- Define and explain direct and indirect cost. Give examples of direct and indirect costs.
- What is the difference between direct and indirect cost.
Definition of Cost Object?
Costs are assigned to objects for a variety of purposes including pricing, profitability studies, and control of spending. A cost object is any thing for which cost data are desired including products, product lines, customers, jobs, and organizational subunits. For the purpose of assigning costs to cost objects, costs are classified as direct cost and indirect cost.
Direct Cost:
Definition and explanation of direct cost:
A direct cost is a cost that can be easily and conveniently traced to the particular cost object under consideration. A cost object is any thing for which cost data is required including products, customers jobs and organizational subunits. For example, if a company is assigning costs to its various regional and national sales offices, then the salary of the sales manager in its Tokyo office would be a direct cost of that office.
Indirect Cost:
Definition and explanation of indirect cost:
An indirect cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration. For example a soup factory may produce dozens of verities of canned soups. The factory manager's salary would be an indirect cost of a particular verity such as chicken noodle soup. The reason is that the factory manager's salary is not caused by any one variety of soup. To be traced to a cost object such as a particular product, the cost must be caused by the cost object. This salary of manger is called common cost of producing the various products of the factory. A common cost is a cost that is incurred to support a number of costing objects but cannot be traced to them individually. A common cost is a particular type of indirect cost.
A particular cost may be direct or indirect, depending on the cost object. While, in the above example, the soup factory manager's salary is an indirect cost of manufacturing chicken noodle soup, it is a direct cost of the manufacturing division. In the first case, the cost object is the chicken noodle soup product. In the second case, the cost object is the entire manufacturing division.
Thursday, October 14, 2010
Cost Classifications for Assigning Costs to Cost Objects (Direct and Indirect Cost):
Learning Objective of the article:
Break Even Point Analysis-Definition, Explanation Formula and Calculation:
Definition of Break Even point:
Break even point is the level of sales at which profit is zero. According to this definition, at break even point sales are equal to fixed cost plus variable cost. This concept is further explained by the the following equation:
[Break even sales = fixed cost + variable cost]
The break even point can be calculated using either the equation method or contribution margin method. These two methods are equivalent.
Equation Method:
The equation method centers on the contribution approach to the income statement. The format of this statement can be expressed in equation form as follows:
[Profit = (Sales − Variable expenses) − Fixed expenses]
Rearranging this equation slightly yields the following equation, which is widely used in cost volume profit (CVP) analysis:
[Sales = Variable expenses + Fixed expenses + Profit]
According to the definition of break even point, break even point is the level of sales where profits are zero. Therefore the break even point can be computed by finding that point where sales just equal the total of the variable expenses plus fixed expenses and profit is zero.
Example:
For example we can use the following data to calculate break even point.
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Calculation:
Sales = Variable expenses + Fixed expenses + Profit $250Q* = $150Q* + $35,000 + $0** $100Q = $35000 Q = $35,000 /$100 Q = 350 Units Q* = Number (Quantity) of units sold. **The break even point can be computed by finding that point where profit is zero |
The break even point in sales dollars can be computed by multiplying the break even level of unit sales by the selling price per unit.
350 Units × $250 Per unit = $87,500
Contribution Margin Method:
The contribution margin method is actually just a short cut conversion of the equation method already described. The approach centers on the idea discussed earlier that each unit sold provides a certain amount of contribution margin that goes toward covering fixed cost. To find out how many units must be sold to break even, divide the total fixed cost by the unit contribution margin.
Break even point in units = Fixed expenses / Unit contribution margin $35,000 / $100* per unit 350 Units *S250 (Sales) − $150 (Variable exp.) |
A variation of this method uses the Contribution Margin ratio (CM ratio) instead of the unit contribution margin. The result is the break even in total sales dollars rather than in total units sold.
Break even point in total sales dollars = Fixed expenses / CM ratio $35,000 / 0.40 = $87,500 |
This approach is particularly suitable in situations where a company has multiple products lines and wishes to compute a single break even point for the company as a whole.
