Concept

Production processes can be simple or multiple:.

Sometimes it happens in certain processes that the production of one product gives rise to the production of others (example: sectors such as mining, chemicals, oil refineries, forestry, livestock...). In these cases, the multiple production process is also called joint production.

Joint production can be defined as the process in which several types of products are necessarily obtained as a consequence of the technical conditions of the production process and without it being possible to voluntarily eliminate the obtaining of a multiplicity of products.

The products obtained in joint production are called joint products or coproducts. In joint production processes there are 2 types of costs:

The classification of costs into joint and autonomous costs is divided or separated by the so-called split off point which establishes, on the one hand, what are the joint costs to the products and the autonomous or specific costs of each of the products.

Byproducts

By-products are joint products that, as a consequence of their economic characteristics (little appreciation by the market and relative low importance in carrying out the joint production process) do not constitute the production object pursued by the company, which is why in the preparation and presentation of accounting information on the economic activity of the company they are usually presented as secondary data.

Sometimes the cost of the by-product is equal to the cost of the main product; Otherwise it has to be accounted for with a process.

Cost allocation

The assignment of the autonomous or specific costs accrued from the separation point does not present any doubt, since they are directly identifiable with the different products.

However, joint costs are not, so it is necessary to determine the value of the factors that have been used to produce each product. There are a number of methods for allocating costs to joint products; These methods are:

This last method is used in cases where the market appreciation (sale price) of the co-products is very different.

Joint costs in decision making

None of the methods for assigning joint costs provide evaluations of the products that can be taken into account to decide if it is interesting to continue manufacturing after the separation point or if, on the contrary, it is more convenient to sell the products at that point, assuming that there is a market for it.

Nor do the allocations of joint costs indicate values ​​of the products that can be taken as a reference to set prices, since:.

Therefore it can be said that with respect to decisions whether or not to continue manufacturing from the separation point:

That is, you have to compare the 'sales value at the separation point' with 'the sales value at the end of the additional production process', the difference between the two is the additional income which, if greater than the additional costs, will indicate the convenience of carrying out the process.

This does not mean that the product as a whole has benefits, but it is certain that the additional process has them, which is enough to decide that it be carried out.

Previous considerations

The decision to invest capital in a certain activity means giving up investing it in another; The cost we assume for having the opportunity to invest in another alternative and not doing so is what we call opportunity cost of investment or cost of financial resources..

Another opportunity cost is formed by the opportunity that the entrepreneur loses to earn his salary in another company by carrying out an activity similar to the one he carries out in his own company. That is, if an individual entrepreneur contributes, in addition to his capital, his work but does not have any salary assigned, he is incurring an opportunity cost whose value is the salary he would receive in any other company for carrying out that activity.

The opportunity cost is an important element to take into account since if we do not include the opportunity costs in the calculation of the benefit, its meaning would be incomplete. The incorporation of opportunity costs complements the previously explained historical cost model, and allows us to know the benefit in a deeper economic sense once each and every one of the production factors as well as the entrepreneur are remunerated. Taking into consideration the opportunity cost model in Analytical Accounting, two types of results appear:

The first will reflect the surplus after remunerating the productive factors but without taking into account that in the company financial resources and an entrepreneur are allocated to one activity and not another; the second is the surplus once all productive factors including financial resources and the entrepreneur have been remunerated.

Calculation of opportunity cost

To calculate the opportunity cost, the following steps must be followed:

The company uses two types of financing for its investments: external and own. External financing is made up of all those resources that the company acquires abroad and has the obligation to return within a period of time: payable in the short term and payable in the long term. Own financing is made up of the resources that the company has generated and has not distributed (reserves) and the resources received but that it does not have to return (partner contributions). The total liabilities and net equity allow the entire asset to be financed.

Once the financial resources have been determined, it will be necessary to define an interest rate to be applied to them and thus obtain a total cost. Thus, due to the use in our investments of external financial sources (loans, borrowings...) the company has to pay interest that entails a cost, thus if a company has a payable liability composed of a loan of 100 u.m. (monetary units) at 18% per year and a loan of 300 monetary units with an interest of 14% per year, the weighted average cost rate of foreign financial resources, denoted as ka, and which is an explicit cost will be:.

