“I can’t keep it in any longer…. I LOVED THIS CHAPTER!!!!  There is so much about it I can relate to in my current role and I feel like I have really, REALLY learnt a lot!  Throughout the reading, there were many items where I was texting managers and work colleagues (on a Sunday!) and getting them to explain terminologies to ensure my interpretations … were correct.”

♦

“How nice it is to sit in silence, no distraction, and no time rush, just read the chapter, breathe it in, Understand what is being said, and really connect to the information with no worry of external factors. Yes, I have the whole day to myself dedicated to my study for the first time this term.”

♦

“Something that I have been thinking about recently and since the start of this unit is why our assignments are not simply summarisations or another form of academic writing; and it was only until recently when Martin was answering a student’s question in one of the video lectures that he explained that when a client asks you your opinion on something you will likely have to do some research on the topic and provide advice based on your thoughts of what you have researched which is kind of like what we are doing in this unit. With this new thought in mind I am keen to commence this assignment.”

Hi

Thank you to everyone who has submitted your ASS#2 Step 2.

I am enjoying reading your ASS#2 Step 2. Here is your general feedback.

I have been having a great time reading what you have to say after you have read Chapter 6 Understanding Key Cost Relationships in the Study Guide.

ASS#2 Step 2 was generally well handled.  Most people have the idea of not simply writing a summary of other people’s ideas (such as those of the author of the reading); but instead to also give your own responses and opinions to the key concepts in the reading, as we seek to develop our own understanding and personal meaning of these concepts.

An area many people could focus on in future in their ASS#2 Step 5 (Chapter 7 of the Study Guide), is to first of all carefully describe in your own words some of the key concepts, using examples from your prior knowledge and previous experience to illustrate your understanding. Then, you can focus on communicating to me your opinions and responses to some of the key concepts, supporting your opinions with evidence and reasons from your prior knowledge and previous experience.

More at ease

Most people have felt more at ease reading Chapter 6 and less overwhelmed, with many of the key concepts easier to relate to our own prior knowledge and previous experience:

“After completing the reading of Chapter 5, I was more at ease … I was feeling pretty comfortable moving on to Chapter 6. As soon as I started to read … I was quickly relating the first paragraph about value exchange needing to be of benefit to both parties to my morning coffee ritual at work.

I work in Newstead of Brisbane, such a vibrant and ‘up-and-coming’ area of Brisbane. When I first started working in the area, there were two coffee shops. I chose the one that was closest and slowly got to know the staff and always felt great going in and having a conversation; so the value to me of getting a coffee at this cafe was higher than at the other one. Now there are five coffee shops to choose from, with another coming soon.  Due to the number of choices, ‘my’ coffee shop downgraded to another site (due to increasing rents) further away from where I worked; and most of the staff moved on to the other coffee shops in the area.  So the value I had in my original coffee shop has gone. I can certainly understand the [concept of] exchanging value between firms and customers.”

Not just words

Plenty of people have commented on how long the readings are:

“I feel as though the first thing I do when I go to read these chapters is check the number of pages … I like to see how much I am about to tackle and I mention this just about every time I start a KCQ, but I feel like I just need to vent about it. In saying this though, this chapter wasn’t too bad to read.”

“The podcasts of the Study Guide are great … I can listen to the readings while cooking or driving …”

Also, some people have commented that the readings are not just words. In the chapters there are many embedded links to videos and other visual material; many different mediums of communication we can use to connect with facts and concepts:

“Direct and Indirect costs … the linked videos help me when I’m trying to understand new concepts … Reading a lot of text doesn’t seem to interest me as much as a nicely structured video.”

Connection of key concepts to prior knowledge and previous experience

Quite a few people found it easier to relate the material in Chapter 6 to their own prior experience:

“When doing my calculations at the time it was just how much do I have to earn before I am not losing any money but it was actually my break-even point. I needed to cover my site fees, material costs, petrol to and from the event, marquee hire, purchase of marquee weights and of course coffee to survive the day. When added up it gave me a solid number, from there I was able to work out how many garments I would need to sell and whether or not that was feasible and a risk I was willing to take. While reading the chapter it occurred again to me just how much accounting is already in my life and how accurate data can make or break a situation.”

Exchange of value in markets

Most people commented on the initial story in the chapter about exchanging value between a firm and its customers:

“Contrary to what people might usually think, the exchange of products and services for money is not actually equal in value from both parties’ perspectives. I previously would often think to myself “those chicken wings are worth $1 each”, but actually if you think about it, those chicken wings aren’t worth $1 each if I’m not hungry; I wouldn’t (usually) buy them if I’m not hungry, therefore making them not ‘worth it’. Similarly, if I am hungry, those chicken wings are worth more than $1 each; because I need food more than I need that bit of money. This would be the same for the firm. If it costs the firm more than $1 to make each chicken wing, then my $1 isn’t ‘worth it’, and if it costs less than $1 to make the each wing, then my money is more valuable than the wings. It’s an odd way to think about it, but I think it works.”