The following formula is also used to calculate break even point
Break Even Sales in Dollars = [Fixed Cost / 1 – (Variable Cost / Sales)]
This formula can produce the same answer:
Break Even Point = [$35,000 / 1 – (150 / 250)] = $35,000 / 1 – 0.6 = $35,000 / 0.4 = $87,500 |
Benefits / Advantages of Break Even Analysis:
The main advantages of break even point analysis is that it explains the relationship between cost, production, volume and returns. It can be extended to show how changes in fixed cost, variable cost, commodity prices, revenues will effect profit levels and break even points. Break even analysis is most useful when used with partial budgeting, capital budgeting techniques. The major benefits to use break even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.
Assumption of Break Even Point:
The Break-even Analysis depends on three key assumptions:
- Average per-unit sales price (per-unit revenue):
This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue $1 and enter your costs as a percent of a dollar. The most common questions about this input relate to averaging many different products into a single estimate. The analysis requires a single number, and if you build your Sales Forecast first, then you will have this number. You are not alone in this, the vast majority of businesses sell more than one item, and have to average for their Break-even Analysis.
- Average per-unit cost:
This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of revenue or unit of service delivered, to deliver that service. If you are using a Units-Based Sales Forecast table (for manufacturing and mixed business types), you can project unit costs from the Sales Forecast table. If you are using the basic Sales Forecast table for retail, service and distribution businesses, use a percentage estimate, e.g., a retail store running a 50% margin would have a per-unit cost of .5, and a per-unit revenue of 1.
- Monthly fixed costs:
Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses). This will give you a better insight on financial realities. If averaging and estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimate—it will be a rough estimate, but it will provide a useful input for a conservative Break-even Analysis.
Limitations of Break Even Analysis:
It is best suited to the analysis of one product at a time. It may be difficult to classify a cost as all variable or all fixed; and there may be a tendency to continue to use a break even analysis after the cost and income functions have changed.
Review Problem:
Voltar Company manufactures and sells a telephone answering machine. The company's contribution format income statement for the most recent year is given below:
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Calculate break even point both in units and sales dollars. Use the equation method.
Solution:
Sales = Variable expenses + Fixed expenses +Profit $60Q = $45Q + $240,000 + $0 $15Q = $240,000 Q = $240,000 / 15 per unit Q = 16,000 units; or at $60 per unit, $960,000 Alternative solution:X = 0.75X + 240,000 + $0 0.25X = $240,000 X = $240,000 / 0.25 X = $960,000; or at $60 per unit, 16,000 units |
Break Even analysis Calculator:
Click here to Launch Break Even Analysis Calculator [This is external link]
In Business | Buying on the Go--A Dot.com TaleStar CD is a company set up by two young engineers, George Searle and Humphrey Chen, to allow customers to order music CDs on their cell phone. Suppose you hear a cut from a CD on your car radio that you would like to own. Pick up your cell phone, punch "*CD." enter the radio stations frequency, and the time you heard the song, and the CD will soon be on its way to you. Star CD charge about $17 for a CD, including shipping. The company pays its suppliers about $13, leaving a contribution margin of $4 per CD. Because the fixed costs of running the service, Searle expects the company to lose $1.5 million on sales of $1.5 million in its first year of operations. That assumes the company sells in excess of 88,000 CDs. What is the company's break even point? Working backward, the contribution margin per CD is $4, the company would have to sell over 460,000 CDs per year just to break even.
Source: Peter Kafka, "Pay It Again," Forbes, July 26, 1999, P.94
8 Things to Know Before Selling Your Accounting Practices:8 Things to Know Before Selling Your Accounting Practices:
1. Understand why you are selling the practice. Buyer's want to know that you are committed to the sale and not just testing the waters. I would say one of this is one of the most common questions buyers ask and for good reason.2. Have a plan for after the practice closes and the deal is done. Will you be helping the new buyer with transiting the client base or are you headed to sunny Florida. This will affect the purchase price as the buyers will be looking for support and guidance in the beginning.
