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“There’s no such thing as a free lunch” but will there be such a thing as a free drink or cheap drink in the future?

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Binge drinking in the UK is a major problem. City centres at the weekend can be full of people that are literally trying to drink as much as possible in as short a period of time. Violence and health issues often ensue.

As well as the disturbances to local residents there are also the costs both health-wise to the drinkers and financially to police forces, hospitals and society at large arising as a result of this binge drinking.

As a potential solution to this problem, the government is currently investigating whether to ban free or cheap drink promotions. One of the ideas being discussed is whether to make it illegal to sell alcohol below cost price. In other words to prevent businesses offering “loss leaders” on drinks so as to encourage higher spending at a later date.

If you’re an accountant, and assuming you’re not reading this in the middle of an actual binge drinking session yourself, this raises an interesting discussion on what exactly is meant by “below cost” and in particular the term “cost”.

The major alcoholic drinks manufacturers produce a range of drinks. Diageo for example produce drinks as varied as Smirnoff vodka, Johnnie Walker whisky and the famous Irish stout Guinness.

Identifying the cost of each particular drink would be challenging exercise. Whilst they no doubt have sophisticated management accounts which allocate overheads and indirect costs in certain ways, there would be a clear debate as to which was the “correct” allocation of these costs.

Apportioning overheads such as head office costs, R&D and marketing to individual products would result in a certain amount of flexibility in terms of identifying the cost figure to use for “below cost” purposes.

One solution to this inherent problem of identifying the cost of individual products has been proposed and that is setting the minimum cost of the drinks as equivalent to the duty and VAT that needs to be paid on the particular drinks.

So, the next time you’re out having a quiet drink with some non finance friends feel free to start a discussion about how much each of your drinks cost to make. You can then explain about the various possible methods of allocating indirect costs. Then again, talking about management accounting cost allocation whilst out with your friends may result in your  non finance friends starting a binge drinking session themselves…

Forget the sunshine, the beaches and the fantastic food – if you live in Australia sell your house and move to America…

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Asset valuation is a tricky business.  It is, however, a skill that accountants are often commissioned to use.  It’s also a useful one to have when making personal decisions, such as whether to buy a home or not.

Some people would argue that a major driver of the current economic slump in many countries is the collapse of house prices.

In a number of countries, house price bubbles were enormous.  There are lots of motivations for buying a home; principally as a place to live, a store of value for the future; certainty come retirement (when the mortgage is paid off so housing costs drop only to be maintenance).

Another motive has been speculation.  In my opinion, speculation in house prices is a bad thing, since it drives up house prices.  This means that new houses are not affordable for the young.  The more that house prices go up, the greater the transfer of wealth from the economically active young to the less economically active old.

Unsustainably high house prices cause uncertainty in an economy and when a crash eventually happens, it can cause people to be locked into homes with loans greater than the value of the asset (negative equity).  As well as a source of human misery, negative equity reduces labour mobility, which is bad for the economy as whole.

The Economist newspaper tracks house prices in different countries, using a method based on rental yields.  The assumption here is that rental markets react more readily to underlying supply and demand conditions.  If one had $500,000 to invest, would one use it to buy a house which could then be rented out, or buy other investments such as bonds?  If the rental yield (rent / initial value x 100) is less than the yield on bonds, then the house price is overvalued.  It’s a simple enough methodology that can give some revealing results.

A couple of years ago, this analysis suggested that UK property prices were 35% overvalued.  A crash followed.  There have been property crashes and recession in many countries where speculation is a big motive to buy property.  The alarming thing is that a recent analysis (Economist 10 July, page 75) revealed that properties are under and overvalued in certain countries:

UK: 33.8% overvalued (following a hard-to-explain recovery in house prices)
USA: 6.5% undervalued
Spain: 50.4% overvalued
Australia: 61.1% overvalued
Germany: 14.5% undervalued
Ireland: 15.7% overvalued.

