Earning revenue by selling products and services is not a foreign concept to me at all as it wouldn’t be for everyone doing this subject. You give your money in exchange for something; it is, however, the concept of value that drives peoples need to buy things. If a customer doesn’t see the value in what a business is offering, they simply won’t buy it. Although value is in the eye of the beholder really, there is no real 100% certainty that every single person will find value in a product, not even electricity from the grid. Some people opt to have solar power and manage to live off grid meaning they have no reason or see no value in purchasing electricity from a provider. But simple maths would assume that if the money going out far exceeds the money coming in, the business wont last long until it needs to close its doors.
6.1 Cost Objects
Costs are entirely unavoidable as every product or service provided costs money in one way or another, even the leanest business run by 1 person providing only a service out of their own home would incur costs of electricity, and consumables at some point and even at the bare minimum it would cost their time. Understanding how, where and when costs are spent is a different story, sometimes not always the most straight forward thing, cost objects remind me of this silly ad that pops up on one of my apps, its for a game and there are 4 different colours of “liquid” in each cup, the aim of the game is to somehow get the cups full with only one colour (no I don’t have the game but sometimes it wont let me skip in the ad 😊). With only one colour in each cup, it would give a much clearer picture, this would work the same as a business with each cost attributed to an activity, a product or really any aspect it would show managers when, where and how they are spending the business’s money. Looking at a product as a cost object would seem simple, yes? You attribute everything that it costs to make a product and voila, not so much. Although products are usually made in bulk say 1000 units, the costs are not all placed in the month or year that they were manufactured in, the costs are evened out over the months or years that the products are sold onto customers. For example, 1000 units are made in March 2022, none are sold in March at all however 200 are sold in April, 200 are sold in May, 500 are sold in June and the final 100 sell in July. The cost of the products is attributed to the months that they sold in respectively to avoid either understating or overstating a month’s revenue and costs.
6.2 Cost of Products
Knowing the true cost of any product is quite important for a business to know, making sure that they can cost it to the correct months, ensuring that the correct costs are being used and to look at anywhere that costs can be reduced to achieve the same result. There are 2 different ways we attach costs to a product, directly, this is anything directly related to the product for example labour, materials, and machinery. Next there is indirect costs, these are any other costs incurred that are not directly linked to the product itself, these costs have taken the scenic route to become part of the costing of the product, this can include the rent or mortgage on the building, utilities and administration and office expenses. You can break down the costs of each product into smaller amounts by separating them into job and process costing. This is simply breaking down each step of making the product and costing accordingly. Lastly there are period costs which are all other costs that are not directly or indirectly attributed to the cost of a product. I think of this as a kick ball selection, each team having 8 players a side but there are 20 people to pick from. The captain chooses 5 direct costs, 2 indirect costs, including the captains that would be 16 players. The remaining 4 players are left to sit and watch or try a different sport.
6.3 Apportioning Indirect Costs
Using the example of a factory that makes small items, thousands of units per day, how is it that any business can figure out what portion of electricity costs are apportioned to each individual unit? It seems wildly insane to imagine how you figure out how much electricity 1 tiny unit out of thousands used. The diagram in the readings helped me understand that the indirect costs are apportioned out to operating departments such as manufacturing as well as the support departments such as human resources. Once it’s been apportioned to the departments it then is absorbed into the products themselves, I see this would be much easier than trying to figure out how many kilowatts a single unit used. From my experience working in a small business and having to attribute each invoice to a cost centre. This helped us understand what all our costs were and where they went, the absorption rate calculation makes sense as I read it as you’d want to make sure that those who have less activity incur less of the costs. Predetermined absorption rates make sense because if you receive bills quarterly or bi-annually, but you know what the bill will be, it makes more sense to break up the bill into more manageable amounts and set them across each month or fortnight.
6.4 How Costs Change
Fixed costs are predictable for any business, these costs don’t change, it’s the same costs month in and month out. It’s the variable costs that can prove a little more problematic, they change for a variety of reasons, at the moment the war in Ukraine has forced the price of fuel through the roof. Businesses need to know at what point they break even, how many units they need to sell or how much they need to sell them for to ensure the break even has been achieved. Estimating future costs is one way that managers and directors make decisions on what and where to invest their money. A break-even analysis can be a good way for the business to get a visual on how much they need to sell to the public to break even.
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