Unit 5. Chapter 28. Costs

Question 1

Important concepts in costing methods (4) (Name)

Answer 1

• Cost centres
• Profit centres
• Over heads
• Units costs

Question 2

Def. Cost centres

Give examples

Answer 2

A section of a business, such as a department, to which costs are allocated or charged.
E.g.
• Manufacturing business: products, factories, departments.
• School: different subjects

Question 3

Def. Profit centres

Give examples

Answer 3

A section of a business to which both costs and revenues can be allocated - so profit can be calculated.
E.g.
• Each branch of a chain of shops
• Each department of the department store
• In a multi-product firm, each product in the overall portfolio of the business.

Question 4

Benefits and Limitations of dividing operations into cost and profit centres (3)

Answer 4

Benefits:
• Provide targets for managers and staff to work towards
• The targets can be used to assess performance
• Aids decision making
Limitations:
• Profit centres can have unnecessary competition
• Some costs (like indirect costs) can be impossible to allocate and cost and profit centres accurately
• Reasons for bad or good performance of a profit centre can be due to external factors

Question 5

How are overheads classified (4 main groups)

Answer 5

• Production overheads e.g. rent, depreciation of equipment
• Selling and distribution overheads e.g. salary, packing
• Administration overheads e.g. rent and rates
• Finance overheads e.g. interest on loans

Question 6

How to calculate unit cost?

Answer 6

Unit cost = total cost of producing the product/ number of units produced

Question 7

Def. Full/absorption costing method

Answer 7

A method of costing in which all fixed and variable costs are allocated to products or services.
Further explanation: Total overheads are allocated using one or more methods. E.g. Can be divided on the basis of office space taken up by each product or service.

Question 8

Benefits and limitations of full/absorption costing methodsp

Answer 8

Benefits:
• Easy to calculate and understand
• Relevant to single product business
• All costs are allocated - no costs are ‘ignored’
• Good basis for pricing decisions in one product firms
Limitations:
• Costs may not be allocated on the basis of actual expenditure e.g. A product can take up more space but use low-cost and easy-to-maintain machinery
• Cost figures can be misleading
• Must be used on the same basis to give accurate comparisons between years

Question 9

Def. Marginal/contribution costing method

Answer 9

Costing method that allocated only direct costs to cost/profit centres, not overhead costs.
This method concentrated on marginal costs and contribution of a product.

Question 10

Explain marginal costs and contribution of a product

Answer 10

• Marginal cost: cost of producing an extra unit (variable direct cost). e.g. if producing 100 units if $400 000, and 101 units is $400 050, then the marginal cost is $50.
• Contribution of a product is revenue gain from selling a product minus its marginal costs. (Not the same as profit as profit is calculated after deduction of overheads.) e.g. If the 101st unit is sold for $70, then contribution is $20.

Question 11

Using costing methods to decide whether to stop making a product

Answer 11

Using marginal costing method: showing managers which product or service is making the greatest or least contribution to overheads and profits.
Using full costing method: The manager may decide to stop producing a good that seemed to be making a loss, even though it might still make positive contribution. This will reduce overall profits of the business. This is because the fixed overhead costs will still have to be paid with less contribution to pay them.

Question 12

Should a business accept a contract or a purchase at below full cost? (decide using costing methods)

Answer 12

If a firm has spare capacity or if it is trying to enter a new market, the business can offer below full cost contracts or purchases.
E.g. Hotels can offer lower prices (below costs) in off peak seasons because it is better to earn some contribution than to leave rooms empty.
However,
• Existing customers may learn lower prices are being offered and demand similar treatment. If all services and products are sold below costs, it is unlikely that profits will be made.
• High prices can be the key feature in establishing the exclusivity of a brand -> lower prices ruin image
• Lower priced goods can be resold into high prices market.

Question 13

Benefits and limitation of contribution costing

Answer 13

Benefits:
• Avoids inaccuracies with allocating overhead costs
• Excess capacity is used more effectively
Limitations:
• Not appropriate for 1 product businesses as the revenue has to cover all of the fixed costs
• Products with low contribution can be a part of the range, and getting rid of that product can make the whole range less appealing.
• Overheads may be completely overlooked and contribution can be confused with profit.