By the nature of bank expenses are divided into six groups: operational, the costs for the business of the bank, to pay bank staff, taxes, contributions to the special reserves, etc.

By operating expenses include, firstly, the payment of interest for attracting bank resources on the basis of deposit and credit operations, issuance of securities. Secondly, the commission paid by the bank from dealing in securities, foreign exchange, cash and settlement transactions, for cash collection. Third, other operating costs (discount rate on promissory notes, a negative result on revaluation of securities and foreign currency accounts, expense (loss) from the resale of securities, transactions with precious metals, etc.). Thus, operating expenses – are costs directly related to banking operations.

Expenses for the business of the bank includes the amortization of fixed assets and intangible assets, the cost of renting, repairing equipment, stationery, contents of vehicles, purchase of clothing, the operational costs of the buildings, etc. Labor cost of bank staff consist of salaries, bonuses, accrued payroll.

Expenditures on taxes associated with taxes on property, land with the owner of vehicles, road user and other taxes related to the cost of bank transactions (ie, taxes, reflected in the expenditure accounts of the bank).

Particular group of costs are the costs to build reserves to cover possible losses on loans and impairment of securities and to cover possible losses on other active operations, the accounts receivable.

Other expenses of the bank varied in their composition. This advertising costs, travel and representation, for training, to offset the costs for bank employees in connection with the use of their personal vehicles for business purposes, marketing costs, costs of audits, litigation, according to published reports, etc.

The shape of different interest, fees and other noninterest expenses.

Interest expense includes interest paid by the bank for a loan, balances of demand deposits and time deposits, which are open to individuals and legal entities, including banks, interest payments on promissory notes, bonds, deposit and savings certificates.

Banks bear the costs in connection with the payment of commissions for securities transactions and foreign exchange services for cash, payment on collection, for received guarantees, etc.

Other non-interest expenses take the form of a discount rate, the cost of the speculative nature of the market, the revaluation of assets, penalties, fines and penalties, administrative expenses (salaries, training, etc.), household spending.

To account for the costs of the bank’s balance account opening balance sheets of the second order. The basis of allocation put a few signs, including the form of consumption, the type of passive operation, the nature of the flow. Based on the balance sheets of the second order divided into the following groups of expenditures:

interest paid for loans raised;

interest paid to legal entities on borrowed funds;

interest paid on deposits of individuals;

expenses on securities transactions;

spending on operations with foreign currency and other currency values;

administrative expenses;

expenses for banks;

fines and penalties paid;

other expenses.

Within each group, costs are allocated more detailed types, which are accounted for on the analytical accounts (for example, costs by type of creditor, fines for violations of the species, interest expense on the nature of the activities and status of the account holders, etc.).

Over the period to which the costs are allocated expenditure for the current period and deferred expenses. The latter may be associated with accrued but unpaid interest on the loan and deposit transactions, transactions with securities, negative revaluation of assets.

By way of limiting the expenses of the bank are divided into normalizable and Nonnormable. By normalized include advertising expenses, travel, staff training, hospitality, to compensate for costs associated with the use of personal vehicles of employees of the bank. These costs are accounted for entirely on the expense accounts of the bank, but the cost in excess of taxable bank.

The effect on taxable cost of the bank are divided into three groups:

1) costs attributable to the cost of banking services (ie, recorded on expense accounts) and bank-deductible when calculating income tax;

2) costs recorded on expense accounts, but not deductible Bank;

expenses directly attributable to the losses of the bank and not taken into account when calculating the taxable base of the bank.

However multiple channel multiple market segments networks can induce complex analyses and would probably be dependent upon a host of Judgements. These would include the likelihood of ‘cannibalisation’ between channels in a three channel system the analysis of the costs imposed by any two rests on assumptions about the market coverage of those two and how much of the third channel’s coverage they would take.

In assessing channel acceptability it may also be necessary to include a number of additional factors, many derived from consideration of the factors considered earlier. They could be combined into a listing of criteria and subjective evaluations made about the actual or likely performance of alternative channels. This might be with each criterion being given a differential weight to reflect its importance to the firm at that time. Or, as discussed in new product, screening some kind of series of hurdles may be operated where each channel alternative is assessed against one criterion and those that pass move on to be assessed against a further criterion and so it continues until all criteria have been employed.

