Professional Documents
Culture Documents
The costs and activity of a business can be related to each other under various levels of behaviour. This behaviour is
useful to management in:
(a)Cost identification- Certain costs arise only after a certain level of activity.
(b)Cost determination – The amount of costs can be determined.
(c)Cost control – Comparison of actual and budgeted costs.
(d)Decision making – Production ,sales etc.
Cost unit- Unit of product or service in relation to which costs are ascertained (e.g per ton ,per brick, per mile)
Cost center- a location, function o item of equipment in respect of which costs may be ascertained and related to cost
units for control purpose.
(Production,service,process cost centers)
Classification of costs
• By function –production costs, selling costs, administrative costs.
• Direct and indirect-Direct cost or traceable costs are those costs which can be identified to a product or
service while indirect costs or common costs are those which cannot be specifically identified to a cost object.
• Product and period costs-product costs are those which can be included in the inventory(e.g material) while
period costs are charged against the revenue of a period in which they are incurred.
• Controllable and uncontrollable costs-Controllable costs are those which can be inflenced by the action of a
specified member of an undertaking while uncontrollable costs are those which cannot be influenced by such an
action.
• Avoidable and unavoidable costs-Avoidable costs are those that may be saved by adopting a given alternative
(materials,rent for a new branch) while unavoidable costs are those that cannot be saved by adopting an
alternative e.g depreciation of an existing equipment.
• Fixed and variable costs – variable costs are those which tend to follow the level of activity while fixed costs
are those which accrue with the passage of time and are unaffected by fluctuatuions in the level of activity up to
a certain level.
Costing methods
Specific order costing
o Job order costing-each job is unique and require different resources for execution-E.g A painting
o Batch costing-Similar or identical items are manufactured as a batch in large quantities e.g bakery
o Contract costing-Job order which spans over an accounting period e.g (Road constructions)
Process costing- method suitable for industries manufacturing goods using a series of continuous processes
Behaviour of costs
See - diagrams
Materials
Basic elements relating to material control
Materials should be purchased only when required and properly authorised from suppliers who represent an
appropriate balance between quality, price and delivery. On delivery, the materials should be properly received and
recorded to ensure physical checks regularly and minimum discrepancy and loss.
Materials control
Causes of material shortage or excess
• Errors
• Pilferage
• Evaporation
• Breaking bulk / Cutting
• Handling wastage
• Contamination/process loss
Measures taken for control and avoiding wastage and losses
• Authorisation of all transactions
• Internal control
• Perpetual inventory system with continuous stocktake
• Regular reconciliation of book and physical stock
Details $ Details $
Balance b/d 150000 General ledger 10000
adj(Returns)
General ledger 1000000 WIP ledger 1040000
adj(Purchases) control(issues)
Production overhead 5000
ledger control
account(shortage)
Bal c/d 95000
1150000 1150000
Integrated accounts
Stores ledger control accounts- Materials control account
Details $ Details $
Balance b/d 150000 Creditors(returns) 10000
Sundry 1000000 WIP ledger 1040000
creditors(purchases) control(issues)
Production overhead 5000
(shortage)
Bal c/d 95000
1150000 1150000
Labour
Direct wages – That proportion of the wages of production employees directly attributable to production (ascertained
from job cards/time sheets).It is charged to the job or operation in which the employee is engaged and the total for that
period is charged to the department’s work in progress.
Indirect wages- Wages of non productive employees e.g storekeepers, inspectors, labourers but also includes overtime
and shift bonuses and these are included in the overheads.
Operation cards
• Also known as piecework tickets used for each operation in a job{cutting, stitching etc]
Ledger entries
Interlocking accounts
Wages ledger control account
$ $
Financial ledger control 5000 WIP 31000
account 0
Production ohds 19000
5000 50000
0
Integrated accounts
Wages ledger control account
$ $
Bank 4000 WIP 31000
0
PAYE 4000 Production ohds 19000
Insurance 3000
Pension 3000
5000 50000
0
Labour turnover
Labour turnover represents the movement of workers from one job to another.A reasonable level of turnover is good
but a high turnover of workers causes decrease in morale , increased costs and reduce productivity.
Information
Planning process
Assess
Operational planning
Further breakdown of the plans into daily,weekly,or monthly plans and targets.
Control
Control can be broken down into two stages:
• Comparison of actual and standards- Identify deviations and take corrective measures.
• Review corporate plan in light of comparisons made.
Marginal costing is the costing principle where all cost units are valued at Variable
production costs (Direct costs+ Variable production overheads) and fixed costs are charged to the P&l a/c.
Under M.C. finished goods are valued at Marginal (variable) Production cost i.e.
