Locked lesson.

Upgrade

About this lesson

It is important to know what category of account you are working with when budgeting and tracking spending.  The different categories of accounts behave differently so knowing which category you are working with will provide insight into the budgeting and tracking process.

Quick reference

Cost Account Characteristics

Business expenses are budgeted and tracked in financial accounts.  While a company may have hundreds of accounts in their system, they can be categorized into three broad categories based upon how they behave. The categories are capital expenditures, operational expenditures, and variable costs also known as cost of goods sold.

When to Use Cost Account Characteristics

It is important to know what category of account you are working with when budgeting and tracking spending.  The different categories of accounts behave differently so knowing which category you are working with will provide insight into the budgeting and tracking process.

Instructions

  • There are three broad categories of expenditures, capital expenditures, operational expenditures, and variable costs.
  • Capital expenditures (CapEx) accounts are the accounts that track the cost of procuring new fixed assets for the business.
    • CapEx costs are budgeted based upon the investment strategy, normally approved during the budget planning process.  Therefore many people think that all costs for strategic projects are CapEx costs.  However, the only costs that are truly CapEx are the costs associated with the fixed assets.  If there are other costs associated with the strategic projects, they should be classified as OpEx.
    • The assets represented by CapEx accounts must be taxed per the appropriate location’s tax laws for property tax.
    • CapEx accounts often include the Depreciation or Amortization accounts associated with each fixed asset (more about this in another module).
    • Since CapEx accounts are usually associated with projects, the timing and tracking of the costs will be based upon the project schedule.
  • Operational expenditures (OpEx) are the costs of running and sustaining the business.  We sometimes think of them as the costs that must be paid just to open the doors for business.
    • OpEx costs are budgeted based upon the business plan for running the operation, normally approved in the annual planning process.
    • OpEx costs can be further subdivided into five categories.
    • Fixed costs – these are costs that have a set amount that occurs each month and that amount cannot be easily changed by operating managers.  The amount is normally controlled by contracts.  Examples are rent, insurance, permits.
    • Overhead costs – these costs are associated with operating the infrastructure of the business.  They are the costs necessary to keep the doors open and the business running.  Since they are tied to business activity, operating managers cannot easily change them on a daily basis, but they can change them through changes to the business structure and operations.  Examples are the HR, Finance, IT, and legal departments, utilities, security, administrative support.
    • Project costs – these are the costs of conducting projects that are not included in the CapEx accounts.  This is budgeted and tracked based upon the project plan and performance.  These costs are the easiest in the business for an operating manager to change – just by changing the date.  They often include travel costs, publication costs, and cost of the materials used in the project.
    • Interest costs – these are the costs to the business to pay outstanding interest on the various types of business debt.  These costs typically are totally outside the control of operating managers and are handled by the corporate Finance department.  The budgeting and tracking is based upon the debt contracts, when they are placed and when they are due.
    • Taxes – these costs are due to government entities and are determined by the nature and volume of business activity at a given location.  Normally a company cannot change their tax liability; however, it is possible to negotiate extensions in order to change the timing of a tax expense.   
  • Variable costs, or Cost of Goods Sold (COGS) are the costs of making the product or service that is sold to external customers. 
    • These costs are determined by the product or service design and the sales volume
    • These costs are budgeted based upon a sales plan and the budget changes whenever the sales plan changes.
    • These costs are recorded in the financial system based upon an actual sale of goods or service and the actual cost of that product or service is what is recorded.
    • These costs will vary based upon the sales varying and the underlying costs of labor or material needed to make and deliver the product varying.

