Transcript costs

COSTING
What is costing
• In cost accounting we analyse costs and calculate the cost
for each unit of production
• Cost depends upon the judgement of the cost accountant in
each situation
• The cost of a product purchased for resale is the price we
pay
• If we make the product the cost of the product includes
Material, Labour and Overheads (other costs)
• The cost of those units of a product sold is not the same as
the total cost of materials, labour and overhead since some
of those costs may relate to unsold units
Example
• Cost of one product: Product X
Material – 3 tons @ £5 per ton
Labour – 5 hours @ £1 per hour
Overhead – 5 hours @£2 per hour
£
15
5
20
10
£30
Variable
Costs
Fixed Costs
The overhead is Estimated and added to the cost of
material and labour to give the total cost of Product X
Classification of Costs
• Costs can be classified into the following areas
Fixed Costs; Variable Costs; Semi variable costs; Direct
costs; Indirect Costs
• Exercise 1 Complete the definitions below
• Fixed costs
• These are costs which will not vary with output but may
change over time. eg Rent & Rates, Heating,
Depreciation.
• Variable Costs
• These are costs which WILL vary with output. The
more produced, the greater the cost eg material, labour,
royalties
Classification of Costs
• Semi Variable Costs
• These costs have a FIXED and a VARIABLE part eg
maintenance costs will have a fixed level for standard
repairs but will also include a variable element for
unscheduled repairs
• Direct Costs
• These are costs that can be traced back to a certain
product – eg cost of raw materials. They can be traced
to a specific cost unit – eg wages
Classification of Costs
• Indirect costs
• These are costs which can’t be traced back to any
individual product – eg electricity, rent and rates etc
• In deciding the cost and possible selling price of a job, the
direct costs of labour and material are easy to identify.
• The main problems arise in charging appropriate amounts
for overhead and profit
Costing
• To determine a fair manufacturing overhead for a job we
find a relationship between the total manufacturing overhead
cost and some known direct costs.
• For example the overhead could be made up of a % of direct
labour or of prime cost
• We may then add a profit % to the total cost to calculate the
estimate selling price
• However
• The customer and the market for the product decide the
actual selling price of the job
Job Costing
• Used to calculate manufacturing costs when the
organisation is making different product for
different customers
• Where each job is different
• Used by Contractors, builders, engineers
Job Costing
• Before an order for a job is placed the customer is
given an estimate of the total cost which includes an
estimate for materials and labour
• It is simpler to estimate material costs than it is
labour costs
Exercise 2
• Job 366X. The direct labour cost in Department A (where 20 hours work
is involved) is £30
• The direct labour cost in Dept B (where 8 hours of work is involved) is
£5.
• The direct material cost is £20
• Production department overheads are recovered at the rate of £1 per hour
in Department A and at a rate of £2 per hour in Department B.
• What is the manufacturing cost of the job
• Answer
• Labour (Department A + Dept B)
£35
• Direct material Cost
£20
£55
Overhead Department A (£1 x 20 hours)
£20
Overhead Department B (£2 x 8 hours)
£16
Manufacturing cost of job 366X
£91
Exercise 3
•
•
•
•
•
•
•
A job has direct labour costs of £10
Direct material costs of £20
Fixed manufacturing overhead of £15
Fixed selling and administrative overhead of £12
Its selling price is £75
What is the profit of the job
Answer
• Direct labour
• Direct material
Manufacturing overhead
Selling & Administrative overhead
Variable Manufacturing Overhead
Manufacturing cost of job
Selling price
Profit on job
£
10
20
15
12
10
67
75
8
Job Costing Card / Statement
This is prepared to keep a record of all the costs incurred in
the job being undertaken.
•
It includes the following details:
1. Job No
2. Customer Order No
3. Customer's Name
4. Job Description
5. Materials used and their cost
6. Labour - time and cost
7. Overhead charged
8. Profit
9. Total Price
Job Costing Card / Statement
•
Job Cards record actual labour time – taken from Clock cards and
time sheets From this actual labour costs can be calculated
•
Material costs – taken from issue notes from stores or from invoices
for material purchased specifically for a job
•
Factory overheads - charged on an overhead absorption basis using
one of the predetermined overhead absorption rate eg rate per
machine hour
•
Administration, selling and distribution overheads will also have to
be charged.
•
A percentage is added to the total cost for profit and to find the final
price to charge the customer.
•
An invoice will be prepared to bill the customer, it will include the
information on the Job Cost Card.
Calculating Profit
• The profit can be calculated
EITHER
• as a percentage of total cost (mark-up)
OR
• as a percentage of the selling price of the job (margin).
Mark-up and Margin
(Calculating profit)
• The profit of a job is calculated on either the % of the cost
price or on the selling price
• This means that a distinction must be made between the %
Margin and the % Markup
• % Markup Job XYZ
Selling Price =
Selling
Price
£625
• Gross profit
Cost + Markup
£500
Less Cost
=£500 + 25%
Cost price
Profit
% Margin
Gross profit
Selling price
£125
Job XYZ
Selling Price
£625
Less Cost
Profit
£500
£125
Profit = Selling
price * Margin
= £625 * 20%
Job Cost Statement – Question 1
Materials
10 Metres of MDF @ 10.50 each
5 rolls of galvanised steel @ £4.50 each
£105.00
£22.50
£127.50
Labour
25 labour hours @£5.50 each
£137.50
30 machine hours @ £6 each
£180.00
PRIME COSTS
£445.00
Overhead £3 x 25 labour hours
£75.00
Cost of job 344A
£520.00
Profit (Markup 20% )
£104.00
SELLING PRICE OF JOB 344a
£624.00
Job Cost Statement – Question 2
Labour
300 labour hours @£6 each
£1800.00
150 machine hours @ £7.50 each
£1125.00
£2925.00
Materials
100 plastic tubes @ £25 each
£2500.00
15 wooden J-stands @ £21.60
£324.00
£1350.00
30 metal plates @ £45 each
PRIME COSTS
Overhead £4.50 x 150 machine hours
£4174.00
£7099.00
£675.00
Cost of job no XYZ
£7774.00
Profit (Markup 15% )
£1166.10
SELLING PRICE OF JOB XYZ
£8940.10
Job Cost Statement – Question 3
Labour
100 labour hours @£10 each (Dept A)
£1000
150 machine hours @ £7.50 each (Dept B)
£1125
£2125
Materials
40 metres of benching at @ £125 each (Dept A)
£5000
30 metal plates @ £45 each (Dept A)
£1350
100 jig borers @ £55 each (Dept B)
£5500
20 metal sheets @ £145 each (Dept B)
£2900
PRIME COSTS
£16875
Overhead £4.50 x 100 labour hours (Dept A)
£450
Overhead £3 x 150 machine hours (Dept B)
£450
Cost of job no BRO15
Profit (Markup 20% )
SELLING PRICE OF JOB BRO15
£14750
£900
£17775
£3555
£21330
Job Cost Statement – Question 4
Labour – 200 labour hours @ £8 each
£1600
Direct Materials
£2500
Variable Overhead £3 x 200 labour hours
£600
Fixed Overhead £1 x 200 labour hours
£200
a)Cost of job no WAL123
£4900
SELLING PRICE OF JOB WAL123
£5500
PROFIT FROM JOB WAL123 (SP – COST)
£600
Job Cost Statement – Question 5
Direct Labour
£975.00
150 hours @ £6.50
Direct Materials
1000 tons @ £20
£20000.00
Variable overhead @£2 x 150 labour hours
£21275.00
PRIME COSTS
Fixed Overhead £1.20 x 150 labour hours
Cost of job 344A
£300.00
(80%)
Profit (Margin 20%)
£21455.00
£5363.75
SELLING PRICE OF JOB 344a
SP = 100%
Profit margin = 20%
£180.00
Cost + Margin = SP
Cost + 20% = 100%
Cost = 80%
£26818.80
Margin = Cost/80 x 20
= £5363.75
Job Cost Statement – Question 5b)
Delivery = 1,000 tons x £0.50 per ton
Delivery = £500
Profit will decrease by this amount
Profit = £5363.75 - £500 =£4863.75
Job Cost Statement – Question 6
Labour – 50 hours @ £12.50 each
Direct Materials
£3800
Overhead £4.50 x 50 labour hours