Setting a price by including a Profit Margin does not guarantee Profit at all. The main flaw of cost-plus pricing is the disregard for the relationship between price and sales volume. A given price does not guarantee sales volume.

The situation becomes dangerous if the price is limiting sales volume. In this case usually, company’s management increases the price to secure profit at the same level and if the market demand is elastic, rising price results in further reduction of the sales volume. At the same time, fixed costs are distributed over a smaller amount of products, and if the company it trying to retain a certain profitability level it looks like it is necessary to increase prices again.

As a conclusion, if a company implements this pricing strategy and is trying to achieve the desired output, planned costs and profitability, it can lead to wrong decisions. There are some other reasons that express the reduced adequacy or even the fact that this method of pricing is a wrong one, such as:

- When setting prices, the allocation of fixed costs per unit of product is a suspect one as the total unit cost calculated on this manner is correct only for particular output volumes. The only case it could be applicable is when the company is producing stable quantities over a long period of time. If there are changes in output the total cost will be different from the one calculated in advance;

- The process of fixed costs allocation per product is significantly influenced by the subjectivism of the entitled persons to perform the assignment as well as by the level of detailed information in respect of a particular fixed costs component. There are many possible ways of how to assign fixed costs to the specific range of products;

- The allocation methods in place can not ever be fully justified;

- Often the Total Unit Costs lead to misunderstandings or wrong interpretation of such information due to the deficiencies of splitting costs into fixed and variable, which again lead to wrong managerial decisions.

Market Oriented Pricing. Cost analysis allows the company to examine consequences of different pricing strategies. With these results, it is much easier to follow the aspects of pricing, which are related to demand elasticity, and the reaction of competitors. The concept of Price Elasticity of Demand is very important in demand analysis: it is percentage change of sales changes as result of a 1% price change. As a rule, price elasticity of demand is negative, which means that price increase results in demand decrease and vice versa. Information regarding the behavior of demand for different products might be gathered through marketing researches or summarization reports developed by specialized bodies.

Microeconomics offers a possibility to set prices which maximize revenues of the company in combination with marketing information. The starting point is the description of the Linear Demand Curve, an example of which is:

If one multiplies Price by Quantity the result is Revenue.

In order to know which price-volume relationship maximizes revenues, it needs to know how total revenue behaves when changing volume by a small amount. Using calculations, this change in revenues can be captured by a derivative of the revenue function. The derivative is called the Marginal Revenue.

The last equation is telling that the marginal revenue curve will have the same intercept with the Y axis as the demand curve, and will cross the X axis half way between the origin and the point where the demand curve meets the X axis. It follows that for the volume-price combination where MR = 0 (where the MR curve intercepts the X axis) revenue is maximized. As a conclusion, the Revenue-Maximizing Price lies in the middle point of the demand curve, and Profits are maximized at the point where marginal revenue equals marginal cost as.

When a company strives for a strong position on the market, price policy becomes a key factor in accomplishing the goal. Price is the tool to stimulate the demand. At the same time, pricing determines the long-term Profitability of a company. For the development of a pricing strategy, it is necessary to consider other profit-related goals such as, sales volume potential and marketing competition. Price determines overall profitability of a company as well as sales volume by implying sales volume at the level above the break-even point for which Cost-Volume-Profit relation is optimal. Price setting directly determines demand level, and consequently, Sales Volume for output with demand elastics. Incorrect pricing (too high or too low) may undermine the position of a given product on the market.

There is a category of businesses that are the only suppliers of a particular product on the market. They face no competition at least in for a visible time span in respect of the particular product or service. The advantage of such a business is the freedom in setting the price and at the same time it is its major danger, expressed by a spoiled image on the market.

These kinds of businesses have to find a balance between the assurance of a sufficient product profitability and simultaneously to not provoke the other companies offering the same “demanded” product through own production or imports.

Another important issue is price setting for the “cannibalized” products, which is the increasing of share of a particular product, implies the shrinkage of the share of other products that is the result of devoting the production capacities to more efficient units from the manufacturer point of view.

There is a practical methodology how to proceed in the establishment of prices for such businesses, which is based on the following steps:

1. Estimation of the satisfactory amount of Profit per annum, deriving from the ROI or from other profitability perspectives. For example the target Income is 3 000 000 MDL/year.

