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FRAME DETAIL

RGAB 2006

BASIC COST ACOUNTING

R. G. A. BOLAND AND J. A. FEATHERS

ACCOUNTING

STEP BY STEP

Four-hour programmes

of self-instruction in accounting

Accounting Step by Step

1.Accounting Reports

2.Debit and Credit

3.Basic Cost Accounting

4.Budgetary Control

Accounting Step by Step, Volume 3

BASIC COST ACCOUNTING

R. G. A. BOLAND

Fellow of the Institute of Chartered Accountants

J. A. FEATHERS

Fellow of the Association of Certified Accountants

Fellow of The Institute of Cost and Management Accountants

ISBN 0 340 04504 3

Copyright © RGAB 2006

All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system, without permission in writing.

The figures in this book are fictitious and do not relate to any particular company or business.

HOW TO USE THIS PROGRAMME

introduction

This is an experimental programme in applying a new technique to the problems of learning accounting. The authors would appreciate comments from both teachers and others who use the programme, to improve the design of later editions.

purpose of the programme

The programme enables you to teach yourself very rapidly the language and basic concepts of cost accounting. It is a programme of instruction which leads you to an understanding of what cost of instruction which leads you to an understanding of what cost accounting reports can and cannot tell you about a business. It is not a textbook, but an aid to the understanding of existing textbooks.

The programme leads you from simple to complex ideas in a gradual fashion. If you are unfamiliar with accounting you will not be able to understand the later parts of the book until you have understood what comes before. The programme is like a ladder and the parts of the programme are like the rungs in a ladder. You cannot reach the top rung of a ladder unless you have first used all the lower rungs. If there are several rungs missing in the ladder, it is not only very difficult to reach the top, but the ladder also becomes unstable. The same things apply to your knowledge of accounting.

contents

This book is divided into five chapters. Chapter I is a brief introduction. Chapters II-V comprise the main programme which is a series of “sets”. In each set, there are ten to sixty “frames” which systematically present new knowledge and also demand from you written answers.

The main programme is followed by a quiz designed to test the knowledge you have acquired. There is also a brief glossary of cost accounting language.

technique

The following technique is used in writing the programme:

1.The number of words needed for a correct response is indicated by the number of dotted lines (................................................).

2.An acceptable answer to a frame is the correct answer, shown, or any reasonable synonym. You are the judge.

3.Answers that require an amount of money are indicated in the frame by “£................” and not by the normal “................”.

accounting step by step routine

routine

The routine for the, student to follow in using the programme is as follows:

1.Read the summary of the set. If you already understand all the words pass on to the next set. If not, do the set.

2.Read each frame and refer to the appropriate exhibit each time.

3.Write your response in the book or on a separate sheet.

4.Check your response with the correct answer which is one frame down. Do not wait until the end, check each answer separately.

5.If your answer is the same as the correct answer or is any reasonable synonym, mark it with a tick and go on to the next frame.

6.If the answer is not correct, read the frame again, write the answer to the frame correctly, and then go on to the next frame.

7.At the end of the set, read the summary of the set again. Count the number of correct answers you have made. If you have 80% correct, move to the next set. If you have less than 80% correct, do the set again.

writing the answers

Writing the answers is essential to the learning process. The answer must be written before you look at the correct solution. If you glance ahead you will lose half of the value of the programme. (However, a little intelligent cheating can be educational!)

sequence

Each frame must be answered in turn. The sequence has been carefully designed to introduce new knowledge and to reinforce old knowledge. Do not skip frames. Any apparent repetitions are there for a good reason. Avoid careless answers. If you begin to make mistakes because you are tired, and have not read the text carefully, take a rest. If you continually miss one particular point, go back to the set in which it first appeared and do that set again.

And now read quickly

through Chapter I:

“Introduction to Cost Accounting”

CONTENTS

HOW TO USE THIS PROGRAMMEvii

Chapter IIntroduction to Cost Accounting9

Chapter IIMeaning of Cost13

Set 1Calculating the cost13

Set 2Organization, objectives and methods21

Set 3Direct and indirect costs33

Set 4Cost estimates and selling prices47

Chapter IIIManufacturing Overhead57

Set 5Cost centres57

Set 6Cash and credit73

Chapter IVCosting Methods83

Set 7Contract, job and batch costing83

Set 8Output costing93

Set 9Process costing99

Chapter VInterpretation of Cost Data107

Set 10Cost statements107

Set 11Relevant costs123

QUIZA Test of Knowledge acquired from

the Programme136

FOR THE TEACHER151

ANSWERS TO THE QUIZ152

GLOSSARY OF COST ACCOUNTING

LANGUAGE153

PROGRESS WORK SHEET

chapter/set

estimated

time

(minutes)

actual

time

(minutes)

total of

frames(

in error

frame no.

of each

error

Chapter I

20

chapter II

Set 1

Set 2

Set 3

Set 4

20

20

20

20

Chapter III

Set 5

Set 6

25

15

Chapter IV

Set 7

Set 8

Set 9

10

10

10

Chapter V

Set 10

Set 11

20

20

Quiz

30

Total time

240

Note: The authors would be pleased to receive the information outlined above and other comments from any serious student who is interested in research into the effectiveness of programmed learning.

(One error in a frame is treated as a frame in error.

Chapter I

INTRODUCTION TO COST ACCOUNTING

Estimated time 10 minutes (twice) (Read at beginning and end of the programme)

Read quickly through the following paragraphs. Do not study them in detail until you have completed the whole programme.

Accounting Language

Accounting has been called the language of business and, like any language, it can never express our thoughts with absolute precision and clarity. Our task of learning this language is complicated by the fact that many of the words used in accounting mean almost, but not quite, the same as they mean in every-day life. You must learn not to think of the words in their popular meaning. In this programme we have used a standard set of accounting terms, although certain other terms are also commonly used in practice. However, frequent repetition and writing of the standard accounting terms reinforces your basic grasp of the accounting language.

Rules and principles

In any language there are some rules of principles that are definite and some others that are not definite. The latter are a matter of opinion or style. Accountants have different opinions just as grammarians have different opinions. As language changes to meet the needs of communication in a society, so accounting changes to meet the needs of business.

Uncertainty

Accounting encompasses the facts about a business that can be expressed in money. However, many important business facts, i.e. the health of management, the morale of the workers, the state of the market, etc., cannot be expressed in money. Accounting must necessarily therefore provide only a limited picture of a business.

accounting step by step routine

Consistency and Comparability

Accounting figures became significant, not in themselves, but when they are compared with other figures for a similar previous period, with a budget estimate, or even with figures for another business.

The accountant, therefore, despite the problems of uncertainty, tries to be consistent in his judgment so that the figures he produces are comparable.

Financial Accounting

Financial accounting generally relates to the records, and to the concepts necessary to prepare balance sheets and income statements (profit and loss accounts) showing a true and fair overall position of a business.

Cost Accounting

Cost accounting is concerned not with the overall results of the business but with the efficiency of the various sections of the business and with the cost of a unit of production. The cost is not in not a scientific fact but depends upon the judgment of the cost accountant. This book shows how the cost of a unit of production may be calculated and the key assumptions underlying this calculation. You should therefore appreciate not only the advantages of cost accounting but also some of its limitations

Actual and Standard Costs

The programme deals with historical or actual cost accounting. A separate programme will deal with the technique of standard cost accounting. The latter involves the setting of standards as measures of performance against which to measure actual cost and efficiency of operations in terms of variances of price, quantity and volume.

Language

In the programme we have used a simple set of standard words in place of highly technical terms. The glossary at the end of the book defines each word used in the book and other words used in practice.

Now start the detailed programme

at chapter II Set 1.

10

Chapter ii

MEANING OF COST

Set 1 CALCULATING THE COST

Estimated time 20 minutes

SUMMARY

In financial accounting we compute for an accounting period the sales, cost and profit for the whole business. However, in cost accounting we analyse costs and compute the cost of each unit of production.

Cost depends upon the judgment of the cost accountant in each situation.

The cost of a product purchased for resale, is the price we pay. But if we buy material to make a product for resale, then the cost of the product includes the material, labour and overhead.

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.

If we buy goods for £4 and sell half of them for £6, our profit to date is £4 (provided the goods left over are still worth £2).