This story was a lead-in to the idea that a firm needs to know what the costs of its products are, to ensure it is getting more from selling the product than it costs to make; just like customers will only  buy a product if it costs them less than the benefit the product gives them. It is all about an exchange of value in markets, with both sides to the transaction ‘winning’. And it is also all about perceptions of value.

Management accounting: no rules

Many people were surprised that management accounting is not regulated by accounting standards or any other rules:

“It is interesting that management accounting information isn’t regulated by laws or accounting standards…”

Cost objects

A key concept many people mentioned was cost objects, although quite a few people did not clearly describe this central concept in their own words. However, some people communicated a very clear understanding of this concept; and also how the illustration of tidying up a messy room can help them connect the concept of cost objects to the experience of tidying their room:

“Cost objects are simply different bits of a firm about which managers want to have some understanding of their costs. I quite liked Martin’s example of this, how putting things away in your room makes it feel much tidier. As I do this quite often, I will remember cost objects as tidying my room. However, for managers to fully understand where all the costs are being incurred it will take more than just knowing that putting things away will make things tidier. So, I cannot just shove my clothes all together in one cupboard, they must be put somewhere in the cupboard where they belong, for example all my shirts will go in one draw and my shorts in another. Is this what is meant by putting the costs where they ‘belong’?”

It sure is … Also, some people referred to the concept of ‘cost objective’.  The concept is cost object not cost objective.

A cost object is any aspect of a firm we are interested in knowing its costs, and so attach costs to it.  We have focused on products as a common (and important) type of cost object.  And yes, we can attach the same cost to more than one cost object; for example, a cost could be attached to both a customer and to a business process.

Direct and indirect costs

There is still quite a lot of confusion about the concepts of direct and indirect costs. However, some people are developing some solid understanding of these key concepts in the reading:

“From my perspective, I believe that direct costs are basically any type of costs that can easily be connected to a cost object, such as a product, service or a customer. For example, my local hairdresser … would have to pay wages and salaries to her employees, which would [be] a direct cost … like that magnet being attached to a fridge door.

Unfortunately, the indirect costs are not so straightforward … From my understanding, I believe that indirect costs have to be allocated … which may not necessarily be [clearly] linked or connected to cost objects. I think that some examples could include … costs such as electricity and maintenance. I can also comprehend the fact that there will be a lot of grey areas once again, especially when it comes to indirect costs.”

Some people are reasonably clear about the concepts of direct and indirect costs; although others are struggling to understand these concepts. Direct costs are those costs obviously connected to a product; indirect costs are less obviously connected to a product and require judgements to connect them to a product.

There were mixed reactions to the image of fridges and fridge magnets as an analogy to show the difference between direct and indirect costs.  Some people found this picture helpful to understand the concepts of direct and indirect costs attaching to products; others did not:

“I liked Martin’s example about separating direct and indirect costs and how direct costs may be seen as a fridge magnet naturally sicking to the fridge door, and indirect costs can be seen as things being stuck to the fridge door with blue-tac or sticky tape.”

And only a few people mentioned possibly one of the most significant aspects of accounting for costs in a business: the difference between indirect costs and period costs.  The reason this distinction is so important is that if a cost is seen as an indirect cost it will be allocated to products (no matter how imperfectly, with lots of judgements and assumptions); and period costs will not.

So who cares?  Why is this important?  Well, if we see a cost in our business as an indirect cost we will attach it to a product and it will be treated as an asset until the product is sold.  It is only when an asset is sold that product costs (direct and indirect costs) are treated as an expense.  Period costs are treated as an expense straight away.  So this distinction we make between indirect costs and period costs (which involves judgements by management) can impact on the level of expenses we have for the year (and thus on our profits, as profit = revenue –expenses) and also on our level of assets (that is, inventory of products).

Also, some people asked whether indirect costs are the same as overheads.  Well, indirect costs can often be called overheads.  However, overheads can be used more broadly to cover not only indirect costs but also period costs.

And, of course, chocolate kept coming up, including giving an illustration about the difference between direct and indirect costs:

“I love that Martin has included the Cadbury factory as the example for explaining direct and indirect costs.”

