Tag Archives | revenue

Cost Control vs Cost Reduction

cut costs There is a difference between cost control vs cost reduction. Most people think that controlling costs and reducing costs are one and the same when, in fact, they can generate two totally different outcomes.

The first thing you need to know is that you can’t grow a company by cost reduction alone. You can get short term gains but, eventually, they fade. When public companies reduce costs through a restructuring there is typically a  short term lift to their stock price. However, for the increased stock value to be sustainable they must grow revenue.

An example might be Barnes and Noble bookstores. No amount of cost cutting is going to change the situation that they find themselves in today. They must reinvent themselves and pivot.

So if we want to add value we must grow revenue, how do we do it? There are three ways that come to mind. We could develop new products or services, increase market share or increase selling efforts. What do all three of these strategies have in common?

You have to increase costs to increase revenue!

So instead of looking for the lowest cost in a transaction you should look, instead, for the largest value received per dollar spent. It is easy to apply this train of thought to selling costs, marketing costs or product development costs, but what about overhead?

Does hiring the candidate at the lowest salary translate into a good value proposition? Does paying a premium get you a better employee?

The answer is: “it depends”. You should evaluate each cost incurred in light of the excess value received and the goals of your company.

We knew a company who wanted to spend as little as possible on their accounting staff. So they hired the cheapest accountants they could find not the most competent. In the end, they spent more money on cleaning up the financial statements, bringing them current and completing the year-end audit than the savings recognized.

The moral of this story is that you can’t build a house with only a hammer. Consequently, you can’t grow a company profitably by just focusing on cost reduction.

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cost control vs cost reduction

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Unearned Revenue

See Also:
Accounts Payable

Unearned Revenue Definition

Unearned revenues are titles for certain revenues that have not been earned. You can also call unearned revenues deferred revenues. Though it seems comically intuitive, unearned revenue is very important and often observed in the real world. In accounting, they are represented as liabilities on the balance sheet. This is because it represents an unfulfilled promise for a service by a company to a buyer. Furthermore, it is represented by a credit on the balance sheet, offset by Cash received by the service provider. In order to balance this liability, service revenue is the debit to the balance sheet that matches up with the unearned revenue credit.

Unearned Revenue Explained

Take, for example, a business situation that would exist between a carpet cleaning company and a homeowner. Before any service takes place, the cleaning company shows up at the house and gives the homeowner an estimate. The homeowner seems pleased with the estimate and pays the cleaner on the spot. At this point, the cleaning company has acquired an unearned revenue liability. In all likelihood, the liability will be cleared overtime with service. Until then, the cleaning company has money that they have not yet earned: “unearned revenue.”

unearned revenue, Deferred Revenues, unearned revenues

 

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Responsibility Center

Responsibility Center Definition

In accounting, a responsibility center refers to an organizational subunit in a corporation. For instance, a large corporation may consist of numerous smaller business groups or divisions, some or all of these organizational subunits could be set up as responsibility centers.

The manager of a responsibility center is responsible for the activities of the organizational subunit. In addition, they are responsible for the results of specified financial and non-financial performance measurements. The concept of the responsibility center as an organizational subunit in a larger corporation is a part of the larger concept of a responsibility accounting system.

Furthermore, there are four different types of responsibility centers. These different types include the following:

Responsibility Accounting

Responsibility accounting is a system of organizational architecture designed to promote goal congruence among managers and employees in a company or organization. It is also intended to appropriately measure and evaluate the performance of people and organizational subunits within the corporation. Many also employ responsibility accounting systems to ensure both responsibility and accountability among the hierarchy of the ranks within the organization.

Types of Responsibility Centers

The following include the types of responsibility centers:

1. Cost Center / Discretionary Cost Center
2. Revenue Center
3. Profit Center
4. Investment Center

Cost center managers are responsible for the incurring as well as controlling costs in their organizational subunit.

Discretionary cost center managers are typically responsible for adhering to a budget.

Revenue center managers are responsible for revenues generated by their organizational subunit.

Profit center managers are responsible for revenues and expenses generated as well as incurred by their organizational subunit.

Investment center managers are profit as well as the capital investments required to generate the profit.


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Responsibility Center

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Responsibility Center

 

Sources:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.

