COSTING.

COSTING

What is costing In cost accounting we analyse costs and calculate the cost for each unit of production Cost depends upon the judgement of the cost accountant in each situation The cost of a product purchased for resale is the price we pay If we make the product the cost of the product includes Material, Labour and Overheads (other costs) The cost of those units of a product sold is not the same as the total cost of materials, labour and overhead since some of those costs may relate to unsold units

Example Cost of one product: Product X £
Material – 3 £5 per ton 15 Labour – 5 £1 per hour 5 20 Overhead – 5 per hour 10 £30 Variable Costs Fixed Costs The overhead is Estimated and added to the cost of material and labour to give the total cost of Product X

Classification of Costs
Costs can be classified into the following areas Fixed Costs; Variable Costs; Semi variable costs; Direct costs; Indirect Costs Exercise 1 Complete the definitions below Fixed costs These are costs which will not vary with output but may change over time. eg Rent & Rates, Heating, Depreciation. Variable Costs These are costs which WILL vary with output. The more produced, the greater the cost eg material, labour, royalties

Semi Variable Costs These costs have a FIXED and a VARIABLE part eg maintenance costs will have a fixed level for standard repairs but will also include a variable element for unscheduled repairs Direct Costs These are costs that can be traced back to a certain product – eg cost of raw materials. They can be traced to a specific cost unit – eg wages

Indirect costs These are costs which can’t be traced back to any individual product – eg electricity, rent and rates etc In deciding the cost and possible selling price of a job, the direct costs of labour and material are easy to identify. The main problems arise in charging appropriate amounts for overhead and profit

Costing To determine a fair manufacturing overhead for a job we find a relationship between the total manufacturing overhead cost and some known direct costs. For example the overhead could be made up of a % of direct labour or of prime cost We may then add a profit % to the total cost to calculate the estimate selling price However The customer and the market for the product decide the actual selling price of the job

Job Costing Used to calculate manufacturing costs when the organisation is making different product for different customers Where each job is different Used by Contractors, builders, engineers

Job Costing Before an order for a job is placed the customer is given an estimate of the total cost which includes an estimate for materials and labour It is simpler to estimate material costs than it is labour costs

Exercise 2 Job 366X. The direct labour cost in Department A (where 20 hours work is involved) is £30 The direct labour cost in Dept B (where 8 hours of work is involved) is £5. The direct material cost is £20 Production department overheads are recovered at the rate of £1 per hour in Department A and at a rate of £2 per hour in Department B. What is the manufacturing cost of the job Answer Labour (Department A + Dept B) £35 Direct material Cost £20 £55 Overhead Department A (£1 x 20 hours) £20 Overhead Department B (£2 x 8 hours) £16 Manufacturing cost of job 366X £91

Exercise 3 A job has direct labour costs of £10
Direct material costs of £20 Fixed manufacturing overhead of £15 Fixed selling and administrative overhead of £12 Its selling price is £75 What is the profit of the job Answer Direct labour 10 Direct material 20 Manufacturing overhead 15 Selling & Administrative overhead 12 Variable Manufacturing Overhead 10 Manufacturing cost of job 67 Selling price 75 Profit on job 8

Job Costing Card / Statement
This is prepared to keep a record of all the costs incurred in the job being undertaken. It includes the following details: Job No Customer Order No Customer's Name Job Description Materials used and their cost Labour - time and cost Overhead charged Profit Total Price

Job Costing Card / Statement
Job Cards record actual labour time – taken from Clock cards and time sheets From this actual labour costs can be calculated Material costs – taken from issue notes from stores or from invoices for material purchased specifically for a job Factory overheads - charged on an overhead absorption basis using one of the predetermined overhead absorption rate eg rate per machine hour Administration, selling and distribution overheads will also have to be charged. A percentage is added to the total cost for profit and to find the final price to charge the customer. An invoice will be prepared to bill the customer, it will include the information on the Job Cost Card.

Calculating Profit The profit can be calculated EITHER
as a percentage of total cost (mark-up) OR as a percentage of the selling price of the job (margin).

Mark-up and Margin (Calculating profit)
The profit of a job is calculated on either the % of the cost price or on the selling price This means that a distinction must be made between the % Margin and the % Markup % Markup Gross profit Cost price % Margin Selling price Job XYZ Selling Price = Cost + Markup =£ % Selling Price £625 Less Cost £500 Profit £125 Job XYZ Profit = Selling price * Margin = £625 * 20% Selling Price £625 Less Cost £500 Profit £125

Job Cost Statement – Question 1
Materials 10 Metres of each 5 rolls of galvanised £4.50 each Labour 25 labour each 30 machine £6 each PRIME COSTS Overhead £3 x 25 labour hours Cost of job 344A Profit (Markup 20% ) SELLING PRICE OF JOB 344a £105.00 £22.50 £127.50 £137.50 £180.00 £445.00 £75.00 £520.00 £104.00 £624.00

Labour 300 labour each 150 machine £7.50 each Materials 100 plastic £25 each 15 wooden £21.60 30 metal £45 each PRIME COSTS Overhead £4.50 x 150 machine hours Cost of job no XYZ Profit (Markup 15% ) SELLING PRICE OF JOB XYZ £ £ £ £ £324.00 £ £ £ £675.00 £ £ £

Labour 100 labour each (Dept A) £1000 150 machine £7.50 each (Dept B) £1125 £2125 Materials 40 metres of benching £125 each (Dept A) £5000 30 metal £45 each (Dept A) £1350 100 jig £55 each (Dept B) £5500 20 metal £145 each (Dept B) £2900 £14750 PRIME COSTS £16875 Overhead £4.50 x 100 labour hours (Dept A) £450 Overhead £3 x 150 machine hours (Dept B) £900 Cost of job no BRO15 £17775 Profit (Markup 20% ) £3555 SELLING PRICE OF JOB BRO15 £21330

Labour – 200 labour £8 each £1600 Direct Materials £2500 Variable Overhead £3 x 200 labour hours £600 Fixed Overhead £1 x 200 labour hours £200 a)Cost of job no WAL123 £4900 SELLING PRICE OF JOB WAL123 £5500 PROFIT FROM JOB WAL123 (SP – COST)

Direct Labour 150 £6.50 Direct Materials 1000 £20 Variable x 150 labour hours PRIME COSTS Fixed Overhead £1.20 x 150 labour hours Cost of job 344A Profit (Margin 20%) SELLING PRICE OF JOB 344a £975.00 £ £300.00 £ £180.00 (80%) £ £ £ SP = 100% Profit margin = 20% Cost + Margin = SP Cost + 20% = 100% Cost = 80% Margin = Cost/80 x 20 = £

Job Cost Statement – Question 5b)
Delivery = 1,000 tons x £0.50 per ton Delivery = £500 Profit will decrease by this amount Profit = £ £500 =£

Labour – 50 £12.50 each £625 Direct Materials £3800 Overhead £4.50 x 50 labour hours £225 a) Cost of job no EXH384 £4650 Profit b) Selling price of job no EHX384 66.6 % (2/3) Margin 33.3 % (1/3) £2325 100% (3/3) £6975

Labour – 200 £8 each £1600 Direct Materials 500 metres of £200 for 10 metres (500/10 x 200) £10000 1000 metres of plastic £9.50 £9500 £19500 Variable £5 x 200 labour hours £1000 PRIME COST £22,100 Fixed £2 x 200 labour hours 400 a) Cost of job £22500 b) Profit (Markup 25% / Margin 20%) £5625 Delivery £375 Selling price of job £28500

