Topic 1 - Costing Flashcards
What is cost accounting?
Cost accounting involves recording, classifying, and summarizing costs to help management with planning, control, and decision-making.
Who are the users of financial accounting and management accounting?
Financial accounting users are external stakeholders (SOFP and SOPL), while management accounting users are internal managers (Forecasts/Budgets).
What is the main difference between financial accounting and management accounting?
Financial accounting focuses on historical data and is legally required, whereas management accounting is forward-looking and used for internal decision-making.
Which of the following statements about cost accounting is true? A) It helps in forecasting future costs.
B) It is primarily concerned with financial reporting.
C) It only considers direct costs.
D) It does not assist in decision-making.
A) It helps in forecasting future costs.
Level of precision required in financial accounting and management accounting?
Financial is true and fair. Management is as accurate as possible
Rules surrounding financial accounting and management accounting?
Financial is set externally by law. Management is set internally.
Scope in financial accounting and management accounting?
Financial is wide: whole company. Management is narrow: specific part of the company.
Frequency required in financial accounting and management accounting?
Financial is annually/quarterly. Management is on demand.
What is a cost unit?
A cost unit is the basic measure of product or service in relation to which costs are determined. Note the output of a service organisation is much harder to measure than that of a manufacturer, because output is not standardised
Is the output of a service organisation harder or easier to measure than that of a manufacturer?
Note the output of a service organisation is much harder to measure than that of a manufacturer, because output is not standardised
Provide an example of a cost unit for a steelworks, hospital, and freight organisation.
Steelworks: Per tonne of steel
Hospital: Per patient treated
Freight organisation: Per tonne-kilometre
What is a freight organisation?
They organise the shipment of goods from one country to another. Help import and export goods.
What is a cost object?
A cost object is anything for which costs can be measured, such as a unit of product (e.g. a car), service unit (e.g. valet service of a car), department (e.g. the accounts department), or project (e.g. the installation of a new computer system).
Which of the following is NOT a cost object? A) A unit of product
B) A unit of service
C) A financial statement
D) A department
C) A financial statement
What is a controllable cost?
A controllable cost is one that can be influenced by management decisions.
Which of the following is an example of a controllable cost?
A) Rent
B) Staff salaries
C) Raw material costs
D) Inflation
Correct Answer: C) Raw material costs
What is a composite cost unit? Give an example
Composite cost units are made up of two elements and are used where a single measure would be inappropriate for control purposes.
For example, in a freight organisation the cost per tonne/kilometre (the cost of carrying one tonne for one kilometre) would be more meaningful for control than the cost per tonne carried, which would vary with the distance travelled.
Are these cost objects a sutable cost object? (Yes or No) Bar
Restaurant
Room/night
Meal served
Conference delegate
Fitness suite
Conference room/day
Yes:
Room/night
Meal served
Conference delegate
Conference room/day
Define Cost Classification
Cost classification is the arrangement of cost items into logical groups, for example by their function (administration, production etc) or by their nature (materials, wages etc).
What is the difference between direct and indirect costs?
Direct costs can be traced to a product, service, or department, while indirect costs cannot be directly attributed to a specific cost unit. Indirect production costs are those costs which are incurred in the course of making a product/service but which cannot be identified with a particular cost unit. Indirect production costs are often referred to as production overheads.
What are prime costs?
Prime costs consist of direct materials, direct labor, and direct expenses.
Prime Cost Formula
Prime cost = Total direct cost = Direct materials + direct labour + direct expenses
What is an idle time payment?
Waiting time for parts to be delivered. Idle time is paid time that an employee is unproductive due to factors that can either be controlled or uncontrolled by management.
What is a product cost?
Product costs are costs identified with goods produced or purchased for resale. They are therefore included in the value of inventory. As the goods are sold, their cost becomes an expense in the form of ‘cost of goods sold’.
What is a period cost?
Period costs are costs deducted as expenses during a particular period.
What is a fixed cost?
