Professional Documents
Culture Documents
C
O “Cost” is not a simple concept. It is
S important to distinguish between
T four different types - fixed,
fixed, variable,
average and marginal.
marginal.
Ir. Haery Sihombing/IP
Sihombing/IP
Pensyarah
Fakulti Kejuruteraan Pembuatan
Universiti Teknologi Malaysia Melaka Monetary measure of resources given up to
attain an objective (such as acquiring a good
Chapter 3 DIRECT COST or delivering a service)
Chapter 4 INDIRECT COSTS
Direct Labor
Indirect manufacturing costs or
Labor costs that are clearly traceable
to, or readily identifiable with, the factory overhead include all costs
finished product. associated with the manufacturing
process that cannot be traced to the
manufactured goods in an economically
Example:
feasible way.
Wages paid to an
automobile assembly
worker.
Product costs are initially identified as part of Period costs are costs
the inventory on hand.
that are deducted as
These product costs (inventoriable costs) expenses during the 1 2 3
become expenses (in the form of cost of goods current period without 4 5 6 7 8 9 10
accounts 25 26 27 28 29 30 31
Indirect Costs
All other costs that cannot be directly attributable to the final
final
product or service. Includes
Indirect materials: factory supplies, small items of material
Indirect labour: admin, cleaning or security staff
Factory overheads; rates, rent, insurance, telephone,
stationery
The Actual Cost System is not timely Product Cost Actual Cost Normal Cost
System System
All costs must be known before Direct Materials Actual Actual
calculating product cost
Direct Labor Actual Actual
Cost
business activity. changes in the level of
z Total fixed costs do business activity.
not change when activity Activity z Total fixed costs do
changes. not change when
z Total variable costs activity changes.
Cost
change in proportion z Total variable costs
to activity changes. change in proportion
to activity changes.
Activity
Cost
CostItem
Item Behavior
Behavior Traceability
Traceability Function
Function
¾ Direct Material Variable
Material
Material Variable
Variable Direct
Direct Product
Product
¾ Direct Labor Variable Assembly
AssemblyWages
Wages Variable
Variable Direct
Direct Product
Product
Advertising
Advertising Fixed
Fixed Indirect
Indirect Period
Period
¾ Overhead Variable, Fixed, or Mixed
Production
ProductionManager's
Manager'sSalary
Salary Fixed
Fixed Indirect
Indirect Product
Product
Office
OfficeDepreciation
Depreciation Fixed
Fixed Indirect
Indirect Period
Period
Direct and Indirect Costs
COST OBJECT
Direct Costs
EXERCISE Example: Oak wood used
Example: 50 Oak
in Mfg. of chairs.
Chairs produced in
May.
Indirect Costs
Example: salary of the
Plant night watchperson.
Bicycles by the Sea incurred $94,500 in What is the leasing (fixed) cost per bicycle
a given year for the leasing of its plant. when Bicycles assembles 1,000 bicycles?
This is an example of fixed costs with $94,500 ÷ 1,000 = $94.50
respect to the number of bicycles assembled. What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
$94,500 ÷ 3,500 = $27
Cost Drivers Relevant Range
Example
The cost driver of variable costs is the level Assume that fixed (leasing) costs are $94,500
of activity or volume whose change causes for a year and that they remain the same for a
the (variable) costs to change proportionately. certain volume range (1,000 to 5,000 bicycles).
The number of bicycles assembled is a 1,000 to 5,000 bicycles is the relevant range.
cost driver of the cost of handlebars.
Relevant Range
Example Relationships of Types of Costs
120000
Direct
100000
Fixed Costs
80000
60000
40000 $94,500 Variable Fixed
20000
0
0 1000 2000 3000 4000 5000 6000
Volume Indirect
Total Costs and Unit Costs Total Costs and Unit Costs
Example Example
$146,500
200000
What is the unit cost (leasing and handlebars) 52x
00 + $
$94,5
when Bicycles assembles 1,000 bicycles? 150000
Total Costs
Total fixed cost $94,500 100000 $94,500
+ Total variable cost $52,000 = $146,500
50000
$146,500 ÷ 1,000 = $146.50
0
0 500 1000 1500
Volume
Assume that Bicycles management uses a What is their budgeted cost for an estimated
unit cost of $146.50 (leasing and wheels). production of 3,500 bicycles?
