Cost Accounting - Decision-relevant Management Accounting

Calculating imputed depreciation

Entrepreneurs want to know what existing and additional investments will be required to generate the planned profit (EBIT) in the coming years. The amounts originally paid for the fixed assets are only partially relevant for this because inflation and technological developments often lead to higher replacement values and therefore higher imputed depreciation. If the replacement value of an asset increases by 20% compared to the previous year, the imputed depreciation for this asset must also be increased by 20%. This reduces the (distributable) profit, but also ensures that the money remains in the company to finance replacement investments.

The annual business plan must therefore determine which and how much fixed assets will be required in the planning year in order to achieve the planned profit. For this purpose, it is necessary to estimate by how much the replacement value of an existing and still used asset will increase in the year to plan. The replacement value is divided by the useful life planned by management and results in the imputed depreciation of the asset in the year to plan.

By stipulating that the imputed depreciation is charged to the income statement each year, the owners ensure that the money for replacement or renewal investments remains in the company’s current assets or is used to reduce interest-bearing loans. The funds for maintaining the company’s ability to perform are thus available because less has been distributed to the owners or been given away through lower sales prices. External cash inflow for the further expansion of the company is only necessary to finance growth.

Replacement value and imputed depreciation

Using the example of cost center 100 (sales management) at Ringbook Ltd., the following steps are required to determine the replacement value and the imputed depreciation:

- The fixed assets of cost center 100 amounted to EUR 96,000 at the end of 2020.
- The management of Ringbook Ltd has determined that machines, equipment and software can be used for 8 years until they need to be replaced. This results in a depreciation of 12.5% of the acquisition or replacement value (EUR 12,000, column j) for 2021.
- The replacement value therefore amounts to EUR 84,000 at the end of 2021.
- In 2022, an online store was set up for cost center 100. Project costs of 86,602 (column f) were incurred for this. These were capitalized so that the replacement value of the fixed assets in cost center 100 amounted to EUR 182,602 at the end of 2022.
- In addition, a general inflation rate of 3% (inflation rate, column g) had to be taken into account in 2022. This had an impact on the replacement value of the original investment of EUR 96,000 at the beginning of 2022 (EUR 2,880, column h).
- In total, 12.5% of the replacement value of 185,482 (column i), i.e. 23,185 (column j), was to be charged as imputed depreciation for 2022.
- In the years 2023 – 2025, the new investments (column e) are added to the existing assets of the cost center. They must also be taken into account in subsequent years.
- The effects of the annual inflation rates (column g) increase the replacement value of the existing investments in cost center 100. Depreciation of cost center 100 also increases (column j) and thus also the balance sheet value to be reported in the internal reporting at the end of the year (column k).

Estimating the replacement values of existing investments is often difficult, as quotations have to be obtained from potential suppliers. For this reason, many companies use the index method to calculate the replacement value of an asset. The question is how much an acquisition will increase in the planning year if it is multiplied by the current inflation rate (columns g and h).

Imputed depreciation is a cost type of cost center costs because the operating resources (assets) are assigned to cost centers and are used in these cost centers to produce services. For large assets that are used by several cost centers often a separate cost center is set up. An example is a factory building in which various cost centers are housed.

Cost plan for the IT-Cost Center

The company’s IT department is responsible for the installation, operation and further development of all applications used throughout the company. In the example company these are: ERP (production planning and control, purchasing and inventories, projects), PLM (product life cycle management), CMS (customer acquisition and support, quotation preparation and tracking, sales orders, analyses), payroll administration, financial and management accounting, internal and external communication (mail, internet presence).

In most cases, several functional areas of a company use these applications. They collect data, analyze content and create evaluations.

The IT department is responsible for the operation, extension and maintenance of the existing applications as well as for the necessary hardware and communication installations. It is also planned that its employees will work 800 hours in the planning year on development projects that can be capitalized and amortized in subsequent years.

For this purpose 7 employees (full-time positions FTE) are employed: (1 IT manager, 4 persons to operate the applications, create evaluations and maintain the hardware and software installations, 2 persons to further develop the applications and work on (capitalizable) projects.

