Chapter 2: Calculating unit costs

(Part 1)
 Contents

1. Identifying direct and indirect costs for cost units

2. Inventory valuation

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 Direct/Indirect cost

Prime cost = Total Direct costs

Prime cost
(Direct cost)

Raw material cost Direct labour cost Direct expenses

Various components of prime cost

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 Direct/Indirect cost
Cost unit: Từng lần sửa chữa
• Classify direct or indirect cost of a particular car repair in a garage

Indirect
CP sưởi ko có trong dịch vụ
Indirect
sửa chữa
Direct
Chỉ tra cho 1 số bp
vì ko đáng kể Indirect

Indirect
Khi ko nói gì thì là general
an ko làm Indirect
à đc trả lương

Indirect

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 Overtime
• Basic rate: 10$/hour
• + Overtime premium: 5$/hour (trả thêm)
• Overtime
• Direct labour:
• - General requirement: Cty có kế hoạch làm tăng ca; Basic rate:
Direct cost; Premium: Indirect cost
• - Specific requirement: Công ty ko biết trước thời gian làm thêm;
Basic: Direct; Pre: Direct
• Indirect labour:
• - General requirement: Cty có kế hoạch làm tăng ca; Basic rate:
Indirect cost; Premium: Indirect cost
• - Specific requirement: Công ty ko biết trước thời gian làm thêm;
Basic: Direct; Pre: Direct

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 Direct/Indirect cost

Further points
 Direct costs are not necessarily bigger in size than
indirect costs
 Indirect costs are not less important than direct costs
 It is easy to confuse fixed (fixed là direct cost ví dụ máy
cẩu thuê để xây nhà) and variable costs with indirect
and direct costs.

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 Inventory valuation
Valuing inventory in financial accounts (IAS 2)
Lower between - Cost
- Net realisable value
Valuing inventory for cost of production or cost of sales
- FIFO (Flow of cost: Đơn giá của đơn nhập đầu tiên sẽ là đơn giá được
xuất đầu tiên); inflation-> Giá vốn thấp so với giá tt-> chi phí bán hàng
thấp -> Profit cao -> Income tax high
- LIFO (Đơn giá nhập sau cùng sẽ là đơn giá được xuất đầu tiên)
- AVCO
- Perpetual (Kiểm kê thường xuyên): Opening inventory + Increase-
Decrease = Closing inventory
- Periofic (kiểm kê định kỳ): Opening + increase- closing= Decrease

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 FIFO
Date Description Kg $/kg Total
Opening 100 10 1000
5/1 Receipt 200 12 2400
10/1 Receipt 100 11 1100
15/1 Issue 250 11,2 100*10+150*12=2800
18/1 Receipt 150 13 1950
20/1 Issue 200 11.75 50*12+100*11+50*13=
2350
Ending 100 (13)

LIFO (Perpetual)
Date Description Kg $/kg Total
Opening 100 10 1000
5/1 Receipt 200 12 2400
10/1 Receipt 100 11 1100
15/1 Issue 250 11,6 100*11+150*12=2900
18/1 Receipt 150 13 1950
20/1 Issue 200 12.75 150*13+50*12=2550
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LIFO
• Periodic: Count closing inventory: 100
- Issue: = opening+ increase- closing= 100+
(200+100+150) - 100= 450
- 150*13+100*11+200*12= 5450

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 ACVO

Date Description Kg $/kg Total

Opening 100 10 1000
5/1 Receipt 200 12 2400
10/1 Receipt 100 11 1100
15/1 Issue 250 11.25 250*11.25= 2250
18/1 Receipt 150 13 1950
20/1 Issue 200 12.125 (150*11.25+150*13)/
300=12.125=> 2425
Ending 100 (13)

Periodic:
At the end: (100*10+12*200+11*100+13*150)/550=11.72
Issue: 450*11.72= 5274

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 Inventory valuation
Example: The Bike Company (TBC)
Date Activities Quantity Unit cost Total
1 Aug Beginning 10 91 910
3 Aug Purchase 15 106 1,590
14 Aug Issue 20
17 Aug Purchase 20 115 2,300
28 Aug Purchase 10 119 1190
31 Aug Issue 23

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 Inventory valuation
Inventory cost flow assumptions

First-In, First-Out Assumes costs flow in the order

(FIFO) incurred.

