Leaders have followers, Managers have subordinates

Posted on May 7, 2012 by Ray

An intriguing question: What is the difference between an effective Manager and a good Leader? Everybody has an opinion and we may come close in defining the difference, but somehow nobody has really pinpointed it for me in such precision as the below table depicts.

This overview below shows how a “Manager” would approach a particular situation and how a “Leader” would. The point being that a good manager does not make a good leader and a good leader is not by default a good manager. And they dont have to be the same… each have different qualities and different leadership style by the nature of their role. Some argue that leadership goes beyond managerial execution as it requires competencies that are hard to learn and are often a natural talent.

See if you disagree…











Managers versus Leaders
Subject Manager Leader
Essence Stability Change
Focus Managing Work Leading people
Have Subordinates Followers
Horizon Short-term Long-term
Seeks Objectives Vision
Approach Plans detail Sets direction
Decision Makes Facilitates
Power Formal Authority Personal charisma
Appeal to Head Heart
Energy Control Passion
Culture Enacts Shapes
Dynamic Reactive Proactive
Persuasion Tell Sell
Style Transactional Transformational
Exchange Money for work Excitement for work
Likes Action Striving
Wants Results Achievement
Risk Minimizes Takes
Rules Makes Breaks
Conflict Avoids Uses
Direction Existing roads New roads
Truth Establishes Seeks
Concern Being right What is right
Credit Takes Gives
Blame Blames Takes





  

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Workings behind Activity Based Management

Posted on May 7, 2012 by Ray

Activity-based management (ABM) is a technique of classifying and evaluating actions that a business performs using activity-based costing (ABC) to carry out a value chain analysis or a re-engineering initiative to develop strategic and operational assessment in an organization.

Activity Based Costing
In simple terms activity-based costing establishes relationships between overhead costs and activities so that overhead costs can be more precisely allocated to services, products and customer segments. Now what is so special about that? Well:

  • ABC systems help companies make better pricing and product mix decisions.
  • ABC assists in cost management decisions by improving processes and product designs.
  • Activities generate transactions.
  • Transactions generate costs.
  • ABC traces costs to activities.

 

 

 

 

 

Activity Based Management

ABM focal point is managing activities and reducing costs and improving customer value. ABM is a distinctive model and ABM is not a technique, it is process of performing management.

Activity-based management is classified into 1) Operational and 2) Strategic ABM.

  1. Operational ABM is about “doing things right”, using ABC information to improve efficiency. Those activities which add value to the product can be identified and improved. Activities that don’t add value are the ones that need to be reduced to cut costs without reducing product value.
  2. Strategic ABM is about “doing the right things”, using ABC information to decide which products to develop and which activities to use. This can also be used for customer profitability analysis, identifying which customers are the most profitable and focusing on them more.

A risk with ABM is that some activities have an implicit value, not necessarily reflected in a financial value added to any product. For instance a particularly pleasant workplace can help attract and retain the best staff, but may not be identified as adding value in operational ABM. A customer that represents a loss based on committed activities, but that opens up leads in a new market, may be identified as a low value customer by a strategic ABM process. Managers should interpret these values and use ABM as a common, yet neutral, ground.



 

 

 

 

 

 

 

 

 

Deployment throughtout the Organization
ABM needs to be understood and applied at different function levels of the organization so its power can be unleashed and the benefits can be obtained from this model. ABM goals for managers will ensure alignment and focus on reducing non-value added activities and waste from the organization.

ABM has evolved over time and is now considerably applied in manufacturing, service companies, logistics, utilities, government bodies, telecommunications and many more sectors. Dramatic improvements are achievable in measuring process and product costs, and more critically customer profitability.

The Hewlett-Packard North American Distribution Organization teams and acronym itself has evolved from ABC to ABCM (activity-based cost management) to ABM, and the application of ABC evolved from a manufacturing product costing orientation to a management philosophy of activity management applied in industries and organizations other than manufacturing. It has also played a role in today’s fast paced world, organizations are moving from managing vertically to manage horizontally. It is a move from a function orientation to a process orientation. Total quality management (TQM), just-in-time (JIT), benchmarking and business process reengineering (BPR) are all examples of horizontal management improvement initiatives. These initiatives are designed to improve an organization’s work processes and activities to effectively and efficiently meet or exceed changing customer requirements.

Organizations that are designing and implementing ABM will find that there are five basic information outputs:

  1. the cost of activities and business processes;
  2. the cost of non-value-added activities;
  3. activity-based performance measures;
  4. accurate product/service cost (cost objects);
  5. cost drivers

Conclusion:
ABM contributes to management improvement initiatives and improved decision making by providing cost and operating information about the activities of the organisation. Activity-based management depicts the key relationship between ABC, and the management analysis tools that are needed to bring full realisation of the benefits of ABC to the organisations. ABC is a methodology that can yield significant information about cost drivers, activities, resources and performance measures. However, ABM is a discipline that offers the organisation the opportunity to improve the value of its products and services.

