Electricity Cost – Fixed or Variable?

What is a Fixed Costs?

Fixed Costs can be defined as the costs that do not wary with the level of output within the company. As a matter of fact, organizations have to incur this particular cost regardless of the level of output they are operating in.

Over the course of time, even if the level of production increases within the company, the total fixed costs still the same. However, fixed cost per unit, tends to decrease with the increasing level of input within the company.

In the same manner, it is also important to consider the fact that fixed costs are also referred to as overheads.

They cannot directly be associated with individual units of output produced within the company. Some examples of fixed costs include office rent, and salaries for office, and other managerial staff.

What is a Variable Cost?

Variable Cost is the cost that changes with the level of output within the company. Factually, it is directly proportional to the level of output that the company produces. This means that higher the total level of output within the company, higher the variable cost.

Hence, at zero level of output, the company has zero variable costs. However, it must be noted that with increasing level of output, the variable cost per unit stays the same.

Some examples of variable costs for an organization include production related expenses, direct material, and direct labor for the company.

Furthermore, it can also be seen that the variable cost for the company is referred to as a direct cost, because it can be directly traced down to one unit of good produced within the company.

Nature of Electricity Bill

During the normal course of operations, there are numerous expenses that a business has to bear in order to stay operationally active. In this regard, they mainly categorize those expenses as either fixed, or variable.

However, in certain types of expenses, there is often ambiguity regarding how they should be classified in order to depict a clear picture to the users of the financial statements.

Electricity tends to be one of such expenses that are often treated with relative ambiguity, because of the reason that it is relatively harder to bifurcate electricity related expenses into fixed and variable.

However, it can be seen that the categorization of electricity related costs can be broken down into several different pieces, and then subsequently tied together to get a better insight.

The electricity bill, by its very nature is often regarded as mixed cost. This is essentially because of the cos that includes both components, fixed, as well as variable.

It normally includes a flat service charge, after which the variable charge accumulates in accordance with the number of electricity units that are consumed within the company.

Therefore, the nature of the electricity expense can be regarded as fixed. This is because it normally involves a fixed component, and a variable component.

Also, it is also regarded as a fixed cost, because even if the company is not producing any goods and services, they would still be paying some fixed amount for electricity every month.  

How to Classify Electricity Bill?

Firstly, electricity is considered to be a utility that is consumed across different departments within the company. Therefore, it is relatively harder to segregate electricity strictly into either fixed or variable.

However, this is something that can be dealt with by keeping production related electricity costs as variable costs, and other miscellaneous costs as fixed electricity costs.

For production related electricity expenses, it makes sense for those costs to be associated as variable costs, because they are directly proportional to the amount of goods and services that are produced. Higher the production, higher the electricity costs.

Therefore, it is best to classify production related electricity expenses as variable costs, and other miscellaneous electricity related expenses as fixed expenses.

Regardless of the fact that holistically electricity related costs are considered as mixed costs, yet they are normally classified as fixed costs, in the Income Statements. This is because of the fact that electricity expense in itself includes both fixed, as well as variable components.

Hence, it is regarded as a cost that cannot be individually attributed to one particular unit of product. Even though production-related electricity expenses are directly proportional to the amount that is produced within the company, yet it still cannot be attributed to one particular unit in an accurate manner. Hence, in most cases, it is classified as fixed costs only.

Net Open Position: Definition, Example, Formula, and Importance

Definition

Net Open Position is defined as the exposure of companies towards foreign exchange risk that the company is exposed towards. The exposure of the foreign exchange risk is defined as the difference between total assets and total liabilities in the foreign currency.

This particular risk element describes the extent to which the company can see volatility in the financials as a result of the foreign exchange risk.

In this regard, it can be seen companies are often exposed to foreign exchange risk because when they are dealing with foreign exchange transactions.

This is because of the fact that currency rates keep on fluctuating because, and hence this makes the financials of the company vulnerable to uncalled for instability in the profitability.

The foreign exchange risk is always inherent within companies particularly in cases where there are more than one currency in operation.

Therefore, this is the exposure that needs to be accounted for by companies in order to identify the element of risk that the organization has undertaken as a result of the foreign exchange related transactions.

