if] Costs LA Pixedandvarabe costs M12 Costvolume-proi analysis 113 Indifference point Inorder to determine the cos ofa produc order or sevice tis eseial tha ‘tganlzation has a lear understanding of cort struct. We sal heefore bein by ‘ttressing the plc of cst behaviour in tron and explain te dierence between ‘aed and valle cosa section IL2 we look sats and exe te inueace of cont ‘behaviour on prot using cos volume prot anaes In wction Ie examine the ‘question of comparing production methods with clifeent cost struts i fFixed and variable costs aoe ot. Cons are incurred by the use fasts. A eatonship exits Sere ule as nea as prodcon nae ade ot ‘Questions that should be asked may be: - ‘lassie by their degree of variability. With regard to '%, + Inwhat way doo costs change when ane more rooms rented fr ight? Andi the oom frente forfour nights? + How are the cots el este agent afeted when anew hous fob eae adisincton between proportional cost epresiv cos and [Troprtonat cons ar tone const ae diet proportonaltothe Ppa tablecosaremainthe mt soiar te rin Prue prods the vanahecnareain + How dosh cos ofa compute chip manufacture change when Sane In pret vail cost ve sully propartonal tele of ‘00 more chips ate produced and sl? proc ‘Usuay the answers to these question te not east obtain. The costs of lierent assets do otal change nthe san way. The propery coset he ‘hotel wll no change when one more oom is rented, bt the casts feos ‘atria or the computer chip manafacuse wll increase when mone ‘hips are produced ‘Te behaviour of fxed and proportional oss is summarize in table I une haw es css se pert css when pean whe ns Costs canbe catego ined et cots or vrable cons depending on he fetes ean nae cee seatonhip othe ecto th business The terns acy an ole raceme tC aoa ne ‘into tothe les ofprodtonafe uses Dosen hea svete s1gEELEPC business or operating ua, thetevel of production In ela peed say be expressd in ters of production value sles, hors worker honbet cothoursofmachine time egrsive cont se ess than propordonallyo production increases Thisis Ragusa erly the case iproducon increased fom lavaylow eve. cat Fegsive cost causes dereasein the coms pa nt. This egresson can ‘etieniof cont svings ound ny hen cal “earning efector through cos or ul pchaes of row aera ot pars (ceoomis of sae). Frcontan costs general increase more than propotonally when the than proporanaly we the increase in producon volume casingthe corte Derunitto ie An example of pogresive costs lbour costs aa et Of rere hing temporary (tate expensive employers. ‘Te posses ae shown nfigre itt and 2 Fmt ats Pd ost or constant cons a costs that do not change relation othe ‘tiv ofa business. The deprecation costo building or amachiae ce determined by the purchaso pice and the length of suse ie, nt the vse that made of ite coets—_Vrable costar costs that change directa tothe actly. The oe ‘Agrcery stove dlversestome puichases by van The purchase pice ofthe van was £16,000. Thee expactany ofthe vans four yeas ads residue valu €2,000, The anual deprecation costs aro eaeuatod on the basis of srlgine Sapoason The fuel costs ofthe van are €0.08 pa Moro. The annual depreiation costs of tho van are (€18,000 - €2,000)/4 = €4,000. Mese costs are not elated to tho numberof nen Klometion, So ncas coos ne aes eet The fel costs af te van ae ropotnal to te even kere, fo example 50,000 ‘lometres are sriven this yar, the fel ost wi eal 20,000 » €D.05 = C2200, Se oa ese Presi Example 11 shows thatthe din nied an variable costs i based on {he behaviour of otal costs. The est per un anges ferent tan ta ‘ant The ves depreciation costs per kilometre derwease when he ume ofklometes ries: The fuel costs per Klomote area ed ats‘Tocaplain this ost behaviour in ore detail we have included a mumeical ‘ample n table 1.2 ‘it (ewes ets) Fixed costs” aed cos are costs that do not change in reation tothe volume of production. The total fed cost do not change in elation o operating ets av asul the Sed est pe unary “Thesecosts ae constant oe gre 1.) he fact they rea, the production capaci. Capacty cannot easly be increased or decrease ‘ver shor periods so cost does not chang. Us Yew reasons why the sbove mentioned capes adustnents cannot take lace ui Fed cost do not vary in relation to changesia production eels the ‘capacity within te given periods constant. howeve he peo s ‘uliciendy long, the aed cons re suscep to change, s production ‘apacity could be adjusted during this pero, For lstance i protons ‘eereased doe to changing market cantons busts nay deci ‘ede its production capacity. The sins could oer tse cots by Selingoff some ofits machinery ar educing te worlfnce Conversely it {sonly posible to increase production by increasing capac this of couse ineretes the fed costs The consiat ware of fed cos resent ina fed level ofthe eapact (se igure I), Peune sa Ftd costs lating te cacy and lear roston range ‘An increase or decease a companys xed consis however not only sles oun» polit AC> profit DC Production volume eles ou 4 pat AC = prot Production volume Cele oun > prot AC (£42 = €38) = €3,000.In exams 126, catermine the arent cost forthe net 500 wits (above a baste volume of 4800 unt). Charging teen sling prices for dene prods with dering ons Known a pr diferentation. Thee howercy an inherent inthis methed,as companies may be expected to cutthe pices "a paricult eiing customers wl yf obtaln lower prices les they se capil lformed dat tise one-off occurrence and nk stand racic. Price diferntation should nat be confuse wth pie discrimination ‘Wi pric dscriminaon th company chases ferent pice ft dente! products withthe seme unit cost Pie scrmination can only ‘achieved ifthe marke canbe segmented. One good examples the ference ngs prices charged ts low-volume consumers and lage sale ‘users (6 indvidal consumers si indstlwacr) laxeminute holidays ate another good example ate booker pay efor ‘heirholday than customers who booked ery The markt has Deon ‘segmented bya factor (ime) Te purpose ofthese discounts esti bso ane seat remained empry the compar woul not pera any "ever. By sling sets ls nite bait alower pes, bat nevertheless exceeding the arable cost), the company ea sete Se eat, afew words bout diferent oss, Diferenial costs donot neces vay consi solely of variabi costa For example may oni be posible increase production by empondingeapaiy eth uber ‘ofmachines This would ene an crease nth sel conte whch ‘ase could be regard ae diferent costs Economic lifespan and replacement of fixed assets depreciation serves to dsebut the investment fixed ase ve se of deployment In order to determine the deprecation foreach yet a tmethods may be used ‘Besides deprecition, investing ina fied ase resus in other costs namely Interest costs The interest costs are called a. percentage oe cpt Inveedin the aset, Depreciation andinterest costs therfore ae consequence of the purchase ofa fined ase. These of wich equpinen es esas cst ‘These cons ar fr insance the cont of te employee who operas he ‘machin, the cost of energy deve the mach, the cost of ew eta that are needed to produce the produc, andthe cot of malntenene 0 keep the machine runing Ailes that re related othe seo ed ‘att areknown as operating cose or running costs oncetot Unga by ‘The perfomance of ied ase (prods, sevice) representa value ‘The ale ofthe performance s determined bythe otal costs that have ten incurred o accompa chm, ‘When aed asset gt oder, to fects may occu + theperformance quant that the Beed ane can telizeperuntoftine ‘decreases «the costs of using the fae ase (the operating costs inerease ‘These effects are the result of wear andaar Wear andes occurs sees Waren tar ofthe operation ofthe xed ase, bt ca even our when te anst it Inactive the asetis wera by ecoson fr instance ue to wear and tea te ied ase no longer abe o peor those things for which ws bought its tectea span ee ‘imanystatons howe hed asset willbe seid before is ‘echnical fespan is avec. The operating cst have becomes high that the ‘ats per product are to high forthe asset tobe deployed peo. ‘The end ofthe econamle espan ofthe ied asset has boon each ‘The economic ifespan ste period uring whic the everage oss per roduc produced ty dhe fe ase ar lowes Beyond ths period the costs Per producie so that tis more ecole to purchase anew (we ‘sue, dente fed asst which makes rodcton et lower ck possible sain ‘News sate the calculation ofthe economic espan with en example {ACE Minis has purchased cement wanspot trucks for €100,000 and wt tees ltespan of fe years, The performance of cement rusk fs measures tem of he nurbar of eabe metres of cement or conctete tat transports fo customers hacen vid, The essa vue operat costs a performance ofthe teks pet Jar are Shown ne fooning taba Yeor Residual vas ond ‘Operating costs Peormanse mh ro 900 e000 10000 em eno “5000 