Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA CHAPTER 3 Accounting for direct costs

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Accounting for direct costs Can be classified into two categories: 1. Payroll accounting, which is concerned with recording the amount due to employees, inland revenue, pension funds, etc. 2. Labour cost accounting, which allocates costs to cost objects (e.g. products/services, individual customers’ orders, overhead accounts) 3.1a

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Materials recording procedure Involves the following stages: 1. Storage of materials 2. Purchase of materials 3. Receipt of materials 4. Issue of materials 5. Assigning the cost of materials to cost objects 3.1b

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Pricing the issue of raw materials 1.The issue of raw materials involves: reducing the value of raw material stocks recording the cost of the materials issued to the appropriate job or overhead account. 2.Difficulty arises in determining which costs should be assigned to material issues. 3.2a

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Example 1 February :1000 units purchased at £1 per unit 1 March :1000 units purchased at £2 per unit 30 March :1000 units sold at £4 per unit Three alternative issue prices: First-in, first-out (FIFO) = £1.00 per unit Last in, first out (LIFO) = £2.00 per unit Average cost = £1.50 per unit A summary of the transactions Raw materials Gross Sales Cost of sales closing stock profit ££££ FIFO x £1.00 = x £2.00 = LIFO x £2.00 = x £1.00 = Average cost x £1.50 = x £1.50 = b

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Planning and control of stocks 1. Relevant costs required for determining EOQ Holding costs Ordering costs 2. Holding costs Opportunity cost of investment in stocks Incremental insurance costs Incremental warehouse and storage costs Incremental material handling costs Costs of deterioration and obsolete stocks 3. Ordering costs Incremental clerical costs of preparing a purchase order, receiving deliveries and paying invoices. 3.3

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA 3.4

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Economic order quantity graph 3.5

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA 3.6a

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Determining when to place the order 1. Assume: EOQ = 600 units; Lead time = 2 wks; Usage per wk = 120 units 2. Re-order point = 2 weeks x120 units = 240 units. With an EOQ of 600 units orders will be placed at 5-weekly intervals. 3.6b

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA 3.7

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Controlling stocks using ABC classification methods 1. Estimate total purchase cost for each item of stock for the period. 2. Each item is then grouped in decreasing order of annual purchase cost: A items = top 10% of items in stock B items = next 20% of items C items = bottom 70% of items 3. It is normal for between 10% and 15% of items in stock to account for between 70% and 80% of the total value of purchases. Therefore, the greatest degree of control should be exerted over the A items. 3.8

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Other factors to be considered not incorporated in the models Shortage of future supplies Future price increases Obsolescence. Assumption of constant demand is questionable where an item is used in several different products or assemblies and demand varies throughout the period. May not be consistent with MRP systems 3.9a

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA MRP systems 1. MRP is a computerized system for planning the production and the acquisition of materials. 2. It recognizes that the demand for materials is dependent upon the demand for assemblies of which they are a part and that the replenishment of stocks cannot be planned independently of each other. 3.10a

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA 3. Operating an MRP system involves: a master production schedule a bills of material file an inventory file a master parts file 3.10b

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA 4. MRP involves a time-phased schedule of planned order releases of lower-level items for purchasing and manufacturing. 3.10c

Cost and Management Accounting: An Introduction, 7 th edition Colin Drury ISBN © 2011 Cengage Learning EMEA Just-in-time systems 1. Elimination of non-value-added activities Many activities add cost but no value to the product. The aim of JIT is to convert raw materials to finished products with lead times equal to processing times. 2. Batch sizes of one The aim is to reduce set-up times, batch sizes and throughput times, thus minimizing stocks. 3. JIT purchasing arrangements More frequent deliveries of material that immediately precede their use. 3.11