Direct materials
Direct labour
Variable production overheads
Contribution refers to the difference between sales revenue and the variable cost of sales
Absorption costing is the costing principle where all cost units are valued at full costs including absorbed fixed costs.
Advantages of absorption costing
1. Realistic-Includes all costs
2. Stock valuation –In compliance with SSAP 9
3. Avoids fluctuation of profits in years of no sale
4. Pricing decisions are made easy
Example
Sales revenue 15000 15000
Details for product X
Selling price per unit -$15
Cost of production Variable production cost per unit - $8
Normal level of activity 1200 units
Variable costs 10400 10400 Budgeted /actual fixed production overheads
for the period - $3600
Fixed costs 3900 Actual production –1300 units
(3×1300) Actual sales – 1000 units
14300 10400
11000 8000
FIFO Receipts
(periodic Jan 1(o.s) Jan 5 Jan 8 Jan 22
&perpetual)
2000 1500 1600 1200
Issues
Jan 7 (1700)
Jan 15 (300) (1500) (400)
Jan 24 (1100)
AVCO
Perpetual Periodic
Date QTY AVCO Amount($) Qty Avco Amount
Jan 1 2000 30 60000 Receipts 2000 30 60000
Jan 5(rec) 1500 35 52500 1500 35 52500
3500 32.14 112500 1600 37 59200
Jan 1700 54643 1200 39 46800
7(issue)
1800 32.14 57857 Isuses 6300 34.6 218500
8
Jan 8(rec) 1600 37 59200 (1700 (58960)
)
3400 34.42 117057 (2200 (76302)
)
Jan 2200 34.42 75743 (1100 (38151)
15(issues) )
1200 41314
Jan 22 1200 39 46800
receipt C/stock
2400 36.71 88114
Jan 1100 36.71 40386
24(issue)
Closing 1300 47728 1300 45087
stock
Overheads
Direct expenses- are those expenses which are directly incurred and can be specifically identified with a product
,process or job. e.g. royalty, cost of drawings etc also known as chargeable expenses.
Overheads consist of indirect material, indirect labour and indirect expenses.
Indirect expenses – are those which cannot be conveniently identified to a job, product, or process e.g. Maintenance,
supervision, rent, rates and taxes.
Since indirect production expenses (production overheads) cannot be identified to a job, it has to be distributed to cost
units in an equitable manner. This distribution is a 3-stage process:
(1) Allocation of overheads-the charging of discreet , identifiable items of cost to cost centres or units. E.g. wages
of storekeeper to stores dept
(2) Apportionment of overheads-The allotment of 2 or more cost centres of proportions of common items of cost
on the basis of benefits received
(3) Reapportionment of service cost centre overheads to production depts.
Bases of reapportionment
(i)Direct redistribution method
(ii)Step distribution method
(iii)Reciprocal method
• Simultaneous equation
• Repeated distribution
Simultaneous equation method
Example: Production dept Service
dept
A B C 1 2
$80 $70 $50 $23 $30
0 0 0 4 0
Overhead distribution table
1 20% 40% 30% 10%
2 40% 20% 20% 20%
Let X represent the total amount of overheads of service department 1
Let Y represent the total amount of overheads of service department 2
Then: X = 234 + 20% Y And Y = 300 + 10% X
Solving the equations we get X = 300 and Y = 300
Production
departments
A B C
$80 $700 $500
0
Reapp 1 60 120 90
2 132 66 66
992 886 656
Repeated distribution method – Easier where there are more than 2 service departments.
Production dept Service dept
A B C 1 2
$80 $700 $500 $234 $300
0
1 46 92 72 (234) 24
2 129 64 64 67 (324
)
1 13 27 20 (67) 7
2 4 1 1 1 (7)
1 1 (1)
992 885 657
Absorption of overheads
o Blanket rate-It is a single OAR used throughout a factory to absorb overheads into units produced.
Is applied where (i)All products spend nearly the same time in each cost centre
(ii)The factory produces only one product or all products are similar.
The drawbacks of using a blanket rate are that:
(i)Distorts the value of WIP-costs not yet used are charged
(ii)Impossible to evaluate the performance of each dept
o Departmental rates- or Multiple OAR –where each dept or centre has its own rate for absorbing overheads.
These are more accurate because:
(i)Some products pass only through a few centres
(ii)Each cont centre has different features(packing and stitching not same)
(iii)Time span is different in each centre.
o Actual OAR
Actual OAR is calculated as follows:
Actual overheads
Actual activity
This can only be calculated at the end of a period when actual figures become available. However it causes a delay
in ascertaining cost figures.
Overheads
Overheads include manufacturing and non-manufacturing overheads.