 

See Also:
Service Department Costs
Transfer Pricing
Value Drivers: Building Reliable Systems to Sustain Growth
Value Chain
Cost Driver

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Point of Sale (POS) Method

See Also:
Accounting Principles
Percentage of Completion Method
Completed Contract Method
Cost Recovery Method
Installment Method

Point of Sale (POS) Method Definition

The Point of Sale (POS) Method also known as the Revenue Method or Sales Method is one of the many methods under the Revenue Principle of Accounting. This method records the revenue at the point of sale because cash is received on site or it is reasonably certain that cash will be received soon and is thus a finalized transaction. They commonly use this method in grocery stores or other entities such as Wal-Mart. Companies can also record a sale if the amount of revenue can be measured objectively and the receipt is certain which becomes useful for companies such as a mining or lumber company. Another use of the method can be associated with a service that is provided like cable, car services, and certain utilities.

Point of Sale (POS) Method Examples

Incorporate the method of sales in several different ways. We will give various examples to explain the method.

Example 1:

Suppose that Fred goes into a music store to buy a CD. He makes a selection and then pays 15 dollars cash or the price of the CD to the store clerk. The music store would then use the sales method to record Fred’s purchase of the CD. The sales method would then post the following journal entries in recording the sale.

Cash…………………………………$15
Sales Revenue………………………………..$15

COGS………………………………..$10
Inventory……………………………………….$10

Example 2:

Timber Inc. specializes in the cutting and transportation of lumber. The company has recently sent a load of lumber with a costs of $10,000 to Furniture Inc. Since Timber Inc. has already delivered the goods to the customer (Furniture Inc.), Timber Inc. can go ahead and recognize the revenue because it has been objectively measured and there is reasonable certainty that the company will receive cash in the near future. Therefore, record journal entries as follows:

At time of Delivery:

Account Receivable (A/R)………..$10,000
Sales Revenue………………………………..$10,000

Upon Receipt of Cash:

Cash…………………………………..$10,000
A/R………………………………………………..$10,000

Example 3:

Plumber LLC performs plumbing work to households. Recently, they performed services to Brian because his kitchen drain was clogged. To unclog the drain Johnny the Plumber, an employee of Plumber LLC, snaked the piping and fixed the problem in an hour. Plumber Inc. can go ahead and bill Brian for an hour of service provided by Plumber LLC. Since the service has already been performed, the company needs to recognize the revenue under the sales method as follows:

At the time service is performed:

A/R……………………………………..$100
Service Revenue……………………………….$100

Upon the receipt of cash:

Cash…………………………………..$100
A/R………………………………………………….$100

Point of Sale (POS) Method

 

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Problems in Chart of Accounts Design

See also:
Standard Chart of Accounts
Chart of Accounts (COA)
Complex COA Number for SGA Expenses
Example Chart of Accounts for Selling General and Administrative
Time Saving Tip for Filing Vendor Invoices

Problems in Chart of Accounts Design

Too Many General Ledger Accounts

Often when using QuickBooks or Peachtree accounting software the number of general ledger accounts grow over time. Usually the person entering the data is not a trained accountant. When faced with an accounting entry that is not specifically described by an existing general ledger account they will often set up a new account. It is especially easy to do in QuickBooks.

Too Much Detail in Selling General and Administrative Expenses

Similar to the problem mentioned above, often the person maintaining the general ledger is a detail oriented employee. This trait is both a blessing and a curse. The theory goes as follows: If a little detail is good then a lot is better! In order to get more and more detail on the general ledger they set up new general ledger accounts. In the end they are counting paperclips with numerous accounts with less than a thousand dollars charged to them.

Not Enough Detail in Revenue and Cost of Goods Sold Categories

Often revenue consists of one line item labeled “Sales” and “Cost of Goods Sold” as another line item. On the other hand there is considerable detail in Selling General and Administrative expenses. Most accountants manage profitability by controlling costs, however, you can create more value by managing “above the line” or gross margin.

Cost of Goods Sold Not Aligned with Revenue

It is not uncommon to see revenue sorted by product or category and the Cost of Goods Sold being tracked under a different segregation. You should sort revenue and Cost of Goods Sold by the same methodology so you can manage gross profit by category.

No Logic in Assigning General Ledger Account Numbers

Account numbers, especially in Selling General and Administrative expenses, are not assigned in any logical order. Accounts are not entered alphabetically or within a logical grouping. Consequently, it is difficult for the clerical staff to code payables properly or consistently.