In relation to own resources, they do not have an explicit cost and depend on each entrepreneur and their alternative investments. If the own capital of 800 monetary units is decided to invest in fixed income securities (obligations) with a profitability of 12%, the weighted average cost rate of the own financial resources, which we will call kp, is 12% and is an implicit cost.

Considering the above, the weighted average cost rate of financial resources (own and external) can be obtained, which we call C, which will be:

In our example it would be:

Once C is obtained, it will have to be attributed to the different factors that have participated in the production process. To do this, it will be necessary to distinguish between circulating factors and fixed factors.

The current factors (K) are those that maintain a cyclical behavior, that is, they are renewed throughout the year and require short-term investments (raw materials, labor, supplies, rentals...).

Fixed factors (F) are those that remain in the company for a period of more than one year, therefore requiring long-term investments (generally the cost of amortization of fixed assets).

Once the circulating and fixed factors have been defined, the cost rate to be attributed to the circulating factors = C/n can be determined where n is the number of annual days of work divided by the average maturity period of the company.

The number of annual days of work can be considered as those actually worked or the number of days that comprise the accounting period and not only those worked.

The cost rate to be attributed to the fixed factors, in this case they are investments of more than one period and the number of rotations that the fixed factors undergo each year, in this case the fixed assets = 1/m, where m is the average duration of the fixed assets in years = fixed assets / annual amortization fee. According to this, the rate C to be imputed to the fixed factors will be expressed:.

The expression that we must know is C0, which is the opportunity cost of financial resources that will be expressed:.

According to this expression, the opportunity cost of financial resources will be equal to the opportunity cost of circulating factors plus the opportunity cost of fixed factors.

The total opportunity cost will be made up of the opportunity cost of financial resources calculated above and the opportunity cost of the entrepreneur's salary, to calculate the latter the remuneration received in the management professional market by people who perform a function analogous to that of the entrepreneur in question is taken as a reference.

Once the amount of the cost is known, it will be recorded in accounting and allocated to the different centers that the company has. Each center will receive opportunity costs based on its use of fixed and circulating factors in proportion to the corresponding costs it has incurred, subsequently the supplements for opportunity costs of the centers will be transferred to the products and results of the period. To apply the opportunity cost model, three tables will be created:

To complete the opportunity cost model, the accounting process is then reflected in order to obtain the result in an economic sense, once the company has made all the annotations of the historical cost model. Steps:.

a) Record of calculated opportunity costs.

b) Allocation of opportunity costs to cost centers.

c) Attribution of opportunity costs to products.

d) Record of the amount of the industrial margin calculated in the general process.

e) Deduction of supplements for opportunity costs calculated for products and works.

f) Cancellation of the industrial margin in the economic sense for its amount, paying the commercial margin account in the economic sense.

g) Deduction of the costs of the shopping center and the supplement calculated for commercial opportunity costs.

h) Cancellation of the commercial margin in an economic sense for its amount, recording the costs of the administration centers, subactivity, and the opportunity cost supplements calculated for said centers, obtaining the economic result of the activity.

i) Closing entry. Transfer of the economic result of the activity to the control account.

It is the National Association of Cost Accountants who published the first studies on Direct Costing in 1953. This new method mainly consists of separating Fixed Costs from Variable Costs since only the latter must be incorporated into production, thus forming the cost of the product. Fixed Costs must be absorbed by the results of the period in which they affect.

Direct Costing is considered an extension of the Profitability Threshold "Dead Point (economics)") and an alternative to Full-Costing.

One of the most notable authors is Wright 1962, according to his theory, Direct-Costing is an accounting system that separates expenses that vary with volume from those that do not vary. In processing companies this means that only the direct production costs will be charged to the inventories for subsequent comparison with the income, which will allow the margin obtained to be determined. The expenses of the period will be charged directly to the profit and loss account of the period in which the disbursements took place.