The following cost center plan was defined for the planning year:

Notes:

If the plan is approved as presented, the head of IT is responsible for adhering to the planned costs of 1,242,000 (line 13).

If IT department services were directly dependent on the actual performance of the receiving cost centers, they would have to be charged to the receiving areas at proportional costs. However, there is rarely a direct cause/effect relationship between the recipient’s activities and those of the IT department.

If the costs of further IT developments are to be capitalized, i.e. written to fixed assets, the proportional personnel costs (45,000, line 13) are included because these directly performance-related costs are causally necessary for the creation of fixed assets. All other cost types of the IT cost center are not directly caused by the IT services purchased. They are period costs.

The calculation of imputed annual depreciation in accordance with lines 5 and 12 depends mainly on the valuation rules applied in the respective company (what is capitalized and what is charged directly to the annual financial statements?)

The IT cost center performs various internal tasks. The costs incurred for these are to be planned and accounted for in this cost center.

Conclusion:

Cost planning and the control of internal tasks take place in the cost centers that perform them, because this is where the personnel and systems work, but their costs can rarely be clearly assigned to an individual internal task.

Internal tasks generate period-related fixed costs. This is because their amount is only indirectly dependent on the services produced or sold. Consequently, the costs of internal tasks cannot be charged to the cost centers consuming them or even to the units produced. They are the result of the company’s willingness to perform and the associated management decisions.

Internal tasks can rarely be measured in units, as they usually comprise a bundle of tasks and are not directly related to sales or production quantities.

The costs of an Internal task can usually only be estimated as often several cost centers contribute to an Internal task. However, it is important to continuously record the working time consumption per Internal task. This is because personnel costs carry the most weight and cause the readiness to perform costs to swell.

The costs of all Internal tasks must be covered by the contribution margins.

Costs of Internal Tasks

In the glossary Internal Tasks are defined as “all work performed in the cost centers that is neither directly caused by the quantity of products manufactured and sold nor requested by other cost centers directly depending on their own output”. The post “Internal tasks” in the Management Control blog lists the types of tasks that count as Internal tasks.

The fulfillment of these tasks leads to readiness to perform costs (fixed costs). They are incurred so that production and sales can take place at all. The fixed costs are incurred in the cost centers, but cannot be allocated to products and services according to cause. Readiness to perform costs are planned and approved by the managers. Consequently, the cost center managers and their superiors are also responsible for their amount.

Cost planning for Internal tasks

Cost center budgets must be prepared so that the costs of internal tasks can be assessed and approved for implementation. This requires the following considerations:

1. Time requirements, time consumption of cost center employees per internal task and year, planned services for project orders, time required for cost center management and further training, training.

2. Costs and usage licenses to be paid externally, per internal task or cost center

3. Services from other companies, external costs to fulfill the internal task

4. Services from other cost centers, genuine internal services, e.g. from energy, maintenance, repair, laboratory, transport or IT cost centers (ordered and measurable).

5. Investments and resulting imputed depreciation, acquisition of machinery, equipment, hardware and software; management decision for the planned useful life, calculation of annual imputed depreciation.

The procedure to plan costs for internal tasks is shown in detail in the post “Planning the costs of the central IT-department”.

Valuing Inventories at Standard

Decision-making and responsible management accounting require that variances from plan are reported where they occurred. This is where corrective actions must first be determined and implemented if the targeted result is to be achieved (see the post “Management Cycle“). This can be achieved if all stock receipts and issues are valued at proportional planned production costs and if the cost center activities are only passed on to products and other cost centers valued at the proportional planned cost rate.

