2 Costing Key Principles Flashcards
What are financial accounts?
- Preparation of statutory financial statements for external users
- In accordance with GAAP/IFRS/IAS
- Typically prepare income statements with absorption costing
What are management accounts?
- Intended for internal stakeholders (managers)
- Might not be prepared in accordance with regulations as made to best suit users
- Management typically care more for each line item than the overall statement and therefore use variable costing
What is a cost
A monetary unit measure of the resource sacrificed or forgone to achieve a specific objective such as acquiring a good or service
What is a cost object?
Any activity that someone wishes to determine the cost of
* Can be a product (table)
* A service (auditing)
* A customer (Tony’s account)
What is a direct cost?
A cost that can be traced back to a cost objective
* For example, cost of materials
What is direct labour?
The cost of labour to make a product
o Hourly wage of assemble workers x time to make a unit
What are indirect / overhead costs?
- A cost that cannot be directly traced back to a cost objective
o Repairs to factory and supervisor salaries - Indirect manufacturing costs are absorbed by products
What are product costs?
- Costs relating to goods purchased or produced
- For manufacturing three main elements are:
o Direct materials
o Direct labour
o Manufacturing overheads
What are period costs?
- Costs not included in inventory calculation
- They are not allocated to a cost objective and are written off in the period
o Sales and distribution costs
What are variable costs?
Costs that varying in direct proportion to level of activity
What are fixed costs?
Costs that do not vary in relative to activity
What are mixed costs?
- Some costs have a fixed and a variable component
- A van might cost £500 a month and £0.20 a mile
What are some ways of calculating mixed costs?
- There are several different techniques by which mixed costs may be analysed into their fixed and variable components.
- The most popular techniques (in order of accuracy, from lowest to highest) are the High-Low Method, the Scatter Graph Method, the Least-Squares Regression Method, and Multiple Regression Analysis.
What is variable costing?
Considers the costs of direct material, direct labour, and only variable manufacturing overheads
What is absorption costing?
Considers the costs of direct materials, direct labour, variable manufacturing overheads and fixed manufacturing overheads.
What is a relevant cost or revenue?
Future costs and revenues that will change based on a decision
What is an irrelevant cost or revenue?
Future costs and revenues that will not be changed by a decision
CVP assumptions
- The selling price per unit of products stays the same throughout the accounting period (e.g. a year)
- Variable costs per unit are assumed to stay the same throughout the accounting period (normally a year).
- CVP analysis apply only to the relevant range (expected range of operation)
- Fixed costs remain fixed within a certain relevant range (and Sales and production volumes given in a CVP problem are assumed to fall within this relevant range).
- Costs can be divided into fixed and variable components
- CVP analysis apply only in the short-term
- Profits are calculated on a variable costing basis
- Total costs and total revenue are linear functions of output
o Note: some questions might have different assumptions
What is CVP?
Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit.
What is contribution margin?
The amount of sales that contributes to fixed costs and profits
What is the contribution margin formula?
Contribution margin = Sales - Variable cos
What is contribution margin per unit?
How much more profit will be made if an additional unit is sold
o Given production is above break-even point
What is the contribution margin ratio?
The CM ratio can be used to predict the amount of extra contribution to be earned if sales revenue increases
What is the formula for contribution margin ratio?
(Contribution margin / Sales) × 100
What is the formula for break even sales?
Total fixed costs / Contribution margin per unit
What is break even sales?
It is useful for a business to know the level of sales at which it breaks even, i.e., it makes neither a profit nor a loss. We can calculate break-even sales in both volume (units) and monetary (£, €, $, Ұ) terms.
Will be when profits are zero
Formula for break even sales value?
Break even units × selling price per unit
or
Total fixed costs / CM ratio
Units needed for target profit formula
(Total fixed costs + Target profit) / Contribution margin per unit
What is the degree of operating leverage?
Operating leverage is how sensitive profit is to a change in sales
Degree of operating leverage formula?
Contribution margin / Profit
Break even analysis with multiple products
If the products are sold in a fixed ratio (5 red or every yellow) then a bundle can be created.
This can then act as the base unit for production
Just make sure to separate out again at the end
