Chapter 1: Cost classification Flashcards
In simple terms, what is financial accounting and what parties is it for?
Financial account can be described as ‘keeping score’. The Financial accounts use historic records of transactions and are presented in standard format laid down in law.
These normally include:
The Statement of profit and loss (SoPL)
The statement of financial position (SoFP).
These records are for external parties, such as investors, HMRC, Bank lenders etc.
In simple terms, what is management accounting and who are the interested parties?
Management accounting provides information for internal users, such as; line managers, department managers and CEOs.
Management account can draw from financial accounting records, but it has no formal layout and the information can be historic and forecasting likely future results.
Management accounting information can presented in any format that is useful to the business and in time frames that are relevant. i.e. monthly.
What are the core aims of management accounting?
The core aims are to assist with;
> Planning
to help prepare annual budgets.
> Co-ordinating
Planning enables different departments to work to common goals.
> Controlling
comparing actual results with predicted results helps identify areas where things aren’t going to plan.
> Communicating
Producing reports and budgets to managers helps to communicate the aims of the business to those managers.
> Motivating
Management accounting includes target setting. These motivate managers and staff to to improve their performance.
How can management information be useful?
Information should be;
> Relevant to their responsibilities
For example, a production manager will want information about inventories, production levels, performance etc.
> Relevant to a particular decision
For example, if deciding to close a division, managers would need to know the likely costs, including lost sales, likely redundancies.
> Timely
Information must be up to date and produced in a time frame that is useful.
> Value
The benefits of having the information must outweigh the cost of producing it.
What is a ‘cost unit’ (AKA unit of output)?
A cost unit is how much it costs a business to produce one unit of output. For different businesses this could mean different things.
For a car manufacturer this could be the cost to produce one car.
For a printing firm, it could be the cost per print.
For a paint shop, it could be the cost of 1L of paint.
For an accountancy firm, it might be the cost per client.
What are cost centres?
Cost centres are a small part of a business for which costs are determined.
Examples may include; > Research and development department. > HR > A warehouse > A factory in a specific location
How are cost centres subdivided?
Cost centres can be subdivided into;
> A cost centre
When a manager is responsible for the costs of the department, but not revenue or investment.
e.g. research and development.
> A profit centre
When the manager of the profit centre is responsible for the costs and revenue, but not investment.
e.g. supermarket manager, pub manager etc.
> An investment centre
An investment centre is when the manager of the centre (usually division) is responsible for costs, revenue and investment.
e.g. a US subsidiary of a global firm. The CEO would usually have authority to open new factories etc.
How are costs classified?
The acronym FERB can be used to remember cost classifications.
F - Function
E - Element
R - Relationship
B - Behaviour.
What does cost classification by ‘function’ mean?
For financial accounting, costs split into functions have the following categories:
> Cost of sales
Also known as production costs. This category would include production labour, materials, supervisors salary and factory rent.
> Distribution costs
These include selling and distribution costs, such as the sales team and delivery costs.
> Administrative costs
This includes head office, IT support, HR and so on.
> Finance
This refers to money paid to lenders, such as banks.
What does cost classification by ‘element’ mean?
To classify costs into elements, you would split costs into;
> Materials
Raw materials for manufacturing, or alternatively the cost of goods sold in a retail organisation.
> Labour
Labour costs can consist of not only basic pay, but overtime, commission and bonuses.
> Overheads
This is ‘any other expenses’, such as; rent, electricity, depreciation and so on.
What does cost classification by ‘relationship’, or ‘nature’ mean?
Costs classed by nature can be either:
> Direct
A cost that can be attributed to a single cost unit.
e.g. A car engine in a car manufacturing factory.
> Indirect
A cost that can’t be attributed to a single cost unit.
e.g. Factory rent, supervisor pay (indirect labour), distribution costs.
What does cost classification by ‘behaviour’ mean?
Costs cab be identified by how they behave:
> Variable costs.
These are costs that vary (usually presumed to be in direct proportion to activity levels).
e.g. if a cost unit costs £10 per unit, 100 units will cost £1000 and 200 units will cost £2000.
> Fixed costs.
These are costs that don’t change regardless of production levels.
e.g. building rent
> semi - variable costs.
These are costs that have a fixed and variable element.
e.g. electric bill may have a fixed cost for factory lighting and a variable element for production machinery, depending on level of activity.
> Stepped costs.
These are costs that are fixed to a point, then jump up to the next level.
e.g. a factory with rent of £40,000 may have an output of 100,000 units. If a company wanted to produce more than the 100,000 they would need to secure a second factory with a second fixed cost for rent.
How does classifying costs by element of nature help accountants?
Element and nature cost classification can be useful to management accounts to help them establish product production costs and how much each unit should be sold for.
How does classifying costs by behaviour help management accountants?
Behaviour cost classification can be useful for budgetary forecasting.
How does classifying costs by function help management accountants?
Classifying costs be function best helps accountants for financial reporting.