Formula

Net Open Position is calculated using three main parameters. These parameters include total assets in the foreign currency, total liabilities in the foreign currency, and the equity or the net worth of the company. Using these parameters, the following formula is then used:

Net Open Position = (Total Assets in the foreign currency – total liabilities in the foreign currency) / (Equity or Net Worth of the company)

However, in order to represent all currencies as one single currency, it is important to convert the international currencies into the functional currency of the organization. This is done using the prevalent spot rate at that point in time. 

Example of Net Open Position

Net Open Position can further be explained using the illustration provided below:

Multinational Inc. is a trading concern sending goods from the US to the UK. They also import some of their raw materials from the UK. As at 31st December 2019, they had the following balances on their balance sheet:

Total Assets (Local Currency) = $ 500,000

Total Assets (Foreign Currency) = £ 200,000

Total Liabilities (Local Currency) = $300,000

Total Liabilities (Foreign Currency) = £ 100,000

 Equity or Net worth of the company -= $ 200,000

As at 31st December 2019, the spot rate between USD and GBP was $0.9 = £ 1

In order to calculate the Net Open Position of Multinational Inc, the following calculations need to be made:

Total Assets (Foreign Currency) = £ 200,000

Total Foreign Assets (local currency) = $ 180,000

Total Liabilities (Foreign Currency) = £ 100,000

Total Foreign Liabilities (local currency) = $ 80,000

Therefore, after these conversions, the net open position of Multinational Inc. can be calculated as the following:

Net Open Position = (Total Assets in the foreign currency – total liabilities in the foreign currency) / (Equity or Net Worth of the company)

Net Open Position = ($180,000 – $80,000) / 300,000

Net Open Position = 100,000 / 300,000 = 33.33%

Importance of Assessing Net Open Position

There are numerous different advantages of calculating net open positions. Firstly, it can be seen that net open position can greatly help companies to assess their inherent risk.

This is important for companies, and their stakeholders because it gives them a much needed insight and overview regarding the existing risk position and how can this risk position be altered for the overall position of the company.

In the same manner, net open position can also be used for business strategies, and in terms of devising a protocol that companies can follow in terms of minimizing and mitigating that risk in the coming years.

Limitations of Net Open Position

However, it can be seen that the net open position has certain limitations, which need to be included in the analysis too. Net Open Position is the risk exposure at a certain point in time. It provides a snapshot, which is based on the existing exchange rates.

However, it does not provide a longitudinal view. It does not incorporate the fact that foreign currency rates might constantly change from time to time, and hence, this is something that might change the net open position of the organization too.

In the same manner, higher net open position is also perceived as a cause of higher risk for the company. However, it must be kept in mind that a lot of companies solely rely on international trade, and therefore, their net open position might be higher.

This does not necessarily mean that the company is a high risk entity. In fact, this risk can be minimized over the course of time using techniques and strategies that can reduce the element of risk.

Repair and Maintenance Expense

Overview

During the normal course of business, there are certain routine expenses that are considered unavoidable. They are part and parcel of the operations of the company, and therefore, need to be paid by the company in order to ensure that there are no bottlenecks that hinder the performance of the company.

Repairs and maintenance expense are one such expense that is incurred by the company on a regular basis.

Repairs and maintenance expense basically include expenses that are incurred as a result of the machinery or other equipment within the company that needs to be kept in proper running condition with the company.

These expenses are considered to be unavoidable and are necessary to ensure smooth functioning of operations without any machine breakdowns, and any relevant hiccups.

In this regard, these expenses are mainly categorized as periodic costs. They cannot be associated with one particular product, and the expense for repairs and maintenance highly varies from one year to another.

By the nature of repairs and maintenance related expenses, it is seen that it is normally considered to be an expense that is a routine expenditure, and it cannot be predicted before it actually happens.

With routine maintenance, the amount is still predictable, but with unforeseen machine breakdowns, predicting the amount for these expenses is relatively hard.

Therefore, this is the amount that is normally deducted from the petty cash of the company, since it is mostly not very substantial. However, it still needs to be accounted for in order to record those expenses in a proper manner.