Want more? Have a look at this white paper (old but excellent material).

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Top 5 Key Industry Financial Performance Indicators (Comparatives)

Posted on April 25, 2012 by Ray

Because I am used to getting the question “what do other industries have as ROS%?” I figured to benchmark performance based on 25 industries and their key metrics. The data is gathered from financial statements of 30,000 companies (yes we did have some help here).

Have a look at the below table:

In case you have some questions on the metrics used here’s a bit of background:

Gross Margin is the difference between revenue and cost before accounting for certain other costs. Generally, it is calculated as the selling price of an item, less the cost of goods sold (production costs, essentially). The purpose of margins is to determine the value of incremental sales, and to guide pricing and promotion decision. Margin on sales represents a key factor behind many of the most fundamental business considerations, including budgets and forecasts. All managers should, and generally do, know their approximate business margins. Managers differ widely, however, in the assumptions they use in calculating margins and in the ways they analyze and communicate these important figures.

Gross Margin = Gross Income / Revenue X 100

 

Net Margin or Return on Sales (ROS%) is calculated by finding the net profit as a percentage of the revenue. ndividual businesses’ operating and financing arrangements vary so much that different entities are bound to have different levels of expenditure, so that comparison of one with another can have little meaning. A low profit margin indicates a low margin of safety and build up of equity meaning higher risk that a decline in sales will erase profits and result in a net loss, or a negative profit margin.

Net Margin = Net Income / Revenue X 100


Debt-to-Equity Ratio (D/E) is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage. The two components are often taken from the firm’s balance sheet or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company’s debt and equity are publicly traded, or using a combination of book value for debt and market value for equity financially.

Preferred shares can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision but will also take into account the specific features of the preferred shares. When used to calculate a company’s financial leverage, the debt usually includes only the Long Term Debt (LTD). Quoted ratios can even exclude the current portion of the LTD. The composition of equity and debt and its influence on the value of the firm is much debated and also described in the Modigliani-Miller theorem. Financial analysts and stock market quotes will generally not include other types of liabilities, such as accounts payable, although some will make adjustments to include or exclude certain items from the formal financial statements. Adjustments are sometimes also made to, for example, exclude intangible assets, and this will affect the formal equity; debt to equity will therefore also be affected. Financial economists and academic papers will usually refer to all liabilities as debt, and the statement that equity plus liabilities equals assets is therefore an accounting identity (it is, by definition, true). Other definitions of debt to equity may not respect this accounting identity, and should be carefully compared.

D/E = Debt / equity


Cash/Assets Ratio are the current value of marketable securities and cash, divided by the company’s current liabilities. Also known as the cash ratio, the cash asset ratio compares the dollar amount of highly liquid assets (such as cash and marketable securities) for every one dollar of short-term liabilities. This figure is used to measure a firm’s liquidity or its ability to pay its short-term obligations. Ideal ratios will be different for different industries and for different sizes of corporations, and for many other reasons.

Cash/Assets = Current Assets (Less Inventory) / Current Liabilities


Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.

Return on Equity = Net Income/Shareholder’s Equity

Manufacturing: Plastic Products Manufacturing: Cement and Concrete Products Manufacturing: Industrial Machinery
Manufacturing: Household, Institutional Furniture and Kitchen Cabinets Manufacturing: Medical Equipment Retail: Automobile Dealers Retail: Automotive Parts, Accessories and Tire Stores Retail: Furniture Stores Retail: Grocery Stores Retail: Gasoline Stations Retail: Clothing Stores Retail: Direct Selling Establishments Health Care: Offices & Physicians Health Care: Offices & Dentist Health Care: Home Health Care Services Health Care: Nursing Care Facilities Professional Services: Advertising and Related Services Professional Services: Employment Services Professional Services: Services To Buildings and Dwellings Professional Services: Computer Systems Design and Related Services Professional Services: Insurance Agencies, Brokerages and Other Related Activities Professional Services: Real Estate Agencies And Brokers Miscellaneous: Cattle Ranching Miscellaneous: Forestry and Logging Miscellaneous: General Freight Trucking

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Considerations when Implementing a Shared Service Center

Posted on April 22, 2012 by Ray

The goal of a shared service center is to increase the efficiency and effectiveness of its internal administrative organization. A shared service center can provide a range of benefits for an organization but can also be a source of frustration if not implemented carefully.

We have listed some considerations to think about when implementing a shared service center. They may seem straightforward but nevertheless they are crucial for success.

