Labor, Land, Tax, & Profit

 I was going to write a different blog post when I realized I was going on a tangent. I think I need to explain my thinking first.

I have been exploring the concept of inflation and I was trying to figure out if it was the products(materials) or labor that was causing the increases in prices. In this blog post, I hope to conceptual deep dive into what it takes to get the products we buy to market.

“If you want to make an apple pie from scratch, you must first invent the universe” - Carl Sagan. I am not going to go down to the atomic or subatomic level, but I am going to go with the premise that there are four elements that go into the cost of the items we purchase. These are labor, land, tax, and of course profit. I am going to show how each of these plays a role and how some overlap.

Labor may seem like an obvious element for the production of a product. In cost accounting, we look at both direct and indirect labor when calculating the cost of goods (sold) manufactured. But labor costs go beyond that. There is the labor for marketing/advertising, selling, and administrative expenses for running the business. What if I told you that labor goes deeper than that? Let's consider the labor that goes into the raw materials that are used to make the product. For this example, we are going to assume that the product uses lumber that is delivered as a main raw material. Labor (and all 4 elements) goes into the cost of the lumber. There is the cost to have the lumber loaded on the truck, the labor to deliver the lumber, and the labor for the vendor to offload the lumber from their supplier's trucks. Now let's take into account other labor for this supplier. What about their clerk who schedules the deliveries, the worker who cleans their warehouse, the worker who maintains their fleet of trucks, the salesperson's salary, and so on? And this goes all the way back through the supply chain to the lumberjack that fell the tree.

And this concept does not just go towards the labor for materials. All four of these elements go towards anything that adds cost to the product, either as a direct cost or as they call it in cost accounting “factory overhead”. So what about the factory? What labor costs does the buildings and facilities a business use have? There are somewhat obvious labor costs like the cost to maintain the building: like plumbers, painters, gardeners, etc. but what about the labor cost to build the building? These labor costs don’t just include the people swinging hammers, but all the labor for the builder's administrative expenses, the inherent labor costs of the materials used (as I demonstrated in the paragraph above), and the inherent labor in the machinery used to build the building.

So, what about machinery? Let's go back to that original product that we were discussing. That product used lumber as a main material. But tools are needed to transform the lumber into the end product. So we can assume some type of saw is needed. There are labor costs that the company pays because of that saw. They need someone to purchase the saw. If it is a big saw they need someone to unload it. For safety, the person or people that operate that saw need to be trained. Now let's dive deeper. The cost of the saw has labor built-in. and these are similar (if not the same) costs as the lumber. And labor is a factor all the way back into the supply chain to the miner that dug up the iron ore used in the saw blade.


Now that we covered labor and inherited labor, let's look and land. At first glance when thinking of land we think of the property that the business occupies. If the business owns the land then the purchase price of the property is the land. We already discussed how the labor is associated with any buildings on that land. So the purchase price is not just land. It is labor, taxes, and profit too. Even if the business rests, the property land is still a factor. Now what about that lumber? Obviously, those trees needed land to grow, but what about all the other steps in the supply chain? The company that the business purchased the lumber from needed land for their warehouses and facilities; and this goes for each of the businesses from the sprouted tree to the end product. And what about the machinery used by all of these companies, the manufacturing, sale, and resale of that saw we mentioned needed land? This started with that iron ore mine all the way to the saw blade used to cut the lumber. And each of these companies has tools and equipment that need land (and all 4 factors). It is a supply web rather than a supply chain.


‘Tis impossible to be sure of anything but death and taxes’ - Christopher Bullock 1716. For our discussion taxes are any government fee. This can include property, sales, or labor taxes, but it can include regulatory and licensing fees. So, that land we mentioned in the paragraph above most likely has property taxes imposed on it. And this goes to any land that is used in the supply chain (or supply web). And that labor probably has payroll and income taxes associated with them. Unless they are using off-the-books labor, but we will assume they are doing everything legally. Now what about any business licenses? Or the fees paid to the Department of Motor Vehicles for the trucks they use? And what about the profit that we have not discussed yet? So the other three elements have something in common; taxes! Now let's dig into those taxes. So every string on the supply web has taxes just like they have labor and land, but do taxes have labor and land? They do; governments are run by people who have salaries. And governments also have land for their facilities. And while someone holds the deed to the land that the businesses in the supply web are on, does the municipality, state, and/or country own the land within their borders? Even if they don’t own it they exert a level of control over that land.


And then there is profit. We won’t go into gross profit vs net profit. But we will touch on profit before and after taxes. Just like land and labor of taxes, so does profit. If you purchase this hypothetical product we are discussing the company that sold it to you is expecting a profit. And the companies that hired the lumberjack and miner expect a profit. And so does every middle man (or middle woman) in between.  And each of these companies serves a purpose (hopefully) in the supply web. It would not be practical for the end company to chop down, mill, and transport their own trees. Or to mine, refine, and fabricate their own saw blades. Companies try to reduce or eliminate costs when possible. But they can’t do everything (unless they are a multi-billion dollar conglomerate ).

Do you agree with me on these four factors? Are there any other factors that I omitted? Which factor do you think is the most responsible for prices to continue to increase?

