Cost Accounting Flashcards
What is Absorption Costing?
- This is when all production costs are absorbed into products, and any unsold inventory is measured at total production cost.
- This means a share of the fixed production overhead is allocated to the individual products and is included in the cost of a unit.
- this is called Full Costing
- this is required to be used for external reporting purposes under IFRS and US GAAP.
What is Marginal Costing?
- this is Variable Costing
- only variable costs are allocated to products.
- unsold inventory is measured at variable cost of production
- fixed production costs are treated as period costs and assigned to the period in which they are incurred.
- used for short-term decision making
- sales minus variable costs = contribution margin
- Contribution margin includes the fixed production costs, other overheads and profit
- used to help make decisions when the level of production changes.
How is ABC different from Absorption Costing?
- Absorption Costing (AC) uses one factor in the production process to calculate how much production overhead should be included in the cost of each unit of production. Usually time.
- ABC uses more than one factor, which is useful for a range of products with:
- a wide variety of complexity
- variety of values
- incurring substantial production overheads
Keywords used for ABC-
- Cost Drivers
- allocation of costs to cost pools
- overhead absorption rate (overheads / production volume)
Limitations of Absorption Costing:
- best to use when fixed production overheads are low
- good to use when manufacturing mainly consists of direct materials and direct labour
4-step process to determine cost allocation under ABC:
- For each activity, indentify the activities and group overheads into Cost Pools.
- Determine the Cost Driver for each activity.
- Calculate a cost per unit of the cost driver. Cost driver rate = total cost of activity / cost driver
- Absorb activity costs into production based on the usage of cost drivers.
What is a Cost Pool?
This involves grouping overheads that are caused by the same activity.
What are the features of a cost driver?
- it should be a good explanation of the cost
- relevant and identifiable with the product
- easily measurable
- easy to obtain
Types of Cost Drivers (ABC)
- Transaction Drivers (number of times an activity is performed, pe number of quality inspections)
- Duration Drivers (the amount of time an activity takes, pe to install a machine)
- Intensity (a charge each time an activity is performed)
Advantages and disadvantages of using ABC for more complex situations:
Advantages:
1. Provide a more accurate costing per product for a range of very different products.
2. Because of the details required to put it in place, this data can be useful for future budgets, forecasting and decision making
3. By having a good overview of the relationship between costs and activities, ABC gives a clearer understanding of what drives overheads.
4. ABC recognises that many indirect costs are not volume based and help identify spare capacity.
Disadvantages:
1. Requires detailed analysis of processes
2. Is time-consuming
3. Is expensive
4. Requires a more complex digital system to manage ABC and produce relevant reports.
6 External stakeholders:
- Lenders
- Suppliers
- Tax authorities
- Local Community
- Customers
- Shareholders
Types of costs:
Manufacturing costs:
- Direct materials (variable)
- Direct labour (variable)
- Manufacturing overhead:
- Variable overhead (packaging for example)
- Fixed overhead (rent of factory)
Non-manufacturing costs:
- variable costs (selling per unit for example)
- fixed costs (advertising)
How to calculate inventory:
Opening inventory
-/- units sold
+ units produced
= closing inventory
Movement in inventory =
The difference between opening and closing inventory
What costs to include to cost something for future decision making:
Relevant costs:
- future costs and benefits
- scrap value of a machine you’re going to sell as a result of the decision
- the value of the inventory that you would receive if you were to use/sell it elsewhere.
Irrelevant costs:
- historical costs. Like inventory already purchased.
- depreciation cost
6 Areas Covered by the CGMA Transformation model:
- Engendering a cost-conscious culture.
- Managing the risks inherent in driving cost-competitiveness
- Connecting products with profitability
- Generating maximum value through new products
- Incorporating sustainability to optimise profits
- Understanding cost drivers
What are direct costs?
Costs directly traceable to a cost object.
Without the cost unit, this cost would not exist.
For example: prime costs = indirect costs of production
What is an indirect cost?
These costs cannot be identified specifically and exclusively with a particular cost object.
They are common to a number of objects.
These costs are called Overheads.
Example: Production Overheads
What are product costs?
These are costs associated with goods purchased or produced for resale.
What are period costs?
These are costs not included in the inventory valuation.
They are expenses in the period in which they occurred.
What are indirect expenses?
These include costs that cannot be directly traced to a cost object (product or service).
For example rent of a factory or depreciation of machinery.
What are variable costs?
Costs that vary in direct proportion to the changes in volume of activity.
Examples of Cost Drivers:
- number of labour hours worked
- number of quality inspection processes
- number of customers
- number of component parts in a product
What is a fixed cost?
These are costs not affected by the level of activity for a specified period.
Stepped fixed costs
Stepped fixed costs stay initially the same and then go up in steps , as activity increases in volume.