Chapter ii

MEANING OF COST

Set 1 CALCULATING THE COST

Exhibit 1 Financial Accounting Report

INCOME STATEMENT

Year ended December 31, Year 1

£

Sales

120

Less Costs

100*

Profit

20

* Relates to four different products produced and sold during the year.

frame detail

correct answers

1 In financial accounting we compute the sales, costs, and profit for all products. However, in cost .......... we compute the cost for each .......... separately.

Now check your answer with the correct answer in the frame below. Tick it if correct

2 Now read Exhibit 1 which is an income statement or profit and loss account for an accounting period of .......... year.

accounting

product

3 It shows total sales and costs during the year, and a figure of total .......... for the year of £20.

one

4 The statement that indicates the total sales, costs and profit for an accounting period is called a .......... and .......... account or .......... statement.

profit

5 In Exhibit 1 the income statement shows the sales, cost, and profit for .......... (how many?) different products produced and sold during the period. Does it show the cost of each product? For this we need not financial accounting but .......... accounting

profit

loss

income

6 If we only make 4 identical units of the same product for £100, the cost of one unit may easily be calculated by dividing the total cost by .......... Thus the cost per unit is £..........

four

no

cost

7 However, if we make four different products we .......... (can, cannot) divide the total cost by the total quantity of the output to get the cost of one product. What do we need?

4

£25

8 If we purchase goods for resale the cost is the purchase .......... that we pay for the goods.

cannot

cost accounting

15

Chapter ii Set 1

CALCULATING THE COST

Exhibit 2 Cost of one product: Product X

£

Material 3 tons @ £5 per ton

15

Labour 5 hours @ £1 per hour

5

20

Overhead 5 hours @ £2 per hour

10

Total cost

30

frame detail

correct answers

9 However, if we buy raw material and manufacture a product, then to the cost of raw material, we must add the cost of manufacture to get the total .......... of the product.

price

10 Read Exhibit 2 relating to .......... (how many) product. It shows the computation of the total cost of product X as £..........

cost

11 To manufacture the product we used .......... tons of raw material at £5 per ton for a total material cost of £..........; similarly we used 5 hours of labour at £.......... per hour for a total labour cost of £ ..........

one

£30

12 Is the cost of labour and material the total cost of product X?

3 tons

£15

£1

£5

13 To arrive at total cost we must add £10 for .......... This overhead cost is an estimate based upon .......... hours at £2 per hour.

no

14 The overhead cost appropriate to a particular product is always an estimate. Therefore the total product cost must also always be an .......... It must depend upon the judgment of the .......... accountant.

overhead

5

17

Chapter ii Set 1

CALCULATING THE COST

Exhibit 3 Importance of the cost of Closing Stock (Inventory)

£

Purchases 5 @ £5 each

Sales 3 @ £9 each

25

27

Apparent profit to date

Cost of goods left unsold (closing stock)

2 @ £5 each

2

10

Actual profit to date

12

Note: The actual profit may also be computed:

£

Sales

27

Less:

Purchases

25

Less goods left unsold

10

Cost of goods sold

15

15

Actual profit to date

12

frame detail

correct answers

15 In the cost of product X we show overhead of £10. If we had decided not to produce this one unit of product, would we have saved £10 of overhead?

estimate

cost

16 Estimates of cost depend upon the .......... of the cost accountant.

probably not

17 Let us now take another example: if we buy goods for £4 and sell half for £6 we make a profit to date of £..........

judgment

18 To compute the £4 profit we deduct from the £6 selling price, the £2 .......... of goods sold. There are £2 of goods left over for subsequent ..........

£4 not £2 (Because we still have £2 of goods left unsold)

19 If the £2 of goods left over are subsequently sold for £4, we make a further profit of £ .......... The entire profit of both sales is now £ .......... The calculation of profit .......... (does, does not depend upon the cost of any goods left) over.

cost

sale

20 Now read Exhibit 3 where we purchase some goods at £5 each to sell again at £9 each. The difference between total purchases and sales to date is only £ .......... Is this the total profit on the transaction?

£2

£6

does

19

frame detail

correct answers

21 If we take into account the cost of the goods left unsold £ .......... the apparent profit of £2 is increased to an actual profit of £ ..........

£2

no

22 Read Exhibit 3 and the note thereto again. Do you see how the profit of £12 may be computed in two different ways? Is £12 the:

(a) profit to date, or

(b) profit on the total transaction, or

(c) both (a) and (b)?

£10

£12

23 If we buy a pig for £1 can we compute scientifically the exact cost appropriate to the pig’s tail?

(a)

24 In summary therefore, the cost of a product includes labour cost, .......... cost and .......... cost, Cost incurred .......... (is, is not) the same as cost of goods sold. Cost is not a scientific fact but depends upon the .......... of the cost accountant.

No! It’s a matter of judgment!

25 Are you writing down the answer to each frame and checking it immediately?

material

overhead

is not

judgment

26 Now read again the summary of the set. Count up the number of your correct answers. If you have more than 20 correct, carry on to the next set.

If not, start writing now. Reading is not enough. We want you to learn and to remember

20

Chapter II

Set 2 ORGANIZATION, OBJECTIVES AND METHODS


SUMMARY

The organization of a manufacturing business provides the basis for cost analysis into:

1.Manufacturing—cost of direct labour, direct material and manufacturing overhead. Overhead expenses are indirect costs and include: indirect labour, indirect material, occupancy, repairs, maintenance, internal transport, factory supervision, etc.

2.Sales and distribution—cost of salesmen’s salaries, sales office expenses, advertising, promotion, packaging, dispatch and carriage outwards, etc.

3.Administration—cost of accounting, office services and general management.

The objectives of cost accounting are to:

1.Estimate the cost of each product (as an aid to pricing).

2.Compute the cost of work in process so that the profit may be properly calculated.

3.Control costs by associating costs with centres of responsibility, comparing actual with planned cost and taking corrective action.

The cost accounting method to achieve these objectives should be appropriate to the business organization and its products. Alternative methods available include: job, contract, batch, output and process costing.

Chapter II Set 2

ORGANIZATION, OBJECTIVES AND METHODS

Exhibit 1 Organization Chart of a Manufacturing Business

managing director

manufacturing

department

sales

department

administrative

department

120

employees

20

employees

10

employees

Direct labourSales overhead:Administrative overhead:

Direct materialSalesmen’s salariesDirectors’ fees

Manufacturing overhead:AdvertisingOffice salaries

Indirect labourTravellingAuditor’s fees

OccupancySales promotionStationery

Repairs

Accounting

Maintenance

General administration

Internal transport

Supervision

Indirect material

Exhibit 2 Objectives of cost accounting

1.Estimate cost and possible selling price of each product.

2.Compute the cost of work in process.

3.Control costs.

frame detail

correct answers

1 Read Exhibit 1 which shows the organization of a typical manufacturing business into three main departments:......., ....... and.……

Check your answer with the correct answer in the frame below. Tick it if correct

2 The majority of workers are employed in the ......... department, which covers direct labour and indirect labour. The employees in the manufacturing department are .......... out of a total of 150 in the business.

manufacturing

sales

administrative

3 However, in the sales department we have ....... employees, and in the administrative department employees.

manufacturing

120

4 Direct labour and direct material are all incurred in the .…… department. However, from the outline of the business, the overheads may be divided into…...., ......... or ........ overhead.

20

10

5 Cost of salesmen’s salaries, advertising, travelling, sales promotion, etc., are all ............ overhead.

manufacturing

manufacturing

sales

administrative

6 Cost of directors’ fees, office salaries, auditor’s fees, stationery, etc., are ......... overhead.

sales

23

framre detail

correct answers

7 Factory costs for occupancy, indirect labour, repairs, supervision, indirect material, etc., are ............. overhead.

administrative

8 What is this “occupancy” overhead?

manufacturing

9 Read again the detail of the manufacturing department in Exhibit 1. Direct labour, direct material............. (are, are not) part of manufacturing, but they are not manufacturing overheads. Overheads are ............. costs.

Costs of “occupying” a factory, e.g. rent, rates, lighting, power, building maintenance, insurance, etc.

10 Now in your own organization, are you part of manufacturing, selling or administration? Does your superior really understand you? Your real problems? Your potential? The real responsibilities you have carried for so long without a word of complaint?

are

Indirect

11 This completes our review of the organization and overhead costs. Now read Exhibit 2 which lists the ............. of cost accounting. These objectives are: to estimate cost and possible selling ............. of each product, to compute the cost of work in ............. and to ............. costs.

