Accounting for decision making

Accounting for Decision Making

Shelter Partnership's Case Study

Purposes of Cost Information

The intended purpose of cost information is to provide a basis for determining the expenses and revenues associated with a particular activity (or cost object). Generally, cost and income is measured in order to determine net income or profit margins. However, as Shelter Partnerships is a non-profit, the cost information forms a basis for the allocation of resources and to assist with decisions about scaling. The cost information of Shelter Partnerships can also be used to address any cycles in the stream of donations and contributions that can impact the overall ability of the non-profit to meet its mission. In addition, since Shelter Partnership regularly applies for grant funding, it is essential that their accounting system be readily interpretable to grant reviewing bodies. Fund development cannot be sustained for long in an environment that is only loosely accountable for revenue -- in fact, this is one of the public's most common criticisms of not-for-profit organizations, and it is often their undoing (or at least that of their executive directors). Shelter Partnership must ensure that their books provide an accurate accounting of all operational expenditures and all funds received -- regardless of the source (including "in-kind").

Cost Objects

Shelter Partnership cost objects. The cost objects for the Shelter Partnership include the technical assistance work, the program development work, and the public policy support work. Each of these cost objects has a discrete focus and cost should be separately measured for those objects (Averkamp 2011).

Shelter Resource Bank cost objects. The cost object for the Partnership Shelter Resource Bank consists of the direct material assistance to the homeless shelters.

Where over-head and administrative costs are shared, the percentage of costs should be allocated to the objects according to use or consumption (Averkamp 2011).

Accuracy of Ruth Schwartz' Estimates

Schwartz did not organize the financial accounts separately for the Shelter and the Resource Bank, though they are essentially two distinct business units. The single stage cost accounting system that Schwartz used creates distortions because more than a single activity is occurring under that accounting system and, further, the percentages of over-head costs used for the different activities are not reflected when a single enterprise-wide accounting system is used. The Shelter Partnership has four distinct activities divided across two business units ("Shelter Partnership" 2011). A traditional two-stage cost allocation system of accounting would provide greater accuracy and detail that would better suit the needs of a non-profit that is active in fund development.

Issues about accounting for revenues were addressed in the section on the purposes of cost information. Suffice it to say -- here -- that Schwartz' method of consolidating all revenue into one pot does not serve the agency well (Martin 2010).

Schwartz' financial statement, as categorically expressed, is a bit of an amalgamation between a budget and a financial statement. With personnel as the largest line item, Schwartz should break down that account in more detail, particularly since personnel are shared across the two main business units. She has carefully delineated costs for office expenses -- which are quite minor compared to personnel costs -- but then resorted to lumping all costs for all regular employees together. Schwartz has identified specific personnel costs by role for the independent contractor positions, and this should definitely be done for the regular employees, if not on the financial statement, then on the annual budget. Schwartz's approach is not consistent on the financial statement: If personnel salaries are to be grouped, then independent contractor wages should also be grouped. Also, costs of benefits and payroll tax expenses (PTE) should not be rolled into the salaries on the budget (as the case study narrative indicates). Benefits are often re-negotiated and PTE can vary across fiscal periods, so both of these items should be segregated (as they have been on the Schwartz' statement -- at least for some of the staff).

Addressing "The Concern"

Schwartz is right to be concerned about her accounting for both the warehouse space and the cost of insurance for the Resource Bank.

The warehouse space. It is not good accounting practice to omit from the books a large in-kind contribution to a non-profit (Averkamp 2011). That Shelter Partnership has a business relationship with the General Services Administration (GSA) conveys a level of organizational stability that funders will find appealing. And, as Schwartz appropriately surmised, the warehouse space might qualify as an asset (or a liability, if it is leased space), depending on the agreement with the GSA. Without acknowledging the warehouse space on the budget or the financial statement, Schwartz leaves a large gap that will set lenders wondering -- which is generally not a good thing to do.

Insurance costs. There is a substantive difference between what was allocated on the budget ($8,000) for insurance and the amount that was actually spent ($2,925) on insurance in 1990. Absent designations of insurance costs to the two business units, it is unclear what accounts for this difference. For simple cost accounting, and to support budget decisions, the insurance costs of the Shelter Partnership and those of the Shelter Resource Bank should be discrete. Particularly important is a clear idea of the cost of automobile insurance and insurance that covers those individuals involved in the loading and unloading of the truck.

Certainly the total premium for Shelter Partnership should not be driven by the Resource Bank, as attributed to Schwartz in the narrative. It is reasonable to expect that the Shelter Partnership will have a business insurance premium that covers office equipment, liability insurance covering Officers and Directors, and an insurance umbrella that covers any liabilities which might occur as a result of carrying out the duties and responsibilities of the business, much of which takes place in community settings. The liability umbrella ought to be written to cover both the Shelter Partnership and the Shelter Resource Bank, or two separate policies should be written. Regardless of policy types, there are likely to be discounts for multiple policies, which have been known to reduce overall insurance costs over a single policy approach.

Prestige Telephone Company

Results of Operations

Depreciation. An accounting irregularity can be seen in the method used for quarterly reporting of depreciation. The computer leasing cost should not appear as a lump sum on the quarterly report. Office equipment, such as computers and servers and peripheral equipment, is depreciated, and it is the depreciated amount -- as determined by the selected depreciation schedule -- that is entered in the reports for the period. Since the quarterly report format used by Prestige Data Service shows three separate months, the depreciation amount in each column will be 1/12 of the annual depreciation cost. Assuming that the $26,500 depreciation cost is accurate, the $95,000 cost of the computer leases would not be listed as a monthly expense on the quarterly report. Correcting this error would result in a positive balance for each month, accordingly: January net income = $53,528; February net income = $54,659, March net income = $73,562. Accrued depreciation costs would actually be shown over the period of depreciation in a contra asset account, Accumulated Depreciation.

