costing
DESCRIPTION
COSTING. What is costing. In cost accounting we analyse costs and calculate the cost for each unit of production Cost depends upon the judgement of the cost accountant in each situation The cost of a product purchased for resale is the price we pay - PowerPoint PPT PresentationTRANSCRIPT
COSTING
What is costing• In cost accounting we analyse costs and calculate the cost
for each unit of production• Cost depends upon the judgement of the cost accountant in
each situation• The cost of a product purchased for resale is the price we
pay• If we make the product the cost of the product includes
Material, Labour and Overheads (other costs)• The cost of those units of a product sold is not the same as
the total cost of materials, labour and overhead since some of those costs may relate to unsold units
Example• Cost of one product: Product X
£
Material – 3 tons @ £5 per ton 15
Labour – 5 hours @ £1 per hour5
20
Overhead – 5 hours @£2 per hour 10
£30
Variable Costs
Fixed Costs
The overhead is Estimated and added to the cost of material and labour to give the total cost of Product X
Classification of Costs• Costs can be classified into the following areas
Fixed Costs; Variable Costs; Semi variable costs; Direct costs; Indirect Costs
• Exercise 1 Complete the definitions below• Fixed costs• These are costs which will not vary with output but may
change over time. eg Rent & Rates, Heating, Depreciation.
• Variable Costs• These are costs which WILL vary with output. The
more produced, the greater the cost eg material, labour, royalties
Classification of Costs• Semi Variable Costs• These costs have a FIXED and a VARIABLE part eg
maintenance costs will have a fixed level for standard repairs but will also include a variable element for unscheduled repairs
• Direct Costs• These are costs that can be traced back to a certain
product – eg cost of raw materials. They can be traced to a specific cost unit – eg wages
Classification of Costs• Indirect costs• These are costs which can’t be traced back to any
individual product – eg electricity, rent and rates etc
• In deciding the cost and possible selling price of a job, the direct costs of labour and material are easy to identify.
• The main problems arise in charging appropriate amounts for overhead and profit
Costing• To determine a fair manufacturing overhead for a job we
find a relationship between the total manufacturing overhead cost and some known direct costs.
• For example the overhead could be made up of a % of direct labour or of prime cost
• We may then add a profit % to the total cost to calculate the estimate selling price
• However• The customer and the market for the product decide the
actual selling price of the job
Job Costing
• Used to calculate manufacturing costs when the
organisation is making different product for
different customers
• Where each job is different
• Used by Contractors, builders, engineers
Job Costing
• Before an order for a job is placed the customer is given an estimate of the total cost which includes an estimate for materials and labour
• It is simpler to estimate material costs than it is labour costs
Exercise 2
Exercise 3
Job Costing Card / StatementThis is prepared to keep a record of all the costs incurred in the job being undertaken.
• It includes the following details: 1. Job No2. Customer Order No3. Customer's Name4. Job Description5. Materials used and their cost6. Labour - time and cost7. Overhead charged8. Profit9. Total Price
Job Costing Card / Statement• Job Cards record actual labour time – taken from Clock
cards and time sheets From this actual labour costs can be calculated
• Material costs – taken from issue notes from stores or from invoices for material purchased specifically for a job
• Factory overheads - charged on an overhead absorption basis using one of the predetermined overhead absorption rate eg rate per machine hour
• Administration, selling and distribution overheads will also have to be charged.
• A percentage is added to the total cost for profit and to find the final price to charge the customer.
• An invoice will be prepared to bill the customer, it will include the information on the Job Cost Card.
Calculating Profit
• The profit can be calculated EITHER• as a percentage of total cost (mark-up)OR • as a percentage of the selling price of the job
(margin).
• The profit of a job is calculated on either the % of the cost price or on the selling price
• This means that a distinction must be made between the % Margin and the % Markup
• % Markup• Gross profit
Cost price
% Margin
Gross profit
Selling price
Mark-up and Margin (Calculating profit)
Job XYZ
Less Cost £500
Selling Price £625
Profit £125
Selling Price = Cost + Markup=£500 + 25%
Job XYZ
Less Cost £500
Selling Price £625
Profit £125
Profit = Selling price * Margin = £625 * 20%
Job Cost Statement – Question 1Materials
10 Metres of MDF @ 10.50 each
5 rolls of galvanised steel @ £4.50 each
Labour
25 labour hours @£5.50 each
30 machine hours @ £6 each
PRIME COSTS
Overhead £3 x 25 labour hours
Cost of job 344A
Profit (Markup 20% )
SELLING PRICE OF JOB 344a
£105.00
£22.50 £127.50
£137.50
£180.00
£445.00
£75.00
£520.00
£104.00
£624.00
Job Cost Statement – Question 2Labour
300 labour hours @£6 each
150 machine hours @ £7.50 each
Materials
100 plastic tubes @ £25 each
15 wooden J-stands @ £21.60
30 metal plates @ £45 each
PRIME COSTS
Overhead £4.50 x 150 machine hours
Cost of job no XYZ
Profit (Markup 15% )
SELLING PRICE OF JOB XYZ
£1800.00
£1125.00 £2925.00
£2500.00
£324.00
£7099.00
£675.00
£7774.00
£1166.10
£8940.10
£1350.00 £4174.00
Job Cost Statement – Question 3Labour
100 labour hours @£10 each (Dept A) £1000
150 machine hours @ £7.50 each (Dept B) £1125 £2125
Materials
40 metres of benching at @ £125 each (Dept A) £5000
30 metal plates @ £45 each (Dept A) £1350
100 jig borers @ £55 each (Dept B) £5500
20 metal sheets @ £145 each (Dept B) £2900 £14750
PRIME COSTS £16875
Overhead £4.50 x 100 labour hours (Dept A) £450
Overhead £3 x 150 machine hours (Dept B) £450 £900
Cost of job no BRO15 £17775
Profit (Markup 20% ) £3555
SELLING PRICE OF JOB BRO15 £21330
Job Cost Statement – Question 4
Labour – 200 labour hours @ £8 each £1600
Direct Materials £2500
Variable Overhead £3 x 200 labour hours £600
Fixed Overhead £1 x 200 labour hours £200
a)Cost of job no WAL123 £4900
SELLING PRICE OF JOB WAL123 £5500
PROFIT FROM JOB WAL123 (SP – COST) £600
Job Cost Statement – Question 5
Direct Labour
150 hours @ £6.50
Direct Materials
1000 tons @ £20
Variable overhead @£2 x 150 labour hours
PRIME COSTS
Fixed Overhead £1.20 x 150 labour hours
Cost of job 344A
Profit (Margin 20%)
SELLING PRICE OF JOB 344a
£975.00
£20000.00
£300.00
£21275.00
£180.00
£21455.00
£5363.75
£26818.80
SP = 100%Profit margin = 20%
Cost + Margin = SPCost + 20% = 100%Cost = 80%
(80%)
Margin = Cost/80 x 20= £5363.75
Job Cost Statement – Question 5b)
Delivery = 1,000 tons x £0.50 per tonDelivery = £500Profit will decrease by this amountProfit = £5363.75 - £500 =£4863.75
Job Cost Statement – Question 6
Labour – 50 hours @ £12.50 each £625
Direct Materials £3800
Overhead £4.50 x 50 labour hours £225
a) Cost of job no EXH384 £4650
Profit
b) Selling price of job no EHX384
Margin 33.3 % (1/3)
66.6 % (2/3)
100% (3/3)
£2325
£6975
Job Cost Statement – Question 7Labour – 200 hours @ £8 each £1600
Direct Materials
500 metres of pipe @ £200 for 10 metres (500/10 x 200)
£10000
1000 metres of plastic ducting @ £9.50 £9500 £19500
Variable overhead @ £5 x 200 labour hours £1000
PRIME COST £22,100
Fixed Overhead @ £2 x 200 labour hours 400
a) Cost of job £22500
b) Profit (Markup 25% / Margin 20%) £5625
Delivery £375
Selling price of job £28500
Job Cost Statement – Question 8 a)Labour
200 labour hours @ £12 each (Dept A) £2400
130 machine hours @ £9 each (Dept B) £1170 £3570
Materials
70 metres of piping at @ £150 each (Dept A) £10500
50 metal discs @ £70 each (Dept A) £3500
100 jig fixers @ £200 each (Dept B) £20000
20 metal plates @ £145 each (Dept B) £2900 £36900
PRIME COSTS £40470
Overhead £6 x 200 labour hours (Dept A) £1200
Overhead £3 x 130 machine hours (Dept B) £390 £1590
Cost of job (80%) £42060
Profit Margin (20%) £10515
SELLING PRICE (100%) £52575
Job Cost Statement – Question 8 b)
Cost of job £42060
Profit Margin (33 1/3%) Markup (50%) £21030
SELLING PRICE (£65000 - £1910 delivery) £63090
Costs
Material Costs
• Costs in buying the parts (raw materials) necessary to produce the cost
unit
Labour Costs
• Wages of ALL of the workers who make the goods and services
(Assembly line workers etc AND managers etc)
Overheads
• The other costs of the running of the business – eg rent, heat etc
CALCULATING LABOUR COSTS
Various records are used in the calculation of wages:
• Personnel Records
• Salaries of workers
• Time Sheets/clock cards
• No of hours worked by employee
• Job Cards
• Time spent on a job and no of units produced
• Payroll
• Record of hours worked/ pay/ deductions to date
CALCULATING LABOUR COSTS
TIME RATE• Fixed hourly rate
Cost of one unit =
Hrs worked on the cost unit x Hrly rate
EG 40 HOURS PER WEEK @ £8 PER HOUR = £320
CALCULATING LABOUR COSTS
PIECE RATE
• Workers are paid for EACH ITEM produced
No of items produced x Rate per unit
EG - A worker produces 500 items
the rate per unit is £0.50
Wage = 500 × £0.50 = £250
CALCULATING LABOUR COSTS
BONUS SCHEME
• Paid in addition to hourly rate as an incentive for meeting targets
No of items produced x Rate per unit
If production of 5000 units are exceeded then a bonus of £0.20 per unit is paid
Therefore if 6000 units are produced then the bonus will be
(6000 - 5000) × £0.20 = £200
CALCULATING LABOUR COSTS
OVERTIME PREMIUM
• Paid over and above hourly rate for extra hours worked
• Can be time and ½ or double time
EG If Hourly rate = £8 per hour
• Time and a Half = £8 × 1.5 for each hour of overtime worked
• Double Time = £8 × 2 for each overtime hour worked.