(We all seem to have the same problem!)

12 The first objective of cost accounting deals with estimating costs to set selling prices. But are selling prices always based on cost? They are often determined by the market and not merely by adding a percentage to the ............. of a product.

objectives

price

process

control

24

Chapter II Set 2


Exhibit 3 Cost, selling price and profit of products A, B and C.

Product

A

B

C

£

£

£

Cost

Selling price

5

8

10

10

15

20

Profit

3

Nil

5

frame detail

correct answers

13 In Exhibit 3 we show for three products, A, B and C the appropriate cost, ............. price and ..........

no

cost

14 Product A costs £.......... and sells for £.......... making a.........of £3. Whereas product B makes a profit of £........... and product C a profit of £..............

selling

profit

15 Strictly on the cost accounting results it appears that we should drop product B. Should other factors be considered before making this decision?

£5

£8

profit

£0

£5

16 Thus cost accounting data may show whether a product makes a profit or loss but ......... (does, does not) indicate finally what management should do. But should management be given cost and profit data by products?

yes—it may be part of a line of products and to sell A and C we have also to sell B

17 The second objective of cost accounting in Exhibit 2 is to record the labour, material and overhead incurred on a product in order that we may value ......... in ...........

does not

yes

18 In Exhibit 4 we compute the value of work in process at ......... (market price, cost). The total cost incurred amounts to £ ......... If we know that the material cost of each unit is £1, then the £250 of material (marked X) is for ............ units.

work

process

27

Chapter II Set 2


Exhibit 4 Computing the cost of work in process

Total

cost

incurred

Cost of

goods

finished

Cost

goods still

in process

(unfinished)

£

£

£

Costs:

Labour

Material

Overhead

200

(X)250

200

150

100

150

50

150

50

650

400

250

Total

Units

Completed

Units

Work in

Process

Units

Units:

Completed

In process

100

150

100

—

—

150

250

100

150

frame detail

correct answers

19 Of these 250 units (cost £650), 100 units are complete for a total cost of £400, and ............. units are work in process at a cost to date of £.............

cost

£650

250

20 For the work in process we ............. (have, have not) incurred the full material cost but we ............. (have, have not) yet incurred the full labour and overhead cost.

150

£250

(Have you got one of these answers wrong? Can you see why?)

21 The computation of the cost of work in process £ ............., is made by the cost accounting section of the business. It is not valued at market price but at the lower of ............. or ............. price.

have

have not

(because we must buy material before we start to make the product)

22 The third objective of cost accounting in Exhibit 2 is to ............. costs by relating costs to the persons responsible for ............. these costs.

£250

cost

market

23 Responsibility cost accounting associates cost with the person .............

control incurring

24 Now read Exhibit 5 which shows the cost control report of the ............. department for the month of August, Who is probably responsible?

responsible

29

Chapter II Set 2


Exhibit 5 Cost control report of the sales department—August

Responsible person: Sales Manager

Actual

Budget

Difference

over (under)

£

£

£

Salaries

Travel expenses

Office expenses

Advertising

Sales literature

230

15

10

25

15

235

20

12

5

8

(5)

(5)

(2)

20

7

295

280

15

Exhibit 6 Examples of different units of cost or production

UnitCost Accounting Method (system)

1. One jobJob costing

2. One contractContract costing

3. One processProcess costing

4. One unit of outputOutput costing

5. One batch of unitsBatch costing

frame detail

correct answers

25 The actual costs for August were £295 against a ....... of £280. The difference of £15 arose because actual costs were ....... (over, under) budget.

sales

sales manager

26 Exhibit 5........ (is, is not) a cost control report for the sales department. It shows where the actual expenses for August exceeded the .......

budget

over

27 Which items were less than budget?

is

budget

28 Which items exceeded the budget? Is this report useful to the sales manager?

salaries

travel expenses

office expenses

29 By presenting timely cost reports to management, cost accounting indicates the difference between planned and actual cost and thereby helps to ........ costs.

advertising

sales literature

yes

30 Now read Exhibit 6 which lists several different ........... of cost. Different methods of cost accounting determine the cost of one unit of production or one unit of ...........

control

31

frame detail

correct answers

31 Cost accounting associates cost with a ....... of production. A job, a contract, a process or a unit of output are all ....... of cost, for cost accounting purposes.

units

cost

32 For each unit of production there is usually a system of cost accounting. One unit, one cost and therefore one ...... Name three possible units of cost.

unit

units

33 To compute the cost and selling price of a product, to value work in process and to control costs, are all ....... of cost accounting.

system

Job, batch, contract, or

process

34 What do engineers usually say about cost accountants?

objectives

35 Now read again the summary of the set. Count up the number of your correct answers. If you have more than 25 correct, carry on to the next set.

! ! !

32

Chapter II Set 3

DIRECT AND INDIRECT COSTS


SUMMARY

Direct costs are conveniently associated with a unit of production.

They are:

1.Direct labour which is direct operating labour. It normally excludes: storemen, foremen, transport drivers, office clerks, salesmen, inspectors, managers and other indirect labour.

or2.Direct material which forms part of the product sold. It normally excludes: oil, grease, machine repairs, rags and other indirect material.

or3.Direct services which are special costs for particular jobs only, e.g. hire of machines.

All other costs are indirect costs known as overheads, which may be analysed in various ways:

1.Manufacturing, selling or administrative.

2.Fixed or variable (with the volume of production or sales).

The elements of cost may now be set out as follows:

Direct labour

Direct material

£

xx

xx

prime cost

Manufacturing overhead

xx xx

manufacturing cost

Selling and administrative overhead

xxx

xx

total cost

xxx

Note: Manufacturing costs incurred in one accounting period are for goods finished and partly finished. In the cost of finished production, we adjust costs incurred during the period for work in process brought forward from the previous period and work in process carried forward.

Chapter II Set 3


Exhibit 1 List of expenditures analysed into direct costs, indirect costs and special items

Normally

F or V

Description

Direct costs

Indirect costs

Special items (not costs)

Manufac- turing overhead

Sales overhead

Admini-strative overhead

v

v

f

Direct labour

Direct material

Indirect labour

x

x

X

v

v

v

Indirect material

Factory rent and rates

Lighting and heating

x

x

x

f

f

v

Foremen’s wages

Storemen’s wages

Power

x

x

x

f

f

f

Machine depreciation expense

Office expenses

Office salaries

x

x

x

f

f

v

Sales salaries

Advertising

Sales travelling expense

x

x

x

f

f

—

—

Auditor’s fees

Solicitor’s fees

Income tax

Dividends

x

x

x

x

* Note: Normal effect of changes in the volume of production:

F—not affected (fixed costs)

V—affected (variable costs)

frame detail

correct answers

1 Read Exhibit 1 which is a list of expenditures analysed into ...... costs, ....... costs and ....... items.

Check your answer with the correct answer in the frame below. Tick it if correct

2 The first two items are direct labour and direct ........ which are ....... costs.

direct

indirect

special

3 Costs that can be conveniently associated with a unit of production are ........ costs. All other costs are indirect costs known as .........

material

direct

4 Dividends and income tax are not costs but ........ ........

direct

overheads

5 The factory rent and rates are ....... (direct, indirect) costs or manufacturing overhead because they are part of the operating costs of running the ........

special items

6 However, the rent and rates paid for sales or administrative offices ........ (are, are not) manufacturing overhead.

indirect

factory

35

Chapter II Set 3


Exhibit 2 Elements of cost of Iob A and Iob B

* Classification

A

B

£

£

Direct labour

Direct material

20

10

10

20

D

D

Prime cost


(100% of direct labour)

30

20

30

10

I

Manufacturing cost

Selling and administrative overhead

(20% of manufacturing cost)

50

10

40

8

I

Total cost

60

48

* Note: D Indicates Direct cost

I Indicates Indirect cost.

frame detail

correct answers

7 Foremen’s wages, ......... wages and power are all ........ overhead. They ........ (can, cannot) conveniently be associated with one unit of production.

are not

8 The total cost of a new machine ........ (is, is not) an overhead expense at the time of purchase. However, machine depreciation may be charged periodically as a ......... overhead.

