Management accountant’s travelogue- part 2 – merendero
While in Northern Spain – Asturias to be exact – we were invited one evening to a meal at a merendero. From my limited knowledge of Spanish, this translates loosely to a picnic area. What we in fact had was a lovely tapas evening in a restaurant with a merendero attached. I have written before about business being child-friendly, or not as is often the case. The merendero concept is so simple; a lot of picnic tables, some play areas/equipment, a simple ordering system where you collect you food. And, all this at minimum cost to the restaurant I would imagine – at least in fixed costs. On the revenue side, the turnover of the restaurant is probably increased quite a bit as 1) more parents come and 2) future customer (the kids) are secured. In the particular merendero we visited, there were at least 100 places outside for people to eat and drink – a sizeable increase in volume without equally high costs. If only the Irish weather were good enough to do this! But, I’m sure a clever restaurant owner could take some of the idea and increase their business success (and revenues).
Management accountant’s travelogue- part 1 – free ferry trips
(Photo credit: Wikipedia)
Sorry about the somewhat cheesy title ! This summer, I spent about 3 weeks on a driving holiday in France and Spain. I love driving to Europe – no airports, luggage limit is a much as you can carry in your car, and you can stop when you want where you want. I drove just over 3,000 miles and stayed in some beautiful places. During my journey, the old business brain was not completely switched off so I’d like to share some things I noticed and thought about. Of course, they will be related to management accounting one way or another.
The first thing I noticed was that the ferry trip to France gave us a free trip to the UK. A free something is nothing new – you can lots of examples of free products, two for three deals etc. in books like Freakonomics and Undercover Economist. The deal was simply I got a free trip in a car ferry to the UK for a car and 2 adults once I completed my trip to Europe. On my return, I phoned and all went perfect. I had to pay a small amount for the kids, but we got the dates we wanted. So how much is this promotion costing the ferry company. I guess there are two ways of looking at it:
1) it costs them the lost revenue from two other paying passengers with a car – so a sort of opportunity cost
2) it costs nil, and in fact increases contribution.
Which one would you use if you were making the decision/reporting to management ? I’d go with the second view, especially in off-season. The ferry in question hardly ever leaves the Irish Sea – going back and forward to the UK three times every 24 hours, all year round. In off-season, the boat is not full – but the costs of running it are the same – both fixed and variable costs. Thus, any extra monies I spend – buying food for example – reduces the fixed costs burden. If I were to think about this free trip in full cost terms, I would probably not offer it to passengers as the fixed cost are unlikely to be covered. This would be the wrong decision in my view, as anything that contributes to the bottom line is better that nothing, or suffering the fixed costs regardless.
Tune in over the coming weeks for some more holiday stories.
A great reporting tool from Excel – PowerMap
As you might know from some of my previous posts, I really like concise presentation of information. The infographic is one of my favourites. Graphical reporting is always great, and managers tend to really like it – it simple, conveys trends, and it’s not boring accounting numbers.
I read a piece on CIMA Insight about a new add-in for Excel 2013 called GeoFlow, or more correctly PowerMap. You can read the full article here. The add-in uses Bing Maps (from Microsoft) and you can plot up to a million rows of data against a map. You can also plot date data, so you could for example see how sales have trended over time on a map. The data can be presented in 3D format, as bubbles, or as a heat map. This tool will certainly create really cool business reports.
The best private companies do …what exactly to be successful?
Short post this week , but no less interesting I hope. Here’s a link to a nice article on Forbes which gives the key habits of successful private companies. Article
Managers should know the numbers
At the end of June this year, Michael O’Leary from Ryanair was his usual self at the Paris Airshow. He let a few jibes fly at almost everyone. He also signed an order with Boeing for new aircraft, worth around $1.5 billion. Plans for future aircraft purchase were mentioned too and O’Leary compared two possible aircraft – one from Boeing and one from Airbus. While he suggested both were similar aircraft, the Boeing has 9 more seats and he said ‘that’s worth a million bucks’. When I read this , I thought is this just another quip or does we know his numbers well?
So, here are my calculations:
9 seats at average revenue of €70 = €630
Assume four flights per day per aircraft, so 630 x 4 =€2,520.
Finally, assume 360 flying days per year, this gives 360 x €2,520 = €907,200.
Let’s not argue over the rounding, and maybe my sums and assumptions are not correct. But a round €1million per aircraft per annum adds up to a lot of money. So although O’Leary’s rule of thumb may seem like a quip, it seems to be quite a good rough measure. He is an accountant after all!
Cash accounting – an alternative to accruals accounting? And what about accounting software?
English: Accounting machine from UK manufacturer Powers-Samas. (Norwegian Technology Museum, Oslo.) (Photo credit: Wikipedia)
In Ireland and the United Kingdom (and maybe come other countries) it has always been possible for smaller business to pay VAT based on cash received rather than on an accruals basis. You probably know what the accruals concept is, but if not click here. When I teach accounting or prepare accounts, the accruals concept is used almost without exception. The profit & loss account (income statement) and balance sheet (statement of financial position) will definitely use the accruals concept. In fact, these financial statement often take a different name and format when prepared for a cash-based business. For example, when I teach how to prepare the financial statement of not-for-profit organisations such as clubs, we often refer to a “Receipts and Payments Account” and a “Statement of Affairs”. The former is like an income statement, but is based on cash records; the latter is a list of assets and liabilities and will normally draw on the accruals concept.