A fixed cost remains unchanged within a relevant range of activity levels. e.g. rent , salaries. Fixed costs are a period cost, in that they relate to a span of time; as the time span increases, so too will the fixed costs.
Which of the following is an example of a fixed cost? A) Wages of temporary workers
B) Factory rent
C) Raw materials
D) Commission on sales
B) Factory rent
What does a fixed cost graph look like?
Y axis is cost. X axis is Volume output (level of activity). Y axis is the same as cost is always consistent so straight line going out from Y (parallel to x axis).
What is a variable cost?
A variable cost increases or decreases in direct proportion to the level of activity. A variable cost tends to vary directly with the level of activity. The variable cost per unit is the same amount for each unit produced whereas total variable cost increases as volume of output increases.
Example of variable costs
VAT, Ingredients, Wages/Labour per hour
What does a variable cost graph look like?
Y axis is cost. X axis is Volume output (level of activity). Starts at zero and goes up diagonally
What is a semi-variable cost?
Semi-variable, semi-fixed or mixed costs are costs that are part fixed and part variable and are therefore partly affected by changes in the level of activity.
Example of semi-variable costs
Bills (as part fixed, part or additional variable), telephone bill, addtional pay for overtime work, commission based roles - base rate + commission on top.
What does a semi-variable cost graph look like?
Y axis is cost. X axis is Volume output (level of activity). Starts at a certain point of the y axis (this is the fixed part) and then from there it goes up diagonally (which is the variable part)
What type of graph are the below. In each case the vertical axis relates to total cost, the horizontal axis to activity level.
Each graph may be used more than once.
a) Electricity bill: a standing charge for each period plus a charge for each unit of electricity consumed.
b) Supervisory labour, which is paid as a monthly salary.
c) Sales commission, which amounts to 2% of sales revenue.
d) Machine rental cost of a single item of equipment. The rental agreement is that £10 should be paid for every machine hour worked each month, subject to a maximum monthly charge of £480.
e) Photocopier rental costs. The rental agreement is that £80 is paid each month, plus £0.01 per photocopy taken.
a) Electricity bill: a standing charge for each period plus a charge for each unit of electricity consumed. = SEMIVARIABLE
b) Supervisory labour, which is paid as a monthly salary. = FIXED
c) Sales commission, which amounts to 2% of sales revenue. = VARIABLE
d) Machine rental cost of a single item of equipment. The rental agreement is that £10 should be paid for every machine hour worked each month, subject to a maximum monthly charge of £480. = VARIABLE WITH A CAP THEN FIXED
e) Photocopier rental costs. The rental agreement is that £80 is paid each month, plus £0.01 per photocopy taken. SEMIVARIABLE
Total cost formula
Total cost = Fixed cost + (Variable cost per unit x number of units)
What does a Cost Card look like?
Production Costs - HEADING 1
Direct Production Costs (Prime Cost)
Indirect Product Costs (Production Overheads)
Non Production Costs - HEADING 2
Administration Cost
Selling and Distribution Cost
ALL THE ABOVE = Total Product Cost
A direct cost is a cost that can be traced in full to the product, service or department that is being costed
Indirect production costs are those costs which are incurred in the course of making a product/service but which cannot be identified with a particular cost unit.
Indirect production costs are often referred to as production overheads.
What is the relevant range?
The relevant range is the range of activity levels within which assumed cost behaviour patterns occur. For example, a fixed cost is only fixed for levels of activity within the relevant range, after which it could ‘step up’ or ‘step down’. The relevant range also broadly represents the activity levels at which an organisation has had experience of operating in the past and for which cost information is available. It can therefore be dangerous to attempt to predict costs at activity levels that are outside the relevant range (extrapolation).
What is responsibility accounting?
Responsibility accounting is a system of accounting that segregates revenue and costs into areas of personal responsibility in order to monitor and assess the performance of each part of an organisation
What is a responsibility centre?
A responsibility centre is a department or function whose performance is the direct responsibility of a specific manager.