3. Understand the purchase price and what you are asking for the practice. Selling your accounting practice is simple supply and demand economics. Price too high and it won't sell, price too low and you could leave some money on the table.
4. Understand your debt obligations and leases. Make sure you are up to date on all payroll taxes, debts, etc. Buyers will want to know what liabilities they will be taking over such as a copy lease, rent, etc.
5. Provide employee records and policies if available. This will instill confidence that your practice is running as a well oiled machine and organized.
6. Identify key employees. Make sure the buyer understands which employees are vital to the success of the practice once it is sold. Also, do the key employee(s) have non-compete agreements in place?
7. Keep organized financial records. This is fairly obvious, but make sure your financials are up to date and "clean." Make sure that all non discretionary expense are taken out or identified. This will help add back cash flow to the bottom-line but may not be accepted by the lender. Kind of a double edge sword.
8. Keep an open mind. You may have decided exactly what and how much you want for the business. An open mind will help in getting the deal closed. You may or may not get the exact price and terms you are looking for but if the deal closes that is end result you were seeking. A little flexibility can help the deal run smoothly for both sides in the end.
3. Understand the purchase price and what you are asking for the practice. Selling your accounting practice is simple supply and demand economics. Price too high and it won't sell, price too low and you could leave some money on the table.
4. Understand your debt obligations and leases. Make sure you are up to date on all payroll taxes, debts, etc. Buyers will want to know what liabilities they will be taking over such as a copy lease, rent, etc.
5. Provide employee records and policies if available. This will instill confidence that your practice is running as a well oiled machine and organized.
6. Identify key employees. Make sure the buyer understands which employees are vital to the success of the practice once it is sold. Also, do the key employee(s) have non-compete agreements in place?
7. Keep organized financial records. This is fairly obvious, but make sure your financials are up to date and "clean." Make sure that all non discretionary expense are taken out or identified. This will help add back cash flow to the bottom-line but may not be accepted by the lender. Kind of a double edge sword.
8. Keep an open mind. You may have decided exactly what and how much you want for the business. An open mind will help in getting the deal closed. You may or may not get the exact price and terms you are looking for but if the deal closes that is end result you were seeking. A little flexibility can help the deal run smoothly for both sides in the end.
7 Best Reasons to Outsource Your Bookkeeping:
If you are like the typical business owner you probably already consider the accounting function as a necessary evil. Yes you want the reports that accounting can provide but you probably consider the data entry, accounting rules, tax planning and all the rest a frustrating time waster. When it comes to your company's accounting you really have only three choices. You can hire an accountant on your staff and accept the cost and liability of brining on an employee, you can do it yourself which almost always ends in disastrous results, or you can outsource the function to a professional bookkeeper service. Of the three options, outsourcing probably makes the most sense for most organizations. 1. Peace of mind at tax time
Actually tax time is an all year long event and the tax planning strategies that a bookkeeper can provide and implement will assure you that there are no nasty surprises when you actually file.
2. Higher profits through better analysis
While counting beans is at the heart of bookkeeping, it is the information gathered from that process that the bookkeeper can use to develop management controls and detailed analysis of financial performance. You may discover that new customer who has been buying like crazy isn't really that great a deal because he's 90 days in arrears. Or you may discover that certain product lines or services are far more profitable and decide to shift your marketing focus.
3. Create added value for clients
It's generally accepted that a business should focus resources on those activities that add value to a client relationship. Most clients don't care how you do your accounting so long as their invoices are correct. Not having to spend hours on the bookkeeping function means you have more time to do what you do best....focusing on the client.
4. Instant access to financial data
Thanks to the technology known as application server provider (ASP) you can have a secure connection to all of your reports anytime anywhere. Bookkeeper services almost universally use this technology that allows clients to view their reports anytime they wish just the same as they would if they had an accountant in house doing the work.
