three financial statements. You can see the accounts here – look at note 2. It is quite detailed and I do like how they have shown the effects, and the note is quite detailed. It is not very often such significant events occur, and as far as I can see BP have done a good job on this note. It certainly should provide an investor with enough information to decide whether to invest in the company or not – a key criteria of what financial statements should do.
Regulation of charities in Ireland is not as good as it could be – we have some legislation waiting to be enacted since 2009 as far as I know. But laws cannot prevent what happens within an organisation from happening; they can only penalise after the event.
So what bugs me? Well, the title of this post really – it is something I picked up from the print media in recent weeks. I am sure I have said somewhere on this blog that accounting is the language of business, so what about accounting for charities? My own opinion is that charities must have proper accounting, and there are accounting standards already in place for charities. But I often wonder should we be careful and not allow charities to become too much like a business? For example, we should be using accounting in charities to drive efficiencies, not necessarily monitor revenue and costs like in a business. Nor should we be using accounting just to get funding for a charity. In short, what I am trying to say is that we need to be careful and try to not let accounting (and other commercial sector notions) detract from what a charity should be.
In recent years many operations – both business and public sector – have been closed or reduced in capacity to save costs. Closing an operation is one of the topics I often teach too. When I teach, the basic message is to focus on the fixed costs, and how much can be reduced or eliminated. Of course, some labour costs are increasingly seen as fixed – and this may be a more certain feature in the public sector.There may also be some hidden or unforeseen costs, which are often not included in the analysis. Let me give you two recent examples, both of which are from the public sector.
In Ireland, the government closed down 139 Garda (police) stations due to economic woes. Most of these closures were in rural areas. The total annual cost saving is estimated at just over €500,000 – see here. This is likely due to the fact that only the only savings were operating costs of the stations e.g. light and heat were the only real costs saved. Police staff and equipment simply moved to another station – where costs may have been incurred to accommodate them. There is a big hidden cost though, which is increased rural crime. While there was probably no money value on this cost in any cost estimates prepared, I’d be quite sure it is higher than closing stations. Recently, the decision to close has been reversed.
A second example comes from Lambeth council in London who closed two libraries – see here . According to a report in the Guardian, the daily security cost is higher than the cost of keeping the libraries open. There seems to have been some protests against the closure of one library in particular, which drove up the costs. This unforeseen cost, if included in the closure decision might have changed things.
Have you ever noticed how some Eco items cost more than, shall we call them traditional items? For example, eco building materials like some insulations are much more costly than the traditional materials. Or more efficient appliances such as heating boilers cost more. What bugs me a little is, if our goal to is to reduce energy consumption, reduce CO2 or live more sustainably, then why are many things that could helps us so costly?
Two reasons come to mind as a management accountant. First, there may have been some capital costs incurred by manufacturers to produce newer and more sustainable products, which are included in the price. These costs may decrease over time as economies of scale creep in. A second reason is that although the costs may be higher, there may be savings to take into account. For example, an certain insulation maybe be twice the cost, but it can seriously reduce your heating bills over the several decades.
You have probably heard about the amount of fruit and vegetables wasted in the food supply chain. This waste “occurs” for three main reasons. First, in less developed countries, poor transport and storage can result in waste. This also happens in larger developed countries, where distances mean fruit/veg cannot survive the trip. Second, the exacting standards imposed by retailers as to the size and shape of fresh fruit and vegetables causes growers to simply dump large quantities each year. Third, end consumers throw away perfectly good food.
Personally, I grow some fruit in a small suburban garden. We never but jam, as I make enough for the household for the whole year. We have 2-3 months worth of pears and apples, and some years the “leftover” fruit become wine – blackcurrant wine is quite nice. So, from a small say 10m2 plot, I can do all this and have zero waste. On a commercial scale, things are different. The waste is immorally high, primarily due to the exacting standards of retailers. I can tell you that the apples and pears I grow may be all shapes and sizes, but they taste so much better than anything I can buy in the supermarket – and my neighbours all agree.
To give a snapshot of how much perfectly good fruit and vegetables we waste each year as a race, National Geographic (March 2016) provides some stark numbers. In total, 53% of fruit and vegetables never makes it to the market – 20% is lost at the farm due mainly to exacting standards, 19% is uneaten and discarded at home, 3% lost in transit/storage, 2% lost in processing (canning/baking) and 9% discarded by wholesales and retailers. Add to this the resources used to harvest and prepare what is wasted – 70 times the oil lost in Deep Water Horizon and enough water to fill the Volga, and that’s just one year in the US alone. To add another number, the annual total food waste (all foods) could feed 2 billion people.
From these stark numbers, what can (management) accountants do? Recently, some documentaries on British TV featured vegetable growers saying the loose perhaps £100,000 per month worth of vegetables – assuming it could be sold at market price. Nowhere is this accounted for, not in their accounts, in supermarket accounts, in our national accounts (GDP). What if these accounts included the cost of waste? I’m sure if they did, we would all stand up and take notice.
Any student of management accounting (or management accountant) will be able to tell you about the costs/revenues which are relevant to decision-making. It is not very often a clear cut example appears in the media however.