Last-In, First-Out Assumes costs flow in the

(LIFO) reverse order incurred.

Weighted Assumes costs flow at an

Average average of the costs available.

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 Inventory valuation
FIFO

Oldest Costs of
Costs Goods Sold

Recent Ending
Costs Inventory

Often parallels actual physical flow of stock.

Generally good business practice to use oldest units first.

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 Inventory valuation

FIFO

The Cost of Goods Sold for the August 14 sale is $1,970,

leaving $530 and 5 units in inventory.

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 Inventory valuation

FIFO

Income Statement 14/8

COGS = $4,570

31/8

Balance Sheet
Inventory = $1,420

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 Inventory valuation

Advantages and Disadvantages of FIFO

Advantages Disadvantages
It is a logical pricing method, FIFO can be cumbersome to
which probably represents what operate because of the need to
is physically happening: in identify each batch of material
practice the oldest inventory is separately.
likely to be used first.
It is easy to understand and Managers may find it difficult to
explain to managers. compare costs and make decisions
when they are charged with varying
prices for the same materials.
The inventory valuation can be In a period of high inflation, inventory
near to a valuation based on issue prices will lag behind current
replacement cost. market value.

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 Inventory valuation
LIFO

Recent Costs of
Costs Goods Sold

Ending
Oldest
Inventory
Costs
Under IFRS, LIFO is not permitted for financial reporting
purposes.

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 Inventory valuation

LIFO

The Cost of Goods Sold for the August 14 sale is

$2,045, leaving $455 and 5 units in inventory.

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 Inventory valuation

LIFO

Additional purchases were made on Aug. 17 and Aug. 28.

On Cost
Aug. 31,of Goods23Sold
an additional for sold.
units were August 31 = $2,685

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 Inventory valuation

LIFO

Income Statement
COGS = $4,730

Balance Sheet
Inventory = $1,260

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 Inventory valuation
Advantages and Disadvantages of LIFO
Advantages Disadvantages
Inventories are issued at a price The method can be cumbersome to
which is close to current market operate because it sometimes results
value. in several batches being only
part‑used in the inventory records
before another batch is received.

Managers are continually aware of LIFO is often the opposite of what is

recent costs when making physically happening and can
decisions, because the costs being therefore be difficult to explain to
charged to their department or managers.
products will be current costs.

  As with FIFO, decision making can be

difficult because of the variations in
prices.

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 Inventory valuation

When a unit is sold,

the average cost of each unit in Average-Cost Method
inventory is assigned to cost
of goods sold.

Cost of
Units on hand
Goods ÷ on the date of
Available for
sale
use

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 Inventory valuation
Cumulative weighted average cost: calculated after each
receipts

The average cost per unit must

be computed prior to each sale.
$100 = $2,500  25

On August 14, TBC sold 20 bikes

Continue
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 Inventory valuation

Average-Cost Method

The average cost per

unit is $100. $100 = $2,500  25

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 Inventory valuation

Average-Cost Method

Additional purchases were made on August 17 and

August 28.
On August 31, an additional 23 units were sold.

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 Inventory valuation

Average-Cost Method

$114 = $3,990  35

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 Inventory valuation

Average-Cost Method

The average cost per $114 = $3,990  35

unit is $114.

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 Inventory valuation

Average-Cost Method

Income Statement
COGS = $4,622

Balance Sheet
Inventory = $1,368

$114 × 12 = $1,368
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 Inventory valuation

Advantages and disadvantages of Cumulative weighted

average cost

Advantages
Fluctuations in prices are
smoothed out, making it easier
to use the data for decision
making.
It is easier to administer than
FIFO and LIFO, because there
is no need to identify each
batch separately.
Disadvantages
The resulting issue price is rarely
an actual price that has been
paid, and can run to several
decimal places.
Prices tend to lag a little behind
current market values when there
is gradual inflation.