Cost Accounting

 # Understanding Cost Accounting: Unveiling the Financial Backbone of Businesses

In the complex world of finance, where every penny counts, cost accounting stands as a pivotal process. It is the unsung hero behind the curtains of many successful businesses, aiding in informed decision-making and ensuring optimal resource allocation. In this comprehensive guide, we'll delve deep into the world of cost accounting, exploring its essence, methods, and why it matters.

## **Chapter 1: The Foundation of Cost Accounting**

Cost accounting is a specialized branch of accounting that focuses on tracking, recording, and analyzing costs associated with business operations. Its primary objective is to provide detailed insights into the cost structure of a company, allowing for efficient cost management and strategic planning.

### **1.1 Cost Types**

In cost accounting, costs are classified into several categories:

#### **1.1.1 Direct Costs**

Direct costs are expenses that can be directly traced to a specific product, project, or activity. For example, the cost of raw materials used in manufacturing a product is a direct cost.

#### **1.1.2 Indirect Costs**

Indirect costs, also known as overhead costs, are expenses that cannot be traced directly to a particular product but are incurred to support overall business operations. Examples include rent, utilities, and administrative salaries.

#### **1.1.3 Variable Costs**

Variable costs fluctuate with changes in production or activity levels. These costs increase as production or activity increases and decrease as they decrease. Examples include the cost of materials used in production and hourly wages for temporary workers.

#### **1.1.4 Fixed Costs**

Fixed costs remain constant regardless of changes in production or activity levels. These costs must be paid even if the business is not producing anything. Examples include rent for office space and the salaries of permanent employees.

### **1.2 Cost Accounting Methods**

To achieve its objectives, cost accounting employs various methods, including:

#### **1.2.1 Job Order Costing**

Job order costing is used when products or services are produced in response to specific customer orders or contracts. Costs are tracked for each job or order separately. This method is common in industries like custom manufacturing and construction.

#### **1.2.2 Process Costing**

Process costing is used when products are produced in a continuous, mass production environment. Costs are averaged over all units produced during a specific time period. This method is common in industries like food processing and chemical manufacturing.

#### **1.2.3 Activity-Based Costing (ABC)**

ABC assigns costs to activities, and then these costs are traced to products, services, or customers based on their usage of these activities. ABC provides a more accurate way of allocating indirect costs and is beneficial in complex business environments.

## **Chapter 2: The Significance of Cost Accounting**

### **2.1 Informed Decision-Making**

Cost accounting equips businesses with the data needed to make informed decisions. Managers can analyze the cost structure of different products or services, helping them determine which offerings are profitable and which require adjustments or discontinuation.

### **2.2 Pricing Strategies**

Cost accounting plays a crucial role in pricing strategies. By understanding the costs associated with producing goods or delivering services, businesses can set competitive prices while ensuring profitability.

### **2.3 Budgeting and Planning**

Budgeting relies heavily on cost accounting data. It enables companies to allocate resources effectively, set achievable financial goals, and monitor performance against these objectives.

### **2.4 Performance Evaluation**

Cost accounting helps in evaluating the performance of various departments, products, or projects within an organization. It aids in identifying areas of improvement and optimizing resource utilization.

## **Chapter 3: Cost Accounting in Action**

### **3.1 Manufacturing Industry**

In the manufacturing sector, cost accounting is paramount. It helps in:

- Determining the cost of producing each unit of a product.
- Analyzing variances between actual and budgeted costs.
- Evaluating the efficiency of production processes.

### **3.2 Service Industry**

Even in service-oriented businesses, cost accounting is essential. It assists in:

- Allocating indirect costs, such as administrative expenses, across different services.
- Setting service prices based on the cost of delivering them.
- Identifying areas where cost reductions can be made without compromising service quality.

## **Chapter 4: Modern Trends in Cost Accounting**

Cost accounting has evolved significantly over the years, and modern trends continue to shape its landscape. Some of these trends include:

### **4.1 Technology Integration**

The advent of accounting software and enterprise resource planning (ERP) systems has streamlined cost accounting processes. Automation reduces errors, enhances data accuracy, and provides real-time insights.

### **4.2 Sustainability Accounting**

As sustainability becomes a central concern for businesses, cost accounting now includes the measurement and analysis of environmental and social costs. This helps organizations make sustainable decisions and report on their environmental impact.

### **4.3 Predictive Analytics**

With the power of data analytics, cost accountants can now forecast future costs more accurately. Predictive analytics helps in proactive cost management and risk mitigation.

## **Chapter 5: Challenges in Cost Accounting**

Despite its many benefits, cost accounting is not without challenges:

### **5.1 Overhead Allocation**

Allocating indirect costs can be complex and may lead to misinterpretations if not done accurately.

### **5.2 Rapid Technological Changes**

The rapid pace of technological advancements requires constant updates and adjustments in cost accounting methods.

### **5.3 Data Security**

As cost accounting relies heavily on data, maintaining data security and privacy is of utmost importance.

## **Chapter 6: Conclusion**

In conclusion, cost accounting is the backbone of financial decision-making for businesses across various industries. It empowers organizations to understand their cost structures, make strategic choices, and thrive in competitive markets. As technology continues to evolve, cost accounting will adapt, providing even greater insights and value to businesses worldwide. Embracing cost accounting is not merely an option; it is a necessity for sustainable growth and success in today's business landscape.

So, whether you're a business owner, manager, or aspiring accountant, understanding cost accounting is key to unlocking the financial potential of any organization.