This may be poor news indeed for the economy of countries with very overvalued property.  With these sorts of valuations, mortgages may become unaffordable the moment that interest rates rise to above the rock bottom levels we have at the moment.  This could release very big downward forces in the economy and dampen out any economic recovery.

On the plus side, the USA looks to have reacted quickly, albeit brutally, to the changed economic circumstances and it might be a good time to sell your home in Australia (cash out your investment while it’s arguably overvalued) and buy somewhere in America.  If you can get a visa.  Oh, and a mortgage!

You know you’ve had too much to drink when your eyesight goes blurry, you slur your words and you spend half a billion dollars…

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Steven Perkins, a 34 year old commodity broker, attended a company golfing weekend, had a bit too much to drink over the weekend and then took the Monday off of work.

This in itself didn’t justify being fined £72,000 earlier this week by the Financial Services Authority (FSA) and being identified as “an extreme risk to the market when drunk”.

It was what he did on the Monday evening that caused all the excitement.

After the golfing weekend, Mr. Perkins felt the need to carry on drinking and started drinking again on the Monday lunchtime. Late that night in a drunken stupor he bought 7 million barrels of oil using $520 million dollars belonging to his then employers PVM Oil Futures.

Because the purchases took place in the middle of the night other traders around the world thought that there was something major happening in the oil market and as a result the price of oil shot up by $1.50 a barrel in less than 30 minutes. Through the alcoholic haze Mr. Perkins gradually increased his bidding price each time to push the price up until at one stage he was responsible for nearly 70% of the global market volume.

He tried to gradually sell down his position in the morning but no doubt with a very dry mouth eventually admitted everything to his employer.

His drunken night time purchases resulted in PVM losing £6million, him being fined £72,000 and banned from the industry for five years. Plus of course, an almighty hangover.

CIMA results and performance with a smile…

First of all congratulations to all CIMA students that received their exam results yesterday and were successful. Your hard work paid off so very well done! We’ve heard from a number of you that were successful and those are always the best type of emails to receive from students!

If your results weren’t as expected though and you didn’t pass then better luck next time.

Various papers have performance management within the syllabus. A rather unusual method of managing performance was recently reported by the press.

Japan’s Keihin Express Railway Co., in an effort to promote a friendlier customer service, has implemented something called “smile scanners” at its stations to assess the smiles of their employees!

Employees have to look into a camera every day and have their smiles scored by a computer that analyses their facial features and gives feedback. The quality of the smile is reportedly rated on a scale ranging from 100 to zero.

Is it effective? Can the scanner distinguish between an artificial and a genuine smile? The jury is still out.

While we at ExP love technology, we’re not sure we would submit to such assessment, at least not before our morning coffee!

Remember the short term and long term

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One item that people should be aware of is that management accounting and financial management are similar to the extent that they are both concerned with resource usage. But there are differences.

I was lucky enough to have recently flown on the new Airbus A380 super jumbo and that got me thinking about some of the financial management issues that Airbus face. Designing and producing the A380 must have been a phenomenal exercise and a real testament to man’s engineering skills. It’s capable of carrying over 800 passengers and has a range of nearly 15,000 km. It’s a fantastic machine.

But what has this all got to do with the difference between management accounting and financial management? One difference is that management accounting tends to deal in short-term timescales whereas financial management is generally more concerned with the longer term. Whilst the longer term is generally considered to be more than one year be aware that certain industries and companies have a distinctly longer “long-term”.

From inception to delivery the A380 took nearly 10 years and the long term view taken by Airbus is certainly longer than some businesses in for example the IT or fashion industries. Some of the businesses in these industries have distinctly shorter “long-terms”.

Anyway, despite the millions spent on design and development of the A380 there was one disappointing thing about my flight and that was I fell asleep during the film and missed the ending…

Thinking of Christmas already?

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Pricing is an important area of ACCA and CIMA. There are a variety of pricing methods discussed in the syllabus including customer based pricing and competition based pricing. Broadly speaking, the former is based on the amount that customers would be willing to pay for benefits whilst the latter involves setting prices based on the prices of competing products.

