1. Cost Accounting

2. The Cost Object TimCo manufactures Chairs, each chair consists of Materials (Wood), Labor (A Carpenter) and Overhead (Rent, Utilities and Manager’s Wages). The Chairs are sold onto a furniture shop. TimCo’s Strategy is to make a profit on its operations

3. Planning The manager asks how many chairs can the company make in a week? The Manager asks you how much the chair needs to sell for to make a profit?

4. Costs Material costs per chair are $10 of wood and nails/glue It takes a carpenter one hour to make a chair Carpenters are paid $300 per week and there are 40 working hours in each week, the company employs 2 carpenters Manufacturing Overheads are $1000 per week, this includes rent, heat light and managerial wages

5. How Many Chairs can be made? One chair per hour, per carpenter, two carpenters 40 hours in a week = 40 x 2 = 80

6. What are the cost of constructing a chair? Direct Materials $10 Direct Labour $7.5 ($300/40 hours) Overhead $12.5 (£1000/80 Chairs constructed in one week) = $30 per chair

7. What should the company sell the chair for? Your manager suggests that the company needs to make a Margin of 30% = $30 x 0.30 = $9 The selling price of the chair is therefore = $39

8. Review Question ABC Plc manufactures Beds the following information is available Direct Materials $10 Direct Labour $5 Overheads $5 Units produced in one week 100 Sales Margin of 25% What is the Total cost of production? What is the selling price of one bed? How much profit will the company make in one week?

9. Answer Total Cost of production is $20 (10+5+5) Selling Price is $25 (20 x 0.25) Profit for one week is $500 (5 x 100)

10. Fixed and Variable Costs Fixed costs are usually the indirect costs of producing a Cost Object Variable Costs are all direct costs which are assigned to the production of a Cost Object Fixed and variable costs behave in different ways

11. Fixed Costs Fixed costs do not change with the volume of production Usually fixed costs include all of the running costs of the business apart from the direct materials and labour involved in the physical aspects of the Cost Object

12. Variable Costs Variable costs increase as production increases Variable costs are usually the direct materials and labour of producing the Cost Object

13. Allocation of Fixed Costs It is unusual for a company to make only one product, but often many products will be made in the same environment, sharing some portion of Fixed Costs Often managers will want more information about the difference between Cost Objects and the cost of production We can do this by allocating overheads in some way

14. Example A company makes two products A and B $AB Direct Materials 37 Direct Labour 59

15. Further Information Fixed Costs$ Utilities and Rent400 Machine Costs200 Managerial Wages600

16. How can we allocate the fixed costs to the Products? We need more information, assume the following Product A utilises 30% of the Factory, Product B utilises 70% Product A utilises 4 Machine Hours per unit, Product B utilises 3 Machine Hours per unit, there are a total of 400 machine hours used per week

17. Allocation of Fixed Costs We need to make a choice on how we allocate these costs, given the information available we can assume the following Allocate the utilities according to the % of space used Allocate the Machine Costs according to the % total machine time each product uses Allocate managerial costs using either of these methods

18. Rent and Utilities Total Fixed cost $400 Product A utilises 30%, Product B utilises 70% Total Fixed Cost allocated to Product A $120 (400 x 0.3) Total Fixed Cost allocated to product B $280 (400 x 0.7) Fixed cost per Unit – Product A $2.4 (120/50) – Product B $5.6 (280/50)

19. Machine Costs Find Total Machine Hours per Product Product A Machine Hours Per Unit = 4, Total Units Produced = 50, total machine hours used producing Product A = 200 (4 x 50) Product B Machine Hours per Unit 3, total units produced 50, Total Machine Hours used producing Product B = 150 (3 x 50)

20. Machine Costs (ctd) Find % of cost to allocate to each product Total Machine Hours= 350 Product A Machine Hours = 200 Product A Percentage = 57% (200/350 x 100) Product B Percentage = 43% (150/350 x 100) Product A = $114 ($200 x 0.57) Product B = $86 ($200 x 0.43) Product A Per Unit = $2.28 (114/50) Product B Per Unit = $1.72 (86/50)

21. Managerial Costs Managerial costs are less clear, we could use either method because there is not enough information, but it is likely that more managerial oversight is required for a bigger area of the factory, so you should use the same methodology as the Rent and Utilities

22. Managerial Cost Ctd Total Managerial Costs = $600 Product A = $180 (600 x 0.3) Product B = $420 (600 x 0.7) Per Unit, Product A $3.6 (180/50) Per Unit, Product B $8.4 (420/50)

23. Allocated Costing CostProduct AProduct B Direct Materials 37 Direct Labour 59 Utilities and Rent 2.45.6 Machine Costs 2.281.72 Managerial Overheads 3.68.4 Total Costs 16.2831.72