Several Advantages of a Shared Service Center Setup:
- Economies of scale and thus cost reduction
- Ability to have 24 hours service
- Automation replace manual processes
- Standardization of processes
- Knowledge centralized and often shared (backup plans)
- Best practice sharing now possible
- Business can now focus on non-transactional and compliance activities
- Standard platform for new acquisitions

Several Downsides of a Shared Service Center Setup:
- High infrastructural investments required at setup
- Loss of local knowledge
- Risk of processes disconnects during/after transfer
- Organizational resistance, fear of loosing jobs
- Service level pre-defined, less flexible on non-standard transactions
- Non-site dedicated resources may create inefficient process
- Language barriers
- Capitalizing on headcount reduction at source location difficicult if only part of the role is transferred
- Definition of process ownership crucial, if not defined in sufficient detail processes may not be executed in full resulting in increased control risk

Commmon Processes to Centralize

  1. Finance:
    - General Ledger
    - Accounts Payables
    - Accounts Receivables
    - Compliance
    - VAT/Corporate Income Tax Filing
    - Insurance
    - Payroll
    - Cash Management / Treasury
  2. Supply Chain Management:
    - Procurement
    - Indirect spend consolidation (travel management, etc.)
  3. Human Resources:
    - Payroll Processing
    - Compensation & Benefits
    - Training Services
  4. Legal:
    - Litigation support
    - Contract Management

Criteria to select centralized processes:
So now we know the ups and downs of implementing a shared service center, what criteria should we use to evaluate whether to move a process? I have listed several items that could be relevant for your organization.

The main question to ask is always “does the transfer of processes make sense”. Second question in my mind is “does leadership at all levels support the initiative?”. If the answers based on logical reasons is no, do not even bother to continue.

Here are several criteria that you can use to evaluate the decision of centralizing processes:

- Efficiency gains
- Cost Reductions
- Implementation effort
- Systems Effort
- Language barriers
- Complexity of the process
- Needed versus Nice to Have

If this summary is of interest to you we highly recommend reading the article “Implementing Shared Services” sponsored by the Institute of Management Accountants. Drop a comment if you like to contribute.

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Percentage of Completion (Installement Method)

Posted on April 15, 2012 by Ray

The Percentage of Completion (POC) technique is regularly used with construction based projects that continue to run over the course of many years. The approach of percentage completion accounting is preferred over the Completed Contract Method by the accountants because it provides a more rational outlook of the company and its revenue streams and cash flows. This revenue recognition method avoids variation in the P&L where costs and revenues have to be matched.

The formula for Percentage of completion basically takes a projected percentage of how close the project or task is to being fulfilled by taking the cost to date for the project over the sum of the estimated cost. Then the percentage calculated is multiplied by the total projected revenue through, which the calculation of revenue for the period is computed. The income for construction then can be derived by subtracting the cost from the period revenue.

The percentage completion formula and other associated formulas can be simplified as follows:

Step 1:
Period Costs (annual, quarterly, etc.) = Percentage Completed
                 Total Estimated Cost

Step 2:
Percentage Completed * Total Project Revenue = Period Revenue

Step 3:
Period Revenue – Period Costs = Project Income

 

Example 1 of the Percentage of Completion Method
The Boulders Construction Company is constructing a modern style office building for a company specializing in clothing wholesale business. Thus far, Boulders has accumulated $810,000 in expenses on the project and billed the customer $1,000,000.  The estimated gross margin on the project is 28%.

The total of expenses and estimated gross profit can be calculated by:

$810,000 divided by 0.72 (1 – 0.28) =  $1,125,000

Since this figure exceeds the billings to date of $1,000,000, the company can recognize additional revenue of $125,000.

Costs + Profit $1,125,000 -/- Billed to Customer $1,000,000 =  $125,000

The resulting journal entry is:

Debit                 Credit

Unbilled contract receivables         125,000
Contract revenue earned                                                   125,000

Since, Boulders must also recognize a proportional amount of expenses in relation to the revenues recognized because of this it should credit the construction in progress account and debit the cost of goods sold account.

The cost of goods sold is derived by multiplying the recognized revenue figure of $125,000 by one minus the gross margin, or 72%.

Cost of Goods sold: $125,000 x 0.72 (1 – 0.28) =  $90,000

 

Example 2 of the Percentage of Completion Method
Under an alternative scenario, Boulders has billed the customer $1,200,000, while all other information remains the same. In this case, the amount of revenue earned is $1,125,000 which is $75,000 less than the amount billed.  Consequently, the company must record a $75,000 liability for the incremental amount of work it must still complete before it can recognize the remaining revenue that has already been billed.  The resulting journal entry would be:

Debit                Credit

Contract revenue earned                                                  75,000
Billings exceeding project costs and margins                                      75,000

Key Requirements for Using this Method:
See also our article on SAB 104 Revenue Recognition but in addition:
Profitability of the project needs to be reasonably determinable
This method should give a more realiable measure of progress towards completion than recognizing income than when the contract would be completed (matching principle)