In the UK, the Toy Retailers Association has just released their list of the top 12 toys that they expect to be most in demand in the UK this coming Christmas.

The interesting thing about the list is that the average price of the toys is just over £26. This compares to an average price of £32 in the Christmas 2007 list. This represents a fall of nearly 20%.

Has this fall been driven by cost savings by the manufacturer on labour or material? Or maybe reductions in transport and storage costs?

My guess is that the toy manufacturers are aware of the recession and the impact on parents buying power (customer based pricing issue). They are also aware that the toy industry is an extremely competitive industry and at the moment their competitors will be offering cheaper products (competition based pricing).

Either way, I’m sure that there won’t be a lot of children debating this issue on Christmas day when they open their presents!

Do you know your cost of capital?

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The other day I was talking to a few local business owners and I asked them if they knew what their cost of capital was. I got a few blank stares.

When we discussed the issue further, people started to warm up to the idea that the cost of capital can be viewed in terms of opportunity costs:

1. One owner said his cost of capital was the interest rate on his bank loans. I suppose he was 100% debt financed and probably not planning to refinance any time soon! Good luck to him!

2. A second owner said he took out all his savings from the bank and put it into his business. Since the bank deposit rate was so low, he figured his opportunity cost was pretty low as well. He has a point, though he must realize that he has moved into a higher risk category by withdrawing his money from the bank and investing it in a start-up business.

3. Another business owner said he started his company by borrowing from his relatives. Since they haven’t asked for it back he assumes its cost is zero. But he does pay a price, I suppose: at family gatherings he gets dirty looks from his relatives and his wife gives him constant grief. He suspects that the relatives complain about him to his wife.

Since all three owners want to expand their businesses, they asked me if I could recommend new sources of finance. I thought of sending them to our P4 candidates (after the exam!).

Cider and spreadsheets

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Cider drinks and spreadsheets – what’s the link?

Cider is an alcoholic drink made out of apples and has become more popular in recent years in the UK. One of the most popular brands of cider in the UK is Magners cider, the brand owned by the C&C Group.

We all know that there are lots of benefits of using spreadsheets such as Excel (e.g. speed of use, quantity of data that can be analyzed, etc) but we should all be aware that mistakes do happen with spreadsheet.

Earlier this summer shares in the C&C Group fell approximately 15% after the group said that revenue in the 4 months to the end of June had fallen by 5% rather than the 3% increase that had been reported a week earlier!

The group’s Finance Director said that the error in the earlier announcement occurred after data was incorrectly transferred from an accounting system to a spreadsheet used to produce the trading statement. Quite an embarrassing mistake and a valuable lesson in that even if spreadsheets are extremely powerful tools in business if the wrong data is inputted you will receive misleading results.

Also, it should be stated that consuming excessive amounts of cider when using excel could result in unpredictable results…

My 85kg and ratio analysis…

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I weigh 85kg (approx 13.5 stone or 187lbs).

So, how am I doing weight wise? More to the point, what has this got to do with the exams?

Ratio analysis is an important area of the syllabus and one overriding principle to remember when looking at ratio analysis is that a ratio is irrelevant when looked at in isolation. Ratios must be looked at against comparatives or benchmarks in order to interpret them and then to look at the underlying causes.

So, back to my weight of 85kg. How am I doing? Is my weight ok?

85kg by itself is irrelevant. We need to look at comparatives for somebody who is my gender and my height. For example, 85kg for an adult male with a height of 1.90m (6 foot, 3 inches) is a healthy weight. 85kg for an adult female with a height of 1.60m (5 foot, 3 inches) is an unhealthy weight with the person being classified as obese.

Using my example of 85kg, by comparing it with people who are the same height as me is in effect comparing it with “industry standards”.

What about my performance over time? Is my weight increasing, decreasing or remaining static when compared to last year and the year before. Comparing movements within this personal ratio analysis unfortunately reveals that my weight has increased.

Now onto the important issue behind ratio analysis and that is of looking at the underlying cause of the movement in the ratio. Unfortunately, it looks like the cake I have with my afternoon tea could be on the way out…