Introduction to

Accounting & Finance

Presented by:
Reshma Nanan F.C.C.A, C.A

Costs & costing

1
Learning outcomes

• explain the different classifications given to production

costs
• understand the uses to which cost data can be put
• analyse which costs of production are likely to vary with
output and which will not

Types of costs

• Direct cost
−Costs directly associated with a product
eg. Material cost

• Indirect cost
−Costs that cannot be directly associated with a product
( also called overhead costs or expenses)
eg. rent

2
Methods of costing

• Marginal costing or variable costing

−A method which only takes into account variable costs
& ignores fixed costs in decision making

• Full costing
−Takes into account both direct & indirect costs
associated with the manufacture of a product

Methods of costing

• Absorption costing*
−Where indirect manufacturing or overhead costs are
spread fairly across a range of products

• Activity-based costing*
−Splits the production into activities and departments

• *Beyond the scope of this module

3
Using cost information to price a product

• Pricing a product depends on many factors, including

market factors.
• Businesses may use their costs to calculate their selling
price.
• Two basic methods:
1) Cost plus
2) Margin pricing

Cost + Profit = Selling price

Cost plus pricing

Where the product is priced to achieve a standard mark-

• Mark up % based on cost price

Cost + Profit = Selling Price

100% + 50% = 150%

Mark-up = Gross profit x 100 = 50 x100 = 50%

Cost of sales 100

4
Margin pricing
where the product is priced to achieve a standard margin based on
the selling price.
• Margin % based on selling price

Cost + Profit = Selling Price

75% + 25% = 100%

Gross profit = Gross profit x 100 = 25 x 100 = 33%

margin Sales 75

Question

1) If Sales are £25,000 and Gross Profit margin is 35%, what

is the Cost of Sales?

2) If Cost of Sales is £140,000 and there is a mark-up of

70%, what is Sales?

5
 Cost Behavior & Marginal
Costing

Management Accounting

• Decision making
• Planning
• Control

6
Fixed costs
• those costs that remain the same
whatever the level of output
(over a limited range of output).
−Eg. Rent

Costs
£

FC

Activity in units

Variable costs
• Vary directly with the number of units
produced. The Variable Cost of producing
one unit is also known as the MARGINAL
COST.

Eg. Materials cost

Costs
£
VC

Activity in units

7
Total Costs
• The Total Cost is the actual cost incurred in the
production of a given level of output.
• The total cost includes both the variable cost and
the fixed cost
TC = FC + VC
Costs
£
TC

Activity in units

Semi- variable costs

• costs that contain both a fixed and variable
element.
Eg. telephone charges may include a fixed rental
cost plus a charge linked to telephone usage.
Costs
£

S-VC

Activity in units

8
 Step-fixed costs
• costs that will remain fixed as output increases until
the activity reaches a level where the costs have to
increase sharply.
Eg. supervision costs where an additional
supervisor is required once a certain level of
output is exceeded.

Costs
£

Step FC

Activity in units

Sales Revenue

£
Costs

SR
Vary directly with the
number of units sold.
= No of units x selling
price per unit

Activity in units

9
 Exercise 1

• Sam has established a business selling printed team kits in

UK and India
• He is considering the possibility of manufacturing hand-
strung tennis racquets

Exercise 3
Sam has estimated his costs.

Hire of machine £550 per month to hire

Material costs £8.50 per racquet

Labour costs £9 per hour

- Racquet framing The machine requires one
person to operate it.
Four racquets can be framed
every hour.
- Racquet stringing Staff who string racquets can
hand string 2 racquets in an
hour.

10
Exercise 3 continued

a) From the list of costs, decide which are fixed and which
are variable costs.
Fixed Variable
−Rent of the machine
−Material costs
−Labour costs

Exercise 3 continued

b) what is the variable cost per racquet?

c) what are the total fixed costs in a year?

11
Contribution

Contribution is defined as the difference between the selling

price of a product and the variable costs incurred in
producing that product.

Contribution = Selling Price – Variable Cost

per unit per unit per unit

Total Contribution

Total = Total - Total

Contribution Sales Revenue Variable cost
SR VC

OR

Total = Contribution per unit x Quantity

Contribution

12
Exercise 1

If Sam can sell the racquets at £25 each;

d) Calculate the contribution for each racquet sold

Marginal Costing

• Marginal cost is often defined as: the cost of producing

‘one more unit’.
• Marginal costing therefore effectively ignores fixed costs,
as they are very unlikely to increase if you are only
producing one more unit.
• Marginal cost is normally the same as variable cost
• This approach to costing is useful for short-term decisions
eg:
−Should we accept a special order?
−Should we make a part ourselves or buy it in?

13
Marginal Costing continued..

• Marginal costing data is usually presented in the form of a

marginal costing statement.
• The format of this statement (see next slide) follows the
marginal costing approach, ie:
SP – VC = Contribution
• The statement then considers fixed costs as one lump sum:
Contribution – FC = Profit
The marginal costing statement is actually a simplified
version of an income statement.

Marginal Costing Statement

for the period ended 31 Dec 2017

Per Unit Per year

£ £
Sales revenue 10.00 150,000
Less Variable Cost (5.25) (78,750)
Contribution 4.75 71,250
Less Fixed Cost (50,000)
Profit/Loss 21, 250

14