1. COSTS A2 Business Studies

2. Covered last year … DIRECT COSTS INDIRECT COSTS FIXED VARIABLE MARGINAL BEP: MARGIN OF SAFETY CONTRIBUTION PER UNIT

3. COSTS – A2 … FULL / ABSORBTION COSTING Def: a method of costing where all fixed and variable costs are allocated to products or services Total overheads are apportioned accordingly Eg: Total overheads for a hotel being divided into each section of the business (Cost Centre), based on the proportion of direct labour costs (in the restaurant, the kitchens, the bar, conference suites etc)

4. FULL / ABSORBTION COSTING A2 Factory and Admin costs can also be allocated based on “space” usage for each product … So, if:TOTAL direct labour costs were $220,000 TOTAL overheads were $200,000 Product A ($)Product B ($) Direct Materials Cost100,000150,000 Total Direct Labour68.2 % of total labour cost32.8 % of total labour cost Apportioned Overheads?? Total Cost??

5. COSTS – A2 … FULL / ABSORBTION COSTING So, if:TOTAL direct labour costs were $220,000 TOTAL overheads were $200,000 Product A ($)Product B ($) Direct Materials Cost100,000150,000 Total Direct Labour150,04069,960 Apportioned Overheads136,40063,600 Total Cost386,440283,560

6. Absorption Costing – an evaluation … It’s nice and easy to calculate – as long as each overhead cost is absorbed using the same basis (eg labour allocation) Ideal for single product businesses ALL costs get accounted for (direct AND indirect costs) Good for pricing decisions (if single product business!) … Mark-up pricing can be applied easily BUT  Is it fair for “Space” cost allocation? More floor space might be used in production but using cheaper labour, efficient machinery and low cost materials  Can be difficult to make decisions based on allocation of costs  Can become difficult to make year on year comparisons of costs if different a cost basis (eg labour or space) is used over a period of time Activity 28.6 Pg 517 Heath Electronics

7. MARGINAL (or contribution) COSTING… Def: Allocation of DIRECT COSTS only – NO OVERHEAD COSTS ALLOCATED So, no problems in deciding where the overheads are to be apportioned. MARGINAL COST – the cost of producing ONE extra unit CONTRIBUTION – Revenue minus the marginal cost (direct variable cost) NOT THE SAME AS PROFIT !!!

8. COSTING… decision making … So, what is the best method? Full Costing (absorbing ALL costs) or Marginal Costing (excluding overheads)? Which one would be the better option for a business with many products/departments? What do hotels and airlines do if they are not working to full capacity? Fixed overhead costs have to be paid regardless – better to have “bums on seats” and PERHAPS make a small profit if all unit cost are covered

9. Problems with selling below cost … Stock may sell out or services to full capacity below cost – so very little profit will be made Brand image could be destroyed – perceptions of low pricing