Accounting Treatment for Repairs and Maintenance Expense

Repairs and maintenance expense is considered to be one of the operational expenses of the company, and therefore, it is categorized as a normal expense.

Repairs and Maintenance expense can either be planned, or unplanned. Planned repairs and maintenance expense means that companies know need to be incurred and carried out over the coming year.

On the other hand, unplanned repairs and maintenance expenses are expenses that occur on an unforeseen basis. For both of these types of repairs and maintenance related expenses, they are treated and categorized in the same manner.

Therefore, repairs and maintenance expense is mainly categorized as an expense account. The expenses are debit in nature, and therefore, as the amount increases, the relevant amount is debited in the Profit and Loss Account.

Normally, organizations settle this amount in cash, and therefore, they barely have any prepaid or accrual balance at the year end. However, in certain cases, organizations do end up having either prepaid or accruing repairs and maintenance expense.

In the case where there is a prepaid repairs and maintenance expense, it means that the company has paid in advance, or has paid an excess amount to the supplier. In that particular case, it is treated as a Current Asset in the Balance Sheet.

On the contrary, it can further be seen that in the case where there is a pending balance of Repairs and Maintenance that needs to be settled before the year-end, there is a need to include that as Current Liabilities in the final year statements.

Double Entry for Repairs and Maintenance Expense

In order to record the repair and maintenance expense when it is incurred, the following journal entry is made:

ParticularDrCr
Repairs and Maintenance Expensexxx
    Cash xxx

Since the repairs and maintenance account is paid in the year where it is due, it is supposed to be expensed and written off at the end of the year.

Therefore, in order to settle the amount that has been carried out as an expense at the end of the year, the following journal entry is made:

ParticularDrCr
Income Statementxxx
       Repairs and Maintenance Expense    xxx

Example

In order to explain and further classify the treatment of repairs and maintenance expense, the following illustration is provided:

Kemp Co. is a manufacturing concern. Over the course of the year, they incurred $25,000 as repairs and maintenance expenses.

However, they got into an agreement with the supplier that they would pay $15,000 as repairs and expense cost upfront, and the remaining amount would be settled in the next year.

In order to record the above transaction in the financial statements, the following transactions need to be made:

ParticularDrCr
Repairs and Maintenance Expense25,000
    Cash 15,000
Current Liability 10,000

In the same manner, it can be seen that at the year end, the following journal entries need to be made:

ParticularDrCr
Income Statement25,000
Repairs and Maintenance Expense 25,000

What is Financial Aid?

Definition:

Financial Aid can be defined as the monetary compensation of leverage that is given to students, or professionals in the cases where they are eligible, but are unable to afford for the particular course themselves.

Financial Aid is regarded as money that helps pay individuals pay for their college, or their career school. It can be received from the government, school, or from any other private entity that supports the cause of helping individuals progressing in their respective fields.

Financial Aid is regarded as a blessing for individuals and students when it comes to facilitating them to complete and move forward with their education and their career.

Regardless of the fact that applying for financial aid might be perceived to be a cumbersome task, yet there is absolutely no doubt to the fact that it is rightfully considered to be extremely beneficial in ensuring that the ecosystem functions properly.

Financial Aid – Categorization

In the same manner, it is also important to consider the fact that financial aid can be subcategorized into two broad categories.

Firstly, there is need based financial aid, that mainly covers expenses for those individuals and students that cannot afford paying for college, or their education themselves.

Secondly, there are merit-based financial aids that are categorized as scholarships and financial assistance that are given to individuals on ground of their exemplary academic track record.

In the same manner, financial aid can also be a lump sum money paid that does not need to be repaid.

Alternatively, financial aid can also act like a loan. Individuals can get the amount for their education against an agreement with the aid provider, which the loan would be repaid across a time period of a number of years.

Types of Financial Aid

There are numerous different types of financial aid that are available to the applicants. The different types of financial aid are given below:

  • Grants: As far as grants are concerned, grants that are issued as financial imbursement that needs to be repaid. There is numerous different financial aid available to the users. In this regard, it can be seen that these are the type of grants that are received in the case where applicants are pursuing a particular cause, for which there are numerous different programs available.
  • Scholarships: Scholarships are also financial imbursements that are given out on records of exceptional academic track record of individuals. However, they are tougher to win, since the eligibility criteria filters out the most deserving candidates from the general pool
  • Loans: Loans are targeted to the applicants that have difficulty in paying the fee. Hence, governments provide them financial assistance, which can be repaid at a later date, once these individuals start earning.  

