2 Costing Key Principles

Question 1

What are financial accounts?

Answer 1

• Preparation of statutory financial statements for external users
• In accordance with GAAP/IFRS/IAS
• Typically prepare income statements with absorption costing

Question 2

What are management accounts?

Answer 2

• 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

Question 3

What is a cost

Answer 3

A monetary unit measure of the resource sacrificed or forgone to achieve a specific objective such as acquiring a good or service

Question 4

What is a cost object?

Answer 4

Any activity that someone wishes to determine the cost of
* Can be a product (table)
* A service (auditing)
* A customer (Tony’s account)

Question 5

What is a direct cost?

Answer 5

A cost that can be traced back to a cost objective
* For example, cost of materials

Question 6

What is direct labour?

Answer 6

The cost of labour to make a product
o Hourly wage of assemble workers x time to make a unit

Question 7

What are indirect / overhead costs?

Answer 7

• 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

Question 8

What are product costs?

Answer 8

• Costs relating to goods purchased or produced
• For manufacturing three main elements are:
  o Direct materials
  o Direct labour
  o Manufacturing overheads

Question 9

What are period costs?

Answer 9

• 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

Question 10

What are variable costs?

Answer 10

Costs that varying in direct proportion to level of activity

Question 11

What are fixed costs?

Answer 11

Costs that do not vary in relative to activity

Question 12

What are mixed costs?

Answer 12

• Some costs have a fixed and a variable component
• A van might cost £500 a month and £0.20 a mile

Question 13

What are some ways of calculating mixed costs?

Answer 13

• 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.

Question 14

What is variable costing?

Answer 14

Considers the costs of direct material, direct labour, and only variable manufacturing overheads

Question 15

What is absorption costing?

Answer 15

Considers the costs of direct materials, direct labour, variable manufacturing overheads and fixed manufacturing overheads.

Question 16

What is a relevant cost or revenue?

Answer 16

Future costs and revenues that will change based on a decision

Question 17

What is an irrelevant cost or revenue?

Answer 17

Future costs and revenues that will not be changed by a decision

Question 18

CVP assumptions

Answer 18

• 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

Question 19

What is CVP?

Answer 19

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.

Question 20

What is contribution margin?

Answer 20

The amount of sales that contributes to fixed costs and profits

Question 21

What is the contribution margin formula?

Answer 21

Contribution margin = Sales - Variable cos

Question 22

What is contribution margin per unit?

Answer 22

How much more profit will be made if an additional unit is sold
o Given production is above break-even point

Question 23

What is the contribution margin ratio?

Answer 23

The CM ratio can be used to predict the amount of extra contribution to be earned if sales revenue increases

Question 24

What is the formula for contribution margin ratio?

Answer 24

(Contribution margin / Sales) × 100

Question 25

What is the formula for break even sales?

Answer 25

Total fixed costs / Contribution margin per unit

Question 26

What is break even sales?

Answer 26

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

Question 27

Formula for break even sales value?

Answer 27

Break even units × selling price per unit
or
Total fixed costs / CM ratio

Question 28

Units needed for target profit formula

Answer 28

(Total fixed costs + Target profit) / Contribution margin per unit

Question 29

What is the degree of operating leverage?

Answer 29

Operating leverage is how sensitive profit is to a change in sales

Question 30

Degree of operating leverage formula?

Answer 30

Contribution margin / Profit

Question 31

Break even analysis with multiple products

Answer 31

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