5. Real cost savings
Generally Bookkeeper services bill by the hour or market specific packages. On average, their services will run 10% to 20% less than the base wage of an in house accountant. That may not sound like a huge savings but when you toss in the savings on benefits and payroll taxes that number can move from 10% to 50%.
6. No employer employee issues
When you outsource this service you also absolve yourself from any employer liability as well. Also gone are the management worries about training, discipline, salary negotiations, firing, hiring and other time consuming activities that are non-income producing. Your bookkeeping service assumes all of those headaches.
7. No loss of control
Some business owners worry about loosing control over their finances if they let an outside firm take charge. The fact is you can custom design a program where the service only does the high volume grunt work and you retain the responsibility for preparing reports from the data. With online banking added, the business owner can be the only person who approves payment to anyone. The service can be as comprehensive or as bare bones as you desire.
With these benefits and more, it's not surprising that nearly 30% of all large businesses outsource to bookkeeper services. Smaller organizations can take a lead from the bigger guys and operate more effectively and competitively by doing the same.
Actually tax time is an all year long event and the tax planning strategies that a bookkeeper can provide and implement will assure you that there are no nasty surprises when you actually file.
2. Higher profits through better analysis
While counting beans is at the heart of bookkeeping, it is the information gathered from that process that the bookkeeper can use to develop management controls and detailed analysis of financial performance. You may discover that new customer who has been buying like crazy isn't really that great a deal because he's 90 days in arrears. Or you may discover that certain product lines or services are far more profitable and decide to shift your marketing focus.
3. Create added value for clients
It's generally accepted that a business should focus resources on those activities that add value to a client relationship. Most clients don't care how you do your accounting so long as their invoices are correct. Not having to spend hours on the bookkeeping function means you have more time to do what you do best....focusing on the client.
4. Instant access to financial data
Thanks to the technology known as application server provider (ASP) you can have a secure connection to all of your reports anytime anywhere. Bookkeeper services almost universally use this technology that allows clients to view their reports anytime they wish just the same as they would if they had an accountant in house doing the work.
5. Real cost savings
Generally Bookkeeper services bill by the hour or market specific packages. On average, their services will run 10% to 20% less than the base wage of an in house accountant. That may not sound like a huge savings but when you toss in the savings on benefits and payroll taxes that number can move from 10% to 50%.
6. No employer employee issues
When you outsource this service you also absolve yourself from any employer liability as well. Also gone are the management worries about training, discipline, salary negotiations, firing, hiring and other time consuming activities that are non-income producing. Your bookkeeping service assumes all of those headaches.
7. No loss of control
Some business owners worry about loosing control over their finances if they let an outside firm take charge. The fact is you can custom design a program where the service only does the high volume grunt work and you retain the responsibility for preparing reports from the data. With online banking added, the business owner can be the only person who approves payment to anyone. The service can be as comprehensive or as bare bones as you desire.
With these benefits and more, it's not surprising that nearly 30% of all large businesses outsource to bookkeeper services. Smaller organizations can take a lead from the bigger guys and operate more effectively and competitively by doing the same.
5 Smart Invoicing Practices For Small Business
Whatever type of small business you run, there's a good chance that a lot of your business comes through invoices that you send out to request payment for your services. Unfortunately, many new business owners are not exactly adept when it comes to setting up smart invoicing policies, and they often have to have a few bad experiences with non-paying clients before they implement better procedures. If you're new to running a business and are not sure how to go about the invoice process in the most secure way, you might want to keep these tips in mind. 1. Lay out your policies in advance: When you enter into an agreement with a client, have them sign a contract that covers your policies with regard to invoicing. In the contract you can outline a number of facets of your process, including:
· How much will be paid up front and how much upon delivery?
· How long do clients have to pay?
· When do late fees apply, and how much will they be?
· What types of payment can you take?
While it's a good idea to have a standard contract that you often return to, you'll probably want to tailor it for each of your clients.
2. Make your policies clear: Even if you include all of these points in your contract, be sure to make the most important points explicit. After all, it's no secret that many contracts never get read, so protect yourself by double checking that your client is aware of the important points in your contract.