The following rules must be observed:

- All purchased material is valued at the planned purchase price (according to annual planning) during the entire year at warehouse entry or exit
- The difference between the planned purchase price and the actual price paid is disclosed as a purchase price variance in the monthly reporting and can thus also be reported on time in financial accounting. Purchasing is responsible for this.
- Withdrawals from stock of raw materials and supplies are also debited to the production orders and the consuming cost centers at planned purchase prices Purchase price variances remain with Purchasing.
- Manufactured semi-finished and finished products are valuated at proportional planned production costs of the respective item at the time of stock receipt (variances remain in the production orders or in the cost centers performing the work).
- Fixed costs are period costs and consequently cannot be allocated to an individual manufactured unit according to the cause.
- Stock withdrawals of semi-finished products for processing in further production stages are valuated at proportional planned production costs, i.e. at standard. This is because any variances were already disclosed in the preliminary stage.
- Stock withdrawals for sales are also made at proportional planned production costs of finished products (variances were already disclosed in the semi-finished products and in the cost centers). In addition, the sales department is rarely responsible for production variances.

This consistent passing on of the services rendered at proportional production costs or at proportional planned cost rates of the cost centers shows all variances from the plan or from the flexible budget where they originally occurred. This is where corrective actions mainly must be found. The respective managers always have the comparison available between the services rendered at standard and the costs for which they are responsible. Variances from preliminary stages remain there because they also have to be eliminated there. All production and cost center managers can thus assess whether they have complied with their planned costs, taking into account the actual activities performed. This is because they are responsible for the costs they can influence directly.

At the turn of the year, the planned purchase prices and the proportional planned costs of the following year must be applied. This is because the processes and thus the production costs can change in the cost centers and other purchase prices must be provided. Although this requires a revaluation of inventories at the beginning of the year (can largely be automated), it also produces the figures in the following year to be able to present target to actual comparisons relevant for decision-making.

Accounting for Management means providing all managers with the systems and data to enable them to plan and control in a target-oriented manner in their area of responsibility and for the company as a whole. The focus is always on decision-relevant internal reporting and the successful management of the individual divisions.

What about external reporting?

The decision and responsibility-based approach pursued here often does not comply with the valuation rules of accounting standards such as IFRS, US GAAP or national tax law requirements. These rules mostly require the presentation of results in the form of full cost accounting and an externally oriented valuation of inventories.

We compiled the legally binding rules and analyzed their impact on the design of corporate accounting for many countries. In particular, we wanted to know whether legal requirements or accounting standards prohibit or prevent the design of a management accounting system that is uncompromisingly focused on decision making and internal accountability.

This analysis was revised and updated several times. Download the 2019 version with the link below (sorry, until now only available in German): Lukas Rieder, Markus Berger-Vogel: “Fixed Cost Allocations: one or none?”

Here we anticipate the key findings from this analysis:

There are no statutory accounting requirements or international reporting standards that prohibit or otherwise prescribe the structure of the decision- and responsibility-driven management isaccounting system recommended in this blog.

In management accounting, the starting points are the individual item, the processes and cost centers and the people working in them. These elements must be planned and controlled in detail if a company is to remain successful in the long term. Evaluations are mostly condensations on higher observation levels, which deny the view of the control-relevant details.

With reference to the valuation of inventories and thus the determination of the externally reported annual result, it makes sense to always value all inventory receipts and issues at proportional planned production costs. It is easy to adjust inventory valuations to accounting rules in an automated side-by-side calculation to generate external reports. However, financial success is generated in the market and internally, not through external reporting.

Management Accounting is a Prerequisite for Financial Accounting

Many companies base their choice of software modules to be used for ERP and accounting on legal requirements. Financial accounting must be kept because profit or loss as well as assets and liabilities must be reported at least once a year. At the same time, accounting regulations must be complied with (local commercial and tax law, internal settlements between companies of a group).

In addition, the rules of the international accounting standards (IFRS, US GAAP and the like) mostly assume the following basic structure of the income statement:

Management Accounting is a Prerequisite for Financial Accounting — Full cost structure of the profit and loss account

This is the usual form of the profit and loss account presented externally and very often internally. It can be created with auxiliary calculations from financial accounting. All consumptions incurred in a period for the plant (material, personnel, external services, depreciation and even pro rata interest costs) are debited to the plant cost center (simplified all costs incurred within the fence of the plant). This results in the full cost of goods sold after accrual of inventory changes. Similarly, all marketing and sales costs are concentrated in the collective cost center for marketing and sales. Also, the costs for administration and management and possibly for research and development are added as a percentage of the full costs of products sold. This presentation mostly meets the requirements of the mentioned external standards of financial accounting.