Advantages:

  • Periodic recognition opposed to irregular streams of income only when contracts are completed
  • More accurate way of reporting income and expenses

Disadvantages:

  • Estimations are used in the process making this method a subjective one
  • Accounting system needs to be projects based with ability to keep track of projects over several years

Full FASB 56 Statement (supplemented by AICPA Statements of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and 81-2, Reporting Practices concerning Hospital-Related Organizations)

http://www.fasb.org/pdf/fas56.pdf

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Revenue Recognition Criteria (SAB 104/ FASB CS 5)

Posted on April 15, 2012 by Ray

Revenue is the largest  item present in the Income Statement and is therefore regarded as the most important and critical area that regulatory bodies and accountants have to deal with.

Revenue Recognition Criteria SAB 104 / FASB 5
SAB 104 states, if a transaction falls within the extent of a specific authoritative literature on revenue recognition its guidance is to be followed, if there is a absence of such direction, then the revenue recognition criterion in FASB Concepts Statement 5 states, that revenue should not be recognized until it is:

(a) realized or realizable and
(b) earned. 

On the other hand, SAB 104 is more precise, stating further requirements to meet the criteria, while respecting the SEC staff’s observation that the four central criteria for revenue recognition should be the basis for all basic revenue recognition principles. Those criteria are:

    1. Persuasive evidence of an arrangement exists.
    2. Delivery has occurred or services have been rendered.
    3. The seller’s price to the buyer is fixed or determinable.
    4. Collectability is reasonably assured.

 

 Revenue is the major item present in the Income Statement and is therefore viewed as the most significant and critical parts that regulatory bodies and accountants cover.
Revenue Recognition Criteria SAB 104 / FASB 5

SAB 104 states, if a transaction falls within the extent of a explicit authoritative literature on revenue recognition its regulation is to be followed, if there is a lack of such a trend, then the revenue recognition criteria in FASB Concepts Statement 5 states, that revenue should not be recognized until it is:

  • Realizable or Realized and
  • Earned

On the other hand, SAB 104 is more precise, stating further requirements to meet the criteria, while respecting the Security Exchange Commission staff’s inspection that the four central criterions for revenue recognition should be the basis for all essential revenue recognition principles. Those criteria are:

    1. Persuasive evidence of an arrangement exists.  
    2. Delivery has occurred or services have been rendered.
    3. The seller’s price to the buyer is fixed or determinable.
    4. Collectability is reasonably assured.

These criterions will be checked with an example of a sale of a car on December 31 and the occurring problems still present, which are analyzed as follows:

Persuasive evidence of arrangement.
This criterion is based on the fundamental that the customer signed all obligatory paperwork and had financing setup / arranged at a local bank, there appears to be adequate indication that a sales agreement is in place and it can be agreed that this criterion has been met. E.g. in this case a contract with the car dealer stipulating the terms and conditions of the sale would do.

Price fixed and collectability assured.
The buyer and seller have agreed on a price. It may be possibility that payment is not assured because ABC faces a risk that the customer cannot obtain financing from his local bank. Other situation that can be put in place is that the dealership offered to finance the purchase even if the customer cannot obtain a loan, the dealership will finance the automobile and, therefore, payment is realizable. Without any evidence to the contrary, the most likely conclusion is that the price and collectability criteria are met for revenue recognition.

Delivery made.
Through the above example it can be argued for constructive receipt that, for all practical purposes, the delivery of the car was made. On the other hand it can be contended that although the “checking of fluids and washing the automobile” are minor, delivery was not completed. This part of the discussion can lead to a hypothetical question: What would happen if the automobile was damaged or stolen from the dealer’s lot before the customer returns to pick up the automobile? Who would be responsible: the dealer, or the customer? A key question is whether the right and risk of ownership was transferred to the customer. If the automobile was stolen or damaged, it is a common believe among the general public that the customer would refuse delivery of this specific automobile. In several cases, the delivery criterion comes down to an interpretation of law.

The Materiality Argument
Common responses from an accountant when presented with this case would be to book a transaction as revenue because the following conditions were met:

•    All significant elements of a sale have been accomplished;
•    The risk of the customer’s not completing the sales transaction is low; and
•    The sale is immaterial to total revenue, net income, and total assets.

In case you are not sure, consult an accountant, who will most likely advise you to take the most prudent route.

SAB 104 provides further direction on the explanation and consideration of the criteria noted above. As additional questions arise, the SEC’s Emerging Issues Task Force addressed them in updated SABs. The sheer volume and specification of the examples provided in those documents exhibit the intricacy of revenue recognition considerations.

