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About this lesson

The business financial system records costs based upon the cost account type.  The costs are often accrued near the end of fiscal quarter or year.

Exercise files

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Cost Behavior
60.1 KB Cost Behavior - Solution
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Quick reference

Cost Behavior

The business financial system records costs based upon the cost account type.  The costs are often accrued near the end of fiscal quarter or year.

When to Use Cost Behavior

The finance system continuously records costs and allocates those to the appropriate accounts.

Instructions

The business finance system creates a chart of accounts that establishes categories for collecting costs.  These categories are determined in part based upon financial accounting and reporting rules and in part based upon what is best for the business managers.

  • Cost accounts are divided into investment accounts and expense accounts.  Finance must follow special tax and compliance rules for tracking and reporting investment accounts.
  • Investment accounts are often strategic in nature with extra oversight by stakeholders.
  • All cost accounts that are not investment accounts are expense accounts.
  • Expense accounts are normally set up to aid finance and business management in the budgeting and tracking of business costs.  Typical categories include business function, location, cost type (personnel, travel, material, etc.) and project.
  • Since all financial transactions have both an amount and a date, finance also closely tracks the date for transactions.  Most businesses assign the date using the accrual method which sets the date based upon when the activity was done, not when it was paid for.  Near the end of a fiscal quarter or year finance will work closely with the functions to determine what expenses should be accrued in the current financial period. 

 