However, the executives of a company, especially the product and cost center managers plan and decide quantities, activities and prices and create new products and services by means of input factors such as working time, material or energy. Corporate management expects all managers of lower levels to take responsibility for the costs of their area. To this end, it must be ensured that there is a causation-based relationship between costs and the units created and sold.

Cost, performance, revenue and profitability accounting

The relationship to quantities, consumption and values can only be established in a management accounting that presents cost, activity, revenue and earnings. This system calculates how much the consumed quantities and services did or should have cost per product or service unit. Accounting for management is a matter of calculating the plan, target and actual of the units produced and sold. Because both the cost and the revenue side are included, the term management accounting became established.

The figure below shows that in the various auxiliary accounts and in the summarizing general ledger accounting, the focus is on the period view for the company. In the right-hand management accounting section, on the other hand, the order or unit view is decisive. Managers at all levels want to know how much it cost to manufacture a product or service unit in their management area. In order to calculate the result for the period, it must also be known by how much the inventory quantities of raw materials, semi-finished and finished products have changed per item. Costing per product unit is a prerequisite for this valuation.

In the accounting-based full cost structure of profitability analysis, both unit and period costs are deducted from net revenues to arrive at Gross Profit. Example:

full product costs per unit — Full product costs per unit

In month 1,100 pieces were produced and sold. This resulted in full production costs of 500, taking into account the cost center costs of production,warehousing and purchasing. In month 2, 120 pieces were produced and sold at the same material purchase price of 2.00 per piece. According to accounting, the personnel costs remained at 300 (the existing employees had enough capacity for the additional production). As a result, the full manufacturing cost per piece dropped from 5.00 to 4.50.

Questions:

- Is the finished goods inventory receipt to be posted at a different valuation each month (moving average)?
- If yes, does the gross profit per unit change each month because the capacity utilization is different? What is the correct valuation approach for planning and managing sales?
- The differing full costs of goods sold per unit are the result of the utilization of the production cost centers. The staffing and machinery of these cost centers is determined by production managers, not by sales.

Planned and actual costing are core functions of management accounting.

The calculated values are not only used for inventory valuation but above all are compared with the net revenues generated by sales. As the sales organization is not responsible for variances in production and procurement this requires that direct material consumption is valued at planned purchase prices and work plan positions are valued at the planned proportional cost rates of the cost centers. Splitting cost center costs into their proportional part (driven by the products) and their fixed part (driven by the dimensions of the cost centers) is a key requirement for decision-relevance.

Controllers and management accountants must therefore set up their system in such a way that a distinction can already be made in the standard cost estimate between proportional costs directly caused by the products manufactured and fixed costs that are mainly the result of management decisions. This is because the net revenue from a sale to a customer must first be compared with those costs that can be allocated to this order in a manner that reflects their cause. In the absence of a direct cause-and-effect relationship, fixed costs can only be allocated to a product or a customer by applying allocation keys that are arbitrarily chosen by the majority. Only small proportions of marketing and selling costs and other cash out costs can be allocated to an individual product or customer on the basis of causation.

In Accounting for Management rules such as IFRS, US GAAP or tax laws do not apply. They lead to incorrect decisions.

Example: A product with a high proportion of material or external activity costs must bear a higher proportion of the fixed costs of purchasing and the warehouse cost centers, even if its procurement is uncomplicated and can be handled with a telephone call or an e-mail. This increases the full manufacturing costs of this product, with the result that the markups for marketing and sales costs and for other cash costs and depreciation also increase. This is because such surcharges are calculated on the basis of the full manufacturing costs. The product then no longer looks particularly worthy of promotion because it is “broken” by surcharges.