3500 a ‘The interest costs are clelatod over the average inestod capital dung th peed the ‘nekis deployed and amount to pr yearWe shat now cause ne average costs pe performance foreach pared o deployment ‘No.of ‘Depreciation Itt conts= Operating Totatearts—_hrench yeorset spurahaee deployment neta po ‘or se k(puchae oe rests eR ea18000 len the tek is deployed for fou years the avrage costs per ar lowest Thus its ‘esznomie fespan is our oars. Peformance value (= average cost x perfarranc) end operating cost re shown tthe ‘gie below Petorance vi i peti cots 90000 mon ‘e000 ‘ea0000 19000 Int gre wo se tat atthe endo he economic fespan the operating costs exceed the perormance vale Arthe end ofthe xed asses economic ifespan, ts performance values Tower than dhe operating cots tht se neces forthe ae to achieve desred performance se dileence between the performance value ad ‘he operating costs Is gunerated by te depreciation and interest cos know the performance vale ofthe fie eet never year ployed, wean calculate the depreciation and interest costa pe eat. ‘We nil now alate the annual deprecation ad interest cots, being the ference bsnoon the ttl pefomance value per year andthe operating costs The Srna terest cost are 4% ofthe svorage vestmentoneage of purchase pice and Tesi voli} The annul depreciation is ealelted in tre net abe. ‘peng “Deprecitons Iorest costs Dope Interest costs Inthe dove calculation the annual depreciation is determinedin such | way thatthe pvformance value per units exact the sme during the ‘ie period of deployment of he fsed ase. This she optimum {rpreiaon plan. The depreciation methods that ae presented in chapter Sdonoraccorpish his eu In practice, however, ane o ese methods [Soles chosen or the sake ofconvenince should alsa be remembered | Sate deprecinoncaleaton method represented heres better in ‘theory, but makes certain sumptions abou the development of formance, operating coms ares vai during the period of | ployment ofthe fed aset boul ts inpoeible to sy beforehand wheter these assumpons are correct. test quemonie3 hich depreciation calculation method trom chapter 3 woul gt cosestto the optima depreciation plan in xamle 12.7? e128 shows he te beeen te development ote perormance was, ‘heopeatingcost andthe economic and etic! expan of a act. Ne less ——attnceterining he econmllilesan we have ofa assumed replacement tyantionted Suede Assert ofc derepmens ated ‘et tha produces mre cheaply may bese svable during of ‘he origin eer A consequence te sanatd cox per unt andthe prfonnance vai ofthe equpeot slower cung the performance {atte ctthe cd equpment ope down aswell Rue tt shows that is ‘orien the economic Mespan ofthe extn sed ast We ae now ontonted with ecnoml agelng' or sconomi war and tar Water {mein replacement th he fee fan re soc under o ‘otmay be daermined yeas fa diferent caleaton hen ASC Mimi nas been using the cement teks fortwo years, 9 nox ype of cament ‘wu is sun wit the seme const in m® But atl costs perm of £7.50. €25,000 on te puchase pels gates We shal cacuate the aferantl costs for eoch of he two atti: 1 continue using the ald cement tucks francine ear 2 replace the os cement tucks win the new ype mediate. ‘The cern! costs of arma 3 consist ofthe onerating ost inthe thi yar ps the misses dscourt(opsorunty eos). ne sitforenta coat of transporting 10,000 ‘ferent emount o €56,000 + €25,000 = €81,000 for this teat. ‘re tran cons wrtoring 10,0001 he cae of neta eacenart Inmodiaterpacemert ofthe od coment tucks wi the new ype three, ests franca avartage of €6,000 per tuck nthe net yet ene ung Glossary Basic volume ‘The baile of production forclelatig cereal oss apaciy ulizatian ate The percentage of companys capacity tars wed | nucture prod Contribution margin Sling priceless variable conte pr uni and/or alesis oat ‘rable coe) Differenia costs “The exra costs associated with an increase in production levels {abot basievolute), Dilferenalcoss per unit ‘The production costs per unit of production above basic volute Die coming ‘Contngnsthod wherein ony ibe variable cons ne aocied tothe products and the sd cons recharged dict the prof and oss acon eonomielifegpan Pod dong which the average Costa pe nae lowest Liming factor ‘The production resource or net that detesines the : ‘maximum posible production yolime, aire no possible o esendeapocty owt shot, ‘The averege expe arty ofa bubines forthe coming ye. ‘The cols eased yah wap ofe dese, [pc] production plan Most pofiabeprosacion schedule. cdifereniation Charging dierent prices ar denal products rarvices with Aiorng unico PPrcedlacriminaton Charging deren’ pris for dential proves or ervies with the samo unico ‘he dference between the calculated Aaed conic over acertai eto and the seul ised costs,Multiple-choice questions ‘company wl ule a negave volume varianceifthe actal volume: eves ron the nornal ome {ste than the capacty Ishigher than the normal acy ‘slower than the norma acy 26 ‘xed cost allen the cost per uit on the basi: ‘hebudgeted volume thenormal volume ‘the atl vlme th average ofnormal and budgeted volume ‘Business As estimated stot production for he coming period st "7500 nit The ied costs re €1400,000and the budgeted arse cots for this psi are €700000 The norma volme pe period 20,000 un "The ll production cost per unitand the expected volume varance ae tio and £17501 ‘0 and €200 00 oss ‘Exavand €175000 ose £€120,and €20000 loss | 424 _Intheastqures he ed manuscsng cons of corporation Xero \| roan andthe (popornal vai cons €72500. The nora Smal podacion ssl ar 160000 ped evenly ve ou | ‘fer Te ata proguson dringth quater ws #500 ‘Boo o which were soda poe of €50 each. The operating rota Emo s2a0 \) £40500 513000 | 530000 325 Underthe rc costing method, period cont const eed production costs feed sales aad genorl costs otha anab ‘eleanor hers Ungar be ‘Under the direct costing sytem, the falowing are charged tothe prot and Toss account otra erin pero 4 allvaribl coats incurred during that period, icing hose eating to Products nor yetsld 2 allied costs Incurred during that period, Including those retngso products not yetsld ‘nly the vacinbl cor fal products so ‘both the variable and eed cost ofl prods sold ‘ {Last month, company X made a prot of €50,000 unde the dec costing ‘method The opening inventory was 13000 unt, ad he closing ventory 18000 units, Atcordngto tho absorption costing method the ed production costs are € per product Under absorption cong. the prt or feporating prot ase month was 35.000 ©2000 80.000 ‘26000 ‘The ont stock company Excelsior last year manufactured 50200 snd sold «sn000 products The ventory atthe sro the ea was 15000. ‘Compared with the absopion costing method, te diet costing meso produces higher prof efor lat year roduees lower value for the losing inventory bothaandb ether aor ‘Company Xhas limited number of hours of machine te to manafcture produets A and. Both products have the same selling pice. The cntuton margin of Als 0%, and tht of Gs, Fourie of take up ‘eich machine tie asthe unis 0B. To maximise profs, capeciy Should be broken down asfollows oom ork 1008 for 1 for and 0% oc mone to manufacture anew produit company has to purchase ‘machine with purchase rcs o €150,00. The mache hs at env ‘rvtuction capacity of 10.000 units. The eperting cost ofthe machine in ‘he fst yar ae €20.000. In each subsequent year he operating cst ie ‘yy €10000 The residual valu ofthe machine at the end of Yor Ie 100000 ate end of Year? €7,00 tthe endo eur 9 £90000 end at ‘he end ofYear4 eh The economic espan of the machine year13 Cost allocation 131 Dangers ofncorrect cost aocaton 153 Overhead pplication rates TBA Contcentee 8S Aciiy-based costing Intheory, cont allocation isa srlghtfrwt process. n practi ican beighly © souptcated the cosa an nlidua unl of prod nme refet oth fe aera cots § andthe manulscurng cos Insome stuaons, his / pe of product. The costaloaton proces concerned with assigning Gide costs to product This isthe fico of his chapter __Tosecton 11, weshall lscuss the difrenc betroen ect andindec costs Setion 142 J tamines he relatvelystalghormad ost alloction approach in amass roducton| fonter. Businesses that condita ret faves (heterogeneous proton epialy ‘allt thelr unit costs using overeod applcason rates This dlscaesed insect 143. oe comples(Undusril)producton processes, cous per unt are way determined using fost centres or acavly-baved costing These methods ae dese insetions 13and 133ini ea ia en rowrtee econ Dangers of incorrect cost allocation fon the ase ftl-aealted cot, sling prices are set too high too low he companys profitably wil mmeately be inflaenced Theres ‘Tocaeulat the cost per unit (order projec service, et), we mnt fis determine the costs that are nested during cerain period and he production volume only one typeof product manufactied ‘So adanger