Why should managers of responsibility centres only be held accountable for costs over which they have significant influence? 2
- Lack of motivation therefore don’t feel incentiviced to control costs. - Harder to measure your performance • Aids control – if you are to be held responsible for something, then you will pay extra attention in doing it correctly.
• Provides incentive – if you are rewarded for something which is in your control, you will try harder. If you are penalised for something which is beyond your control, you will have no incentive.
What is a controllable cost?
A controllable cost is one that can be influenced by management decisions.
What is a uncontrollable cost?
An uncontrollable cost is a cost that cannot be affected by management within a given time span.
Which of the following is an example of a controllable cost? A) Rent
B) Staff salaries
C) Raw material costs
D) Inflation
C) Raw material costs
Controllable or Not Controllable cost - Raw material purchase costs for the manufacture of a CD
Controllable - The purchasing manager can switch supplier if costs are too high
Controllable or Not Controllable cost - Raw material purchase costs (junior purchasing manager being appraised who has no authority to contract with new suppliers)
Not Controllable - The junior purchasing manager does not have the authority to contract with anyone else, so is stuck with the current costs
Controllable or Not Controllable cost - Staff costs of a company (whose costs have just increased due to the introduction of national minimum wage legislation)
Not Controllable - The imposition of a minimum wage means that the company cannot pay below a certain level
Controllable or Not Controllable cost - Photocopier costs of the sales department (sales department manager being appraised)
Not Controllable - The sales department manager is not responsible for the photocopier costs. They are arranged by IT
Controllable or Not Controllable cost - Petrol costs for a road haulage company
Not Controllable - While there is some variability of petrol prices between different petrol companies, the difference is small and is largely driven by global oil prices and government tax policy
Controllable or Not Controllable cost - Factory rent (existing lease currently up for renewal)
Controllable - Factory rent is usually not controllable; however, if the lease is up for renewal, the company can choose to renew or move to alternative premises
How is inventory valued in financial accounts?
Inventory is valued at the lower of cost and net realizable value.
What is inventory valuation?
Inventory valuation involves determining the cost of goods issued to production on a consistent basis.
What are the 3 ways a storekeeper might issue goods to customers in a number of different ways?
It is important to be able to distinguish between the way in which the physical items in inventory are actually issued and the way in which inventory is costed.
A storekeeper might issue goods to customers in a number of different ways:
• The oldest item in stock first, as this is about to go beyond its best-before date
• The newest item in stock, first as this is at the front of the shelf and within easy reach
• The product which is closest to hand first, which is in a box containing both new and old stock
By comparison, the cost of goods issued must be determined on a consistently applied basis.
What are the three main inventory valuation methods?
- FIFO (First-In, First-Out)
- LIFO (Last-In, First-Out)
- Weighted Average Cost
What is FIFO?
FIFO assumes that materials are issued in the order in which they were received, meaning the oldest inventory is used first.
Advantages of FIFO 3
Logical if the oldest inventory is likely to be used first
Easy to understand
Inventory valuation close to the current replacement cost
Disadvantages of FIFO 3
Cumbersome as each purchase needs to be recorded separately
Comparison of costs and decision making are complicated if prices are fluctuating
In times of high inflation the cost of inventory issues will lag behind current market value
What is LIFO?
LIFO assumes that materials are issued in the reverse order in which they were received, meaning the newest inventory is used first.
Advantages of LIFO 2
Inventory issued at a price close to the current market value
Managers more aware of up to date costs
Disadvantages of LIFO 2
Not usual that newest items are issued so not reflective of what is actually happening
Cumbersome to manage as (like FIFO) the purchases need to be kept separate in the accounting records
What are the types of weighted average pricing methods?
- Cumulative weighted average pricing
- Periodic weighted average pricing
What is cumulative weighted average pricing?
A weighted average price is recalculated whenever a new delivery of materials is received.
What is periodic weighted average pricing?
A single weighted average calculation at the end of the period based on all purchases during that period.
What is Cumulative weighted average pricing?
The cumulative weighted average pricing method calculates a weighted average price for all units in inventory.
A new weighted average price is calculated whenever a new delivery of materials is received into stores. Each issue of materials is priced at the most recent weighted average price.
