Finance (Question 2) Flashcards
Direct Costs (Statement)
1
Overheads (Statement)
1
Define ‘Direct Costs’
Direct costs are those that are related to a given cost object (product, department etc.) and that can be traced to it in an economically feasible way.
Define ‘Indirect Costs’
Indirect costs are related to the particular cost object but cannot be traced to it in an economically feasible way.
Define ‘Variable Costs’
Variable costs vary in direct proportion with activity (i.e., change in total in proportion to changes in the related level of total activity or volume).
Define ‘Fixed Costs’
Fixed costs remain constant over wide ranges of activity (i.e., do not change in total for a given time period despite wide changes in the related level of total activity or volume)
Define ‘Prime Costs’
Prime cost the accumulation of all the direct costs
Define ‘Period Costs’
Period costs are non-manufacturing costs such as training, advertising and invoice (debt) collection.
Period costs are not attached to the products and are not included in the inventory (stock) valuation.
All period costs will be recorded as an expense in the current accounting period.
e.g.
£15,000 advertising is a period cost.
£16,000 marketing and attending trade fair is a period cost.
Define ‘Product Costs’
Product costs are those costs that are attached to the products and therefore included in the inventory (stock) valuation.
Calculate ‘Product Cost’
Rent and business rates absorbed on basis of area 90,000/3,000sq.metres = £3 per sq metre
Utility bills absorbed on the value of plant 42,000/150,000 = 0.28 per £
Service centre split on call outs 8,800/2,200=£4 per call out
Calculate ‘Prime Cost’
Rent and business rates absorbed on basis of area 90,000/3,000sq.metres = £3 per sq metre
Utility bills absorbed on the value of plant 42,000/150,000 = 0.28 per £
Service centre split on call outs 8,800/2,200=£4 per call out
Prime cost:
- 336,000/8000 = £42
- 308,230/6,500 = £47.42
Explain the ‘Pricing Mechanism’
The pricing mechanism is governed by the laws of demand and supply.
Demand is the amount of a good and service demanded at a particular price.
Supply is the amount of a good or service that is supplied at a given price.
For demand in general if price increases the quantity demanded will fall.
For supply if price increases the amount supplied will increase.
Price below equilibrium excess demand, margins too low or loss made suppliers leave, price goes back up. From firm- can sell all but will not miss out on potential profit.
Explain how Market Prices are determined
The market price is where demand meets supply.
Where the price is above this there will be an excess of supply and lack of demand will reduce price to sell. From a firm viewpoint price above equilibrium stock will be unsold as customers buy cheaper substitutes.
Price below equilibrium excess demand, margins too low or loss made suppliers leave, price goes back up. From firm- can sell all but will not miss out on potential profit.
(Suitable diagram could be added).
Explain the effect of the Life Cycle on a pricing decision
Life cycle likely to be 2 years of patent and then competitors can compete
Increased suppliers after 2 years will push price down
If only supply of a new product at beginning of life cycle will have high demand and can charge a premium price.
Demand may well be inelastic so an increase in price will not reduce quantity demanded.
On launch need to quickly recoup any patent cost R&D costs.
Company may have other development costs on products that never make it market to recoup.
Also need to recover other period costs. Any price well in excess of £660 accepted.
Only 3 marks if don’t relate to scenario and just discuss life cycle.
State what is included in Product Costs
The product cost will be:
Explain how a ‘Management Accountant’ can help in the running of a company
Specialists in the provision of financial information for use within the business.
- Present your company’s financial picture clearly to bankers and potential investors
- Track and use information about any aspect of your business that can be quantified.
- Management accounting offers the advantage of current and relevant numbers that show which parts of your business are profitable and how your overall financial performance has unfolded over time.
Define ‘Absorption Costing’
Absorption costing is the way a business will be able to obtain the production cost for its output, that is the direct costs plus indirect production overheads
Define ‘Market Pricing’
The market price will be the point where the demand and supply curve intersect, this is the market equilibrium.
If the price is set any higher than Market Price supply will outstrip demand forcing suppliers to cut their price.
If the price is any lower than Market price demand will outstrip demand and customers will be forced to pay more for the goods and services.
Market pricing is relevant for those goods and services where there are a large number of buyers and sellers, with lots of similar products.
Define ‘Cost Plus Pricing’
This approach to pricing first establishes the cost and then adds on a ‘plus’ factor - the required level of profit.
Cost plus pricing or absorption pricing based on the level of overheads is dangerous as the overheads are high and it is important that they are allocated realistically or a profitable product may look unprofitable.
