Financial Accounting Question

[Shaun.P]

I am doing an introduction to accounting class (we are doing Cost Accounting) , and one of the questions I have for an assignment asks you: "Costs are a matter of opinion. Discuss why this might be so".

The lecturer is hopeless and I think this question is too vague to answer. My answer so far:

Costs can vary depending on the costing system used. It also matters how 'deep' you analyze the situation and the perspective you take. For example, (one we talked about in class) the cost of Strathclyde University running a particular course. They could work out the cost of a lecturer per month by dividing his/her salary by 12, or they could calculate the cost per student, and work out how much the lecturer costs per lecture, and divide it by the amount of students in the class to work out the cost of the lecturer for each student, which in turn lets the University know how much each student costs for all their courses and lets them set 'tuition fees'. You can also work out the cost of heating and lighting a room per student, or it could just be monthly. Another way to look at things is that the costs will be the same no matter how many students are in the class. If there is one student, they still need a room, to heat and light the entire room. You can't light one twentieth of a room, or heat one twentieth of a room if one student turns up and the class size is twenty students.

It's a bit messy. The answer is to be 400 words, this is only 200 and I feel like I'm beating about the bush with the answer. Any help would be appreciated.

 

[mkrishnan]

Hmmm, my thoughts:

1) It's not such an unfair question. I don't think anyone can expect you to provide any kind of omnibus or exhaustive answer to this question, in 400 words or 40,000 words, but I don't think that makes it unfair.

2) Don't forget paragraph mechanics and essay composition, just because you only have 400 words. One doesn't say "You can do this..." and "You can do that..." in an essay either.

3) I think there are lots of other relatively discrete approaches to this question that you could also consider for incorporation. You provide a painfully long example of just one way in which cost is subjective. Another option you could consider for inclusion would be something like opportunity cost or the idea of TCO. Very simple examples are, for instance, that university may cost one tens of thousands of pounds and have hundreds of thousands of pounds of positive impact on their wage-earning. One computer might cost 500 pounds more than another, but by virtue of lower likelihood of defect, better longevity, and improved resale value, it may arguably be cheaper on a lifespan basis.

Relatedly is the idea of relatively intangible motivators. People don't make purchasing or economic decisions solely based on price or even TCO. One could argue that other "emotionally valent" aspects of a purchase are "not cost," but why aren't they cost? If I buy a pair of jeans for 20 pounds, and they detract 20 pounds from my wallet and some intangible element from my general fashionability, why is the impact on the wallet a cost and the impact on my fashion statement not a cost?

 

[rhsgolfer33]

Well I guess it could be argued that costs can be viewed in many different ways. You could say that some people take into account only the cost of the asset or inventory and don't take into account Product costs or (if its PPE) cost to prep the building, land, etc. Though its more appropriate in Economics, you could argue that people fail to take into account implicit costs and only think about the explicit cost of the asset when they analyze cost. I suppose you could use the Opportunity Cost argument as well. They could also be a matter of opinion because of the cost flow assumption. If a company adopts SL, Activity, DDB, or SYD, they probably have an opinion about how the useful life and cost of their asset.

Honestly, this is kind of a weird question, its pretty difficult for an entry level accounting student and its kinda vague. My personal opinion is that costs really aren't that much of an opinion in accounting; there are many different systems and FASB statements set up to make sure that you don't have a huge choice about how or what your costs are. However, cost is much more of an opinion in economics.

 

[Macky-Mac]

LOL I'm sure my accountant would tell you that his clients have widely varying opinions as to what qualifies as a "cost"......and so would the government when they look at his clients' tax returns!

Some things are quite obviously "costs" but for other items, it's not so clear. It becomes a matter of opinion as to where you draw the line between what is and isn't a "cost."

In your example, the salary for the lecturer is obviously a "cost," but what about the salaries of the administrators of the University? They spent time having meetings to consider offering the class, should some part of their salaries be included as a "cost" of offering the class? Or the salaries of the secretaries of the administrators on the committee? Or the printing costs for the committee's report to the Dean of the school? How about the cost of the lunch they shared when the meeting ran long? And what about the time they spent discussing possible alternative classes to offer in lieu of the one they did offer?

 

[Shaun.P]

Thank you for the help, all your information has been really helpful.

 

[Caezar]

Thank you for the help, all your information has been really helpful.

There are different types of cost measures: cost of production (what you paid for it), cost of replacement (what you ould have to pay to replace it), economic cost (cost of the next best use for the product or service), etc.

Economic cost is not easy to grasp at first, but the idea is simple. If you own an apartment and you choose not occupy or rent it, does this decision have a cost? You might think it does not, since there this decision does not result in any cash outlay. But the value of the second-best solution (e.g. rent it for let's say 1,000 USD) is your economic cost.

 

[Shaun.P]

Hello again! In regards to my initial post, I typed up my solution and submitted it to my lecturer. It failed. I asked for him to email it back to me with my distribution of marks, but he never ever replied. Due to failing that assignment, I have to submit a more detailed assignment which asks five questions. The assignment has to be between 1600 and 2000 words. I think this is stupid, pointless and bit unusual considering this class is an Introduction to Accounts.