Manufacturing or production overheads refer to those indirect costs which are incurred in the course of
manufacturing the product e.g Depreciation of factory machinery, rent of factory etc.
Non-manufacturing overheads , the main components of which are selling and distribution overheads and
administration overheads are those indirect expenses which are incurred after the product has left the factory e.g
Advertising , office staff salary etc
Although sometimes such costs are treated as costs not relevant to the product, and are therefore charged to the profit
and loss as an item of expense, however it is better to include them into the cost of the product to have a better picture
of the total costs that have been incurred in relation to that product.
We need to know certain basic terms in relation to manufacturing overheads
Manufacturing overheads incurred relate to the actual amount of overheads that have arisen in a period.
The journal entries for overheads incurred are given below:
Interlocking accounts Integrated accounts
Indirect material Indirect material
Dr Factory overhead control account Dr Factory overhead control account
Cr Stores ledger control account Cr Stores ledger control account
Indirect wages Indirect wages
Dr Factory overhead control account Dr Factory overhead control account
Cr Wages ledger control account Cr Wages ledger control account
Indirect expenses Indirect expenses
Dr Factory overhead control account Dr Factory overhead control account
Cr General ledger adjustment Cr Cash or creditors
Manufacturing Overheads absorbed (i.e. overhead actually attributed to the product) is calculated as follows:
Actual activity × Overhead absorption rate
Non-integrated Integrated
Dr Overhead adjustment Dr Overhead adjustment
Cr Factory overhead control Cr Factory overhead control
Since budgeted and actual results are usually not the same under or over absorption arises as shown below:
Non-integrated Integrated
Under absorbed Under absorbed
Dr Overhead adjustment Dr Overhead adjustment
Cr Factory overhead control Cr Factory overhead control
Over absorbed Over absorbed
Dr Factory overhead control Dr Factory overhead control
Cr Overhead adjustment Cr Overhead adjustment
The same accounting treatment applies to all other types of overheads e.g Administrative and Selling and distribution
overheads.
Deprival value
Is the lower of
Higher of
Sunk costs
Also termed past costs are those costs have already been incurred and therefore are irrelevant or decision making
Research and development cost incurred..
Historical costs
Costs already incurred which are not going to be affected by the decisions taken.
Replacement costs
Until now it has been assumed that items needed are bought. Most of the times however they are taken from stocks. In
such cases the relevant costs would be the future cost of replacing the stock
Budgeting
A budget is defined as a plan.Usually it is prepared for each operation or dept existing in a business and such plans are
known as functional or operating budgets.E.g Sales budget or production budget.It is all then accumulated to provide
the master budget which is the Budgeted Profit and Loss account and Balance sheet.
When preparing budget we have to consider the factor which limits our activity and therfore the budget for that factor
has to be prepared first.This is known as the Principal budget factor and is usually the sales but can be any of the
following:
-Materials
-Labour
-Machinery
Advantages
• Helps to establish a plan
• Coordination is made easy among dept
• Control will be exercised on the performance of depts
• Communication is facilitated
• Evaluation of performance of each dept is easy
• Creates motivation in different units
Linear programming
This is a mathematical technique used to optimise scarce resources in cases of product mix problems, production
planning, etc
LP can be used if:
• Problem can be stated numerically
• All factors have a linear relationship
• The problem permits a choice
• There must be one or more restrictions
• Solutions must be feasible
Example
A manufacturer produces two products B and S with contributions of $3 and $4 respectively. The manufacturer wishes
to establish weekly production plan which will maximise contribution.
Per unit
Machine hrs Labour hrs Material kgs
Biss 4 4 1
Soub 2 6 1
Total available 100 180 40
Sales of B are limited to a weekly maximum of 20 units and a minimum of 10 units of S must be produced.
Required: Calculate the number of B and S to be produced.
Solution
First we identify the objective: Maximisation of contribution
Next we identify the constraints: Machine hrs, Labour hrs, material qty, B maximum qty, S minimum qty.
Production costing
♦ Job Costing
♦ Process costing
Abnormal gains and losses
Equivalent units
Joint costs and by products
♦ Batch costing
Job costing
Specific order costing used when a customer orders a specific job. Each job is unique and priced separately.
$
Materials 1375
Labour 138
Overheads 242
Other charges 23
1778
Profit 622
Invoice 2400
Process production
Mass production of identical units which involves several processes e.g tins of paint, bars of chocolate.
Process 1 account
Units $ Unit $
s
Mterials 1000 20000 Transfer to 1000 24000
process 2
Labour 3000
Overheads 1000
24000 24000
Process losses
Normal losses occur due to evaporation,wastage of materials,and is expected in any process.
