CIMA Paper P1 Management Accounting 江西财经大学 会计学院 熊家财 xiongjc-p@163.com

1 Chapter Traditional Costing

Chapter Content Traditional Costing Absorption Costing Marginal Costing Traditional Costing Pricing

迎评工作 一 Section 1 Cost behavior

The purpose of costing

Cost behavior

Cost behavior

Cost behavior Fixed costs

Cost behavior Fixed costs Relevant range

Cost behavior Stepped fixed costs

Cost behavior Variable costs

Cost behavior Variable costs

Cost behavior Non-linear variable costs

Cost behavior Semi-variable costs

Cost behavior Analysing semi-variable costs

Variable Cost per Unit = The “High-Low” method Take highest and lowest levels of output and the associated costs:- Period Total Cost Output 1 2 3 4 5 $10,000 $12,000 $8,000 $17,000 $20,000 10,000 12,500 7,500 18,750 22,500 $20,000 - $8,000 = 22,500 – 7,500 = 80p per unit Lowest Output Highest Output STEP 1: Variable Cost per Unit = STEP 2: Change in cost Change in output Absolutely fundamental, and always tested. Try Q 2.6 from p29 Fixed costs = $20,000 – (22,500 x 80p) = $2,000 TOTAL COST = TOTAL FIXED COST + TOTAL VARIABLE COST TOTAL COST = 2,000 + ($0.08 X UNITS)

The scattergraph method x Output (units) Cost $ a = $200 $200 $400 400 units b = Change in Y = $400 - $200 $0.50 per unit y = a + bx a = y axis intercept b = gradient Explain that this is very similar to the high low method, only showing it graphically. With high low, we said: TOTAL COST = FIXED COST + (VARIABLE COST x UNITS) Writing this algebraically: Y = a + bx Where: y = total cost a = fixed cost (where the line intersects the y axis) b = variable cost per unit (gradient of the line) x = number of units Now try Q2.5 from p 28 Change in X Therefore predicted total costs for 1000 units = $200 + (0.5 x 1000)

Section 2 Absorption costing 迎评工作 一 Section 2 Absorption costing

Absorption costing Absorption costing is a method of costing in which the cost of a product is built up as the sum of direct costs and a fair share of production overhead cost Determine the full production cost per unit A fully absorbed cost is used to value inventory and as a basis for pricing

Absorption costing 生产经营费用

Absorption costing card $ Direct materials x Direct labour x Variable overheads x Fixed production overheads x Full production cost per unit x OAR

Absorption costing Overhead allocation Apportioning general overhead Reapportioning Service costs Overhead absorption (recovery)

Step 1: Allocation A production department “To assign a whole item of cost, or of revenue, to a single cost unit, centre, account or time period” A production department An selling or distribution department An administrative department An general overhead cost center Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 2: Apportioning general overhead Overhead that relates to a number of cost centres (i.e. factory rent) will be shared or “apportioned” between those cost centres on an equitable basis. Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 2: Apportioning general overhead Bases of Apportioning Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 2: Apportioning general overhead Example 1: Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 2: Apportioning general overhead Example 1: Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 2: Apportioning general overhead Example 1: Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 3: Re-apportion service cost centre overhead Service cost centre overhead is re-apportioned on the basis of the benefit provided to the production cost centres. Production Cost Centre 1 Production Cost Centre 2 Service Cost Centre 1 Service Cost Centre 2 Typical service cost centres might be: Canteen Stores Maintenance Now we have the overhead split between the 4 cost centres, but 2 of them do not directly produce the goods, so we need to re-apportion the service cost centres to the production ones Problem – again the problem is what basis to use to reapportion the costs – again this will be subjective, or what is available Example: Factory canteen – could be reapportioned on the basis of the number of staff in each of the 2 production departments Maintenance – could use time spent in each department, or number of machines Canteen costs are $59,500. these are to be apportioned to the 2 production departments on the basis of staff numbers. There are 25 staff in Assembly and 10 in Painting: Assembly will pick up 25/35 x $59,500 = $42,500 Painting will pick up 10/35 x $59,500 = $17,000 We will then be left with just the costs in the 2 production cost centres Now try TYU 2.2 (p80) and TYU 3 (a) (p83)