How does it work?

Financial Aid is often considered to be a gruesome process, which involves paperwork and documentation. Regardless of the fact that it is perceived to be a stringent process, yet there is no doubt to the fact that financial aid can actually prove to be beneficial in the longer run, if it is secured. This is only possible if there is clarity about the financial aid system, and how it works.

Firstly, it can be seen that financial aid mainly revolves around proper documentation. Therefore, when universities and colleges open up their applications, they also issue a financial aid documentation. It has all the details about the documents that need to be presented in order for the aid to be granted.

The applicant must ensure that all those documents are properly attached, and there is no misrepresentation of information. It might lead to cancellation, and blacklisting from the country wide universities, if there is any hint of malpractice or representation.

Followed by this, the department issuing the financial aid checks for all the compliance related issues. These include the academic standing scores, entrance tests performances, as well as the financial positon of the parent (or the guardian) of the applicant.

After this information has been scrutinized, the applicants who clear the eligibility criteria are called for an interview, which helps the department to second-screen the deserving candidates.

After all the relevant documentation and the paper work, they then give out the aids to individuals who deserve it the most, in order to ensure that aids are disbursed properly.

Once the aid has been given out, there is also a regular follow up to check if the aids were given out correctly, and if there is any change that needs to be reflected in the existing policy framework.

Hence, the aid that has been given out is subject to change and can be revoked without prior notice. Therefore, all applicants should ideally be aware of these situations in order to get a better idea.

Gross Charge Off (Definition, Formula, Example, and Importance)

Definition:

Gross Charge Off can simply be defined as the amount of finance that is not repaid to the bank. In other words, it is categorized as bad-debts for banks, or other financial institutions.

During the operational cycle, banks and other financial institutions are often involved in carrying out transactions with other different organizations who seek financial support from the banks.

However, there are certain times when these organizations are unable to honor their debts. In those cases, the amount that is not recovered from the debtors is written off from the books, and that is referred to as the gross charge off.

Gross Charge Off is an increasingly important metric for the company, because it shows how well the credit risk department is functioning within the company.

During the normal course of the business, it is often challenging to guarantee that all the debtors will honor their obligations, and pay back on time.

However, it is then the responsibility of the credit risk department to ensure that companies are able to reduce the amount of irrecoverable debt, because that is an expense that has a negative repercussion on the company in terms of profitability.

Formula:

As described earlier, gross charge off is the final amount that the company is unable to collect from its debtors. Therefore, gross charge off can be calculated by adding all the figures of debts that have not been honored by the company.

At the end of the year, organizations mostly do a round-up of collectibles, in order get an idea about the position of the debtors, and if there are any red flags they should look out for.

Depending on those insights, they are able to get an idea about the amount they might not recover. However, they only write the amounts as gross charge offs when they are absolutely certain that the amount can no longer be recovered from the party.

Example:

In order to further explain the concept of Net Charge Off, the following example is provided.

Mia Co. is a bank that that has managed to extend loans worth $2,150,000 over the year end 31st December 2020. However, over the past year, around $ 150,000 were declared as irrecoverable amounts from debtors. It is anticipated that out of this amount, 10% might be recovered upon liquidation of the company.

In the example above, it can be seen that Mia Co. has irrecoverable amounts of debts amounting to $150,000. Therefore, this is the amount that needs to be written off as a gross charge off.

Regardless of the fact that around 10% of this amount is expected to be recovered, yet it will not be treated as such unless it is actually received by the company.

Importance:

Given the fact that Gross Charge Offs are mostly used by banks, and other financial institutions, it can be seen that it is very important metric for organizations from both, an internal as well as external point of view.

As a matter of fact, gross charge off can be regarded as one of the most important and crucial metrics that hints towards the overall ability of the company to keep their risk profile moderate.

A significant amount of gross charge offs means that the company has a weaker credit control and risk management policy. Therefore, it calls for companies to ensure to implement new standard operational procedures in order to minimize this particular amount of write offs.