a) Cost of job no EXH384
Profit
£625
66.6 % (2/3)
£225
£4650
Margin 33.3 % (1/3)
£2325
b) Selling price of job no EHX384 100% (3/3)
£6975
Job Cost Statement – Question 7
Labour – 200 hours @ £8 each
£1600
Direct Materials
500 metres of pipe @ £200 for 10 metres
(500/10 x 200)
1000 metres of plastic ducting @ £9.50
Variable overhead @ £5 x 200 labour hours
PRIME COST
Fixed Overhead @ £2 x 200 labour hours
a) Cost of job
b) Profit (Markup 25% / Margin 20%)
Delivery
Selling price of job
£10000
£9500
£19500
£1000
£22,100
400
£22500
£5625
£375
£28500
Job Cost Statement – Question 8 a)
Labour
200 labour hours @ £12 each (Dept A)
£2400
130 machine hours @ £9 each (Dept B)
£1170
£3570
Materials
70 metres of piping at @ £150 each (Dept A)
£10500
50 metal discs @ £70 each (Dept A)
£3500
100 jig fixers @ £200 each (Dept B)
£20000
20 metal plates @ £145 each (Dept B)
£2900
PRIME COSTS
£36900
£40470
Overhead £6 x 200 labour hours (Dept A)
£1200
Overhead £3 x 130 machine hours (Dept B)
£390
£1590
Cost of job (80%)
£42060
Profit Margin (20%)
£10515
SELLING PRICE (100%)
£52575
Job Cost Statement – Question 8 b)
Cost of job
£42060
Profit Margin (33 1/3%) Markup (50%)
£21030
SELLING PRICE (£65000 - £1910 delivery)
£63090
Costs
Material Costs
• Costs in buying the parts (raw materials) necessary to produce the cost
unit
Labour Costs
• Wages of ALL of the workers who make the goods and services
(Assembly line workers etc AND managers etc)
Overheads
• The other costs of the running of the business – eg rent, heat etc
CALCULATING LABOUR COSTS
Various records are used in the
calculation of wages:
• Personnel Records
• Salaries of workers
• Time Sheets/clock cards
• No of hours worked by employee
• Job Cards
• Time spent on a job and no of units
produced
• Payroll
• Record of hours worked/ pay/ deductions to
date
CALCULATING LABOUR COSTS
TIME RATE
• Fixed hourly rate
Cost of one unit =
Hrs worked on the cost unit x Hrly rate
EG 40 HOURS PER WEEK @ £8 PER HOUR =
£320
CALCULATING LABOUR COSTS
PIECE RATE
• Workers are paid for EACH ITEM produced
No of items produced x Rate per unit
EG - A worker produces 500 items
the rate per unit is £0.50
Wage = 500 × £0.50 = £250
CALCULATING LABOUR COSTS
BONUS SCHEME
• Paid in addition to hourly rate as an incentive
for meeting targets
No of items produced x Rate per unit
If production of 5000 units are exceeded then a
bonus of £0.20 per unit is paid
Therefore if 6000 units are produced then the
bonus will be
(6000 - 5000) × £0.20 = £200
CALCULATING LABOUR COSTS
OVERTIME PREMIUM
• Paid over and above hourly rate for extra
hours worked
• Can be time and ½ or double time
EG If Hourly rate = £8 per hour
•
Time and a Half = £8 × 1.5 for each hour of
overtime worked
•
Double Time = £8 × 2 for each overtime hour
worked.
STOCK CONTROL
All forms of stock have a cost to the
Business:
• Purchase price
• Storage costs e.g. warehousing costs wages, heat and light
• Buying costs e.g. administration
• Insurance
• Pilferage (theft)/spoilage/damage
• Obsolescence - stock may go out of date
and never be sold
• Opportunity Cost of the money used to buy
the stock - i.e. what else could have been
bought with that money
FIFO
This form of costing the direct materials used in
any job values them at the same price as the
OLDEST BATCH first
•
Eg The first stock received into the warehouse
will be the first stock to be used up
•
If a stock room had
•
200 units at £5 = £1000 – received 1/1/ 12
•
200 units at £10 = £2000 – received 5/1/12
•
If a job requires 300 units it will be issued 200
units @ £5 and 100 units at £10
•
The cost of materials for the job would be £2000
•
The balance would be 100 units at £10 = £1000
LIFO
This form of costing the direct materials used in
any job values them at the same price as the
NEWEST BATCH first
•
Eg The most recent stock received into the
warehouse will be the first stock to be used up
•
If a stock room had
•
200 units at £5 = £1000 – received 1/1/ 12
•
200 units at £10 = £2000 – received 5/1/12
•
If a job requires 300 units it will be issued 200
units @ £10 and 100 units at £5
•
The cost for materials would be £1500
•
The balance would be 100 units at £5 = £500
AVCO
This form of costing the direct materials used in any job values
them at the AVERAGE PRICE of all materials available
(Existing units x p price)+(New units x p Price)
Total number of units in stock
•
Eg The most recent stock received into the warehouse will be
the first stock to be used up
•
If a stock room had
•
200 units at £5 = £1000 – received 1/1/ 12
•
200 units at £10 = £2000 – received 5/1/12
All units in stock would be valued at £7.50
(200 x £5)+(200 x £10)
400
•
If a job requires 300 units it will be issued 300 units @ £7.50
•
The cost for materials would be £2250
•
The balance would be 100 units @ £7.50 = £750
Sample Exercise
Below is the receipts and issues of stock for Splash
Cans engineering company. Calculate the value of their
stock at the 31 December 2011 using the following
methods:
FIFO and LIFO
On 1 January 2011 the stock of Splash Cans on hand
comprised of 7 cans with a total value of £96.60
SPLASH CANS
Receipts
10 Jan 20@ 14.00
4 April 10@ £14.00
2 June 12@ £14.30
22 September 20@ £15.10
9 November 14@ £15.20
Issues
28 February 15
8 May 6
20 July 14
11 October 18
3 December 20
Splash Cans (FIFO)
Date
Receipts
Q
Unit price
Issues
Value
Balance
Job
no
Q
Unit
Price
Value
1/1
10/1
20
14.00 280.00
28/2
4/4
10
20/7
13.80
8
14.00 112.00
6
12
14.30
14.00
84.00
171.60
14
Unit
Price
Value
7
13.80
96.60
7
13.80
96.60
20
14.00 280.00
12
14.00 168.00
22
14.00 308.00
16
14.00 224.00
96.60
14.00 140.00
8/5
2/6
7
Q
14.00 196.00
16
14.00 224.00
12
14.30 171.60
2
12
14.00
28.00
14.30 171.60
Splash Cans (FIFO Cont)
Date
Receipts
Q
Unit price
Issues
Value
Balance
Job
no
Q
Unit
Price
Value
20/7
22/9
20
15.10
302.00
9/11
3/12
14.00
14.30
15.10
2
12
4
11/10
14
15.20
28.00
171.60
60.40
212.80
16
4
Q
Unit
Price
Value
2
14.00
28.00
12
14.30
171.60
2
12
20
14.00 28.00
14.30 171.60
15.10 302.00
16
15.10
16
14
15.10 241.60
15.20 212.80
10
15.20 152.00
241.60
15.10 241.60
15.20
60.80
Splash Cans (LIFO)
Date
Receipts
Q
Value
Balance
Q
Unit
Price
Value
1/1
7
13.80
96.60
10/1
7
20
20
Unit price
Issues
Job
no
Q
Unit
Price
Value
14.00 280.00
15
14.00 210.00
28/2
4/4
10
8/5
2/6
6
12
14.30
171.60
7
13.80
96.60
5
14.00
70.00
7
15
14.00 140.00
14.00
84.00
13.80 96.60
14.00 280.00
13.80 96.60
14.00 210.00
7
13.80
96.60
9
14.00 126.00
7
13.80
96.60
9
14.00 126.00
12
14.30 171.60
Splash Cans (LIFO Cont)
Date
Receipts
Q
Issues
Unit price
Value
Job
no
Balance
Q
Unit
Price
Value
2/6
12
2
20/7
22/9
20
15.10
14.30
14.00
171.60
28.00
302.00
18
15.10
271.80
11/10
9/11
3/12
14
15.20
212.80
14
2
4
15.20
15.10
14.00
212.80
30.20
56.00
Q
Unit
Price
Value
7
13.80
96.60
9
12
14.00
14.30
126.00
171.60
7
13.80
96.60
7
14.00
98.00
7
13.80
96.60
7
20
14.00
15.10
98.00
302.00
7
7
2
7
13.80
14.00
96.60
98.00
15.10
13.80
30.20
96.60
7
2
14
14.00
15.10
15.20
98.00
30.20
212.80
7
13.80
96.60
3
14.00
42.00
Charles plc(AVCO)
Date
Receipts
Q
Issues
Unit price
Value
Balance
Job
no
Q
Unit
Price
Value
Q
1/3
1000
1.00 1000.00
1000
4/3
1000
1.10 1100.00
2000
6/3
8/3
15/3
1200
600
1.05 630.00
1300
600
1.71
600
300
1.80
1.32 1716.00
1026.00
18/3
20/3
1.05 630.00 1400
1.50 1800.00
16/3
17/3
600
540.00
1.50
900.00
Unit
Price
Value
1.00 1000.00
1.05
2100.00
1.05 1470.00
800
1.05 840.00
2000
1.32 2640.00
700
1.32
924.00
1300
1.50 1950.00
700
1.50 1050.00
1000
1.59 1590.00
OVERHEAD (INDIRECT) COSTING
These are costs related to the general production
process itself
Examples:
•
Materials not used in production of cost units
•
Supervisors and non production labour wages
•
General manufacturing expenses – rent/ rates etc
Therefore:
•
Overheads are traced back (allocated) or shared
out (apportioned) to COST CENTRES (areas which
created the overheads and through which jobs will
pass)
•
Apportionment can be on a Blanket/standard rate
or Departmenatl rates.