Step 3: Re-apportion service cost centre overhead Now we have the overhead split between the 4 cost centres, but 2 of them do not directly produce the goods, so we need to re-apportion the service cost centres to the production ones Problem – again the problem is what basis to use to reapportion the costs – again this will be subjective, or what is available Example: Factory canteen – could be reapportioned on the basis of the number of staff in each of the 2 production departments Maintenance – could use time spent in each department, or number of machines Canteen costs are $59,500. these are to be apportioned to the 2 production departments on the basis of staff numbers. There are 25 staff in Assembly and 10 in Painting: Assembly will pick up 25/35 x $59,500 = $42,500 Painting will pick up 10/35 x $59,500 = $17,000 We will then be left with just the costs in the 2 production cost centres Now try TYU 2.2 (p80) and TYU 3 (a) (p83)

Step 3: Re-apportion service cost centre Example 1 (continue): Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 4: Absorption into cost units Fixed production overhead that have been allocated, apportioned and re-apportioned into a production cost centre is then absorbed into cost units using a pre-determined overhead absorption rate (OAR). Production Cost Centre 1 Production Cost Centre 2 Service Cost Centre 1 Service Cost Centre 2 OAR 1 OAR 2 Fixed Production Cost Centre Overhead OAR = Cost Units QTY of absorption base Absorption bases commonly used: It may be worth recapping the steps in slide 26 to remind them where they are in the process We are now in a position to get the cost to the product (cost unit) Again this is subjective – how will we absorb the overhead into the product? Traditionally, we use: Number of units produced Labour hours Machine hours You have to use the one you feel gives the fairest cost to the product, but there is no right or wrong answer We first calculate an OVERHEAD ABSORPTION RATE, based on the total overhead divided by the total base we are using (BASED ON BUDGET) Example: If the total overheads for Production Cost centre A were $120,000. IF we base the absorption on labour hours (with a budget of 20,000 labour hours) OAR = 120,000/20,000 = $6 per labour hour IF Product X uses 3 hours in production department A, then each unit of product X will pick up $6 x 3 = $18. Note: The OAR is calculated using the BUDGETED figures Units produced Labour hours Machine hours

Step 4: Absorption into cost units Example 1 (continue): Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 4: Absorption into cost units Example 1 (continue): Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 4: Absorption into cost units During a period overhead is charged or “absorbed” into cost units according to the predetermined OAR multiplied by the number of units produced. Actual overhead incurred is likely to be different to the overhead absorbed leading to an under or over absorption. (under)/over absorption = overhead absorbed – actual overhead It may be worth recapping the steps in slide 26 to remind them where they are in the process We are now in a position to get the cost to the product (cost unit) Again this is subjective – how will we absorb the overhead into the product? Traditionally, we use: Number of units produced Labour hours Machine hours You have to use the one you feel gives the fairest cost to the product, but there is no right or wrong answer We first calculate an OVERHEAD ABSORPTION RATE, based on the total overhead divided by the total base we are using (BASED ON BUDGET) Example: If the total overheads for Production Cost centre A were $120,000. IF we base the absorption on labour hours (with a budget of 20,000 labour hours) OAR = 120,000/20,000 = $6 per labour hour IF Product X uses 3 hours in production department A, then each unit of product X will pick up $6 x 3 = $18.