Management is budgeting costs for 3,500 × $146.50 = $512,750
different levels of production.
What should the budgeted cost be for an
What is their budgeted cost for an estimated production of 600 bicycles?
estimated production of 600 bicycles?
600 × $146.50 = $87,900
Use Unit Costs Cautiously Use Unit Costs Cautiously
Total fixed cost $ 94,500 What should the budgeted cost be for an
Total variable cost ($52 × 600) 31,200 estimated production of 3,500 bicycles?
Total $125,700 Total fixed cost $ 94,500
$125,700 ÷ 600 = $209.50 Total variable cost (52 × 3,500) 182,000
Total $276,500
Using a cost of $146.50 per unit would
underestimate actual total costs if output $276,500 ÷ 3,500 = $79.00
is below 1,000 units.
Merchandising Service
Classification of
Inventoriable Costs
Manufacturing Costs
Period costs are all costs in the income Bicycles by the Sea had $50,000 of direct
statement other than cost of goods sold. materials inventory at the beginning of the period.
Period costs are recorded as expenses of the Purchases during the period amounted to
accounting period in which they are incurred. $180,000 and ending inventory was $30,000.
How much direct materials were used?
$50,000 + $180,000 – $30,000 = $200,000
Direct labor costs incurred were $105,500. Assume that the work in process inventory
at the beginning of the period was $30,000,
Indirect manufacturing costs were $194,500. and $35,000 at the end of the period.
What are the total manufacturing costs incurred? What is the cost of goods manufactured?
Direct materials used $200,000 Beginning work in process $ 30,000
Direct labor 105,500 Total manufacturing costs 500,000
Indirect manufacturing costs 194,500 Ending work in process 35,000
Total manufacturing costs $500,000 Cost of goods manufactured $495,000
Flow of Costs Flow of Costs
Example Example
Indirect Indirect
Labor Materials Other
Measuring Costs
Conversion Costs
Requires Judgment
How much is the overtime premium? A product cost is the sum of the costs
$18 × 50% = $9 per overtime hour assigned to a product for a specific purpose.
If this worker works 44 hours on a given 1. Pricing and product emphasis decisions
week, how much are his gross earnings? 2. Contracting with government agencies
Direct labor 44 hours × $18 = $792 3. Preparing financial statements for external
Overtime premium 4 hours × $ 9 = 36 reporting under generally accepted
Total gross earnings $828 accounting principles
Work in Work in
Raw Process Finished Raw Process Finished
Materials Goods Materials Goods
Partially complete
Materials products. Completed
Manufacturing waiting to be products
Inventory processed. Material to which for sale.
some labor and/or
Classifications overhead have
been added.
Income Statement of a Manufacturer Income Statement of a Manufacturer
Merchandiser Manufacturer Cost of goods sold for manufacturers differs only
Beginning Beginning slightly from cost of goods sold for merchandisers.