2. Knowing the Fixed Costs of the business, the target Contribution Margin, is calculated by adding up the Income and Fixed Costs. For example the target Contribution Margin is 5 500 000 MDL/year.

3. Deriving from the market research and other possibilities, the approximate product mix for the year is determined in terms of the share of each product in the total product mix.

4. The Productivity and the Contribution Margin per Unit for all products included in the product mix.

5. The Contribution Margin Statement produced, which comprises the following items:

a. Quantity of each product

b. The annual production capacity for each product

c. Unit price per products

d. Contribution margin per unit

e. Total contribution margin per product

6. The Capacity Utilization Ratio for the initial production program is calculated, and based on it, the Target Contribution Margin per 1% of Production Capacity Used.

In order to reach the target Contribution Margin, one must observe the level of production capacities utilization. If the capacity is already used in a high proportion, then the adjustment procedure for prices is required. The prices for those products that have the lowest Contribution Margin per 1% of Production Capacity Used must be increased until 1% of Production Capacity would result in at least 1% of Contribution Margin.

This procedure is followed until the target Contribution Margin (Profit) is reached. If the initial Contribution Margin is already higher than the targeted one, then some price reduction could be applied. The core issue in this context is the actual level of Production Capacity Utilization. It should be appropriately analyzed. The minimum PCU which is acceptable for price setting using this methodology is 75%. At the same time, higher than 95% capacity utilization is not advised. The normal range used for this purposes must fall within 75-90%. In any case, the use of existing output capacities are the second indicator taken into account in the pricing after the demand requirements.

The process of determining the costs of all units that can be sold, and then allocating these costs between the units sold during the period (cost of goods sold) and the units unsold at the end of the period (inventory) is referred to as Product Costing. Only product costs are use in product costing, not period costs.

Product Costs are costs that are closely associated with units produced by the enterprise or purchased for resale by a retailer or wholesaler. Examples: Cost of materials and labour used in production. Thus, Product Costs are inventory costs when incurred and these costs are assets until the units are sold. At the moment of sale, several things happen:

- The economic benefit, sales revenue, is realized;

- The asset expires;

- No longer recognizing the product cost as an asset, it is now recognized as an expense, cost of goods sold;

- The Cost of Goods Sold is matched with the sales revenue on the Income Statement.

Period Costs are costs that are recognized as expenses as soon as they are incurred. They are not assigned to the product; instead, they are immediately assigned to the Income Statement as an expense of that period. The benefits provided by period costs are realized fully when the costs are incurred and are recognized in the current period. Examples: Administrative salaries, Marketing expenses.

It is important to classify product costs and period costs correctly. If these costs are classified incorrectly, they will be expensed at the wrong time, and the financial statements for the period will be inexact.

There is a third group into which costs can be classified when they occur: Non inventoriable unexpired costs. These costs represent assets when they are incurred, but they are not costs that can be assigned to inventory. Example of such costs: Expenditures for prepaid insurance, prepaid rent, machinery, buildings. Each of these costs is an asset, other than inventory. Many of these assets are used up or consumed as time passes. As they expire over time, the amount expired can then be classified as a product cost or a period cost.

Manufacturers must maintain three different inventory accounts:

- Raw materials inventory. Materials purchased from a supplier;

- Work in progress. The unfinished goods in production – the units that are being worked on;

- Finished goods inventory. The completed product awaiting sale.

Categories of Product Cost used in Moldovan National Accounting System:

- Direct materials. Raw materials that become an integral part of the completed product;

- Direct labour. It is the work that directly converts the raw materials into finished goods;

- Manufacturing overhead. The total costs of production department minus direct costs. Examples: indirect materials, indirect labour, rent, property tax, maintenance and repair, utilities, depreciation, idle time.

The Cost Flow of a retailer goes directly from purchase of goods to sale. The Cost Flow for a manufacturer is much longer:

- Purchase and use of raw materials;

- Use of labour;

- Use of manufacturing overhead;

- Transfer of manufacturing overhead to Work in Progress;

- Completion of production;

- Sale of finished goods.

Overhead Allocation between Product Types

Cost allocation is a process of assigning cost to specific products. It rises the issue of what share of costs need to be assigned to a particular product. The answer to this question has the effect on the viability of the business.