Rental space. Further, the cost to rent space is an expense to Prestige Data Services, but it is revenue for Prestige Telephone Company. As such, it should be deducted from the overall net income (for purposes of analysis, not in actuality) when considering the real costs of operations. It is wholly appropriate for the subsidiary journals to show the cost of rent, but it may be an arbitrarily assigned cost if the building space is owned by Prestige Telephone Company. In that case, it is fair to assume that costs for utilities and maintenance should reasonably be charged to the subsidiary, but a direct expense for leased space may be a burden unfairly charged against the profit margin. Should Prestige Telephone Company elect to maintain the space rent arrangement with its subsidiary, it would be appropriate for the two entities to establish a consolidated income statement that accurately shows revenue derived from Prestige Data Services.

Available service hours. Since service is made available to commercial customers for 24 hours each weekday and for 8 hours each Saturday, it does not make sense to include the service hours in the calculations for the total revenue hours. Not only should this figure be listed separately, but any variation from month to month -- prorated by the number of days in the month -- should be discernable and attributable. If the contractor providing the computer service and maintenance cannot be held to a half-day Saturday and Sunday schedule, the company should consider hiring a different contractor.

Monthly Breakeven

The commercial sales of computer use would need to approach 224 hours on average each month in order for the Prestige Data Systems business unit to break even (Arsharm 2011). The calculations are as follows:

Where:

Q = Break-even point (units of production)

FC = Fixed Costs

VC = Variable Costs per Unit*

UP = Unit Price

Q = FC / (UP -- VC)

Since more than one unit type contributes to revenue, the percentage of contribution to the total revenue for each unit type (intracompany and commercial hours) was calculated. This percentage provides the base for calculating the proportionate break even.

*The assumption is that all costs are fixed and no costs are variable for the production of computer hours capable of generating revenue. The only variable costs would be power to operate the servers and computers, but it is doubtful that they would be shut down during off hours, though they may have a "sleep" function, and any adjustments to worker hours, but since we don't have a base from which to calculate these figures, the results would be speculative, at best. Regardless, the variable costs are likely to be very small -- $5 to $25 per hour -- and can reasonably be omitted from gross estimates.

Estimated Average Revenue

82000

42%

105600

54%

186,933

95%

10370

5%

197,303

Total

Intracompany

Commercial

FC =

57423

73829

Units

Var Cost

0

0

UP=

Q=

92

82000

105600

Impact on Operations

Assumption A

By increasing the commercial price of computer service hours to $1,000, generating an estimated reduction in demand of approximately 30%, the company would experience a loss of revenue in the amount of $39,600 over Q2. The estimated figure for April alone would be a loss of revenue of approximately $13,200. Calculations are shown in the Addendum.

Assumption B

Reducing the commercial price of computer service hours to $600, all other things remaining the same, would reduce revenue to $171,570 for the month of April. However, if the demand picked up by 30% as estimated, then the revenue for April should approach $195,330. Calculations are shown in the Addendum.

Assumption C

All other things being equal, an increase in demand by 30% should result in monthly revenue of approximately $195,330. If the average fixed expenses figure is $136,720, as calculated from Q1, then the net profit is $58,610. This figure is well above any reasonable anticipated expenditure for sales promotion costs. Calculations are shown in the Addendum.

Assumption D

Reducing by 20% the number of hours that commercial computer service is available would reduce revenue to $176,850 for the month of April. Calculations are shown in the Addendum.

Suggestions for Changes

"Corporate services" is used as a catch-all category for work provided by Prestige Telephone Company employees for Prestige Data Systems. While it is reasonable for the costs of the corporate services to be based on some percentage of the full-time equivalents (FTE) of the personnel doing the work, these percentages should show up explicitly in association with an identified role. For example, the percentage of time that payroll personnel expend to calculate and pay wages and benefits to the Prestige Data Systems employees should be a line item in the budget, and should also be listed under Wages and Salaries on the quarterly statement. Ostensibly, the statement could retain the line item "Corporate services," but the line item should be moved to the appropriate activity.

As explained in the section on Available Service Hours, the accounting for revenue hours should be adjusted to separate the hours set aside for computer maintenance and servicing.

Body Glove

Purposes of Budgeting System

The budget was used during the year primarily to monitor production performance, and to detect early "red flags" of potential problem areas. Management compared budget-to-actual for each month and on a year-to-date basis. Budget monitoring occurred monthly, and discrepancies could be reflected on the performance ratings of department heads if reasonable factors -- circumstances beyond the control of the department heads causing budget overruns -- could not be ascertained.

Key Events in Budgeting Process

The body suit production process entails two manufacturing cycles corresponding with preparation of the spring line and the fall line. Because of their denser and more expensive fabric, body suits in the fall line consumed more labor. However, production continued for both lines throughout the year. A three-phase order cycle consists of the following stages: 1) pre-book, 2) build, and 3) deliver. Pre-book takes place during October and November for the fall line, and May/June for the spring line. Estimates of upcoming orders were formed during the pre-book period when salespeople visited retail stores to show samples of the new styles in the seasonal line-up. Volume discounts and waived freight charges were granted to retailers who ordered during the pre-book period. From this initial period of ordering and estimating orders, the stock was built in readiness for production. The build period takes place in November/December for the fall line and in June/July for the spring line. The target time period for having the fall in the retail stores and outlets was August/September, and the target time period for the spring line was February/March. The delivery period for the fall lines runs January through June and the delivery period for the spring line runs September through December.