Job-costing and process-costing

A few people discussed the approaches used to help attach costs to products, namely job-costing and process-costing:

“I believe the job-costing approach is the one we can use to attach costs to a specific product/s, whereas the process-costing approach is the one where we can attach costs to a manufacturing process. The example of the Cadbury Chocolate Factory really assisted me to better understand how the two approaches work, and how these approaches can be applicable to any company. I believe that this also really brought out my chocoholic-ism too!!”

Allocating indirect costs

There is some confusion about functional-based and activity-based approaches to allocating indirect costs.  The main thing to keep in mind is that whatever approach we use, allocating indirect costs will involve judgements and assumptions that will to some extent be different to what is really going on in a business.

Functional-based Costing System

This approach apportions overhead (or indirect) costs based on an assumed or estimated functional relationship between the costs and how they are incurred in various production and service departments:

Total overheads of a production department/Level of activity

Common activity measures:

• Machine hours
• Direct material costs
• Direct labour hours
• Direct labour costs

Activity-based Costing System

This approach identifies the activities (what is actually being done in a firm) that drives or uses up overhead (or indirect) costs. It measures the costs of these activities and attaches these costs to each product to the extent the product uses the activity.

Variable and fixed costs

Most people seem to have a reasonable initial understanding of variable and fixed costs; and we will look at these two concepts more in the coming weeks:

“To put it in my own terms, fixed costs are costs that do not increase or decrease [with changes] in the level of activity within a firm … as opposed to variable costs that (like the name suggests) … change … with increases and decreases in activity levels.”

Absorption and variable costing

And we also looked at how we can use two different methods to allocate costs to our products, which will result in quite different values for our inventory and profits each year (more about this in our workshops):

“Absorption costing and variable costing: these are two methods to attach costs to a product and I had never heard about them before …. Absorption costing attaches both indirect and direct costs to products; and variable costing involves attaching only the variable costs to products.”

Production and service departments

Another key concept people are still developing their understanding about are the movement of costs between production and service departments. People often found it helpful to connect this concept to their prior knowledge and previous experience:

“I was familiar with the [concept of] production and service departments because when I went to the mint (where coins are made) in Canberra I learnt about the groups of people that are in the production department and the groups of people that work within the service department. For instance, people in the production department would help make the coins, whereas people in the service department were the maintenance team and they would service and repair the machinery so that the production process could work successfully.”

Allocation of overhead costs: more judgements in accounting

Another theme that many people commented on is that there are estimates and judgements in deciding how to allocate costs to cost centres, such as products. This is partcularly the case with indirect costs:

“The thing that I found interesting was that some assumptions have to be made for determining the indirect costs for a period because a firm cannot wait until the end of the year to know all the costs. So it becomes necessary to make some estimates. I thought it would be a difficult task for the firm to make precise estimates. The question that came to mind was [how] do the managers estimate [indirect costs] to be [as close as possible] to the actual costs at the end of the year? And what happens if [and when] the estimates made are wrong?”

Accounting can ‘create’ reality

It is gradually dawning on more and more people that accounting requires judgements and estimates … and may not be the ‘hard-and-fast’ sort of thing people may have thought before studying accounting in our unit.  Others are realising more and more the importance of focusing on the business and not simply on the ‘numbers’ (as if the numbers are somehow the ‘answer’).

And people have noted that judgements made in allocating costs to cost objects affects the way the business is viewed (its ‘reality’) and decisions made about where to take the business:

“Martin asked the question; ‘How might numbers create reality, rather than ‘merely’ reflect it?’ I thought about this and came to the conclusion that if numbers were merely a reflection of reality then they would simply be showing us what has happened. However, since we look at the numbers to influence our future decisions they are in fact creating reality, because without the numbers the decision would not have been made. Since we all seem to love chocolate and sweets I might liken it to a chocolate cake; a photo of a chocolate cake would be a reflection of reality, yet the recipe for a chocolate cake can create reality.”

And people are understanding that accounting is not simply about taking photos of the reality of a business, but involves judgements in how the reality of the business is shaped and presented:

“I found the whole notion of assigning indirect costs and the many judgements and assumptions going into the process fascinating. It is almost as though the practice of accounting is shaping the economic reality rather than communicating a reality.”

And a number of people communicated a growing realisation that the many judgements involved in accounting gives scope for deliberate manipulation and ‘tailoring’ of accounting information to tell people the stories you may want them to hear:

“One item that struck me … is that a lot of costing is based on estimates. One issue I have with this is how accurate are these estimates? There is only so much an individual can get right with an educated guess. I feel that these estimates leave a lot to be desired and can be manipulated far too easily. A company could make the figures better or worse to change share prices or taxation.”