How to account for revenue can have different meanings and guidelines are often conflicting. There are several sources that could offer help:

Since, no comprehensive standard exist on revenue recognition because of this there is a significant gap among the broad conceptual guidance in the Financial Accounting Standards Board’s (FASB) Concepts Statements. In addition there is guidance in the AICPA Statements of Position (SOPs), Emerging Issues Task Force (EITF) Issues, Accounting Principles Board Opinions (APB) , American Institute of Certified Public Accountants (AICPA) Audit and Accounting Guides, FASB Interpretations, Securities and Exchange Commission (SEC) Staff Accounting Bulletins (SAB).

Each focuses on an explicit practice issue and has a constricted scope, and the regulation is not always consistent across pronouncements.

See from page 9 of SAB104: SAB104 – Revenue Recognition
See FASB Concept Statement Number 5: fasbconceptstatement5

 

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Sarbanes Oxley: The Original Act

Posted on April 8, 2012 by Ray

An Act

To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.

Download the full orginal act here! <– Click there

Here’s the extract of the 2 most important aspects of the Act.

SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS.
(a) RULES REQUIRED.—The Commission shall prescribe rules
requiring each annual report required by section 13(a) or 15(d)
of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d))
to contain an internal control report, which shall—
(1) state the responsibility of management for establishing
and maintaining an adequate internal control structure and
procedures for financial reporting; and
(2) contain an assessment, as of the end of the most recent
fiscal year of the issuer, of the effectiveness of the internal
control structure and procedures of the issuer for financial
reporting.
(b) INTERNAL CONTROL EVALUATION AND REPORTING.—With
respect to the internal control assessment required by subsection
(a), each registered public accounting firm that prepares or issues
the audit report for the issuer shall attest to, and report on, the
assessment made by the management of the issuer. An attestation
made under this subsection shall be made in accordance with standards
for attestation engagements issued or adopted by the Board.
Any such attestation shall not be the subject of a separate engagement.

 

SEC. 302. CORPORATE RESPONSIBILITY FOR FINANCIAL REPORTS.
(a) REGULATIONS REQUIRED.—The Commission shall, by rule,
require, for each company filing periodic reports under section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m,
78o(d)), that the principal executive officer or officers and the principal
financial officer or officers, or persons performing similar
functions, certify in each annual or quarterly report filed or submitted
under either such section of such Act that—
(1) the signing officer has reviewed the report;
(2) based on the officer’s knowledge, the report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements
made, in light of the circumstances under which such statements
were made, not misleading;
(3) based on such officer’s knowledge, the financial statements,
and other financial information included in the report,
fairly present in all material respects the financial condition
and results of operations of the issuer as of, and for, the
periods presented in the report;
(4) the signing officers—
(A) are responsible for establishing and maintaining
internal controls;
(B) have designed such internal controls to ensure
that material information relating to the issuer and its
consolidated subsidiaries is made known to such officers
by others within those entities, particularly during the
period in which the periodic reports are being prepared;
(C) have evaluated the effectiveness of the issuer’s
internal controls as of a date within 90 days prior to
the report; and
(D) have presented in the report their conclusions
about the effectiveness of their internal controls based on
their evaluation as of that date;
(5) the signing officers have disclosed to the issuer’s auditors
and the audit committee of the board of directors (or
persons fulfilling the equivalent function)—
(A) all significant deficiencies in the design or operation
of internal controls which could adversely affect the issuer’s
ability to record, process, summarize, and report financial
data and have identified for the issuer’s auditors any material
weaknesses in internal controls; and
(B) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the issuer’s internal controls; and
(6) the signing officers have indicated in the report whether
or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
(b) FOREIGN REINCORPORATIONS HAVE NO EFFECT.—Nothing
in this section 302 shall be interpreted or applied in any way
to allow any issuer to lessen the legal force of the statement
required under this section 302, by an issuer having reincorporated
or having engaged in any other transaction that resulted in the
transfer of the corporate domicile or offices of the issuer from
inside the United States to outside of the United States.
(c) DEADLINE.—The rules required by subsection (a) shall be
effective not later than 30 days after the date of enactment of
this Act.

Enjoy the read…! Amendments may have been made and are available on SEC website.

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Importance of Reducing Setup / Change-over Times

Posted on April 8, 2012 by Ray

A set-up is defined as the time that the last product leaves the machine until good products are coming out1. The quality of a set-up is determined by three key elements:

  • the technical aspects of equipment and tools
  • the organisation of the work “who does what when” and
  • the method used “how”

All these elements around change-overs must be examined and optimised. Why? Well, for one to reduce costs. But perhaps more importantly if this is achieved the operators will be more motivated to do their job right. Even with a perfectly designed machine, made to enable fast set-ups, and the most efficient method and organisation of work, described in a set-up work instructions, there will be no good set-up if the people who have to perform the work don’t see the importance of a short set-up or are not motivated for obtaining short set-up times. It is clear that the optimization of the key elements mentioned above is not an exclusive issue for production people.

