5.2. ABC for a retail firm (1)

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En provenance du cours de Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

2 notes

Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

2 notes

Cours 3 sur 5 dans Specialization Understanding Modern Finance

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

À partir de la leçon

Activity-Based Costing (ABC). Relevant Costs

In Week 5 we will study the more advanced approaches to costing – activity-based costing (ABC) and relevant costs – that provide for the more accurate costing of products, projects, and divisions, and allow to reveal actual relationship between numbers and people. We start with the analysis of ABC on an example of a small retail firm. Then we move on to the more detailed example of the use of ABC in manufacturing. Both examples will help us gain insight in the role of ABC in identifying ways to improve performance. Finally, we analyze the idea of relevant costs and its application to managerial actions –make-or-buy decisions, product mix under capacity constraints, customer profit analysis. Of special attention will be the role of relevant and opportunity costs in valuation.

5.1. Activity-based costing (ABC) – an overview8:38

5.2. ABC for a retail firm (1)9:01

5.3. ABC for a retail firm (2)13:21

5.4. ABC in manufacturing (1)13:37

5.5. ABC in manufacturing (2)13:21

5.6. Insights provided by ABC8:30

5.7. Relevant costs – an idea10:53

5.8. Make-or-buy decisions (1)6:04

5.9. Make-or-buy decisions (2)10:30

5.10. Product mix under capacity constraints8:33

5.11. Customer profit, ABC, and relevant costs7:32

5.12. Irrelevance of past costs10:43

Rencontrer les enseignants

Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

In this part, we will study an example.

And the example will be very simple.

It's ABC for a retail store.

So, we have a small store.

And this store sells soft drinks,

packaged foods, and fresh produce,

just a corner store.

And the owner of the store has a system

of tracing direct cost and also the system within direct cost,

that is very simple and looks like this.

[inaudible] old cost system.

We talk about both direct and indirect cost.

So, we have here indirect cost pool, just one,

then cost allocation base,

then here direct cost,

and here in below, I'll put just cost object,

and here it will be the product line.

Now, see what they got.

They have just one indirect cost pool that is called store support.

And as a cost allocation base,

they take the cost of goods sold,

better to say cost of goods purchased for sale,

but clearly only those that have been sold.

And as for direct costs, they use the same.

This is cost of goods sold.

So basically, if they purchase a pack of coffee,

then they say, that was purchased,

let's say for two dollars.

And then, they use some measure of

indirect cost and that contributes to the overall pool here.

So the top part is indirect cost and here we have direct cost.

So the scheme is clear,

the only thing that is so far missing is,

how much do we charge over this cost allocation base?

And historically, they said if this is cost of goods sold,

then 30% of that in monetary terms goes here.

For example, if we purchase a pack of coffee for two dollars,

then 60 cents go to store support.

And that is the system that has been used,

and like I said,

they sell three product lines,

they sell soft drinks that I will further call just SD,

then fresh produce that will be FP,

and then packaged food and that will be PF.

And on the next page,

we will see what is the result of this old system.

Well, I'll put some numbers here.

I will count in thousands,

not to put so many zeros.

This is soft drinks,

this is fresh produce,

this is packaged food,

and then in blue, I will put totals.

Now, see what we have.

First of all, we have revenues and then,

we have costs of which this is the cost of good sold, the direct one.

Now, we have the next thing is gross margin and then,

we have indirect costs that are

30% of cost of good sold.

And that leads to total costs,

then operating income, and the final line will be operating income

as percentage of revenue

because we would like to study the profitability of product lines.

Let's see what our system gives us,

just not to mix things up.

Let's say revenues.

This is 40,000 for soft drinks,

85 for fresh produce,

55 for packaged foods,

and the total will be 180.

Now costs, so we put first cost of good sold,

that's 30 here, 60,

40, the total of 130,

and gross margin comes as 10,

25, 15, the total of 50.

And now comes the part that is interesting,

but for us it's clear because we take these numbers.

And 30% of that,

we assign as indirect cost.

So here, we will have 9,

18, 12, the total of 39,

and the total cost here will be,

this direct plus indirect so that will be 39,

78, 52, the total is 169.

And then, we have operating income that I will put in black here;

it is just 1,000 here;

7,000 for fresh produce;

three for packaged food;

and the total of 11.

But the interesting thing is that if we divide that by revenues,

then we see the following numbers.

So, this is 2.5% for soft drinks,

8.24% for fresh produce,

5.45% for packaged food,

and the total is 6.11.

Now, if we looked at these numbers,

what managerial decisions come to our mind?

We can see that the highest profit margin is on fresh produce.

So, why wouldn't we order more strawberries?

And the lowest is on soft drinks.

And it seems kind of strange.

It's easy to sell soft drinks.

They arrive in a small truck by these boxes and big packs,

so you put them,

you don't have to put them in the fridge,

you don't have to move them around,

they all have very long best before terms,

so they really don't take up much of your resources.

When you sell them, people normally don't buy can,

but buy a pack of cans,

maybe a dozen or two dozen.

So, it's easy to order,

deliver, put on your shelves,

and then control like I said,

you don't have to really throw them away because they

are always prepared to be sold and used.

So, it seems strange that the product line of

that sort of takes least resources for it,

is the least profitable.

And all that leads to the idea that maybe we can refine the system and

reveal certain important things that in

this rough system that just assigns 30% on the cost of good sold,

that really it masks some of the important cause of the fact things.

That's what these people in this small retail store decided

to do and that is what we'll start doing in the next episode.

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