3. Make all contact information clear: On every invoice that you send out, make sure you include your name, address, email address, and phone number in a very prominent position. Some of your clients might be large companies with separate accounting apartments to handle invoices, so you want to make sure that whoever is processing your invoice can reach you with any questions.
4. Follow up politely: When you reach the due date for an invoice that has not been paid, follow up politely with the client to find out the status of payment. This is one area where good people skills are a must, as being too rude or forceful may discourage that client from working with you in the future. When you contact them, mention that the invoice is due, and ask if there is anything you can do to facilitate their payment before the late fee kicks in.
5. Number your invoices: Especially if you're dealing with a large company that probably processes many invoices in a regular basis, make sure your invoice is numbered in such a way that makes it easy to file. This allows your clients to easily account for your invoice, and it also helps you to keep close tabs on how long your invoices have been out and whether they have been paid. As your business grows, this system of numbering will become even more vital for orderly functioning.
· How much will be paid up front and how much upon delivery?
· How long do clients have to pay?
· When do late fees apply, and how much will they be?
· What types of payment can you take?
While it's a good idea to have a standard contract that you often return to, you'll probably want to tailor it for each of your clients.
2. Make your policies clear: Even if you include all of these points in your contract, be sure to make the most important points explicit. After all, it's no secret that many contracts never get read, so protect yourself by double checking that your client is aware of the important points in your contract.
3. Make all contact information clear: On every invoice that you send out, make sure you include your name, address, email address, and phone number in a very prominent position. Some of your clients might be large companies with separate accounting apartments to handle invoices, so you want to make sure that whoever is processing your invoice can reach you with any questions.
4. Follow up politely: When you reach the due date for an invoice that has not been paid, follow up politely with the client to find out the status of payment. This is one area where good people skills are a must, as being too rude or forceful may discourage that client from working with you in the future. When you contact them, mention that the invoice is due, and ask if there is anything you can do to facilitate their payment before the late fee kicks in.
5. Number your invoices: Especially if you're dealing with a large company that probably processes many invoices in a regular basis, make sure your invoice is numbered in such a way that makes it easy to file. This allows your clients to easily account for your invoice, and it also helps you to keep close tabs on how long your invoices have been out and whether they have been paid. As your business grows, this system of numbering will become even more vital for orderly functioning.
5 Free Things You Can Do Today to Get Bookkeeping Clients:
Do you find yourself struggling to get bookkeeping clients for your business? Many freelance bookkeepers are faced with this problem after the initial excitement of setting up the bookkeeping business has worn off. If you are one of those people and you also have a limited advertising budget, here are five ways you can promote your business that won't cost you a red cent.1. Talk to Someone:
You'll find that the more people you inform about your business, the more you'll discover people who know someone needing a bookkeeper. So tell everyone you come across that you are a freelance bookkeeper. Referrals are usually the number one method when you want to get bookkeeping clients.
2. Place an Ad on Craigslist:
Find your local city and place an ad under the "Services - Financial" section of Craigslist advertising your bookkeeping business. Don't post your phone number online unless you are comfortable doing that. Instead, have potential clients email you for additional information confidentially through Craigslist.
3. Chat on a Forum:
Find an online forum that is in the same category as the type of businesses you are targeting for your bookkeeping business. For example, if you are looking for plumbers, find a forum that plumbers like to hang out in. Make helpful posts without promoting yourself, as this could get you banned from the forum. You can however, add a signature to your profile promoting your bookkeeping business if the forum allows it.
4. Setup a Squidoo Lens:
This is a free way to promote your business which is almost as good as having your own website. Setting up a Squidoo lens will take about 30 minutes of your time and will get you listed in the Search Engines. If you use relevant keywords such as "your city name bookkeepers", potential clients will be able to find your bookkeeping business listed in local Google searches.
5. Write an Article and Submit it to an Article Directory:
If you have a talent for writing, put together some articles that would be helpful to small business owners and submit them to article directories. You should have a link in the bio section that goes to either your bookkeeping website or Squidoo lens.