STOCK CONTROLAll forms of stock have a cost to the Business:
• Purchase price
• Storage costs e.g. warehousing costs - wages, heat and light
• Buying costs e.g. administration
• Insurance
• Pilferage (theft)/spoilage/damage
• Obsolescence - stock may go out of date and never be sold
• Opportunity Cost of the money used to buy the stock - i.e. what else could have been bought with that money
FIFOThis form of costing the direct materials used in any job values them at the same price as the OLDEST BATCH first
• Eg The first stock received into the warehouse will be the first stock to be used up
• If a stock room had
• 200 units at £5 = £1000 – received 1/1/ 12
• 200 units at £10 = £2000 – received 5/1/12
• If a job requires 300 units it will be issued 200 units @ £5 and 100 units at £10
• The cost of materials for the job would be £2000
• The balance would be 100 units at £10 = £1000
LIFOThis form of costing the direct materials used in any job values them at the same price as the NEWEST BATCH first
• Eg The most recent stock received into the warehouse will be the first stock to be used up
• If a stock room had
• 200 units at £5 = £1000 – received 1/1/ 12
• 200 units at £10 = £2000 – received 5/1/12
• If a job requires 300 units it will be issued 200 units @ £10 and 100 units at £5
• The cost for materials would be £1500
• The balance would be 100 units at £5 = £500
AVCOThis form of costing the direct materials used in any job values them at the AVERAGE PRICE of all materials available
(Existing units x p price)+(New units x p Price)
Total number of units in stock
• Eg The most recent stock received into the warehouse will be the first stock to be used up
• If a stock room had
• 200 units at £5 = £1000 – received 1/1/ 12
• 200 units at £10 = £2000 – received 5/1/12
All units in stock would be valued at £7.50(200 x £5)+(200 x £10)
400
• If a job requires 300 units it will be issued 300 units @ £7.50
• The cost for materials would be £2250
• The balance would be 100 units @ £7.50 = £750
Sample ExerciseBelow is the receipts and issues of stock for Splash Cans engineering company. Calculate the value of their stock at the 31 December 2011 using the following methods: FIFO and LIFO On 1 January 2011 the stock of Splash Cans on hand comprised of 7 cans with a total value of £96.60
SPLASH CANS
Receipts Issues10 Jan 20@ 14.00 28 February 154 April 10@ £14.00 8 May 62 June 12@ £14.30 20 July 1422 September 20@ £15.10 11 October 189 November 14@ £15.20 3 December 20
Splash Cans (FIFO)Date Receipts Issues Balance
Q Unit price Value Job no
Q Unit Price
Value Q Unit Price
Value
1/1 7 96.6013.80
10/1 20 280.0014.007 13.80 96.60
20 14.00 280.00
28/27 96.6013.80
8 14.00 112.00 12 14.00 168.00
4/4 10 140.0014.00 22 14.00 308.00
8/5 6 84.0014.00 16 14.00 224.00
2/6 12 171.6014.30 16 14.00 224.00
12 14.30 171.60
20/7 14 196.0014.00 2 14.00 28.00
12 14.30 171.60
Splash Cans (FIFO Cont)Date Receipts Issues Balance
Q Unit price Value Job no
Q Unit Price
Value Q Unit Price
Value
20/7 2 28.0014.00
12 14.30 171.60
22/9 20 302.0015.1012 14.30 171.60
11/102 28.0014.00
16 15.10 241.60
14 15.20 212.809/11 14 212.8015.20
10 15.20241.60
152.00
2 28.0014.00
20 15.10 302.00
12 171.6014.304 60.4015.10
16 15.10 241.60
3/12 16
4
15.10
60.8015.20
Splash Cans (LIFO)Date Receipts Issues Balance
Q Unit price Value Job no
Q Unit Price
Value Q Unit Price
Value
1/1 7 96.6013.80
10/1 20 280.0014.007 13.80 96.60
20 14.00 280.00
28/2
15 210.0014.00 7 13.80 96.60
5 14.00 70.00
4/4 10 140.0014.00
8/5 6 84.0014.00
9 14.00 126.00
2/6 12 171.6014.307 13.80 96.60
9 14.00 126.00
12 14.30 171.60
7 13.80 96.60
15 14.00 210.00
7 13.80 96.60
Splash Cans (LIFO Cont)Date Receipts Issues Balance
Q Unit price Value Job no
Q Unit Price
Value Q Unit Price
Value
22/9 20 302.0015.107 14.00 98.00
11/1018 271.8015.10
7 13.80 96.60
7 14.00 98.009/11 14 212.8015.20
14 15.2030.20
212.80
7 96.6013.80
20 15.10 302.00
7 96.6013.807 98.0014.00
2 15.10 30.20
3/12
2 15.10
20/712 171.6014.30
2 14.00 28.00
2/67 13.80 96.60
9 14.00 126.0012 14.30 171.60
7 13.80 96.60
7 14.00 98.00
14 15.20 212.8030.202 15.1056.004 14.00
7 13.80 96.60
3 14.00 42.00
Charles plc(AVCO)Date Receipts Issues Balance
Q Unit price Value Job no
Q Unit Price
Value Q Unit Price
Value
1/3 1000 1000.001.00
4/3 1000 1100.00
1.10 2000 1.05 2100.00
6/3600 630.001.05 1400 1.05 1470.00
8/3 600 630.001.05
15/3 1200 1800.001.50
16/3 1300 1.32 1716.00
17/3 1.71600
700 1.32 924.00
1026.00 1300 1950.00
18/3
1.50
800 1.05 840.00
2000 1.32 2640.00
1000 1000.001.00
600 900.001.50 700 1050.001.50
20/3 300 540.001.80 1000 1590.001.59
OVERHEAD (INDIRECT) COSTING
These are costs related to the general production process itself
Examples:
• Materials not used in production of cost units
• Supervisors and non production labour wages
• General manufacturing expenses – rent/ rates etc
Therefore:
• Overheads are traced back (allocated) or shared out (apportioned) to COST CENTRES (areas which created the overheads and through which jobs will pass)
• Apportionment can be on a Blanket/standard rate or Departmenatl rates.