From April 1st 2013, the UK tax authorities permits smaller unincorporated businesses to use a cash based accounting scheme where the turnover is less than £77,000 (see here for more detail). I’m not a UK tax expert, but from my reading about the topic on the web, the “income” of a small business will be the cash received, and the “expenses” will be cash paid for business expenses. This sounds like a reasonable effort to simplify the tax system for the smallest of businesses. The accruals concept may not be that relevant to many of these businesses as, for example, they may have few assets (to depreciate) and receive payment for most work as soon as it is done. So all fine? Well apparently, many accountants protested this new scheme, and that’s not surprising given how the accruals concept is engrained not only in the teaching of accounting, but also in accounting regulations. As a management accountant, I would always encourage the smallest of businesses to think in cash terms – it is easier for business owners with little accounting skills to understand. But I do see one big problem with this scheme in the UK. It centres around what happens when turnover exceeds £77,000. Once this happens, the business must revert to accruals accounting. This would cause much confusion if a business is using accounting software. Normally, accounting software incorporates accruals accounting, but some also support cash accounting in the way described here. I’m not 100% sure, but I would imagine if you set up software to work in one method, it may not be that easy to switch. So even though this cash scheme is easier and optional for small UK business, if they use accounting software (and more and more do) then it is probably best to stick to accruals accounting.
What is activity-based costing?
You may have heard of activity-based costing (or ABC), and here I will try to explain the basics of ABC. First, just a short reminder of the types of cost an organisation may have.
Costs are often classified as fixed or variable. Variable costs change in line with volume/output, and are often called direct costs as they can be attributed easily to a product or service. Fixed costs, often called indirect costs, do not change when business output changes. For example, a fixed cost might be rent of a premises or the salary of a general manager. Such costs cannot be easily traced to a product or service. However, if no effort is made to trace fixed costs to products or services, then the business does not know the full cost. This makes decision-making more difficult.
Traditionally fixed production costs are absorbed into a product by means of a rate per labour hour. For example if overhead was planned at €1 million for a year and 100,000 labour hours were to be worked, then each labour hour would mean a €10 overhead cost. So a product taking two labour hours to make would be charged €20 overhead.
The traditional method can be criticised as over the years more and more overhead has been non-production type overhead and not related to the number of labour hours spent making a product – indeed automation of production in many industries has seen labour being of decreasing importance.
Another more modern way to allocate overhead to products is using ABC. The key in ABC is the word “activity”. In ABC, we can think of an activity as a collection of tasks which are linked in terms of being an overhead cost. For example, customer service, facilities management, quality control and machine setup are all examples of activities. The resources of the activity are determined, which are used to determine the cost of the activity – typically for a year. Then, what causes these resources to increase or decrease is determined. This is called a cost driver. For example, more complaints from customers will increase the resources needed by a customer service department. Using the cost driver, the overhead cost driver rate can be determined. Here’s a brief example:
A design department costs €100,ooo per annum – costs such as salaries, design materials, computer running costs etc. The more designs for new products the greater the cost, this designs are the cost driver. Lets assume there are 5,00o designs per annum, thus the cost driver rate is €20 per design. A product which needs say three designs will thus incur a €60 overhead costs for designs using ABC. If a product has nor designs, then zero overhead is incurred.
In a business, design (as per the above example) may just be one cost driver. Thus, the more resources (activities) consumer by a product the higher the overhead cost. This seems to make a lot of sense, and thus ABC is often used where overhead costs are not easily traced using direct labour hours (or similar) as a means to allocate overhead cost.
With ABC, all direct costs are assigned to the product/service in the same way as traditional costing methods. It is just the allocation of overheads that differs. Typically, ABC considers not only production overhead costs, but many other overhead costs which can be defined within activities.
Related articles
- Two activities for ABC and the appropriate cost drivers for those activities (globalexperts4u.wordpress.com)
- Introducing Overhead Cost (thebangaloresnob.wordpress.com)
Article in MAR – management accounting at Guinness over a century or so
Over the last year or two I have done some research on changes to management accounting practices over a century or so at the Guinness cooperage. This work is now available as a an article in Management Accounting Research see here
CVP in farming
Farmers Market (Photo credit: Macomb Paynes)
As you may know CVP analysis looks at costs, revenues and volumes to determine things like at what output level a business will break even or make a certain profit. This post provides a simple example of the effects of volume on the viability of a business.
Recently, a local authority in Dublin, Ireland announced plans to build a large sewage treatment in the north of the city. As part of this, a vegetable farmer in the area will lose 35 of his 120 or so acres to the plant. I listened to a radio broadcast where the farmer simply said this is too much land to lose and his operation becomes uneconomic.