What is the formula for calculating periodic weighted average price?
Periodic Weighted Average Price =
(Cost of Opening Inventory + Total Cost of Receipts) / (Units in Opening Inventory + Total Units Received)
This average price is used to value all the units issued and the units in the closing inventory.
Unless stated to the contrary, assume the cumulative method is required in an exam question.
Advantages of cumulative weighted average pricing 2
Fluctuations in price are smoothed out making decision making easier
Easier to administer than FIFO and LIFO
Disadvantages of cumulative weighted average pricing 1
Resulting value of inventory issues rarely same as what the items cost
With all average price systems where it is required that prices be kept up to date, in which one of the following situations is it not necessary to recalculate the average price?
A Each time an issue is made
B Each time excess material is returned from the factory floor to the stores
C Each time a purchase is made
D Each time an item is transferred into inventory from work in progress
A Each time an issue is made
Each time an issue is made the average price of remaining inventory items is not altered when an issue is made at the average price.
Each time a purchase is made it is likely to change the average price of the items held in inventory. If it is necessary to keep prices up to date, the average price must be recalculated each time a purchase is made at a different price. Similarly, if an item is transferred into inventory from work in progress or from the factory floor it is likely to change the average price of the items held in inventory.
How do different inventory valuation methods affect profitability?
Different methods result in different levels of profitability depending on price fluctuations.
Which inventory valuation method gives the highest closing inventory value during inflation?
FIFO (First-In, First-Out).
LIFO would result in the lowest closing inventory valuation
The weighted averages would result in a closing inventory valuation somewhere between LIFO and FIFO
What is absorption costing?
Absorption costing includes all fixed and variable production costs in the total cost of a product. Absorption costing is the method by which a share of total production overheads is added to the prime cost, in order to calculate the full production cost of a product/service per unit.
What is the objective of absorption costing?
The objective of AC is to calculate the full production cost for a unit of output. It does this by including an appropriate share of the organisation’s overheads in the total cost of a product.
What is the formula for Overhead Absorption Rate (OAR)?
OAR = Total Production Overhead / Activity Level
What are the steps in absorption costing? 3
- Allocate and apportion production overheads
Allocate whole cost items are charged to a cost centre.
Apportion cost items are divided between several cost centres. - Reapportion overheads in service centre costs to production centres
- Absorb overheads into cost units
An example of absorption costing step 2 Reapportion overheads in service centre costs to production centres
Factory cost centres can be broken down into two types:
* a) Production cost centres, through which cost units actually flow – these make the cost units.
* b) Service cost centres, which support/service the production cost centres and each other – production staff need somewhere to eat and somewhere to store the raw material for production, finished goods and so on.
We therefore need to transfer all service cost centre overheads to the production centres so that all production overheads for the period are shared between the production cost centres alone – as it is through these cost centres that cost units flow.
To reapportion service cost centre overheads to production cost centres, we use the ‘step down’ method.
The service department that serves most other service centres should be reapportioned first. We then ‘step down’ to the service centre that provides the second most service centres, and so on.
An example of absorption costing step 3 Absorb overheads into cost units
Step 3 – Absorption of overheads into production (cost units)
All of the production overhead costs have now been apportioned to the production cost centres. We now need to charge these to the cost units passing through the production cost centres. This is termed absorption. We are going to absorb an element of total production overhead into each cost unit. Production overheads are therefore included in the value of inventories of finished goods.
Non-production overheads eg administration, selling and distribution overheads are not included in the value of closing inventory
Which of the following is a method of absorbing overheads? A) Per unit
B) Per labour hour
C) Per machine hour
D) Percentage of direct materials/labour cost
E) Percentage of prime cost
All of the above
Where the OAR has been calculated using an activity other than units, some extra calculation will be required to get the cost for the cost card, what are the 3 steps?
a) Calculate the overhead absorption rate using an appropriate activity level (eg machine hours):
OAR = Production overhead Activity level (eg machine hours)
b) Find the activity level per unit (eg machine hours per unit) and then apply the OAR calculated to the specific unit:
OAR per unit = OAR per machine hour × machine hours per unit
c) Repeat for all production cost centres.