APPORTIONMENT (Sharing Out)
Overheads are SHARED FAIRLY between the cost centres which benefit from them eg:
APPORTIONMENT
Non traceable overheads to production and service departments
Department value for basis for apportionment
Total value for basis of apportionment (eg total area)
x Total value of overhead being reapportioned
For Example
Factory Rent £100,000
Area of Dept A 40,000 m2
Area of Dept B 10,000 m2
Total Area 50,000 m2
Apportioined to Dept A = 40,000 / 50,000 x £100,000
= £80,000
Apportioined to Dept B= 10,000 / 50,000 x £100,000
= £20,000
Reapportionment
• Overheads of service depts to production departments
• Done to show the benefit each Production dept gets from the service depts
Reapportion OH of Service Depts to production Depts
Department value for basis for apportionment (eg area)
Total value for basis of apportionment (eg total area)
x Total value of service dept OH being reapportioned
For Example
Stores Overheads £90,000
Raw materials used by Dept A 10,000 units
Raw materials used by Dept B 20,000 units
Total Materials 30,000 units
Apportioined to Dept A = 10,000 / 30,000 x £90,000= £30,000
Apportioined to Dept B= 20,000 / 30,000 x £90,000= £60,000
Overhead Absorption rates
• Calculated AFTER allocation and apportionment to production depts
• Calculated in a manner which best represents the way that a job makes use of the departments resources
Dept Type Basis of Apportionment
Overhead rate
Labour Intensive Direct Labour Hours £ x labour Hour
Capital Intensive Direct Machine hours £ x per machine hour
Overhead Absorption rateTotal Dept Overheads
Total number of machine or direct labour hours
= Dept Overhead absorption rate per machine or direct labour hour (£)
For Example
Finishing Depts Overheads £100,000
Total Machine Hours 25,000 hr
Total Labour hours 5,000 hours
100,000/25,000 = £4 per machine hour
Exercise 1O/Head Cost Basis of
Apportionment
Preparation
Cooking Personnel
Total
Rent and Rates
30,000
Dep of Machinery
500
Supervision 18,000
Machine Insurance
Value of Machinery 3,500 1,750
Departmental Total
36,750
Reapportion Personnel
15,750
Total OH for Prod Dept
79,500
Overhead Absorption Rate
90,000
3,500
54,000
12,250
Area
Value of machinery
No of Employees
37,500 22,500
1,000 2,000
24,000 12,000
7,000
58,500 64,500
21,000
80,250
3.18 mach hr 4.01 lab hr
Exercise 1 Continued
Direct Materials 200 mtrs @ £10 per mtr
Direct Labour 12 hrs @ £15 per lab hr
Direct Expenses £750
Overheads 6 machine hours in preparation
8 labour hours in cooking
A profit of 25% on the cost of a job
Total cost of job
2,000.00
180.00
750.00
19.08
32.08
745.29
3726.45
Exercise 2O/Head Cost Basis of
Apportionment
Denim Cotton General Office
Total
Rates
Dep of Machinery
Insurance of buildings
Vending Machines
Departmental Total
Reapportion Personnel
Total OH for Prod Dept
Overhead Absorption Rate
10,000
30,000
4,000
10,800
Area
Value of machinery
No of Employees
4,000 1,000
12,000 14,000
2,000 400
5,400 1,800
25,00022,600
29,320
6.37 mach hr 1.47 lab hr
Value of Buildings
5,000
4,000
1,600
3,600
7,200
2,880 4,320
25,480
Exercise 2 Continued
Direct Materials 120 mtrs @ £9.20 per mtr
Direct Labour 24 hrs @ £17 per lab hr
Direct Expenses £310
Overheads 6 machine hours in denim
8 labour hours in cotton
A profit of 25% on the cost of a job
Total cost of job
1104.00
408.00
310.00
38.22
11.76
468.00
2339.98
Predetermined overhead rates
• Quite often these are set by an organisation rather than actual overhead rates.
• They are based on the average costs of average production.
BUT
• The amount charged to jobs might be too little (under absorption)
• Or it might be too much (over absorption)
Predetermined overhead rates
For Example
Budgeted overheads £200,000
Budgeted Machine hours40,000
Absorption rate per machine hour £5
Case A CaseB
Actual Overhead Incurred 200,000180,000
Actual Machine Hours worked 30,000 40,000
Overheads Absorbed 150,000 200,000
In case A there has been an under absorption of £50,000 (the budgeted machine hours were more than the actual machine hours)
In case B there has been an over absorption of £20,000 (the actual overhead incurred is less than the budgeted one)
Summary Overhead Apportionment and Absorption
1. Overheads are apportioned or allocated to each production / service dept
2. Service department overheads are then re-apportioned to the production departments
3. Appropriate overhead absorption rates are calculated
4. The overhead costs are absorbed (taken into consideration when costing a job or making a product by applying a certain rate
Summary Overhead Apportionment and Absorption
Step 1 Allocate and Apportion
Step 2 Re-Apportion
Step 3 – Calculate Absorption
Steps 4 – Absorption
Service/Operating Costing
• An estimated cost of providing services rather than products• Used by Hospitals, dental practices, lawyers etc• Estimated cost calculated over a year - in the most
appropriate units – eg hospital (patient/ days), Restaurant (meals served)
WHY• Enables comparison between cost of hiring/leasing and
owning equipment• Determines how much other cost centres should be charged
for the use of the service• Determines price for service to ensure profit • Promote efficiently – can compare prices charged between
periods
Service/Operating Costing
MacPherson Passenger Transport Ltd Operates 6 x 57 seater buses on routes in the Glasgow area. Each bus cost £40,000 and has an estimated useful life of 6 years – after which it will be sold for an estimated £4,000
Depreciation
• Cost of new bus £40,000
• Residual Balance £4,000
• Fall in value over life £36,000
• Depreciation per annum £6,000
Service/Operating Costing
a) Each bus is used for 50 weeks per annum, the anticipated annual mileage being 33,000.