APPORTIONMENT (Sharing Out)
Overheads are SHARED FAIRLY between
the cost centres which benefit from them
eg:
COST
Rent, Rates, Light&Heat, etc
Employee expenses: Canteen,
Managers etc
Depreciation / Insurance of
Assets
BASIS OF
APPORTIONMENT
Area
No of employees
Value of asset
APPORTIONMENT
Non traceable overheads to production and service
departments
Department value for basis for apportionment
Total value for basis of apportionment (eg total area)
x Total value of overhead being
reapportioned
For Example
Factory Rent
£100,000
Area of Dept A 40,000 m2
Area of Dept B 10,000 m2
Total Area 50,000 m2
Apportioined to Dept A = 40,000 / 50,000 x
£100,000
= £80,000
Apportioined to Dept B= 10,000 / 50,000 x
= £20,000
£100,000
Reapportionment
• Overheads of service depts to production
departments
• Done to show the benefit each Production
dept gets from the service depts
Service Dept
Stores
Canteen
Maintenance
BASIS OF
APPORTIONMENT
Materials used
No of employees
Value of plant
Reapportion OH of Service Depts to
production Depts
Department value for basis for apportionment (eg area)
Total value for basis of apportionment (eg total area)
x Total value of service dept OH being
reapportioned
For Example
Stores Overheads
£90,000
Raw materials used by Dept A 10,000 units
Raw materials used by Dept B 20,000 units
Total Materials
30,000 units
Apportioined to Dept A = 10,000 / 30,000 x
= £30,000
£90,000
Apportioined to Dept B= 20,000 / 30,000 x
= £60,000
£90,000
Overhead Absorption rates
•
Calculated AFTER allocation and apportionment to
production depts
•
Calculated in a manner which best represents the
way that a job makes use of the departments
resources
Dept Type
Basis of
Apportionment
Overhead rate
Labour Intensive
Direct Labour
Hours
£ x labour Hour
Capital Intensive
Direct Machine
hours
£ x per machine hour
Overhead Absorption rate
Total Dept Overheads
Total number of machine or direct labour hours
= Dept Overhead absorption rate
per machine or direct labour hour
(£)
For Example
Finishing Depts Overheads
£100,000
Total Machine Hours
25,000 hr
Total Labour hours
5,000 hours
100,000/25,000 = £4 per machine hour
Exercise 1
O/Head Cost
Basis of
Apportionment
Rent and Rates
Area
Dep of
Machinery
Value of
machinery
Supervision
No of Employees
Machine
Insurance
Value of
Machinery
Preparation
30,000
24,000
18,000
3,500
Reapportion
Personnel
21,000
79,500
3.18 mach hr
Personnel
22,500
500
2,000
58,500
Overhead
Absorption
Rate
37,500
1,000
Departmental
Total
Total OH for
Prod Dept
Cooking
7,000
64,500
15,750
80,250
4.01 lab hr
Total
90,000
3,500
12,000 54,000
1,750
36,750
12,250
Exercise 1 Continued
Direct Materials
200 mtrs @ £10 per mtr
2,000.00
Direct Labour
12 hrs @ £15 per lab hr
180.00
Direct Expenses
£750
750.00
Overheads
6 machine hours in preparation
19.08
8 labour hours in cooking
32.08
A profit of 25% on the cost of a job
Total cost of job
745.29
3726.45
Exercise 2
O/Head Cost
Basis of
Apportionment
Rates
Area
Dep of
Machinery
Value of
machinery
Value of
Buildings
Insurance of
buildings
Vending
Machines
Departmental
Total
Reapportion
Personnel
Total OH for
Prod Dept
Overhead
Absorption
Rate
No of Employees
Denim
Cotton
General
Office
Total
5,000
4,000
1,000
10,000
12,000
14,000
4,000
30,000
2,000
1,600
400
4,000
1,800
10,800
3,600
22,600
5,400
25,000
2,880
4,320
25,480
29,320
6.37 mach hr
1.47 lab hr
7,200
Exercise 2 Continued
Direct Materials
120 mtrs @ £9.20 per mtr
Direct Labour
24 hrs @ £17 per lab hr
408.00
Direct Expenses
£310
310.00
Overheads
6 machine hours in denim
38.22
8 labour hours in cotton
11.76
A profit of 25% on the cost of a job
Total cost of job
1104.00
468.00
2339.98
Predetermined overhead rates
•
Quite often these are set by an
organisation rather than actual overhead
rates.
•
They are based on the average costs of
average production.
BUT
•
The amount charged to jobs might be too
little (under absorption)
•
Or it might be too much (over absorption)
Predetermined overhead rates
For Example
Budgeted overheads
£200,000
Budgeted Machine hours
40,000
Absorption rate per machine hour
£5
Case A
CaseB
Actual Overhead Incurred
200,000
180,000
Actual Machine Hours worked
30,000
40,000
Overheads Absorbed
150,000
200,000
In case A there has been an under absorption of £50,000 (the budgeted
machine hours were more than the actual machine hours)
In case B there has been an over absorption of £20,000 (the actual
overhead incurred is less than the budgeted one)
Summary Overhead Apportionment and
Absorption
1. Overheads are apportioned or allocated
to each production / service dept
2. Service department overheads are then
re-apportioned to the production
departments
3. Appropriate overhead absorption rates
are calculated
4. The overhead costs are absorbed (taken
into consideration when costing a job or
making a product by applying a certain
rate
Summary Overhead Apportionment and
Absorption
Step 1 Allocate and Apportion
Step 2 Re-Apportion
Step 3 – Calculate Absorption
Steps 4 – Absorption
Service/Operating Costing
• An estimated cost of providing services rather than products
• Used by Hospitals, dental practices, lawyers etc
• Estimated cost calculated over a year - in the most
appropriate units – eg hospital (patient/ days), Restaurant
(meals served)
WHY
• Enables comparison between cost of hiring/leasing and
owning equipment
• Determines how much other cost centres should be charged
for the use of the service
• Determines price for service to ensure profit
• Promote efficiently – can compare prices charged between
periods
Service/Operating Costing
MacPherson Passenger Transport Ltd Operates 6 x 57 seater
buses on routes in the Glasgow area. Each bus cost £40,000
and has an estimated useful life of 6 years – after which it will
be sold for an estimated £4,000
Depreciation
• Cost of new bus
£40,000
• Residual Balance
£4,000
• Fall in value over life
£36,000
• Depreciation per annum
£6,000
Service/Operating Costing
a)
b)
Each bus is used for 50 weeks per annum, the anticipated
annual mileage being 33,000.