of poor management decisions, swe stowed in secon 123 Somes however management can choove not allocate indie! cos {oearain pots frinnaneeo beable set alow seling price or these (homogencous production), te clcalaton ny srightorward athe ‘ducts or eompedon reasons. This ca happen ifthe company has such fost per nit canbe caulted onthe bass of proces coming see {barketdominane for some products ta tis abeto set igh sling ‘ection 132). Thesuation becomes move complicate for businesses tha ce for tose products that overs llndtet cost The retin ofl ranulas diferent ype of prodit (heerogineus production a cost Allocation approach isrequred here. This process invlvelloeating the total oss othe varios prodct yes Inthe espace itis niportant to tmakea dadaction benween direct ons and nec cost ober products Direc costs ve cost that re ect abitable tothe manufactur fa ‘eran product and eam be idee pecially wih that partial ‘create unfalrcompeton or unreasona product Duet costs ince he cost of ae material components sd fern products {rect labour Thealoction of det cots iy saghitorwatd process Tho same cannot be sd for indie cont: Most businesses ‘manufacture more than one product ype In this nstane, here wl ‘etainy be some confusion so which costs late o which product ypes samples include labour cost anager’ wages), maintenance costs co fothetng and deprecation ofthe industria) penises These cont ate ‘grouped together intros costs nec vee costae cot Sse not det ateputabie ocean products, steve sno een ink To calalte tefl production cox per unt is naessary to incorparste thoseindiect costs Specie meting are ued for ths process ncudlng thee of overhead apices 13) a cnt cnr Figure 1 shows the caus lnk beeen costs ad probes egg Ta a | In 2010, the UK apts operator BAA was esr uesnonsas facings battle wt some of tains facing ‘A manstaxtung company has comsseted four orders in a week sire, The £4 bllen cost fo new ray Ores AB and C were manuletured dang egar woking hours Stansted port wou bo pst met by ‘rca D, however, mola overtine work, generating et Inbour cst Passengers usig the London airports, Invrich stuatons cn tobe extra costs te slcated det orn? Sich as Heath ana Gatwick Every assenge vaveling tom or oan alpot ocaus ofthelack ofa ea latin with production, charpinginaet has to poy fe, whic nlude inthe ‘oss to products involves subjective elements we wil dscoer a he ceo the arine vt. nore to hae {oloeing ection, diferent cost allastion mods ead to diferent cos ‘has foo low at Stansted, BAA incu part, perunit Beeause the fll cost ofa product the ve init othe rll ce one shouldbe well aware fie and make areaconed ols of ine ‘oe allocation method, {eli ries or producti compete market by set igh picesina ‘ot eompetive market awn a5 cs-sbsaisaton. The company ftidss soo speak, ae o ore products ftom the igh revenue of Governments eto that companies donot abuse thelr markt potions iy high connumer pies for Peek ied of ts Stansted costs inthe fees of te ‘ther aot Eon before the new unwayfbult at ‘ready beng coss subsidised bythe usors Heathrow have made lea tht they wi foros fap core sbsidsaton In laton tothe new ramay at Stostod‘The direct costs oft rading company inchide the purchase price of products plus any astocated cots uch es inport des and warapor ests. The indict costs ae type labour conte store employees), ‘depreciation oese a premises Hightng heating insure, ce These indirect oss ate usally covered by spying goss profit argo the purchate prices, based on historia res the erantsetoe The owner of furture stow hes goss soft magn of 6% Amst! oa pose for £750 rte asa sling pce oF €.200 ox VAT ‘he ro and loss account of » frst (smal busines) fs foows: cae or Gr 29 Coacteg icone 28 ‘he gross proft margins 42.8/57.3 100% = 75.43% rounded to TSK) of the puch price the purchase pre of @ Bunch offowers ls €3 the sling pce wi be €5.25, Ges lt mg 225 (DKx€9) ‘The margin of €225 therefore serves to cover the Inde costs an the poft onsale. (On te bass ofthis fomaten, we ean concudo thatthe nah const of epPoX {1.50 (30.3% €5,25)ndrect casts and spon. €0.08 12.0% » €5.25) po In he examples, the fll cos per unit isnot acute, T cael th ‘ont per unt overhead appli ates mst ised ste section 133) bnarestaunt only a smal part of te cost restauent omer wats toda simple way fa meal is mace up of erect cos, ‘of caleltng no costae tho seling vce Fanely the costs ofthe bought neesents of meal Forti eacon nthe eaten (rector eh vegetabes ete) vest Sector are of uno has been develope ts ae the cots ofthe cook nthe Tha eelng pico is ealouatd using the ‘eters, te depreciation or er of the “puchase pce x 3" metod. The sling Dulding ane exupment advertising costs, price fs seta tree times the pursiase ‘te Therefore, te cletion of sts per rie ofthe ingredients pus VA fre! ls complicate ou can agin that 2 Process costing Calelating the cos per unis generally steaghforward forthe mass (homogeneos) produeion of ental goods. Ths simply involves assessing theft cows and volume produced per manfacuring period Spe week The average ost per uni canthen be calulted by diving the toa costsby the production volume. Thissmple metiodisknown as Paces proces eotng ‘owing ‘The ued mor costs fw cement factory are €60,000. Tho business estimates nat ssl manufacture thi thousend 0 Kg bape of rene normal volume) nest month Th ‘ursponding raw material and packing costs aro €47,500 an 5,600, respectively “he total manutacurng costs next marth ate €60,000 + £47,500» £5,000 = 142.500 e112.500 The svorage cost por uri is hus e75 ea‘Te tution becomes ite more complicated for production process {hat involve semi-manufctred goods o partly Bnshed goods atthe Deginningand end ofa manufacturing period, ais case the prod ‘volume drng this period consist 1 theopening inventory of semt-menufactared goods manufactured ‘nished produce + products manufactured berwoen the beginning and end ofthe ‘manufacturing period + theclosing inventory oem mancrred goods Tn this case, the production volume daring tis period cannot simply be ‘letemined by adding together the thee components The opening Inventory ofsem-manufacaured goods was produced inthe rececing peo while te hosing inventory wil be complete inthe nex peo, ‘Thethre peso output must be ueated ale by accumlatngand sveraging thet opening and losing inventories and expressing them in {ota numberof frished proditsmanuscrred in thet pti. nore othis wemmus guage how near completion the inventres are, ‘Norcgad manufactures one typo of paving bk. The business produces 200,000 ‘Smock Al the start of te wen, te opening nventoy of party shed bcks nos 410,000 unt, and the cos ivertery was 80,000 unts he tal costs at week We £33,000, From manuactang point of vow, beth Inventories can be regarded 05 50% ‘ready. Te prediction volume sieved tht eek can therfore be alate 35 lone £200,000 50% 0,000 » 5D x 50,000 » 220,000 bricks “he average cost po units therefore: €33,000 + 220,000 = €0.1. ‘The prooos costing method Snot suitable for non homogeneos mass ‘proton though the products ate Ketan nature ty ifr omtets or weight. Under wehted average proces coming sate Droit ypesare converted Int egulen wnt andthe ol produc ‘expressed in ers ofa single product ype. Tis ia tur produces one ‘homogeneous uni ofoupt which enables the cox per ual 0 Be calelated ppiyng the proces costing method. Department A of he chocolate manufacturer Chocolate hc manufactures 40a ‘egfem ana 200 7m bars of choot. ne chocolat has have the sane mera andar of ets! quality. The cots po nar based onthe weit. The standart prosucson auto per pes sane milion 40 gram rs, 400,000 1 bs and 100,000 2007am bar. The standard manufacturing costs are €540000- |. 