Hints and Tips

  • If you are having trouble understanding what is happening financially in your project or department, work with finance to redefine the cost accounts in a manner that gives you insight.
  • If you are burdened by a large number of cost accounts that you need to track monthly and there are very few costs recorded in each account, work with finance to consolidate the accounts, reducing bureaucracy – just don’t reduce then number of accounts to the point that you can’t tell what is going on.
  • If you have long and high cost activities occurring near the end of a quarter or year, create a way of estimating the percent of work that has been accomplished at the end of the fiscal period.
  • Finance gets very picky about the investment accounts.  There is a good reason.  If those accounts get messed up, the business can be accused of filing fraudulent tax returns or financial reports.  So don’t take it personally if they apply extra rigor on those accounts.
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  • 00:03 Hi, this is Ray Sheen.
  • 00:05 I'd like with talk to you now about the behavior of different types of
  • 00:08 cost accounts.
  • 00:09 Now, by behavior, I mean how the financial transactions occur.
  • 00:14 Let's go.
  • 00:15 >> Our focus in this module is on how costs occur and are recorded.
  • 00:19 Recall that the business and functional departments have set up cost accounts
  • 00:23 to plan and track the different cost categories within the business.
  • 00:26 Different types of costs occur and are recorded differently.
  • 00:30 Investment costs must be treated in a special manner.
  • 00:33 They are normally recorded in separate accounts from those that are recording
  • 00:36 expense costs.
  • 00:37 Finance must track these carefully to record them correctly on the balance
  • 00:40 sheet and cash flow statement.
  • 00:42 In addition, finance must start a depreciation schedule for
  • 00:45 each capital investment.
  • 00:47 There are special accounting rules and tax implications for these.
  • 00:50 Not to mention,
  • 00:51 that these investment costs are often part of implementing the corporate strategy.
  • 00:55 So senior management is tracking them closely also.
  • 00:59 Every cost that is not an investment is, by definition, an expense.
  • 01:03 As operational managers, those are the only two types of cost that we deal with.
  • 01:08 As an operational manager, you need to know what costs are occurring in
  • 01:11 your area of responsibility and manage them.
  • 01:14 Don't rely on finance to do everything.
  • 01:16 You are the manager in your area, not finance.
  • 01:19 You must make the decisions.
  • 01:20 Make sure you know what is happening, and
  • 01:22 check the financial reports to be certain that they accurately reflect reality.
  • 01:27 If the reports aren't right,
  • 01:28 work with finance to understand what is wrong and fix it.
  • 01:32 Some types of expenses are very stable, such as rent or insurance.
  • 01:35 Both the amount and time are very predictable.
  • 01:38 Other expenses can vary dramatically for many reasons.
  • 01:41 It may be the date that varies or it may be the amount that varies.
  • 01:44 There may be seasonal effects, the cost for
  • 01:46 plowing snow from the parking lot only occurs in winter.
  • 01:49 Some cost categories may be trending up or down.
  • 01:52 Health care costs have been trending up for years.
  • 01:55 Some costs categories may be tied to other business activity.
  • 01:58 Shipping costs go up when sales go up.
  • 02:00 And of course,
  • 02:01 project costs will vary depending upon the activities scheduled in the project plan.
  • 02:05 Make sure that the costs that are being recorded in the financial system
  • 02:09 truly reflect what is happening.
  • 02:11 Let's look at some principles about recording costs.
  • 02:15 It should be obvious, but let me clearly state it.
  • 02:18 All costs need to be recorded in the business financial system.
  • 02:21 Don't keep two sets of books.
  • 02:23 Don't withhold costs or inflate costs.
  • 02:26 If you're having a financial problem, manage the business better.
  • 02:30 Don't cook the books.
  • 02:32 If you are thoughtful when setting up the accounts,
  • 02:35 the recording of costs will be very easy for both you and finance.
  • 02:38 Remember that an account represents business activity.
  • 02:41 So accounts should be structured the way you manage the business.
  • 02:44 If that is not the case, work with finance to update your chart of accounts.
  • 02:48 The categories I use, within a department accounting structure, are to separate
  • 02:52 accounts by location, department or function, and then the type of activity.
  • 02:57 If there are major projects, I give them their own account.
  • 03:00 Any of these categories can be further divided into sub-accounts.
  • 03:04 When recording a cost, it's nice to have very few accounts.
  • 03:07 Then you don't have difficulty deciding into which account to record it.
  • 03:10 But that will make it much harder to analyze and
  • 03:12 understand what is happening if there is a variance.
  • 03:15 So set up your account structure to match the level of management oversight you
  • 03:18 intend to apply.
  • 03:20 Make sure the finance system records the costs in the cost accounts.
  • 03:24 Check the costs each month.
  • 03:26 Sometimes errors are made and they need to be corrected.
  • 03:29 Otherwise, a financial report with errors could be submitted to a customer
  • 03:32 or the government.
  • 03:33 The next thing you know, the headlines of the blogs and
  • 03:36 newspapers are about how your company is filing false financial reports.
  • 03:41 A tricky aspect of recording costs is accruing for costs.
  • 03:44 You may recall that we said the accrual accounting method consists of
  • 03:47 recording a cost based upon when the activity occurred,
  • 03:51 rather than when cash changes hands.
  • 03:53 However, if the business is engaged in a lengthy process, the determination of how
  • 03:57 much activity has actually occurred could be a judgment call.
  • 04:02 When close to the end of a fiscal quarter or
  • 04:03 a fiscal year, finance watches the accruals very closely.
  • 04:07 They need to accurately reflect the real level of work in the financial reports
  • 04:11 that they will file with the government and send to investors.
  • 04:15 Based upon how profitable the quarter or year has been,
  • 04:18 they may want you to take partial credit for work and increase accruals.
  • 04:22 Or they may ask you to delay work to decrease accrual charges.
  • 04:25 For that reason, they may be asking for some documentation to support any accrual
  • 04:30 charges that they record for work that is partially completed.
  • 04:34 Help them out.
  • 04:35 This is not a case of them doubting your word or not trusting you.
  • 04:38 It's just that they may need to defend some of those charges in an audit.
  • 04:42 Of course the audit won't actually occur until at least a year later.
  • 04:46 And by then, no one can remember what the accrue was based upon.
  • 04:50 So give them some documentation for
  • 04:52 the files to refresh everyone's memories when that happens.
  • 04:58 >> Reporting and tracking cost is an important duty of a business manager.
  • 05:01 The management of those costs often means managing the date when
  • 05:04 the cost will occur.

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