b) Fuel consumption is 3 miles per litre of diesel. Each litre of diesel costs £0.80
Fuel
• Annual mileage per bus 33,000
• Miles per litre diesel 3
• Diesel required (33000/3) 11,000
• Cost of diesel (11000x0.80) £8,800
Service/Operating Costing
c) Each bus has 6 wheels. They tyres cost £250 each and are estimated to last 60,000 miles
Tyres
• Set of tyres (250 x 6) £1,500
• Portion of set per annum
(33000 (annual mileage)/ 60,000 miles x £1,500 £825
Service/Operating Costing
d) Each bus requires to be thoroughly inspected and serviced every 5,000 miles at a cost of £1,030
Inspection & Service
• Miles per annum 33,000
• Miles between inspections / services 5,000
• Inspections/services required
• (33,000 miles/ 5,000 miles) 6.6
• Annual cost (£1,030 x 6.6) £6,798
Service/Operating Costing
f) Admin Cost for the fleet of buses are estimated to be £21,000 per annum
Administration Costs
• Total cost – 6 buses 21,000
• Cost per bus (£21,000 / 6) £3,500
Service/Operating Costing
g) The firm employs 9 drivers, each of whom works a basic 40-hour week at £5.50 per hour
• Each driver has 4 weeks holiday per annum during which he/she is paid at the basic rate
• Each driver works on average 6 hours overtime per working week. All overtime is paid at time and a half
Driver’s wages
• Basic wages per driver (52 wks x 40 hrs x £5.50) £11,440
• Overtime per driver (48 wks x 6 hrs x £8.25) £2,376
• Wages per driver per annum £13,816
• Total annual wages (£13,816 x 9 drivers) £124, 344
• Driver’s wages per bus (£124,344/ 6 buses) £20,724
Service/Operating Costing
a) Total cost per bus per annum £
• Depreciation 6,000
• Fuel 8,800
• Tyres 825
• Inspection and Service 6,798
• Administration Costs 3,500
• Driver’s wages 20,724
• Licence, insurance & test 3,513
£50,160
Service/Operating Costing
b) Cost per mile £
• Total cost per bus per annum50,160
• Anticipated annual mileage33,000
• Cost per mile (50,160/33,000 miles)£1.52
c) Cost per passenger/mile (average 40 passengers)
• Total cost per bus per annum50,160
• Cost per mile1.52
• Cost per passenger/mile (£1.52/40 passengers)3.80p
Service/Operating Costing
a) Charge per passenger/mile in pence if mark up is 20%
• Cost per passenger mile
3.80
• Mark up 20% (3.80 x 0.20)
0.76
• Charge per passenger mile
£4.56
Process Costing
• Used in industries where the end product is more or less identical
• unit cost = costs of production/ number produced (over a time period)
• Units pass through a series of production stages until final completion
• Each production dept transfers its completed production to the next department where it becomes the input for further processing
• The completed item is transferred from the last department to the finished goods stock
• Costs from one department to another are cumulative
Process Costing
Normal/ Uncontrollable Loss• Losses which occur under efficient operation
conditions• These are absorbed by the production of the itemAbnormal/ Controllable Loss• Losses which are not expected to occur under
efficient operating conditions eg incorrect cutting of cloth
• These are removed from the appropriate process account• Reported separately as an abnormal loss• Treated as a cost and written off to the P&L account
Process Costing
Calculating the transfer of goods between processes• Calculate the unit cost of production (establish
expected output) eg• In a process there is an input of 1,200 gallons
costing £1• An output of 1,000 gallons is expected• Therefore normal loss for this process is 200 gallonsCost of production £1200 £1.20Expected output 1,000
Process Costing Accounting for the sale of scrap• Sometimes process losses can be sold for some small value• The resulting sales revenue should be offset against the costs
of the appropriate process• Therefore
Cost of production less scrap value of normal lossExpected output
• If the normal loss from the last example had a scrap value of 50p per unit then
£1200 - 100 £1100 £1.10 1,000 1,000
• If the production had actually only been 900 units then there would be normal loss of 200 units and abnormal loss of 100
Process Costing WORK IN PROGRESS• When a process account is drawn up there will be some
material in each process which is partly finished• This work in progress must be valued and accounted for• Work in progress consists of direct materials labour and
overheadsABNORMAL LOSSThis is unexpected loss due to carelessness, inferior material
etcAn abnormal loss account is opened and the total cost of the
abnormal loss charged to it.The units lost unexpectedly are charged at the unit price of
actual output.
Summary Process CostingStep 1 Calculate & enter input values in to the process account
Step 2 Calculate the normal loss and its scrap value & enter it into the output section of the process account
Step 3 Calculate the value of WIP &enter it into the output section of the process account
Step 4 Calculate the unit cost price of normal output
Step 5 Calculate the cost of actual output & enter it into the outputs section of the process account
Step 6 Calculate the value of abnormal loss & enter it into the outputs section of the process account
Summary Process CostingStep 7 Transfer the abnormal loss to an abnormal loss account
Step 8 Calculate the income from the sale of abnormal loss for scrap and enter it in the output section of the abnormal loss account
Step 9 Calculate the amount to be output to the profit and loss account and enter it in the output section of the abnormal loss account
Break Even
What is Break Even?
Break even is a process that shows organisations how many units they must produce and sell in order to cover their costs. It allows them to see when they start to make a profit.
What Costs are associated with Break Even?
There are three types of costs:
•Fixed Costs
•Variable Costs
•Semi Variable costs
Break Even - Costs
FIXED COSTS
Fixed Costs are costs that don’t change(constant) in relation to output. These are TIME BASED COSTS.
VARIABLE COSTS
•Variable costs are costs that change with output. These are ACTIVITY BASED COSTS
SEMI VARIABLE COST
This is a combination of a fixed cost and a variable cost.
Break Even - Costs
Total Costs
Fixed Costs and Variable Costs = Total Costs
If Sales (revenue) > than Total Costs = Profit
If Sales (revenue) < than Total Costs = Loss
If Sales (revenue) = Total Costs = Break Even Point.
Break Even Point is the level of sales where the company neither makes a profit or a loss (simply cover their costs)
Benefits Of Break Even For Managers
• The level of Break Even is important for Managers as it indicates specifically the level of output required to generate a profit
• It illustrates the returns an organisation should get at each level of output
• It clearly indicates information on a firm’s MARGIN OF SAFETY (level above Break Even)
BREAK EVEN CHART
Fixed Costs
Variable Cost
Total Cost
Output
£ Sales
50
150
100
0
10 20 30 40 50 60 70 80 90 100
BREAK EVEN CHART
Fixed Costs
Sales
Total Cost
Output
£ Sales
50
150
100
0
10 20 30 40 50 60 70 80 90 100
BEPVariable Costs
Break Even
From the chart above we can see immediately that the break even point is 50 units or At Sales Revenue equal to £100
The area above break even point is referred to as the margin of safety. This indicates to managers the level of output they can expect to drop before hitting the break even point.
Calculating Break Even
CONTRIBUTION
This is the difference between the Selling Price and the Variable Cost. The difference between what it cost to make and what you are selling it for
Contribution is that part of the Selling Price that ‘contributes’ towards paying off the Fixed Costs
Break Even Calculations
Contribution = Selling Price – Variable Cost
BEP (Units) = Fixed Costs / Contribution
Sales Revenue at BEP = (FixedCosts/Contribution)*Selling Price
Target Profit = (Fixed Costs + Target Profit)/ Contribution
Profit/Loss (units)= Total Contribution – Fixed Costs
(Total Contribution = Contribution per unit * No of units sold)
Margin of Safety (In sales) = Actual Sales output – Sales at Break even point (to convert to units divide answer by selling price per unit)
PVR (profit volume ratio) = Contribution/Selling Price * 100
Example exercise (Int 2)
Fixed Costs
Total Costs
Sales
BEP Units
BEP Sales Value
Example exercise (Int 2)a) Selling price per unit
Sales revenue / Output (better to use BE values)
£20,000/2,500 = £8
b) Variable cost per unit
Variable cost per unit = Total costs per unit – Fixed costs per unit
Variable costs per unit (use BE values) =
( 20,000 – 10,000) / 2,500 units
= £4 per unit
Example exercise (Int 2)c) Contribution per unit
Selling price per unit – Variable cost per unit
Using previous answers £8 - £4 = £4 per unit
d) Profit from 3,500 units
(Using graph) 3,500 units = Sales £28,000
3,500 units = Total costs £24.000
35,000 units – Profit = £4,000
Easier method £4 per unit contribution
Contribution x Units above break even = profit
= £4 x 1000 units = £4,000
Example exercise (Int 2)v) Sales required to make a profit of £14,000
Target Profit = (Fixed Costs + Target Profit)/ Contribution
£14,000 = (10,000 +14,000) / 4
= 24,000/4 = 6,000 units
ExampleMFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be £72,000. The labour cost is £6 per chair and the material to make each chair costs are £10. Each chair sells for £24.
You have to calculate the following:
i. Contribution per chair
ii. Break Even Point in Units
iii. Sales Revenue at Break-Even Point
iv. Number of chairs to be sold to make a profit £4000
ExampleMFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be £72,000. The labour cost is £6 per chair and the material to make each chair costs are £10. Each chair sells for £24.
You have to calculate the following:
i. Contribution per chair
Selling Price – Variable Cost = Contribution
= £24 - £16 = £8
ii. Break Even Point in Units
BEP = Fixed Costs / Contribution
£72,000 / £8 = 9,000 units
Example
MFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be £72,000. The labour cost is £6 per chair and the material to make each chair costs are £10. Each chair sells for £24.
You have to calculate the following:
iii. Sales Revenue at Break-Even Point
Sales Revenue at BEP = (FixedCosts/Contribution)*Selling Price
(£72,000 /£8 ) * 24 = £216,000 (must have £ in exam)
iv. Number of chairs to be sold to make a profit of £4000
Target Profit = (Fixed Costs + Target Profit)/ Contribution
= (£72,000 + 4,000) / £8 = 9500 chairs (must mention units in exam)
Margin of Safety The Margin of Safety is the distance between actual sales
achieved and the sales level needed to break-even. Actual Sales - Sales at Break Even Point
It can be measured in units or sales revenue terms.