In addition to this, there are external factors, which are completely outside of the control of production employees, which can influence set-up times in a positive or a negative way. Here begin the responsibilities of functions, outside of production. Although long set-up times are more visible in production, many causes can be found that are outside the boundaries of production. Some of these external factors lie in necessary maintenance, error messages due to wrong material on the lines.

Theoretical traditional view on changeovers on a production line can be represented as follows:

 

 

 

 

The actual change most likely does not go without start up problems. If a machine starts it does not go back directly to full capacity, this takes time. Furthermore, it often happens that something goes wrong in the start up process, which therefore takes more time. This is how the efficiency looks like of a real change-over:

Here is where typically finance gets interested. Clearly there are savings to be achieved when optimizing the production lines and reducing change overs. Sophisticated cost accounting models “charge” a product when a change over occurs. But how to determine the right allocation key. Which product do we charge the change-over to? In reality, for the sake of simplicity, the cost price of each product has an element for setup costs (number of change-overs x average setup time x labor cost per hour). Important here is when applying this type of allocation to product cost we should take into consideration the “actual” instead of the “theoretical” change-over time.

Enjoyed the read? Please leave a comment with your views!

[1] Source: S. Shingo, A study of the Toyota Production System, 1989

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Manufacturing Accounting: Value Add and Vital for Decision Making

Posted on April 8, 2012 by Ray

Manufacturing (part of cost) accounting has been designed to let production managers, planners, operations and financial controllers know what went well or wrong in their production processes. It shows them where the value-added processes delivered against expected performance and where there are further opportunities for maximizing efficiency. It is a systematic tool that can be refined and once understood can be expanded far beyond the example below (see picture). 

The main advantage it has is that this concept allocates the overhead by using cost drivers into different measurable sections, also known as variances. These variances result from differences between standard and actual cost and can pinpoint where the over or under-spend occurred, even sometimes down to machine level. A manufacturing location can have cost drivers defined at  a plant level but more sophisticated manufacturing sites have either activity based costing or multiple overhead rates at their key production points.

In summary having a robust and refined manufacturing accounting process has the following benefits:

  • Helps maximize the efficiency of your workforce,  production lines or plant
  • Overhead is allocated based on cost-drivers allowing for a fair allocation t
  • Offers insights in your capacity model
  • Allows you to compare to a baseline (standard costing)
  • Basis for decision making
  • Focuses on added-value processes (waste reduction)
Main condition is that you have a good management/cost accounting system that allows you to track these activities and an engaged management team that drives performance on variances.   

We will devote some more time on the different variances that can occur in a production process and how this can link with Activity Based Costing but for now this should give you a high level tool to understand the basics of manufacturing accounting (again you can make it more complex by expanding your overhead allocation to any cell on your production floor):


Work in Progress (Balance Sheet) Debit Credit Standard Material Cost x Actual Material Used Standard Material Cost x Actual Materialerial Used Standard Rate x Actual Labor Hours Used Standard Rate x Actual Labor Hours Used Standard OH Rate x Actual Labor Hours Standard OH Rate x Actual Labor Hours Finished Goods (Balance Sheet) Debit Credit Standard Cost x Quantity Produced Standard Cost x Quantity Sold Cost of Goods Sold (Profit & Loss) Debit Credit Standard Cost x Quantity Sold Sales Debit Credit Selling price x Quantity (excl. VAT) Accounts Receivables Debit Credit Selling price x Quantity (incl. VAT) Actual Spend During the Year Works order is issued, parts are picked and produced Works order is completed, parts are produced Sales is made: record the cost of sale Sales is made: record the sale

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Accounting of Forward Exchange Contracts

Posted on March 28, 2012 by Ray

Companies deal daily with foreign currency transactions (e.g. imports and exports). To settle these payment payments are normally done in their local currencies or in the benchmark currency i.e. in US Dollars.

These payments to the counterparties are subject to currency exchange risk (i.e. the risk of an investment’s value changes due to changes in currency exchange rates due to an adverse movement in exchange rates). A great way to cover these exchange risks is by entering into the forward exchange contracts.     

What is a Forward Contract?

In order to avoid the risk of losses due to foreign exchange rate fluctuations, a company may enter into a forward exchange contract to manage the amount of the reporting currency required or available at the settlement date of transaction. Forward contract are the derivative instruments. The forward contracts are not tradable instruments through centralized exchange.

How Foreign Currency Instruments treated under IFRS versus US GAAP?