Merchandise Finished Goods
Merchandising Company Manufacturing Company
Inventory Inventory
Cost of goods sold: Cost of goods sold:
+ + Beg. merchandise Beg. finished
Cost of Goods The major Cost of Goods inventory $ 14,200 goods inv. $ 14,200
Manufactured + Purchases 234,150 + Cost of goods
Purchased difference
_ _ = Goods available
for sale $ 248,350
manufactured
= Goods available
234,150
Direct materials used in production $ 85,500 Direct materials used in production $ 85,500
Direct labor 60,000 Direct labor 60,000
Total factory overhead costs 30,000 Total factory overhead costs 30,000
Total manufacturing costs for the period $ 175,500 Total manufacturing costs for the period $ 175,500
Add: Beginning work in process inventory 2,500 Add: Beginning work in process inventory 2,500
Total cost of work in process $ 178,000 Total cost of work in process $ 178,000
Less: Ending work in process inventory 7,500 Less: Ending work in process inventory 7,500
Cost of goods manufactured $ 170,500 Cost of goods manufactured $ 170,500
Direct Costing
ST 10.1
Mts Manufactured 9000
Treatment of Fixed Manufacturing Mts Sold 8600
That is, it is written off (expensed) in the period in which Manufacturing cost per metre
it is incurred rather than included as a cost when Total costs $ 204,300.00
Number of Metres produced 9,000
determining the cost of inventory Manufacturing cost per metre $ 22.70
Sales
Closing inventory
Opening Stock 20,000 22,000
add Production 100000 110000
less Sale 98000 98000
Closing inventory 22,000 ltrs 34,000 ltrs
ST.5 $ $ $
Revenue Statements with applied
Sales 274,543
factory overheads
Less Variable costs
Cost of goods sold
Inventory 1 July 26,485
There may be a variance between factory
Variable costs of production overheads applied and actual factory overheads
Diect materials 45,965 incurred
Direct labour 46,980
Variable factory overheads 22,698 115,643 Any under-
under-or-
or-over-
over-applied overhead may be
142,128 added or subtracted from the COGS
Less Inventory 30 June 25,660 116,468
In absorption costing the under-
under-or-
or-over-
over-applied
Gross contribution Margin 158,075 overhead may include both variable and fixed
less variable marketing expense 16,258 elements
Net Contribution Margin 141,817
However in direct costing under-
under- or-
or- over applied
less Fixed Costs overhead will only include variable fixed overhead
Factory Overhead 72,458 as the fixed overhead is not applied but written
Mark eting & Admin Exp
Net Profit
57,632 130,090
11,727
off as a period cost
ST 6 Part A ST 6 Part B Calculations
ST 6 Part B ST 6 Part C
Revenue statements using absorption costing Revenue statements using direct costing
Sales
7d $ 338,000.00
add Fixed costs in opening inventory using Direct costing can be:
absorption costing
4000 units @ $5 20000
integrated with job, process or operation
52,620 costing
Used together with standard costing and
Less Fixed costs in closing inventory using
absorption costing activity based costing
8000 @ $5 40000
$ 12,620.00
Fixed manufacturing overhead is debited
to the general ledger to an account
Alternatively
Increase in inventory of 4000 units * fixed Factoy o/h $5 = 20000
called fixed factory overhead
(32620-12620) = 20000
Exercise 1 Solution 1
Cost unit OAR Cost unit OAR
The cost unit OAR is the simplest to use and the
formula is Formula Bottling Warehouse
Cost centre overheads Cost centre £64,000 £45,000
Number of cost units passing through overhead
104,000 units were produced during the period
Number of cost 104,000 104,000
Production overheads were £64,000 for the units
bottling department and £45,000 for the
Ros has
Cost decided
unit OAR to use the£cost
0.62unit
perOAR to£0.43
absorb the
per
warehouse warehouse production overheads into the cost of a bottle
unit unit
Required of water (the cost unit)
Using the formula, calculate the cost unit OAR
for each cost centre
Exercise 2
Direct Labour Hour OAR Machine hour OAR
An alternative is the labour hour OAR An alternative is the machine hour OAR
Cost centre overhead costs Cost centre overhead costs
Total direct labour hours Total machine hours
104,000 units were produced during the period
Cotswold Coolers cannot use this OAR because the
Production overheads were £64,000 for the
firm does not use a pay scheme that is linked
bottling department and £45,000 for the
directly to the product
warehouse
The labour hour OAR is typically used to absorb Total machine hours were 16,000 for the bottling
production overheads where the firm operates a department and 2,000 for the warehouse
time-
time-based pay scheme and the level of direct Required
labour hours in production cost centre is high
Using the formula, calculate the machine hour
OAR for each cost centre
Solution 2 Exercise 3
Machine hour overhead absorption rate Production cost per unit
Direct costs per unit are
Formula Bottling Warehouse
Mineral water £0.30; bottle, lid and label £0.75
Cost centre £64,000 £45,000
overhead The OAR in the bottling department will be
Total machine 16,000 2,000 £4.00 per machine hour (from Exercise 2)
hours The OAR in the warehouse will be £0.43
Machine
To hour
reflect the high number£of
4.00 per hours in
machine £22.50 per
the bottling per unit (from Exercise 1)
department,
OAR Ros has decided to use the machine
m/hour hour OAR
m/hour
for absorbing the production overheads into the cost of a
Required
bottle of water (the cost unit) Complete the production cost statement and
calculate the production cost per unit
Pro forma Cotswold Coolers Solution 3
Production cost statement (1 unit) Cotswold Coolers
Production cost statement (1 unit)
£ £
Direct materials £ £
Direct materials
Mineral water 0.30 Mineral water 0.30
Bottle, lid and label 0.75 Bottle, lid and label 0.75
Prime cost ? Prime cost 1.05
Production overheads Production overheads
Bottling dept (0.15 machine hour x £4.00) 0.60
Bottling dept ? Warehouse (cost unit OAR) 0.43 1.03
Warehouse ? ? Production cost 2.08
Production cost ?