A narrow margin of safety would indicate that a small fall in volume of sales might have a significant effect on profits.
A wide margin would mean that there would have to be a large fall in sales volume before the BEP was reached.
A wide margin of safety is therefore desirable if a firm is going to cope with competition and decreases in demand.
An increase in selling price could improve the margin of safety whilst an increase in fixed costs (with no corresponding changes in contribution and sales volume) would reduce the margin of safety
Total cost includes several elements which have to be added together. Marginal Costing requires that total cost be classified into fixed and variable costs.
On a Break-even Chart the total cost line is a combination of the fixed costs and the variable costs.
At nil level of activity the total costs will equal the fixed costs.
Where the total cost line intersects the sales line an angle of incidence is formed
Total Costs
• Profit in this ratio refers to contribution
• Volume refers to total sales value
• The P/V Ratio does not mean profit in relationship to sales but the contribution in relation to sales
Formula = (Contribution / Sales ) *100
• The Profit/Volume Ratio (P/V) shows the contribution as a percentage of sales.
• With higher percentage the contribution towards the fixed costs will be greater and profits will be achieved earlier
• The P/V ratio can be improved by - increased selling prices, reduced variable costs; concentrating on those products which provide the highest contribution.
Profit/Volume ratio
Assumptions of Break Even ASSUMPTION LIMITATION
There is only one product being produced.
This is likely to be the case in very few businesses.
The selling price per unit is constant throughout the range of output. (ie straight line)
It may be necessary to lower prices to achieve higher levels of output, and if output falls a business may cut prices to attract sales.
The variable cost per unit is constant throughout the range of output i.e. it is proportionate to output.
At higher outputs it may be necessary to pay overtime rates to increase production, but this may be offset to some extent by achieving quantity discounts on purchases of raw materials
Assumptions of Break Even
ASSUMPTION LIMITATION
Fixed Costs are constant (i.e. a horizontal line on the graph) throughout the production range.
Fixed costs are not fixed forever. There will for instance be a need for more machinery at very high output levels which will increase depreciation and perhaps more space will be required leading to higher rent etc in the long run
All costs can be classified as fixed or variable
There are semi-variable costs which do not behave according to the break-even model
All output is sold There will be opening and closing stocks to be taken into account in most cases.
Marginal Costing
• Marginal Costing is a decision-making tool which focuses on variable costs and variable incomes
• It ignores fixed costs
CONTRIBUTION
• The difference between the SELLING PRICE of a product and its VARIABLE COST of production
• Any product which makes a contribution is potentially worth making
CALCULATING PROFIT
• Profit = Total contribution – Fixed costs
If possible all products making a positive contribution would be produced
However there is usually a “Limiting Factor” which determines how much can be produced.
Marginal Costing LIMITING FACTOR
The factor that limits profits eg
• Skilled labour
• Machine capacity
• Raw materials
The limiting factor must be used in such a way that contribution is maximised
You must maximise contribution by
• Labour hour
• Machine Hour
• Unit of materials – eg per kilo
Product A B C D E F
Selling Price £20 £30 £25 £40 £55 £60
Materials £10 £15 £10 £15 £25 £20
Labour £5 £5 £15 £15 £15 £20
Variable OH £2 £1 £3 £5
Total Variable Cost (Mat+Labour + V OH)
Marginal Costing Exercise 1
Unit Contribution = Selling Price – Total V Cost
£20 £27 £31£15 £43 £45
£10 -£2 £9£5 £12 £15
Step 1 – Calculating Unit Contribution
If there was no limiting factor then all products except C would be made
Product A B C D E F
Selling Price £20 £30 £25 £40 £55 £60
Materials £10 £15 £10 £15 £25 £20
Labour £5 £5 £15 £15 £15 £20
Variable OH £2 £1 £3 £5
Total V Cost (Mat+Labour + V OH)
Marginal CostingStep 2 – Work out contribution according to limiting factor eg labour and prioritise - (Assume labour is paid at £5 per hour)
Unit Contribution = Selling Price – Total V Cost
£20 £27 £31£15 £43 £45
£10 -£2 £9£5 £12 £15
No of hours per product =Total labour/ hourly rate (£5)
1 - 31 3 4
Contribution per hour(Unit cont / hours per product) £10 - £3£5 £4 £3.75
Order of production based on limiting factor = Product B,A,E, F, D
Product A B CContribution £5 £10 £12
Machine hours 1 4 3
Contribution per machine hour £5 £2.5 £4
Maximum Demand 1000 2000 2000
Marginal CostingStep 3 - Calculating Production Quantities
•Assume that fixed costs are £10,000 and machine time is limited to 12,500 hours per annum
Prioritise Production Order
A then C and finally B
To Satisfy demand the firm needs (1 x 1000) + (4x2000) + (3 x 2000) =15000 hours but it only has 12,500
Product Units Hours Required
Hours Left
A
B
C
Marginal Costing (Ex 2)Step 3 – Calculating actual units produced
Make as much of C as you can
Make as much of A as you can
Hours Available12,500)
1000 11,500
6000 (Unitsx3 hrs)2000 5,500
Make as much of B as you can5,500 01375
(5500/4 hrs)
1000
Product Units Contribution per unit
Total Contribution
A 1000 £5
C 2000 £12
B 1375 £10
Total Contribution
Less Fixed Costs
£10,000
PROFIT
Marginal Costing (Ex 2)Step 4 - Calculating Maximum Profit
•Profit = contribution per unit x number of units – fixed costs
£5,000
£24,000
£13,750
£42,750
£32,750
UNIT DATA X Y
Selling price
Direct Materials
Direct Labour
Variable Overheads
ii) Unit Contribution
iii) Cont per labour hour
Exercise 3
£10 £15
£8
£40
£12
£2
£10
£18
£6
£20
a) i)Total variable cost - Product x = £20 x 5000 = £100,000
Total Variable cost – Product Y = £31 x 5000 = £155,000
£49
£4
£20 / 2 hours £18 / 3
UNIT DATA X
X =20 x 5,000
Y = 18 x 5000
Total contribution
Less fixed Costs
Total Profit
Exercise 3 continuedTotal profit (b)
£90,000
£190,000
£40,000
c) Order of production = X then Y as X has greater contribution per labour hour than Y
100,000
£150,000
Product Units Hours Required
Hours Left
X
Y
Exercise 3
d) Allocating labour hours
Make as much of X as you can
Hours Available22,000)
5000 12,000
Make as much of Y as you can12000 04000
(12000/3 hrs)
10,000
UNIT DATA X
X =20 x 5,000
Y = 18 x 4000
Total contribution
Less fixed Costs
Total Profit
Exercise 3 continuedNew profit (e)
£72,000
£172,000
£22,000
Change in profit = £40,000 - £22,000 = £18,000
100,000
£150,000
Marginal Costing MINIMUM PRODUCT REQUIREMENT• There may sometimes be a complication which restricts the
ability to produce the amount of goods in the quantity that will give maximum profits
• For example if it is management policy not to produce fewer than x amount of your last ranking product
If this is the case:• Redo the production order ensuring that at least the
minimum amount of the least profitable product is produced
BE CAREFUL - IT IS NOT SIMPLY A STRAIGHT SWAP!
Marginal Costing MINIMUM PRODUCT REQUIREMENT• There may sometimes be a complication which restricts the
ability to produce the amount of goods in the quantity that will give maximum profits
• For example if it is management policy not to produce fewer than x amount of your last ranking product
If this is the case:• Redo the production order ensuring that at least the
minimum amount of the least profitable product is produced
BE CAREFUL - IT IS NOT SIMPLY A STRAIGHT SWAP!