storemen’s

manufacturing

cannot

9 Machinery costs are charged to manufacturing overhead periodically in the form of ........

is not

manufacturing

10 Sales overhead includes such items as sales salaries, ....... and sales .......

depreciation

11 Auditor’s fees, office salaries and office expenses are all ........ overhead.

advertising

travelling expense

12 Indirect costs are overheads. However income tax and dividends ......... (are, are not) costs or overheads. They are special items treated as allocations of profit and not as .........

administrative

37

frame detail

correct answers

13 All costs may be divided into direct costs and indirect costs. In Exhibit 2 what do the marks “F” and “V” mean? Which item marked “V” should normally be marked “F”?

are not

costs

14 Direct labour ........ (does, does not) usually include storemen’s wages, inspectors’ wages and managers’ salaries. These items are manufacturing overhead unless they can be ........ ........ (what)?

fixed or variable cost factory rent and rates (normally fixed cost)

15 Indirect material is a ........ overhead. It ........ (does, does not) usually include grease, rags, small tools, etc.

does not

conveniently associated

with a unit of production

16 Now read Exhibit 2 which shows the ........ of cost of job A and job B.

manufacturing

does

17 For job A the direct labour cost was £20. The direct material cost was £10 and therefore the ........ cost was £30.

elements

18 To the prime cost of £30 we add manufacturing overhead at 100% of direct labour to get a ........ cost.

prime

38

frame detail

correct answers

19 Manufacturing cost equals manufacturing over head plus ........ cost.

manufacturing

20 Selling and administrative overhead of £10 being .........% of manufacturing cost (£50) is added to manufacturing cost to give the ......... cost of £60.

prime

21 In the total cost of job A (£60) the easily identifiable direct costs amounted to £......... and the overhead (indirect) costs amounted to £...........

20%

total

22 Thus for job A only one half of the total cost was clearly defined as direct cost conveniently associated with the job, and the other half was ..........

£30

£30

23 Similarly for job B prime cost amounts to £......... Manufacturing overhead at the rate of .......... % of direct labour is added to form a manufacturing cost of £...........

overhead

24 The total cost of job B is £48 of which £30 is .......... cost and £18 is ........ cost or overhead.

£30

100%

£40

39

Chapter II Set 3


Exhibit 3 Cost of all finished production and cost of finished goods sold during one month

(In thousands of pounds)

£

Direct labour

Direct material


2

3

5

Manufacturing cost incurred

Work in process: opening

plus

10

1

Work in process: closing

minus

11

2

Cost of finished goods produced

Finished goods: opening inventory

plus

9

5

Finished goods; closing inventory

minus

14

3

Cost of finished goods sold

11

Note: Alternatively you may thick of this calculation as:

£000

Work in process:

Opening inventory

Cost incurred

1

10

Closing inventory

11

2

Goods finished (below)

9

Finished goods :

Opening inventory

Goods finished (above)

£000

5

9

Closing inventory

14

3

Cost of finished goods sold

11

frame detail

correct answers

25 The manufacturing overhead is charged as a percentage of ........... .......... Is this the only method for charging manufacturing overhead?

direct

indirect

26 Direct labour plus direct material equals ......... cost.

direct labour

no

27 Prime cost plus manufacturing overhead equals ........ cost.

prime

28 This seems to be a terribly long set. Will it ever end?

manufacturing

29 Manufacturing cost plus selling and administrative expenses equal ........ cost. This completes our review of the ........ of cost.

Yes! Don’t despair! 24

frames to go.

30 Now we come to the complication of stocks (inventories) which affect the figures we have accepted above. Read Exhibit 3 which shows not the cost of one product but the cost of all ............. production for a month, and the cost of finished goods ........... The figures are in thousands of pounds, marked ...........

total

elements

41

frame detail

correct answers

31 Costs incurred (spent) during the period are: direct ............ £2,000, direct ........... £3,000 and manufacturing overhead £........

finished

sold

£000

32 In Exhibit 3, £10,000 is the manufacturing; cost ........ (spent) for the month. Is this the cost of goods finished during the month?

labour

material

£5,000

33 Work in process brought forward at the beginning of the period amounted to £1,000. The manufacturing cost incurred plus the work in process brought forward amounts to £...........

incurred

no (work in process has changed)

34 The work in process at the end of the period amounts to £2,000. Thus of the manufacturing cost incurred during the month (£10,000) and the work in process brought forward (£1,000) only £........ related to work finished (completed) during the period.

£11,000

35 To compute the cost of goods finished during the period we therefore take the costs incurred, add .......... work in process and deduct ........... work in process.

£9,000

36 Now we do the same computation for finished goods. At the beginning of the period we had finished goods in stock (inventory) of £.......... and at the end of the period we had finished goods in stock (inventory) of only £...........

opening

closing

42

frame detail

correct answers

37 To compute the cost of finished goods sold (cost of goods sold) during the period we take the cost of the finished goods ........, add ........ stock of finished goods and deduct ........ stock of finished goods.

£5,000

£3,000

38 Thus the cost of finished goods produced during the month was £........... to which we added the opening stock of finished goods £........... and deducted the closing stock of finished goods £.........., to calculate the cost of the finished goods sold during the period £..........

produced

opening

closing

39 Manufacturing costs incurred and cost of finished goods produced ............ (are, are not) the same. We must adjust for changes in ........... in ...........

£9.000

£5,000

£3,000

£11,000

40 Cost of finished goods produced........ (is, is not) the same as cost of finished goods sold. We must adjust for opening and closing ........ of ........ goods. Now read again the note to Exhibit 3.

are not

work

process

41 For the last part of this set we return to our analysis of costs. To summarize: costs may be analysed into direct costs and indirect costs. In direct costs may be manufacturing, sales or administrative. Alternatively they may be classified into fixed or ............

is not

stocks (inventory)

finished

(Have you got the idea? If not, do frames 30–40

again, please)

42 Now read Exhibit 4 which shows the effect of variable and fixed costs at different ........ of production and sales, from one unit up to ........ units

variable

43

Chapter II Set 3


Exhibit 4 Effect of variable costs and fixed costs at different volumes of production and sales

No. of units of sales

1

£

100

£

500

£

1,000

£

Variable costs

Fixed costs

1

1,000

100

1,000

500

1,000

1,000

1,000

Total costs

Sales

1,001

3

1,100

300

1,500

1,500

2,000

3,000

Profit (loss)

(998)

loss

(800)

loss

nil

break-even

1,000

profit

Total cost per unit

£1,001

£11

£3

£2

Note: The basic data for this statement is:

1. Variable cost per unit£1

2. Selling price per unit£3

3. Fixed overhead £1,000

4. No inventory changes.

frame detail

correct answers

43 What is the variable cost per unit? Is it the same cost per unit for all volumes?

volumes

1,000

44 What is the total fixed cost? What is the fixed cost per unit at the different volumes? 1 unit? 100 units? 500 units? 1,000 units?

£1

yes

45 Why is the total cost over £1,000 for one unit, as against only £2,000 to make and sell a thousand units?

£1,000

£1,000 (£1,0004(1)

£10 (£1,000(100)

£2 (£1,000(500)

£1 (£1,000(1,000)

(Do you see how it falls continually?)

46 What is the break even volume? (units). It occurs when total sales equal total ........ Below this volume we make a loss and above it we make a ........

Because of heavy fixed costs

47 To determine the effects of different volumes of production and sales we must divide costs into ....... and ....... costs.

500 units

cost

profit

48 In practice determination that a cost is fixed or variable is extremely difficult. Direct costs tend to be (but are not always) .......... (fixed, variable).

fixed

variable

45

frame detail

correct answers

49 Overheads ........ (are, are not) always fixed, irrespective of the volume of production.

variable

50 The cost accountant must therefore investigate each direct and indirect cost very carefully before he can define it as fixed or variable. It is not a matter of scientific analysis but practical ........

are not

(some overheads do vary with the volume of production)

51 Would you say cost accounting is just clerical routine?

judgment

52 Now read again the summary of the set. Count up the number of your correct answers, and if you have more than 40 correct, take a short break, and then continue on to the next set.

We hope not, the routine work is done after the cost accountant has used his judgment to make the necessary assumptions

46

Chapter ii

Set 4 COST ESTIMATES AND SELLING PRICES


SUMMARY

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.