Job Cost Statement – Question 8 a)
Labour 200 labour £12 each (Dept A) £2400 130 machine £9 each (Dept B) £1170 £3570 Materials 70 metres of piping £150 each (Dept A) £10500 50 metal £70 each (Dept A) £3500 100 jig £200 each (Dept B) £20000 20 metal £145 each (Dept B) £2900 £36900 PRIME COSTS £40470 Overhead £6 x 200 labour hours (Dept A) £1200 Overhead £3 x 130 machine hours (Dept B) £390 £1590 Cost of job (80%) £42060 Profit Margin (20%) £10515 SELLING PRICE (100%) £52575

Job Cost Statement – Question 8 b)
Cost of job £42060 Profit Margin (33 1/3%) Markup (50%) £21030 SELLING PRICE (£ £1910 delivery) £63090

Costs Material Costs Costs in buying the parts (raw materials) necessary to produce the cost unit Labour Costs Wages of ALL of the workers who make the goods and services (Assembly line workers etc AND managers etc) Overheads The other costs of the running of the business – eg rent, heat etc

CALCULATING LABOUR COSTS
Various records are used in the calculation of wages: Personnel Records Salaries of workers Time Sheets/clock cards No of hours worked by employee Job Cards Time spent on a job and no of units produced Payroll Record of hours worked/ pay/ deductions to date

TIME RATE Fixed hourly rate CALCULATING LABOUR COSTS
Cost of one unit = Hrs worked on the cost unit x Hrly rate EG 40 HOURS PER £8 PER HOUR = £320

PIECE RATE Workers are paid for EACH ITEM produced No of items produced x Rate per unit EG - A worker produces 500 items the rate per unit is £0.50 Wage = 500 × £0.50 = £250

BONUS SCHEME Paid in addition to hourly rate as an incentive for meeting targets No of items produced x Rate per unit If production of 5000 units are exceeded then a bonus of £0.20 per unit is paid Therefore if 6000 units are produced then the bonus will be ( ) × £0.20 = £200

OVERTIME PREMIUM Paid over and above hourly rate for extra hours worked Can be time and ½ or double time EG If Hourly rate = £8 per hour Time and a Half = £8 × 1.5 for each hour of overtime worked Double Time = £8 × 2 for each overtime hour worked.

STOCK CONTROL Purchase price
All forms of stock have a cost to the Business: Purchase price Storage costs e.g. warehousing costs - wages, heat and light Buying costs e.g. administration Insurance Pilferage (theft)/spoilage/damage Obsolescence - stock may go out of date and never be sold Opportunity Cost of the money used to buy the stock - i.e. what else could have been bought with that money

FIFO This form of costing the direct materials used in any job values them at the same price as the OLDEST BATCH first Eg The first stock received into the warehouse will be the first stock to be used up If a stock room had 200 units at £5 = £1000 – received 1/1/ 12 200 units at £10 = £2000 – received 5/1/12 If a job requires 300 units it will be issued 200 £5 and 100 units at £10 The cost of materials for the job would be £2000 The balance would be 100 units at £10 = £1000

LIFO This form of costing the direct materials used in any job values them at the same price as the NEWEST BATCH first Eg The most recent stock received into the warehouse will be the first stock to be used up If a stock room had 200 units at £5 = £1000 – received 1/1/ 12 200 units at £10 = £2000 – received 5/1/12 If a job requires 300 units it will be issued 200 £10 and 100 units at £5 The cost for materials would be £1500 The balance would be 100 units at £5 = £500

Total number of units in stock
AVCO This form of costing the direct materials used in any job values them at the AVERAGE PRICE of all materials available (Existing units x p price)+(New units x p Price) Total number of units in stock Eg The most recent stock received into the warehouse will be the first stock to be used up If a stock room had 200 units at £5 = £1000 – received 1/1/ 12 200 units at £10 = £2000 – received 5/1/12 All units in stock would be valued at £7.50 (200 x £5)+(200 x £10) 400 If a job requires 300 units it will be issued 300 £7.50 The cost for materials would be £2250 The balance would be 100 £7.50 = £750

Sample Exercise SPLASH CANS Receipts Issues 10 Jan 20@ 14.00
Below is the receipts and issues of stock for Splash Cans engineering company. Calculate the value of their stock at the 31 December 2011 using the following methods: FIFO and LIFO On 1 January 2011 the stock of Splash Cans on hand comprised of 7 cans with a total value of £96.60 SPLASH CANS Receipts Issues 10 Jan 14.00 28 February 15 4 April £14.00 8 May 6 2 June £14.30 20 July 14 22 September £15.10 11 October 18 9 November £15.20 3 December 20

Splash Cans (FIFO) Receipts Issues Balance 1/1 7 13.80 96.60 7 13.80
Date Receipts Issues Balance Q Unit price Value Job no Unit Price 1/1 7 13.80 96.60 7 13.80 96.60 10/1 20 14.00 280.00 20 14.00 280.00 7 13.80 96.60 28/2 8 14.00 112.00 12 14.00 168.00 4/4 10 14.00 140.00 22 14.00 308.00 8/5 6 14.00 84.00 16 14.00 224.00 2/6 12 14.30 171.60 16 14.00 224.00 12 14.30 171.60 20/7 14 14.00 196.00 2 14.00 28.00 12 14.30 171.60

Splash Cans (FIFO Cont)
Date Receipts Issues Balance Q Unit price Value Job no Unit Price 20/7 2 14.00 28.00 12 14.30 171.60 2 14.00 28.00 22/9 20 15.10 302.00 12 14.30 171.60 20 15.10 302.00 2 14.00 28.00 11/10 12 14.30 171.60 16 15.10 241.60 4 15.10 60.40 16 15.10 241.60 9/11 14 15.20 212.80 14 15.20 212.80 3/12 16 15.10 241.60 10 15.20 152.00 4 15.20 60.80

Splash Cans (LIFO) Receipts Issues Balance 1/1 7 13.80 96.60 7 13.80
Date Receipts Issues Balance Q Unit price Value Job no Unit Price 1/1 7 13.80 96.60 7 13.80 96.60 10/1 20 14.00 280.00 20 14.00 280.00 15 14.00 210.00 7 13.80 96.60 28/2 5 14.00 70.00 7 13.80 96.60 4/4 10 14.00 140.00 15 14.00 210.00 8/5 7 13.80 96.60 6 14.00 84.00 9 14.00 126.00 7 13.80 96.60 2/6 12 14.30 171.60 9 14.00 126.00 12 14.30 171.60

Splash Cans (LIFO Cont)
Date Receipts Issues Balance Q Unit price Value Job no Unit Price 7 13.80 96.60 2/6 9 14.00 126.00 12 14.30 171.60 12 14.30 171.60 7 13.80 96.60 20/7 2 14.00 28.00 7 14.00 98.00 7 13.80 96.60 22/9 20 15.10 302.00 7 14.00 98.00 20 15.10 302.00 18 15.10 271.80 7 13.80 96.60 11/10 7 14.00 98.00 2 15.10 30.20 14 15.20 212.80 7 13.80 96.60 9/11 7 14.00 98.00 2 15.10 30.20 14 15.20 212.80 14 15.20 212.80 7 13.80 96.60 3/12 2 15.10 30.20 3 14.00 42.00 4 14.00 56.00

Charles plc(AVCO) Receipts Issues Balance 1/3 1000 1.00 1000.00 1000
Date Receipts Issues Balance Q Unit price Value Job no Unit Price 1/3 1000 1.00 1000 1.00 1000 1.10 2000 1.05 4/3 600 1.05 630.00 1400 1.05 6/3 8/3 600 1.05 630.00 800 1.05 840.00 15/3 1200 1.50 2000 1.32 16/3 1300 1.32 700 1.32 924.00 17/3 600 1.71 1300 1.50 18/3 600 1.50 900.00 700 1.50 20/3 300 1.80 540.00 1000 1.59

OVERHEAD (INDIRECT) COSTING
These are costs related to the general production process itself Examples: Materials not used in production of cost units Supervisors and non production labour wages General manufacturing expenses – rent/ rates etc Therefore: Overheads are traced back (allocated) or shared out (apportioned) to COST CENTRES (areas which created the overheads and through which jobs will pass) Apportionment can be on a Blanket/standard rate or Departmenatl rates.

