Topic 4 - costing?

Question 1

what is the definition of traditional absorption costing?

Answer 1

Also known as full costing, absorption costing is an approach that takes account of all of the cost of producing a particular product or service. In absorption costing, the cost of an individual unit produced will include direct materials, labour, and fixed and variable manufacturing overhead costs.

• the logic of full costing is that the entire cost of running a facility, such as an office or factory, must be regarded as part of the cost of the output that it helps to generate.

Question 2

why would managers want to know the full cost?

Answer 2

1) pricing and output decisions: can help managers make decisions on price to charge customers, as well as determining number of units produced when combined with relevant information concerning prices.
2) Exercising control: where reported full cost figure is considered too high, could lead to finding new sources of supply etc or opportunities for saving etc..
3) Assessing relative efficiency: can help compare cost of carrying out an activity in a particular way or place
4) assessing performance : to measure the profit arising from a particular product or service, the sales revenue that it generates should be compared with the costs consumed in generating that revenue.

Question 3

what are the three stages of dealing with overhead costs?

Answer 3

1) cost allocation
2) cost apportionment
3) cost absorption

Question 4

what is the cost per unit for a single product firm?

Answer 4

total costs of output / number of units produced

= process costing

Question 5

what is the cost per unit for batch costing?

Answer 5

cost of the batch(direct and indirect) / number of units in batch

Question 6

what is the full absorption cost for a multi product business?

Answer 6

= direct and indirect costs

Question 7

what are some problems with process costing?

Answer 7

cost of depreciation only an estimate, and problems with raw materials costs. can also be problems in calculating how much output was produced

Question 8

what costing approach is used for a multi product business and why is process costing inappropriate?

Answer 8

job costing approach is used - process costing is inappropriate because for example, to assign the same cost to each car repair carried out by a garage, irrespective of the complexity and size of the repair

Question 9

what is the job costing approach?

Answer 9

involves accumulating costs for each individual unit of output in order to determine its full cost. for this you need to understand the difference between indirect and direct costs

Question 10

what is the difference between gross markup and gross margin?

Answer 10

Definition of Gross Margin
Gross margin or gross profit is defined as net sales minus the cost of goods sold.

However, some people intend for the term gross margin to mean the gross margin as a percentage of sales (or percentage of selling price). Others will use the term gross margin ratio to mean the gross margin as percentage of sales or selling price.

Example of Gross Margin
If a retailer sells a product for $10, and its cost was $8, the gross profit or gross margin is $2.

The gross margin ratio is 20%, which is the gross profit or gross margin of $2 divided by the selling price of $10.

Definition of Markup
Markup in dollars is the difference between a product’s cost and its selling price. [Note: some retailers may use the term markup to mean an additional markup from an earlier selling price.]

The markup is also expressed as a percentage of cost (not selling price).

Example of Markup
Assume that a product has a cost of $8 and the seller sets a selling price of $10. In dollars, the markup is $2 (the same as the $2 gross profit).

However, the markup is usually expressed as a percentage of the product’s cost (not its selling price). Therefore, the $2 markup divided by the product’s cost of $8 results in a markup that is 25% of cost.

Thus, if a retailer wants its income statement to show a gross profit that is 20% of sales, the retailer must mark up its products’ costs by 25%

Question 11

what are some problems associated with indirect costs?

Answer 11

how can they be assigned to individual cost units?

Question 12

what is the overhead absorption rate?

Answer 12

budgeted overhead / budgeted level of activity

– a means of attributing overhead to a product or service based for example on direct labour hours, labour cost or machine hours

Question 13

what is the 2 step process for dividing overheads between cost centres?

Answer 13

cost allocation - allocate indirect cost elements that are specific to particular cost centres. (part of the direct cost of running the cost centre) examples include; salaries of indirect workers whose activities are wholly in the cost centre, rent and electricity where they can be separately identified

cost apportionment - apportion the more general overheads to the cost centres, overheads that relate to more than one cost centre, perhaps all of them. it would include; rent, where more than one cost centre is housed in the same building, electricity where it is not separately measured, salaries of cleaning staff who work in a variety of cost centres.

Question 14

what are the 7 steps in having overheads handled on a cost centre basis

Answer 14

1) allocate specific cost centre overheads to the relevant cost centre
2) general overheads between cost centres
3) total the allocated and apportioned overheads to total for each cost centre
4) apportion service cost centre costs to product cost centres
5) total the product cost centre overheads
6) calculate a cost centre overhead absorption rate for each product cost centre
7) cost units absorb overheads as they pass through product cost centres.

Question 15

what is batch costing?

Answer 15

Batch costing is another form of job costing. Under this method, homogeneous products are taken as cost unit. A batch consists of a specific number of products or units or articles. The number varies from one batch to another. Hence, batch cost is used to determine the cost per unit or article per unit

Question 16

what are some errors with full (absorption) costing and estimation?

Answer 16

while deriving the full cost of some activity can be done after the work is completed, it is frequently estimated In advance. this may be because some idea of full cost is needed as a basis for setting a selling price. however, where actual outcomes differ from estimated outcomes, an over recovery or under recovery of overheads will normally occur.