200 7am bar is equivalont 0 fe 40gram bars, and a 75am bars aque to 15/40 = 1.875 40qam bar, Using hese cqutiones ats, te ene production Of ‘ean bo exressed in 40ram bars §5% 100,000 + 1.875 x 400,000 + 1,000,000 = 2,250,000 bars (40 grams) By diving the total costs of €540,000 bythe equal production of 2,250,000 wits, tho average cost pr unt (0 gram bx i ave at €0.28 “he cost por unt of» 754ram bari hreore 1.875 €0.24 = €0.45, whl the cost per, Ut ot 200 gram boris 60.28 =€1.20, Usng te metnes explained in example 135, calculate th average costs pervnt ifthe entire production cubits expressed in tome of 2004am Bee ample 135 shows thatthe use of equivalent units assumes theresa xed Fat between the cose per unio the dierent prods. The equivalent this can also be derved onthe bass ofthe quantiyofresourees sede tanufcrte the prodctypes sich ashore worked and quay fe tater Overhead application rate: Aswehave seen the system of process costings bes sited to homogeneous mass production processes Allcosts nludig thos oss not eet essoclted with the production process mustbeincludedin the proton cos per unit and must be recouped bythe sales evense Th sition changes somevat for bsineses hat manvlacare vasety ofproduts In this case a separate calculation must be applied according {oeach product type product or oder ob costing). Te dsineton becnoen rect and inditet costs sgacant ints respecy ands fect determined bythe acre of the manutecturiag process The renal or Jnasecost of premises, machinery and equipment (managerial) Wes, ‘decry eae usually Inde cost Those costs are noe specicaly tated the manufacture of certain product but late co the overall production process Irgeera we can say tha the cost per unit consis the det costs ps seasonale portion ofindret cont. How should we interpret the term “reasenabe poron’ In order allocate he ndiect cots tthe product ‘ype projet or order we est need io ident the allcation ates enabling Aalstieallocstion oindiet cost tothe products. A certain dg of Jndgmenc orden segue! One of tie mostcomon indict cost allocation methods isthe ws of. read application rats which enable the ndrest costs be related 12 the direct costs y expressing them asa percentage of he direct costs, The lie cons pr product or order ae calle est The cost per unit fan then be determined by chargingn overhead to cover Iheinaeet, fox Theineet cot slated this order ae Us vated to he det fs generated by tis onder When calculating the aerhesdappiation aes, one as to use estimated amounts which are based o the normal Yolume inorder ogetacorectellocaton ofthe eed costo the products.Ellen wry tls best to use estimates amounts and normal volume to ‘actlat averted appieston ras Ints most besiform, the ue of overhead application rates relate indict const dict coets ‘Ati of eonracors has budgeted he flowing costs forte coming oa norma ac eus25000 by rating the total ndec costs tothe ota ract costs, we ce clei the folly ex0.000 "1008" 9% ‘A nous entersion projet coats €3,400 in matt: th det labour costs fr this Project re €1,600 ns case, the project ost Dtome camo +eiow-—€ 5000 [om of tho total costs of removal fm Xa indies costs, How much ‘he overhead rate to eve the doc costs? "The calculation shown in example 18.6 so-called simple overhead “pplication based on singe ate, Overhead ates an aso be base ‘rect marl costo ect abour cos Even quatiies can be Calelaton basis such asthe numberof hours worked. The possibile iruaiy endless rte coets of 75% (€375,000/€500,000 « 100%) of the dreet, fis cect cost. Tis produces the fotonng costs forte project. Sroead ale mato o e570 Dorstor — €1900 Paxeism e120 Asadrantage of using the simple overhead application tht he cost Peron varies accordingto te llocation base. Amore deed analysis edo determine the met elite cost per unit In crdrto determine redaction be, we need exslish whether the nde costs emily othe conte of taser about the allocation base re the consequence can be serous fhe cost er ut ntmated, orders may be ejected or mised the cos per nit riestimaed the pote of the sins maybe feted sr euesron sas yaw gary esed oerbed metod be peered tow wee besed simple overhead sppicason method ths assumes thatthe allocation and indlvect casts ar dicey proportional cach thee. There ey vere be le orn proportional, resulting nan Incomes calculation fini cos. This sk sminimied by deploying multiple overhead es The use of multiple overhead appleation ats provides alle accurate pictreofthe relationship beeen Inret cos andthe Bocaton base by diving the indirect costs categories and applying Se a,‘he ndret coos ofthe fm of contractors can be dived 2s flows a 275000 ‘Te wardhous costs ar elated tothe use of mater. Te Init abou costs and toa nd equipment are mast osey elated tothe det iabour cots, wl the other west Costs are proportenato to to tal coats. ‘he overhead rates ae a flows: 60,000 00 g0x = 8x overhead on erect mei costs eran.008, an 205000 $225000 00m = em oven on drectabour cos 500.00 a £228 so008 128 ond oti ccs ‘is project, consisting €3,400 material costs snd €1,000 dct labour ost, hus ‘The overhead application rats lo use by service providers alu thei cos per uit In this case, the unt cost unally based on an boul ta, addingan overhead charge othe det boul labor oss 0 cv indie cots “The service sector comprises awe tenge of serves om aytam development onder hardware and sehuare nsilon and malensnce tof constancy. ‘Tne average sang costs of constancy Gein re €48 pe hee costs). Gein pales an overhead rate of 25% to cover Indract costs suchas depression, ‘sreommadsten taining end marsotng. Tet costs per hor are Ea 1.25 = €60 Inorcer to schiew ts pretax pot tage of 208 of als, Gemini hos to hie ets stat ‘In cxample 137 the labour costs per hou re given In pace clelating Inbour costs per hour snot alway straighterard On top ofthe wages selves tobe paldo employees a company’s labour conte consis a other Componeats aswell An employers expenses includes premiums for soll Secu, pension schemes, costs of raining a caten ee These exe ost ashe inclued inthe ons ofthe products We shal tet ls bymeans ofthe caleulaon of workshop rates oa parage/ service sation Ditors Service Staton apps a workshop at fo repair and maintenance works Tis noun at consist oF rect our costs ofthe mechanis nd an eerneod {pcation for indirect costs such a to use of eaupment. The inde costs amount etal of €216502 on an annual basi Disord employs ten mechani who ern, on average, £16 goss ger hour not eluding 6 Sanuses and tenets, The aditonal soci! socurty care forthe ernst to 20h othe oss anual woges. Annual, he mochancs have 24 po Hoays and anaihe! _ Sk dys of fox pubic roays. Moreover tf tae no aceaurt tht ereny emotoyee tse tom work due tines for ten days eer year. Tho cost af tee sick dye (he _secales qalving days for sks beet is old by Disord the athe ck dys are _Srnpensate for byte industal nuance boos, neudng soc aecurty choos. _Themechenes hav 8 tve-doy week of 40 Routs andi assumed tat hy re at _Mocucive fora an hour everyday 28a rst of personal ere, yng Ute erage, ec Te abou costs tobe included Inthe workshop rate can now be caked 3 els: _The rune of haus tobe palo each mechan s $2 weeks of 40 hours, minus the _ [sok dos that arent pal by Ona: 52 x 40-7 8 = 2,024 hours ich mechanic how costs Disord €16 In wages, hoveased by 8% bonuses and beefs 25% soil secu chargos, so €16 1.08 1.28 = €24,60. ‘Qh an annual basis te total soour costs per mechani re therefore 2,024 x €24,60 = THB. These costs ive to be dstbuted over to nub of pode hours, whichis 52 weeks 3 (40~2.5)= 375 hours mins (24+ 6 +10) ~ 40 nanaalaie cay. Consequety, he | 2? rumber of prosutve hous pr machane i 62x37 40x78 = L680,abou costs por proctve how ate therefore 43,728.40 + 1,650 = €26.50, ‘This mount nas tobe ineided nthe workho ratas a8 labour costs Dior total rect abou costs ate: 10x £43,718.40 = €437,184, The owemnead appleation rate or insrect costs i €218,500/€437 184 x 100% = So, “Tho workshop ate pr hou Direct abou oat 2850 Incect casts: 50% €26.50= €1325 Teta e978 Cost centres Formore complicated production processes such as those of integrated production distrtbudon company ora hoepial, cos allocation ns comp Issue. The total oss pleally consi mainly findnet cost, stereos vially important allocate conte secre, a cow per uni determines ‘imate proc price, ‘The'costcente’ method is relableforcostallacton in such cases, ‘Thismethod clasites the function and sete Inelved in business ‘peracons and specifies the cost structure inthe production process The functions are known as ost contre Beery department, aniston unitand acy tat provides goods or services as partofcompany’s operations ia cost cent nthe cost allocation proces, st the inde ‘as ofeach ost centre are determined and then charged othe ont ‘cents and nly, othe fashed products There are dhe ypes of cost cee: ' Aucilary departmentsThiss nota physical deparenent or business tna cost group created fo eostalortion purposes, amples are he “doperment sccsnunynians and gener menage 2 Serie departments These ae oratzaonal untied no cary ‘ut recy productive aevites buteary out actdes footer ‘departments and full a service orented purpose. Examples ncude te ‘maintenance department, ociniel services department the produce laniagofice andthe damingroom, 2 {8 Reveruedeparmens This ype of os cent makes a dct cont ‘othe fished produc. They ste ‘produte’ departments ‘The direc cons ar alocated dec tthe product or oder. Indirect costs re allocated othe product onder thee eps. ist the ndtect costs ae allocated tthe ferent cost eaten llocaied eos) Secondly, sing specie allocation rates sel on Ube (cost driers) the inde onts ee ellocated fom on ost centre 0 O26 ‘cost centres, Under ths method al indict costs are allocated to-do Le. ftom one deparament to another uni alin costs have bee allocated to therevene depertsents, ‘Thin all eos allocated the revere departments are allocated 0 ‘output (produts or orders) This process represented graphically a gure 12 me) | x) 10 = ssn dzomner: 50 = ss detect 20 = menue esr ‘The overhead allocation rates otal nrc oss the products are determined by ding he tot cost of evenue department the tol production volume For many businesses, isles naa pet hour machine te. The indirect cor ofan oder at then be ealealted ‘bymaliplying the requisite number of machine hous by this rate, Byaddngon the iret costs the cost per product or onde cn be alate, sty shouldbe noted that when determining allocation ries Adistnedan shouldbe made between fed and variable costs The fed ‘outs mustbe related othe normal ome, the variable costs io he acs (or budgeted volume The equation so apples here, Weshallnow lustratethe concept ofcost centes wing worked out ‘xanple The following oper wil be dened ‘he cosallocatian sheet in which th total indet costae divided sccrdingto eostiype and ens cee ect allocated cos) ® description per cost centre of he (reallocation rates used ‘snoverviw ofthe cost allocations talelaon ofthe overhead vats of the revere departments ‘aleulaion ofthe cost pe ulThe tet ued arcs or et ero tte tty Rl Oak re 2350 00 {© dt ts en ns nen ung snp res append Cos ease rote wot The woes novo! oe 12516 for next year. it ‘Sueno wot cent, owes lls ath costs casted one ec of the snl cveaaapotnton me mac No aes thtowcorpny ie i he emo ebarnaascimodata’ bd Beet mangerot sate, Spr nacre’ nb os etn enon WOE Be into meron cost cents, Deca ues (i Saanémin {Wt sawing (0. te sng tun ate oregon 1) evace ©) Mecano cos “The eccommadation costs ao relocated tthe other dopartnorts in proportion t thee _foorarea, The business has a total floor area of 1.500 me, dived as flows ocairannen Oe ) eo soe 00 "Te tts acoommedtion costs ar £120,000, The cost aloaton rates £20000 ope Fer example the gener menagement depetment 8 charged 250% £80 = £20,000. General monagement The total alecatod gnarl managorant costs aro €300,000 (€280,000 det allocated oss pls €20,000 relocated costs For azcormodston These oot aro alate othe eter doparenerts in popoton tothe cote of hose Goprtments, Ae €200,000 ofthe tla indrect costs (1,350,000) locates to general Iranagerert, €3,080,000 ie allocated tothe ther depron. To charge the omer erarments wit the general management costs, the allocation ate pe department would ia. 000 Tre total secommoation, gente management and minenance costs must be ‘ealocated tothe evenve dopartmarta marfartrng, ishing ond sais Tis s done ty a topdown preeess The asommodeton costs are chong to ea ost sets as ar the general anager costs arth mantra cost A € 30m ¢ 250m‘Tre total maintenance costs are charged to the maruftrng and fishing departs In roortion tothe energy costs ofthese coparoments, The costs a hus cared a Beensano- cospn Beenigam espn The aborementones cost alocatons ae hue inthe cos the folowing result bie 13. sd cot ema, (548,000 + €5418/000 + €184,000 = €1 380,000 These costs can now be aloratod othe ened pros. For mancfacturng, rote pe machine ours detormiogd and fr frshng rte per man Mo ‘he sales costs ae alested onthe basso the mansfactusng cots of the estimated soles, Te estimated total marutacung coat of sales fr net yer et €2,500,000. “he figure tor net year's podurton was ne: ‘enacting Fishing Emcee 200 e102 “emnontt ungeen by cost Lacan "on tv asi ofthis ifomtion, we can exeuat he folowing overhead rates ortho ovnue departments = 201.000 rable cst: a oad costs seme rieing Viable costs: te per man hour eragT + esnane estat £124,000 separ The ovetoad cost per units MEO 1008-73 eal Ok sodices to particule popu table models. Te following rodution as Wantacting Pring wend ‘ioe ‘ie rei000 os Sho 2a 320 Using tne above information we ean now eke tho costs per unit fr both models 12emiehomsateeo70= ——€ 9684288 PART sone accoUNTINS Nosh Utaees enna Unger cosraunesmon 297 earean ecanesretraeireonaere Forte factory Resi Oak nw uses actvtybeses costing oer mete te Fel On: as jt actos Inthe flowing cost pos imcishowesres070= €12105 *purcase 2Smonmawetesiat= e128 5 Inavtectire Because not al aces canbe entered in ae of thase cost pools, thee i fourth cot took oer Irae to setemine the amount ofthe cost each othe cost ool, me will use the ‘gure in ele 13.1 the cost sleation set. Sargon dton cats 736% € 3810 Purchase Inthe example, costs aeallocsted fom lt to ight (se cot lloction fuchase costs ate of accounting oot and 20% of managomont costs shee) We ca stun therefore tht the department at solely carrying $75,000» 20% > €125,000 = €50,000. ‘ut ecdvide forthe higher ening epertoents and not the lover ranlag “ro cos rer fo purchase costs Ise rurter of purchase ores, The annua number ot epariments tn many cass, however ecproeT services are delivered '€60,000 Thiscrestes«'mutual dependency betvoen the uit coe and the serves purchase order is 4,000, The cost per purchase ones throne 1280, or atvtes provided: the costs ofone department can only be determined 4,000 {fthe costs of other department re on advice sere Tis robes decent canbe rected by defining these dependencies onthe basis of Shyrvesnsys vance cot sri fe sons ote raat, rants tind Fane e che cpeoltibost Suomana ccios cease coamcae ean ' ‘Tatar Se fr nance cnt «pein eh stated ta peduten i 2B Activity-based costing wn aris 18 480 nou. ot gerne te 2? a, i sao eat aman, compoty an ineguiono an i tracts Se popstiontinecen k esis Rotter eo non been ae stale cot St cota jo szuning cons 0 of managemet its a cots fe os | [Buoueeas congas eat steno eee Sprien'$e75000s en Cas Ce oD S EN o i aecllicaie serosa trons aereracing br a ‘Neca oncr isso lone, Ts ent sss una ens ar 00 it i: Fe preteen ester rer fconeres isso maser artes lectc ee crptrtee ey Tass 1 nt perl tre 124 a0, aan ete pnts cetrcoe ended a ee a6 stipaent reentconissnaon mastic aane to sport ee Sea nekaypsaeetetge The absent ec Cons wpadicsacordngo casi eee produc ad Th nt ist cer ace ae 4.30.00 + €50000+€091.000 + cutenon Scie cape te gorarses eapstncomy spe Cisse ae ‘Sin Ths supose herapanteenan ef cs Scere del of tose aie, cman costes ao es. Terk Teed. Aco crivr is something tht determines te demand fr 'Sceced oat these costs ar tobe cides oaull overs slé prods The rate ths operational actives Fr the purchasing atv, or example, tis coul €275000 PeStpente uf Sac gues tn det css sat ec S00 determined by the production volue eg the number of machine ou) bhtether bythe complexity and verso he producton ’ The rleant data ofthe two table models re Because ther re many actives na company the ABC system rOUPS Purchase aris femtyece lated aces in a smaller number of om poole *ere Uae 220 lossary Tho cost per ant now Direct costs 0.15 m? x €1,000 = Pachan 141250 sviy-based coming Allocation of indirect conta to produc according to Ue eausl county soe ta bee rc nd sctoc Direct costs. 0.2 mx €1,00¢ o sc _ re — —~ Pachase cere ‘para (igo Dos) inane ta dae Mente eranon epson ocean te rs). ‘Costs that can be ely aibuted a product oF serie, Tet os tha are dred assigned wa deparenent (cot - cent). Pivalent i ‘Aeostallocation method used lornoe-homagencous production that expetes the total production a tre of gle product ype ‘Act based coming took lo ike wing cost cent. The biggest “ifeencesare . fe + ABC roups relates acts in cos pools that cover several existing departments whl com cents monty comespond wih easing depa: + ABC does nor involve the relocation afin costs between ost ool whereas coat centre allocation involves teeallocation ofc ftom sul and service departments to events departments balore Allocating the costs tothe rods, direct oat ‘Gost af ot deci anaibuile oa product service ead application The proces of locating indret oss o products by charting smowshead to dict cot to cover indirect eat ‘method ofaloating to procs homogeneous production seaMultiple-choice questions aaa Indect cont ar cose that aenot necessarily related othe activity ofa business ‘anno llocsted in any ay ise ently eat production volume fannotbe ascribed direct finished products Aetiler asa gon profit margin of 0% on purchase prices exuding van The seling price of product is €1285 (inhading 196 VAT) What isthe purchase price excluding VAT? eee eine ese cust Price a percentage othe prchase price! ‘The following east allocation method is most sutabl fo heterogeneous production tse ofequvalencunis tse fost centres proces casting ‘Te allowing cost location method is most suitable fr semi- homogeneous production use ofequvalent unis tee of simple overbead pplcaon rate tse ofmulple ovebead ppleton eles tee fost centes ‘The use ofan overhead applaton rate Involves ‘2 charging an overheat doc corso cover indirect ost 2 charging an overhead der cont cove fe cose € sharing an overhead tinct oats to cover variable cots 6 charging an overhead to arable cot Gover ed oss “The ross profit on a products 