Accounting Summary Session 2

Indifference point
Indifference point: it lets you compare two alternatives to see when one alternative
dominates the other.

Costs, assets and expenses

Costs: is the value of a resource. It can be the value of the time that a person works
for a company, reflected in that person’s salary. It can also be the value of raw
materials or of production equipment. Costs indicate that a resource has a value.
When resources are fully consumed in a period, these costs are expenses. For
example, the salaries of marketing managers.
When resources are not fully consumed in a period, these costs are assets. For
example, equipment that will be used over several years.
With the distinction between costs and expenses in mind, we can define profit as:
Profit = revenues – expenses

Depreciation
Depreciation: the value that an asset has lost during a period through usage and/or
passage of time.
Over time, assets become expense through depreciation.
The usual approach is to assume that an asset loses the same amount of value each
year of its life, this is called the straight-line depreciation method.
Depreciation is an estimation of the value lost by an asset during a period. As such, it
is an expense because it reflects the value that has been consumed during the
period.

Cost systems
Prices over the long term have to be higher than what managers call full cost.
The full cost reflects the value of all resources used to make a product or serve a
customer. It includes variable costs per unit, as well as a reasonable proportion of the
fixed costs.
For example, manufacturing full cost includes manufacturing resources only.
Cost systems are needed to know if a product or customer is profitable.
Companies with just one product need a cost system when they have variable and
fixed costs.
Cost systems give you the full cost of producing a product or serving a customer.
This model, called a cost system, traces, assigns or allocates (all of these words
have the same meaning in the management world) the costs of the resources to
products.
The fixed costs should be divided by volume.

Death spiral
When allocating fixed costs to units, you should take great care at choosing the
volume you will use in your denominator.
Do not use the actual volume produced but an estimate of the practical capacity.
If you use actual volume you can end up in the death spiral. Because if you divide
the fixed costs by a lower volume produced, the cost per unit becomes higher and
thus you think you have to raise the price, eventually leading to having no customers.
If volume produces is lower than practical capacity, then you have a cost of excess
capacity.