APPORTIONMENT (Sharing Out)
Overheads are SHARED FAIRLY between the cost centres which benefit from them eg: COST BASIS OF APPORTIONMENT Rent, Rates, Light&Heat, etc Area Employee expenses: Canteen, Managers etc No of employees Depreciation / Insurance of Assets Value of asset

APPORTIONMENT Non traceable overheads to production and service departments
Department value for basis for apportionment Total value for basis of apportionment (eg total area) x Total value of overhead being reapportioned For Example Factory Rent £100,000 Area of Dept A 40,000 m2 Area of Dept B 10,000 m2 Total Area 50,000 m2 Apportioined to Dept A = 40,000 / 50,000 x £100,000 = £80,000 Apportioined to Dept B= 10,000 / 50,000 x £100,000 = £20,000

BASIS OF APPORTIONMENT
Reapportionment Overheads of service depts to production departments Done to show the benefit each Production dept gets from the service depts Service Dept BASIS OF APPORTIONMENT Stores Materials used Canteen No of employees Maintenance Value of plant

Reapportion OH of Service Depts to production Depts
Department value for basis for apportionment (eg area) Total value for basis of apportionment (eg total area) x Total value of service dept OH being reapportioned For Example Stores Overheads £90,000 Raw materials used by Dept A 10,000 units Raw materials used by Dept B 20,000 units Total Materials ,000 units Apportioined to Dept A = 10,000 / 30,000 x £90,000 = £30,000 Apportioined to Dept B= 20,000 / 30,000 x £90,000 = £60,000

Overhead Absorption rates
Calculated AFTER allocation and apportionment to production depts Calculated in a manner which best represents the way that a job makes use of the departments resources Dept Type Basis of Apportionment Overhead rate Labour Intensive Direct Labour Hours £ x labour Hour Capital Intensive Direct Machine hours £ x per machine hour

Overhead Absorption rate
Total Dept Overheads Total number of machine or direct labour hours = Dept Overhead absorption rate per machine or direct labour hour (£) For Example Finishing Depts Overheads £100,000 Total Machine Hours 25,000 hr Total Labour hours 5,000 hours 100,000/25,000 = £4 per machine hour

Exercise 1 O/Head Cost Basis of Apportionment Preparation Cooking Personnel Total Rent and Rates 30,000 Dep of Machinery 500 Supervision 18,000 Machine Insurance Value of Machinery 3,500 1,750 Departmental Total 36,750 Reapportion Personnel 15,750 Total OH for Prod Dept 79,500 Overhead Absorption Rate Area 37,500 22,500 90,000 Value of machinery 1,000 2,000 3,500 54,000 No of Employees 24,000 12,000 7,000 12,250 58,500 64,500 21,000 80,250 3.18 mach hr 4.01 lab hr

Exercise 1 Continued Direct Materials 200 £10 per mtr Direct Labour 12 £15 per lab hr Direct Expenses £750 Overheads 6 machine hours in preparation 8 labour hours in cooking A profit of 25% on the cost of a job Total cost of job 2,000.00 180.00 750.00 19.08 32.08 745.29

Exercise 2 O/Head Cost Basis of Apportionment Denim Cotton General Office Total Rates Dep of Machinery Insurance of buildings Vending Machines Departmental Total Reapportion Personnel Total OH for Prod Dept Overhead Absorption Rate Area 10,000 5,000 4,000 1,000 Value of machinery 12,000 4,000 30,000 14,000 Value of Buildings 2,000 1,600 400 4,000 10,800 3,600 5,400 1,800 No of Employees 7,200 22,600 25,000 2,880 4,320 25,480 29,320 6.37 mach hr 1.47 lab hr

Exercise 2 Continued Direct Materials 120 £9.20 per mtr Direct Labour 24 £17 per lab hr Direct Expenses £310 Overheads 6 machine hours in denim 8 labour hours in cotton A profit of 25% on the cost of a job Total cost of job 408.00 310.00 38.22 11.76 468.00

Predetermined overhead rates
Quite often these are set by an organisation rather than actual overhead rates. They are based on the average costs of average production. BUT The amount charged to jobs might be too little (under absorption) Or it might be too much (over absorption)

Predetermined overhead rates
For Example Budgeted overheads £200,000 Budgeted Machine hours 40,000 Absorption rate per machine hour £5 Case A CaseB Actual Overhead Incurred 200, ,000 Actual Machine Hours worked 30, ,000 Overheads Absorbed 150, ,000 In case A there has been an under absorption of £50,000 (the budgeted machine hours were more than the actual machine hours) In case B there has been an over absorption of £20,000 (the actual overhead incurred is less than the budgeted one)

Summary Overhead Apportionment and Absorption
Overheads are apportioned or allocated to each production / service dept Service department overheads are then re-apportioned to the production departments Appropriate overhead absorption rates are calculated The overhead costs are absorbed (taken into consideration when costing a job or making a product by applying a certain rate

Step 1 Allocate and Apportion
Summary Overhead Apportionment and Absorption Step 1 Allocate and Apportion Step 2 Re-Apportion Step 3 – Calculate Absorption Steps 4 – Absorption

Service/Operating Costing
An estimated cost of providing services rather than products Used by Hospitals, dental practices, lawyers etc Estimated cost calculated over a year - in the most appropriate units – eg hospital (patient/ days), Restaurant (meals served) WHY Enables comparison between cost of hiring/leasing and owning equipment Determines how much other cost centres should be charged for the use of the service Determines price for service to ensure profit Promote efficiently – can compare prices charged between periods

MacPherson Passenger Transport Ltd Operates 6 x 57 seater buses on routes in the Glasgow area. Each bus cost £40,000 and has an estimated useful life of 6 years – after which it will be sold for an estimated £4,000 Depreciation Cost of new bus £40,000 Residual Balance £4,000 Fall in value over life £36,000 Depreciation per annum £6,000

Each bus is used for 50 weeks per annum, the anticipated annual mileage being 33,000. Fuel consumption is 3 miles per litre of diesel. Each litre of diesel costs £0.80 Fuel Annual mileage per bus 33,000 Miles per litre diesel 3 Diesel required (33000/3) 11,000 Cost of diesel (11000x0.80) £8,800

c) Each bus has 6 wheels. They tyres cost £250 each and are estimated to last 60,000 miles Tyres Set of tyres (250 x 6) £1,500 Portion of set per annum (33000 (annual mileage)/ 60,000 miles x £1,500 £825

d) Each bus requires to be thoroughly inspected and serviced every 5,000 miles at a cost of £1,030 Inspection & Service Miles per annum 33,000 Miles between inspections / services 5,000 Inspections/services required (33,000 miles/ 5,000 miles) 6.6 Annual cost (£1,030 x 6.6) £6,798

f) Admin Cost for the fleet of buses are estimated to be £21,000 per annum Administration Costs Total cost – 6 buses 21,000 Cost per bus (£21,000 / 6) £3,500

g) The firm employs 9 drivers, each of whom works a basic 40-hour week at £5.50 per hour Each driver has 4 weeks holiday per annum during which he/she is paid at the basic rate Each driver works on average 6 hours overtime per working week. All overtime is paid at time and a half Driver’s wages Basic wages per driver (52 wks x 40 hrs x £5.50) £11,440 Overtime per driver (48 wks x 6 hrs x £8.25) £2,376 Wages per driver per annum £13,816 Total annual wages (£13,816 x 9 drivers) £124, 344 Driver’s wages per bus (£124,344/ 6 buses) £20,724

