Chapter 6
KCQ #1 – Importance of costs
While some companies have a large number of costs, costs can determine whether a company makes a profit or not. Therefore, each cost has to be accounted for. If the costs went unnoticed, it could easily get out of hand and have a detrimental effect on the business. With that said, it would be an extremely time consuming task to associate costs with different cost objects. Therefore, I believe that large companies need strong accounting departments to keep on top of this. The company cannot have costs just “floating” around, without anyone knowing where it has come from because this will take the company away from making a profit. Doing this will allow the company to assess what costs can be cut if need be, and what costs are not as important and therefore could be mitigated to boost the companies profit instead. Costs are one of the most vital accounting factors in a firm, as many important decisions are made from looking at the costs. For example, in my own personal life, if I am struggling financially one week, looking at my costs in the previous week, I will be able to work which ones I can reduce in order to financially survive. This is why it is also important to keep a thorough record of costs.
KCQ #2 – Knowledge value vs economic value
Sometimes the value of knowledge can outweigh the economic value of a company. For example, keeping a highly skilled and highly experienced employee will be a much more efficient decision then training a new employee. Without employees in a firm, it could not operate. Therefore fostering the development and progression of employees is of higher value in the long-term as it is setting them up to ensure the company can function, even if management was not there. Providing training or mentoring to an employee could be seen as an indirect cost because currently they are not operating directly in the firm but one day, they will be and their skills will be generating the revenue for the firm.
KCQ #3 – Confusion with indirect costs and apportioning them to cost objects.
It seems, in a firm, organising and determine where indirect costs should be apportioned too, sounds like a complicated topic and often causes conflict amongst the firm. Also, what is considered an indirect cost is subjective and therefore each employee will have their own opinion on that too. A clear example of an indirect costs, associated with supporting the operation of a firm, could be the engineers which service the plan in between flights. These engineers are not directly related to the operation of an airline, rather the staff boarding the passengers at the gate is a direct cost because they are directly involved in the airline operation.
KCQ #4 - Functional-based and activity-based costing systems.
Functional-based costing systems allow the indirect costs to be divided and associated according to the function of an activity. For example, in a supermarket, part of the electricity bill will be associated with the running of the fridges. Since there are usually a lot of fridges in a supermarket, more of this indirect cost (electricity bill) will be associated with the fridges as opposed to the one microwave in the staff lunch room. Therefore, the indirect cost is divided according to its role in the operation.
Whereas, activity-based costing system is concerned with which activities are causing these indirect costs. For example, manufacturing a car, the machinery that constructs the car is relatively important and therefore the engineering and maintenance associated with this machinery would have a higher indirect cost associated with it due to its role with the production of the product (car).
KCQ #5 - Contribution Margin
Contribution margin (CM) = sales (S)- variable costs (VC)
Contribution margin ratio = contribution margin / sales revenue.
This concepts first confused me when I read it. I had to re-read it multiple times. I was trying to understand what was contributing to what. And what did it matter when minusing just the variable costs. Don't we want to minus all costs? Cause that is where the profit lies? However, after thinking about it a bit longer, this concept of a contribution margin is concerned with working out what money contributes to paying the fixed costs. The less variable costs the better because fixed costs stay the same.
Chapter 8
KCQ #1 – Forward looking in accounting + predicting the future
When I read about forward-looking and having to predict the future in accounting, it reminded me a lot of forecasting in aviation. We often forecast to predict traffic growth or demand growth in the future for an airport or even an airline. This is to ensure the appropriate measures are in place to handle the future and to ensure the required resources are ready, like an extra runway or extra staff. This is similar to accounting in the sense that firms want to predict the future so they can make decisions for their firm. Forecasting uses the same technique for both these industries, aviation and accounting, where it looks at the history trends through a time-series analysis. Simply by plotting the historical data on a graph, we are able to obtain an general idea of what the future would look like too.
KCQ #2 – Irrelevant costs + sunk costs
Sunk costs are like costs that have sunk to the bottom of the ocean and on one has anyway of retrieving them. This is because once a firm has paid the cost, they can no longer get it back. For example, in life, a sunk cost is the cost paid for a new microwave because it has been paid and we have no one of getting that cost back. If we were trying to budget and predict our future budget for our household, we wouldn’t consider the cost of the microwave as it is irrelevant to any decision making for the future.
KCQ #3 – How do we work out variable costs?
In a large company, how is it possible to work out the variable costs for each product? How is it possible to know the exact variable cost if it is changing all the time? How do I work out the variable cost per unit of the product produced? This concept of variable costs still confuses me because for example, in an airline, there would be endless amounts of variable costs, depending on the time of day with landing fees, depending on the airport they are flying too and then considering if there is a diversion. So, wouldn’t it be so variable to know the exact variable cost?
KCQ #4 – time value of money
Another thought that I had while reading about the time value of money is also the fact of a always changing exchange rate and the value of money. For example, $5 now is not as valuable as it was 50 years ago. In the past, you would have been able to purchase a multitude of items with $5, however nowadays, it would be a struggle to even get a coffee for $5. Therefore, when making investments in a firm, it is important to consider that fact that $1000 now, might be become worth more in 20 years time.
Another consideration, mainly for international/worldwide companies and firms is the ever changing exchange rate. Currently, the US dollar as dropped drastically making the exchange rate very poor from AUD to USD. This could potentially effect a firm when making transactions internationally as they will be losing money if going from AUD to USD, as an example.
KCQ #5 – Confusion with NPV
What does it mean by discounted rate? Is it like when you get staff discounts on a items at the store you work at? How do we work out the discount rate? Does it change each year? Does it depend on the accountant or manager – therefore will each firm do it differently? This method concerns me with the subjectivity of it, and it seems to be open to biases. For example, the firm could manipulate the discount rate to ensure a higher positive NPV to make the company “look better”.
To be honest, I have not heard of NPV until reading the study guide either so I am still trying to understand the concept. However, from what I know, it is about determining if an investment will add value to the firm in the future. And this is achieved by using a discount rate – what the discount rate is and how little or big it is, I am not sure. However, it would be an important tool for a firm to use because they would not want to invest in something that is going to remove value from their firm.
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