Semi-variable costs
This is a variable cost that doesn’t change at the same proportion when the level of activity changes.
For example minimum cost followed by a proportionate increase when a certain level is reached.
Or a retainer plus a fee per activity.
Marginal costing pros:
- Fixed costs are often less relevant for short-term decisions. It can be misleading to include these costs.
- In MC profit does not fluctuate due to movements in inventory. Because the fixed costs are included as period costs. Instead profit is driven by sales volume.
- It negates the risk of carrying forward fixed costs that will not be recovered through future sales.
Absorption costing pros + 1 con:
- Consistent with financial reporting (IAS2) Inventories
- Consistency of internal and external reporting
- Long-term recovery of fixed costs
- Seasonal demand leading to profit distortions. Fixed costs are spread out over the units. So if sales are slow the losses are smaller than when using MC, where fixed costs are allocated in the period they occur.
- if the overheads are high, absorption costing reflects the cost per unit more accurately, while the cost per unit in this case under MC will be very low. - More useful type of costing when determining selling price.
Con:
The absorption rate (absorption of the fixed cost per unit) is wrong when the level of production changes.
What is Throughput accounting?
This method only classes Direct Materials as a variable costs.
All other costs are Fixed Costs = Total Factory Costs
Or TFC Conversion Costs
Throughput Contribution =
Sales - Direct Material Costs
All other costs are period costs.
Profit = Throughput contribution - all TFC and operating expenses
Throughput Performance Indicator:
What is Return per Factory Hour
TP Contribution per unit / number of factory hours per unit
Throughput Performance Indicator:
What is Cost per Factory Hour
TFC / Total Number of Factory Hours
Throughput Performance Indicator:
What is TP Accounting Ratio
Return per factory hour / Cost per factory hour
Ratio needs to be > 1, in order to cover the factory costs.
Throughput Accounting cons:
- it’s considered only useful in the short term
- in the long term, all costs are influenced by volume of units produced in some way.
2 Types of Cost Centres:
- Production Cost Centres
- Service Cost Centres
What is apportioning costs:
To spread them out over several cost units or cost centres
How to calculate the Overhead Rate:
Cost centre production overheads / cost centre direct labour hours or machine hours
What is Standard Costing:
The practice of substituting the expected costs of manufacturing a product or delivering a service for the actual cost in the accounting records.
Why use variances?
They provide a starting point for judging the effectiveness of managers in controlling the costs for which they are held responsible.
4 Types of standards in standard costing:
- Ideal standards
- Basic standards = often costs set at inception of the business. Not relevant after a while.
- Attainable standards (usually the basis of Variance analysis)
- Current standards (taking into account current abnormal circumstances)
What is variance analysis:
Comparing actual performance at the end of a period to the standard costing.
What is a Flexed Budget?
It shows the sales revenue and variable costs Flexed to the actual sales volume.
To measure the price variance:
- Use actual volume * the difference in actual price v. Standard price
To measure a volume variance, use:
(Actual volume v. Standard volume) * the Standard Price
Calculation of Labour Rate Variance:
Actual Hours Paid * (standard rate - actual rate)
Labour efficiency rate =
(Standard hours - actual hours (excluding idle hours) * standard rate
Labour idle time variance =
(Actual hours worked - actual hours paid) * standard rate per hour
Idle time is always an adverse variance, as it’s usually not included in the standard cost card
Variable overhead variance =
Actual hours worked * (standard rate - actual rate per hour)
Variable overhead efficiency rate =
(standard hours - actual hours) x standard overhead hourly rate
The standard overhead rate per hour = the absorption rate, rather than just the pay rate. (Which gives the Labour efficiency variance)
Fixed overhead variance =
Budgeted fixed product overhead -/- actual fixed production overhead
Fixed overhead volume variance =
(Actual production -/- budgeted production) x standard fixed overhead per unit
Fixed overheads expenditure variance and marginal costing:
There is no flexed budget, as the total standard fixed costs are the same regardless of the volume sold or produced.
So you’re just comparing standard fixed overheads to actual fixed overheads.
No need to first adjust to a flexed budget.
Fixed Overhead variance using Absorption Costing:
Here you need to first update the costs to a flexed budget, as the fixed overheads are spread out over the units.
The Total Fixed Overhead variance = the difference between the actual FO and the Flexed Budget FO
Fixed Overhead Variance can be divided in:
- fixed overhead expenditure variance AND
- fixed overhead volume variance
Which can be split in: - FO Capacity Variance AND
- FO Efficiency Variance
To calculate FO Capacity and Efficiency Variance, we need FO absorption rate per labour hour =
Total budgeted fixed production overheads / total budgeted labour hours
FO Capacity Variance =
This measures the total number of labour hours to achieve the actual production compared to labour hours budgeted to produce the standard number of units.