Unit Data 1 2 3
Contribution in units £10 £20 £30
Kilos per unit 5 4 10
Annual Demand 800 1000 1000
Contribution per kilo £2 £5 £3
Marginal CostingExample – Limiting factor only - 15000 kilos
Rank Units Kilos Left
2 1000 4000 11000
3 1000 10000 1000
1 200 1000 0
Product Units Unit cont Total
1 200 £10 £2000
2 1000 £20 £20000
3 1000 £30 £30000
Total Cont 52,000
- F Cost 12,000
Profit 40,000
Unit Data 1 2 3
Contribution in units £10 £20 £30
Kilos per unit 5 4 10
Annual Demand 800 1000 1000
Contribution per kilo £2 £5 £3
Marginal Costing
Example – Limiting factor 15000 kilos (at least 250 of each product)
Method – Redo production schedule starting with the need to produce 250 of P1
P Units Kilos Left Cont
Cont
- FC 12000
Profit
1 250 1250 13750 £2500
2 1000 4000 9750 £20000
3 975 9750 0 £29250
£51750
£39750
MARGINAL COSTING - SUMMARY Focuses on variable costs and variable incomes. Step 1 - work out the contribution per unit.Contribution = unit selling price - unit variable cost. Step 2 – work out the contribution per unit of limiting factor eg (machine or labour hours or kilos, £s or units of raw material) Step 3 – work out production order – highest contribution firstStep 4 – take account of any complication – eg redo production order to take account of any contractual obligations or company policyStep 5 – Work out total contribution and then deduct total fixed costs to give Profit
NOTE – IF FIXED COSTS ARE GIVEN IGNORE THEM WHEN CALCULATING CONTRIBUTION
Introducing a new product
When introducing a new product you need to:
1.Work out its unit contribution to see if it is viable or not (anything with a negative contribution will not be worth making)2.calculate its contribution per limiting factor and then place it in the production order in the appropriate place3.Recalculate how many of each product you can make4.Calculate the total contribution 5.If asked to find the Total Profit you must deduct the fixed costs
Introducing a new product - Example Exercise
A business is working at full capacity and a new product is being considered. for example:
Current production: •5000 units of A earning a contribution of £20 in 2 machine hours,•4000 units of B earning a contribution of £15 in 3 machine hours,•2000 units of C earning a contribution of £20 in 5 machine hours.
Unit Data A B C
Contribution in units £20 £15 £20
Labour hours per unit 2 3 5
Annual Demand 5000 4000 2000
Contribution per hour £10 £5 £4
Introducing a new product - Example Exercise
• Order of production before new product A, B Ca) Total Contribution before new product = (5000 * £20)
+ (4000 *£15) + (2000 * £20) =£200,000b) Total number of hours being used before new product
= 32000 (A 10,000 + B 12,000 + C 10,000)c) Capacity = 32000 (The first line of the exercise tells
you they are working at full capacity)
• Put information into order
Introducing a new product - Example Exercise
A new product Z is being considered. Z has a selling price of £60, a variable cost of48 (including 2 machine hours). Demand for Z is 1000 units. d) Calculate the contribution per hour for product Z
Selling price – Variable cost per unit = £60 - £48 = £12
Unit Data A B C Z
Contribution in units £20 £15 £20 £12
Labour hours per unit 2 3 5 2
Annual Demand 5000 4000 2000 1000
Contribution per hour £10 £5 £4 £6
Introducing a new product - Example Exercise
e) Decide the order of production• New order of production A, Z, B, C
• Organise Product Z’s data
Introducing a new product - Example Exercise
Pr Units Hrs Left Cont
A
Z
B
C
Unit Data A B C Z
Contribution in units £20 £15 £20 £12
Labour hours per unit 2 3 5 £2
Annual Demand 5000 4000 2000 1000
Contribution per hour £10 £5 £4 £6
f) New total contribution at full capacity (32,000 hours)
100005000
1000
22000
200002000
1600 8000
4000 800012000
0
No of units x Unit contribution
£100,000
£12,000
£60,000
£32,000
£204,000
Introducing a new product - Example Exercise
Pr Units Hrs Left Cont
A
Z
B
C
Unit Data A B C Z
Contribution in units £20 £15 £20 £12
Labour hours per unit 2 3 5 £2
Annual Demand 5000 4000 2000 1000
Contribution per hour £10 £5 £4 £6
g)Maximum contribution at 30,000 hours
20000
18000
1200 6000
6000
0
No of units x Unit contribution
100005000
1000 2000
4000 12000
£100,000
£12,000
£60,000
£24,000
£196,000
Introducing a new product - Example Exercise
Pr Units Hrs Left Contribution
A 5000 10000 20000 £100,000
C
Z
B
Unit Data A B C Z
Contribution in units £20 £15 £12
Labour hours per unit 2 3 5 2
Annual Demand 5000 4000 1000
Contribution per hour £10 £5 £6
New Production Order
h)Maximum contribution if Price of C rises by £15 and demand falls to 1500 – 30,000 hours available
£35
1500
1 4 2 3£7
75001500 12500 £52,500
105003500 0 £52,500
20001000 10500 £12,000
£217,000
MARGINAL COSTING – SPECIAL ORDERS
This is where a customer offers to buy the product at less than its normal selling priceREJECT IFThe firm is already working at full capacityACCEPT IFThere is spare capacity and the item still makes a contribution at the lower price
MARGINAL COSTING – SPECIAL ORDERS ExampleA firm is working at 80% capacity and is producing 20,000
units per annum. Unit informationSelling price £10Materials £2Labour £2Variable Exp £2Fixed Costs £2
Should a special order of 2,000 units at £8 each be accepted
Is the capacity there Yes 20,000 is 80% so full capacity is 25,000Is there a contribution at the new price?Yes SP (£8) – VC (£6) = Cont (£2)
If the offer is accepted, Contribution, and hence profit will increase by 2000 (no of units) x £2 (Cont per unit )
MARGINAL COSTING – SPECIAL ORDERS The following data applies to the production and sale of 2,000 units of
product M
£
Sales 20,000
Materials 6,000
Labour 4,000
Variable Cost 2,000
Fixed Costs 3,000
Total cost 15,000
Profit £5,000
Unit cost
£10.00
£3.00
£2.00
£1.00
£1.50
a) SP (£10) – VC(£6) = Contribution per unit (£4)
MARGINAL COSTING – SPECIAL ORDERS
Unit cost
Selling Price £10.00
Material £3.00
Labour £2.00
Variable OH £1.00
Fixed Costs £1.50
SP (£10) – VC(£6) = Contribution per unit (£4)
Capacity is currently at 80% and an order is received for 400 units at £7 each
b) Does the firm have enough spare capacity to produce the extra order Yes 2,000 is 80% so full capacity is 2,500
c) Is there a contribution at the new price?Yes SP (£7) – VC (£6) = Cont (£1)
d) By how much will profit change if the order is acceptedIncrease by extra units(400) x Unit Cont (£1) = £400
MARGINAL COSTING – SPECIAL ORDERS
Unit cost
New Selling Price £7.50
Material £3.00
Labour £2.00
Variable OH £1.00
Fixed Costs £1.50
A second order for 150 units at a price of £7.50 is also being considered
e) Calculate the total contribution from this order. SP (£7.50) – VC (£6) = £1.50 contribution
f) Should this order be accepted?No – accepting both orders will take you over capacity and the last order will bring you in more profit (£400) than this one (£225)
MARGINAL COSTING – Make or Buy Decisions
OPPORTUNITY COSTThe opportunity cost of an item can be described as the cost of what you give up to produce it.
Example – a business working at full capacity (so time is a limiting factor) makes Product Z , which earns a contribution of £20. It takes 2 hours to produce and therefore makes a contribution of £10 per hour
If it then decides to do something else then one of the “costs” of that “something else” must be the fact that it is no longer earning £10 per hour from making Z
MARGINAL COSTING – Make or Buy Decisions
OPPORTUNITY COSTAnother example of opportunity cost would be a business making a product which contains a component and it is considering purchasing the component instead of making it.