Step 4: Absorption into cost units (under)/over absorption = overhead absorbed – actual overhead Example Budgeted Fixed Production overhead = $60,000 Budgeted Production (units) = 1500 units Therefore budgeted OAR = 60,000/1500 = $40/unit During the period actual results were: Actual Fixed Production overhead = $50,000 Actual units produced = 1200 units It may be worth recapping the steps in slide 26 to remind them where they are in the process We are now in a position to get the cost to the product (cost unit) Again this is subjective – how will we absorb the overhead into the product? Traditionally, we use: Number of units produced Labour hours Machine hours You have to use the one you feel gives the fairest cost to the product, but there is no right or wrong answer We first calculate an OVERHEAD ABSORPTION RATE, based on the total overhead divided by the total base we are using (BASED ON BUDGET) Example: If the total overheads for Production Cost centre A were $120,000. IF we base the absorption on labour hours (with a budget of 20,000 labour hours) OAR = 120,000/20,000 = $6 per labour hour IF Product X uses 3 hours in production department A, then each unit of product X will pick up $6 x 3 = $18. Therefore overhead absorbed:- 1200units X $40 = $48,000 Overhead under-absorbed:- $48,000 - $50,000 = ($2000)

Step 4: Absorption into cost units Example 1 (continue): Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Step 4: Absorption into cost units Example 1 (continue): Step1 – gather all of the fixed production overhead costs together Step 2 – need to know all the production and service cost centres: Example: Production cost centres could be assembly or painting (areas directly involved in producing the product) Service cost centres could be maintenance or the factory canteen (part of the overall factory cost, but not directly involved in producing the product) Allocate – this is the easy one where the costs can easily be allocated to one of the cost centres, some cost may only relate to one or two cost centres Apportionment – this is the difficult one. Stress to students that there is no one right way to do this – it is always subjective. How we apportion the costs can depend on what dta is available: Examples: Electricity – if available, can use t he electricity used in each area Rent – could use floor area Depreciation of machinery – value of machines Insurance – value of machines etc Now try TYU 2.1 (p80)

Absorption costing Overhead allocation Apportioning general overhead Reapportioning Service costs Overhead absorption (recovery)

Proforma of Income Statement Selling, admin, distribution cost Full costs

Absorption costing

Absorption costing

Section 3 Marginal costing 迎评工作 一 Section 3 Marginal costing

Marginal cost

Marginal Cost $ Direct materials x Direct labour x Inventories and production are valued at the variable production costs per unit. $ Direct materials x Direct labour x Variable production overheads x Marginal cost X Contribution is emphasised.

Contribution Contribution = Sales Less Variable Costs Direct Materials Direct Labour Variable Overheads

Marginal costing 1. Only variable costs are charged to the cost of sales 2. Fixed costs are treated as period costs and are deducted from total contribution to derive profit 3. The valuation of units of output and hence closing Inventory is therefore at variable production cost

Proforma of Income Statement variable costs Fixed costs

Marginal costing Example 2 (p.13)

Marginal costing

Marginal costing

Section 4 Reconciliation of profits 迎评工作 一 Section 4 Reconciliation of profits

Reconciliation of profits The only difference between the two approaches is the value of inventories. Absorption costing values inventory at a higher value as it includes the fixed production overhead in the standard cost card. Therefore: increased inventory increases current period’s profit compared with marginal costing. decreased inventory decreases current period’s profit compared with marginal costing.

Reconciliation of profits

Reconciliation of profits Example 3 - Water Co. make a product, the Splash, which has a variable cost of $5 per unit and a sales price of $10 per unit. There were no inventories at the beginning of Sep. Production during the month was 1,000 units. Fixed cost for the month were $10,000. Required: Calculate the profit , contribution using Absorption costing and Marginal costing at each of the following sales levels: 500 splashes (b) 1000 splashes (c) 1500 splashes Testing 5 in P27

Section 5 Pricing Strategic based on costs 迎评工作 一 Section 5 Pricing Strategic based on costs

Pricing using absorption costing

Pricing using absorption costing

Pricing using absorption costing

Pricing using marginal costing

Target return on capital Target return on investment in the product =Total investment x target rate of return Example 5

Profit margin

Profit margin Example 6

迎评工作 一 Section 6 Summary

Summary