(Budgeted labour hours - actual labour hours) X Standard FO absorption rate per hour
FO Efficiency Variance
(Standard labour hours - actual labour hours) X Standard FO absorption rate per hour
= the FO volume variance
FO capacity variance + FO efficiency
Controllable Variance Factors:
These provide opportunities for improvements in subsequent budget periods
6 Uncontrollable planning factors contributing to variances:
(PESTEL)
1. Changes in legislation
2. Technological advancements
3. Social factors
4. Changes in the economy
5. Weather conditions (environmental changes)
6. Actions of competitors
Sales mix quantity variances:
Step 1: work out actual sales volume in actual mix in %.
Step 2: work out actual sales volume in standard mix (difference with step 1 gives Sales Mix Variance) (multiply by Standard Profit)
Step 3: budgeted sales volume in standards mix (Difference with step 2 gives Sales Quantity Variance)
- Sales Mix Variance +/- Sales Quantity Variance = Sales Volume Variance
6 Causes of variances:
- The type of standard set (ideal, attainable or current)
- Wastage
- Economies of scale
- Learning effect
- Inflation
- Skills mix
Variances are interdependent:
Example:
More expensive materials, can lead to efficiency or labour savings.
Overabsorption =
When too many overheads were included in the annual absorption rate.
We can now add this portion of the overheads that we didn’t spent back in as profit.
Under-absorption =
Is when we under-estimated our overheads. We need to deduct the additional overheads spent from our profit.
How to move to Absorption Costing: 4 Steps
1) identify Cost Centres and allocate overheads to the cost centres
2) decide what cost centres are production centres and which ones are services cost centres + Apportion the overheads pro rata to the correct cost centres.
3) Re-apportion the Service Cost Centres, over the Production Cost Centres
4) Apportion the overheads to cost units of production (= labour hours or number of units produced)
Why do we need to know the cost per unit?
- To decide what the selling price is going to be.
- To value inventories
- For budgeting and planning
- to measure performance (variances and KPIs).
Why do we need to know the cost per unit?
- To decide what the selling price is going to be.
- To value inventories
- For budgeting and planning
- to measure performance (variances and KPIs).
SIAM
When Stocks Increase Absorption Costing Profit is More.
How to calculate difference in profit between Marginal Costing and Absorption Costing:
Change in the number of units x OAR (Overheads Absorption Rate or Fixed production cost per unit.)
What’s the job of a management accountant:
- Costing
- Planning & budgeting
- decision making
- Control (KPIs & Variances)
- Performance Evaluation
Types of decision making:
- Strategic planning (5-10yrs)
- Tactical planning (medium term - in 12 months time)
- Operational planning (day-to-day)
ABC costing classifications:
- Unit level costs
- Batch level costs (like machine set-up)
- Product sustaining cost ( design costs)
- Facility level costs (overheads, like admin costs)
Why calculate Throughput ratio: 3
- To compare and decide if products are viable/profitable
- to be calculated per product for comparison.
- needs to be higher than 1. Otherwise Factory Costs (Fixed Costs) not covered.
Throughput ACC: 2 reasons not to withdraw a loss-making products. (TPR lower than 1):
- Product may be linked to other product
- Company may want to optimise machine hours available.
What are Joint products?
2 products that are made together in the same process.
What is a by-product:
It’s a product that gets produced by accident during a production process. It’s a waste product.
For example: wood chippings during tree surgery.
Accounting treatment of a by-product and of joint products:
- Sale proceeds of the by-product are subtracted from the joint costs of the process.
- the Net total cost of the process is split between the joint products:
a) on a physical unit basis Or
b) the Market Value at the point of separation basis. (Market is the number of units produced x the sales price) (This method always leads to a profit, as the outcome is linked to the sales price.)
NOTE: To calculate the cost using the Market Value, use the number of units produced, not the number of units sold.
What is the Net Realisable Value in Joint Cost Accounting:
- It’s the Market Value minus the costs that were made after the products were separated.
- once you’ve calculated the cost at separation, you need to add the additional costs to get the full cost cards for each of the products.
Why is it more difficult to use traditional costing for Digital Products:
- Marginal costs are often zero
- lifespan can be uncertain
- overheads and drivers are difficult to identify.
- Rapid changes in technology can affect costs and selling prices with little warning
- potentially large upfront costs, can incur royalties, testing and marketing
- can evolve over different accounting periods.
What is the purpose of the Cost Transformation Model:
Implementing areas in the business to ensure the company is constantly working towards working in a cost-effective way and how to optimise more and reduce costs.
- introduce a cost conscious culture
- understand cost drivers
- managing risks
- connecting products with profitability
- look at producing new products in a profitable way
- work in a sustainable way
Digital Costing Systems:
= Expensive to implement, but cost-saving once implemented. A clever system that can work out the cost of complex production scenarios, incl supplier lead times, buying behaviour, recommendations for changes to product design etc.
