lecture 15 workbook: cost accounting systems Flashcards
what is cost behaviour and its purpose
the analysis of cost by behaviour - entails determining how a cost will vary if the level of the activity in the organisation varies
purpose: enable us to analyse cost into its 2 distinct behaviours = fixed costs vs. variable cost
what categories can costs be classified by behaviour into
- variable cost
- fixed cost
- semi variable cost
- stepped cost
what are variable/ marginal costs
costs that vary directly with the level of output
- the higher the output, the higher the level of total variable cost into
- variable cost per unit is however a constant amount within the relevant range
what are fixed costs
costs that dont vary with the level of output within the relevant range
semi variable cost
costs that contain both fixed and variable elements
- total cost is generally a semi variable cost
what is traditional absorption cost
a full costing approach which is required by the accounting standards and the law
- both variable and fixed production costs are charged to units produced
- the value of the units in closing inventories consist of variable production cost and fixed production overhead
- the format of an absorption costing income statement is the normal financial accounting format prescribed by accounting standards
what are stepped costs
costs that are fixed within a relevant range but increase by a constant once the maximum capacity is reached
what is marginal costing
known as variable costing, direct costing and contribution approach
- not allowed for use in financial accounting
- only the cost that is charged to units produced are variable production cost - direct materials, direct labour and variable manufacturing overhead
- all fixed costs is treated as a period cost and expensed totally in the period
- the value of the units in closing inventories only consists of variable production costs
what is the concept of contribution
contribution = sales - total variable cost
what are the main differences between absorption costing and marginal costing
there is only one difference that cause the difference in net profit
- the difference in profit is due to treatment of fixed production overhead
- marginal costing treats fixed production overheads as a period cost (expense)
- absorption treats fixed production overheads as a product cost
how does different periods of inventory levels affect absorption costing and marginal costing
- in periods of rising inventory levels, production exceeds sales = absorption costing produces higher net profit and ending inventory valuation
- cuz in absorption costing, fixed overheads are allocated to each unit of production included in inventory valuation.
- When production exceeds sales, some of the fixed overheads costs remain in ending inventory rather than being expenses
- this defers part of the fixed costs to future periods = higher net profit
- in periods of falling inventory levels, sales exceeds production, marginal costing produces a higher net profit
- when inventory decreases, the previously deferred fixed costs are released from inventory and expensed in the cost of goods sold = increased net profit
- under marginal costing, fixed overheads are always expensed in full during the period incurred
- since the fixed costs were already accounted for in previous periods, net profit remains higher
argument for using marginal costing
- simple to operate - no need to compute the fixed overhead absorption rate
- profit is a function of sales, not production = the only way to increase profit is to increase sales - profit cannot be increased simply by increasing production units only
- useful for use by internal management for planning and decision making purposes
BUT cannot be used for external financial reporting purposes
argument for absorption costing
- in period of rising inventory levels, this method gives higher net profit and closing inventories values = enhancing the balance sheet value
- absorption costing must be used for external financial reporting purposes in accordance with accounting standards
what does cost volume profit study
it is the study of the interrelationships between costs, volume and profit at various levels of activity
- used by managers for more than just the initial determination of break even point or the activity required for a specified target income
- helps managers in the decision making process = allows them to see how proposed changes in the selling price and cost structure affects the breakeven point and target income activity level
what are the assumptions that CVP analysis relies on
- changes in revenues and cost occur only because of changes in output
- total costs can be separated into fixed and variable costs
- revenues and cost are linearly related to output within the relevant range
- unit selling price, unit variable cost, and fixed costs are known and constant
- the analysis only covers a single product/ product mix
- the analysis is not impacted by the time value of money
what is the break even point
it is the point of no profit, no loss
- point at which the contribution margin provided by the units sold is equal to the fixed cost for the period
- it is the output level at which the total revenues equal to the total costs - operating revenues is equal to zero
- since total costs = sum of total variable costs and total fixed costs - breakeven point is the output at which total contribution margin equals total fixed costs
breakeven point = fixed costs / contribution margin
target operating profit = (fixed costs + TP)/ contribution margin
what is margin of safety
its the difference between the actual sales level and break sales level
- can be expressed in sales units or sales dollar value
- gives an indication of the level of risk involved
the larger the margin of safety the better
margin of safety = budgeted output - breakeven point output
margin of safety
= (budgeted output - breakeven point)/ presented output x 100
what are the limitations of cost volume analysis
- the analysis assumes a linear revenue function and a linear cost function
- the analysis assume that what is produced is sold
- the analysis assumes that fixed and variable costs can be accurately identified
- analysis assumes that selling prices and costs are known with certainty