The Direct Costing model had more echo in the Anglo-Saxon countries, however in the countries of the European continental area they opted for the section method perhaps due to the influence of the German plan of accounts of 1937 and the French plan of 1957.

In short, Direct Costing attempts to attribute as the costs of a product exclusively the variable costs caused by it. Therefore in this model the cost price of a product will be:.

COST PRICE OF A PRODUCT= SUM OF TOTAL VARIABLE COSTS OF THE PRODUCT/NUMBER OF UNITS PRODUCED.

Within the variable costs that we have incorporated into this formula, it will be necessary to distinguish between those incurred as a consequence of the supply and transformation process (industrial costs) and those resulting from the marketing or sale of the products (commercial costs), thus we can obtain the following relationships:

INDUSTRIAL MARGIN = SALES REVENUE - INDUSTRIAL VARIABLE COSTS OF SALES.

COMMERCIAL MARGIN= INDUSTRIAL MARGIN - VARIABLE MARKETING COSTS.

PROFIT OR LOSS= COMMERCIAL MARGIN - FIXED COSTS OF THE PERIOD.

Advantages and disadvantages

The main advantages of Direct Costing are that it facilitates the study of the relationship between costs, manufacturing volumes, sales and profits of a period, it avoids the arbitrariness that is often incurred when trying to distribute Fixed Costs among the products manufactured in a period since it determines the costs of the products by the sum of the variable costs incurred for their manufacture. Another favorable aspect is that it has a simple application.

Among the drawbacks of this model, the difficulty that companies may encounter in its application stands out: it can be difficult to determine which costs are fixed and which are variable, having to resort to methods to separate these costs. The main methods are: the graphic method, the method of extreme points and the method of least squares.

accounting process

According to the above, two important aspects must be taken into account when applying Direct Costing. The cost price of the products is given by the sum of variable costs incurred to obtain them and the results are calculated following a procedure other than rational imputation.

To calculate the cost of the products, the following steps will have to be followed:

Concept

Production processes can be simple or multiple:.

Sometimes it happens in certain processes that the production of one product gives rise to the production of others (example: sectors such as mining, chemicals, oil refineries, forestry, livestock...). In these cases, the multiple production process is also called joint production.

Joint production can be defined as the process in which several types of products are necessarily obtained as a consequence of the technical conditions of the production process and without it being possible to voluntarily eliminate the obtaining of a multiplicity of products.

The products obtained in joint production are called joint products or coproducts. In joint production processes there are 2 types of costs:

The classification of costs into joint and autonomous costs is divided or separated by the so-called split off point which establishes, on the one hand, what are the joint costs to the products and the autonomous or specific costs of each of the products.

Byproducts

By-products are joint products that, as a consequence of their economic characteristics (little appreciation by the market and relative low importance in carrying out the joint production process) do not constitute the production object pursued by the company, which is why in the preparation and presentation of accounting information on the economic activity of the company they are usually presented as secondary data.

Sometimes the cost of the by-product is equal to the cost of the main product; Otherwise it has to be accounted for with a process.

Cost allocation

The assignment of the autonomous or specific costs accrued from the separation point does not present any doubt, since they are directly identifiable with the different products.

However, joint costs are not, so it is necessary to determine the value of the factors that have been used to produce each product. There are a number of methods for allocating costs to joint products; These methods are:

This last method is used in cases where the market appreciation (sale price) of the co-products is very different.

Joint costs in decision making

None of the methods for assigning joint costs provide evaluations of the products that can be taken into account to decide if it is interesting to continue manufacturing after the separation point or if, on the contrary, it is more convenient to sell the products at that point, assuming that there is a market for it.

Nor do the allocations of joint costs indicate values ​​of the products that can be taken as a reference to set prices, since:.

Therefore it can be said that with respect to decisions whether or not to continue manufacturing from the separation point:

That is, you have to compare the 'sales value at the separation point' with 'the sales value at the end of the additional production process', the difference between the two is the additional income which, if greater than the additional costs, will indicate the convenience of carrying out the process.