75% ofthe sling plc, Whats the selling Abusinessis mass producing product A. The total production cots in January were €12,000 Work stared on 30000 unit and 45000 unite were ‘completed On| January, there was no opening inventory opal fished ‘ode: 608 ofthe closing inventory at anus can be considered complete The cost per unit in anaary were: a0 as es es Amotahrorking company manufactures 5000 bot A, 4.00 bolts B and 2,00 bolts Ca week The tel material cost sel) for this production ine ar €600 per work. The quantity ostel per bot has the flowing ato Absce2:3-5 ‘The mae cote por bolt Care: ‘ensees eases ei0ees An entrprencur has budgeted €300.00for rae material, €200000 for ‘ect abour costs and €2250 for indect conte. thd ofthe indict ‘oats cont of ndiectabou costs the est eles a teil wage Tora pacalaroner the esimatd costs re €150in dec lou and €350 {nrae materials The ost of thi onder Afuritar maker bas been commision o manufactures number of ‘cupboards. The tol purchase price of wood und other diet materiel cots sr €5805 (inching 19% VAD) Th estimated diet abou costs for his ‘order are €5000 excluding VAT. The overhead rate ford nec costs s Zeya total det cons The com ofthe onder eie2s ‘Ina particular production period, the actual production volume ofa business is 75% ofnorma activi. The dct material eos are €60,000 and the diet labour costs €75,00 (60% ed, the rest proportionally variable). ‘Theroral indie costs are €45,000 (60% fad) In the coming pod the material costs are enpectedt increase the ect abour costs by 1% Sd the niet cons by 9. The overhead ae forthe next period, based fn normal volume nd king no ect the pice increases, maThe following cosallocation sheet has been produced by company (1000) “Management Maintenance Product A Product 8 “The management costs are charged tothe otber department in proportion tothe abou costs The con ofthe malntenance deparement are charged 1 the manufacturing deprtmentsinpropordon to tht drely allocated ‘machine cons ‘The normal production 15,000 and 15,000. The costs per unitofAand Bore Ressao BET.Budgets and variance analysisBudgets In chapter 4 we saw how the formulated ganization objectives are tanslted ino a business plan The business plan peal consis ofa ‘marketing pannel management pan and a prodction pan ts Primary alm sto provide clear pctre ofthe inter flted managerial fecson-making processes. ‘The organiatlonl objectives ze rnsated ino activities, which are Inhuedin short-term sub plans oe budgets A budget i quantatve, targeting nancial expression of petits and ates Guinge Pattcular pevod. In order achieve the organieasonal objectives ls ‘ally important achieve synchronization between the varouesub-plans land the seeded asks and actives, Badges ce therefore an excelent, ‘managerial tool for controling and overseeing complex processes ‘Budgets are ype dav upfor one-year period ad canbe divided into quarto monly o even wey badges. The shorter the period the more ‘euled the badger sould be. ug shoul aso relate othe ergata Seructre Budgets tein ees for department manages an employees i, ayarstck aust which acides an be ested and monsore. Inshore we can stat that budgets serve a range of manager purposes. We an generalydtngueh the folowing budget unctons panaiog 1 Communication and coordination © tanger seuingand authorization 4 evaluation Planning ‘A fomald budgeting system ores an ornate to pln te activites sa valuable al le focusing on organizational ply and for tmidersanding the consequences. This prevents adhoc decision-making Communication and coordination Due othe iterelted nate of ogsnizional actives or operations bridget should so be iterated. Fr example the claonship bene production andsales mst be clearly shown; this in turn neces cleat lines of communseaton between the relevant departients In hs context, Dbdgets an be seen av an organizational communication and cordinatan tool Tags ting and ushorzation General speaking, budgets are dawn up in consultation with the budget holder he person for whom the buds drawn up. By approving the bout. the budget olde becomes responsible or the budge thus has ‘asesting faneon. The budge dona represents taser of powers and responses the budget holder authorised to near budget related expenditure The budget holder thus Knows exactly whats ‘expected ain, and for which areas he fe aenomtable end esponsbe ‘The burge is also a valuable evaluation too, comparingal actives with the scheduled tks and acves, Appropriate measures are taken rel ‘any ascrepacies. The budge can len be usd o ates he pesformanee ‘ofthe stall members). whom ator bas been seid. ‘By nature planing focused on the future Planing sets the deetion for fre active, Ths known a Teedlorwar The tahundon of budget fate of feedback. Comparing planned and actual ests can ead an ‘nhurtmentof activites Secure 4. ‘What ae the pctontt consequences forthe nxt period the busgoted Gnd he eet rests do ot corespone? ‘Budge variances the diferenc beeen actual an budgeted income and expenses) may occur and increase during dhe relevant budge perio. ‘cond be deta tra orem cra poems Forage thesalesbudget drawn up fortis year no longer provides an accurate ‘lection of the achievable soul sales duets nidden changin, ‘competive markt condisons. The budget therfore no longer an ‘courte tol for measuring and evaluating the sles actives. ‘This problem can be largely avolded by periodically eviewing and adjusting thebudgeto changing sucumsances: Badges ee not sai ens, but rather dynamic and Mud. A budgetisa means to an end tsa too Most businesses use oling budget, for examploa our-quarey or -month —Rallag Tugs Ruther than drawing pasate anal badpt ae = feasible bates batt crv pons quarter (monthly) bas for te net four ‘quarters and/or 12 mons This approach eiates continuous ~and ‘The way departmental badges are drawn up maybe diferent or each organization. Beauseof the argc song character of budget, tp. ‘iown approach ean be chosen whereby the company management decides fn the budget sing its own judgement Sich an approach risk ack ‘commer among employees particulary when employees el that the bbudger is nreaisdeAbottom-sp sproach in which the budge set ‘akingino account information proved bythe department tell resus in Fight commitment but nay hevex weaker ink othe organization's objectives‘Buagesing also has ts drawbacks. Nor only does the badging process ake alotof ume and incr loro co butt Can also be eouterprodvetve Departmental manages wil be focused on achieving the Dodge nd Wil sy more attention departmental (and ther own) concer than the ‘veralleompany interests Manager of os ocused deprtments wl yt teigher budgets, whereas her colegues in sales department wl Wa Ioderats budge Purtbermor, budge argetdiven management decison in arm a company. Forerample sles manager ignoring cet etaadards in aceptingan order tom anew customer may succeed in achieving his sles target, but may also endanger the company's nancial eth Inorder to ofethis drawback, the astenment of dopartmenta manages ‘nowadays takes place on more than ast nan performance A widely Spread ateement methods th seo the bance scorecard The Dalene scrcard measures perfornaace tion fur perspertves: custome, ‘business processes learning and wowth, and nance. See gure 42 Since attention pal stultaneoony 0 ifeenpeformance area, thee sn dominanceefone area In oer words, aeesment much more baled isaisaction withthe budgesing proces ha led to search for sltematives ‘Beyond budgting sale at creating adaptive organitons With leblestrutur and innovative management modes Budgeing no longer important. Beyond budgeting ln ening management ‘methods ke the balanced scorecard rolingestimates and perforce ‘management toa coherent model The base et itt rgeazations a no longer be manage fom the top down. Inbusinespracice beyond budgeting not yet widely adopted. Many lange companies had ono thebudgeting model. Theydo not wantt0J0 say with budgets Aste you progresses, a budge provides pols at ‘eference Budge aligned ote busines plan help the company raluate posto, Because ofthe creates, the pottabity through stat meetings, business process fangs Is under pressur. Peformance’ redesq ane acolo fa management ‘managorant can help to set lar gals, dashoordooraling relevant performance ‘jects. The pople at Tansavacom planes leaving on tine rose rm 40% to hate undertong tis wery wel rtieal” BER customer slistacton 088 from 6.1 Sizcess factors ae planes leaving on ime, 7.9 ona selerom 1 to 10) and vase ‘istomersetisfcion and low vale. gosta deceased by 31%, cess Impevoment were nvoauced The master budget ‘The toa budget forthe entre organlzation known asthemaster budget Water but (Gee gure 1.3). This isa summary ofthe various sub-budges and ‘roiaes a Bdgsted profit and los account and lance set athe end {fthereeeantidget