To determine a fair manufacturing overhead for a job we find a relationship between the total manufacturing overhead cost and some known direct cost. For example:

Total CostsPossible Manufacturing

of a Recent or Future PeriodOverhead Rates

£

Direct labour600200% of Direct Labour

Direct material1,800

Prime cost2,40050% of Prime Cost

Manufacturing overhead1,200

To the direct costs of the job we add first manufacturing overhead, and then sales, distribution and administrative overhead, to arrive at total job cost.

We may then add a profit percentage to total cost, to compute an estimated selling price. However, the customer and the market for the product decide the actual selling price of the job.

The excess of selling price over total cost, is the profit from making and selling that particular job. The contribution of a job is the excess of selling price over variable costs. It contributes a margin for fixed costs and profit.

Chapter II Set 4

COST ESTIMATES AND SELLING PRICES

Exhibit 1 Estimated cost and selling price of job no. 1234

£

Direct labour5 hours @ £1 per hour5

Direct material3 tons @ £5 per ton15

Prime cost20

Manufacturing overhead?

Manufacturing cost?

Sales and administrative overhead?

Total cost?

Profit?

Estimated selling price of the job?

frame detail

correct answers

1 For any job it is usually easy to determine the cost of labour and material, which are ........ (direct, indirect) costs.


2 The principal direct costs of a job are called direct ......... and direct ........ whereas the indirect costs of a job are called .........

direct

3 Overheads are paid to cover the whole volume of production. They ........ (are, are not) paid for one specific job alone.

labour

materials

overheads

4 Are you getting tired?

are not

5 Now read Exhibit 1. It shows how a computation of cost of job no. 1234 was prepared to estimate the ........ price.

Yes?

Then stop now and start again later

6 Which costs are definitely incurred for job no. 1234 alone?

selling

7 Now read Exhibit 2 to see how the overhead rates may be calculated. It shows results of operations for a ......... period.

direct labour

direct material

49

Chapter II Set 4


Exhibit 2 Results of operations on all jobs for a recent period

£

Direct costs:

Labour

5,000

Material

15,000

Prime cost

20,000

Indirect costs:



10,000

rates:

50% of prime cost, or

200% of direct labour cost

Manufacturing cost

30,000

Sales and administrative

Sales and administrative overhead

overhead

6,000

rate:

20% of manufacturing cost

Total cost

36,000

Profit

9,000

Profit: 25% of total cost

Sales

45,000

frame detail

correct answers

8 During the recent period the total cost of direct labour was £.......... and manufacturing overhead £.......... We may now calculate one possible manufacturing overhead rate as ..........% of direct labour.

recent

9 A manufacturing overhead rate of 200% of direct labour means that for every £1 of labour we have £.......... of overhead. This is a method of charging manufacturing overhead to a particular job. Are there any other methods?

£5,00°

£10,000

200%

10 An alternative overhead rate would be to say that for every £1 of prime cost (£20,000) we have £.......... of manufacturing overhead (£10,000). Now compute the manufacturing overhead for job no. 1234 in Exhibit 1, using a rate based on prime cost.

£2

Yes

11 To relate sales and administrative overhead to manufacturing cost, we again examine the results of the recent period given in Exhibit 2. For the £.......... of sales and administrative overhead we have manufacturing costs of £.........., and we may compute an overhead rate of ..........%.

£½

£10

12 A selling and administrative overhead rate of 20% means that for each £100 of manufacturing cost we charge £.......... of selling and administrative overhead. Now compute the charge in Exhibit 1.

£6,000

£30,000

20%

13 Finally we must decide how much profit shall we estimate for the job. in Exhibit 2 we find the relationship between profit £.......... and total cost £.......... in the recent period was .......... %.

£20

£6

51

Chapter II Set 4


Exhibit 3 Revised cost and estimated selling price of job no. 1234

£

Direct labour

Direct material

5

15

Prime cost

20

Manufacturing overhead (50% of prime cost)

10

Manufacturing cost

Selling and administrative overhead (20% of

manufacturing cost)

30

6

Total cost

Profit (25% of total cost)

36

9

Estimated selling price

45

frame detail

correct answers

14 Thus from Exhibit 2, using the recent period we have computed rates to cover manufacturing overhead, selling and administrative overhead and also a rate to add finally for .......... Could we charge more?

£9,000

£36,000

25%

15 Using these overhead and profit rates, now complete Exhibit 1. Then read Exhibit 3. Did you get it right?

profit

Yes, if customer still

accepts the price

16 Direct costs amount to £.......... The manufacturing overhead based on 50% of .......... cost amounted to £.......... giving a total manufacturing cost of £..........

Yes? Good!

No? Why? start the set

again please.

17 Are manufacturing overhead and selling and administrative overhead both charged on the basis of a percentage of labour costs?

£20

prime

£10

£30

18 Selling and administrative overhead is charged at the rate of 20% of ...... ......

no

19 The estimated profit on the job no. 1234 is £.........., based upon ..........% of the total cost.

manufacturing cost

53

Chapter II Set 4


Exhibit 4 Computation of the contribution of job no. 1234

£

ESTIMATED SELLING PRICE

45

£

Less variable costs:

Direct labour

5

Direct material

15

Variable manufacturing overhead

3

Variable sales and administrative overhead

4

27

CONTRIBUTION

18

Less fixed costs:

Fixed manufacturing overhead

7

Fixed sales and administrative overhead

2

9

ESTIMATED PROFIT (per Exhibit 3)

9

Note: To compute the contribution we must first analyse the overhead as follows:

Total

Fixed

Variable

£

£

£

Manufacturing

10

7

3

Sales and administrative

6

2

4

16

9

7

frame detail

correct answers

20 Cost accounting techniques have helped us to estimate the .......... and selling .......... of job no. 1234.

£9

25%

21 Of the total cost of £36 only the direct.........., £5, and direct .........., £15, are actual costs. The balance of £16 is not direct cost but charges for........

cost

price

22 Overhead charges are based upon rates computed from cost of total operations. In this case we could have used a budget or a forecast of future costs, but instead to compute the rates, we used the results of the operations of a .......... period.

labour

material

overhead

23 Now study “contribution” in Exhibit 4. Try to understand the breakdown of fixed and variable costs. The contribution is the difference between the selling price and the .......... costs.

recent

24 We compute the “contribution” of job no. 1234 by deducting the variable costs of £.......... from the selling price of £.......... The contribution to fixed overhead and profit is £.......... whereas the profit on the job is only £.......... Does this all agree with Exhibit 3?

variable

25 If the business is short of work, a job may be worth doing so long as its variable costs are less than its .......... The difference between these two things is called the .......... of the job towards fixed costs and profit.

£27

£45

£18

£9

Yes

55

frame detail

correct answers

26 in Exhibit 4 how much was the total overhead? How much fixed? How much variable? Before we could calculate the contribution we had to analyse the .......... into .......... and .......... costs.

selling price

contribution

27 Now to summarize this set; we have seen that the cost of the job may be estimated as the direct cost of .......... and .........., plus manufacturing overhead and selling and administrative.......

£16

£9

£7

Overhead

Fixed

Variable

28 If the cost accounting is properly co-ordinated with the financial accounting the total costs on all jobs .......... (can, cannot) normally be reconciled with the total costs in the income statement.

labour

material

overhead

29 We have also learned how to estimate the selling price of a job given the .......... costs and the results of a .......... period. Alternatively we could use a budget which is an estimate of results of a .......... period.

can

30 The contribution of a job is the excess of selling price over.......... ......... It .......... (is, is not) the same as the profit on the job

direct

recent

future

31 Now read again the summary of the set. Count your correct answers and if you have more than 24 correct, stop for ten minutes and then continue to the next set.

selling

variable cost

is not

56

Chapter III

MANUFACTURING OVERHEAD

Set 5 COST CENTRES


SUMMARY

Analysis of manufacturing overhead by cost centres enables us to replace one overall manufacturing overhead rate with specific overhead rates for each cost centre. Thus one hour in cost centre I may be costed differently from one hour in cost centre II.

Manufacturing overhead cost centres may be:

1.Productive cost centres directly engaged in. manufacturing operations.

2.Service cost centres for factory services such as: power house, maintenance, internal transport, general factory overhead, etc.

The routine for analysis of manufacturing overhead by cost centre is:

1.Charge specific costs (foreman’s salary, indirect labour, etc.) to productive or service cost centres.