This does not mean that the product as a whole has benefits, but it is certain that the additional process has them, which is enough to decide that it be carried out.

Previous considerations

The decision to invest capital in a certain activity means giving up investing it in another; The cost we assume for having the opportunity to invest in another alternative and not doing so is what we call opportunity cost of investment or cost of financial resources..

Another opportunity cost is formed by the opportunity that the entrepreneur loses to earn his salary in another company by carrying out an activity similar to the one he carries out in his own company. That is, if an individual entrepreneur contributes, in addition to his capital, his work but does not have any salary assigned, he is incurring an opportunity cost whose value is the salary he would receive in any other company for carrying out that activity.

The opportunity cost is an important element to take into account since if we do not include the opportunity costs in the calculation of the benefit, its meaning would be incomplete. The incorporation of opportunity costs complements the previously explained historical cost model, and allows us to know the benefit in a deeper economic sense once each and every one of the production factors as well as the entrepreneur are remunerated. Taking into consideration the opportunity cost model in Analytical Accounting, two types of results appear:

The first will reflect the surplus after remunerating the productive factors but without taking into account that in the company financial resources and an entrepreneur are allocated to one activity and not another; the second is the surplus once all productive factors including financial resources and the entrepreneur have been remunerated.

Calculation of opportunity cost

To calculate the opportunity cost, the following steps must be followed:

The company uses two types of financing for its investments: external and own. External financing is made up of all those resources that the company acquires abroad and has the obligation to return within a period of time: payable in the short term and payable in the long term. Own financing is made up of the resources that the company has generated and has not distributed (reserves) and the resources received but that it does not have to return (partner contributions). The total liabilities and net equity allow the entire asset to be financed.

Once the financial resources have been determined, it will be necessary to define an interest rate to be applied to them and thus obtain a total cost. Thus, due to the use in our investments of external financial sources (loans, borrowings...) the company has to pay interest that entails a cost, thus if a company has a payable liability composed of a loan of 100 u.m. (monetary units) at 18% per year and a loan of 300 monetary units with an interest of 14% per year, the weighted average cost rate of foreign financial resources, denoted as ka, and which is an explicit cost will be:.

In relation to own resources, they do not have an explicit cost and depend on each entrepreneur and their alternative investments. If the own capital of 800 monetary units is decided to invest in fixed income securities (obligations) with a profitability of 12%, the weighted average cost rate of the own financial resources, which we will call kp, is 12% and is an implicit cost.

Considering the above, the weighted average cost rate of financial resources (own and external) can be obtained, which we call C, which will be:

In our example it would be:

Once C is obtained, it will have to be attributed to the different factors that have participated in the production process. To do this, it will be necessary to distinguish between circulating factors and fixed factors.

The current factors (K) are those that maintain a cyclical behavior, that is, they are renewed throughout the year and require short-term investments (raw materials, labor, supplies, rentals...).

Fixed factors (F) are those that remain in the company for a period of more than one year, therefore requiring long-term investments (generally the cost of amortization of fixed assets).

Once the circulating and fixed factors have been defined, the cost rate to be attributed to the circulating factors = C/n can be determined where n is the number of annual days of work divided by the average maturity period of the company.

The number of annual days of work can be considered as those actually worked or the number of days that comprise the accounting period and not only those worked.

The cost rate to be attributed to the fixed factors, in this case they are investments of more than one period and the number of rotations that the fixed factors undergo each year, in this case the fixed assets = 1/m, where m is the average duration of the fixed assets in years = fixed assets / annual amortization fee. According to this, the rate C to be imputed to the fixed factors will be expressed:.

The expression that we must know is C0, which is the opportunity cost of financial resources that will be expressed:.

According to this expression, the opportunity cost of financial resources will be equal to the opportunity cost of circulating factors plus the opportunity cost of fixed factors.

The total opportunity cost will be made up of the opportunity cost of financial resources calculated above and the opportunity cost of the entrepreneur's salary, to calculate the latter the remuneration received in the management professional market by people who perform a function analogous to that of the entrepreneur in question is taken as a reference.