Cost allocation is needed in order to determine product costs, which in turn are needed for (1) reporting to external authorities (Statutory Accounting) and for (2) analyzing product line profitability (Managerial Accounting).

In the process of cost allocation, Direct and Indirect Costs must be assigned to specific products. Direct Costs are easy to allocate because they are linked to particular products, based on the internal standards supported by a normative base. The common Direct Costs are:

- Raw materials;

- Energy;

- Production Labour;

- Subcontracted services.

In order to allocate Direct Costs it is enough to match products made and direct expenses incurred, however, even direct cost allocation sometimes causes difficulties if there are many products made in one place and they use the same machinery an the same materials. In this case direct costs are assigned proportionally to standard norms which are developed by the technological and planning departments. Periodically, standard norms must be compared with actual consumption patterns to make adjustments.

Indirect Costs, often called Overheads, are the hardest to allocate because they are not directly traceable to products. The common Indirect Costs are:

- Top management expenses;

- Social assets;

- Depreciation of buildings;

- Repair and maintenance;

- Interest expenses;

- Rent;

- Security;

- Heating and ventilation.

The Overhead Expenses are allocated in a Two-Stage Process. At the first stage the factory overheads (G&A, Marketing, and other overheads) are assigned to Cost Centers (product line A, product line B) and only then they are assigned to particular products, using specific allocation bases. Identifying Cost Centers is important for accurate cost allocation. A Cost Center is a responsibility center where managers are accountable for the expenses which fall under their control. Normally, cost centers are represented by workshops.

Overhead allocation is a very complex calculation process. All allocation methods are subjective and therefore disputable. The more indirect the cost is, the more subjective its allocation is likely to be. The purpose of the allocation is not to be fully accurate, but simply to spread costs in a fair and efficiency-improving manner.

Allocation bases should be chosen according to the following criteria:

- They should be related to the cost considered, i.e. of the resources effectively used;

- They should be representative of the normal operating conditions;

- If possible, they should be a factor of which decision-makers can have an impact;

- In some cases, they can take the special objectives of cost management into account.

The following are commonly used simple allocation bases:

1. Direct Labour. It is acceptable when manufacturing processes are highly Labour-intensive, overhead a small percentage of total costs and low product diversity. It’s not relevant when Labour costs are low (e.g. 10%) and overhead high (e.g. 30%);

2. Depreciation of machines. It is justified in highly capital-intensive industries. It is also relevant for some types of overhead which are often linked to production facilities (interest expenses, chief engineer. It is not relevant in non capital-intensive industries and for overhead caused by the number of staff;

Sales. This method will be “painless”, as only best-selling products will be penalized. It is not representative in terms of cost generation and it removes part of the incentives to increase sales;

Energy. Only relevant if other bases related to production processes do not apply (e.g. if some departments are grossly overstaffed, or if machines for different products vary widely), as it then becomes the only possible way to assess resources used.

Management should be aware of the consequences to their business when choosing an allocation base. For example, the common Moldovan practice of splitting overhead by a proportion of direct Labour tends to distort the costs of hand-produced products versus those machine-produced products. Choosing “Sales” as an allocation base often penalizes products that are high revenue generators. A good basis on which to allocate overhead in a Moldovan manufacturing company is often a mix of direct Labour and machines.

Changing the itemization and overhead allocation base usually yields different profitability estimates for individual production lines or individual products. The higher the share of overhead costs, the greater the expected changes in profitability estimates for individual products as a result of overhead reallocation. There is no ideal base for overhead allocation but there are more appropriate bases of allocation for each company. Potential benefits from a more detailed allocation of overhead must exceed the related costs.

Incorrect overhead allocation between product types and production divisions can result in (1) inconsistency between the price ratio for individual products and market demand, (2) unjustified reduction of output for some products, (3) incorrect assessment of divisions operations.

The choice of overhead allocation base is determined by company specifics, industry characteristics, as well as by the relative value of certain costs within the overall structure of company costs.

Cost Drivers

The Cost Driver is a factor which affects the level of a particular cost dramatically: it can have a positive or a negative impact. A cost driver is the element of a cost that exerts great influence over its account, such that a change in the cost driver necessarily results in a change in the cost. Knowing the cost driver of products is vital to understand the elements of cost and to make decisions accordingly. Mastering cost drivers allows enterprises to make operational decisions with some degree of certainty as to their cost impact.