Exercise 4 Solution 4
Apportioning non-production overheads Apportioning non-
non-production overheads
The final step is to apportion the non-
non-production Non-
Non-production overheads are £43,250 and the
overheads (eg administration, selling and production cost is £216,320
distribution, research and development costs) Non-
Non-production overheads x 100
A simple method is to add a percentage based on Production cost
the following formula
Non-
Non-production overheads x 100 = £43,250 x 100
Production cost £216,320
Required
Using the formula, calculate the percentage if = 20% of production cost
non-
non-production overheads are £43,250 and the If we also add a gross profit mark up of 50% of the
production cost is £216,320 production cost, we can calculate the selling price …
Cotswold Coolers
Using predetermined absorption rates
Total cost (1 unit)
£ £ Normally predetermined overhead absorption rates
Direct materials (based on estimates) are used because the actual
Mineral water 0.30 figures are not available until the end of the period
Bottle, lid and label 0.75
Where the predetermined overhead that has been
Prime cost 1.05
Production overheads absorbed is higher than the actual overhead, the
Bottling dept (0.15 machine hour x £4.00) 0.60 variance is known as overabsorption and this
Warehouse (cost unit OAR) 0.43 1.03 reduces expenses in the profit and loss account
Production cost 2.08
Where the predetermined overhead that has been
Non-production overheads (£2.08 x 20%) 0.42
Total cost 2.50 absorbed is lower than the actual overhead, the
Profit (£2.08 x 50%) 1.04 variance is known as underabsorption and this
Selling price 3.54 increases expenses in the profit and loss account
Total operating income 10,780 Interest Coverage = Total Income / Interest payments
Non-
Non-operating Revenues and
(28,610 -17,250) /120 = 94.7
Expenses
Rents $400
Interest 180
receipts
(minus) Interest payments -120 Net profit ratio = Net profit / Net sales revenue
Total Non-
Non-operating income 460
7,310 / 28,030 = 0.261 = 26.1%
Net Income Before Taxes 11,240
Income Taxes (35%) 3,930
Net Profit (loss) for year 2005 $7,310
Example Example
Total Overhead is $850,000 Total Overhead is $850,000
Standard Premium Total Standard Premium Total
Labor cost $300,000 $200,000 $500,000
OH (DL cost.) 400*1.70 = 680 500*1.70 = 850 OH (DM cost.) 550*1.100 = 900*1.100 =
605 990
Unit cost 1630 2250 Unit cost 1555 2390
CONCLUSIONS
Direct costs are allocated to the cost unit
Production overheads are allocated or apportioned
to the cost centres on a fair basis and absorbed CHAPTER 5
into the cost unit using an appropriate OAR
Non-
Non-production overheads can be absorbed into
the cost unit by adding a percentage based on the
MARGINAL COST
proportion of non-
non-production overheads to the
total production cost Using direct (marginal) costing
But a limitation of absorption costing is that it is for decision making
based on arbitrary decisions about the basis for
apportionment and absorption of overheads
What is Direct Costing? The Principles of Marginal Costing
The Direct Costing method (Marginal costing) is an 1. For any given period of time, fixed costs will be the
inventory valuation / costing model that includes same, for any volume of sales and production
only the variable manufacturing costs: (provided that the level of activity is within the ‘relevant
range’
range’). Therefore, selling an extra item of product or
direct materials (those materials that become an
service:
integral part of a finished product and can be
conveniently traced into it) Î Revenue will increase by the sales value of the item sold
Î Costs will increase by the variable cost per unit
direct labor (those factory labor costs that can be
easily traced to individual units of product. Also Î Profit will increase by the amount of contribution earned
called touch labor) from the extra item
- only variable manufacturing overhead in the cost 2. The volume of sales falls by one item Î the profit will
of a unit of product. The entire amount of fixed fall by the amount of contribution earned from the item.
costs are expenses in the year incurred.