perio. The maser get type an anual pla, ‘Should have a cea and logical oer Depending on the estimated sles and taking into account the expacty, openinginventory and eoxing ventory 3 Production plan canbe draws ip.ume a2 The master budge ucon oa | al ag beeen Peano ‘om the basis ofthe production plan, budge can be draw up relating ‘a materia materi staingregurementleel etc. The next step is te daw up te purchastog budget cash ow forces andthe budgeted Dalance sheet and poi andloss account Shar ns manutectsng company of 9 ution Sharp manufactutes rales, supe In pacts af ve en Sod otal companies a romel many volume ef 800,000, ts broken down 3 flows! Fat manage The varabo song ad lsrburion costs aro €0:10 per ut andthe fd sling and tsrston costs are €€0,000 per month. The corral ot Sharp draws pam internal rport constr ofa budgetod pret and loss account (absortion costing) 26 28h fw forecast. On the bass ofthe forecast of the sales compares, the Flown ‘Stes bagel was dawn op fo the socond quate of Us Yor eal 600000 uns ‘Te flowing ntarmaton must also be taken ito ascot: + 50% ofthe proscts supplied to the sales companies are pai or in the same month the otetandng amounts ae paid te folowing meen Se mentor of fried products at the end f each month shoul be 30% of ne ctimotes ones ne folowing mont, wa the inventory of raw mst Must be Suttovnt to cover 208 of production nth coming month. {0% of te purchased material (at €0.40 per ack Is paid erin he month of purchase nd GOW inthe following oath. ‘he imerfories #31 Mech donot covespond withthe stacking polly: 150,000 Unis of ished grote ar hal in eck wet entry of rw atrial fie for 190,000 packs. 100,00 unt were sald in Merch, an aw material was purchased for 900,000 (a 0.40 per unt £25,000 othe ted month costs se depreciation costs; unless sped ote, ‘Te controler draws up te budgeted pret nd oss aecount and he eash fw forecast, inorder to gauge wheter volume vane has influenced the satan oss account the reducton budget must be dawn up et This production badge is is used to ‘Come the purchasing budget on the bass of wien the cash low occas can be dawn Tecan Det cos ony penne ety iy pon Porchastng budget (aw materia AD ‘equa pan: 70005 D0 = 2045 900009 00 = 73200 pang ema 150000 €040= ~ € 200 una puesta ge 373200‘Becta sees: 800,000 ot €2— = 1.200000 Dentr weer: 60,0005 11 € e000 € s:0000 eum 5.00 6030= € 3500 Steg debe ote irate ch ow forecast A Fromipl es 686000 a €2 = pete Fr oe rtd Mas 0 €40 00 Fm me urn pd 08> €323.200- od mangoes €240.000-€25.000= Draw up the bugete balance sheet a5 at 30 Aol for Sharp (example 14.) ‘he Bok vale of the hed agets at 21 Mares 3,600,000 ar eat 531 Moreh is €75,000. Variance analysis, Although the budgeting proces primary gered wands accompli ‘onganlzatinal bjecives budgets are so an elective and important cit ‘onl instrument Wid ost budgets the emphasis son efeiency. A factor inthis respects the (percentage) contbuon of ech os 7 ‘otal cot of production. ffor example the labour carts are 10% andthe ‘material eats 70% athe total costs the inital empha bean controling th nates cost T this end, ts ponibleto define cost ‘andar expressed in cost budget for he person(s) to whom author hs ben aged When éraving up cost budgets portant to ‘inderstand how costs change este valume of production changes (cost teavous ee chaper 10), Some cost respond immediately to changes ‘upu volumes, whl others remain tate Moos re proportionally variable tothe volume of production, a ariale Yale ast ‘ost get an be dave up Per activity or performance, standard et {mount the so-aled budgeted rate, canbe determine. ‘The total budget wlincease sx esl of ny increate in she vekume of sei In this en, here lea input-output elatonshi for example ‘he transformation of aw material energy and machine hours nto hed afte coats re aot diet elated to the volume of ety ov volume of ‘oduct dificult to messure cost canbe Included inthe budge te priole amount. Ths ised cou budge covers cacy related cows, suchas depreciation Insurance and lease costs tals elas 0 Prodetermined costs Le costs tt a certain level by senior management ‘ich ar an annual budget for advertising or research and development Morebusinesse ute amine of budget A mis budget na combination favarable budget and a Bed budge For example, te costs fae Instr for manulstring department ney be shown in a varble budget we he abou costs (pemanent sta) are included tn fed budget The department would therefore havea mixed budget Name 9 dowbock othe use of fied buet tthe end ofeach budget prod tis esentil to compar the actual and ssid rere The cause of any vrianoes mite explored andthe Pesan to whom authority as been stigned brought account to eplala thedscrepances in this respect budgets have an aout and ‘enluarion function, xablshing budgets by organizational ey of manage froma vewpolnt fcostcontolispartothe stem ofesponibity accounting Inthls_Rsposy ‘ystema managerisrespensibleonlyfrthecostshe caninfuence the seat nota costs in principle, non-contrlable costs shoudl not be Included na budget Sometimes non-contollable costs are nevertheless ‘ered inthe budget. Ths ves department manager night nt the "otal ose elated bis department, pouibly encouraging cost arenes wih respecto budgeting a cot contl instrument we can distinguish between state budgets and fexble budgets Asta budgeis based on the ‘expected evel of output and ot adjusted aherwards fac output does ‘not equal budgeted ouput. Evident «comparison between budgeted and ‘cual costs wilt be very uefa inthis tuatlon, Torthis reason aflxile dg! should hese: bdget tat is aRerwards Reale badge adjusted to eflect the actual volume of production,20 pon see acco noe urge ‘A supplier of home elecwonzsbugets its ttl cots forthe complaints depsrtment in arch a €700,000; the buaget based on a srojected eure of corelas of 800. Im Apn appears tat he actual costs wore €720,000 and he ectual olme of “Te conclude thet ere isa untacurblevranee betheen budgeted ae actual costs of £30,000, of couse, sinpiiatin, Due tothe higher ‘roduction elu eis only tobe expected that cual costs exceed ugeted costs In orcerto aust the budget itis necoseary to unaeratand the Cost stcture of the compen. ‘Suppose the fad costs ofthe complains department ae €500,000 pe ronth, an the arable costs €28 per comps In that case te ajuted bust wl show tot costa ‘mounting to €750,000(€500,000 + 10,000. €25). Mmerefore te variance ls €20,000 ferourbe. ‘When entiing budget standards (such asthe quay andplo of mates per unt) is aly moran use acute data Thiscan be ‘one, fo ample by eons nfrmation poet the ‘maniacurer ofthe equipment Its formation not raat willbe ‘nscasry fo condueta through analyst seg andar nln ‘nayzng historical gues Ake) eneron in hespect isto determine ‘he standart too rig. Ove ig standards have a demotrsting eect 8 ‘heycan only be actived under ideal cremstances, Asclscusod elsewhere in this chapte, one ofthe purposes the budgeting process st graluate the varons operational) acts. ‘Any variances between the budgeted gues andthe acl figures nut be {examined to iden the undeying causes and wo take rectifying messee. ‘This so-aled arian anata ppios bot to salsaties end eo roducton processes Variances beneen he budgeted and the actual sles figures ould be due olowerhan expected sls, ferences beeen scald budgeted sling pices or iferenes in productrange ‘onpositon. We shall imi teseope o our uy to ne producion "arlanes namely price ariancy, lnc variance and volume variance. ‘Under he standard costing tes, for ach coe component standard ‘quantity (Q,) and standard price) atest On the basi these Parameters de budgeted cost per unit can be determined the parameters te elecivel the allan block ofa budget "To gauge the eicieney ofthe production procs tthe endo te plan period the actual quate (0,) and the acta prices) ant be ‘detemined. The budge arances the aiference between te ta ‘andard cost and the eal acta cout ude variance = (Q)xP) (4X29) The undesying causes can then be enti per cost componest. The “lelene variance denotes te diference between the acta ua UH fd the standard usage This stance fe calenlatedaglnet standard ekeney variance =(0,-0))xP, heres diflerence between the price pld and the standard pecs, there Isaprice variance, which scaleulatod oa the basis of actual quay ene Price variance = (P,Q, [stander qsnty of 0.4K rw mtr hasbeen determines for produ X The stand pie ofthe row meters € pe ha. The eatnateg production for March is 10,000 units, esti na ost budget Fx a mei €20,000, .xP.=(20,000%0,8)€5= €20,000 (Oh 31 Mate, the actual costs re €18.104 Fourie variance © 1086 (On the basis ofthe above information, its not posible to conclude thatthe company has ‘nade «prof of €3,856. The cua! poductan must be known, eo that 2 fxs bud inte drown up. Say eniy 8,000 uns were manufactured mviving 3260 kof ow ‘matrl te folowing vee canbe an Standaa costs budget) 8,000.x0.4x€5= €16,000 otal ste eiaaas Unfavorable budget variance 2a ‘Senematcaly reoresertod xrer8es xP, 16,600 xP=€16,900 “S In this aso, bth varances are unavourabe de to the higher than pormitedpic ond highethanaxpecod use of raw marl wi respect to te actual prosucon volume. ‘Meso variances and te standard costs can be prosenod a falewe: sao 9.3080,“he standard ost po unt: Roumanaiesigaterso= E125 Fad andg ete e000 The fed manctacrng costs are based on oa ud quarter ost of €150,000 Last uartar'spodton ror shows tht 7-380 fram mara were uted to manufacture 4,600 products, rong 1,500 erect labour hors The costs o 3 Corresponded to hose ofthe badge ‘ne bes ft ifomatan, me can cw up he folowing ana: cual cost: €49 46 + €38,000 + 150.000 exar.aas ‘Standard cost: 4.600 una at £48.75 — 220280 Untavowabie busier variance 13396 ‘Ts result canbe cies into the flowing ric arco Usnour 4.500 xe25-€28,0005 Unfvouabie Raw materials (4600 « 14/2 ~ 7.380) x €7.50 = nfooursbie {about (600 «0.3 ~ 1,500) €25 = ‘ntoeurebie N='200,000 60 = 5,000 units (4,600 ~ 5,000) €30 = € 12.000 unfroursbie Budget vronce © 13,196 unfooursble ‘many compants the poducon managers not responsible for purchasing aces. Hes esponsibe for eficeny varances, whl the tusersrexponsble for any pice variances more detailed analysts o he variances may, however evel eusallinkbetwoen the efcency and price mrances! Te fevourable pecs variance for example, nay De due "he fcr tht the buyer has puretiasd raw materi alow pices. Howe the inferior quay ofthese materials may have had an undvoureble {nfuence onthe eficiency cate hats he posse relationship setween the sales figures andthe Untncurabie rice variance on labour cots?” Audet variance may also be the result of more ores pola than ‘budgeted. Spoage cones finished products or semt-Anished produc Spalage that are rejected because they do not mest quality standards The spall ‘ate ay bea measure ote producti, the degree ofeficiencyorthe ‘ually performance ofthe manufactilng proces. ‘Xigher spoilage ate than normal may have several causes such as poor ‘work inseuctions inadequate working conditions ines ran materia an Incorrectly adjusted machin ora machine a he end ats seal ie Therejecon of product takes place na ont at he end tage a the production process bul t pesos phases. Fors eaton interim ons (quality eno) ae necesary atthe end ofthe production ele it becomes clear that the actual amber tlrejected products deviates fom the standard spolage ata opollage tarance cers snmple 13 explains this An epproved product has cos of €25 pe unt. The busted spotage rate of shed produets is 2x, Last ear 14,000 units mere manoetred, of nich 240 were ected Rejected products have no vale. The sponge variance an be caleulated a folows: Budgetesspoiege: 2% «24,000 units = 280 unis tua spotege 340 ts Sponge verance: G0 units €25 1,500 (unfavourable) ‘Chack hs eat by comparing te ost ofthe actualy ejected probes wth te budgeted spotage cost ofall manutacuod aoduets ‘On thesis of he abowe examples itscems safe to ase tat he standard costing method provides management wits te necessary cor ont nfomation. However ths depends on how accurately he ‘andar and parameters have been defined The nature the production process plasa an his espect Standard costing paral able fermase prodiction senate, ln general, costs are cairo cont rom a quantity perspective than fom price perspective Moreover efciency wil certainly nob improved by ‘omparng actual cost ad standard costs and anairngthe ferences without aking further aeton Ase have elteady mentioned, variance ‘alysis raises specie questions that mist be ansineed Ont basis ofthis process, measures ean be taken omprove eficenc. Wieshall conclude this chapter witya more dealed example, which ‘uayzes the variance between budgeted andl actual poi in deta‘Sngora ie ranufactures product A, Per unt fou, te flowing standard coating parameters hove been dened Dect rw mato coss: Sigat€2.40= €12.00, Diet labour coste: 0.5 noursat €26.40= £13.20, (ther aibla manuocturing costs € 296 Fred manufacturing costs €16.00 Total manufacturing cost e4ga6 Variable sling and tribution costs €12.00, Fed sling and sstrbton cost € 354 Prot mara 2000 Seting pice 80.00 A vorae cost te propatonalyvarabe. The normal anual podictin and sles {olume 2 20,000 uns, Powever, lt yor the actual production and eles volume nae 22,000 uit and the avrago price of to raw mates wos €2.50 pe” Ke ‘ne our wage was on average 5 higher tan the staré amour Due to quay Varances diecurts ware ooasional extended. The proft and eas acount or the aoe Years as fotons Pont ent 8) bie tment cots ‘om Fondatigand ene 00 ‘The sernce beboen the actual prt and the budgeted profs {aug S44 ~20 000 x €20 = €40,544 favourable valance, The board f decors asks te ‘ortolerta ean hearer, The carrer in tun proses the flowing overview: 2 reroasod prot vot erease in sales (2,000 - 20,000) x €20 = €80,000 favourabe variance rane due to decouns 2,000 €80 ~ €1,742,400 = €17,600 unovouabe variance _Etiinay vronce ram materi ‘etal usage: (€288.250 * €250) = 114,500 kg Standard usage 22,000 5 110,000 Ke fess usage +4500 Ke Unterourble variance: 4,500 ke €2.40 = €10,800 $EUA,300 tg (€2.50 ~ €2.40) = €12450 unfovoursle variance Emcor vance det iabour ‘etal Nous werkod:€290,136 + (1.08 x €26.40) ‘Stardara nous 22,000 0.8 wre 10,408.67 hows 13,000 hoor Favourable eiency vrlorce 1538.39 hows Fovourable vance: 535.33 hours a €26.40 10,486.67 hours x 5% x €26.40 = €13,816 unfavourable variance Sanco variable manufacturing eos £65,200 2,000 x £2.96 = E80 unfavourable vrionce Variance variable seing and asrbuton cost: 22,000 » €12 ~ €263,500 ~ €500fevoursbie vrionce Proascton: (2,000 ~ 20,000) x €16 = €32,000 Sale: (22000 20,00)€3.84~ #7680 ‘ Fourie volume vornce 29.680 suman: Favourable variances Unfovowrabe vances © «000 © i140 € ao © 10800 <0 € 1140 € s9880 € nia or nenaGlossary Multiple-choice questions [uthoistion and eralustion The diference beeen an ecru and «budgeted moun better nor botiaandb Bficleneyvariance __Thedifference between standard and acual quant, Calelated aginst the andar price ‘The nal stage of rating dhe master budge involves drawing up budgeted balance sheet red bodget ‘badge tha doesnot kent acount porn variations in budgeted pro end ost acount busines acy budgeted eas fow Hamictedge Abate ttt susie lr changsinwohine coeeaeeeeaeae .——— eet ‘The production budget covering pen pid leu tothe budgeted ater badge “Toman organizational badge summarising te planned ceeoe en se ‘cts of al uni of an orgeation Pte planned incre in ventory Br the dese clsinginventory “The combinston os ned budget anda variable budget Ieath planned incre weary teeth ested closing inventory “The difrncs beeen he andar (budge roe nde tere price maid el quay ed Animpore of sors clothing calcul pati argin 20% is - Purchase prices Ons March tempore has tl cohingivetary of Pros that do not ee quality anda and are eet lsn.00 lance shee guts). The budgeted sales volume fr Apa naan — £21000 inancprton of neressed salen the sramer aon the ‘Ade vari with acy ohne ad price lve ste ny a9 Ae shone A highs hana ach ‘The purchasag budget for Apri i es00.000 ezr5000 280.000 200.000 fd cost budget relates: a planned volume of production tether orb In general cost conta is party dependent on ‘helength ofthe budge period the atthoreton ofthe budget holder both and nether norAbudget drawn up atthe end ofthe planned period on the basi of the ‘ctu business acti is known as: Sacer cae S exble budget {imaed badger The standard aw material costs of produc Aare kg at price of €10 pe 50. Ate end ofthe budget period eanspirs that the company hae Purchased 4500 gata pice of €1050 perl” 4000 ky has ben eto ranfacur a otal of 750 product, The unavourbl efciene variance fe e200 ©2500 e500 ‘The budgeted weekly production of product i300 ns. The standard Ishour costae four hours prin san houry cot of €3. These outputs 250 units, andthe sverage labour costs ae 3 hour at £39 per bo The unfavourable labour variance ts e000 e700 e220 “The sandard aw material oats forthe (mas) proditonof 00 densa units re €¢ perk, In week 12,190 unite were manfstied. The aca ‘a mater costs were €1.960, resulting ina favourable rice variance of ass 200 kg Sas ke mak Budget variances the diference betwee: total evened tot ost actual come and standard cost $lansed production and ecual production The unt cos ofa product includes wo direc abour ours at €90.In8 Petiod dhe company manufactures 200 product, ivalving abou os £3000 for 390 outs worked In hs period, which othe folowing ap tothe diecrlabour cons ficiency variance Price vartance 200Gvourable €900 nevourabe Execoiavourable E4000 unfvourabe L000 favourable €3900 univourabe