Examples of Cost Drivers:

- Labour – Location, efficiency of work;

- Raw materials – Purchasing sale, wastage, delivery costs;

- Financing costs – Interest rates, inflation, location;

- Repairs cost – Number of machines to be repaired, age of machines;

- Energy cost – Volume of buildings to be heated, efficiency of heating system, waste;

- Sales department – Number of invoices issued, number of customers;

- Accounting department – Number of transactions, average transaction processing time;

- Warehousing costs – Average length of storage, number of pallets handled;

- Distribution costs – Complexity of route structure, number of owned vehicles.

Product engineering has a significant effect on the cost of each product. Beyond the basic product engineering, the detailed product specification such as purity, quality, and finish could add further costs. Design specification can often add significant additional cost that customers may not be prepared to pay or may simply not want. The company must analyze whether what is produced is really expected by the customer at the proposed price.

The areas where cost gains can be obtained:

- Input costs can be reduced;

- Switching from one technology to another;

- Labour productivity improvement;

- Efficient organization of the business process;

- Economy of scale;

- Change of location;

- Distribution costs.

The CVP relationships suggest that a useful way of studying the basic profit characteristics of a business is to focus on the Profit per Unit (which is different at every volume), but rather on the Total Fixed Costs and the Contribution Margin.

There are four basic ways in which the profit of a business can be increased:

- Increase in selling price per unit;

- Decrease variable cost per unit;

- Decrease fixed costs;

- Increase volume.

There are 2 approaches to the Cost Accounting in respect of profit analysis:

- Traditional method (cost-plus approach);

- Contribution margin method.

The Contribution Margin is the difference between Sales and Variable Costs and serves to cover Fixed Costs and to bring a certain Profit. In order to maximize Profit volume, it is necessary to maximize the Contribution Margin. Each additional unit of production sold at a given price will directly contribute to the Profit. The Unit Price should not exceed the Variable Unit Costs, otherwise a revision of the Selling Price or discontinuing the manufacturing of the product is required. The uppermost advantage of the Contribution Margin per Unit is that unlike the Profit per Unit it does not varies with the change of the output.

The Cost-Volume-Profit Analysis is based on the following basic assumptions, which are valid only within a certain range of production and sales:

Fixed Costs remain constant within a certain range of output;

Variable Costs per Unit of production do not change with volume of output;

The Sales Price per Unit of production remains fixed for set volume of sales.

The Cost-Volume-Profit Analysis gives answers to the following questions:

At what level of sales is the product profitable?

What will income be at a given sales level?

What could income be if the company operates at maximum capacity?

What will the impact of changes in price, fixed costs, variable costs, and volume be on income?

The basic formula of the Cost-Volume-Profit analysis is:

Another useful indicator of the Cost-Volume-Profit analysis is the Financial Safety Margin (Safety Threshold), which evaluates the sales volume above the Break-Even Point:

It shows how much the actual volume of sales exceeds the Break-Even point in percentage. The higher the margin the larger the profitability corridor of the company.

The Cost Structure effect on Profit is best characterized by the Operating Leverage, which shows the relationship between the change in Profit and change in Sales volume:

The Operating Leverage shows the percent change in Profit with a 1% change in Sales. It is related to the level of company risk. The greater the Operating Leverage, the higher the company risk. The greater the risk, the higher the potential reward. A high Operating Leverage means that there is a high level of fixed costs and a low level of variable costs per unit of production. Operating Leverage becomes higher the closer the sales volume is to the Break-Even point.

The concept of the Contribution Margin is most useful when analyzing one product company. For a company that makes several types of products it is more convenient to use the Contribution Margin Ratio for individual product types, divisions and for the company as a whole. The calculation formula is:

The significance of Contribution Margin is supported by the following:

It is the most important and useful tool of the product profitability analysis or for groups of products measuring changes in monetary terms;

The higher the Contribution Margin Ratio for a particular product the more attractive the manufacturing and selling of this product, from the manufacturer’s point of view, is;

It is the most qualitative and appropriate principle of product portfolio optimization, especially when there is a production capacity limitation.