Allocating costs to products

A number of people had some moments of fresh insight, when they realised that we allocate costs to products (an asset: inventory) and that they then become expenses when the product is sold (cost of goods sold). This is a key insight to understand about accounting:

“One thing I have learnt reading the chapter is that we do not include the cost of these items in the accounts until they are sold, and when they are sold these costs go to “cost of goods sold” or COGS.  This matches revenues and expenses in the same period.  I don’t ever remember having this aspect explained to me and now it just makes sense and I have greater understanding.”

Break even analysis

Most people found the story of the gigs helpful to understand about CVP (‘Cost-Volume-Profit) analysis and break-even points.  Although one or two people asked me what is a ‘gig’?  Answer:  A ‘gig’ is a performance by a band, usually at a pub or bar, but could include a performance at a large stadium or anywhere.

“I enjoyed reading the explanation of Fixed and Variable Costs with the example of Martin’s son and his band The Henderson Experience. It broke down the difference between fixed and variable costs, what a Break Even point is, the Contribution Margin and the Contribution Margin Ratio in an easy-to-understand way.”

♦

“Chapter 6 has really opened the flood gates on why accounting and tracking of costs within a business is so essential. Earlier we are asked: Do numbers create reality? For businesses this is definitely the case … Budgets, forward planning and company decisions are all made based on the numbers that are available to managers at the time. It is crucial that these numbers are as accurate as possible so that the best decisions for a company can be made.”

Some people have asked what Martin’s son Mark is now doing with his music. He is based in London with his band Superorganism. And here is a link to a music video on their song Everybody Wants to be Famous.

Martin was messaging his son Mark a while ago and he mentioned:

“I met an old school friend the other day who is a lawyer now and he had you for first year accounting and was talking about how I was in the Study Guide haha!”

Challenges of English language … and of jargon/terms

A number of people in our unit have English as their second language; and quite a few in our unit are very new to Australia and in their first term of study here. This is a concern for a number of people, who worry about the quality of their writing in English. Do not worry. The best thing to do is to just get writing, such as writing in the Steps in your Assignments. As you practice more and more, your English writing will get better; and it is often surprising just how much it can improve in just a few months. But you do have to get writing as much as you can. And this also applies to those of us who have English as our first language:

“[I am] from overseas, [and I am] having some difficulties … to understand … the meaning of some word[s]. Therefore, I had to look up the dictionary to get their meaning. [For] example, words such as variable cost, revenues, especially the words apportion, allocate, and share. There are so many meaning[s] but I am not sure what [they] exactly mean.”

♦

“When I reached the part about cost of products, I was quite confused by the word apportion. After a quick google search I found out that it meant to divide up and share out.”

Learning experience: past half-way in our unit

Many people have also reflected on their experience of learning in our unit so far, with some people feeling less fearful and worried about studying accounting and dealing with ‘numbers’:

“I have survived thus far! As mentioned in my other assignments, I don’t think accounting is a strong suit of mine. However, I have to admit that the further into the unit we get the more it is growing on me. The complexity that I often perceived with numbers is gradually fading…”

Quite a few people are experiencing the excitement and interest that come from learning actively and ‘for real’, as we develop our own emerging understanding of something that is new to us:

“Overall, excitement and interest would be the words I would use to describe this entire chapter. The ideas and concepts were easy and straightforward and I found them to be absorbing and didn’t want to stop reading. I loved the underlying maths, and it was easy to engage in. I really connected with the reading and especially enjoyed the story about the music gigs. What I have found surprising though, is the amount of creative accounting that can be implemented without breaking the rules.”

However, there are some people who have limited time to give to their studies and who are struggling with learning for understanding and developing personal meaning. They would prefer a quicker approach of just ‘getting to the facts’ and can find the readings rambling and repetitive:

“What I feel when reading these chapters is that there is a lot of repetition in what is written. It is written forwards, backwards, upside down, sideways and inside out. I am guessing to appeal to all types of learners to help us better understand what accounting is all about.“

And ‘real’ learning is enjoyable. Perhaps it is challenging and stretching at times (maybe most of the time), and requires us to make the mental effort to understand new concepts and ideas for ourselves; but ‘real’ learning is just fun. And it is addictive: once bitten, you can find yourself learning everyday for the rest of your life. And if you do this, you will end up knowing a lot; really knowing it in your heart, and in your life, and in your mind and thoughts. And you will be a different person; changing just a little bit everyday:

“What I will say, is I cannot wait to be able to do an assessment like this again. When I learnt it the first time I did not enjoy it but I feel with this unit I will find enjoyment out of it as this chapter has helped me further my knowledge and gain a deeper understanding.”

Thank you for all your contributions in your ASS#2 Step 2.

I look forward to your continuing discussions on issues you may face with your ASS#2 on various forums; and we also look forward to reading your ASS#2 Steps 3 and 4 (your restated financial statements).