Total cost per bus per annum £ Depreciation 6,000 Fuel 8,800 Tyres 825 Inspection and Service 6,798 Administration Costs 3,500 Driver’s wages 20,724 Licence, insurance & test 3,513 £50,160

b) Cost per mile £ Total cost per bus per annum 50,160 Anticipated annual mileage 33,000 Cost per mile (50,160/33,000 miles) £1.52 c) Cost per passenger/mile (average 40 passengers) Cost per mile 1.52 Cost per passenger/mile (£1.52/40 passengers) 3.80p

Charge per passenger/mile in pence if mark up is 20% Cost per passenger mile 3.80 Mark up 20% (3.80 x 0.20) 0.76 Charge per passenger mile £4.56

Process Costing Used in industries where the end product is more or less identical unit cost = costs of production/ number produced (over a time period) Units pass through a series of production stages until final completion Each production dept transfers its completed production to the next department where it becomes the input for further processing The completed item is transferred from the last department to the finished goods stock Costs from one department to another are cumulative

Process Costing Normal/ Uncontrollable Loss
Losses which occur under efficient operation conditions These are absorbed by the production of the item Abnormal/ Controllable Loss Losses which are not expected to occur under efficient operating conditions eg incorrect cutting of cloth These are removed from the appropriate process account Reported separately as an abnormal loss Treated as a cost and written off to the P&L account

Process Costing Calculating the transfer of goods between processes Calculate the unit cost of production (establish expected output) eg In a process there is an input of 1,200 gallons costing £1 An output of 1,000 gallons is expected Therefore normal loss for this process is 200 gallons Cost of production £1200 £1.20 Expected output 1,000

Process Costing Accounting for the sale of scrap Sometimes process losses can be sold for some small value The resulting sales revenue should be offset against the costs of the appropriate process Therefore Cost of production less scrap value of normal loss Expected output If the normal loss from the last example had a scrap value of 50p per unit then £ £1100 £1.10 1, ,000 If the production had actually only been 900 units then there would be normal loss of 200 units and abnormal loss of 100

Process Costing WORK IN PROGRESS When a process account is drawn up there will be some material in each process which is partly finished This work in progress must be valued and accounted for Work in progress consists of direct materials labour and overheads ABNORMAL LOSS This is unexpected loss due to carelessness, inferior material etc An abnormal loss account is opened and the total cost of the abnormal loss charged to it. The units lost unexpectedly are charged at the unit price of actual output.

Summary Process Costing
Step 1 Calculate & enter input values in to the process account Step 2 Calculate the normal loss and its scrap value & enter it into the output section of the process account Step 3 Calculate the value of WIP &enter it into the output section of the process account Step 4 Calculate the unit cost price of normal output Step 5 Calculate the cost of actual output & enter it into the outputs section of the process account Step 6 Calculate the value of abnormal loss & enter it into the outputs section of the process account

Summary Process Costing
Step 7 Transfer the abnormal loss to an abnormal loss account Step 8 Calculate the income from the sale of abnormal loss for scrap and enter it in the output section of the abnormal loss account Step 9 Calculate the amount to be output to the profit and loss account and enter it in the output section of the abnormal loss account

Break Even What is Break Even?
Break even is a process that shows organisations how many units they must produce and sell in order to cover their costs. It allows them to see when they start to make a profit. What Costs are associated with Break Even? There are three types of costs: Fixed Costs Variable Costs Semi Variable costs

Break Even - Costs FIXED COSTS
Fixed Costs are costs that don’t change(constant) in relation to output. These are TIME BASED COSTS. VARIABLE COSTS Variable costs are costs that change with output. These are ACTIVITY BASED COSTS SEMI VARIABLE COST This is a combination of a fixed cost and a variable cost.

Break Even - Costs Total Costs
Fixed Costs and Variable Costs = Total Costs If Sales (revenue) > than Total Costs = Profit If Sales (revenue) < than Total Costs = Loss If Sales (revenue) = Total Costs = Break Even Point. Break Even Point is the level of sales where the company neither makes a profit or a loss (simply cover their costs)

Benefits Of Break Even For Managers
The level of Break Even is important for Managers as it indicates specifically the level of output required to generate a profit It illustrates the returns an organisation should get at each level of output It clearly indicates information on a firm’s MARGIN OF SAFETY (level above Break Even)

BREAK EVEN CHART £ Sales Total Cost 150 Variable Cost 100 50
Fixed Costs Output

BREAK EVEN CHART £ Sales Sales Total Cost 150 100 Variable Costs BEP
Fixed Costs Output

Break Even From the chart above we can see immediately that the break even point is 50 units or At Sales Revenue equal to £100 The area above break even point is referred to as the margin of safety. This indicates to managers the level of output they can expect to drop before hitting the break even point.

Calculating Break Even
CONTRIBUTION This is the difference between the Selling Price and the Variable Cost. The difference between what it cost to make and what you are selling it for Contribution is that part of the Selling Price that ‘contributes’ towards paying off the Fixed Costs

Break Even Calculations
Contribution = Selling Price – Variable Cost BEP (Units) = Fixed Costs / Contribution Sales Revenue at BEP = (FixedCosts/Contribution)*Selling Price Target Profit = (Fixed Costs + Target Profit)/ Contribution Profit/Loss (units)= Total Contribution – Fixed Costs (Total Contribution = Contribution per unit * No of units sold) Margin of Safety (In sales) = Actual Sales output – Sales at Break even point (to convert to units divide answer by selling price per unit) PVR (profit volume ratio) = Contribution/Selling Price * 100

Example exercise (Int 2)
Sales Total Costs BEP Sales Value Fixed Costs BEP Units

Selling price per unit Sales revenue / Output (better to use BE values) £20,000/2,500 = £8 Variable cost per unit Variable cost per unit = Total costs per unit – Fixed costs per unit Variable costs per unit (use BE values) = ( 20,000 – 10,000) / 2,500 units = £4 per unit

c) Contribution per unit Selling price per unit – Variable cost per unit Using previous answers £8 - £4 = £4 per unit d) Profit from 3,500 units (Using graph) 3,500 units = Sales £28,000 3,500 units = Total costs £24.000 35,000 units – Profit = £4,000 Easier method £4 per unit contribution Contribution x Units above break even = profit = £4 x 1000 units = £4,000

v) Sales required to make a profit of £14,000 Target Profit = (Fixed Costs + Target Profit)/ Contribution £14,000 = (10, ,000) / 4 = 24,000/4 = 6,000 units

Example MFL plc manufactures and sells patio chairs.
It is estimated that the Fixed Costs for year 1 will be £72,000. The labour cost is £6 per chair and the material to make each chair costs are £10. Each chair sells for £24. You have to calculate the following: i. Contribution per chair ii. Break Even Point in Units iii. Sales Revenue at Break-Even Point iv. Number of chairs to be sold to make a profit £4000

It is estimated that the Fixed Costs for year 1 will be £72,000. The labour cost is £6 per chair and the material to make each chair costs are £10. Each chair sells for £24. You have to calculate the following: i. Contribution per chair Selling Price – Variable Cost = Contribution = £24 - £16 = £8 ii. Break Even Point in Units BEP = Fixed Costs / Contribution £72,000 / £8 = 9,000 units

It is estimated that the Fixed Costs for year 1 will be £72,000. The labour cost is £6 per chair and the material to make each chair costs are £10. Each chair sells for £24. You have to calculate the following: iii. Sales Revenue at Break-Even Point Sales Revenue at BEP = (FixedCosts/Contribution)*Selling Price (£72,000 /£8 ) * 24 = £216,000 (must have £ in exam) iv. Number of chairs to be sold to make a profit of £4000 Target Profit = (Fixed Costs + Target Profit)/ Contribution = (£72, ,000) / £8 = chairs (must mention units in exam)

