1 Tracey Courtney Business Management Techniques Session 2

2 Tracey Courtney Engineering Business - Cost  What is an Engineering Business ?  One thing in common ?

3 Tracey Courtney Engineering Business - Cost  A small manufacturing company  Approximately 100 people  Making one specialist product  How do you think the organisation chart will look ?  What sort of ordering system do you feel they should use ?

4 Tracey Courtney Engineering Business - Cost  Manufacturing would take place under a production manager who would relay on the production control department for scheduling work  Work awaiting delivery to the customer at any given time should be as short as possible

5 Tracey Courtney Engineering Business - Cost  Reducing the requirement for storage and cost associated with it  How would the company cope if a large order was to occur ?

6 Tracey Courtney Engineering Business - Cost  Why do we need a costing system ?  What cost should be taken into account ?

7 Tracey Courtney Engineering Business - Cost  In this example we are looking at, where only one or a small number of products are being produced  Job Costing Direct Labour Direct Materials Absorbed overheads

8 Tracey Courtney Engineering Business - Cost  Other types Contract Costing Parts Costing Process Costing

9 Tracey Courtney Job Costing  Case Study Task 1

10 Tracey Courtney Contract Costing  A method relating to larger jobs and is conceptually the same as job costing. It is usually used for jobs in civil engineering, shipbuilding, oil/gas & petrochemical activities and defense. Although contract costing follows the same principles as job costing it is a more complex process than job costing and hence more complex to handle.

11 Tracey Courtney Contract Costing  Relates to larger Jobs Civil Engineering Shipbuilding Defence  More complex than job costing

12 Tracey Courtney Parts Costing  A straight forward technique where the cost of all components contained in a product is obtained and these costs are added together to obtain the total cost.

13 Tracey Courtney Parts Costing  Case Study Task 2

14 Tracey Courtney Process Costing  A method where the cost of all the manufacturing processes involved in the making of a product is taken into consideration.  This method is usually used in industries that operate on a continuous basis such as an oil refinery, a chemical plant and a food processing plant. In order to do this, the product has to be costed at each individual process till the cost of the completed product is obtained.

15 Tracey Courtney Process Costing  Continuous Manufacturing Process  Parts cost by process  Typical Processes  Forming, Bending, or machining of metal and plastic parts  Flow soldering of PCB’s  Heat treatment of metal parts  Paint spraying and finishing

16 Tracey Courtney Process Costing  As an example, consider the making of a bi- cycle crank. The processes involved would typically be: Forge the crank into shape Drill holes for pedals and sprocket Polish the crank Electro plate the crank

17 Tracey Courtney Process Costing  Businesses that operate on a Continuous Basis  Product cost at each stage  When total cost of manufacturing a product (it is essential to account other cost of the process)

18 Tracey Courtney Process Costing  Case Study Task 3

19 Tracey Courtney Costing Techniques  The production volume required to make a profit  The cost of in-house manufacturing of a component vs. external purchase  Profit and how it is influenced by changes to production  Profit and how it is influenced by changes in the cost of parts, raw materials and other factors such as energy prices.

20 Tracey Courtney Absorption Costing  This is based on the determination of the total cost by adding the cost of overheads to the direct cost by a process of allocation, apportionment and absorption. Since overheads or indirect cost can be allocated as whole items to production departments, it is possible to arrive at a notional amount that must be added to the cost of each product in order to cover the production overheads.  Mark-up = The sum of fixed and variable costs allocated to the product/ total number of units produced

21 Tracey Courtney Marginal Costing  This is a way of looking at costs and it provides insights into the way cost behaves.  It is defined as: The amount by which aggregate costs change if the volume of output is increased or decreased by one unit.

22 Tracey Courtney Advantages  It is simpler to operate than absorption costing systems because it avoids the problems related to overhead appointment and recovery.  It is easier to make decisions based on marginal cost than on absorption cost techniques. Where several products are being produced, marginal costing can show which one is making a profit and which ones are not.

23 Tracey Courtney Disadvantages  The effect of time and hence delays seem to be overlooked in marginal costing  There is a temptation to spread fixed cost, or to simply neglect these in favour of more easily quantified variable costs.

24 Tracey Courtney Costing  Marginal costs avoid using estimations to determine overheads. The choice of whether to go for absorption costing or marginal costing is usually governed by such factors as: The system of financial control used within the company The production method used The significance of the prevailing level of overhead costs

25 Tracey Courtney Activity Based Costing  This is an attempt to assess the ‘true’ cost of providing a product or service. Knowledge of this will help with both strategic decisions and identification of opportunities for cost improvement.  Activity based costing focuses on indirect costs by making costs that would traditionally be considered indirect into direct costs.

26 Tracey Courtney Activity Based Costing  The method for carrying out activity based costing is as follows: 1. Identify all activities 2. Determine all costs related to each activity 3. Determine the factors that drive the costs 4. Collect the activity data 5. Calculate the product cost

27 Tracey Courtney Principles of Activity Based Costing

28 Tracey Courtney Terms Used in Costing  Direct Cost  Indirect Cost  Variable Cost  Fixed Cost  Overheads  Allocation  Absorption  Semi-Fixed  Semi-Variable  Job Costing  Process Costing  Contract Costing