Fuel consumption is 3 miles per litre of diesel. Each litre
of diesel costs £0.80
Fuel
•
Annual mileage per bus 33,000
•
Miles per litre diesel 3
•
Diesel required (33000/3) 11,000
•
Cost of diesel (11000x0.80) £8,800
Service/Operating Costing
c) Each bus has 6 wheels. They tyres cost £250 each and are
estimated to last 60,000 miles
Tyres
• Set of tyres (250 x 6) £1,500
• Portion of set per annum
(33000 (annual mileage)/ 60,000 miles x £1,500 £825
Service/Operating Costing
d) Each bus requires to be thoroughly inspected and serviced
every 5,000 miles at a cost of £1,030
Inspection & Service
• Miles per annum 33,000
• Miles between inspections / services
• Inspections/services required
• (33,000 miles/ 5,000 miles) 6.6
• Annual cost (£1,030 x 6.6) £6,798
5,000
Service/Operating Costing
f) Admin Cost for the fleet of buses are estimated to be £21,000
per annum
Administration Costs
• Total cost – 6 buses 21,000
• Cost per bus (£21,000 / 6) £3,500
Service/Operating Costing
g) The firm employs 9 drivers, each of whom works a basic 40-hour week at
£5.50 per hour
• Each driver has 4 weeks holiday per annum during which he/she is paid
at the basic rate
• Each driver works on average 6 hours overtime per working week. All
overtime is paid at time and a half
Driver’s wages
• Basic wages per driver (52 wks x 40 hrs x £5.50)
£11,440
• Overtime per driver (48 wks x 6 hrs x £8.25)
£2,376
• Wages per driver per annum £13,816
• Total annual wages (£13,816 x 9 drivers) £124, 344
• Driver’s wages per bus (£124,344/ 6 buses) £20,724
Service/Operating Costing
a)
•
•
•
•
•
•
•
Total cost per bus per annum
£
Depreciation
6,000
Fuel
8,800
Tyres
825
Inspection and Service
6,798
Administration Costs
3,500
Driver’s wages
20,724
Licence, insurance & test
3,513
£50,160
Service/Operating Costing
b)
•
•
•
Cost per mile
Total cost per bus per annum
Anticipated annual mileage
Cost per mile (50,160/33,000 miles)
£
50,160
33,000
£1.52
c)
•
•
•
Cost per passenger/mile (average 40 passengers)
Total cost per bus per annum
50,160
Cost per mile
1.52
Cost per passenger/mile (£1.52/40
passengers)
3.80p
Service/Operating Costing
a)
Charge per passenger/mile in pence if mark up is 20%
•
•
•
Cost per passenger mile
Mark up 20% (3.80 x 0.20)
Charge per passenger mile
3.80
0.76
£4.56
Process Costing
• Used in industries where the end product is more or less
identical
• unit cost = costs of production/ number produced (over a time
period)
• Units pass through a series of production stages until final
completion
• Each production dept transfers its completed production to
the next department where it becomes the input for further
processing
• The completed item is transferred from the last department to
the finished goods stock
• Costs from one department to another are cumulative
Process Costing
Normal/ Uncontrollable Loss
• Losses which occur under efficient operation
conditions
• These are absorbed by the production of the item
Abnormal/ Controllable Loss
• Losses which are not expected to occur under
efficient operating conditions eg incorrect cutting of
cloth
• These are removed from the appropriate process account
• Reported separately as an abnormal loss
• Treated as a cost and written off to the P&L account
Process Costing
Calculating the transfer of goods between processes
• Calculate the unit cost of production (establish
expected output) eg
• In a process there is an input of 1,200 gallons
costing £1
• An output of 1,000 gallons is expected
• Therefore normal loss for this process is 200 gallons
Cost of production
£1200 £1.20
Expected output
1,000
Process Costing
Accounting for the sale of scrap
• Sometimes process losses can be sold for some small value
• The resulting sales revenue should be offset against the costs
of the appropriate process
• Therefore
Cost of production less scrap value of normal loss
Expected output
• If the normal loss from the last example had a scrap value of
50p per unit then
£1200 - 100
£1100
£1.10
1,000
1,000
• If the production had actually only been 900 units then there
would be normal loss of 200 units and abnormal loss of
100
Process Costing
WORK IN PROGRESS
• When a process account is drawn up there will be some
material in each process which is partly finished
• This work in progress must be valued and accounted for
• Work in progress consists of direct materials labour and
overheads
ABNORMAL LOSS
This is unexpected loss due to carelessness, inferior material
etc
An abnormal loss account is opened and the total cost of the
abnormal loss charged to it.
The units lost unexpectedly are charged at the unit price of
actual output.
Summary Process Costing
Step 1 Calculate & enter input values in to the process account
Step 2 Calculate the normal loss and its scrap value & enter it into
the output section of the process account
Step 3 Calculate the value of WIP &enter it into the output section
of the process account
Step 4 Calculate the unit cost price of normal output
Step 5 Calculate the cost of actual output & enter it into the outputs
section of the process account
Step 6 Calculate the value of abnormal loss & enter it into the
outputs section of the process account
Summary Process Costing
Step 7 Transfer the abnormal loss to an abnormal loss account
Step 8 Calculate the income from the sale of abnormal loss for
scrap and enter it in the output section of the abnormal loss account
Step 9 Calculate the amount to be output to the profit and loss account
and enter it in the output section of the abnormal loss account
Break Even
What is Break Even?
Break even is a process that shows organisations how
many units they must produce and sell in order to cover
their costs. It allows them to see when they start to make
a profit.
What Costs are associated with Break Even?
There are three types of costs:
•Fixed Costs
•Variable Costs
•Semi Variable costs
Break Even - Costs
FIXED COSTS
Fixed Costs are costs that don’t change(constant) in relation to
output. These are TIME BASED COSTS.
VARIABLE COSTS
•Variable costs are costs that change with output. These are
ACTIVITY BASED COSTS
SEMI VARIABLE COST
This is a combination of a fixed cost and a variable cost.
Break Even - Costs
Total Costs
Fixed Costs and Variable Costs = Total Costs
If Sales (revenue) > than Total Costs = Profit
If Sales (revenue) < than Total Costs = Loss
If Sales (revenue) = Total Costs = Break Even Point.
Break Even Point is the level of sales where the
company neither makes a profit or a loss (simply
cover their costs)
Benefits Of Break Even For Managers
• The level of Break Even is important for
Managers as it indicates specifically the level of
output required to generate a profit
• It illustrates the returns an organisation should
get at each level of output
• It clearly indicates information on a firm’s
MARGIN OF SAFETY (level above Break
Even)
BREAK EVEN CHART
£ Sales
Total Cost
150
100
Variable Cost
50
Fixed Costs
0
Output
10 20 30 40 50 60 70 80 90 100
BREAK EVEN CHART
£
Sales
Sales
Total Cost
150
100
BEP
Variable Costs
50
Fixed Costs
0
Output
10 20 30 40 50 60 70 80 90 100
Break Even
From the chart above we can see immediately
that the break even point is 50 units or At Sales
Revenue equal to £100
The area above break even point is referred to
as the margin of safety. This indicates to
managers the level of output they can expect to
drop before hitting the break even point.
Calculating Break Even
CONTRIBUTION
This is the difference between the Selling Price and the
Variable Cost. The difference between what it cost to
make and what you are selling it for
Contribution is that part of the Selling Price that
‘contributes’ towards paying off the Fixed Costs
Break Even Calculations
Contribution = Selling Price – Variable Cost
BEP (Units) = Fixed Costs / Contribution
Sales Revenue at BEP = (FixedCosts/Contribution)*Selling
Price
Target Profit = (Fixed Costs + Target Profit)/ Contribution
Profit/Loss (units)= Total Contribution – Fixed Costs
(Total Contribution = Contribution per unit * No of units
sold)
Margin of Safety (In sales) = Actual Sales output – Sales at
Break even point (to convert to units divide answer by selling
price per unit)
PVR (profit volume ratio) = Contribution/Selling Price * 100
Example exercise (Int 2)
Sales
Total Costs
BEP Sales Value
Fixed Costs
BEP Units
Example exercise (Int 2)
a) Selling price per unit
Sales revenue / Output (better to use BE values)
£20,000/2,500 = £8
b) Variable cost per unit
Variable cost per unit = Total costs per unit – Fixed
costs per unit
Variable costs per unit (use BE values) =
( 20,000 – 10,000) / 2,500 units
= £4 per unit
Example exercise (Int 2)
c) Contribution per unit
Selling price per unit – Variable cost per unit
Using previous answers £8 - £4 = £4 per unit
d) Profit from 3,500 units
(Using graph) 3,500 units = Sales £28,000
3,500 units = Total costs £24.000
35,000 units – Profit = £4,000
Easier method £4 per unit contribution
Contribution x Units above break even = profit
= £4 x 1000 units = £4,000
Example exercise (Int 2)
v) Sales required to make a profit of £14,000
Target Profit = (Fixed Costs + Target Profit)/
Contribution
£14,000 = (10,000 +14,000) / 4
= 24,000/4 = 6,000 units
Example
MFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be
£72,000. The labour cost is £6 per chair and the
material to make each chair costs are £10. Each chair
sells for £24.
You have to calculate the following:
i.
Contribution per chair
ii. Break Even Point in Units
iii. Sales Revenue at Break-Even Point
iv. Number of chairs to be sold to make a profit £4000
Example
MFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be
£72,000. The labour cost is £6 per chair and the
material to make each chair costs are £10. Each chair
sells for £24.
You have to calculate the following:
i. Contribution per chair
Selling Price – Variable Cost = Contribution
= £24 - £16 = £8
ii. Break Even Point in Units
BEP = Fixed Costs / Contribution
£72,000 / £8 = 9,000 units
Example
MFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be £72,000. The
labour cost is £6 per chair and the material to make each chair costs
are £10. Each chair sells for £24.
You have to calculate the following:
iii. Sales Revenue at Break-Even Point
Sales Revenue at BEP = (FixedCosts/Contribution)*Selling Price
(£72,000 /£8 ) * 24 = £216,000 (must have £ in exam)
iv. Number of chairs to be sold to make a profit of £4000
Target Profit = (Fixed Costs + Target Profit)/ Contribution
= (£72,000 + 4,000) / £8 = 9500 chairs (must mention units in exam)
Margin of Safety
 The Margin of Safety is the distance between actual sales
achieved and the sales level needed to break-even. Actual Sales Sales at Break Even Point
 It can be measured in units or sales revenue terms.
 A narrow margin of safety would indicate that a small fall in
volume of sales might have a significant effect on profits.
 A wide margin would mean that there would have to be a large
fall in sales volume before the BEP was reached.
 A wide margin of safety is therefore desirable if a firm is going
to cope with competition and decreases in demand.
 An increase in selling price could improve the margin of safety
whilst an increase in fixed costs (with no corresponding changes
in contribution and sales volume) would reduce the margin of
safety
Total Costs
 Total
cost includes several elements which have to be added
together. Marginal Costing requires that total cost be
classified into fixed and variable costs.
 On
a Break-even Chart the total cost line is a combination of
the fixed costs and the variable costs.
 At
nil level of activity the total costs will equal the fixed
costs.

Where the total cost line intersects the sales line an angle of
incidence is formed
Profit/Volume ratio
• Profit in this ratio refers to contribution
• Volume refers to total sales value
• The P/V Ratio does not mean profit in relationship to sales but
the contribution in relation to sales
Formula = (Contribution / Sales ) *100
• The Profit/Volume Ratio (P/V) shows the contribution as a
percentage of sales.
• With higher percentage the contribution towards the fixed
costs will be greater and profits will be achieved earlier
• The P/V ratio can be improved by - increased selling prices,
reduced variable costs; concentrating on those products
which provide the highest contribution.
Assumptions of Break Even
ASSUMPTION
LIMITATION
There is only one product being
produced.
This is likely to be the case in
very few businesses.
The selling price per unit is
constant throughout the range of
output. (ie straight line)
It may be necessary to lower
prices to achieve higher levels of
output, and if output falls a
business may cut prices to
attract sales.
The variable cost per unit is
constant throughout the range of
output i.e. it is proportionate to
output.
At higher outputs it may be
necessary to pay overtime rates
to increase production, but this
may be offset to some extent by
achieving quantity discounts on
purchases of raw materials
Assumptions of Break Even
ASSUMPTION
LIMITATION
Fixed Costs are constant (i.e. a
horizontal line on the graph)
throughout the production range.
Fixed costs are not fixed forever.
There will for instance be a need
for more machinery at very high
output levels which will increase
depreciation and perhaps more
space will be required leading to
higher rent etc in the long run
All costs can be classified as fixed
or variable
There are semi-variable costs
which do not behave according
to the break-even model
All output is sold
There will be opening and
closing stocks to be taken into
account in most cases.
Marginal Costing
• Marginal Costing is a decision-making tool which focuses on variable
costs and variable incomes
• It ignores fixed costs
CONTRIBUTION
• The difference between the SELLING PRICE of a product and its
VARIABLE COST of production
• Any product which makes a contribution is potentially worth making
CALCULATING PROFIT
• Profit = Total contribution – Fixed costs
If possible all products making a positive contribution would be produced
However there is usually a “Limiting Factor” which determines how much
can be produced.
Marginal Costing
LIMITING FACTOR
The factor that limits profits eg
• Skilled labour
• Machine capacity
• Raw materials
The limiting factor must be used in such a way that
contribution is maximised
You must maximise contribution by
• Labour hour
• Machine Hour
• Unit of materials – eg per kilo
Marginal Costing Exercise 1
Step 1 – Calculating Unit Contribution
Product
A B
Selling Price
£20
£30
£25
£40
£55
£60
Materials
£10
£15
£10
£15
£25
£20
£5
£5
£15
£15
£15
£20
£2
£1
£3
£5
Labour
C
Variable OH
D
E
F
Total Variable Cost
(Mat+Labour + V OH)
£15
£20
£27
£31
£43
£45
Unit Contribution = Selling
Price – Total V Cost
£5
£10
-£2
£9
£12
£15
If there was no limiting factor then all products except
C would be made
Marginal Costing
Step 2 – Work out contribution according to limiting factor eg
labour and prioritise - (Assume labour is paid at £5 per hour)
Product
A
Selling Price
£20
£30
£25
£40
£55
£60
Materials
£10
£15
£10
£15
£25
£20
£5
£5
£15
£15
£15
£20
£2
£1
£3
£5
£20
£27
£31
£43
£45
£5
£10
-£2
£9
£12
£15
1
1
-
3
3
4
£5
£10
-
£3
£4
£3.75
Labour
B
C
Variable OH
Total V Cost (Mat+Labour £15
+ V OH)
Unit Contribution = Selling
Price – Total V Cost
No of hours per product
=Total labour/ hourly rate (£5)
Contribution per hour
(Unit cont / hours per product)
D
E
F
Order of production based on limiting factor = Product B,A,E, F, D
Marginal Costing
Step 3 - Calculating Production Quantities
•Assume that fixed costs are £10,000 and machine time is limited to
12,500 hours per annum
Product
Contribution
Machine hours
Contribution per machine hour
Maximum Demand
A
B
C
£5
£10
£12
1
4
3
£5
£2.5
£4
1000
2000
2000
To Satisfy demand the firm needs (1 x 1000) + (4x2000) + (3 x 2000)
=15000 hours but it only has 12,500
Prioritise Production Order
A then C and finally B
Marginal Costing (Ex 2)
Step 3 – Calculating actual units produced
Product
Units
A
1000
B
1375
(5500/4 hrs)
C
2000
Hours
Required
1000
5,500
6000
(Unitsx3 hrs)
Hours
Left
11,500
0
5,500
Hours Available
12,500)
Make as much of A
as you can
Make as much of
B as you can
Make as much of C
as you can
Marginal Costing (Ex 2)
Step 4 - Calculating Maximum Profit
•Profit = contribution per unit x number of units – fixed costs
Product
Units
Contribution
per unit
Total
Contribution
A
1000
£5
£5,000
C
2000
£12
£24,000
B
1375
£10
£13,750
Total
Contribution
£42,750
Less Fixed
Costs
£10,000
PROFIT
£32,750
Exercise 3
UNIT DATA
X
Y
Selling price
£40
£49
Direct Materials
£10
£8
Variable Overheads
£2
£15
£12
£4
ii) Unit Contribution
£20
£18
iii) Cont per labour hour
£10
Direct Labour
£20 / 2 hours
£6
£18 / 3
a) i)Total variable cost - Product x = £20 x 5000 = £100,000
Total Variable cost – Product Y = £31 x 5000 = £155,000
Exercise 3 continued
Total profit (b)
UNIT DATA
X
X =20 x 5,000
100,000
Y = 18 x 5000
£90,000
£190,000
£150,000
Total contribution
Less fixed Costs
Total Profit
£40,000
c) Order of production = X then Y as X has greater contribution
per labour hour than Y
Exercise 3
d) Allocating labour hours
Product
Units
X
5000
Y
4000
(12000/3 hrs)
Hours
Required
Hours
Left
10,000
12,000
12000
0
Hours Available
22,000)
Make as much of X
as you can
Make as much of
Y as you can
Exercise 3 continued
New profit (e)
UNIT DATA
X
X =20 x 5,000
100,000
Y = 18 x 4000
£72,000
£172,000
£150,000
Total contribution
Less fixed Costs
Total Profit
£22,000
Change in profit = £40,000 - £22,000 = £18,000
Marginal Costing
MINIMUM PRODUCT REQUIREMENT
• There may sometimes be a complication which restricts the
ability to produce the amount of goods in the quantity that
will give maximum profits
• For example if it is management policy not to produce fewer
than x amount of your last ranking product
If this is the case:
• Redo the production order ensuring that at least the
minimum amount of the least profitable product is
produced
BE CAREFUL - IT IS NOT SIMPLY A STRAIGHT SWAP!
Marginal Costing
MINIMUM PRODUCT REQUIREMENT
• There may sometimes be a complication which restricts the
ability to produce the amount of goods in the quantity that
will give maximum profits
• For example if it is management policy not to produce fewer
than x amount of your last ranking product
If this is the case:
• Redo the production order ensuring that at least the
minimum amount of the least profitable product is
produced
BE CAREFUL - IT IS NOT SIMPLY A STRAIGHT SWAP!
Marginal Costing
Example – Limiting factor only - 15000 kilos
Unit Data
1
2
Contribution in units
£10
£20
£30
5
4
10
800
1000
1000
£2
£5
£3
Units
Unit cont
Total
1
200
£10
£2000
2
1000
£20 £20000
3
1000
£30 £30000
Kilos per unit
Annual Demand
Contribution per kilo
Product
Rank Units Kilos
2
1000
3
1000
1
200
Left
4000 11000
10000
1000
1000
0
3
Total Cont
52,000
- F Cost
12,000
Profit
40,000
Marginal Costing
Example – Limiting factor 15000 kilos (at least 250 of each product)
Method – Redo production schedule starting with the need to produce 250 of P1
Unit Data
1
Contribution in units
Kilos per unit
Annual Demand
Contribution per kilo
Kilos
Left
2
£10
£20
£30
5
4
10
800
1000
1000
£2
£5
£3
P
Units
Cont
1
250
1250
13750
£2500
2
1000
4000
9750
£20000
3
975
9750
0
£29250
Cont
3
£51750
- FC
12000
Profit
£39750
MARGINAL COSTING - SUMMARY
Focuses on variable costs and variable incomes.
Step 1 - work out the contribution per unit.
Contribution = unit selling price - unit variable cost.
Step 2 – work out the contribution per unit of limiting factor eg
(machine or labour hours or kilos, £s or units of raw material)
Step 3 – work out production order – highest contribution first
Step 4 – take account of any complication – eg redo production
order to take account of any contractual obligations or company
policy
Step 5 – Work out total contribution and then deduct total fixed
costs to give Profit
NOTE – IF FIXED COSTS ARE GIVEN IGNORE THEM
WHEN CALCULATING CONTRIBUTION
Introducing a new product
When introducing a new product you need to:
1. Work out its unit contribution to see if it is viable or not
(anything with a negative contribution will not be worth
making)
2. calculate its contribution per limiting factor and then place it
in the production order in the appropriate place
3. Recalculate how many of each product you can make
4. Calculate the total contribution
5. If asked to find the Total Profit you must deduct the fixed
costs
Introducing a new product - Example Exercise
A business is working at full capacity and a new product is being
considered.
for example:
Current production:
• 5000 units of A earning a contribution of £20 in 2 machine hours,
• 4000 units of B earning a contribution of £15 in 3 machine hours,
• 2000 units of C earning a contribution of £20 in 5 machine hours.
Introducing a new product - Example Exercise
• Put information into order
Unit Data
Contribution in units
Labour hours per unit
Annual Demand
Contribution per hour
A
B
C
£20
£15
£20
2
3
5
5000
4000
2000
£10
£5
£4
• Order of production before new product A, B C
a) Total Contribution before new product = (5000 *
£20) + (4000 *£15) + (2000 * £20) =£200,000
b) Total number of hours being used before new product
= 32000 (A 10,000 + B 12,000 + C 10,000)
c) Capacity = 32000 (The first line of the exercise tells
you they are working at full capacity)
Introducing a new product - Example Exercise
A new product Z is being considered. Z has a selling price of
£60, a variable cost of48 (including 2 machine hours). Demand
for Z is 1000 units.
d) Calculate the contribution per hour for product Z
Selling price – Variable cost per unit = £60 - £48 = £12
Introducing a new product - Example Exercise
•
Organise Product Z’s data
Unit Data
Contribution in units
Labour hours per unit
Annual Demand
Contribution per hour
A
B
C
Z
£20
£15
£20
£12
2
3
5
2
5000
4000
2000
1000
£10
£5
£4
£6
e) Decide the order of production
• New order of production A, Z, B, C
Introducing a new product - Example Exercise
A
B
C
Z
£20
£15
£20
£12
2
3
5
£2
4000 2000
1000
Unit Data
Contribution in units
Labour hours per unit
Annual Demand
5000
Contribution per hour
f)
Pr
£10
£5
£6
£4
New total contribution at full capacity (32,000 hours)
Units Hrs
Left
Cont
A
5000
10000
22000
Z
1000
2000
20000
B
4000
12000
8000
£60,000
C
1600
8000
0
£32,000
£100,000
£12,000
£204,000
No of units x Unit
contribution
Introducing a new product - Example Exercise
A
B
C
Z
£20
£15
£20
£12
2
3
5
£2
4000 2000
1000
Unit Data
Contribution in units
Labour hours per unit
Annual Demand
5000
Contribution per hour
£10
£5
£4
£6
g)Maximum contribution at 30,000 hours
Pr
Units Hrs
Left
Cont
A
5000
10000
20000
Z
1000
2000
18000
B
4000
12000
6000
£60,000
C
1200
6000
0
£24,000
£100,000
£12,000
£196,000
No of units x Unit
contribution
Introducing a new product - Example Exercise
h)Maximum contribution if Price of C rises by £15 and demand
falls to 1500 – 30,000 hours available
Unit Data
Contribution in units
Labour hours per unit
Annual Demand
C
Z
£20
£15
£35
£12
2
3
5
2
4000 1500
1000
£7
2
£6
3
£10
1
New Production Order
Units
B
5000
Contribution per hour
Pr
A
Hrs
Left
£5
4
Contribution
A
5000
10000
20000
£100,000
C
1500
7500
12500
£52,500
Z
1000
2000
10500
£12,000
B
3500
10500
0
£52,500
£217,000
MARGINAL COSTING – SPECIAL ORDERS
This is where a customer offers to buy the product at less
than its normal selling price
REJECT IF
The firm is already working at full capacity
ACCEPT IF
There is spare capacity and the item still makes a
contribution at the lower price
MARGINAL COSTING – SPECIAL ORDERS
Example
A firm is working at 80% capacity and is producing 20,000
units per annum.
Unit information Should a special order of 2,000 units
Selling price £10 at £8 each be accepted
Materials £2
Is the capacity there
Labour
£2
Yes 20,000 is 80% so full capacity is
Variable Exp £2
25,000
Fixed Costs £2
Is there a contribution at the new
price?
Yes SP (£8) – VC (£6) = Cont (£2)
If the offer is accepted, Contribution, and hence
profit will increase by 2000 (no of units) x £2
(Cont per unit )
MARGINAL COSTING – SPECIAL ORDERS
The following data applies to the production and sale of 2,000 units of
product M
Sales
£
Unit cost
20,000
£10.00
Materials
6,000
£3.00
Labour
4,000
£2.00
Variable Cost
2,000
£1.00
Fixed Costs
3,000
£1.50
Total cost
15,000
Profit
£5,000
a) SP (£10) – VC(£6) = Contribution per unit (£4)
MARGINAL COSTING – SPECIAL ORDERS
SP (£10) – VC(£6) = Contribution per unit (£4)
Capacity is currently at 80% and an order is received for 400 units at £7
each
Unit cost
b) Does the firm have enough spare capacity
Selling Price
£10.00
Material £3.00
Labour £2.00
Variable OH £1.00
Fixed Costs £1.50
to produce the extra order
Yes 2,000 is 80% so full capacity is 2,500
c) Is there a contribution at the new price?
Yes SP (£7) – VC (£6) = Cont (£1)
d) By how much will profit change if the order
is accepted
Increase by extra units(400) x Unit Cont (£1) =
£400
MARGINAL COSTING – SPECIAL ORDERS
A second order for 150 units at a price of £7.50 is also being considered
Unit cost
New Selling Price
£7.50
Material £3.00
Labour £2.00
Variable OH £1.00
Fixed Costs £1.50
e) Calculate the total contribution from this
order.
SP (£7.50) – VC (£6) = £1.50 contribution
f) Should this order be accepted?
No – accepting both orders will take you over
capacity and the last order will bring you in more
profit (£400) than this one (£225)
MARGINAL COSTING – Make or Buy Decisions
OPPORTUNITY COST
The opportunity cost of an item can be described as the cost
of what you give up to produce it.
Example – a business working at full capacity (so time is a
limiting factor) makes Product Z , which earns a
contribution of £20. It takes 2 hours to produce and
therefore makes a contribution of £10 per hour
If it then decides to do something else then one of the
“costs” of that “something else” must be the fact that it is
no longer earning £10 per hour from making Z
MARGINAL COSTING – Make or Buy Decisions
OPPORTUNITY COST
Another example of opportunity cost would be a business
making a product which contains a component and it is
considering purchasing the component instead of making it.