Margin of Safety The Margin of Safety is the distance between actual sales achieved and the sales level needed to break-even. Actual Sales - Sales at Break Even Point It can be measured in units or sales revenue terms. A narrow margin of safety would indicate that a small fall in volume of sales might have a significant effect on profits. A wide margin would mean that there would have to be a large fall in sales volume before the BEP was reached. A wide margin of safety is therefore desirable if a firm is going to cope with competition and decreases in demand. An increase in selling price could improve the margin of safety whilst an increase in fixed costs (with no corresponding changes in contribution and sales volume) would reduce the margin of safety

Total Costs Total cost includes several elements which have to be added together. Marginal Costing requires that total cost be classified into fixed and variable costs. On a Break-even Chart the total cost line is a combination of the fixed costs and the variable costs. At nil level of activity the total costs will equal the fixed costs. Where the total cost line intersects the sales line an angle of incidence is formed

Formula = (Contribution / Sales ) *100
Profit/Volume ratio Profit in this ratio refers to contribution Volume refers to total sales value The P/V Ratio does not mean profit in relationship to sales but the contribution in relation to sales Formula = (Contribution / Sales ) *100 The Profit/Volume Ratio (P/V) shows the contribution as a percentage of sales. With higher percentage the contribution towards the fixed costs will be greater and profits will be achieved earlier The P/V ratio can be improved by - increased selling prices, reduced variable costs; concentrating on those products which provide the highest contribution.

Assumptions of Break Even
LIMITATION There is only one product being produced. This is likely to be the case in very few businesses. The selling price per unit is constant throughout the range of output. (ie straight line) It may be necessary to lower prices to achieve higher levels of output, and if output falls a business may cut prices to attract sales. The variable cost per unit is constant throughout the range of output i.e. it is proportionate to output. At higher outputs it may be necessary to pay overtime rates to increase production, but this may be offset to some extent by achieving quantity discounts on purchases of raw materials

Assumptions of Break Even
LIMITATION Fixed Costs are constant (i.e. a horizontal line on the graph) throughout the production range. Fixed costs are not fixed forever. There will for instance be a need for more machinery at very high output levels which will increase depreciation and perhaps more space will be required leading to higher rent etc in the long run All costs can be classified as fixed or variable There are semi-variable costs which do not behave according to the break-even model All output is sold There will be opening and closing stocks to be taken into account in most cases.

Marginal Costing Marginal Costing is a decision-making tool which focuses on variable costs and variable incomes It ignores fixed costs CONTRIBUTION The difference between the SELLING PRICE of a product and its VARIABLE COST of production Any product which makes a contribution is potentially worth making CALCULATING PROFIT Profit = Total contribution – Fixed costs If possible all products making a positive contribution would be produced However there is usually a “Limiting Factor” which determines how much can be produced.

Marginal Costing LIMITING FACTOR The factor that limits profits eg
Skilled labour Machine capacity Raw materials The limiting factor must be used in such a way that contribution is maximised You must maximise contribution by Labour hour Machine Hour Unit of materials – eg per kilo

Marginal Costing Exercise 1
Step 1 – Calculating Unit Contribution Product A B C D E F Selling Price £20 £30 £25 £40 £55 £60 Materials £10 £15 Labour £5 Variable OH £2 £1 £3 Total Variable Cost (Mat+Labour + V OH) £20 £27 £31 £15 £43 £45 Unit Contribution = Selling Price – Total V Cost £10 -£2 £9 £5 £12 £15 If there was no limiting factor then all products except C would be made

Marginal Costing Product A B C D E F
Step 2 – Work out contribution according to limiting factor eg labour and prioritise - (Assume labour is paid at £5 per hour) Product A B C D E F Selling Price £20 £30 £25 £40 £55 £60 Materials £10 £15 Labour £5 Variable OH £2 £1 £3 Total V Cost (Mat+Labour + V OH) £20 £27 £31 £15 £43 £45 Unit Contribution = Selling Price – Total V Cost £10 -£2 £9 £5 £12 £15 No of hours per product =Total labour/ hourly rate (£5) 1 - 3 4 Contribution per hour (Unit cont / hours per product) £10 - £3 £5 £4 £3.75 Order of production based on limiting factor = Product B,A,E, F, D

Marginal Costing Product A B C
Step 3 - Calculating Production Quantities Assume that fixed costs are £10,000 and machine time is limited to 12,500 hours per annum Product A B C Contribution £5 £10 £12 Machine hours 1 4 3 Contribution per machine hour £2.5 £4 Maximum Demand 1000 2000 To Satisfy demand the firm needs (1 x 1000) + (4x2000) + (3 x 2000) =15000 hours but it only has 12,500 Prioritise Production Order A then C and finally B

Marginal Costing (Ex 2) Step 3 – Calculating actual units produced
Hours Available 12,500) Product Units Hours Required Hours Left A B C Make as much of A as you can 1000 1000 11,500 Make as much of B as you can 1375 (5500/4 hrs) 5,500 Make as much of C as you can 6000 (Unitsx3 hrs) 2000 5,500

Marginal Costing (Ex 2) Step 4 - Calculating Maximum Profit
Profit = contribution per unit x number of units – fixed costs Product Units Contribution per unit Total Contribution A 1000 £5 C 2000 £12 B 1375 £10 Less Fixed Costs £10,000 PROFIT £5,000 £24,000 £13,750 £42,750 £32,750

Exercise 3 Selling price Direct Materials Direct Labour
UNIT DATA X Y Selling price Direct Materials Direct Labour Variable Overheads ii) Unit Contribution iii) Cont per labour hour £40 £49 £10 £15 £8 £12 £2 £4 £20 £18 £10 £6 £20 / 2 hours £18 / 3 a) i)Total variable cost - Product x = £20 x 5000 = £100,000 Total Variable cost – Product Y = £31 x 5000 = £155,000

Exercise 3 continued Total profit (b) X =20 x 5,000 Y = 18 x 5000
UNIT DATA X X =20 x 5,000 Y = 18 x 5000 Total contribution Less fixed Costs Total Profit 100,000 £90,000 £190,000 £150,000 £40,000 c) Order of production = X then Y as X has greater contribution per labour hour than Y

Exercise 3 d) Allocating labour hours Product Units Hours Required
Hours Available 22,000) Product Units Hours Required Hours Left X Y Make as much of X as you can 5000 10,000 12,000 Make as much of Y as you can 4000 (12000/3 hrs) 12000

Exercise 3 continued New profit (e) X =20 x 5,000 Y = 18 x 4000
UNIT DATA X X =20 x 5,000 Y = 18 x 4000 Total contribution Less fixed Costs Total Profit 100,000 £72,000 £172,000 £150,000 £22,000 Change in profit = £40,000 - £22,000 = £18,000

Marginal Costing MINIMUM PRODUCT REQUIREMENT
There may sometimes be a complication which restricts the ability to produce the amount of goods in the quantity that will give maximum profits For example if it is management policy not to produce fewer than x amount of your last ranking product If this is the case: Redo the production order ensuring that at least the minimum amount of the least profitable product is produced BE CAREFUL - IT IS NOT SIMPLY A STRAIGHT SWAP!