RULES TO REMEMBERIf the firm has spare capacity it is pointless purchasing it if you can make it cheaper
However if there is no spare capacity then the time saved by not making one component could be used to earn more contributions making another
MARGINAL COSTING – Make or Buy Decisions
Data for Product X – working at full capacity
Selling Price £50
Materials £10
Part Y £10
Labour (2 hours) £16
Contribution £14
• It is currently making £7 per hour contribution
• (£50 (SP) - £36 (VC) = £14 per unit
• Each unit takes 2 hours so contribution = £7 per hour
• Part Y can be purchased from outside for £12• The time saved making Part Y can be used to earn more contributions
making the rest of the product• Therefore (assuming Part Y takes ½ an hour to produce) the true cost of
Part Y is £10 PLUS £3.50 (½ of the £7 per hour contribution for product x) in lost contributions = £13.50
• The company should therefore purchase the component from an outside supplier as they supply it for £12
MARGINAL COSTING – May or Buy Decisions
Example Exercise 2• Tango requires 10 hours to produce and sells for £50. • It has a marginal cost of £20 (variable cost)• Samba could also be made. It takes 4 hours at a marginal /variable
cost of £15. A supplier has offered to make it for £ 20a) Should it be bought or manufactured if there is surplus capacity?
Manufactured b) Should it be bought or manufactured without surplus capacity • If Samba is bought in then the hours saved making it can be used to
make more of Tango • Opportunity cost = 4hours (time saved per Unit of samba) x £3
( hourly contribution for Tango) = £12• True cost of producing Samba therefore is £15 + £12 = £27
Therefore it should be purchased from outside for £20
Contribution Tango - £50 - £20 = £30Hourly contribution = £30 / 10 hours = £3
MARGINAL COSTING – May or Buy Decisions
Example Exercise 3• Component X requires 3 hours to produce and makes a unit
contribution of £4.50. (Hourly cont £4.50/3 hours = £1.50 per hour)• Component Y could also be made. It takes 4 hours at a marginal
cost of £ £15.• A supplier has offered to make it for £ 22.
a)Should it be bought or manufactured if there is surplus capacity? Manufactured
b): Should it be bought or manufactured without surplus capacity • If Component Y is bought in then the spare hours can be used to
make more of Component X• Opportunity cost = 4hours (time saved per Unit from Component
Y) x £1.50 (hourly contribution for Component X= £6• True cost of producing Component Y therefore is £15 + £6 = £21• Therefore it should NOT be purchased from outside as it costs
more than the cost of manufacture + the opportunity cost
MARGINAL COSTING – Make or Buy Decisions(Opportunity Cost)
Turra Builders is working at full capacity making garden sheds. The following data applies to each shed.Selling Price £400 Direct labour 4 hours @ £7 = £28 hrsMaterials £192Turra builders have been offered a contract at a price of £9000Details are - Labour required – 80 hours @ £7 and Materials £5,200
a)Calculate contribution currently being earned per hour from garden sheds. Contribution per unit = SP (£400) – VC (£220) = £180
Contribution per hour = £180/4 hours = £45
b) Calculate additional profit or loss if the contract is accepted.Money earned from new contract £9,000
Variable costs – Labour 80 hours x £7 = £560Materials £5200
£5,760+ Opportunity cost lost from sheds £3,600 (£45 x 80 hours)
£9,360Therefore a loss of £360 will be made if this contract is accepted
MARGINAL COSTING – Make or Buy Decisions(Opportunity Cost)
The following applies to product Z which is being produced at full capacity.Selling Price £50 Materials £20Labour 2hours £10 Variable overheads £2Fixed costs £3(Contribution = 50 – 32 = £18 / 2 hours = £9 per hour)An order has been received for a batch of a similar product. The order is worth £800 and can be produced at a total variable cost of £700 in 10 hours
a) Calculate the increase or decrease in profits if the order is accepted. Money earned from new contract £800Variable costs £700 Opportunity cost lost from Z £90 (£9 x 10 hours)
790Therefore an increase of £10 will be made
MARGINAL COSTING – Retain or Close
• Marginal costing can be used to help a business to decide whether to keep or drop a product/department which appears to be making a loss or to keep a factory open when it is losing money
• If a department/ product is making a loss the management should aim to reduce this loss
• When making a decision they must decide• Whether another product can be made instead to increase
contribution• Whether to close the department and sell the assets to raise
money for other departments• Whether the product making a loss is connected to other
products and if discontinued will affect their sales• They must also look closely at what will happen to fixed costs
MARGINAL COSTING RETAIN OR CLOSE A DEPT/PRODUCT
Product A B C TOTAL
£000 £000 £000 £000
Sales 100 60 40 200
Variable costs 70 40 35 145
Fixed Cost 12 12 12 36
Total Cost 82 52 47 181
Profit/Loss18 8 -7 19
The management wishes to stop producing any loss making product. However if C is no longer produced, it might at first seem that there would be a saving of £7,000,but this is not necessarily the case. The firm’s total fixed cost bill is £36,000.It will still be £36,000 if C if not produced. If it is not being charged to C, it will have to be charged to A and B.
MARGINAL COSTING RETAIN OR CLOSE A DEPT/PRODUCT
The overall profitability has fallen from £19,000 to £14,000, i.e. by £5,000 because there is no longer a contribution of £5,000 from CIf, however, you are told that as a result of not making C there will be a reduction in fixed costs of £8,000 (because, for example, part of the premises will no longer be used) this would have to be taken into account.E.g. If C is not produced - lose £5,000 contribution, save £8,000 in fixed cost, overall gain £3,000, so C should not be produced..
MARGINAL COSTING RETAIN OR CLOSE A DEPT/PRODUCT
A firm has 3 branches, Aberdeen, Edinburgh and Glasgow.Details are as follows:
A E G
£000s £000s £000s
Sales 300 200 100
Variable cost 210 150 80
Fixed Cost 40 30 24
Management policy is to close any non-profitable branch.This will result in the fixed costs of that branch being reduced by 50%. (i.e. although the branch is closed there will still be some fixed costs to pay e.g. security/rent/insurance.)Calculate the effect on total profits of implementing this policy
Profit 50 20 -4
A E
£000 £000
300 200
210 150
46 36
44 14
MARGINAL COSTING PROFIT PLANNING
• Where a number of different options are possible chose the one which maximises total contribution
• In some instances it will be necessary also to take into account any changes in total fixed costs e.g. a reduction in fixed costs has the same effect as if it were additional contributions
MARGINAL COSTING PROFIT PLANNING
Example• Smith & Sons is working at less than full capacity making and selling a
product which has a contribution of £5 per unit.• Annual sales are 10,000 units.• Fixed costs are £20,000• The Production Manager wants to purchase a new machine which will
cut variable costs per unit by £1, but it will add £5,000 per annum to fixed cost.
• Calculate the effect on profits of accepting this suggestion.METHOD Calculate contributions & profit for both situations
Present total contribution
Present Profit
New Contribution
New Profit
Accept/ Reject
10,000 units x £550,000
Cont – Fixed Cost20,000
10,000 units x £660,000Cont – Fixed Cost35,000
Accept
Limitations of Financial Accounting system alone
• It is historical i.e. it is out of date therefore it is too late to change anything now for that time of year!
• It is in total form (e.g. the total profit earned by the whole business last year). This - doesn’t say anything about the success of individual products
• Layout is dictated by outsiders e.g. FRS – lacks detail• Does not apply to areas of responsibility - the Production
Manager, for example, does not know what cost levels are expected to be achieved in the factory.
Duties of a Management Accountant
• Collecting detailed information on costs and preparing
cost/profit statements
• Providing relevant information for decision making
• Planning and target setting
• Monitoring Performance
Aims of Managerial Accounting
• Provides information that will help management decision
making and control on a day to day basis
• To provide information regarding REVENUE and COSTS
of goods or services that the company provides (COST
UNITS)
Documents Produced
• Cost, revenue and profit statements
• Budgets
• Variance Analysis
• Breakeven analysis
Revenue
• Money that an organisation receives from the sale of its
goods or services
• One item is known as a COST UNIT
• Revenue for ONE cost unit = the selling price
• Total revenue = Selling price per unit x No of units sold
Classification of costsManufacturing
• Raw materials, labour and overhead costs specifically incurred in the
production of the organisations COST UNITS
Direct
• Can be traced to a specific cost unit
Indirect
• Cannot be traced to a specific cost unit
• They are general costs necessary for all production to take place (eg rent of
factory)
Non Manufacturing
• Raw materials, labour and overhead costs that are NOT related in any
way to the manufacture of the organisations COST UNITS
• Costs for the sale of the organisations goods and services and
administration
Behaviour of costsFIXED COSTS
• Will not vary with output
• Will however change over time
• Examples – rent, rates, depreciation
Fixed costs
Quantity Produced
C
O
S
T
Behaviour of costsVARIABLE COSTS
• Will vary with output
• The more units produced the higher the cost
• Examples – direct labour, raw materials,
VARIABLE COSTS
Quantity Produced
C
O
S
T
0
Cost Systems
JOB COSTING
• Used to calculate manufacturing costs when the organisation
is making different product for different customers
• Where each job is different
• Used by Contractors, builders, engineers
PROCESS COSTING
• Used to calculate manufacturing costs when the organisation
is making the same product in one continuous process
• Used by chemical or textile manufacturers
Cost Systems
MARGINAL COSTING (VARIABLE COSTING)
• Used to calculate manufacturing costs without taking
account of the impact of FIXED OVERHEADS on unit
costs
ABSORPTION COSTING (TOTAL COSTING)
• Used to calculate manufacturing costs by examining ALL
relevant costs (including FIXED OVERHEADS)
Cost Systems
CONTRACT COSTING
• Used to calculate manufacturing costs for a company who
manufactures one large long term project.