3. Marginal Contribution
2. Stock/
Stock/Inventory Valuation
Marginal costing technique makes use of
Under marginal costing, inventory/stock for marginal contribution for marking various
profit measurement is valued at marginal decisions. Marginal contribution is the
cost. It is in sharp contrast to the total unit difference between sales and marginal cost.
cost under absorption costing method It forms the basis for judging the
profitability of different products or
departments
Systematic method of examining the relationship All other variables remain constant
between changes in activity and changes in total A single product or constant sales mix
sales revenue, expenses and net profit Total costs and total revenue are linear functions
CVP analysis is subject to a number of underlying of output
assumptions and limitations The analysis applies to the relevant range only
Costs can be accurately divided into their fixed and
The objective of CVP analysis is to establish what variable elements
will happen to the financial results if a specified
The analysis applies only to a short-
short-time horizon
level of activity or volume fluctuates
Complexity-
Complexity-related fixed costs do not change
A Mathematical Approach to
CVP Diagram
CVP Analysis
NP=Px
NP=Px--(a+bx),
(a+bx),
NP – net profit
x – units sold
P – selling price
b – unit variable cost
a – total fixed costs
Break-
Break-Even and Related Formulas Margin of Safety
TR –Profit = FC + VC Indicates by how much sales may decrease
before a loss occurs
Contribution = TR – VC
Profit = Contribution – FC
Margin of safety (units)= Profit/Contribution
Break-
Break-even (units) = FC/Contribution per unit
per unit
Break-
Break-even (sales revenue) =FC/PV ratio, where PV
(profit - volume) ratio = Contribution/Selling
price Margin of safety (sales revenue) = Profit/PV
ratio
Range of Goods Planning (1)
Increases in Activity Level (unlimited)
A B C
1000 1200 1500
per unit total per unit total per unit total
A B C
Price(
Price(sales)
sales) 35 35 000 40 48 000 25 37 500 120 500
Price(
Price(sales)
sales) 35 35 000 0 0 25 37 500 72 500
Costs 33 64 118 43 51 934 24 35 458 161 510
VC 21 21 000 0 0 15 23 010 44 010
FC (allocated
(allocated)) 19 19 310 0 0 6 20 690 40 000 Profit 2 +9150 23 382 -3 -3 934 1 2 042 11 490
Costs 40 40 310 0 0 29 43 700 84 010
Profit -5 -5 310 0 0 -4 -6 200 -11 510 Contribution 14 35 000 10 12 000 10 14 490 61 490
Contribution 14 14 000 0 0 10 14 490 28 490
FC (allocated
(allocated)) 12 11 618 27 31 871 8 12 448 40 000 per unit total per unit total
Demand in units 6000 7000 6000 19000 Contribution 200 2 000 000 120 1 440 000
THE END
STANDARD COSTS
WHAT ARE STANDARD COST ?
Standard costs are the expected costs of manufacturing
the product.
Example : 1 Example : 1
Example : 1 (Question) Direct Labor Wage Variance
A STANDARD COST is
a PER UNIT BUDGET amount
Ideal Vs. Normal Standards Analysis of Direct Material Variances
Direct costs--
costs--can
can be traced to units
produced
direct labor
direct materials
Overhead--
Overhead--can
can’’t be traced to units
indirectlabor--
labor--e.g.,
e.g., janitorial, supervisory
indirectmaterials--
materials--e.g.,
e.g., miscellaneous supplies
other--
other--e.g.,
e.g., depreciation, utilities, rent
allocated to units based on “drivers”
drivers”
Steps in recording Steps in recording
¾ Place purchases in raw materials inventory ¾ Add in direct labor and overhead to WIP
From Schedule of Cost of Goods Manufactured From Schedule of Cost of Goods Sold
Questions
What is the difference between a fixed and
variable cost?
What are the three components of product
cost?
What are the three inventory accounts for
a manufacturing company?