24. Cost Behaviour

25. Basic Cost Revision Direct or Variable Costs are generally the materials and direct labour which go into making a Cost Object (Product or Service) Indirect or Fixed Costs are generally the Overheads which are Allocated to the Cost Object Together these make up the Total Cost of the Cost Object

26. Ctd Selling Price is the Total Cost plus a Contribution or Revenue from the Cost Object Revenue is often expressed as a Sales Margin or a percentage (%) of the Total Costs Plus Total Costs

27. Common Abbreviations Variable (Direct) Cost = VC Fixed (Indirect) Cost = FC Units of Production = U Total Costs = TC Revenue = R Sales Margin = M (Expressed as a %) Selling Price = SP Total Profit = TP

28. Some Relationships TC = VC + FC (Total Costs = Direct + Indirect Costs) R = (TC x M%) + TC (Revenue = Total Costs x Margin as a percentage) + Total Cost SP = TC + M (Selling Price = Total Costs + Margin)

29. Assumptions of Cost Behaviour We assume that Variable Costs are Linear to Units Produced, as production increases so to does Variable Cost We Assume that Fixed Costs do not change with production, so as units produced increases Fixed cost remain even

32. True? Sometimes this is true, but only in very simple cases Fixed and Variable Costs are usually more complex There are a number of reasons for this – Economies or Dis-economies of scale – Step Effects – Mixed Costs

33. Variable Costs Most costs are variable, they change in relation to something else In our simple model the Variable Costs share a Linear Relationship with Units Produced, as units produced increase so too do Variable Costs In more complicated analysis Variable Costs change in relation to the Activity Base

34. Activity Base The Activity Base is whatever causes the costs to vary In the simple model the Units Produced are the Activity Base The Activity Base can be anything Common Activity Base’s can be: – Batches of Production – Changes to Direct Labour But there are many more, and often they are unique to the organisation

35. Example A good example of this is the Variable Cost of offering some Services We are an Electrical Repair Company Our Allocation base is Number of Repair Jobs Completed per day We pay our Repairman a daily wage of $10 Our Repairman completes 5 Jobs per day

36. Ctd Our Allocation Base is therefore not the number of Jobs completed but how many Repairmen we need to employ to service the demand We can understand this cost by plotting a Graph of $ cost and Jobs completed assuming that each Repairman completes 5 Jobs per day

37. Linearity Assumptions Economics states that cost behave in a curvilinear way Accountants assume Linear Relationships (or as we have seen Step Variability) Who is right? Its the Economists

38. Why Curvilinear? There are economies and diseconomies of scale. For instance: – Price per unit of raw material will often fall as larger numbers of units are orders – Prices are subject to discounts for minimum orders – As Volume increases more problems can occur in production or larger units of labour are required than in a strict linear relationship

39. Fixed Costs In the modern manufacturing environment there is a Trend to Fixed Costs The Manufacturing Environment has become dominated by Technology The Price of operating and maintaining highly technical equipment is very high This has meant that Overheads such as maintenance and depreciation of machinery has become the major cost, rather than Labour or Direct Materials

40. Committed Fixed Costs Types of Committed Fixed Costs – Investment in Facilities, Machinery and Depreciation – Salaries of Managers and Costs of Sales Committed Fixed Costs generally – Remain relatively constant – Stay stable over fairly long periods of time

41. Discretionary Fixed Costs Types of Discretionary Fixed Costs – Advertising – Research and Development – Company Relations Discretionary Fixed Costs will generally – Have a short term planning horizon – Be relatively unique

42. Fixed Costs and the Relevant Range Fixed costs are subject to the same relevant range idea as Variable costs Fixed Costs tend to step in line with production Therefore we need to understand how relevant the range is to our cost assumptions

43. Cost Analysis So we need to ‘diagnose’ the costs involved and discover the ‘relevant range’ that applies to our production levels We can do this by plotting graphs of Dependant Variables and Independent Variables

44. Independent Variables Independent Variables are plotted on the X Axis Independent Variables are the Activity Base

45. Identifying the Relevant Range The Relevant Range can be identified by plotting a scatter graph and applying linearity where it is seen You run a hotel, it has enough room for a maximum of 60 Guests, and you have the following cost information

46. Hotel Stays (People)Cost $ 1080 1580 2080 2580 3080 3588 4096.8 45106.48 50117.128 55128.8408 60141.7249

47. Cost Analysis 1) You Have the following information: Direct Materials $4 per unit Direct Labour $3 per unit Indirect Costs $3 per unit Total Units Produced 20 Sales Margin 25% Provide the following information Total Indirect Costs Total Costs per unit Selling Price Revenue

48. Answers Total Indirect Costs $60 (20 x 3) Total Cost per unit $10 (4+3+3) Selling Price =$12.50 (10 x 25% + TC) Revenue = $12.50 x 20 units = $250

49. Review Questions What is Cost Behaviour? What is Linearity? Is Linearity true? What can cause Curvilinear Cost Behaviour? What is the Relevant Range? How can we identify the Relevant Range