One really good example is the cost of discontinuing Irish Water – a public water utility formed three years ago in Ireland. The utility has been plagued with political interference and has become the topic of much debate in political circles.
In late February/early March of this year, the utility became a bargaining tool in the formation of a new government. Media reports started to note how much it would cost to discontinue the utility. One reasonably good media report puts the cost at up to €7 billion – see the report here The report draws on internal Irish Water figures, which include the following costs and revenues:
- paying off staff
- sunk costs of €670 million – cost such as business systems and meter installation
- over €3 billion in benefits forgone – lost revenues and future cost savings over the term of the current 5 year strategy of Irish Water.
Including the sunk costs is incorrect, as sunk costs are not relevant to a decision such as this – well maybe they are for political circles! Including the future revenues and cost savings is correct. These are future savings/incomes which will be lost if the utility is discontinued. It seems wise to continue with the utility, as otherwise a lot of money will go down the drain – excuse the pun.
The above headline appeared in an article in The Times recently. There is something fundamentally incorrect in what it says, which I detail below. Let me say first that I am bashing the article author or the paper, as most papers do such things when covering firm performance.
So what is wrong with above statement? Simply, it is the application of the accruals concept in accounting. Under this concept, revenues and expenses are matched, and when cash is received/paid is not relevant – at least in the calculation of profit.
Here is a simple example. Let’s assume a business sells goods for $1,000 cash but has not paid the supplier. The goods cost $600. The profit on this is $400. If the supplier is never paid, or is paid in 10 days, the profit will not change.
While the article is incorrect in terms of the title, it’s message is solid – that you can benefit by not paying people. In the simple example above, the business has $1000 in the bank.
A colleague pointed to an article on The Guardian Food and Drink blog recently which posed a question “Is £2 a fair price for a cup of hot water and lemon”. The article describes a review of a coffee shop on TripAdvisor where a customer complained about the price. The manager duly drafted a long and detailed reply, justifying the cost. The justification included everything from the staff member cutting a slice of the lemon, walking in and out of the kitchen and so on – you can read it all at the above link. He argued the cost might be even more than £2.
So what is my view? The manager is right if you include all costs (i.e. full costing). But here is another way to think about this. The waiter, chef, light, rent, cups, equipment, decor etc have all been paid for and are sunk costs. Thinking about it this way, the extra cost of the coffee/tea/water & lemon or whatever else is simply the water and ingredients. Thus, a cup could be sold for a few cent and still make a profit on that one cup as long as the costs are covered. Of course to do this all the time would probably not make business sense, but sometimes if a business has already covered all its costs (or wants to minimise losses) it can engage in such marginal cost thinking – take GroupOn vouchers as an example. Such thinking about pricing and costs is not of course supported by financial reporting, which encourages us to think only in full cost terms. But going back to our coffee shop, if a waiter costs €/$/£10 per hour to employ, then this cost will not change regardless of whether (s)he serves 1 cup or 20 cups in an hour. Lowering prices might bring more people in, and they might buy more than just a cup of coffee – but to do this the manager needs to be aware of the nature of costs and make an informed decision.
Twenty five years ago, I first saw Dire Straits live in Dublin. It was one of the first gigs I ever went to. Back then, there was a guy on O’Connell St in Dublin selling bootleg cassettes of live gigs for maybe £5. The quality was awful, but fans loved it. And it was illegal of course, making it all the more fun.
Move forward to 2015, and I was lucky enough to see Mark Knopfler live in Leipzig. Still an amazing guitarist. Of course, times have moved on and almost everyone has a smartphone to record a gig on – I hate doing this, but some artists don’t seem to mind. To my surprise, Knopfler in his 2015 tour not only seemed to encourage recordings at gigs, but found a way to make some extra revenue.
At each gig – including Leipzig, and yes, I did buy – you could download the actual gig recording for €15. This was sound desk quality, and unique. Add an extra €20 and you got the recording posted to your home on a souvenir USB stick.
Now think of this in marginal costs and revenues. The marginal cost is close to zero, as the stadium is fitted out, staff there and the sound desk set up. Maybe the only cost is a bit of rented space on a cloud server somewhere. On the revenue side, it is pretty much a no-brainer really – the full amount of the €15 per download is revenue, as I just argued the cost is close to nil. So if 1,000 fans at each gig buy the recording, that’s €15,000 x maybe 20 gigs = €300,000, a tidy sum. And of course, it is a legal recording 🙂
I have written before on sustainability, and it is a tricky topic to define and pin down. However, one thing that helps bring any issue to the fore is to measure and/or report on it. Many companies do report on sustainability and environmental issues. Whether such reporting is genuine or “green-washing” is another debate.
CGMA recently conducted a global survey of management accountants, and the report can be found here. A nice infographic of the key points can be seen here in the December CGMA magazine. One of things that jumped out at me was that the highest perceived benefits of reporting on sustainable issue came from management accountants in Africa. The report/survey suggests that management accountants are very aware of the need to report on sustainability and note it is beneficial. It also surprisingly suggests that the greatest barrier to reporting is no demand from decision makers.