Conclusion: A management accounting system is built to support all managers of a company in their decision-making so that they can achieve an overall improvement in the company’s results. Fixed cost allocation does not help in this optimization process. According to the current state of knowledge, it is recommended to set up management accounting as marginal costing, combined with multi-level contribution margin accounting .

The Institute for Management Accounting IMA still trains and propagates the “full cost structure of profit and loss accounting”. The focus is still on external reporting, not on internal decision making. These non-decision-making guidelines led to the establishment of the Profitability Analytics Center of Excellence (PACE). Find practical examples and technical papers on how management accounting can increasingly fulfill its mandate to show executives ways to improve results on their homepage.

Variators for Cost Splitting

In many textbooks and partly also in cost accounting software the variator method is recommended to split cost center costs into their proportional and their fixed part. The planned proportional costs are given as a percentage of the planned costs of a cost type in a cost center and the complement is the fixed costs of this cost type. Using variators for cost splitting should be omitted because it generates incorrect cost rates. The example explains this:

Initial situation in annual planning

The annual production plan shows that the cost center to be planned should work 14,400 hours on production orders. The cost center manager plans, including himself, a staff of 10 persons, each working 1,600 hours per year. The planned yearly personnel costs will amount to 480,000 EUR, the average rate per presence-hour and employee thus to 30.00 EUR. 90% of the planned 16,000 presence time hours are to be used for manufacturing (14,400 hours) and 10% for organization ant training. Thus the variator of 90% results (row 6).

The planned non-personnel costs (including depreciation) amount to 100,000, of which it is estimated that 5.00 are to be used per hour of planned employment. This corresponds to proportional non personnel costs of 72,000 and thus a variator-rate of 72% (rows 9 and 10).

Comparing the variator method and direct activity-based planning shows (still) the same planned cost rates, e.g. 35.00 proportional hourly cost rate.

But the executives and the cost center manager expect stronger fluctuations of the production quantities in the plan year. They decide to equip the cost center with an eleventh employee (security variant). This increases the installed capacity to 17,600 hours and the planned personnel costs to 528,000. But the planned employment remains at 14,400 hours per year. Due to the variator of 90% the higher personnel costs raise the proportional hourly rate from 35.00 to 38.00, although the same number of hours is worked for the products to be manufactured.

It is the fixed cost-rate that has to change from 5.61 to 8.61 as more fixed costs are included in the products. The proportional planned costs per unit remain the same. This is appropriate, since the costs of the additional employee only become proportional costs when his hours are used for manufacturing.

Variators belong to the master data of cost accounting and it is not intended that they be adjusted by cost element each time there is a change in normal capacity or planned employment. The variant with 11 employees results in incorrect cost rates. This is because also in the second variant, 30.00 personnel costs and 5.00 material costs are incurred for each hour worked on order; it is the same people with the same wages who perform this work. If, as a result of a revised sales plan, plan employment were increased, each variator would also have to be adjusted.

If in the subsequent plan year, non-personnel costs increase from 100,000 to 120,000 because fixed depreciation and non-personnel costs increase, a portion of the fixed costs will be “shifted” to the proportional plan cost rate if the 72% variator remains the same. As a result, period fixed costs are understated.

Conclusion: Variators are unsuitable for the design of a flexible budget costing and a real contribution margin accounting. They have to be adjusted cost type by cost type in the master data with every activity change. Flexible budgeting produces the correct values. In addition, it ensures that the proportional planned cost rate remains the same even with changes in the production program and thus with other planned activities.

Target and Actual of Production Orders

Product costing follows the planning and control process of a company:

1. In sales, the quantity-based annual sales plan is drawn up per finished item, be it a physical product or a service unit.
2. Production management determines the quantities to be produced per item on the basis of the sales plan. In doing so, it takes into account the existing inventory, the machine and personnel capacities of the production cost centers as well as expected interruption times due to vacations, public holidays and machine maintenance. Production management wants to have enough semi-finished products in inventory at all times in order to deliver the units sold on time and still manage with minimum average inventory levels. Therefore, production management must determine the lot sizes of the individual production orders.
3. Purchasing ensures that the material requirements resulting from production and sales planning are available in stock on time. In addition, it negotiates with the potential suppliers in good time the planned purchase prices of the products and services to be bought. This is necessary to calculate the planned costs of the products and services.
4. The managers of the manufacturing cost centers prepare the planning of their cost center on the basis of the planned activities resulting from the production plan. To do this, they need the planned production quantities, the standard times from the work plans for the items they produce and the setup-times to be scheduled for each production order. With this information they determine the planned activity of their cost center, i.e. the activity that is to be performed directly for the production orders to be processed.In the next step, the cost center managers consider how much auxiliary or operating materials will be required from the warehouse or directly from the suppliers in order to be able to perform the planned activity. They also plan which services will have to be procured from internal auxiliary cost centers (e.g. energy, water, compressed air, repairs and maintenance) depending on the planned employment.

The sum of these planned costs is divided by the planned activity, which results in the proportional planned cost rate of the cost center. This rate is used for the calculation of proportional product costs in planning as well as in actual (5). This data can be used to calculate the planned proportional (standard) costs of an item and the precalculation of a real production order. If these are deducted fromnet sales, the contribution margin I per product and summarized per product or customer group can be calculated, also in planned and actual data.

The precalculations of the orders of a month are decisive for the calculation of the monthly flexible budgets of the production cost centers. If the actual costs deviate from the flexible budget, consumption variances arise (per cost element). The cost center manager is responsible for these. He must ensure that corrections are made so that the company can achieve its profit targets.

See also “Management Control with Integrated Planning“, Chapters 4 and 5.

Order Variances

Only a few variance types can clearly be assigned to the individual production order:

A lot size variance occurs when the production lots ordered deviate from the planned lot size in the annual plan. If the quantity ordered in a production order is larger than the quantity planned in the standard cost estimate for the article in question, the setup costs are spread over more units. As a result, the item produced costs slightly less per unit.

Yield variances occur when more or fewer “good quality” pieces result from the production order than planned. This happens primarily in process manufacturing, e.g. in the production of chips for processors or in chemical processes.

Material quantity variances occur when the input material did not fully meet the specifications or when the processing machines were not precisely adjusted. They lead to cost overruns in the respective production order.

Work time variances occur in the cost centers of production when more or less process time has been used than in the plan-calculation of the order. These over- or under-consumptions can be assigned to the individual order if the processing cost centers record their output per order.

Purchase price variances occur when the really price paid for raw materials and purchased services does not correspond to the planned price (especially in the case of inflation). They can be calculated in purchasing when the supplier invoice is recorded. Because the purchasing department negotiates the contracts with the suppliers, it is also responsible for purchase price variances.

As the same material can be used for different products and in many production orders, most purchase price variances can neither be assigned to an individual production order nor to a cost center according to cause. Direct assignment is only possible when materials or services are procured directly for a production order or a cost center.

Usually, raw materials and supplies are first stored in inventory and are only assigned to the production orders or cost centers when they are taken from the warehouse (material withdrawal slip). If actual purchase prices are used to value the inventory, the same material is in stock at different purchase prices. As a result, production would encounter a different average purchase price for the material each time they use this material.

If the production orders are debited according to the first in – first out principle, the order processed earlier still benefits from the lower-priced material, while the subsequent order is charged the higher prices. Valuing inventories with moving average prices does not help either. This is because each production order delivered to inventory results in new (proportional) unit costs and thus different valuation approaches in the warehouse for the same finished item.

If all warehouse receipts and issues are valued at standard purchase prices, this dilemma can be avoided. Production and sales can then (internally) purchase the materials throughout the year at the standard purchase price, and purchasing can determine the purchase price variance at the moment of purchase, i.e. when it occurs.

In the cost centers, the flexible budget costs, i.e. the planned costs of the actual activity performed, must be adhered to. The cost center managers are responsible to avoid negative differences between target and actual costs, i.e. spending variances, and for ensuring that these variances disappear in subsequent periods.

The example below has already been presented in a similar form in the post “Complete variance analysis“. All variances from the target are presented at the lowest hierarchical level to which they can be clearly assigned. This is also the place to intervene if these variances are to be avoided in the future.