2.Charge general costs (factory manager’s salary, etc.) to a special service cost centre called general factory overhead.

3.Charge non-specific costs to productive or service cost centres on an appropriate basis (floor space, units used, number of workers, etc.).

4.Recharge all service cost centre costs on appropriate bases to productive cost centres to arrive at a revised total overhead cost for each productive cost centre.

Chapter III Set 5

COST CENTRES

Exhibit 1 General overhead rate

Total

Overhead

Total direct labour cost

Overhead as %

of direct labour

cost

Manufacturing,

Selling and

Administrative

£100,000

£40,000

250%

Exhibit 2 Overhead rates, distinguishing between manufacturing, selling

and administrative overhead

Total

overhead

Total direct

labour cost

Overhead as %

of direct labour

cost

£

£

Manufacturing

Selling and

Administrative

80,000

20,000

200%

50%

100,000

40,000

frame detail

correct answers

1 The costs of a business may be divided into direct costs and indirect costs. Overhead expenses are .......... costs.


2 if we grouped all overhead costs into one cost centre and compared this total with the direct labour, we could compute the .......... rate as a percentage of direct labour.

indirect

3 However, we usually do not put all overhead into only .......... cost centre.

overhead

4 To facilitate more accurate costing we develop separate overhead rates for a series of separate operating centres known as ......... .........

one

5 Now read Exhibit 1 which shows the total overhead of a business as £............ against total direct .......... of £40,000.

cost centres

6 For £40,000 of direct labour, the overhead rate is ..........% or £100,000.

£100,000

labour

59

Chapter III Set 5

COST CENTRES

Exhibit 3 Manufacturing overhead rates, distinguishing between cost centres

Productive cost centre


Direct labour

cost

Overhead as %

of direct labour

cost

£

£

No. 1

10,000

5,000

200%

No. 2

15,000

6,000

250%

No. 3

25,000

20,000

125%

No. 4

30,000

9,000

333%

Total

80,000

40,000

Note: This analysis is explained in Exhibit 7.

frame detail

correct answers

7 Now read Exhibit 2 in which we subdivide the overhead into ............. £80,000 and selling and administrative £...........

250%

8 From Exhibit 2 we may now calculate another overhead rate based on direct labour by comparing the direct labour of £40,000 with a manufacturing overhead of £80,000 to give a rate of ...........%. This rate ........... (does, does not) include selling and administrative overhead of 50%.

manufacturing

£20,000

9 Now read Exhibit 3 in which we divide the manufacturing overhead into ............ (number) cost centres. Cost centre 1 has £.......... and cost centre 4 has £...........

200%

does not

10 From Exhibit 3 we may calculate an overhead rate for cost centre 2 by comparing the direct labour of £6,000 with the overhead of £15,000 to give a rate of ..........%.

4

£10,000

£30,000

11 Similarly the overhead rate for cost centre 4 would be ........%. Is cost centre 3 probably more highly mechanized (i.e. more machinery overhead costs) than cost centre 4?

250%

12 Cost centre 3 has direct labour of £.......... against manufacturing overhead of £.......... and therefore has an overhead rate of ........%.

333%

no (lower overhead rates are often due to low machine depreciation)

61

frame detail

correct answers

13 Is cost centre 3 probably a manual or machine department?

£20,000

£25,000

125%

14 In Exhibit 2 we have only one manufacturing overhead rate of ..........% and all direct labour bears this same rate of overhead. However, in Exhibit 3 we have four different rates by cost centres of 200%, 250%, ..........% and 333%.

manual

15 These rates ........ (do, do not) include selling and administrative overhead.

200%

125%

16 If we have only one overhead rate for the whole factory, a product which has one labour hour in cost centre 4 (a machine shop) will be charged with the .......... (same, different) amount of overhead as a product using one hour in cost centre 2.

do not

17 By using different rates by cost centres for different activities, we .......... (do, do not) tend to associate the overhead of a cost centre with the labour of that particular cost centre.

same

18 Remember the overhead rates referred to up to this point .......... (do, do not) include selling and administrative overhead.

do

62

frame detail

correct answers

19 By dividing the direct labour and the manufacturing overhead into cost centres, the overhead rates, may be .......... (more, less) precise.

do not

20 We shall now deal with the detailed analysis of manufacturing overhead by cost centres. Read Exhibit 4 which shows the ............. for charging manufacturing overhead to .......... ............

more

21 Depreciation of machinery and foremen’s salary, indirect labour are examples of .......... (specific, non-specific) costs which may be easily charged to the correct cost centres. However they are still in direct costs or ..........

bases

cost centres

22 By contrast some costs such as rent, general building repairs, personnel dept. etc. may not be easily identified with particular cost centres. They must therefore be charged to cost centres on an .......... ......... Such costs are .......... (specific, non-specific) costs, but they are still ..........

specific

overheads

23 The cost for rent may be analysed to each cost centre on the basis of the number of square feet of .......... area occupied by each cost centre. If the total floor space was 10,000 sq. ft. and cost centre no. 1 occupied 5,000 sq. ft., would it be allocated half of the rental cost?

estimated basis

non-specific

overheads

24 What other item could be analysed on the basis of floor space?

floor

Yes

63

Chapter III Set 5

COST CENTRES

Exhibit 4 Bases for charging manufacturing overhead to cost centres

Possible Basis of Analysis

Manufacturing

Overhead

No. of workers

Floor

area

Units

used

Technical estimate

Actual cost

Specific costs:

x

Non-specific costs:

Rent

x

Lighting and heating

x

Cleaners’ wages

x

Supervision

x

Repairs and maintenance

x

Personnel dept. costs

x

Timekeeper’s wages

x

Chapter III Set 5

cost centres

Exhibit 5 Partial analysis of manufacturing overhead by cost centre

Basis

for

analysis

Total

cost

Productive cost centres

Service cost centres

I

II

III

IV

A

B

General

£

£

£

£

£

£

£

£

Specific costs

Actual

50,000

3,000

2,000

10,000

14,000

2,000

1,000

18,000

Non-specific costs

Various

30,000

2,000

6,000

10,000

10,000

1,000

1,000

—

Sub-total

80,000

5,000

8,000

20,000

24,000

3,000

2,000

18,000

Recharge of general manufacturing service cost centre

No. of employees

—

3,000

5,000

4,000

3,000

2,000

1,000

(18,000)

Sub-total

80,000

8,000

13,000

24,000

27,000

5,000

3,000

—

Recharge of service cost centres:

A

B

TOTAL COSTS BY PRODUCTIVE COST CENTRE

DIRECT LABOUR COST OVERHEAD RATE

frame detail

correct answers

25 The second item listed in Exhibit 4 is .......... and heating which is analysed on the basis of the number of .......... used.

cleaners’ wages

26 If there are no separate electricity meters, some other basis of analysis must be found. Some businesses analyse lighting and heating on the same basis as rent i.e. .......... area occupied.

lighting

units

27 Was it really such a good idea to learn cost accounting?

floor

28 Some other items are analysed on the basis of the “number of workers in each cost centre”. These items are .......... .......... costs, timekeepers, wages and .......... This basis .......... (is, is not) useful as a general basis of analysis. The cost accountant must select the appropriate basis by using his ..........

Definitely!

29 Now read Exhibit 5 which shows .......... (number) productive and .......... (number) service cost centres.

personnel dept.

supervision

is

judgment

30 There are two types of cost centres. A cost centre concerned directly with manufacturing the product is a .......... cost centre. By contrast cost centres for factory services such as maintenance, stores, production control, internal transport, etc., are .......... cost centres.

4

3

65

frame detail

correct answers

31 Manufacturing costs of a very general nature which would be difficult to analyse on any reasonable basis to cost centres, are normally accumulated in a special service cost centre called ............. ............. ............. cost centre. How much did these costs amount to?

productive

service

32 Now for the routine of overhead analysis in Exhibit 5. First the specific costs, easily identified for specific cost centres, were charged on the basis of .......... .......... Easily identifiable costs are .......... costs.

general

manufacturing

service

£18,000

33 Total specific costs were £............ of which productive cost centre IV was charged with £............

actual cost

specific

34 Then the non-specific costs of £.......... were charged to cost centres on appropriate bases such as: no. of workers, .......... area, .......... used etc. The total of specific and non-specific costs amounts to £..........