RULES TO REMEMBER
If the firm has spare capacity it is pointless purchasing it if
you can make it cheaper
However if there is no spare capacity then the time saved
by not making one component could be used to earn more
contributions making another
MARGINAL COSTING – Make or Buy Decisions
Data for Product X – working at full capacity
Selling Price
£50
Materials
£10
Part Y
£10
Labour (2 hours)
£16
Contribution
£14
• It is currently making £7 per
hour contribution
• (£50 (SP) - £36 (VC) = £14 per
unit
• Each unit takes 2 hours so
contribution = £7 per hour
• Part Y can be purchased from outside for £12
• The time saved making Part Y can be used to earn more contributions
making the rest of the product
• Therefore (assuming Part Y takes ½ an hour to produce) the true cost of
Part Y is £10 PLUS £3.50 (½ of the £7 per hour contribution for product x)
in lost contributions = £13.50
• The company should therefore purchase the component from an outside
supplier as they supply it for £12
Tango MARGINAL COSTING – May or BuyContribution
Decisions
£50 - £20 = £30
Hourly contribution =
£30 / 10 hours = £3
Example Exercise 2
• Tango requires 10 hours to produce and sells for £50.
• It has a marginal cost of £20 (variable cost)
• Samba could also be made. It takes 4 hours at a marginal /variable
cost of £15. A supplier has offered to make it for £ 20
a) Should it be bought or manufactured if there is surplus capacity?
Manufactured
b) Should it be bought or manufactured without surplus capacity
• If Samba is bought in then the hours saved making it can be used to
make more of Tango
• Opportunity cost = 4hours (time saved per Unit of samba) x £3 (
hourly contribution for Tango) = £12
• True cost of producing Samba therefore is £15 + £12 = £27
Therefore it should be purchased from outside for £20
MARGINAL COSTING – May or Buy Decisions
Example Exercise 3
• Component X requires 3 hours to produce and makes a unit
contribution of £4.50. (Hourly cont £4.50/3 hours = £1.50 per hour)
• Component Y could also be made. It takes 4 hours at a marginal
cost of £ £15.
• A supplier has offered to make it for £ 22.
a)Should it be bought or manufactured if there is surplus capacity?
Manufactured
b): Should it be bought or manufactured without surplus capacity
• If Component Y is bought in then the spare hours can be used to
make more of Component X
• Opportunity cost = 4hours (time saved per Unit from Component
Y) x £1.50 (hourly contribution for Component X= £6
• True cost of producing Component Y therefore is £15 + £6 = £21
• Therefore it should NOT be purchased from outside as it costs
more than the cost of manufacture + the opportunity cost
MARGINAL COSTING – Make or Buy Decisions
(Opportunity Cost)
Turra Builders is working at full capacity making garden sheds. The
following data applies to each shed.
Selling Price
£400
Direct labour 4 hours @ £7 = £28 hrs
Materials
£192
Turra builders have been offered a contract at a price of £9000
Details are - Labour required – 80 hours @ £7 and Materials £5,200
a) Calculate contribution currently being earned per hour from garden sheds.
Contribution per unit = SP (£400) – VC (£220) = £180
Contribution per hour = £180/4 hours = £45
b) Calculate additional profit or loss if the contract is accepted.
Money earned from new contract
£9,000
Variable costs – Labour 80 hours x £7 = £560
Materials
£5200
£5,760
+ Opportunity cost lost from sheds
£3,600 (£45 x 80 hours)
£9,360
Therefore a loss of £360 will be made if this contract is accepted
MARGINAL COSTING – Make or Buy Decisions
(Opportunity Cost)
The following applies to product Z which is being produced at full
capacity.
Selling Price
£50
Materials
£20
Labour 2hours
£10
Variable overheads
£2
Fixed costs
£3
(Contribution = 50 – 32 = £18 / 2 hours = £9 per hour)
An order has been received for a batch of a similar product. The
order is worth £800 and can be produced at a total variable cost of
£700 in 10 hours
a) Calculate the increase or decrease in profits if the order is accepted.
Money earned from new contract
Variable costs
Opportunity cost lost from Z
Therefore an increase of £10 will be made
£800
£700
£90
790
(£9 x 10 hours)
MARGINAL COSTING – Retain or Close
• Marginal costing can be used to help a business to decide whether
to keep or drop a product/department which appears to be making
a loss or to keep a factory open when it is losing money
• If a department/ product is making a loss the management should
aim to reduce this loss
• When making a decision they must decide
• Whether another product can be made instead to increase
contribution
• Whether to close the department and sell the assets to raise
money for other departments
• Whether the product making a loss is connected to other
products and if discontinued will affect their sales
• They must also look closely at what will happen to fixed costs
MARGINAL COSTING
RETAIN OR CLOSE A DEPT/PRODUCT
Product
A
B
C
TOTAL
£000
£000
£000
£000
100
60
40
200
Variable costs
70
40
35
145
Fixed Cost
12
12
12
36
Total Cost
82
52
47
181
Profit/Loss
18
8
Sales
-7
19
The management wishes to stop producing any loss making product.
However if C is no longer produced, it might at first seem that there
would be a saving of £7,000,but this is not necessarily the case.
The firm’s total fixed cost bill is £36,000.
It will still be £36,000 if C if not produced.
If it is not being charged to C, it will have to be charged to A and B.
MARGINAL COSTING
RETAIN OR CLOSE A DEPT/PRODUCT
Product
A
£000
Sales
B
C
TOTAL
£000
£000
£000
100
60
40
200
V Costs
70
40
35
145
F Costs
12
12
12
36
Total
Costs
82
52
47
181
Profit/Loss
18
8
-7
19
The overall profitability has fallen from £19,000 to £14,000, i.e. by £5,000
because there is no longer a contribution of £5,000 from C
If, however, you are told that as a result of not making C there will be a
reduction in fixed costs of £8,000 (because, for example, part of the
premises will no longer be used) this would have to be taken into account.
E.g. If C is not produced - lose £5,000 contribution, save £8,000 in fixed
cost, overall gain £3,000, so C should not be produced..
MARGINAL COSTING
RETAIN OR CLOSE A DEPT/PRODUCT
A firm has 3 branches, Aberdeen, Edinburgh and Glasgow.
Details are as follows:
A
E
G
A
E
£000s
£000s
£000s
£000
£000
Sales
300
200
100
300
200
Variable cost
210
150
80
210
150
Fixed Cost
40
30
24
46
36
Profit
50
-4
44
14
20
Management policy is to close any non-profitable branch.
This will result in the fixed costs of that branch being reduced by 50%. (i.e.
although the branch is closed there will still be some fixed costs to pay e.g.
security/rent/insurance.)
Calculate the effect on total profits of implementing this policy
MARGINAL COSTING
PROFIT PLANNING
• Where a number of different options are possible chose the
one which maximises total contribution
• In some instances it will be necessary also to take into
account any changes in total fixed costs e.g. a reduction in
fixed costs has the same effect as if it were additional
contributions
MARGINAL COSTING
PROFIT PLANNING
Example
• Smith & Sons is working at less than full capacity making and selling a
product which has a contribution of £5 per unit.
• Annual sales are 10,000 units.
• Fixed costs are £20,000
• The Production Manager wants to purchase a new machine which will
cut variable costs per unit by £1, but it will add £5,000 per annum to
fixed cost.
• Calculate the effect on profits of accepting this suggestion.
METHOD
Calculate contributions & profit for both situations
Present total contribution
New Profit
50,000
20,000
60,000
35,000
Accept/ Reject
Accept
Present Profit
New Contribution
10,000 units x £5
Cont – Fixed Cost
10,000 units x £6
Cont – Fixed Cost
Limitations of Financial Accounting
system alone
• It is historical i.e. it is out of date therefore it is too late to
change anything now for that time of year!
• It is in total form (e.g. the total profit earned by the whole
business last year). This - doesn’t say anything about the
success of individual products
• Layout is dictated by outsiders e.g. FRS – lacks detail
• Does not apply to areas of responsibility - the Production
Manager, for example, does not know what cost levels are
expected to be achieved in the factory.
Duties of a Management Accountant
• Collecting detailed information on costs and preparing
cost/profit statements
• Providing relevant information for decision making
• Planning and target setting
• Monitoring Performance
Aims of Managerial Accounting
• Provides information that will help management decision
making and control on a day to day basis
• To provide information regarding REVENUE and COSTS
of goods or services that the company provides (COST
UNITS)
Documents Produced
• Cost, revenue and profit statements
• Budgets
• Variance Analysis
• Breakeven analysis
Revenue
• Money that an organisation receives from the sale of its
goods or services
• One item is known as a COST UNIT
• Revenue for ONE cost unit = the selling price
• Total revenue = Selling price per unit x No of units sold
Classification of costs
Manufacturing
• Raw materials, labour and overhead costs specifically incurred in the
production of the organisations COST UNITS
Direct
• Can be traced to a specific cost unit
Indirect
• Cannot be traced to a specific cost unit
• They are general costs necessary for all production to take place (eg rent of
factory)
Non Manufacturing
• Raw materials, labour and overhead costs that are NOT related in any
way to the manufacture of the organisations COST UNITS
• Costs for the sale of the organisations goods and services and
administration
Behaviour of costs
FIXED COSTS
• Will not vary with output
• Will however change over time
• Examples – rent, rates, depreciation
C
O
S
Fixed costs
T
Quantity Produced
Behaviour of costs
VARIABLE COSTS
• Will vary with output
• The more units produced the higher the cost
• Examples – direct labour, raw materials,
C
VARIABLE COSTS
O
S
T
0
Quantity Produced
Cost Systems
JOB COSTING
• Used to calculate manufacturing costs when the organisation
is making different product for different customers
• Where each job is different
• Used by Contractors, builders, engineers
PROCESS COSTING
• Used to calculate manufacturing costs when the organisation
is making the same product in one continuous process
• Used by chemical or textile manufacturers
Cost Systems
MARGINAL COSTING (VARIABLE COSTING)
• Used to calculate manufacturing costs without taking
account of the impact of FIXED OVERHEADS on unit
costs
ABSORPTION COSTING (TOTAL COSTING)
• Used to calculate manufacturing costs by examining ALL
relevant costs (including FIXED OVERHEADS)
Cost Systems
CONTRACT COSTING
• Used to calculate manufacturing costs for a company who
manufactures one large long term project.