Losses can be sold and generate a revenue called scrap proceeds or scrap value.
Example :
Process 1 data:
Materials input 1000 units costing $10000.
Labour costs $8000
Overheads $6000
Normal loss is 4% of input and is sold as scrap for $12 per unit.
Prepare:
(a) Process 1 account
(b) Scrap account
(c)Calculate the average cost per unit.
Answer
Process 1 account
Units $ Unit $
s
Materials 1000 10000 Transfer to 960 23520
process 2
Labour 8000 Normal loss 40 480
Overheads 6000
24000
Scrap account
$ Units $
Process 1 480 480
Example :
Materials 1000 units costing $10000
Labour cost $8000
Overheads $6000
Normal loss is 4% of output and is scrapped at 412 per unit.
Actual output is 944 units
Process 1 account
Units $ Unit $
s
Materials 1000 10000 Transfer to 944 23128
process 2
Labour 8000 Normal loss 40 480
Overheads 6000 Abnormal loss 16 392
24000 24000
Scrap account
$ Units $
Process 1 480 480
Example
Opening work in progress in Process 2- 200 units (25% complete) valued at $2500.
800 units received from Process 1 valued at $4300.
840 units were transferred to process 3.
Closing WIP 160 units (50% complete)
Costs for the period were $16580- No scrap units.
Prepare process account for Process 2 using:
(i)FIFO (ii)AVCO methods of valuing WIP.
FIFO method
Units
Completed units transferred 840
+ Closing WIP 160 × 50% 80
- Opening WIP (200×25%) (50)
Effective units for the period 870
Cost per unit = Total cost per period (Process costs + Transfers in)
Effective units of production
AVCO method
Units
Completed units transferred 840
+ Closing WIP 160 × 50% 80
Effective units for the period 920
Process 2 account
Units $ Unit $
s
Opening WIP 200 2500 Process 3 840 21347
Process 1 800 4300 Closing WIP 160 2033
Process costs 16580
1000 23380 1000 23380
Service/function costing
“Cost accounting for specific services or functions e.g canteen ,maintenance, personnel. These maybe referred to a
service centers, departments or functions. The service can either be for sale(tpt) or for use within the
organization(canteen).
Typical cost units in a service costing system
Service Possible cost unit
Transport Tonne-mile
Hospital Patient days
Electricity Kilowatt-hrs
Hotels Bed nights
Example
City Hospital County Hospital
Number of beds 780 500
Number of 23472 8165
inpatients
Average stay 7.5 days 85% occupancy
Number of 216500 63920
outpatients
Cost breakdown
Indirect costs
Answer:
(i)Average stay in county hospital
Total bed days in a year = 500×365 = 182500 bed days
City County
16285590 12166840
23472×7.5 8165×19
=$92.51 = $78.43
Production Costs($)
(units)
Lowest 2000 8000
Highest 4000 12000
25
20
15
Cost
10
5
0
0 2 4 6 8
Output(000’s) 1 2 3 4 5 6 7
Costs(000’s) 14 17 15 23 1 2 3
8 2 1
∑y =an +b∑x.......( i)
∑xy = a ∑x +b∑x 2
.........( ii )
Where a is the fixed cost and b is the variable cost per unit.
Output(000’s)- Cost(000’s)-
x y xy X2
1 14 14 1
2 17 34 4
3 15 45 9
4 23 92 16
5 18 90 25
6 22 132 36
7 31 217 49
∑x = 28 ∑y =140 ∑xy = 624 ∑x 2
=140
Solving the simultaneous equations:
140 = 7a + 28 b
624 = 28 a + 140 b
a=
∑y ∑x 2
− ∑x ∑xy
n∑x − ( ∑x )
2 2
n∑xy − ∑y ∑x
b=
n ∑x 2 − ( ∑x )
2
Correlation
Once we know that a causal relationship exists evidence of good correlation has to be tested prior to carrying out a least squares calculation.
The coefficient of determination is calculated as follows:
Coefficient of determination = r2
n∑ xy − ∑ x ∑ y
Where r = = 0.839
n∑ x 2 − ( ∑ x ) n ∑ y 2 − ∑( y )
2 2
n −2
T= 0.839 × = 3.45
1 − ( 0.839 )
2
Output(000’s) Cost(000’ X2 Y2
-x s)- xy
Y
1
1 14 196 14
2 17 4 289 34
3 15 9 225 45
4 23 16 529 92
5 18 25 324 90
6 22 36 484 132
7 31 49 961 217
∑x = 28 ∑ y =140 ∑x 2 =140 ∑y 2
= 3008 ∑xy = 624