• Eg – ship builders
• STANDARD COSTING
• Sets predetermined cost levels and analyses any differences
COSTS1. Raw materials2. Labour3. Overheads
Manufacturing Costs
1. Direct2. IndirectCan be:1. Fixed2. Variable3. Semi Variable
Non Manufacturing Costs
Can be:1. Fixed2. Variable3. Semi Variable
Analysed throughJob Costing Con tract CostingProcess Costing Marginal Costing
Absorption Costing Standard Costing
DOCUMENTS
PURCHASES
DEPT
SUPPLIER
SUPPLIER
PURCHASE REQUISITIONRequest from Departments for goods
STOCK RECORD CARD/BINRecords the quantity of stock as it changes
STOCK LEDGER CARDRecords the value of stock as it changes
LETTER OF ENQUIRYSent to potential suppliers
QUOTATIONSReturned by potential suppliers
ORDERSent to chosen suppliers
GOODS RECEIVED NOTESent with the goods and checked
BUDGETS
Detailed plans of action for the future which
• Improve efficiency through
• Co-ordination (areas working together and in the same manner)
• Better communication between areas
• Providing targets which
• Motivate staff
• Allows assessment
• Aid Control by
• Providing information about financial performance of specific areas of the business
CASH BUDGET
The cash budget is divided into 4 areas
1. Opening balance – bank balance at start of year2. Add income – ALL monies ACTUALLY received during the
month – (Sale of assets, income from sales etc)3. Less Expenditure – ALL monies ACTUALLY spent during the
month – (eg payments to creditors, purchase of assets, bill payments, wages etc)
4. Closing balance = (opening balance + Total receipts) – Total Payments
THE CLOSING BALANCE FOR ONE YEAR WILL BECOME THE OPENING BALANCE FOR THE NEXT
CASH BUDGET EXERCISE 1SCUFFERS PLC
June July Aug Sept Oct
Sales (Units)
Unit Data
10,000 15,000 10,000 7,000 5,000
Production (Units)
17,000 12,000 8,500 6,000 5,000
Selling Price
Raw material costDirect Wages
Variable Prod OH
£20
£9
£5
£2
August September October
Opening Bank Balance
Receipts
Payments
Total Payments
Closing Bank Balance
18,000
Credit Sales
Sale of Equipment
300,000 200,000 140,000
18,000
Total Receipts
Raw Materials 153,000 108,000 76,500
Direct Wages 42,500 30,000 25,000
Variable Production OHs 24,000 17,000 12,000
Fixed Costs 18,000 18,000 18,000
Equipment 60,000 12,000
Loan 25,000
237,500
80,500
80,500
258,000
40,500
40,500
300,000 218,000 140,000
143,500
37,000
Money for July Received in Aug)
= 15,000 (Units) x £20 (S Price)
(Production Units x Raw materials) – 2 months later
= 17,000 (Units) x £9 (Unit cost)
CASH BUDGET EXERCISE 2Kids Palace plc
Feb Mar Apr May
Unit Data £
260 300 340 360
Production (Units)
1200 1400 1800 1700
Credit Sales
Cash Sales (-10%)Raw Materials
Direct Wages
50
45
15
10
1040 1200 1360 1440
5 If sales over 1500 unitsCommission
Credit Sales Units
Cash Sales Units
Kids Palace plc March April May
Opening Bank Balance
Receipts
Total Receipts
Payments
Total Payments
Closing Bank Balance
10750
Cash Sales
Credit Sales
13500 15300 16200
52000
Loan
Raw Materials 18000 21000 27000
Direct Wages 14000 18000 17000
Commission 1000 1500
£49250
49250
£84550
84550
70500 75300 124200
£163750
60000 68000
5000
Share Issue 40000
32000 40000 45000
Exercise 7 Higher
The following budgeted data relate to the manufacturing firm Components 4U Plc for the period June to October Year
June July Aug Sept OctSales in Units 6,000 7,000 8,000 9,000 10,000
Closing stock at the end of each month is equal to the level of credit sales of the following month. Credit sales are 20% of total sales. Prepare the Production Budget for the period June to September
PRODUCTION BUDGETA Production budget calculates how many units are available for sale each month and must include stock at the beginning and production per month
Exercise 7 Higher
Step 1 – Calculate cash and credit unit sales for each month
Credit sales are 20% of total sales therefore
Sales
June July Aug Sept Oct
Cash Sales
Credit Sales (20%)
Total Sales
4,800
1,200
6,000
5,600
1,400
7,000
6,400
1,600
8,000
7,200
1,800
9,000
8,000
2,000
10,000
Exercise 7 HigherStep 2 Work out stock figures (Needed for production budget)
• Closing stock at the end of each month is equal to the level of credit sales of the following month
• Therefore the closing stock for June is equal to the credit sales of July and so on
Sales
June July Aug Sept Oct
Credit Sales 1,200 1,400 1,600 1,800 2,000
Closing Stock
Opening Stock
1,600 1,800 2,000
The closing stock for one month becomes the opening stock for the next month
1,600 1,800 2,000
1,400
1,200 1,400
So in fact the opening stock for each month is equal to the credit sales for that month – ie June’s Opening stock will be 1200 units
June July Aug Sept
Exercise 7 HigherStep 3 Work out production units
• You know that • Opening stock + production units - sales = Closing stock• So production units = closing stock + sales – Opening stock
1600 1800 20001400Closing Stock
+ Sales (units)
7000 8000 90006000
1600 18001200 1400-opening stock
Production Units
8200 92006200 7200
Exercise 7 HigherStep 4 Create production budget
Opening Stock
1600 18001200 1400
Production Units
8200 92006200 7200
Available for Sale
9800 110007400 8600
Exercise 8 Higher - Crownpoint
Step 1 – Calculate cash and credit unit sales for each monthCredit sales already given
Step 2 Work out stock figures (Needed for production budget)• The closing stock for each month is maintained at 20% of the cash sales for
the following month• Cash sales for Jan year 3 are estimated at 2000 units
July Aug Sep Oct Nov Dec
Cash Sales 1,300 1,400 1,500 1,600 1,700 1,800
Closing Stock
Opening Stock
280 300 340 400360320
260 280 320 360340300
Exercise 8 HigherStep 3 Work out production units
• You know that • Opening stock + production units - sales = Closing stock• So production units = closing stock + sales – Opening stock
July Aug Sep Oct Nov Dec
Closing Stock
+ Cash Sales
+ Credit Sales
-Opening Stock
Production Units
320 340 360300280 400
1,500 1,600 1,7001,4001,300 1,800
8,300 5,600 4,8007,4006,500 7,500
300 320 340280260 360
9,820 7,220 6,5208,8207,820 9,340
Exercise 8 HigherStep 4 Create production budget
July Aug Sep Oct Nov Dec
Opening Stock
+ Production
- Cash Sales
- Credit Sales
Closing Stock 320 340 360300280 400
1,500 1,600 1,7001,4001,300 1,800
10,120 7,540 6,8609,1008,080 9,700
300 320 340280260 360
9,820 7,220 6,5208,8207,820 9,340
8,300 5,600 4,8007,4006,500 7,500