Hints and Tips

  • Remember that each transaction has both an amount and a date.  It is often easier to change the date on a transaction in a CapEx and OpEx account than it is the amount of the transaction.  The date for Variable Cost accounts is based upon the sales date, so it is harder for an operating manager to impact those.
  • Just to be very clear – you change the date by changing when something actually happened.  Do not put false information into your financial system.  It must record the actual date and the actual amount.  Management must be proactive in order to ensure the transaction occurs on the desired date.
Login to download
  • 00:03 Hi, this is Ray Sheen.
  • 00:04 I'd now like to talk with you about some of the characteristics of financial
  • 00:08 accounts, that are used to plan and track cost expenditures.
  • 00:13 Lets start with a description of what I mean by financial accounts.
  • 00:17 The finance system is organized into accounts.
  • 00:19 Think of these as a set of envelopes with a different name on them.
  • 00:23 Each envelope will represent the money used by the business for
  • 00:25 a type of business activity.
  • 00:27 When the budget is approved, the money for that activity is put in the envelope.
  • 00:31 Then whenever money is to be spent to that activity,
  • 00:33 money is taken from that envelope.
  • 00:36 The finance system manages those envelopes.
  • 00:38 Depending upon the type of account, finance will need to do different types of
  • 00:42 analysis and report how the money is being used differently.
  • 00:45 One type of account is called Capital Expenses or CapEx.
  • 00:49 I'll talk more about that on the next slide.
  • 00:50 There are five subcategories within the next major category called
  • 00:54 operational expenses, or OPEX.
  • 00:56 I'll look at each of those later in this module.
  • 00:59 There are three subcategories of variable cost, or cost of goods sold (COGS).
  • 01:04 I'll also talk about those later in this module.
  • 01:07 So let's dig deeper into the CAPEX accounts.
  • 01:10 CapEx accounts represent investment into new capital assets for the business.
  • 01:14 That means land, buildings, and equipment or systems.
  • 01:17 Because these are major expenses with long term implications,
  • 01:20 they are typically tied to strategy implementation.
  • 01:23 There are special accounting rules for CapEx business activity.
  • 01:26 They are recorded separately on the balance sheet and cash flow statement.
  • 01:30 Also, they are not directly recorded on the earnings statement at all.
  • 01:33 In addition, CapEx spending leads to property taxes.
  • 01:36 For this reason, finance watches these expenses very closely
  • 01:39 to make sure they're recorded correctly.
  • 01:42 The date for CapEx is tracked very closely, for both the date of delivery and
  • 01:46 the date of actual transfer of money.
  • 01:49 The date for this transaction will also impact the start of depreciation,
  • 01:53 which has another massive set of rules that apply.
  • 01:55 These expenses lead to multiple financial reports, for both investors and
  • 02:00 taxing agencies.
  • 02:02 Let's now talk about OpEx.
  • 02:04 OpEx is the term used for accounts that are associated with running the business,
  • 02:08 and the basic elements of strategy implementation.
  • 02:11 Remember if the strategy requires new buildings or
  • 02:13 equipment, that will be CapEx.
  • 02:15 This is the planning and day to day execution of the strategy.
  • 02:19 The OpEx accounts are set up during the annual budgeting process.
  • 02:22 At that time, the amount of money for
  • 02:24 the year is figuratively put into the envelope.
  • 02:26 There are five categories I would like to discuss here.
  • 02:29 The financial purists will tell you these are not all precisely OpEx.
  • 02:33 But since they are recorded on the financial reports in a similar manner,
  • 02:36 I'm talking about all of them right now.
  • 02:38 In each case, the costs are recorded on the earnings statement.
  • 02:41 They are also recorded on the cash flow statement as operating activities, and
  • 02:45 they are not directly recorded on the balance sheet at all.
  • 02:48 The first is fixed costs.
  • 02:49 These are fixed because the company needs to pay them due to a contract, policy, or
  • 02:53 regulation.
  • 02:54 They must be paid, regardless of how well the business is running.
  • 02:58 Examples are rent, permits, and the depreciation charge.
  • 03:01 The next category is overhead expenses.
  • 03:05 These are the costs needed to sustain business operations.
  • 03:08 If the door is open, these must be payed.
  • 03:10 These include support and
  • 03:11 maintenance functions, along with business administration, and general management.
  • 03:15 Next is program costs.
  • 03:17 These are easily the most discretionary of the OPEX costs.
  • 03:21 These are all project costs that are not CAPEX,
  • 03:23 so there's usually a lot of salaries and support contracts.
  • 03:27 These can be easily stopped, but that will also slow or
  • 03:30 stop the strategy implementation.
  • 03:32 The last two are very straight forward.
  • 03:34 Interest is the interest on debt and bonds.
  • 03:36 Taxes are just that, and are tied to business assets and performance.
  • 03:40 The final category of accounts is the variable cost, or COGS,
  • 03:44 cost of goods sold.
  • 03:46 These are the costs of building product or delivering service.
  • 03:49 They're incremental to running and sustaining the business.
  • 03:52 These cars represent what is shipped out the door.
  • 03:55 These envelopes are budgeted or filled up based upon a sales forecast.
  • 03:59 Whenever the forecast changes,
  • 04:00 the variable cost budget changes to match the new mix of products and services.
  • 04:05 There are three components to this type of cost.
  • 04:07 And typically, there are account envelops for
  • 04:09 every product representing each of these three components.
  • 04:13 One account is the direct material.
  • 04:14 This is the raw material used in the product, and
  • 04:17 is based upon the building materials for the product.
  • 04:19 The next account is the direct labor, and
  • 04:21 this is the cost of labor to make the product or deliver the service.
  • 04:25 The final component is called variable overhead.
  • 04:27 Although it is some of the same type of activities as mentioned in the OpEX
  • 04:31 overhead category, it is variable overhead, because the need for
  • 04:34 it varies directly with the manufacturing activity.
  • 04:37 For instance, if the company works two hours of overtime,
  • 04:39 there are two more hours of shop supervision required.
  • 04:43 So shop supervision is one type of variable overhead.
  • 04:46 In most cases this component is less than 10% total of variable cost.
  • 04:51 So whether it's CapEx, OpEX, or COGS,
  • 04:53 the different types of accounts has some fundamental differences.
  • 04:58 They're budgeted differently, they're recorded differently,
  • 05:01 and the cost often accumulate differently in each type.

Lesson notes are only available for subscribers.

PMI, PMP, CAPM and PMBOK are registered marks of the Project Management Institute, Inc.

Gift this course