Order variances — Different types of variances

This illustration only shows internal variances within the company. Changes in net sales are analyzed in contribution accounting.

Personnel Costs in Cost Accounting

Include the non-wage personnel costs in the hourly presence rate of employees.This simplifies cost accounting.

Personnel costs in Cost Accounting

In this post we understand personnel costs as the costs for the work done by the employed persons . The costs of external persons who work for the organization are not included since the wages of these persons are accounted for and paid out in the performing organization.

Each person employed by an organization is assigned to a cost center, usually the cost center of the person’s boss. If employees perform work for projects, their personnel costs are incurred in the cost center of origin and, as far as measurable, are charged to the projects as internal services with corresponding hourly rates. Each employee is assigned to one and only one cost center. Should a person have two employment contracts in the same company, these are to be assigned to the respective cost centers.

Cost center managers are responsible for the costs of their personnel . Therefore they want to know the monthly personnel costs of their management area in plan and actual.

Requirements for the personnel department, financial accounting and software

Payroll accounting is becoming increasingly complicated, since different types of non-wage labor costs have to be taken into account and since payments occur at different times, e.g. monthly salary, vacation pay, Christmas bonus, child allowances, gratuity, bonus. For each employee, the payroll must usually be created monthly in the payroll system for each wage type and wage deduction type. This detail is necessary that employees can understand what net amount is due to them and is to be paid out per payroll period.

The payroll accounting system must also be structured in such a way that the social insurance companies, the governmental control organizations and the auditors can understand whether all wage and wage deduction items have been calculated correctly. For the company’s own financial accounting, this system must prepare the expenditures for wages and salaries and deductions according to expense types so that they can be posted and checked on an accrual basis.

In most countries, employees receive a monthly pay slip. This shows the contractual gross wage earned in the period and which allowances for overtime and shift work have been accounted for and credited. If supplements for 13th month wages, vacation or Christmas bonuses have been agreed in the employment contract, these items are also listed in the wage statement for the month of payment.

Deductions to be borne by the employee are subtracted from the resulting wage total, e.g. employee contributions for social security and health or accident insurance, in various countries the wage taxes, contributions to pension insurance and similar. This results in the net wage to be paid out for the individual. The company must pass on these deductions to the relevant governmental organizations or insurance companies.

In cost center accounting, however, it is not the cash flows and settlements that are relevant, but the consumption of a reporting period.

Information requirements of cost center managers

Cost center managers are responsible for the costs incurred in their management area that can be directly influenced by them. Consequently, cost accounting must be designed that the personnel costs of a period can be compared with the work performed in the period.

For this purpose, it must be calculated in planning how much a certain person should cost per hour of presence according to the employment contract, if all wage components and the non-wage costs to be paid by the employer are included. Example:

In the example, it is assumed that the person, including the 13th month’s salary and possibly other fringe benefits, is to receive an annual salary of 58,620.90 and is to be present for 1,700 hours (212.5 working days of 8 hours each) in accordance with the annual work calendar. For the non-wage costs to be paid by the employer (i.e. unemployment insurance, pension plan, possibly health insurance), a surcharge rate of 16% on the gross wage sum was calculated. In total, this employee costs the company EUR 68,000 per year or EUR. That is 40.– EUR per planned hour of presence. This is the key information for the cost center manager: For each work/presence hour, this person costs the company EUR 40.

If this person works exactly the 1,700 hours during the year (line 7), the following personnel costs result according to the recording of the presence time (line 8), for which the cost center manager is responsible:

In the example the company is closed for company vacations during July. Since the employee does not have any presence hours in July, no personnel costs are debited for him, although he receives a salary payment. This is because the hours were worked in the other months (the total presence hours in line 7 is 1,700 hours). Even if the employee is paid the same wage every month, it makes sense for the cost center manager to see the personnel costs based on the really worked hours .