- Target Costing = first looking at the possible sale price in a competitive market. Then work backwards to decide on the profit margin and what the costs can be.
When do you need linear programming:
When you try to work out the optimal production subject to more than 1 limiting resource.
6 Steps of Linear Programming:
1) Define the variables (these are the items that could be a constraint, for example Demand of the product, Materials, Labour hours)
2) Formulate an equation for the objective function = what is the maximum contribution going to be.
3) Formulate an equation for the constraints.
- formulate a formula separately for each constraint.
4) graph the constraints, shade the feasible region and label its vertices
5) plot the iso contribution line and use it to find the optimum solution.
6) Confirm solution with simultaneous equation
2 Methods to work out Linear Programming:
- Simplex: the actual calculation, which we don’t need to learn
- Plot and interpret the information from a graph. Understand and be able to explain what the graph tells us.
What is the area called in a Linear Programming graph, which represents the different amount of product combination a company could produce, taking into account all constraints (materials, labour hours etc)
Feasible area
What is the line called in a Linear Programming graph, that shows the contribution for a certain number of product combinations.
- The Objective Line (it’s the objective of what we are looking to achieve - maximum contribution)
OR - the ISO-Contribution Line (ISO means the Same. So anywhere on that line generates the same contribution)
How to work out maximum contribution in Linear Programming:
Solve the equation of the 2 constraint lines that meet. Example:
If this is maximum materials and max. Labour:
- put both equations one under the other.
- multiply one of them, so one of the variables is the same. (For example they both contain 5S).
- Then you can drop the 5S in both and will now what the other variables is, if S is zero.
- you can then work out what S is, of E is zero, by either one of the equations.
What is Spare Capacity or Slack in Linear Programming:
These are the resources that are not used at full capacity, due to other constraints.
What is the additional called, that a company is prepared to pay, over and above the current resource price per unit:
The Shadow Price or Dual Price
What do you know about the Shadow Price:
This is the value of the Extra Profit that would result if one extra unit of the limited resource was available.
NB: if there is slack, then the Shadow Price is nil.
Which fixed overhead variance is not relevant in absorption costing a d why?
Fixed overhead volume variance.
Because the fixed costs are absorbed per unit.
What does an Operating Statement look like and what is its purpose:
List:
Original budgeted profit
+ or -/- Each Variance for Variable Costs
+ or -/- Fixed cost variance
= Actual profit
How to absorp Fixed Costs into a unit, when using Absorp Cost:
By dividing total Fixed Costs by Total Number of Labour Hours for the total number of units made.
Then work out how many hrs are required at that cost for 1 unit.
What does the Operating Statement look like using absorption costing:
Budgeted profit
+/- Sales Volume Variance
+/- Sales Price Variance
+/- the different variable cost variances
+/- Fixed Overhead Expenditure Variance
+/- Fixed Overhead Volume Variance
When deducting Fixed Overhead Volume Variance from Budgeted Profit, in an operating statement, when is it Favourable and when is it Adverse.
If Actual is more the variance is Favourable. So needs to be added to the budgeted profit.
If Actual volume is lower, the variance is Adverse and needs to be deducted from profit.
Analysis of the Fixed Overhead Variance.
Why does it occur:
- we need to look at the Labour hours:
1) Capacity Variance (was the actual number of working hours available higher than the budgeted hours. More overtime or extra staff)
(Actual hours -/- Budgeted hours) x (Standard Fixed Labour Rate)
2) Efficiency variance:
Did the workers, work quicker?
(Actual Hours -/- Budgeted hrs for the actual volume) x (Standard Fixed Labour Rate)
Planning Variances
These are Variances we can’t control.
For example if the price increases of raw materials or of distribution, due to increased oil prices, we have no control over this.
We need to update our budget and do this by using the planning variance:
Number of Hours expected for labour for the Actual Production of units. So adjust to Actual Production of units.
X (the new standard price —/- the old standard price)
Operational Variances
Are variances that we can control and that management will be interested in. They represent performance.
Sales Volume Variance:
- Difference in actual sales versus budgetted sales
- this times the Standard Profit or Margin
Which two factors influence the outcome of the Sales Volume Variance in a Sales Mix:
1) if we sell more products, we make more profit (actual volume x standard profit)
2) it could be that the sales mix has changed. So we could have a lower profit, because we sold more products than expected with a lower margin, rather than with a higher margin.
Sales mix variance =
Work out the percentage of a certain product sold as part of a mix, looking at the Actual Mix.
400 units =
200 prod A = 50%
100 B = 25%
100 B
- update the budgetted mix number of units to match the percentages of the Actual mix.
Then multiply by the Standard Profit.