Anyway, I've been looking at my notes. For the first question, I cannot find anything relating to this in my notes (or my course book). For question two, my answer is short because this is all the notes on this I have and I don't fully understand it.
Question 3 is one of his famously vague questions, and I have tried to answer it as best as possible. Question 4 I found the answer in my notes, but the answer is short, but I don't think there is anything that can be added to it.
Question 5 is very similar to the initial question I posted with. Unfortunately it failed, and I have received no feedback as to why it was wrong. Hence I am afraid to go down the same path again.

I would appreciate it if any of you could help me with these questions, either explain it a bit more or point me in the right direction, or add to my current answers.

Any help is greatly appreciated.


1. Why do we say that accounts should show a true and fair view of the affairs of a business? Why not just say true?

2. Explain the differences between relevant costing and CVP analysis. Give examples of the circumstances in which each technique might be used.

Relevant costing and Cost Volume Profit (CVP) analysis are both methods of using cost information to help make decisions. Relevant costing would be used when considering whether to make or buy a product, close down or continue operations (maybe in a particular division of a company) and whether or not to take on special contracts.
CVP analysis would be used on how to price a product, determining levels of product output (activity levels) and in business strategy.
CVP analysis is concerned only with costs that must either be fixed or variable (in the case of semi-variable costs, these must be split up into variable and fixed parts), whereas relevant costing is concerned with opportunity costs and costs which entail a future outlay and vary under different circumstances.


3. CDC Limited is a manufacturing company which sells all its output on credit. The company is successful. Its sales have been increasing rapidly recently and the company is highly profitable. What steps should CDC take to ensure that it always has sufficient funds to meet all its needs? If the company encountered any cash flow problems what steps might it consider taking to resolve its difficulties?

Since CDC Limited sells all of its output on credit; it increases its chances of the company gathering bad debt from customers. If the company were to encounter cash flow problems (such that there were insufficient funds to continue operations, or insufficient funds to provide goods on credit to customers) I would recommend that CDC Limited do the following:

• For the customers (debtors) who owe CDC Limited money, CDC Limited should encourage the debtors to pay on time. Either with some sort of financial incentive for paying on time, or paying off their credit agreements with CDC Limited early. Perhaps a percentage refund on interest paid, or preferential interest rates in the future.​

• Reduce the length of the credit agreements, which will mean that CDC Limited receives the money quicker. For example, CDC Limited sells 1000 laptops to PC World on a 24 month payment plan, on 24 equal payments, at 7% APR. CDC Limited could offer a 12 month payment plan with less interest. Although the payments would be higher to PC World, the lower rate of interest could perhaps encourage them.​

• Rather than sell all the goods entirely on credit, try to get a deposit from the customers for some of the goods. Even a deposit of say, 10 per cent would reduce the risk of bad debt (as a 10% payment has already been paid). This would increase the funds available to CDC Limited.​

If bad debt is not so much a problem, CDC Limited should try to increase its capital. Either by a loan from the bank, or issue new shares (although this may be difficult due to CDC Limited being a limited company, hence the shares will not be traded on a public stock exchange).

CDC Limited should take the following steps to ensure it always has sufficient funds to meet all of its needs:

• It is important for CDC Limited to have good liquidity. The current assets of the company must be very liquid to ensure the availability of funds to be able to sell goods on credit, and to continue to produce goods. If the company is currently highly profitable, I would make sure that a lot of this is kept as cash in the bank (rather than long term investments).​

• As the company is expanding rapidly, CDC Limited will need a lot more capital in order to manufacturer goods, pay all overheads and pay suppliers. Since CDC Limited offers these goods on credit; CDC Limited might not receive any down payment (i.e. no deposit). Current income might not be enough for this. A line of credit from the bank would be recommended so that if CDC Limited runs into any liquidity issues the line of credit is available. However, if the company saves a lot of its money, this may be avoidable.​

• Ensure appropriate credit checking of companies to reduce exposure to bad debt. CDC Limited should obviously have standards for who it offers credit to. If CDC Limited was to offer credit to everyone, this would not be sensible and this business model would surely fail. CDC Limited has to be selective and ensure that the companies are credit worthy and pay their bills on time. Credit scoring can also help with assigning companies with an appropriate credit rating (less credit worth companies would pay more interest – similar to how credit cards work).​

4. Why don't companies include the value of their employees and their reputation with their customers in their Balance Sheets? Should they do so?

The value of a companies employees and their reputation with their customers are both items that should not be included in the balance sheet. The reason for the omission for employees is that any company does not hold exclusive rights of control over their employees, and the value of employees is something that cannot be measured or calculated in a reliable, conventional monetary way.
In regards to the reputation with their customers, again, this is something that is difficult to calculate with any degree of reliability and cannot be calculated in a conventional way, like say depreciation can be calculated on a car.​

5. Why might we consider some costs to be a matter of opinion? If costs are a matter of opinion does that mean that all cost estimates are useless?