Understanding Business Accounting For Dummies, 2nd Edition (88 page)

Non-salary benefits are more favourably treated for the sole trader. You can generally get tax relief on the business element of costs that are only partly business related, such as running a vehicle. A director of a company will be taxed on the value of the vehicle's list price and will not be allowed travel to and from work as a business expense.

Bear in mind that these calculations will change with every change of tax rates in each budget.

Chapter 12
:
Cost Conundrums

In This Chapter

Determining costs: The second most important thing accountants do

Comprehending the different needs for cost information

Contrasting costs to understand them better

Determining product cost for manufacturers

Padding profit by manufacturing too many products

M
easuring costs is the second most important thing accountants do, right after measuring profit. But really, can measuring a cost be very complicated? You just take numbers off a purchase invoice and call it a day, right? Not if your business manufactures the products you sell - that's for sure! Businesses must carefully record all their costs correctly so that profit can be determined each period, and so that managers have the information they need to make decisions and to control profit performance.

Previewing What's Coming Down the Road

One main function of accounting for a manufacturing business is measuring
product cost
. Examples are the cost of a new car just rolling off the assembly line or the cost of this book,
Understanding Business
Accounting For Dummies
. Most production (manufacturing) processes are fairly complex, so measuring product cost is also fairly complex in most cases. Every step in the production process has to be tracked very carefully from start to finish. One major problem is that many manufacturing costs cannot be directly matched with particular products; these are called
indirect costs
. To arrive at the
full cost
of each separate product manufactured, accountants devise methods for allocating the indirect production costs to specific products. Different accountants use different allocation methods. In other respects, as well, product cost accounting is characterised by a diversity of methods. Generally accepted accounting principles provide very little guidance for measuring product cost. Manufacturing businesses have a lot of leeway in how their product costs are determined; even businesses in the same industry use different product cost accounting methods.

In addition to measuring product costs of manufacturers, accountants in all businesses determine many other costs: the costs of the departments and other organisational units of the business; the cost of pensions for the company's employees; the cost of marketing initiatives and advertising campaigns; and, on occasion, the cost of restructuring the business or the cost of a major recall of products sold by the business. A common refrain among accountants is ‘different costs for different purposes'. True enough, but at its core, cost accounting serves two broad purposes - measuring profit and providing relevant information to managers.

This chapter covers cost concepts and cost measurement methods that are used by both retail and manufacturing businesses, along with additional stuff for manufacturers to worry about. We also discuss how having a good handle on cost issues can help you recognise when a business is monkeying around with product cost to deliberately manipulate its profit figure. Service businesses - which sell a service such as transportation or entertainment - have a break here. They do not encounter the cost-accounting problems of manufacturers, but they have plenty of cost allocation issues to deal with in assessing the profitability of each of their separate sales revenue sources.

What Makes Cost So Important?

Without good cost information, a business operates in the dark. Cost data is needed for different purposes in business, including the following:

Setting sales prices:
The common method for setting sales prices (known as
cost-plus
or
mark-up on cost
) starts with cost and then adds a certain percentage.

Measuring gross margin:
Investors and managers judge business performance by the bottom-line profit figure. This profit figure depends on the
gross margin
figure you get when you subtract your cost of goods sold expense from your sales revenue. Gross margin (also called
gross profit
) is the first profit line in the profit and loss account (see Figures 9-1 and 12-2 for examples).

Valuing
assets:
The balance sheet reports cost values for many assets, and these values are, of course, included in the overall financial position of your business.