Marginal Costing Example – Limiting factor only - 15000 kilos Rank
Unit Data 1 2 3 Contribution in units £10 £20 £30 Kilos per unit 5 4 10 Annual Demand 800 1000 Contribution per kilo £2 £5 £3 Product Units Unit cont Total 1 200 £10 £2000 2 1000 £20 £20000 3 £30 £30000 Total Cont 52,000 - F Cost 12,000 Profit 40,000 Rank Units Kilos Left 2 1000 4000 11000 3 10000 1 200

Marginal Costing P Units Kilos Left Cont - FC 12000 Profit
Example – Limiting factor kilos (at least 250 of each product) Method – Redo production schedule starting with the need to produce 250 of P1 Unit Data 1 2 3 Contribution in units £10 £20 £30 Kilos per unit 5 4 10 Annual Demand 800 1000 Contribution per kilo £2 £5 £3 P Units Kilos Left Cont - FC 12000 Profit 1 250 1250 13750 £2500 2 1000 4000 9750 £20000 3 975 9750 £29250 £51750 £39750

MARGINAL COSTING - SUMMARY
Focuses on variable costs and variable incomes. Step work out the contribution per unit. Contribution = unit selling price - unit variable cost. Step 2 – work out the contribution per unit of limiting factor eg (machine or labour hours or kilos, £s or units of raw material) Step 3 – work out production order – highest contribution first Step 4 – take account of any complication – eg redo production order to take account of any contractual obligations or company policy Step 5 – Work out total contribution and then deduct total fixed costs to give Profit NOTE – IF FIXED COSTS ARE GIVEN IGNORE THEM WHEN CALCULATING CONTRIBUTION

Introducing a new product
When introducing a new product you need to: Work out its unit contribution to see if it is viable or not (anything with a negative contribution will not be worth making) calculate its contribution per limiting factor and then place it in the production order in the appropriate place Recalculate how many of each product you can make Calculate the total contribution If asked to find the Total Profit you must deduct the fixed costs

Introducing a new product - Example Exercise
A business is working at full capacity and a new product is being considered. for example: Current production: 5000 units of A earning a contribution of £20 in 2 machine hours, 4000 units of B earning a contribution of £15 in 3 machine hours, 2000 units of C earning a contribution of £20 in 5 machine hours.

Put information into order Unit Data A B C Contribution in units £20 £15 Labour hours per unit 2 3 5 Annual Demand 5000 4000 2000 Contribution per hour £10 £5 £4 Order of production before new product A, B C Total Contribution before new product = (5000 * £20) + (4000 *£15) + (2000 * £20) =£200,000 Total number of hours being used before new product = (A 10,000 + B 12,000 + C 10,000) Capacity = (The first line of the exercise tells you they are working at full capacity)

A new product Z is being considered. Z has a selling price of £60, a variable cost of48 (including 2 machine hours). Demand for Z is 1000 units. d) Calculate the contribution per hour for product Z Selling price – Variable cost per unit = £60 - £48 = £12

Organise Product Z’s data Unit Data A B C Z Contribution in units £20 £15 £12 Labour hours per unit 2 3 5 Annual Demand 5000 4000 2000 1000 Contribution per hour £10 £5 £4 £6 Decide the order of production New order of production A, Z, B, C

Unit Data A B C Z Contribution in units £20 £15 £12 Labour hours per unit 2 3 5 £2 Annual Demand 5000 4000 2000 1000 Contribution per hour £10 £5 £4 £6 f) New total contribution at full capacity (32,000 hours) Pr Units Hrs Left Cont A Z B C 5000 10000 22000 £100,000 No of units x Unit contribution 1000 2000 20000 £12,000 4000 12000 8000 £60,000 1600 8000 £32,000 £204,000

Unit Data A B C Z Contribution in units £20 £15 £12 Labour hours per unit 2 3 5 £2 Annual Demand 5000 4000 2000 1000 Contribution per hour £10 £5 £4 £6 g)Maximum contribution at 30,000 hours Pr Units Hrs Left Cont A Z B C 10000 5000 1000 2000 4000 12000 £100,000 £12,000 £60,000 20000 No of units x Unit contribution 18000 6000 1200 6000 £24,000 £196,000

h)Maximum contribution if Price of C rises by £15 and demand falls to 1500 – 30,000 hours available Unit Data A B C Z Contribution in units £20 £15 £12 Labour hours per unit 2 3 5 Annual Demand 5000 4000 1000 Contribution per hour £10 £5 £6 New Production Order £35 1500 £7 Pr Units Hrs Left Contribution A 5000 10000 20000 £100,000 C Z B 7500 1500 12500 £52,500 2000 1000 10500 £12,000 10500 3500 £52,500 £217,000

MARGINAL COSTING – SPECIAL ORDERS
This is where a customer offers to buy the product at less than its normal selling price REJECT IF The firm is already working at full capacity ACCEPT IF There is spare capacity and the item still makes a contribution at the lower price

Example A firm is working at 80% capacity and is producing 20,000 units per annum. Unit information Selling price £10 Materials £2 Labour £2 Variable Exp £2 Fixed Costs £2 Should a special order of 2,000 units at £8 each be accepted Is the capacity there Yes 20,000 is 80% so full capacity is 25,000 Is there a contribution at the new price? Yes SP (£8) – VC (£6) = Cont (£2) If the offer is accepted, Contribution, and hence profit will increase by (no of units) x £2 (Cont per unit )

The following data applies to the production and sale of 2,000 units of product M Sales 20,000 Materials 6,000 Labour 4,000 Variable Cost 2,000 Fixed Costs 3,000 Total cost 15,000 Profit £5,000 Unit cost £10.00 £3.00 £2.00 £1.00 £1.50 a) SP (£10) – VC(£6) = Contribution per unit (£4)

SP (£10) – VC(£6) = Contribution per unit (£4) Capacity is currently at 80% and an order is received for 400 units at £7 each Unit cost Selling Price £10.00 Material £3.00 Labour £2.00 Variable OH £1.00 Fixed Costs £1.50 b) Does the firm have enough spare capacity to produce the extra order Yes 2,000 is 80% so full capacity is 2,500 c) Is there a contribution at the new price? Yes SP (£7) – VC (£6) = Cont (£1) d) By how much will profit change if the order is accepted Increase by extra units(400) x Unit Cont (£1) = £400

A second order for 150 units at a price of £7.50 is also being considered Unit cost New Selling Price £7.50 Material £3.00 Labour £2.00 Variable OH £1.00 Fixed Costs £1.50 e) Calculate the total contribution from this order. SP (£7.50) – VC (£6) = £1.50 contribution f) Should this order be accepted? No – accepting both orders will take you over capacity and the last order will bring you in more profit (£400) than this one (£225)

MARGINAL COSTING – Make or Buy Decisions
OPPORTUNITY COST The opportunity cost of an item can be described as the cost of what you give up to produce it. Example – a business working at full capacity (so time is a limiting factor) makes Product Z , which earns a contribution of £20. It takes 2 hours to produce and therefore makes a contribution of £10 per hour If it then decides to do something else then one of the “costs” of that “something else” must be the fact that it is no longer earning £10 per hour from making Z

OPPORTUNITY COST Another example of opportunity cost would be a business making a product which contains a component and it is considering purchasing the component instead of making it. RULES TO REMEMBER If the firm has spare capacity it is pointless purchasing it if you can make it cheaper However if there is no spare capacity then the time saved by not making one component could be used to earn more contributions making another

Data for Product X – working at full capacity Selling Price £50 Materials £10 Part Y Labour (2 hours) £16 Contribution £14 It is currently making £7 per hour contribution (£50 (SP) - £36 (VC) = £14 per unit Each unit takes 2 hours so contribution = £7 per hour Part Y can be purchased from outside for £12 The time saved making Part Y can be used to earn more contributions making the rest of the product Therefore (assuming Part Y takes ½ an hour to produce) the true cost of Part Y is £10 PLUS £3.50 (½ of the £7 per hour contribution for product x) in lost contributions = £13.50 The company should therefore purchase the component from an outside supplier as they supply it for £12