Once the amount of the cost is known, it will be recorded in accounting and allocated to the different centers that the company has. Each center will receive opportunity costs based on its use of fixed and circulating factors in proportion to the corresponding costs it has incurred, subsequently the supplements for opportunity costs of the centers will be transferred to the products and results of the period. To apply the opportunity cost model, three tables will be created:

To complete the opportunity cost model, the accounting process is then reflected in order to obtain the result in an economic sense, once the company has made all the annotations of the historical cost model. Steps:.

a) Record of calculated opportunity costs.

b) Allocation of opportunity costs to cost centers.

c) Attribution of opportunity costs to products.

d) Record of the amount of the industrial margin calculated in the general process.

e) Deduction of supplements for opportunity costs calculated for products and works.

f) Cancellation of the industrial margin in the economic sense for its amount, paying the commercial margin account in the economic sense.

g) Deduction of the costs of the shopping center and the supplement calculated for commercial opportunity costs.

h) Cancellation of the commercial margin in an economic sense for its amount, recording the costs of the administration centers, subactivity, and the opportunity cost supplements calculated for said centers, obtaining the economic result of the activity.

i) Closing entry. Transfer of the economic result of the activity to the control account.

It is the National Association of Cost Accountants who published the first studies on Direct Costing in 1953. This new method mainly consists of separating Fixed Costs from Variable Costs since only the latter must be incorporated into production, thus forming the cost of the product. Fixed Costs must be absorbed by the results of the period in which they affect.

Direct Costing is considered an extension of the Profitability Threshold "Dead Point (economics)") and an alternative to Full-Costing.

One of the most notable authors is Wright 1962, according to his theory, Direct-Costing is an accounting system that separates expenses that vary with volume from those that do not vary. In processing companies this means that only the direct production costs will be charged to the inventories for subsequent comparison with the income, which will allow the margin obtained to be determined. The expenses of the period will be charged directly to the profit and loss account of the period in which the disbursements took place.

The Direct Costing model had more echo in the Anglo-Saxon countries, however in the countries of the European continental area they opted for the section method perhaps due to the influence of the German plan of accounts of 1937 and the French plan of 1957.

In short, Direct Costing attempts to attribute as the costs of a product exclusively the variable costs caused by it. Therefore in this model the cost price of a product will be:.

COST PRICE OF A PRODUCT= SUM OF TOTAL VARIABLE COSTS OF THE PRODUCT/NUMBER OF UNITS PRODUCED.

Within the variable costs that we have incorporated into this formula, it will be necessary to distinguish between those incurred as a consequence of the supply and transformation process (industrial costs) and those resulting from the marketing or sale of the products (commercial costs), thus we can obtain the following relationships:

INDUSTRIAL MARGIN = SALES REVENUE - INDUSTRIAL VARIABLE COSTS OF SALES.

COMMERCIAL MARGIN= INDUSTRIAL MARGIN - VARIABLE MARKETING COSTS.

PROFIT OR LOSS= COMMERCIAL MARGIN - FIXED COSTS OF THE PERIOD.

Advantages and disadvantages

The main advantages of Direct Costing are that it facilitates the study of the relationship between costs, manufacturing volumes, sales and profits of a period, it avoids the arbitrariness that is often incurred when trying to distribute Fixed Costs among the products manufactured in a period since it determines the costs of the products by the sum of the variable costs incurred for their manufacture. Another favorable aspect is that it has a simple application.

Among the drawbacks of this model, the difficulty that companies may encounter in its application stands out: it can be difficult to determine which costs are fixed and which are variable, having to resort to methods to separate these costs. The main methods are: the graphic method, the method of extreme points and the method of least squares.

accounting process

According to the above, two important aspects must be taken into account when applying Direct Costing. The cost price of the products is given by the sum of variable costs incurred to obtain them and the results are calculated following a procedure other than rational imputation.

To calculate the cost of the products, the following steps will have to be followed: