Elements of Costing Flashcards
Things Businesses Gather Information On
Sales transactions, data on costs associated with business processes, records of people employed by the business, inventory files
Why Business Managers Gather Information
Make decisions, make plans, control
Short Term Decisions
For example, which products to make and how much raw material to order
Long Term Decisions
For example, which products to stop making and how many staff to employ
Make Plans
Business has to look forward to plan its long-term operations, usually involving the preparation for budgets,which are financial plans for either the whole or part of the business for a period of time in the future
Control
Management will be concerned with how the business has actually performed in comparison with budgets set out in the previous period
Financial Accounting
Involves the production of financial accounts, which are a historic record of all the organisation’s statements. Normally include: statement of financial position (balance sheet), statement of profit or loss (profit or loss account). Typically produced annually, presented in set formats which are laid down by law. Usually provided to external groups, e.g. potential (or existing) investors or tax authorities, show how business has performed over a period of time.
Management Accounting
Provides information to internal users, e.g. managers. Normally includes: preparation of budgets + comparison to actual results, calculation of costs of manufacturing products that the business sells. Tend to be produced on a regular basis (often monthly) and can be in any format. Contain whatever info management feels will be useful. Typically forward looking and try to predict future costs/income to help managers make key business decisions
Cost Units
An individual unit for which the costs can be separately identified. Usually a product that the company makes, such as a particular car
Cost Centres
A part of the business for which costs can be separately determined. For a car manufacturer, there could be several, such as warehouse or factory. Each will have different sets of costs attributed to it.
Profit Centres
Similar to a cost centre, but has identifiable revenues in addition to costs. A car manufacturer’s sales division would have both costs (inc. salaries and rent) and revenue (sales of cars to customers) that could be directly attributed to it
Investment Centres
Similar to a profit centre, but occurs when the manager of the centre is responsible for costs, revenues and the level of investment in assets within the division. For example, manager of car manufacturer’s sale division may have control over office’s expenditure on computers and furniture. This would mean the division would be an investment centre
Cost Classification by Function
Split costs into 4 types: cost of sales (production costs), selling and distribution, administrative costs, finance costs
Cost of Sales
Known as production costs. Could include: production labour, materials, supervisor salaries and factory rent
Selling & Distribution
Includes any cost involved in selling, advertising or distributing our product, and may include sales team commission or delivery costs
Administrative Costs
Includes head office costs, IT support and human resource management costs
Finance Costs
Refers to money paid to providers of finance (e.g. banks) and includes bank charges, and interest charged on loans
2 Issues when Classifying Costs by Function
1) Examine what the company produces or the service it offers, e.g. book publisher buys paper - cost of sale, but car manufacturer buys paper, used at head office and likely an administrative cost
2) look out for depreciation - measure of how much an asset is wearing out or being used up. Classification will depend on the asset - depreciation of delivery vans would be distribution cost, but depreciation of production machine would be cost of sales
Cost Classification by Element
Costs Classified by what type of cost they are. 3 types: materials, labour and overheads
Materials
Costs of the purchases of raw materials to be used in the manufacturing process in a manufacturing organisation, OR the cost of purchasing goods that are to be resold in a retail organisation
Labour
Consists of the costs of business employees, such as basic pay, overtime, commissions and bonuses
Overheads
Also known as ‘other expenses’ - costs incurred by the organisation other than labour and materials, such as rent, rates, heat and light, cleaning, advertising etc.