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 Inventory valuation

Periodic weighted average cost: calculated after all

receipts

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 Inventory valuation

Periodic weighted average cost: calculated after all receipts

   Quantity  Unit cost  Total  Market value

cost per unit on
date of
transaction
    Units   £   £  £
Opening balance, 1 May   100   2.00   200  
Receipts, 3 May   400   2.10   840  2.11
Issues, 4 May   200      2.11
Receipts, 9 May   300   2.12   636  2.15
Issues, 11 May   400      2.20
Receipts, 18 May   100   2.40   240  2.40
Issues, 20 May   100      2.42
Closing balance, 31 May   200          2.45
        1,916  
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 Inventory valuation
Periodic weighted average cost: calculated after all receipts

= £2.129 per unit

This average price is used to value all the units issued and
the units in the closing inventory.
   £    
Cost of issues = 700 units  £2.129  1,490
Closing inventory value = 200 units  £2.129     426
   1,916
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 Inventory valuation and profitability
Worked example: Inventory valuation and profitability
On 1 November 20X2, Delilah’s Dresses Ltd held 3 pink satin dresses with orange
sashes, designed by Freda Swoggs. These were valued at £120 each. During
November 20X2, 12 more of the dresses were delivered as follows.
A number of the pink satin dresses with orange sashes were sold during November
as follows.
Date  Dresses received  Purchase cost per dress
10 November  4  £125
20 November  4  £140
25 November  4  £150

A number of the pink satin dresses with orange sashes were sold during November
as follows.
Date  Dresses sold  Sales price per dress
14 November  5  £200
21 November  5  £200
28 November  1  £200

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 Inventory valuation and profitability
Worked example: Inventory valuation and profitability
Requirements
Calculate the gross profit from selling the pink satin dresses
with orange sashes in November 20X2, applying the following
principles of inventory valuation.
(a) FIFO
(b) LIFO
(c) Cumulative weighted average pricing
Calculate gross profit using the formula: gross profit = (sales –
(opening inventory + purchases – closing inventory)).

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 Inventory valuation and profitability
FIFO
Worked example: Inventory valuation and profitability
      Cost    Closing
Date  of sales  Total  inventory
     £  £
14 November  3 units  £120    
   + 2 units     
£125
     610  
21 November  2 units  £125    
   + 3 units     
£140
     670  
28 November  1 unit  £140  140  
       
Closing inventory  4 units  £150      600
     1,420  600

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 Inventory valuation and profitability
LIFO
Worked example: Inventory valuation and profitability
   Cost of    Closing
Date     sales  Total  inventory
     £  £
14 November  4 units  £125    
   + 1 unit  £120    
     620  
21 November  4 units  £140    
   + 1 unit  £120    
     680  
28 November  1 unit  £150  150  
Closing inventory  3 units  £150    
   + 1 unit  £120    
         570
     1,450  570

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 Inventory valuation and profitability
Worked example: Inventory valuation and profitability
Cumulative weighted average pricing
       Balance  Cost of  Closing
in
   Units  Unit cost  inventory  sales  inventory
    £ £    £      £
1 November 3  120.00  360    
10 November 4  125.00  500    
  7  122.86  860    
14 November 5  122.86  614  614  
  2    246    
20 November 4  140.00  560    
  6  134.33  806    
21 November 5  134.33  672  672  
  1    134    
25 November 4  150.00  600    
  5  146.80  734    
28 November 1  146.80  147   147    
30 November 4  146.80  587  1,433  587

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 Inventory valuation and profitability
Worked example: Inventory valuation and profitability
Profitability      Weighted
   FIFO  LIFO  average
   £      £      £    
Opening inventory  360  360  360
Purchases  1,660  1,660  1,660
   2,020  2,020  2,020
Closing inventory   600   570   587
Cost of sales  1,420  1,450  1,433
Sales (11 £200)  2,200  2,200  2,200
Gross profit   780   750   767

Different inventory valuation methods produced different costs of sale and

hence different gross profits. As opening inventory values and purchase costs
are the same for each method, the different costs of sale are due to different
closing inventory valuations. The differences in gross profits therefore equal the
differences in closing inventory valuations. The profit differences are only
temporary.

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