To this audience I ask two questions
- do you understand short-term versus long-term? If you do, which applies to your decision-making?
- are there any trained management accountants working in banks? I know there are, so read below if you are one of them.
While driving back from Cork recently, I heard a decent sounding lady with six kids telling a story about how a bank was repossessing the house her family rented – it was the Joe Duffy show on RTE Radio 1. The landlord could not afford the loan repayments it seemed and the bank wanted to sell the house. The family worked, and had sufficient income to pay rent into the future. The husband worked in a state-job, so as secure as you could get. She tried to communicate with the bank, but got a “computer says no” type response from the bank. To me, and I am just a management accountant, not a banking expert I could not see the logic in selling the house. Something instinctively told me taking a longer term view is a better choice.
Based on the information she gave during the radio show, when I reach my home I opened an Excel sheet. I checked the rent the lady might be paying – from daft.ie – and then I started to use the simple PMT function in Excel. I made assumptions that the landlord stopped paying the bank loan based on the original house value in 2010; that the bank would allow the lady to take over the mortgage at the present market value of the house and at the present interest rate. I did not adjust for the time value of money. You can see all my workings at this link:
The total time to do the above calculations was about 20 mins. I admit, Excel is not perfect, and I do not adjust for the time value of money – I don’t think it will make things vastly different. To keep it short, if the bank allowed the lady to take over the house as described above, they would gain to the tune of just under €86,000. Based on my simple calculations, the lady could afford to pay this. So, taking a longer term view, the bank (and by definition it’s shareholders) would benefit compared to ditching the house now.
Some further points on costs. I ignore legal costs, as the bank would have to suffer legal costs on either a sale or re-mortgage. But there is a bigger elephant in the room on costs. The lady would be homeless, someone would have to pay this cost – directly or indirectly, and ultimately the state. If I extrapolate the social costs, what is the family (who seemed decent) became homeless, the family fabric was disturbed and the kids turn to crime in the future. How much would this cost in money terms ?
So back to my questions. The scenario I describe above is being repeat all across Ireland. As a person, and an accountant this annoys me. The view of banks seems to be short-term only, driven by profit only. Now don’t get me wrong, profit is good, it creates jobs and investment. But we must not view profit from a short-term perspective. So, to the bankers, give me an answer to the above questions. If you are a trained management accountant, you should be thinking long-term, and if not, don’t think you cannot fail by taking short-term views. As you know banks have failed, as the leading image here should remind you.
It’s 13 years since Ireland introduced a plastic bag levy of 15c, then 22c. Since then, around €200m has been collected from consumers. England recently introduced a similar scheme and this prompted me to reflect on what the less use of plastic bags has meant for Ireland – with a cost/accounting angle of course.
The first thing that strikes me is the lack of plastic bags stuck in hedges. Not only does this mean a cleaner countryside, but much lower clean up costs for local councils.Second, I would say the packaging industry did not lose out, as paper bags are generally available in stores – cost neutral in terms of employment. This is good too as paper is renewable, but also lost people have a car boot full of reusable bags. I still have some dating back to 2002 believe it or not. Third, as a tax it worked in that it changed our behaviour as a nation – for the good of the exchequer and the environment.
Following from my last post, here is another example of costs and design problems -but this one is a real project. A bridge crossing the Bay Area in San Franciso had an original cost estimate of $250, but the final cost was in excess of $6 billion. This occurred for many reasons, bad cost estimates, politics and the length of time involved. Read the article at the link for full detail – it’s a great example of the cost problems associated with infrastructure projects.
Marketing and design people tend to be very creative, and fair play to them, it’s part of what they are. But design is one thing and actually building or making sometime is tougher – if you have ever built even a standard house you will know what I mean.
The one thing I have learned about design of products is to not change the design after you agree it – this typically causes costs to go upwards. If a customer is willing to pay for this great, but that’s usually the exception.
My experience of product design is it is best to involve someone with good management accounting knowledge from the outset. This person need not be an accountant, but must has good knowledge of costs and or processes to build or make the final product. Otherwise big surprises can occur.
Maybe it’s an extreme example but take the main stadium design for the 2020 Olympic Games in Tokyo. According to reports, the cost of the design to be built has doubled to $2 billion since inception. Surely if someone with half decent knowledge of costs working with the designer would have spotted the additional costs.
You may or may not know that Ireland has only recently started to charge for domestic water use. There has been some heated debate, but here are some simple numbers based my own household.
With two simple water butts – small 100l capacity costing about €60 In total (see the photo above) – I have saved at least 6,000 litres of water in the past year. At the metered rates this is not a lot saved financially, about €22. But if half of Irish households did this (about 600,000 houses) that is a total of €13.32 million per annum across the country. Not to mention how I have seen my kids get instilled with the idea of conserving water.
Of course that’s only half the story. Saving water from rainfall means less produced water, less stress on infrastructure, less energy consumed and so on. I have no idea what these effects would do to my savings figure above – certainly a multiplier.
Typical accountant you may be thinking, but that’s it, we need to think not only about costs we pay for water, but other costs too.