IFRS

US GAAP
The International Accounting Standards IAS 32 and 39 defines the accounting of derivative financial instruments. IAS 32 defines a “financial instrument” as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity”. Therefore, a forward contract or option would create a financial asset for one entity and a financial liability for another.The entity required to pay the contract holds a liability, while the entity receiving the contract payment holds an asset. These would be recorded under the appropriate headings on the balance sheet of the respective companies. IAS 39 gives further instruction, stating that the financial derivatives be recorded at fair value on the balance sheet. The US Generally Accepted Accounting Principles (GAAP) also includes instruction on accounting for derivatives. For the most part, the rules are similar to those given under IFRS. The standards that include these guidelines are SFAS 133 and 138. SFAS 133, written in 1998, stated that a “recognized asset or liability that may give rise to a foreign currency transaction gain or loss under Statement 52 (such as a foreign-currency-denominated receivable or payable) not be the hedged item in a foreign currency fair value or cash flow hedge”. Based on the language used in the statement, this was done because the FASB felt that the assets and liabilities listed on a company’s books should reflect their historic cost value, rather than being adjusted for fair value. The use of a hedge would cause them to be revalued as such. (OLD US GAAP treatment)Remember that the value of the hedge is derived from the value of the underlying asset. The amount recorded at payment or reception would differ from the value of the derivative recorded under SFAS 133.

Thus, two years later FASB issued SFAS 138 which amended SFAS 133 and allowed both cash flow and fair value hedges for foreign exchanges. Citing the reasons given previously, SFAS 138 required the recording of derivative assets at fair value based on the prevailing spot rate.

Example: Accounting Entries as per IFRS & GAAP

Case: On 1st January, 2005, a company entered into a foreign currency transaction by taking a loan of US $ 100,000. The amount of loan is required to be paid on 30th June, 2005. On 1st January 2005 itself, the company entered into a forward exchange contract for the transaction to mitigate the risks associated with changes in exchange rates.

The exchange rates (FC per US $) are as below: 

Period

01.01.11

31.03.11

30.06.11
Spot rate

90

92

95
Forward rate (for six months)

93

 

 
Forward rate (for three months)

 

94

 

Journal entries for Forward Contract 

                                                                                                DR.                         CR.

01.01.2011
Foreign Currency Receivable A/c                                     9,300,000
To Amount payable to bank A/c                                                                      9,300,000
(Entry passed for entering into forward exchange contract)

31.03.2011
Foreign Currency Receivable A/c.                                  100,000
To Exchange Gain A/c                                                                                        100,000
(Entry passed for marking to market of forward exchange contract (94-93)*100,000)

30.06.2011
Foreign Currency Receivable A/c                                    100,000
To Exchange Gain A/c                                                                                        100,000
(Entry passed for marking to market of forward exchange contract (95-94)*100,000. If you report monthly financials this entry has to be made each month using the new month-end rate)

Bank A/c.                                                                               200,000
Amount payable to bank A/c.                                            9,300,000
To Foreign currency receivable A/c.                                                              9,500,000             
(Entry passed for settling the forward exchange contract)

Conclusion:
Forwards exchange contacts are derivatives that can be used to speculate or to hedge the exchange currency risk. The proper use of the instruments greatly suffices the exchange risk even get the profit to the buyers and sellers.

Leave a comment if you wish to contribute or add anything to this write-up.

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Currency Alt Codes

Posted on March 28, 2012 by Ray

Always looking for the Alt-codes that go with different currency combinations?

Print this out and hang over your desk and never go wrong.

Enjoy!

CODE Symbol Currency
Alt+36 $ Dollar Sign
Alt+155 ¢ Cent
Alt+156 £ Pound
Alt+0128 € Euro
Alt+157 ¥ Yen
Alt+158 ₧ Peseta
Alt+159 ƒ Gulden
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Looking for Co-Bloggers!

Posted on March 10, 2012 by admin

Our site is growing fast and to keep our information hungry readers happy on a daily basis we decided to expand, together with you!

We are looking for finance professionals that are willing to share experiences and write 1 or 2 interesting articles a week, a month, a year (all flexible) and post it on our site. 

If you are interested to join us, drop a mail to: iblog@raynet.nl

:)

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Fixed is Fixed… Is it not?

Posted on March 10, 2012 by admin

Cost price and volume is key to understand in a manufacturing environment. Lets take a simplistic look at his:

You will find that the most common way to think about cost price is to take variable costs per unit + fixed cost per unit equals standard cost. Add to that you other SG&A expenses to get to fully loaded cost per unit. Add to that the profit margin to get to your selling price.

Symplicstically said the formula for the first part (standard cost per unit) is as follows:

Fixed Cost + Variable Cost per unit = Standard Cost per Unit
  Volume           

What is important here is to realize that fixed costs per unit are not fixed, they go down when volume drops. Variable costs per unit on the contrary are fixed.

Lets look at an example.