£50,000

£14,000

35 We then recharge service cost centres on appropriate bases. First general manufacturing service cost centre was charged on the basis of .......... .......... ...........

£30,000

floor

units

£80,000

36 Is general manufacturing service cost charged to both productive and service cost centres?

no. of employees

67

Chapter III Set 5

COST CENTRES

Exhibit 6 Recharge of service cost centre costs to productive cost centres

Service

cost centre

Service

cost centre

A

B

£

£

Specific costs

2,000

1,000

Non-specific costs

1,000

1,000

3,000

2,000

General manufacturing service cost centre

2,000

1,000

Total cost to be recharged to

productive cost centres (exhibit 5)

5,000

3,000

Basis of recharging

Units

Used

Floor

Area

£

£

Productive cost centre I

1500

500

”””II

1,000

1,000

”””III

600

400

”””IV

1,900

1,100

Total (Exhibit 7)

5,000

3,000

frame detail

correct answers

37 Now read Exhibit 6 which shows the transfer of the costs of .......... cost centres to productive cost centres, so as to incorporate these costs into the final overhead rates of the .......... cost centres.

Yes

38 First we accumulate the specific costs of the service cost centres. A £............ B £...........

service

productive

39 To this we add the non-specific costs and the allocations of the general manufacturing service cost centre from Exhibit ..........

£2,000

£1,000

40 Now we charge service cost centre costs to productive cost centres. The total cost for service cost centre A was £.......... which is apportioned to the productive cost centres on the basis of ..........

5

41 Similarly service cost centre B is allocated to productive cost centres on the basis of .............. ..............

£5,000

units used

42 Now trace the data in Exhibit 6 to Exhibit 7 which is the completed analysis. We compute the total costs of productive cost centres. To the specific and non-specific costs of the productive centres we recharge a proportion of .............. manufacturing service overhead.

floor area

69

Chapter III Set 5

cost centres

Exhibit 7 Completed analysis of manufacturing overhead by cost centre

Basis

for

analysis

Total

cost

Productive cost centres

Service cost centres

I

II

III

IV

A

B

General

£

£

£

£

£

£

£

£

Specific costs

Actual

Various

50,000

3,000

2,000

10,000

14,000

2,000

1,000

18,000

Non-specific costs

30,000

2,000

6,000

10,000

10,000

1,000

1,000

—

Sub-total

80,000

5,000

8,000

20,000

24,000

3,000

2,000

18,000

Recharge of general manufacturing service cost centre

No. of

employees

—

3,000

5,000

4,000

3,000

2,000

1,000

*(18,000)

Sub-total

80,000

8,000

13,000

24,000

27,000

5,000

3,000

—

Recharge of service cost centres:

A

B

units used

floor area

—

—

1,500

500

1,000

1,000

600

400

1,900

1,100

*(5,000)

—

—

*(3,000)

—

—

TOTAL COSTS BY PRODUCTIVE COST CENTRE

**80,000

10,000

15,000

25,000

30,000

—

—

—

DIRECT LABOUR COST OVERHEAD RATE

**40,000

5,000

200%

6,000

250%

20,000

125%

9,000

333%

—

—

—

Note: *Figures in brackets denote deductions.

** See Exhibit 3.

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correct answers

43 Then the service cost centre A £............ is transferred to production cost centres on the basis of ......... ..........

general

44 Similarly the cost of service cost centre B £........... is transferred to the productive cost centres on a basis of ......... area occupied.

£5,000

units used

45 Finally the revised manufacturing overhead of each of the productive cost centres is computed as follows:

cost centre I£10,000

cost centre II£15,000

cost centre III£............

cost centre IV£............

£3,000

floor

46 Against this revised overhead by cost centre, we can compare the direct labour costs. For cost centre I against an overhead of £10,000 we have direct labour cost ......... giving an overhead rate of .........%.

£25,000

£30,000

47 Similarly we have analysed overhead via service cost centres to arrive at an overhead rate for:

cost centre II.........%

cost centre III.........%

cost centre IV.........%

£5,000

200%

48 Do these overhead rates agree with Exhibit 3?

250%

125%

333%

71

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correct answers

49 The technique of using cost centres enables us to subdivide the .......... overhead into a series of centres and to compute separate overhead ............

Yes (in frames 32–47 you have followed the routine to get this data)

50 Finally the analysis by cost centres enables us to relate the overhead costs of the business to persons responsible for each .......... ..........

manufacturing

rates

51 Have we now completed (successfully) the longest set in the programme?

cost centre

52 Some of the possible bases to be adopted for analysing overhead to cost centres include .......... area occupied, .......... of workers, .......... of power used, or if known the .......... cost.

Not quite.

53 What is the name generally given to the special cost centre in which miscellaneous general manufacturing overheads are grouped together before being charged on the most reasonable basis to the various service and productive cost centres? .......... .......... .......... cost centre.

floor

number

units

actual

54 We accumulate costs by productive centres and service centres and subsequently re-charge the service centre costs to the productive cost centres, to accumulate total overhead costs for each .......... cost centre.

general

manufacturing

service (or works general overhead)

55 Now read again the summary of the set. Count up the number of your correct answers. If you have more than 44 correct, stop for coffee and then start the next set.

productive

(You have now completed the most difficult part of the programme. Now it is “downhill” all the way home.)

72

Chapter III Set 6

OVERHEAD RATES


SUMMARY

To determine the manufacturing overhead rate for a cost centre:

1.Compute total overhead cost for the cost centre (Set 5).

2.Select a measure of activity.

3.Divide the overhead cost by the measure of activity to compute the overhead rate.

Measures of activity for overhead rates are:

1.Direct labour cost.

or2.Direct labour hours.

or3.Machine hours.

or4.Prime cost.

Manufacturing overhead rates may be computed separately for individual cost centres or departments or for the whole business.

The estimated level of activity selected to compute the overhead rate significantly affects the rate and the accuracy of the job costs. If the actual activity is less than estimated, there will be a balance of overhead not charged to jobs. This is known as undercharged overhead. Conversely if the actual activity exceeds estimate there will be overcharged overhead.

Chapter III Set 6

OVERHEAD RATES

Exhibit 1 Computation of three possible overhead rates for a cost centre

Measure of Activity

Basis 1

Basis 2

Basis 3

Overhead Cost

£40,000

£40,000

£40,000

Measure of activity:

Direct labour—cost

£10,000

Direct labour—hours

20,000 hours

Machine hours

40,000 hours

Overhead rates based on:

Direct labour cost

400%

Direct labour hours

£2 per hour

Machine hours

£1 per hour

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correct answers

1 In this set we shall discuss the method of computing overhead charges to jobs in the form of manufacturing overhead ..........


2 We associate the direct costs with an appropriate amount of the overhead cost by using an .......... ..........

rates

3 Now read Exhibit 1 which is a computation of overhead rates for a cost centre. It shows .......... (number) possible bases or measures of activity.

overhead rate

4 To compute the rate we associate the overhead cost of £.......... with a .......... of ..........

three

5 In basis No. 1 we associate the overhead cost with the .......... .......... cost of £10,000, Thus for £10,000 of direct labour we incur £40,000 of overhead or ..........%.

£40,000

measure

activity

6 However, this is not the only way of charging overhead. In basis No. 2 we may associate the overhead cost of £40,000 with the 20,000 direct labour ............. and produce an overhead rate of £.......... per hour.

direct labour

400%

75

Chapter III Set 6

OVERHEAD RATES

Exhibit 2 Effect of changing levels of activity on overhead charged

Estimated overhead£40,000

Estimated direct labour cost£20,000

Overhead rate200% of direct labour

Case 1

Case 2

Case 3

High

Activity

Estimated

Normal

Activity

Low

Activity

£

£

£

Actual direct labour cost

30,000

20,000

10,000

Overhead charged to job costs

60,000

40,000

20,000

Actual overhead cost

40,000

40,000

40,000

Overhead over- (under-) charged to job costs

20,000

—

(20,000)

over-charged

Nil

under-charged

Note:(1)In job costs, overhead is charged at 200% of the direct labour for the job.

(2)If there is a large amount of overhead over-charged or under-charged, the job costs do not then reflect fair overhead charges.

(3)The accuracy of the overhead charges in the job costs therefore depends upon the amount of overhead under- or over-charged.