• Eg – ship builders
• STANDARD COSTING
• Sets predetermined cost levels and analyses any differences
1.
2.
3.
COSTS
Raw materials
Labour
Overheads
Manufacturing Costs
1.
Direct
2.
Indirect
Can be:
1.
Fixed
2.
Variable
3.
Semi Variable
Non
Manufacturing Costs
Can be:
1.
Fixed
2.
Variable
3.
Semi Variable
Analysed through
Job Costing Con tract Costing
Process Costing Marginal Costing
Absorption Costing Standard
Costing
DOCUMENTS
P
U
R
C
H
A
S
E
S
D
E
P
T
PURCHASE REQUISITION
Request from Departments for goods
LETTER OF ENQUIRY
Sent to potential suppliers
QUOTATIONS
Returned by potential suppliers
ORDER
Sent to chosen suppliers
GOODS RECEIVED NOTE
Sent with the goods and checked
STOCK RECORD CARD/BIN
Records the quantity of stock as it changes
STOCK LEDGER CARD
Records the value of stock as it changes
S
U
P
P
L
I
E
R
S
U
P
P
L
I
E
R
BUDGETS
Detailed plans of action for the future which
•
Improve efficiency through
• Co-ordination (areas working together and in the
same manner)
• Better communication between areas
•
Providing targets which
• Motivate staff
• Allows assessment
•
Aid Control by
• Providing information about financial
performance of specific areas of the business
CASH BUDGET
The cash budget is divided into 4 areas
1.
2.
3.
4.
Opening balance – bank balance at start of year
Add income – ALL monies ACTUALLY received during the
month – (Sale of assets, income from sales etc)
Less Expenditure – ALL monies ACTUALLY spent during the
month – (eg payments to creditors, purchase of assets, bill
payments, wages etc)
Closing balance = (opening balance + Total receipts) – Total
Payments
THE CLOSING BALANCE FOR ONE YEAR WILL BECOME THE
OPENING BALANCE FOR THE NEXT
CASH BUDGET EXERCISE 1
SCUFFERS PLC
June
Sales (Units)
July
10,000 15,000 10,000
Production (Units) 17,000 12,000
Unit Data
Selling Price
Aug
£20
Raw material cost
£9
Direct Wages
£5
Variable Prod OH
£2
8,500
Sept
Oct
7,000
5,000
6,000
5,000
Money for July Received in Aug)
Opening Bank Balance
= 15,000 (Units) x £20 (S Price)
Receipts
Credit Sales
(Production Units x Raw
Sale of Equipment
materials) – 2 months later
Total Receipts
= 17,000 (Units) x £9 (Unit cost)
Payments
August
18,000
300,000
September
October
80,500
40,500
200,000
140,000
18,000
300,000
218,000
140,000
Raw Materials
153,000
108,000
76,500
Direct Wages
42,500
30,000
25,000
Variable Production OHs
24,000
17,000
12,000
Fixed Costs
18,000
18,000
18,000
Equipment
60,000
12,000
Loan
25,000
Total Payments
Closing Bank Balance
237,500
258,000
143,500
80,500
40,500
37,000
CASH BUDGET EXERCISE 2
Kids Palace plc
Feb
Mar
Apr
May
Cash Sales Units
260
300
340
360
Credit Sales Units
1040
1200
1360
1440
Production (Units)
1200
1400
1800
1700
Unit Data
£
Credit Sales
50
Cash Sales (-10%)
45
Raw Materials
15
Direct Wages
10
Commission
5
If sales over 1500 units
Kids Palace plc
Opening Bank Balance
March
April
10750
May
49250
84550
Receipts
Cash Sales
13500
15300
16200
Credit Sales
52000
60000
68000
Loan
5000
40000
Share Issue
70500
75300
124200
Raw Materials
18000
21000
27000
Direct Wages
14000
18000
17000
1000
1500
40000
45000
£84550
£163750
Total Receipts
Payments
Commission
Total Payments
32000
Closing Bank Balance
£49250
Exercise 7 Higher
The following budgeted data relate to the manufacturing firm
Components 4U Plc for the period June to October Year
June July
Aug
Sept
Oct
Sales in Units 6,000 7,000 8,000 9,000 10,000
Closing stock at the end of each month is equal to the level of credit
sales of the following month. Credit sales are 20% of total sales.
Prepare the Production Budget for the period June to September
PRODUCTION BUDGET
A Production budget calculates how many units are available for sale
each month and must include stock at the beginning and production
per month
Exercise 7 Higher
Step 1 – Calculate cash and credit unit sales for each month
Credit sales are 20% of total sales therefore
Sales
June
July
Sept
Aug
Oct
Total Sales
6,000
7,000
8,000
9,000
10,000
Cash Sales
4,800
5,600
6,400
7,200
8,000
Credit Sales (20%)
1,200
1,400
1,600
1,800
2,000
Exercise 7 Higher
Step 2 Work out stock figures (Needed for production budget)
• Closing stock at the end of each month is equal to the level of credit sales of
the following month
• Therefore the closing stock for June is equal to the credit sales of July and so
on
Sales
June
Credit Sales
1,200
July
1,400
Aug
Sept
1,600
1,800
Closing Stock
1,400
1,600
1,800
2,000
Opening Stock
1,200
1,400
1,600
1,800
Oct
2,000
2,000
The closing stock for one month becomes the opening stock for the
next month
So in fact the opening stock for each month is equal to the credit sales
for that month – ie June’s Opening stock will be 1200 units
Exercise 7 Higher
Step 3 Work out production units
• You know that
• Opening stock + production units - sales = Closing stock
• So production units = closing stock + sales – Opening stock
June July
Aug
Sept
Closing Stock
1400
1600
1800
2000
+ Sales (units)
6000
7000
8000
9000
-opening stock
1200
1600
1800
Production Units
6200
8200
9200
1400
7200
Exercise 7 Higher
Step 4 Create production budget
Components 4U – Production Budget
Opening Stock
1200
1400
1600
1800
Production Units
6200
7200
8200
9200
Available for Sale
7400
8600
9800 11000
Exercise 8 Higher - Crownpoint
Step 1 – Calculate cash and credit unit sales for each month
Credit sales already given
Step 2 Work out stock figures (Needed for production budget)
• The closing stock for each month is maintained at 20% of the cash sales for
the following month
• Cash sales for Jan year 3 are estimated at 2000 units
July
Cash Sales
Aug
Sep
Oct
Nov
Dec
1,300
1,400
1,500
1,600
1,700
1,800
Closing Stock
280
300
320
340
360
400
Opening
Stock
260
280
300
320
340
360
Exercise 8 Higher
Step 3 Work out production units
• You know that
• Opening stock + production units - sales = Closing stock
• So production units = closing stock + sales – Opening stock
July
Aug
Sep
Oct
Nov
Dec
Closing Stock
280
300
320
340
360
400
+ Cash Sales
1,300
1,400
1,500
1,600
1,700
1,800
+ Credit Sales
6,500
7,400
8,300
5,600
4,800
7,500
-Opening Stock
Production
Units
260
280
300
320
340
360
7,820
8,820
9,820
7,220
6,520
9,340
Exercise 8 Higher
Step 4 Create production budget
July
Opening Stock
+ Production
Sep
Oct
Nov
Dec
260
280
300
320
340
360
7,820
8,820
9,820
7,220
6,520
9,340
8,080
- Cash Sales
Aug
1,300
9,100
1,400
10,120
1,500
7,540
1,600
6,860
1,700
9,700
1,800
- Credit Sales
6,500
7,400
8,300
5,600
4,800
7,500
Closing Stock
280
300
320
340
360
400