Production volume is expected to be 500. Variable Mfg Costs are 4 per piece and Fixed Mfg Costs are 15.000. At the beginning of the year we set our standard cost to be Variable costs per unit are thus 4 and Fixed costs per unit  15.000/500 = 30. Total standard cost per unit = 34.

Now during the year, production volume changes to 1.000, total variable costs will double (variable means: costs increase when production volume increases). So Variable costs per unit are still 4 (no change). Fixed costs per unit however have now halved to 15.000/1.000 = 15. Actual cost price is now only 19. Quite favorable situation as you are recovering more fixed costs than planned.

Why is this important? Fixed expenses are absorbed completely by producing the volume you set when determining your fixed cost per unit (usually once per year). If you are producing below the volumes expected you will not recover enough fixed costs (the absorption is too low). This will show up in the P&L on the absorption line in the variance section called “Overhead Volume Variance”, leaving you at a loss. Of course vise versa is true as well as is in this example above. Having higher volumes produced compared to plan means you recover more fixed costs than needed.

There is another type of variance that may occur around fixed costs. It may be that your fixed costs spending pattern does not happen the way you planned it out to be. E.g. if your insurance bill suddenly gets increased, or your rental agent gives you a reduction in price. The 15.000 of Fixed costs above could suddenly be very different, even though we thought they were fixed. In that case you will have a positive or negative impact on the P&L called “Overhead Spend Variance”.

In Summary:
Variable costs move with production volume (1 more unit produced = (depending on the correlation) 1 more variable cost). Variable costs per unit do not change. It is abosolutely key to make sure this relation is true as assumed at the beginning of the year. Why? Because if you think something is variable and its not in reality you may come to stand for surprises when volumes drop or increase.

Total Fixed costs are expected not to change when output changes (1 more unit produced = same level of fixed costs). Fixed costs per unit however do move with volume produced. If you do not meet the levels of volume set at the beginning of the year when building your standard cost, you will see a loss in the P&L on the variance line (absorption).

If you believe fixed is not fixed, tell the world, let us know and leave a comment!


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Linking Excel to Powerpoint: Automatic Updates of Data Tables

Posted on February 26, 2012 by Ray

Tools often used interchangably by Finance professionals are Excel and Powerpoint. Most of us copy paste between the two systems but if you have the time set the following up you may save in the long run: Automatic updating of Excel to Powerpoint.

The advantage is that you are ensuring you have data integrity between the two values and you prevent accidential copy-paste errors. This is how you set this up for your files:

A. Start an Excel spreadsheet

Setup your Excel spreadsheet the way you want it to appear on the Powerpoint slide. Try to be exact on the formatting of headers, columns, row heights, colors, etc. Once you have completed this step, highlight the area to be included in Powerpoint and Right-click –> Copy.

B. Start a new Powerpoint slide

Now paste the table by Right-click –> Paste Special and Select Paste Link. In the new version of Windows you may need to click on Paste Special from the toolbar. 

 
 

 

 

 

This is what you are looking for — PAST LINK:

 

 

 

 

C. Format the Inserted Table

You can resize the embedded worksheet by grabbing the handles on the sides of the object (hold left mouse and drag). Right-Click on the object gives more options related to sizing, filling colors, and much more.

D. Updating the Excel / Powerpoint Data

When you reopen the PowerPoint file, it will ask you whether you wish to update links, click “Update Links”. Now your new Powerpoint slide will be refreshed and displayed direct from your Excel tables. From Powerpoint you can double click on the embedded item to go to the Excel data directly.

Final note

If you send the file to others the link will obviously be broken and people can only see the last time you opened the Powerpoint slide. If you dont want others to be able to edit your Excel file by double clicking on the embedded item in Powerpoint, make the Excel file read-only (Windows Explorer –> Select File –> Right Click –> Properties –> Read-Only).

This should make your lives easier!

Leave a comment, tip or post here if you wish to contribute… its free and helps others!

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Founder & Father of Accounting: Pacioli

Posted on February 26, 2012 by Ray

nce upon a time there was a Franciscan Friar named Luca Bartolomes Pacioli (1445 – 1517). This mathematician stands at the basis of our current accounting principles and transactions as we know it today.

The bookkeeping instructions were included in Fray Pacioli’s book La Summa, which contained 36 chapters about bookkeeping. It was not introduced as an accounting discipline but as part of mathematical procedures, which merchants could utilize in monitoring their assets, liabilities and investment exposure (capital).Pacioli even taught mathematics to Leonardo da Vinci.

La summa included topics on jouralizing, posting and balancing the entries in the general ledger through the use of the double-entry system of recording.

For those who are truely interested we posted La Summa, “Reading Luca Pacioli’s Summa in Catalonia: An early 16th-century Catalan manuscript on algebra and arithmetic” here:

http://www.sciencia.cat/biblioteca/documents/Docampo_Algebra.pdf

Enjoy the reading!

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