1. PAUL FEARNLEY Management Accounting and Finance Full Costing Part 2 Atrill & McLaney Accounting & Finance for non-specialists Chapter 8 M L7

2. Course material on PC L PBS LectData FearnleyP MACCFIN

3. Principle All costs of business are part of the cost of the output Consider if we make only 1 product Consider if we make many products Is the Managing Directors salary part of the cost of product 35? Or not?

6. Historical background Formerly –Labour intensive –Low overhead –price=cost+ More recently –Capital intensive –High overhead –Low direct labour –Market pricing – customers, competition etc.

7. How has this effected costing? Much more emphasis on nature and control of overheads Need to deal with them more scientifically More emphasis on cost drivers How overheads are apportioned now more open to scrutiny Activity based costing more prevalent

8. Pricing Formerly a strong justification for full costing Pricing was often full cost + a profit mark-up But beware. Pricing now nearly always dictated by market and competition, not cost. Price needs to at least cover each products variable costs, but make an economic profit for the company in total

9. Justification of full costing Pricing Match income with costs (fireworks!) Valuing stock (especially when stock levels fluctuate) if we dont include it, it may get forgotten!!! Overheads are controllable

10. Match income with costs Consider firework factory Constant production all year Nearly all sales in 1 month Profit = sales-cost of sales Marginal costing – fixed overhead is a cost each month Full costing – fixed overhead absorbed in stock and only hits profit when sold Therefore full costing matches costs and income

11. Problem with fixed overhead Overheads are generally period costs These are costs incurred over a period of time and the actual cost not known until the end of the period e.g. rent, electricity. But to calculate full costs we may not want to wait until the end of the period Also if output varies from one period to the next, and the overhead stays fixed, the overhead absorbed in each period will differ

12. JanFeb overhead £ 20,000 production hours 4,000 10,000 overhead rate £/hour 5.00 2.00

13. Predetermined overhead rates To get over these problems we estimate what the overhead will be over a representative period of time We also estimate what the average production volume will be over this period We then calculate an estimated absorption rate

14. JanFeb estimate for year overhead £ 20,000 240,000 production hours 4,000 10,000 84,000 overhead rate £/hour 5.00 2.00 2.86

15. What if our estimate is wrong? It is bound to be! If after the end of the period we find the rate was too high, we will have included too much overhead Similarly, if too low, not enough We will have over absorbed or under absorbed the overhead We need to show this as an adjustment to our profit figure

16. Under absorption of overhead

17. Stock In marginal costing, fixed overheads not part of cost of production In full costing, all manufacturing overhead is part of cost of production Stock cost is therefore the variable cost of production in marginal costing, but includes a share of manufacturing fixed overhead in full costing For external reporting purposes we have to value stock to include all manufacturing costs

18. Stock Stock values are therefore higher in full costing than in marginal costing How does this affect profit? If stock level remains constant, no difference in profit between using full costing and marginal costing But if stock level changes, there is a difference. Stock increase soaks up overhead Stock decrease releases overhead