As you can see, promoting your business so you can get bookkeeping clients doesn't have to be expensive. As along as you make an effort every day to build your client base, you'll soon have more clients than you can handle.
You'll find that the more people you inform about your business, the more you'll discover people who know someone needing a bookkeeper. So tell everyone you come across that you are a freelance bookkeeper. Referrals are usually the number one method when you want to get bookkeeping clients.
2. Place an Ad on Craigslist:
Find your local city and place an ad under the "Services - Financial" section of Craigslist advertising your bookkeeping business. Don't post your phone number online unless you are comfortable doing that. Instead, have potential clients email you for additional information confidentially through Craigslist.
3. Chat on a Forum:
Find an online forum that is in the same category as the type of businesses you are targeting for your bookkeeping business. For example, if you are looking for plumbers, find a forum that plumbers like to hang out in. Make helpful posts without promoting yourself, as this could get you banned from the forum. You can however, add a signature to your profile promoting your bookkeeping business if the forum allows it.
4. Setup a Squidoo Lens:
This is a free way to promote your business which is almost as good as having your own website. Setting up a Squidoo lens will take about 30 minutes of your time and will get you listed in the Search Engines. If you use relevant keywords such as "your city name bookkeepers", potential clients will be able to find your bookkeeping business listed in local Google searches.
5. Write an Article and Submit it to an Article Directory:
If you have a talent for writing, put together some articles that would be helpful to small business owners and submit them to article directories. You should have a link in the bio section that goes to either your bookkeeping website or Squidoo lens.
As you can see, promoting your business so you can get bookkeeping clients doesn't have to be expensive. As along as you make an effort every day to build your client base, you'll soon have more clients than you can handle.
3 Techniques to Find an Accountant:3 Techniques to Find an Accountant:
Finding a good accountant can be a complicated process if you do not know where to look. Many hours can be spent making pointless phone calls or asking friends who have never had the need for an accountant. Although there are many places to look for a new accountant, and this article lists a few sources that are most easily accessible. 1) Internet. This is the largest source of information that most people have access to, meaning it will most likely be the first place to look. There are multiple sources online that help you find an accountant in your area, and they can even narrow searches to the specific type you are looking for. Many of these sites also post reviews from previous clients describing their experience. This is a great resource to have because you can see what other people have used the accountant for, as well as what they thought of them. Another reason why the Internet is such a great resource is because you can easily compare what you will be charged. Most firms will have a general number for what they charge, depending on your situation. Although these are very helpful in making your decision, be prepared to have the rates vary because every case will be different, and the posted price is most likely just a guideline.
2) Phone book. Although this method is not as efficient as using the Internet, it can be easier because it will not be as overwhelming. The phone book will give you a consolidated list of who is in your immediate area, unlike the Internet, which will bombard you with information about the accounting firm. Be careful though, just because some boast low rates do not mean they are your best bet. Call and ask questions first that pertain to your situation. It is better to pay a little more up front for a better accountant than to pay large fees down the road because your work was done wrong.
3) Talk to your financial advisor. Speaking with another person who manages your money is a great resource because they know where you or your company stands financially. A financial advisor is also a great person to ask because they have great knowledge of who is in the industry. Chances are very high that your advisor currently works with, or have worked in the past with a good accountant.
2) Phone book. Although this method is not as efficient as using the Internet, it can be easier because it will not be as overwhelming. The phone book will give you a consolidated list of who is in your immediate area, unlike the Internet, which will bombard you with information about the accounting firm. Be careful though, just because some boast low rates do not mean they are your best bet. Call and ask questions first that pertain to your situation. It is better to pay a little more up front for a better accountant than to pay large fees down the road because your work was done wrong.
3) Talk to your financial advisor. Speaking with another person who manages your money is a great resource because they know where you or your company stands financially. A financial advisor is also a great person to ask because they have great knowledge of who is in the industry. Chances are very high that your advisor currently works with, or have worked in the past with a good accountant.
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