Poor Titles on General Ledger Account Descriptions

In some instances, you may use acronyms to title accounts. This makes it difficult for a reader of the financial statements to decipher the accounts.

Inadequate Detail in Chart of Accounts

Too little detail in the chart of accounts can be as bad as having too much. An example is having two inventory subsidiary ledgers posting to one general ledger control account making reconciliation difficult.

No Departments, Product Lines or Regional Data Tracked

Part of a company’s strategic plan should be to manage growth and profitability by major categories. By putting this level of detail in the general ledger, you will refocus management’s focus or target on strategic goals.

Chart of Accounts Does Not Relate Back to Pricing Model

In bidding jobs or quoting sales orders it is important to estimate indirect overhead or direct overhead. If you do not compare these estimates to actual results, then over time profitability may suffer.

Using the Chart of Accounts for Job Costing

In companies where job costing is important it is common to see the Chart of Accounts used to track job cost. This is a result of not setting up the accounting software properly or not purchasing the appropriate accounting software package.

No Standard Chart of Accounts for Different Companies

In this situation multiple companies are either formed or acquired over time. Because they are often in different industries, use a different Chart of Accounts for each company. It would be preferable to use a standard Chart of Accounts customized in the few areas necessary.

Too Many Digits in Chart of Accounts Numbering

Accountants trained in a large company environment often bring that same logic to an entrepreneurial company. The result is an account numbering system six or more digits long. Most modern day accounting software use departmental accounting making the required digits to be no more than five.

Not Using a Numbering System

QuickBooks is great accounting software for beginners and non-accountants. Consequently, use an alpha system to establish the Chart of Accounts. This practice makes it difficult to sort accounts in anything other than alphabetical order.

Using Alpha Numeric Chart of Accounts

Another problem is using a combination of alpha/numeric accounts. Just as using alpha only systems causes organization problems so does a combination of alpha/numeric.

Not Leaving Gaps in the Numbering System

When you set up a chart of accounts for the first time, assign account numbers sequentially. Later when you want to add an account in alphabetical order there is not a gap in the numbering system to allow you to insert the new account.

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Problems in Chart of Accounts Design

 

Problems in Chart of Accounts Design

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Percentage Completion (POC) Method

See Also:
Percentage Completion Method Example
Accounting Principles
Point of Sale Method (POS)
Installment Method
Completed Contract Method
Collection Method
Work Breakdown Structure (WBS)

Percentage Completion (POC) Method

Use the Percentage Completion (POC) method with construction based projects that extend over the course of several years. Furthermore, many accountants prefer the percentage completion accounting over the Completed Contract Method. It also paints a more realistic view of the company. Because the projects are usually long term lasting several years, it estimates completion for the company. So it shows revenues year by year than to just all of the sudden have one large inflow at the end where the project was completed.


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Percentage Completion (POC) Method Formula

The Percentage of completion formula is very simple. First, take an estimated percentage of how close the project is to being completed by taking the cost to date for the project over the total estimated cost. Then multiply the percentage calculated by the total project revenue to compute revenue for the period. Then derive the construction income by subtracting the cost from the period revenue.

Use the following simplified equations for the percentage completion formula and other associated formulas:

Period Costs (annual , quarterly, etc.)/ Total Estimated Cost = Percentage Completed

Percentage Completed * Total Project Revenue = Period Revenue

Period Revenue – Period Costs = Project Income

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Percentage Completion (POC) Method

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Net Income

See Also:
Net Sales
Net Operating Loss Carryback and Carryforward
Financial Ratios
Financial Reporting
Accounts Payable

Net Income Definition

The net income definition is a company’s profit in a given fiscal period. It consists of total revenues earned in the period less total expenses incurred to generate the revenues in the period. When revenues exceed expenses, the company has a net profit. When expenses exceed revenues, the company has a net loss. Report it on a company’s income statement. Net income is an important measure of a company’s profitability and financial performance for the relevant fiscal period. Also, call it net earnings, net profit, or the bottom line.

Net Income Formula

Basically, compute this income by subtracting all relevant costs and expenses from total revenue. Start with total revenue, also known as the top line as it is shown at the top of the income statement. Then subtract the costs of sales, operating expenses, non-operating expenses, and taxes. This gives you NI. It is also known as the bottom line because it is shown at the bottom of the income statement.

NI = Revenues – Cost of Sales – Operating Expenses – Non-Operating Expenses – Taxes

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Net Income

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Net Income

 

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