Remember each production cost centre may absorb overheads on a different basis.
Define a blanket absorption rates and departmental absorption rate?
A blanket or single factory overhead absorption rate is an absorption rate used throughout a factory for all units irrespective of the department in which they were produced.
Why do companies use a predetermined overhead absorption rates? 3
Businesses need to cost their production throughout the year, not just at the end of an accounting period.
A company would use a predetermined (estimated) rate rather than actual figures every month for the following reasons:
Many actual overheads are not known until the year end Overheads vary during the year
Activity level varies during the year
Predetermined OAR (Overhead Absorption Rate)
OAR = Budgeted overhead/budgeted activity
OAR per unit
OAR per unit = OAR per hour x number of hours per unit
Overhead absorbed
Overhead absorbed = Actual activity (hours or units) x OAR
Cost per unit manufactured in a batch
Cost per unit manufactured in a batch = Total batch cost / No of units in a batch
What is under-absorption and over-absorption of overheads?
Under-absorption occurs when overheads charged are less than actual costs, while over-absorption occurs when overheads charged exceed actual costs.
What is the formula for under/over absorption of overheads?
Under/over absorption = Actual overhead - overhead absorbed
Under = +ve = recognised too less so need to DR expense
Over = -ve = recognised too much so need to CR income
An adjustment to reconcile the overheads charged to the actual overhead is likely to be necessary. Any over absorbed overhead will be written as a credit (income), and any under absorbed overhead as a debit (expense), to the income statement at the end of the accounting period, in order that the actual overheads incurred during the period are correctly recognised.
What are the advantages of using predetermined overhead absorption rates?
- Helps in budgeting and cost control
- Accounts for fluctuations in costs throughout the year
- Avoids reliance on actual figures which may not be known until the year-end
What is the impact of predetermined overhead absorption rates?
They help compare forecasted overheads with actual overheads, highlighting over or under absorption.
Which costing method is best suited for long-duration projects?
Contract costing is appropriate for long-duration projects where costs are accumulated over time.
What is job costing?
Job costing is used when each cost unit or job is separately identifiable, such as in custom-made products.
What is batch costing?
Batch costing is similar to job costing, but applies to a batch of identical items.
What are the alternative approaches to costing? 4
- Job costing
- Contract costing
- Batch costing
- Process costing
What is job costing?
Job costing is used when each cost unit or job is separately identifiable, such as in custom-made products. Job costing is appropriate where each separately identifiable cost unit or job is of relatively short duration. Each job would be allocated a separate job number and costs would be accumulated against this number in order to determine the total cost of the job. For example, a builder fitting a bathroom.
What is batch costing?
Batch costing is similar to job costing, but applies to a batch of identical items. – for example, a batch of ball bearings.
The cost per unit manufactured in a batch is the total batch cost divided by the number of units in the batch.
Batch costing: Cost per unit
cost per unit manufactured in a batch = the total batch cost / the number of units in the batch.
What is contract costing?
Contract costing is appropriate where each separately identifiable cost unit is of relatively long duration. Contracts are often undertaken away from the organisation’s own premises. For example, the construction of an airport runway.
Each contract would be allocated a separate number and costs would be accumulated against this number in order to determine the total cost of the contract.
Because of the nature of contracts, there will usually be a high proportion of direct costs, although administrative/head office overhead might be absorbed into contract costs using some form of absorption basis.
What is process (continuous operation) costing?
Some organisations have a continuous flow of operations and produce a large number of identical products – for example, the production of chemicals, shower gel or bottled sauces.
Such operations often consist of a number of consecutive processes where the output of one process becomes the input of the subsequent process and so on until the finished output is produced.
How is the cost per unit calculated in process costing?