Cost Classification by Nature
Helpful when wanting to calculate cost per unit. 2 types: direct costs and indirect costs
Direct Costs
Costs that can be directly traced to individual units of production (cost units). May include direct materials and direct labour, which could be traced to an individual item (e.g. serial number on a car chassis). Total direct cost may also be known as prime cost
Indirect Costs
AKA overheads - costs incurred by the company which cannot be traced to any one finished unit. For example, factory rent - does not link to a specific product
Variable Costs
Costs that vary directly with the level of activity, most costs are variable (make fewer units, buy fewer materials and will save on labour costs)
Fixed Costs
Costs that are not affected by changes in the level of activity, for example annual building rent
Semi-Variable Costs
Costs that have both a fixed and variable element, for example cost of electricity will include a fixed standing charge followed by a variable cost based on the amount of electricity used
Stepped Costs
Costs that are fixed up to a certain level of activity, but which rise to a higher fixed level if activity goes beyond that range, for example, supervisor salaries, if the business needs one supervisor per every 50 production staff
Combining Cost Classifications
You can use more than one classification at a time for many costs, for example factory rent is both fixed and indirect, and direct materials are a production cost and also variable
High-Low Method
If semi-variable cost has both a fixed and variable element, it stands to reason that total cost = fixed cost + (variable cost per unit X activity level)
Cost Classification by Behaviour
How costs will change in relation to the level of activity
Code
A system of letter and/or numbers designed to be applied to a classified set of items, to give brief, accurate reference, which helps entry into the records, collation and analysis
Codes are Designed to
Facilitate data processing
Enable logical arrangement of records
Simplify comparisons of similar expenses
Types of Codes
Numeric
Alphabetic
Alpha-numeric
Direct Materials
The materials that are used directly as part of the production of the goods that the organisation makes, for example fabric or buttons at a shirt factory
Indirect Materials
Other materials used in the production process which are not used in the actual products themselves. May also include the cost of certain materials that are too small to bother tracing to individual products. For example, at a shirt factory, the oil to lubricate the sewing machines, diesel to power a machine or thread for sewing on buttons
Prime Cost
The total direct cost for a product (direct materials and direct labour costs of producing it)
Methods of Pricing
FIFO - first in first out
LIFO - last in first out
AVCO - average cost or weighted average
FIFO
First in first out, assumes that the issues into production will be made from the newest inventory available, leaving the most recent purchases in inventory, for example milk in a dairy
LIFO
Last in first out, assumes that the issues into production will be made from the newest inventory available, leaving the oldest purchase in inventory, for example a computer manufacturer wanting to use the most up-to-date processors in production
AVCO
Average cost or weighted average, assumes that the issues into production will be made at an average price, which is derived from taking the total value of the inventory and dividing it by the total units in inventory, hence giving average price per unit. For example, a builder’s merchant selling sand, or paint manufacturer
Advantages of FIFO
Up to date inventory value at SOFP date
Disadvantages of FIFO
Out of date valuation on issues (if prices change or old inventory held)
Tedious record keeping
Identical jobs have different costs
Advantages of LIFO
Up to date valuation of issues
Disadvantages of LIFO
Out of date closing inventory value (if inventory purchased some time ago)
Tedious record keeping
Advantages of AVCO
A compromise on inventory valuation and issues
Simpler record keeping
Disadvantages of AVCO
Calculation of weighted average tedious (on every receipt/issue)
The average price rarely reflects the actual purchase price of the material
Unit Basis
Each unit gets the same level of overhead
Labour Rate Basis
Overheads are absorbed at a rate per direct labour hour. This means that for every hour someone works on the unit, an hour’s worth of overhead is given to the unit as well
Machine Hour Basis
Overheads are absorbed at a rate per direct machine hour. This means that for every hour of machine time worked on the unit, an hour’s worth of overhead is given to the unit as well
Ways to Calculate Pay
Time related pay
Output related pay
Time Related Pay
Employees are paid for the hours they spend at work, regardless of the amount of output or production they achieve. Split into two types: salaried employees and hourly-rate employees
Salaried Employees
Have their pay agreed at a fixed amount for a period of time, regardless of the number of hours the employee works in the period. Salaried staff will form part of an organisation’s fixed costs
Hourly-Rate Employees
Paid a set amount for each hour that they actually work. These employees will form part of an organisation’s variable costs
Overtime
The number of hours worked by an employee which is greater than the number of hours set by the organisation as the working week. Can be earned by both salaried and hourly-rate employees, and often paid at a higher rate than standard hours
Overtime Premium
The amount over and above the normal hourly rate that employees are paid for overtime hours
Output Related Pay
AKA piecework or payment by results, where a fixed amount is paid by unit of output produced, irrespective of the time taken
Advantages and Disadvantages of Piecework
Employees can earn whatever they wish (within reason)
The harder an employee works, the more they earn
Accurate recording of the output of each employee is required
Product quality could be compromised if employees rush to earn more
If company does not need extra units, employee will earn nothing
Piecework with Guarantee
If the employee’s earnings for the number of units produced in a period are lower than the guaranteed amount, then the guaranteed amount is paid instead
Bonuses
May be paid for many reasons, and to any number of employees in a company. Can be paid to both time related and output related employees
Bonus Caps
Where a bonus is paid for achieving a certain level of output, a cap will be placed so that it can only be paid up to a certain level
Variance
The difference between actual and expected income or costs
Favourable Variance
When the actual cost is lower than expected, or when actual income is higher than expected. Favourable because both will have the effect of increasing profit
Adverse Variance
When actual cost is greater than expected, or when actual income is lower than expected. Adverse because both will have the effect of reducing profit
Reporting Variance
May be asked to report to relevant person, for example: sales variance to sales manager, materials price variance to purchasing manager, materials usage variance to production manager, labour variance to production manager
