Cost Accounting

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

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?

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

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

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

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

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?

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)

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

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

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

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

Example A company makes two products A and B $ A B Direct Materials 3 7 Direct Labour 5 9

Further Information Fixed Costs $ Utilities and Rent 400 Machine Costs 200 Managerial Wages 600

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

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

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)

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)

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)

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

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)

Allocated Costing Cost Product A Product B Direct Materials 3 7 Direct Labour 5 9 Utilities and Rent 2.4 5.6 Machine Costs 2.28 1.72 Managerial Overheads 3.6 8.4 Total Costs 16.28 31.72