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7 Thus for every hour of direct labour in the cost centre we shall charge £............ for overhead. Does this include sales and administrative overhead?

hours

£2

8 Direct labour may be a suitable basis for charging overhead where there is .......... (little, much) mechanization. However, if there is much mechanization and the overhead rate would exceed 200% of direct labour cost, it may be useful to consider an overhead rate related to basis No. 3 .......... hours.

£2

No

9 For basis No. 3 we associate the overhead of £40,000 with .......... (number) machine hours, to compute an overhead machine hour rate of £.......... per hour.

little

machine

10 Each basis assumes that the overhead of the cost centre .......... (will, will not) vary directly with’ the measure of activity chosen.

40,000

£1

11 However, each basis assumes an estimated level of activity. Now read Exhibit 2 which shows the effect on the cost accounting of changing levels of ..........

will

12 We have assumed that the cost centre overhead of £40,000 will entail direct labour of £20,000 so that we get an overhead rate of ..........%. The estimated activity was the amount of ............. ............ £............

activity

77

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13 In Exhibit 2, case no. 1 indicates actual activity which is .......... (higher, lower) than the estimate.

200%

Direct labour

£20,000

14 The direct labour cost was not £20,000 as estimated but amounted to £.......... With the estimated £40,000 of overhead, the 200% rate would charge £.........., and leave £20,000.......... (over-, under-) charged.

higher

15 In case No. 2, however, our estimated activity was correct and the direct labour amounted to £.......... The amount of overhead over- or under- charged therefore was ..........

£30,000

£60,000

over

16 In case No. 3 the actual direct labour was only £.......... leading to an overhead charge of £.......... and a balance of £20,000 ............. (over-, under-) charged.

£20,000

nil

17.When the overhead is charged to a job it becomes part of the cost of the job. If the job cost includes direct labour £20, the cost of the job will include £40 for overhead, because we have used an overhead rate of ..........%.

£10,000

£20,000

under

78

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18 Now to analyse the effect of these three situations on job costs. In each case we charged out overhead at an estimated rate of 200% whereas the actual overhead rates should have been:

£actual overhead

rate

Basis 1Overhead40,000..........%

Direct labour30,000

Basis 2Overhead40,000200%

Direct labour20,000

Basis 3Overhead40,000..........%

Direct labour10,000

200%

19 However we could not wait until the end of the year to compute the actual overhead rate, so we used an estimated rate, as in Exhibit 2. To compute this estimated rate we have estimated:

(a) .......... cost £40,000

(b) .......... .......... cost £20,000

133%

400%

20 If the actual direct labour cost is less than the estimate we will have overhead .......... (over-, under-) charged.

overhead

direct labour

21 If the actual direct labour cost is more than the estimate we will have overhead .......... (over-, under-) charged.

under

22 Since we could not wait until we knew the actual level of activity we made an estimate and had an amount of overhead under- or over- .......... at the end of the period.

over

79

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23 After charging out overhead at the estimated rate during the year, we could still re-compute the charges again at the end of the year. However we normally decide to leave the amount of overhead under- or over- ............ as a loss or profit in the income statement. An undercharge is a ............ (loss, profit) whereas an overcharge is a ............ (loss, profit).

charged

24 Overhead absorbed, overhead recovered, overhead charged, overhead allocated. These terms .......... (do, do not) mean substantially the same.

charged

loss

profit

25 Overhead rates relate overhead costs to a measure of activity and thereby ensure that overhead costs are .......... to the ..........

Do (see glossary for the finer points of the language)

26 Overhead under-charged indicates that the actual level of production was .......... (above, below) the expected level. In such circumstances the job costs include too little overhead and the true job cost is .......... (more, less) than the cost prepared using the estimated overhead rate.

charged

jobs

27 Conversely over-charged overhead indicates that the actual level of activity was .......... (above, below) the expected level. Job costs therefore tend to include too much overhead cost and therefore be too .......... (high, low).

below

more

80

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28 We think that at this point you should be allowed to express your thoughts about the programme!

above

high

29 Incidentally do you now understand that “under-absorbed overhead” is a ……. (profit, loss) and “over-absorbed overhead” is a ……. (profit, loss) in the income statement of the period?

Thank you!

30 List the different measures or activity which could be used for overhead rates.

Loss

Profit

(If not, do frames 18-29 again, please)

31 Now read again the summary of the set. Count up the number of your correct answers. If you have more than 24 correct, continue on to the next set. (But if you still feel a little unsure, do the set again anyway)

direct labour cost

direct labour hours

machine hours

prime cost

81

Chapter IV

COSTING METHODS

Set 7 CONTRACT, JOB AND BATCH COSTING


SUMMARY

In contract costing the unit of cost is one contract. Labour and materials and some other costs are direct contract costs. General overhead is charged to contracts on an appropriate basis.

In job costing we associate cost with a job. Labour and material are direct costs. Manufacturing overhead is charged on an appropriate basis. Sometimes selling and administrative overhead is charged to job costs, as a percentage of manufacturing cost, to compute total job cost.

The actual cost of the contract or job may subsequently be compared with the original estimate as a control on the:

1.Profitability of the job.

2.Efficiency of production operations,

and3.Accuracy of the estimating procedures.

The conservative practice is to ignore profit to date on jobs or contracts not yet completed. However, for contracts lasting several years it is customary to take credit for part of the profit each year, to avoid profit fluctuation.

Batch costing is job costing for a group or batch of identical products.

Chapter IV Set 7

CONTRACT, JOB AND BATCH COSTING

Exhibit 1 Contract cost

Contract No. 1

£

Estimated selling price

– Estimated total cost

150,000

100,000

= Estimated total profit

50,000

Actual cost to date:

Labour

20,000

Material

26,000

Direct services

14,000

Total direct cost

60,000

Overhead charged

20,000

Total cost to date

80,000

Proportion of profit earned to date

000

,

50

100

80

£

´

£40,000

Note:By taking a proportion of the profit of long term contracts each year we avoid wide fluctuation of profits.

However there may be unexpected losses on the remainder of the contract and it is not conservative to take the whole of the calculated £40,000 profit to date as profit in the income statement this year.

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correct answers

1 We can now discuss the various methods of cost accounting which differ according to the …….. of cost, or unit of …….. selected.


2 First read Exhibit 1, It shows an example of a ......... cost. The unit of production is one............

unit

production

3 The total estimated cost of the contract was £100,000 and the estimated selling price £........ Therefore the estimated total ......... amounted to £50,000. Have we earned all of this profit to date?

contract

contract

4 Up to the present time the contract is still un completed and the direct costs on the contract to date are labour £20,000, material £26,000 and direct services £........ This makes a total direct cost to date of £........

£150,000

profit

no

5 To this cost we have added a charge for over head £.......... at a rate of ........% of direct cost giving a total cost to date of £.........

£14,000

£60,000

6 It is more conservative not to take profits until the ........ of a contract, but as we have spent £80,000 cost out of a total estimated cost of £100,000 could we perhaps, after making reason able allowance for possible future losses, assume that the profit is earned in relation to the cost incurred? Or even be conservative and take only three quarters of this amount?

£20,000

331/3%

£80,000

85

Chapter IV Set 7

CONTRACT, JOB AND BATCH COSTING

Exhibit 2 Batch costing—estimated cost

Estimated

Cost

£

Labour:£

Dept. A15

Dept. B5

20

Material

10

Manufacturing Overhead:

Dept. A45 (300%)

Dept. B5 (100%)

50

Manufacturing Cost

80

Selling and administrative over-

head (10%)

8

Total Cost

88

Profit

12

Selling price

100

Note: A “batch” is a group of identical products.

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correct answers

7 Adopting these assumptions, the proportion of profit earned to date is :

¾

.........

000

,

50

000

,

100

..

..........

£

£

£

£

=

´

´

end (completion)

yes

yes

8 Thus in costing for long term contracts, we accumulate direct and indirect costs in the usual way and we may take credit for a …… of the profit in relation to the cost incurred, after making reasonable allowance for possible future..........

£80,000

£30,000

9 Now read Exhibit 2, which shows an example of ......... costing. A batch is simply a ........... of identical ............

proportion

losses

10 The direct costs of the batch amounted to £............

batch

group

products

11 The manufacturing overhead costs total £50 of which £45 relates to Department ......... and £5 to Department...........

£30

12 Does the business use only one overhead

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