Week 6 - Costs for Management Decision Making

Question 1

What is inlcuded in Costs of Sales?

Answer 1

• Cost of sales is the product (or service) cost => Production Costs
  
  • The cost of providing a service
  • The cost of buying goods sold by a retailer
  • The cost of raw materials and production costs for a manufacturer
• Cost of sales are the direct or prime costs, indirect costs or production overhead

Question 2

What is included in Expenses? (subtracted from gross profit to get operating profit)

Answer 2

• Period costs: Non-production overhead
• Selling, administration (and finance expenses)

Question 3

What is the purpose of overhead allocation? /what is it?

Answer 3

• The process of spreading production overhead (i.e. indirect costs) equitably over the volume of production

Question 4

What is the overhead allocation problem?

Answer 4

Overheads can be arbitrarily allocated across products/services which can lead to inappropriate pricing and misleading information about product/service profitability

Question 5

What are the three methods for Overhead allocation?

Answer 5

1. Variable costing
2. Absorption costing
3. Activity-based costing

Question 6

What are the two ways to calculate the budgettet overhead rate for the absorbtion method?

Answer 6

Business wide

By cost centre

Question 7

What are the three steps in the absortion method when using cost centre rates?

Answer 7

1. Identify indirect costs with particular cost centres where possible
2. Determine a suitable method of allocating other costs across the cost centres
3. Allocate service cost centre costs to production cost centres

Question 8

What are the three steps for activity based costing?

Answer 8

1. Trace costs for business processes to cost pools
2. Identify cost drivers for each cost pool
3. Determine number of activities for each cost driver

Question 9

Difference between absorbtion costing and activity based costing (ABC)?

Answer 9

Absorption vs. Activity-based Costing

• Under both methods, direct labour and material costs are the same and the total overhead incurred is the same
• Under absorption costing, overheads are allocated in proportion to an arbitrary allocation base, typically direct labour hours - the more labour hours allocated to a product/service, the more overhead will be allocated to it.
• Under activity-based costing, overheads are traced through their drivers (the causes of activity) to the product/services that consume those activities - the more overheads a product/service causes to be incurred, the more overheads will be allocated to it.

Question 10

Formulae for sensitivity analysis

Answer 10

• Net profit = revenue – (fixed costs + variable costs)w