Question 17

how can the overheads absorbed for the year be calculated

Answer 17

overheads absorbed = overhead recovery rate x actual direct labour hours

Question 18

what is full cost plus pricing

Answer 18

a business may seek to set its selling prices by simply adding a profit loading to the full cost of a product or service, the amount of profit is often calculated as a percentage of the full absorption cost figure.

Question 19

what is the difference between price makers and price taker?

Answer 19

A price maker is the opposite of a price taker: Price takers must accept the prevailing market price and sell each unit at the same market price. Price takers are found in perfectly competitive markets. Price makers are able to influence the market price and enjoy pricing power.

Question 20

what is an alternative fo full absorption costing?

Answer 20

variable ( maringal costing) = Marginal costing is the accounting system in which variable costs are charged to cost units and fixed costs of the period are written off in full against the aggregate contribution.

Question 21

what are key differences between the two approaches?

Answer 21

Variable costing, profit influenced only by changes in sales, however absorption costing profits influenced by changes in sales and production. page 407

Question 22

what are the limitations of traditional absorption costing?

Answer 22

assumes products consumer recourses in relation to volume measures

it can give distorted product cost where a diverse range of products with a high and low volume exists

hence it provides inadequate information for managers to make informed decisions about ; accurate costing of production and so whether it is profitable or not, whether the existing cost attribution practises reflect the resource consumption of a companies different product lines

therefore, activity based costing developed as a response to this

Question 23

what is activity based costing

Answer 23

aims to overcome problem of overheads linking to particular units of output. done on the basis that the particular units of output that cause overheads are linked to them

the cost of support activities goes to make up total overhead costs

the purpose of tracing activity costs in this way provides a more realistic, and finely measured account of the overhead cost element for a particular unit of output.

Question 24

to implement a system of ABC, managers must begin by carefully examining the businesses operations. what will they need to identify?

Answer 24

each of the various support activities involved in making products

the costs to be assigned to each support activity

the factors that cause a change in the costs of each support activity ; cost drivers.

Question 25

what are ABC’s view of activities?

Answer 25

unit level activities - performed each time a unit is produced

batch related activities - performed each time batch of goods is produced

product sustaining activities - enable production or sale of individual products

facility sustaining activities - general support activities such as plant management and property

Question 26

what are the benefits of ABC?

Answer 26

cost reduction as better understanding of costs

ability to build in low cost production through new product design

more accurate product / service pricing

more management focus on potentially unprofitable products
more focused product marketing

Question 27

how does assigning over heads work for ABC?

Answer 27

Once the various support activities have been identified along with their costs and the factors that drive the costs, ABC requires three steps:

1) establishing overhead cost pool for each support activity. one cost pool for each separate cost driver
2) assigning the total cost associated with each support activity to the relevant cost pool
3) charging the units of output with the total cost within each pool using the relevant cost driver - involves dividing the amount in each cost pool by the estimated total usage of the cost driver to derive a cost per unit of the cost driver. this unit cost figure is then multiplied by the number of units of the cost driver used by a particular unit of output, to determine the amount of overhead cost to be attached to it.

Question 28

differences between traditional and activity based costing

Answer 28

both approaches: adopt two stage allocation process for assigning overheads. traditional, overeheads usually first assigned to the product cost centres, the costs accumulated in the cost centres are then charged to units of output using overhead recovery rate. its ABC approach, overheads are first assigned to cost pools and costs accumulated are then charged to units of output using the driver rate for each activity

traditional - cost centre usually based around a department whereas a cost pool in ABC - usually based around an activity

Question 29

benefits of abc

Answer 29

more accurate cost figure for each unit of output

helps product profit ability

help managers gain better understanding of business operations

In turn should improve performance

Question 30

costs of abc

Answer 30

can be costly - setting up and updating the costing system

can be complex and time consuming, paritularly with a large number of activities and cost drivers

management reports therefore likely to be complex

measurement and tracing problems

also critisiced the same way as traditional costing for not providing relevant information for decision making

Question 31

how does percentage of differenct sectors who use ABC differ?

Answer 31

predominately finance and commercial sectors, least is manufacturing

Question 32

what Is cost based pricing

Answer 32

Establish cost per unit – options include MC, prime cost, full cost
Calculate price using target mark-up or margin - The profit added to the full cost or marginal cost of a product may be expressed in one of two ways:
Percentage of sales, such as 20% margin
Percentage of cost of sales, such as 20% mark-up

Often used as a starting point even when using other methods

Question 33

advantages and disadvantages of cost plus pricing

Answer 33

Advantages
Widely used and accepted.
Simple to calculate if costs are known.
Selling price decision may be delegated to junior management.
Justification for price increases.
May encourage price stability.

Disadvantages
Ignores link between price and demand.
No attempt to establish optimum price.
Which absorption method? 
How much % return?
Does not guarantee profit 
Which cost?
Inflexibility in pricing.
Circular reasoning