Cost per unit = Total Process Cost / Number of Units Produced in the Period
Which of the following is NOT a feature of process costing? A) Identifiable cost per job
B) Continuous production
C) Cost per unit determined at the end of a period
D) Costs are accumulated by process
A) Identifiable cost per job
Which costing method is best suited for long-duration projects?
Contract costing is appropriate for long-duration projects where costs are accumulated over time.
What is marginal costing?
Marginal costing considers only the variable production cost of a product or service. Fixed costs are treated as period costs and not included in inventory valuation.
COST CARD - MARGINAL COSTING
COST CARD - MARGINAL COSTING
Direct Materials
Direct Labour
Var Overheads
= Marginal Costing
What is absorption costing?
Absorption costing includes both variable and fixed production costs in inventory valuation.
COST CARD - ABSORPTION COSTING
COST CARD - ABSORPTION COSTING
Direct Materials
Direct Labour
Var Overheads
Fixed Overheads
= Absorption Costing
Define Contribution
Contribution is a fundamental concept in marginal costing. Contribution is an abbreviation of ‘contribution towards fixed costs and profit’. It is the difference between selling price and all variable costs (including non-production variable costs), usually expressed on a per unit basis.
What is the formula for contribution?
Contribution
= Sales - Var COS - Other Var costs (selling/admin)
OR
= Sales - Production and Non Production
Contribution is a fundamental concept in marginal costing. Contribution is an abbreviation of ‘contribution towards fixed costs and profit’. It is the difference between selling price and all variable costs (including non-production variable costs), usually expressed on a per unit basis.
How are fixed production overheads treated under marginal costing?
Fixed production overheads are treated as a period cost and are not included in inventory valuation.
How are fixed production overheads treated under absorption costing?
Fixed production overheads are treated as a product cost and are included in inventory valuation.
What is the difference between marginal costing and absorption costing in inventory valuation?
Marginal costing: Inventory is valued at variable production costs only.
Absorption costing: Inventory is valued at full production cost, including a share of production overheads.
Note. Contribution takes account of all variable costs. Marginal costing takes account of
variable production costs only. Inventory is valued at marginal cost
Note. Contribution takes account of all variable costs. Marginal costing takes account of
variable production costs only. Inventory is valued at marginal cost
SOPL UNDER MARGINAL COSTING
SOPL UNDER MARGINAL COSTING
Sales
Less Var COS
Less Other Var costs (selling/admin)
= Contribution
Less Fixed Costs (Production/Selling and distribution/Administration)
= Net Profit
SOPL UNDER ABSORPTION COSTING
Topic 1 Costing
SOPL Absorption Costing
Sales - HEADING 1
Less COS
: Opening Inventory
: Var Production Costs
: Fixed Production Overhead Absorbed
: Closing Inventory
: Fixed Overhead (under/over) Absorbed
Gross profit - HEADING 2
Less selling, administration etc costs (non-production) - inclu variable and fixed
Net profit - HEADING 3
How do stocks affect profits in marginal and absorption costing?
When stocks increase, absorption costing profit is higher than marginal costing profit. When stocks decrease, the opposite is true.
SIAM
Profits generated using AC and MC can also be reconciled as follows:
Stocks
Increase
Absorption profit
More
What is the formula for reconciling marginal costing profit and absorption costing profit?
Difference in marginal costing and absorption costing profit = Change in inventory units x OAR per unit
What factors cause the difference in profit between marginal and absorption costing? 3
- Production vs Sales levels
- Opening inventory vs Closing inventory
- AC profit vs MC profit
What are the advantages of absorption costing? 2
- Recognizes that selling price must cover all costs
- Complies with IAS 2 Inventories
What are the disadvantages of absorption costing? 2
- Profits can be manipulated by changing production levels
- Based on the assumption that overheads are volume related
What are the advantages of marginal costing? 3
- Highlights contribution and is useful for decision making
- Fixed costs are treated in accordance with their nature
- Profit depends on sales and efficiency, not production levels
What are the disadvantages of marginal costing? 3
- There is a danger that contribution fails to cover fixed costs
- Does not comply with IAS 2
- Requires analysis of mixed costs between fixed and variable