MARGINAL COSTING – May or Buy Decisions
Contribution Tango - £50 - £20 = £30 Hourly contribution = £30 / 10 hours = £3 Example Exercise 2 Tango requires 10 hours to produce and sells for £50. It has a marginal cost of £20 (variable cost) Samba could also be made. It takes 4 hours at a marginal /variable cost of £15. A supplier has offered to make it for £ 20 a) Should it be bought or manufactured if there is surplus capacity? Manufactured b) Should it be bought or manufactured without surplus capacity If Samba is bought in then the hours saved making it can be used to make more of Tango Opportunity cost = 4hours (time saved per Unit of samba) x £3 ( hourly contribution for Tango) = £12 True cost of producing Samba therefore is £15 + £12 = £27 Therefore it should be purchased from outside for £20

MARGINAL COSTING – May or Buy Decisions
Example Exercise 3 Component X requires 3 hours to produce and makes a unit contribution of £4.50. (Hourly cont £4.50/3 hours = £1.50 per hour) Component Y could also be made. It takes 4 hours at a marginal cost of £ £15. A supplier has offered to make it for £ 22. a)Should it be bought or manufactured if there is surplus capacity? Manufactured b): Should it be bought or manufactured without surplus capacity If Component Y is bought in then the spare hours can be used to make more of Component X Opportunity cost = 4hours (time saved per Unit from Component Y) x £1.50 (hourly contribution for Component X= £6 True cost of producing Component Y therefore is £15 + £6 = £21 Therefore it should NOT be purchased from outside as it costs more than the cost of manufacture + the opportunity cost

(Opportunity Cost) Turra Builders is working at full capacity making garden sheds. The following data applies to each shed. Selling Price £400 Direct labour 4 £7 = £28 hrs Materials £192 Turra builders have been offered a contract at a price of £9000 Details are - Labour required – 80 £7 and Materials £5,200 Calculate contribution currently being earned per hour from garden sheds. Contribution per unit = SP (£400) – VC (£220) = £180 Contribution per hour = £180/4 hours = £45 b) Calculate additional profit or loss if the contract is accepted. Money earned from new contract £9,000 Variable costs – Labour 80 hours x £7 = £560 Materials £5200 £5,760 + Opportunity cost lost from sheds £3,600 (£45 x 80 hours) £9,360 Therefore a loss of £360 will be made if this contract is accepted

(Opportunity Cost) The following applies to product Z which is being produced at full capacity. Selling Price £50 Materials £20 Labour 2hours £10 Variable overheads £2 Fixed costs £3 (Contribution = 50 – 32 = £18 / 2 hours = £9 per hour) An order has been received for a batch of a similar product. The order is worth £800 and can be produced at a total variable cost of £700 in 10 hours a) Calculate the increase or decrease in profits if the order is accepted. Money earned from new contract £800 Variable costs £700 Opportunity cost lost from Z £90 (£9 x 10 hours) 790 Therefore an increase of £10 will be made

MARGINAL COSTING – Retain or Close
Marginal costing can be used to help a business to decide whether to keep or drop a product/department which appears to be making a loss or to keep a factory open when it is losing money If a department/ product is making a loss the management should aim to reduce this loss When making a decision they must decide Whether another product can be made instead to increase contribution Whether to close the department and sell the assets to raise money for other departments Whether the product making a loss is connected to other products and if discontinued will affect their sales They must also look closely at what will happen to fixed costs

RETAIN OR CLOSE A DEPT/PRODUCT
MARGINAL COSTING RETAIN OR CLOSE A DEPT/PRODUCT Product A B C TOTAL £000 Sales 100 60 40 200 Variable costs 70 35 145 Fixed Cost 12 36 Total Cost 82 52 47 181 Profit/Loss 18 8 -7 19 The management wishes to stop producing any loss making product. However if C is no longer produced, it might at first seem that there would be a saving of £7,000,but this is not necessarily the case. The firm’s total fixed cost bill is £36,000. It will still be £36,000 if C if not produced. If it is not being charged to C, it will have to be charged to A and B.

MARGINAL COSTING RETAIN OR CLOSE A DEPT/PRODUCT Product A B C TOTAL £000 Sales 100 60 40 200 160 V Costs 70 35 145 110 F Costs 12 36 18 Total Costs 82 52 47 181 88 58 146 Profit/Loss 8 -7 19 2 14 The overall profitability has fallen from £19,000 to £14,000, i.e. by £5,000 because there is no longer a contribution of £5,000 from C If, however, you are told that as a result of not making C there will be a reduction in fixed costs of £8,000 (because, for example, part of the premises will no longer be used) this would have to be taken into account. E.g. If C is not produced - lose £5,000 contribution, save £8,000 in fixed cost, overall gain £3,000, so C should not be produced..

MARGINAL COSTING RETAIN OR CLOSE A DEPT/PRODUCT A firm has 3 branches, Aberdeen, Edinburgh and Glasgow. Details are as follows: A E G £000s Sales 300 200 100 Variable cost 210 150 80 Fixed Cost 40 30 24 A E £000 300 200 210 150 46 36 44 14 Profit 50 20 -4 Management policy is to close any non-profitable branch. This will result in the fixed costs of that branch being reduced by 50%. (i.e. although the branch is closed there will still be some fixed costs to pay e.g. security/rent/insurance.) Calculate the effect on total profits of implementing this policy

MARGINAL COSTING PROFIT PLANNING Where a number of different options are possible chose the one which maximises total contribution In some instances it will be necessary also to take into account any changes in total fixed costs e.g. a reduction in fixed costs has the same effect as if it were additional contributions

MARGINAL COSTING PROFIT PLANNING
Example Smith & Sons is working at less than full capacity making and selling a product which has a contribution of £5 per unit. Annual sales are 10,000 units. Fixed costs are £20,000 The Production Manager wants to purchase a new machine which will cut variable costs per unit by £1, but it will add £5,000 per annum to fixed cost. Calculate the effect on profits of accepting this suggestion. METHOD Calculate contributions & profit for both situations Present total contribution Present Profit New Contribution New Profit Accept/ Reject 50,000 10,000 units x £5 20,000 Cont – Fixed Cost 60,000 10,000 units x £6 35,000 Cont – Fixed Cost Accept

Limitations of Financial Accounting system alone
It is historical i.e. it is out of date therefore it is too late to change anything now for that time of year! It is in total form (e.g. the total profit earned by the whole business last year). This - doesn’t say anything about the success of individual products Layout is dictated by outsiders e.g. FRS – lacks detail Does not apply to areas of responsibility - the Production Manager, for example, does not know what cost levels are expected to be achieved in the factory.

Duties of a Management Accountant
Collecting detailed information on costs and preparing cost/profit statements Providing relevant information for decision making Planning and target setting Monitoring Performance

Aims of Managerial Accounting
Provides information that will help management decision making and control on a day to day basis To provide information regarding REVENUE and COSTS of goods or services that the company provides (COST UNITS)

Documents Produced Cost, revenue and profit statements Budgets
Variance Analysis Breakeven analysis

Revenue Money that an organisation receives from the sale of its goods or services One item is known as a COST UNIT Revenue for ONE cost unit = the selling price Total revenue = Selling price per unit x No of units sold

Classification of costs
Manufacturing Raw materials, labour and overhead costs specifically incurred in the production of the organisations COST UNITS Direct Can be traced to a specific cost unit Indirect Cannot be traced to a specific cost unit They are general costs necessary for all production to take place (eg rent of factory) Non Manufacturing Raw materials, labour and overhead costs that are NOT related in any way to the manufacture of the organisations COST UNITS Costs for the sale of the organisations goods and services and administration

Behaviour of costs FIXED COSTS Will not vary with output
Will however change over time Examples – rent, rates, depreciation Fixed costs Quantity Produced C O S T

Behaviour of costs VARIABLE COSTS Will vary with output
The more units produced the higher the cost Examples – direct labour, raw materials, VARIABLE COSTS Quantity Produced C O S T