Let’s think about this briefly in CVP terms. If we assume a stable price for the farmer’s products and stable variable costs (seeds, labour, fuel, fertilisers for example), then it would seem that a loss of about 25% of capacity would reduce the farmer from a profit scenario to a loss one. I am not an agricultural expert, but I would assume that the fixed costs consist largely of the equipment and buildings needed to operate the farm. If the land area is reduced (i.e. capacity is reduced), then the farmer simply does not have enough land left to produce enough revenue to cover these fixed costs and make a profit.
You can read more here.
Big data and business decisions – humans still needed
Here is a good article from CGMA magazine which highlights the importance of human interpretation of data. It is a reminder that although we have technology to analyse data which we could not do ourselves, we still need the human eye to make sense of data trends etc. and relate it to organisational context.
Related articles
- Infographic: The Physical Size of Big Data (domo.com)
The power of an infographic
I have written a few posts previously with infographics. I like them. They convey a message in an easy to understand way. Of course, as a management accountant, I would say they may also include some really useful information to help managers (and others) make decisions.
Recently, Dr Stephen Jollands from Exeter sent me this one. It is so clear and it’s message is direct and simple – despite the many complexities within renewables and the environment etc.
What is depreciation?
Okay, the last two posts were about assets, and now I’d like to give a brief introduction to depreciation. As you may know the accruals concept (also known as the matching concept) sets out how revenues and expenditures should be matched against each other – when cash is paid/received is nots relevant. When a business buys a non-current asset, the accruals concept kicks-in. The asset itself is typically used by the business for several years, and thus generates revenue. So applying the accruals/matching concept, the cost of an asset needs to be matched against revenue over several years. How do we do this? Well, we depreciate the asset. This means the cost of the asset is spread over several years.
This raise two questions 1) how much per year and 2) over how many years? This is where certain assumptions are made. First, an estimated useful life of an asset is determined, for example from previous experience of a similar asset. Second, then business will attempt to assume whether the assets contributes to revenue earned equally over time, or more in earlier years for example. In the former case, the business might use what is termed the straight-line method – which charges an equal amount each year. For example, is an asset cost €10,000 and it’s useful life is 5 years, then the depreciation expense in the income statement each year is €2,000. On the statement of financial position, the asset value falls by €2,000 each year. If an asset is assumed to earn more revenue in earlier years, for example a motor van or truck, then the reducing balance method can be used. This method charges more depreciation in the earlier years. For example, if we assume an asset costs €10,000 and is depreciated at 10% reducing balance, here is what will happen:
Cost €10,000
Year 1 (1,000) x 10%
Balance 9,000
Year 2 (900) x 10%
and so on…
Thus, using the reducing balance method, the asset will still have a value in the accounts for many years, but the depreciation charge will be smaller each year. If you think about the total costs of owning a car/van/truck, the repairs tend to get higher as it gets older, so the reducing balance method reflect this too.
How are assets classified in accounting?
In my previous post, I introduced assets. Now let’s see how assets are classified in accounting.
There are two major asset classifications 1) non-current and current, 2) tangible and intangible. Let’s have a brief look at each.
Non-current versus current assets
A non-current assets is one which typically cannot be converted into cash within one year. The classic example of a non-current asset is plant, property and equipment. Current assets normally convert into cash within one year e.g. receivables from customers, inventories. This non-current and current classification is used in the financial statements of most organisations.
Tangible versus intangible assets
This one is a little more tricky to understand, and it is something not normally seen on financial statements. As you might guess, a tangible asset is one which you can see and touch i.e it physically exists. Typically examples are again, plant, property and equipment, but also inventories are a tangible asset. Money due from customers is also arguably a tangible asset, as it does exist as money albeit somewhere outside the business. Intangible assets are those which do not physically exist, but yet have a value. This value may arise from intellectual or legal rights. For example, trademarks, patents, in-house software or knowledge built up through research and development are intangible assets. The accounting standard which governs intangible assets is IAS 38, and it gives some examples:
- computer software
- patents
- copyrights
- motion picture films
- customer lists
- mortgage servicing rights
- licenses
- import quotas
- franchises
- customer and supplier relationships
- marketing rights.
What is an asset?
The next few posts will provide some basic accounting terms and definitions – concentrating mainly on assets.
So what is an asset? If I look at a dictionary, I might see something like “a useful thing” or a “desirable quality”. This may be correct in a general sense, but in accounting we need to get a bit more specific. But before we do that, would you regard something which is useful or desirable as having some value to you? I’ d hope you say yes. Now keep that in mind.
If I look to some accounting rules such as the IASB Framework I get the following:
” An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”
Let’s break that down:
- It is controlled – does this mean you must own an asset. Simply, no, as you can control something, but not legally own it
- It as a result of past events – this means you bought it or somehow acquired it or rights to use it in the past
- Future economic benefits will flow – this means it will be something which directly or indirectly allows the business to make money. For example, an office building does not sell anything (usually) or deliver goods, but without on the business cannot carry on its work to bring in those economic benefits i.e. cash and profits.
So, going back to the general idea I introduced at the start, if you want a very basic tip to identify an asset, think of it as something of value to a business – a truck, a machine, a building, customers you owe money etc,
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