Types of Costs

Direct costs are those costs that cann be directly attributed to a product or product line, or to one source of sales revenue, or one business unit or operation of the business. An example of a direct cost would be the cost of tires on a new automobile.

Indirect costs are very different and can't be attached to any specific product, unit or activity. The cost of labor or benefits for an auto manufacturer is certainly a cost, but it can't be attached to any one vehicle. Each business has to devise a method of allocating indirect costs to different products, sources of sales revenue, business units, etc. Most allocation methods are less than perfect, and generally end up being arbitrary to one degree or another. Business managers and accounts should always keep an eye on the allocation methods used for indirect costs and take the cost figures produced by these methods with a grain of salt.

Fixed costs are those costs that stay the same over a relatively broad range of sales volume or production output. They're like an albatross around the neck of business and a company must sell its product at a high enough profit to at least break even.

Variable costs can increase and decrease in proportion to changes in sales or production level. Variable costs vary proportionately with changes in production/

Relevant costs are essentially future costs that could be incurred, depending on what strategic course a business takes. If an auto manufacturer decides to increase production, but the cost of tires goes up, than that cost needs to be taken into consideration.

Irrelevant costs are those that should be disregarded when deciding on a future course of action. They're costs that could cause you to make a wrong decision. Whereas relevant costs are future costs, irrelevant costs are those costs that were incurred in the past. The money's gone.

About GAAP

While many businesses assume that accountants are bound by generally accepted accounting practices and that these are inviolate, nothing could be further from the truth. Everything is subject to interpretation, and GAAP is no different. For one thing, GAAP themselves permit alternative accounting methods to be used for certain expenses and for revenue in certain specialized types of businesses. For another, GAAP methods require that decisions be made about the timing for recording revenue and expenses, or they require that key factors be quantified. Deciding on the timing of revenue and expenses and putting definite values on these factors require judgments, estimates and interpretations.

The mission of GAAP over the years has been to standardize accounting methods in order to bring about uniformity across all businesses. But alternative methods are still permitted for certain basic business expenses. No tests are required to determine whether one method is more preferable than another. A business is free to select whichever method it wants. But it must choose which cost of good sold expense method to use and which depreciation expense method to use.

For other expenses and for sales revenue, one general accounting method has been established; there are no alternative methods. However, a business has a fair amount of latitude in actually implementing the methods. One business applies the accounting methods in a conservative manner, and another business applies the methods in a more liberal manner. The end result is more diversity between businesses in their profit measure and financial statements than one might expect, considering that GAAP have been evolving since 1930.

The pronouncement on GAAP prepared by the Financial Accounting Standards Board (FASB) is now more than 1000 pages long. And that doesn't even include the rules and regulations issued by the federal regulatory agency that jurisdiction over the financial reporting and accounting methods of publicly owned businesses - the Securities and Exchange Commission (SEC).

Budgeting

Ugh, budgeting is one of those topics we'd rather avoid, but in business, it's an absolute necessity. To prepare a reasoned and thoughtful budget, an accountant must start with a broad-based critical analysis of the most recent actual performance and position of the business by the managers who are responsible for the results. Then the managers decide on specific and concrete goals for the coming year. It demands a fair amount of management time and energy. Budgets should be worth this time and effort. It's one of the key components of a manager's job.

To construct budged financial statements, a manager needs good models of the profit, cash flow and financial condition of your business. Models are blueprints or schematics of how things work. A business budget is, at its core, a financial blueprint of the business. Budgeting relies on financial models that are the foundation for preparing budgeted financial statements. Those statements include:

--Budgeted income statement (or profit report): This statement highlights the critical information that managers need for making decisions and exercising control. Much of the information in an internal profit report is confidential and should not be divulged outside the business.

--Budgeted balance sheet: The connections and ratios between sales revenue and expenses and their corresponding assets and liabilities are the elements of the basic model for the budgeted balance sheet.

--Budgeted statement of cash flows: The changes in assets and liabilities from their balances at the end of the year just concluded to the projected balances at the end of the coming year determine cash flow from profit for the coming year.

Budgeting requires good working models of profit performance, financial condition, and cash flow from profit. Constructing good budgets is a strong incentive for businesses to develop financial models that not only help in the budgeting process but also help managers in making strategic decisions.

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Financial Accounting

Financial Accounting: Tools for Business Decision Making

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From the Publisher
This user-friendly book teaches readers fundamental accounting procedures with an emphasis on the relationship between the procedural detail and the fundamental accounting equation. It gives readers the conceptual and procedural accounting tools they need in order to make sound internal and external business decisions. --This text refers to an out of print or unavailable edition of this title.View product details at Amazon

Principles of Accounting

Needles, Powers, and Crosson continue to help instructors stay on top of the change curve with Principles of Accounting. Balanced, flexible content in this market-leading text is supported by an array of integrated print and technology supplements. Whether an instructor wants to present a user or procedural orientation, incorporate new instructional strategies, develop students' core skills and competencies, or integrate technology into the classroom, Principles of Accounting provides a total solution, making it the natural choice for accounting instructors. Ideal for two-semester courses, the Tenth Edition focuses primarily on the use of accounting information in today's business world--beginning with sole proprietorships--and represents the most significant revision of the text to date. Content updates reflect current accounting and business practices, while greater attention is given to ethics, service enterprises, and international issues. In addition, the text features a more concise, accessible writing style; a new design to emphasize the user-oriented content; and enhanced technology components for both instructors and students. Accuracy reviewers check every line and work through each exercise in the text and supplements, making Principles of Accounting the most accurate among similar texts on the market. View product details at Amazon

Accounting Handbook

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