Financial Managers, it Is Important

¶ … financial managers, it is important that you identify and allocate costs appropriately. Discuss the major cost categories. What are some of the methods used to determine the cost category?

Two primary categories of costs exist: direct costs and indirect costs. Direct costs, as their name suggests, are those that can be identified specifically as having a relatively stable contribution to the final cost of a project. Indirect costs tend to be more variable. A good example of direct and indirect costs may be found when constructing a budget for going to college. Examples of direct costs might include tuition, mandatory activity fees, and housing fees (such as the cost of a dormitory room). Without satisfying these costs, which are all directly paid to the institution, attending school is impossible. However, there are also indirect, contingent costs not paid to the school which are just critical and must be satisfied to successfully complete a degree such as books, transportation and off-campus rent (if not living on-campus), a computer, and personal expenses (Direct and indirect costs, 2010, Sallie Mae).

How can service organizations benefit from activity-based management to become competitive?

Activity-based management focuses on maximizing organizational value from streamlining processes, which makes it ideal for service-based organizations. For service organizations, 'people' and 'processes' rather than 'products' are the focus. Moving individuals more effectively from task to maximize their knowledge base or simply reduce transportation costs; eliminating wasteful extra salaries by consolidating tasks for workers; using technology to speed worker processes; and encouraging 'horizontal' management strategies rather than forcing workers to wait for top-down controlled decisions are possible reforms that can be facilitated with ABM. "Processes and activities are the central nervous system of the process-based organization and represent the core of what the organization does to create value for its customers and shareholders" (ABM, 2001, CIMA)

Cost flows in an accounting system

Cost flow assumptions involve how costs are allocated within an enterprise: the two most typical methods are LIFO and FIFO. Last in, first out (LIFO) means "the units remaining in ending inventory are costed at the oldest unit costs available; the units in cost of sales are costed at the most recent unit costs available" (Gibson, 2001, p1.). For industries with relatively stable demand and costs, and large inventories and predictable growth, LIFO is often used. It also tends to be more advantageous for tax purposes. FIFO "assumes that the cost of items sold in a period reflects the oldest cost in inventory just before sale. As a consequence, remaining inventory valued at FIFO more closely represents current or replacement cost," and is a more accurate reflection of the physical flow of goods, but can be disadvantage for a producer in an inflationary market (Gibson, 2002, p.1)

Just-in-time manufacturing (JIT)

JIT focuses on keeping inventories low to minimize waste and the accumulation of excess products. Stockpiled inventories quickly grow obsolete and often must be sold at a loss. Thus JIT is dependant upon maintaining close relationships with suppliers, to flexibly respond to shifts in demand. Suppliers for JIT firms tend to be relatively few, and there tends to be a high degree of compatibility between different component parts, to further streamline processes and enable all inventories to be used during production surges. The relatively few suppliers and replacement parts demands that quality control must be extremely high at JIT firms. The demand pulls the manufacturing processes, rather than the supply.

JIT has required a new approach to accounting, as "traditional and standard costing systems track costs as products pass from raw materials, to work in progress, to finished goods, and finally to sales" (Johnson 2004). JIT has resulted in the creation of so-called "backflush accounting' which focuses on the output of an organization and then works "backwards" when allocating costs between cost of goods sold and the cost of available inventories (Johnson 2004).

Product vs. period classification

Product costs are the relatively stable material costs that are involved in making the product, such as input materials, labor, and overhead (Product cost vs. period cost. (2010). Accounting for Management). Period costs include the more variable and less predicable costs of manufacturing such as administrative costs and marketing and sales costs.

Value chain