In the same manner, it is also considered important for the long-term sustenance and profitability of the company. Otherwise, the bank, or the organization will continue to lose substantial sums of money in the form of bad debts.

In the same manner, even from an investors perspective, a higher gross charge off is considered to be problematic. This is because it shows that the company is not doing that well on grounds of doing a proper background check.

By comparing it with other financial institutions, they can get a relative idea about the industry performance.

Net Charge Off vs Gross Charge Off

Net Charge Off and Gross Charge off is similar, except for the amount that is actually recovered after those bad debts have been written off. In the case no amount is recovered is from the debtors, net charge off is going to be similar to gross charge off.

However, the greater the difference between the net charge off and the gross charge off, the more beneficial it is for the company. This is because it shows that a significant majority of bad debts have finally been recovered.

Net Charge Off (Definition, Formula, Example, and Importance)

Definition:

During the normal course of the business, there are numerous different transactions that take place on credit. In this regard, it can be seen that not all the credit transactions have a complete recovery rate.

In the case where the organization has bad debts, the amount is supposed to be written off from the records of the company. In that particular case, the write off is referred to as Gross Charge Off.

It must be noted that gross charge off is normally the term that is used for banks, and other financial institutions. Gross charge off, can therefore be described as the amount that is declared as irrecoverable by the organization.

However, there are certain cases when the company is able to retrieve some of the finances from the general public. In that particular case, it can be seen that the amount is then declared as net charge off.

Therefore, net charge off is the final amount that needs to be written off the financial statements, because this is the amount that is declared as bad debt for the organization.

Formula:

As described earlier, Net charge off is the final amount that the company is unable to collect from its debtors. Therefore, net charge off can be calculated using the following formula:

Net Charge Off = Gross Charge Off – Amount of Bad Debt recovered

Where Gross Charge off is described as the amount that was previously written off as bad debts.

Example:

In order to further explain the concept of Net Charge Off, the following example is provided.

Care Co. is a company dealing in automobile manufacturing. Over the past year, they extended loans amounting to $100,000 to various different parties. However, two of those parties defaulted during the year end, and therefore, the amount needs to be written off.

The amounts that both these companies owed was $15000 and $5000 respectively. Additionally, it is to be noted that upon the liquidation of both the companies, the amounts that were received by Care Inc. against the amount owed was $4000 and $1000.

In the example above, it can be seen that Care Inc. suffered a financial loss in the form of bad debt amounting to $15000 and $5000 respectively. The amount was declared as bad debt for the company. Therefore, Gross Charge Off amounted to $20,000.

However, the amount that was recovered from both the parties was calculated as $4000, and $1000 respectively. Hence, in this case, the net charge off that is going to be represented in the financial statements is going to be as follows:

Net Charge Off = Gross Charge Off – Amount Recovered = 20000 – 5000 = $15000.

This is the net amount that is declared as irrecoverable bad debt, and therefore, this should be the amount expensed in the Income Statement prepared at the year end.

Importance:

Net Charge Offs are mostly used by banks, and other institutions that extend loans to other companies. In this regard, it is important to ensure that this is a very important concept, which is used as a metric to evaluate the credit risk policy of the company.

A higher amount of net charge offs is an indication that the company has a significant amount as bad debts, and this particular amount needs to be reduced in order to ensure that the company sustains itself in the coming years.

Since this loss is directly subtracted from the operating profit of the company, it can be seen that it is important for companies to realize the fact that they need to rethink and revamp their credit risk policy, so that there are no bad debts in the forthcoming years.

From an investor’s perspective too, a higher net charge off is not favorable, because it shows that the company is not doing that well on grounds of doing a proper background check. By comparing it with other financial institutions, they can get a relative idea about the industry’s performance.

Net Charge Off vs Gross Charge Off

Net Charge Off and Gross Charge off is similar, except for the amount that is actually recovered after those bad debts have been written off. In the case no amount is recovered is from the debtors, net charge off is going to be similar to gross charge off.

However, the greater the difference between the net charge off and the gross charge off, the more beneficial it is for the company. This is because it shows that a significant majority of bad debts have finally been recovered.