However, in payroll accounting and consequently in financial accounting, the payment values can be found. They differ from the costs:

In the payrolls, Monthly Payments to Employee 1/12 appears as the gross monthly wage, cf. line 1. Vacation and Christmas bonuses are also included in personnel costs but are paid in June and November. Payments of child allowances are not listed because they are reimbursed to the company by Social Security. Social security costs charged to the company are included in the 16% for non wage costs (line 4). They represent the amounts the company (not the employees) must pay for unemployment insurance, retirement benefits, and possibly health insurance (9,379.34).

The monthly personnel costs are calculated by multiplying the hourly presence rate (line 6) by the time worked. Thus the personnel cost for the work done in a period is charged to the cost center, not the amount from the pay slip (line 8). The data source for charging personnel costs to the cost centers are the amounts from cost center planning and the presence times, not the payrolls for the employees.

Necessary personnel cost-types in management accounting

In many companies it is sufficient to set up only one cost type “personnel costs” in management accounting. This is because in most cases, a person’s hourly presence rate includes all compensation, as shown in line 6. Cost center managers cannot influence the conditions for non wage labor costs because they are governed by regulations. Therefore, as shown in line 4, they can be included directly in the planned hourly rate. This facilitates planning and control for cost center managers.

Additional personnel cost types indicated by

- Shift bonuses and/or bonuses for weekend work
- Bad weather bonuses (construction industry)
- Danger bonuses
- Overtime bonuses and
- Bonuses on achieved sales or contribution margins

are to be aligned. This is because these bonuses are planned and settled on the basis of hours actually worked or sales results achieved.

Imputed Depreciation

Imputed depreciation

“Imputed depreciation is the cost equivalent of the value depletion of long-term usable operating resources (Wolfgang Kilger, Flexible Plankostenrechnung und Deckungsbeitragsrechnung, 9th improved edition, Wiesbaden, Germany, 1988, p. 398)”.

Imputed depreciation should lead to corresponding amounts of money for replacement investments being “bunkered” in financial assets in the operating profit and loss account in order to be able to procure replacement equipment if necessary and thus continue to fulfill the purpose of the business. The depreciation equivalents mentioned by W. Kilger must be calculated on the basis of the replacement values of the investments from the point of view of value preservation.

The result is that imputed depreciation should not be calculated o from the basis of the historical acquisition value of equipment that can be used in the long term, but on the basis of the amount that would have to be paid at the end of the year for equipment with the same performance. In our view, the profit potential of a company is only maintained when equally efficient resources can be bought again. Only when the existing elements of the fixed assets can be procured again at current purchase prices is the substance preserved. Only the profit after deducting depreciation that preserves substance can be distributed to the owners / shareholders with a clear conscience.

The valuation at replacement value and the derivation of imputed depreciation from this requires that it be clarified before the annual financial statements what changes in purchase prices are to be expected for the various parts of the fixed assets. There are many reasons for impending cost price increases or expenditure for updates:

- Inflation in the procurement markets
- New technical or legal regulations to be complied with
- Changes in safety regulations for the operation of systems (and buildings)
- Adaptation of computer programs, program extensions and release changes
- Change to another machine supplier because the previous one no longer exists.

On the other hand, systems to be replaced can become cheaper to purchase because physical system parts are replaced by electronics or metal by plastic.

Both with expected rising and falling purchase prices of assets and intangible assets, imputed depreciation must be recalculated for the year to plan and taken into account in the planned cost calculations. This is because in management accounting, like other costs, depreciation is one of the factors determining the level of profit.

Imputed depreciation should not only be calculated for long-term assets such as buildings, equipment, machinery and vehicles. Operating resources also increasingly include rights and potential benefits of a non-physical nature such as ERP and CRM systems, rights of use and usage and sale, purchased customer addresses and time-limited usage licenses. If such potential benefits lose their value over time and new investments are required to maintain them, the corresponding estimated amounts must be included in the replacement value, which in turn leads to higher imputed depreciation.

Sustainably successful corporate management requires the inclusion of imputed depreciation in the internal income statement. This prevents money from being distributed to the owners that will be needed to maintain the company’s potential for success and thus its continued existence.