The Cost-Volume-Profit analysis can also be used to analyze multi-product companies, which is a common situation for most of the businesses. In addition to answering questions covered by the single-product analysis, the modified model also covers the following topics:

Identifying which products are most profitable and vice-versa;

Comparative profitability of products;

How to utilize limited resources more efficiently;

In which product line to invest;

Identifying the optimum product portfolio;

Support for pricing decisions.

- Fixed or Variable – depending on whether the costs change with variations in production volume;

- Direct or Indirect – depending on whether costs are directly related to a certain product.

The purpose of these classifications is:

- Fixed/Variable Costs are used for the Cost-Volume-Profit Analysis and for the optimization of the structure of production;

- Direct/Indirect Costs are used in assessing the allocation of a cost to a particular product or company division.

Fixed Costs do not vary with the quantity produced, no matter what the output is, the amount of fixed costs will be the same. (rent, interest, G&A expenses); Variable Costs vary with the quantity produced. A variation in output will cause a variation in the cost by the same proportion. (raw materials, wages, power energy); Semi-Fixed Costs depend on the quantity produced, but will not vary in direct proportion to the quantity produced. They increase in steps, i.e., they are fixed until a certain level of output is reached at which point they become variable. (shipment for bulk).

Direct Costs are incurred exclusively for one product. They can easily be traced to a specific product. They are generally incurred in the production/marketing process. Dropping the product would eliminate this cost. (raw materials, power energy, wages);

Indirect Costs are incurred for more than one product. They can not be traced for a specific product. Dropping the product would not eliminate this cost. (energy to heat, production supervision Labour).

Classification of costs as Fixed or Variable is necessary for making decisions that affect the volume of output. Managers want to know how such decisions will effect Cost and Revenues, and most importantly – Income.

Cost Management consists of:

- Having a systematic approach to determining what your real costs are;

- Understanding why costs are incurred;

- Taking action based on your analysis and understanding, in order to improve the company’s cost structure (cost reduction, strategic choices);

- Always looking for opportunities to save money.

Advantages of effective Cost Management:

- More cost competitive products, and thus increased sales opportunities;

- Appropriately priced products and flexibility in pricing;

- Availability of qualitative and real information about the cost of certain types of products and their position in the market in comparison with the other competitors’ products;

- Better resources allocation and a better managed business;

- Providing objective data for generating company budgets;

- Capability of evaluating performance of each division in the enterprise from the financial point of view;

While understanding the true costs the company has the opportunity to take better management decisions. The appropriate management of costs will lead to a more competitive enterprise.

The consequences of inefficient Cost Management are:

- Cash is wasted;

- Product prices are set incorrectly;

- Resources are dedicated to “wrong” products, activities or customers;

- Management does not know how the company can reduce its costs;

- Costs rise without being noticed because they are not managed;

- Profitability drops for unknown reasons.

The answer to the question: “How could the production strategy from a cost point of view be optimized in such a way that it would contribute to an appropriate pricing of products and to selling them in a profitable way” could be found through the comparison of the Costing Models.

Full Absorption Costing Model – is based on the calculation of the product cost by applying the total cost incurred for the company or for a particular production line to the total range of products. This model was widely used in countries with controlled economy. It does not provide an accurate or sensitive measurement framework for price computation in competitive markets, and does not provide a basis for determining which products are making profits and which are causing losses. In competitive markets, those companies that can cut their Per Unit Production Costs to a minimum are going to be able to sell their products at a lower price. Those companies that cannot cut their costs will lose market share or suffer losses.

Avoidable Costing Model. It is used by some western companies. It involves selecting of some of the overhead costs and attributing them to a particular product. Avoidable Costs are those overhead costs that would be eliminated if a particular product was completely withdrawn from the production. This method provide a more accurate assessment of the cost of producing a product than the Full Absorption Method, but still does not accurately measures the costs involved for that product.

Variable Costing Model. It is also called the “Marginal Costing Model’, that provides an accurate measure of the costs involved in producing a unit of a particular product. It is the model used most widely in the West, nevertheless in the last years this model is getting more popularity among former SU countries.

Variable Costing Model identifies the costs of producing each additional unit for a given product and focuses on how product costs change when the volume of production changes. It entails identifying which costs are directly attributable to a product (variable costs), e.g., the raw material costs and energy costs. Once these variable per unit costs are known, by subtracting them from the price of the product, one can determine how much of the price is available to cover overhead costs. This amount that contributes to covering fixed costs is called Contribution.