Cost Systems JOB COSTING
Used to calculate manufacturing costs when the organisation is making different product for different customers Where each job is different Used by Contractors, builders, engineers PROCESS COSTING Used to calculate manufacturing costs when the organisation is making the same product in one continuous process Used by chemical or textile manufacturers

Cost Systems MARGINAL COSTING (VARIABLE COSTING)
Used to calculate manufacturing costs without taking account of the impact of FIXED OVERHEADS on unit costs ABSORPTION COSTING (TOTAL COSTING) Used to calculate manufacturing costs by examining ALL relevant costs (including FIXED OVERHEADS)

Cost Systems CONTRACT COSTING
Used to calculate manufacturing costs for a company who manufactures one large long term project. Eg – ship builders STANDARD COSTING Sets predetermined cost levels and analyses any differences

COSTS Raw materials Labour Overheads Manufacturing Costs Direct Indirect Can be: Fixed Variable Semi Variable Non Manufacturing Costs Can be: Fixed Variable Semi Variable Analysed through Job Costing Con tract Costing Process Costing Marginal Costing Absorption Costing Standard Costing

DOCUMENTS S PURCHASE REQUISITION U P P U
Request from Departments for goods S U P L I E R LETTER OF ENQUIRY Sent to potential suppliers QUOTATIONS Returned by potential suppliers ORDER Sent to chosen suppliers GOODS RECEIVED NOTE Sent with the goods and checked STOCK RECORD CARD/BIN Records the quantity of stock as it changes STOCK LEDGER CARD Records the value of stock as it changes

BUDGETS Detailed plans of action for the future which
Improve efficiency through Co-ordination (areas working together and in the same manner) Better communication between areas Providing targets which Motivate staff Allows assessment Aid Control by Providing information about financial performance of specific areas of the business

CASH BUDGET The cash budget is divided into 4 areas
Opening balance – bank balance at start of year Add income – ALL monies ACTUALLY received during the month – (Sale of assets, income from sales etc) Less Expenditure – ALL monies ACTUALLY spent during the month – (eg payments to creditors, purchase of assets, bill payments, wages etc) Closing balance = (opening balance + Total receipts) – Total Payments THE CLOSING BALANCE FOR ONE YEAR WILL BECOME THE OPENING BALANCE FOR THE NEXT

CASH BUDGET EXERCISE 1 SCUFFERS PLC June July Aug Sept Oct
Sales (Units) Unit Data 10,000 15,000 7,000 5,000 17,000 12,000 8,500 6,000 5,000 Production (Units) Selling Price £20 Raw material cost £9 Direct Wages £5 Variable Prod OH £2

August September October Opening Bank Balance Receipts Payments Total Payments Closing Bank Balance Money for July Received in Aug) = 15,000 (Units) x £20 (S Price) 18,000 80,500 40,500 300,000 200,000 140,000 Credit Sales (Production Units x Raw materials) – 2 months later = 17,000 (Units) x £9 (Unit cost) Sale of Equipment 18,000 Total Receipts 300,000 218,000 140,000 Raw Materials 153,000 108,000 76,500 Direct Wages 42,500 30,000 25,000 Variable Production OHs 24,000 17,000 12,000 Fixed Costs 18,000 18,000 18,000 Equipment 60,000 12,000 Loan 25,000 237,500 258,000 143,500 80,500 40,500 37,000

CASH BUDGET EXERCISE 2 Kids Palace plc Feb Mar Apr May Unit Data 260 300 340 360 Cash Sales Units Credit Sales Units 1040 1200 1360 1440 1200 1400 1800 1700 Production (Units) Credit Sales 50 Cash Sales (-10%) 45 Raw Materials 15 Direct Wages 10 If sales over 1500 units Commission 5

Kids Palace plc March April May Opening Bank Balance Receipts Total Receipts Payments Total Payments Closing Bank Balance 10750 49250 84550 Cash Sales 13500 15300 16200 Credit Sales 52000 60000 68000 Loan 5000 Share Issue 40000 70500 75300 124200 Raw Materials 18000 21000 27000 Direct Wages 14000 18000 17000 Commission 1000 1500 32000 40000 45000 £49250 £84550 £163750

Exercise 7 Higher PRODUCTION BUDGET
The following budgeted data relate to the manufacturing firm Components 4U Plc for the period June to October Year June July Aug Sept Oct Sales in Units 6,000 7,000 8,000 9, ,000 Closing stock at the end of each month is equal to the level of credit sales of the following month. Credit sales are 20% of total sales. Prepare the Production Budget for the period June to September PRODUCTION BUDGET A Production budget calculates how many units are available for sale each month and must include stock at the beginning and production per month

Exercise 7 Higher Step 1 – Calculate cash and credit unit sales for each month Credit sales are 20% of total sales therefore Sales June July Aug Sept Oct Cash Sales Credit Sales (20%) Total Sales 4,800 1,200 6,000 5,600 1,400 7,000 6,400 1,600 8,000 7,200 1,800 9,000 8,000 2,000 10,000

Exercise 7 Higher Step 2 Work out stock figures (Needed for production budget) Closing stock at the end of each month is equal to the level of credit sales of the following month Therefore the closing stock for June is equal to the credit sales of July and so on Sales June July Aug Sept Oct Credit Sales 1,200 1,400 1,600 1,800 2,000 Closing Stock Opening Stock 1,400 1,600 1,800 2,000 1,200 1,400 1,600 1,800 2,000 The closing stock for one month becomes the opening stock for the next month So in fact the opening stock for each month is equal to the credit sales for that month – ie June’s Opening stock will be 1200 units

Exercise 7 Higher June July Aug Sept Step 3 Work out production units
You know that Opening stock + production units - sales = Closing stock So production units = closing stock + sales – Opening stock June July Aug Sept 1600 1800 2000 1400 Closing Stock + Sales (units) 7000 8000 9000 6000 1600 1800 1200 1400 -opening stock Production Units 8200 9200 6200 7200

Exercise 7 Higher Components 4U – Production Budget June July Aug Sept
Step 4 Create production budget Components 4U – Production Budget June July Aug Sept Opening Stock 1600 1800 1200 1400 Production Units 8200 9200 6200 7200 Available for Sale 9800 11000 7400 8600

Exercise 8 Higher - Crownpoint
Step 1 – Calculate cash and credit unit sales for each month Credit sales already given Step 2 Work out stock figures (Needed for production budget) The closing stock for each month is maintained at 20% of the cash sales for the following month Cash sales for Jan year 3 are estimated at 2000 units July Aug Sep Oct Nov Dec Cash Sales 1,300 1,400 1,500 1,600 1,700 1,800 Closing Stock Opening Stock 280 300 320 340 360 400 260 280 300 320 340 360

Exercise 8 Higher Step 3 Work out production units You know that
Opening stock + production units - sales = Closing stock So production units = closing stock + sales – Opening stock July Aug Sep Oct Nov Dec Closing Stock + Cash Sales + Credit Sales -Opening Stock Production Units 320 340 360 300 280 400 1,500 1,600 1,700 1,400 1,300 1,800 8,300 5,600 4,800 7,400 6,500 7,500 300 320 340 280 260 360 9,820 7,220 6,520 8,820 7,820 9,340

Exercise 8 Higher Step 4 Create production budget July Aug Sep Oct Nov
Dec Opening Stock + Production - Cash Sales - Credit Sales Closing Stock 300 320 340 280 260 360 9,820 7,220 6,520 8,820 7,820 9,340 10,120 7,540 6,860 9,100 8,080 9,700 1,500 1,600 1,700 1,400 1,300 1,800 8,300 5,600 4,800 7,400 6,500 7,500 320 340 360 300 280 400

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