Theory in Action 6.2 Dan 5.2

Theory in Action 6.2 Outsourcing and costs

1.

Iden Identi tify fy the pote potent ntia iall prob proble lems ms asso associ ciat ated ed with with alloca allocati ting ng costs costs that that ‘att ‘attac ach’ h’ to to serices proided by firms such as Infosys Technologies.

The allocation of costs to a service provided by a firm can be problematic. While direct costs can normally be easily traced to a particular service, indirect costs such as depreciation and overheads may not be so easily determined for a particular service. The allocation of these costs may require the use of an arbitrary allocation method or the determination of cost drivers in order to allocate the costs over multiple services.

2.

!hat crit !hat criter eria ia woul would d mana manage geme ment nt use use whe when deci decidi ding ng to e"pen e"pense se or capi capita tali lise se e"penditures associated with its serices#

Under the historical historical cost approach, approach, management management would need to determine determine which costs have ‘expired’ ‘expired’ as these will need to be matched matched expensed! expensed! against income. "ny unexpired unexpired costs will be capitalised and carried forward as unmatched assets on the balance sheet. sheet. #eady to be matched against future revenue as it flows in.

1

!hy is the !hy the deci decisio sion n to e"pens e"pensee or capita capitalise lise e"pen e"pendit ditur ures es so so impor importan tantt to the costs costs attach principle which underlies the historical cost system#

The historical system of accounting relies on the $correct% matching of expenses against revenues in determining profit. &xpenditures under the historical system are bro'en into expense and asset components, with the asset component transferred progressively from the statement of financial position to the income statement as the future economic benefit of  revenue is received. The reliability of this system relies on costs being measured and attached correctly and the correct allocation of these costs to expenses or assets. (owever, the decision to capitalise or expense is not always straight)forward and often *udgement may need to be made on whether the expenditures have expired and what the probability is of that asset generating future revenue.

Theory in Action $.2 %apital or income#

1

!hy is the measurement distinction between capital and income important#

+n theory and practice! income is the incremental increase in beginning period capital. Therefore income cannot be measured unless the beginning period capital amount is 'nown.

1.

!hat do you thin& is real financial capital maintenance and what is physical capital maintenance#

inancial capital maintenance is having the same amount of financial resources or net assets valued in money terms! at the end of the period as at the beginning of the period. #eal financial capital maintenance means maintaining the same purchasing power so an ad*ustment for inflation is needed!. -hysical capital is the ability to produce the same level of  goods and services at the end of the period.

2.

Is the increase in the alue of a house you lie in income or capital#

+f you wish to continue to live in the same level of housing then any increase in value is capital. +f you sell then you have to purchase a similar house that provides accommodation services at a similar price. (owever, some students will argue that you will eventually sell so it is some form of future income or increase in value. '.

(oes your answer to )uestion ' change if your house is an inestment property#

Then you may legitimately use a financial or real financial! concept of capital. tudents should now realise some of the complexity of the arguments about measuring income and capital.