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Zulfiqar
Shah
Warwick Business
School
Learning Objectives
After this lecture, the associated readings and seminar
work you should be able to understand:
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School
Why Does Your Cappuccino Cost
Such a Lot?
Profit 8p
VAT 35 P
Other ingredients/pack 10 p
Head office 16 p
General operational costs 33 p
Cost of drink
1.99
Warwick Business
School
Why Do We Need Product
Costs?
1. 3.
Stock Product Mix
Valuatio Decisions
n
2. 4.
Pricing Cost
Decisions Control
How do we arrive at
full cost for a
Warwick Business School
Determination of Unit
M
Manufacturing Cost
P
R
A
DIRECT MATERIALS I
N
DIRECT LABOUR
M
E
T
U
C
DIRECT EXPENSES
O
F O
S A
T C T
INDIRECT T
EXPENSES
(FACTORY U
A
OVERHEADS)
R
SELLING AND I L
ADMINISTRATION COSTS
N
Warwick Business C
School
Job Costing and
Process
There are twoCosting
basic systems used to
assign costs to products or services:
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School
Costing a Widget:
Illustration
Direct Costs:
Direct materials
Direct labour
Direct expenses
Prime Cost
Factory
Overheads:
Welding
Machining
Assembly
Total factory
overheads
Manufacturin
g cost
Selling
and admin
Warwick Business
School
Standard Cost Card: Direct Cost of one
Unit
Direct of Widget
Materials:
1kg wood @1.50 per kg 1.50
1.5kg steel plate at 5.00 per kg 7.50
1 brush (bought out) 2.00
11.00
Direct Labour:
Welding* 0.5 hours at 5.00 /hour 2.50
Machinin 0.5 hours at 8.60 /hour 4.30
g*
Assembly 2.0 hours at 5.50 /hour 11.00
*
17.80
Royalties at 1.70 per 1.7
Direct
widget expenses: 0
Prime Cost of one unit 30.50
of Widget
Notes:
* Time spent on automatic welders = 1
hour
* Time
Warwick Businessspend
School on machining cell = 1.5 hours
Costing a Unit of
Widget
Direct Costs:
Direct 11.00
materials 17.80
Direct
1.70
labour
Direct
30.50
expenses
Prime Cost
Factory
Overheads:
?
Welding
Machini
ng
Assembl
y
Total
Warwick Business
School
Three Cost Assignment
MethodsCost of Resources
Cost Objects
(Drury, 2013)
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School
Identifying Cost Centers
No of Emp. 6 12 14 3 8 2 45
TotalWelding
factory 19.50
overheads
Machini
Manufacturing 50.00
ng
cost Selling
Assembl ?
Totaland
y admin
Non-Manufacturing
Overheads
Treated as a period costs for external
reporting
Need to be absorbed to get full
product cost
But is there a fair absorption base?
May be absorbed on ability to bear
basis
Common to use a fairly arbitrary base
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School
Under and Over-Absorption of
Overhead Costs (under-absorbed) indirect
Under-allocated
costs occur when the allocated amount of
indirect costs in an accounting period is less
than the actual amount incurred.
= Under-absorbed by 19,000
3. What is the under or over absorption?
Warwick Business Why?
School
Departmental Allocations
Three methods are widely used to allocate
the costs of
support departments to operating
departments:
Direct Material
Product
Direct Labour
Cost Product
Variable O/H
Cost
Fixed Mfg. Period
O/H Cost
S&A O/H Period
(Fixed+Var.
Warwick Business School Cost
Example: AC and MC
Cheeky Limited commenced business on 1 March,
2010 making one product only, the cost of which is
as follows:
Direct Labour
5
Direct Material 8
Variable Production Overhead 2
Fixed Production Overhead 5
Allocated
Standard Production Cost 2
The fixed production overhead figure has been 0 calculated on
the basis of a budgeted normal output of 36,000 units per
annum.
Monthly production is budgeted to be 3,000 units per month.
March and April are to be taken as equal period months.
Selling, distribution and administration expenses are:
Fixed 120,000 per annum. These are to be treated as Period
Example: AC and MC
The selling price per unit is 35 and the number of
units produced and sold was:
March April
Units Units
Productio 2,000 3,200
n
Sales
Required: 1,500 3,400
a) Prepare profit statements for each of the months of
March and April using:
(i)Marginal Costing; and
(ii)Absorption Costing (showing any
under-absorption or over- absorption of
fixed costs).
b) Present a reconciliation of the profit or loss figure for
each
Warwick month given in your answers to (a) (i) and (a)
Business
School
Marginal Costing
Example: AC
March and MC
Sales: (1500 units x 52,5
VC of 35) (2,000 30,0 00
production units x 15) 00 22,5
Closing stock (500 units x (7,50 00
15) 0) 30,0
Contribution
Less: Monthly fixed costs Monthly fixed cost
00
Production: (36,000 units x 5 15,00
12) Selling + Distribution Cost 0 25000
(120,000 12) 10,00
0
Profit
5,00
Absorption Costing March 52,5
0
Cost
Sales:of (2,000 units x 40,00 00
production: 20) (500 0 30,00
Closing stock units x 20) (10,00 0
GrossSelling
Less profit & Distribution Cost 0) 22,50
(120,000 12) Profit 0
Underabsorbed fixed costs: (1,000 10,00
units x 5) 0
Example: AC and MC
Marginal Costing April
Sales: 119,000
VC of
production: 7,50
Opening 0
Stock 48,00
Production 0
Less: Closing 51,000
Stock 55,50
0
Contribution 68,000
(4,50
Less: Fixed costs (as calculated
0) 25,000
for March) Profit 43,000
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School
Example: AC and MC
Absorption Costing April
Sales 119,00
0
51,000
Less: Selling and Distribution 10,000
Costs
41,000
Profi 42,000
Overabsorbed
Warwick Business
t Fixed costs 1,000
School
Example: AC and MC
Reconcilia
tion
Absorption
Period 1 cost 7,50
profit: Remove 0
fixed costs: ---
Add Fixed costs in (500 x 2,50
opening stock: 5) 0
Less Fixed costs in 5,00
Period
closing stock: 2 Marginal 0
Absorption
cost profit cost profit 42,0
Add Fixed costs in op, 2,50 00
stock: Less Fixed costs in 0 1,00
closing stock: 1,50 0
Marginal cost profit 0 43,0
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School
Comparison of MC and
AC
MC AC
Simple Recognises
No arbitrary importance of fixed
apportionme costs
nts Inclusion of fixed
Avoids costs necessary
over/under where stock is
absorption building up
Logical to write fixed More accurate cost
costs off as occur plus pricing
Closer to cash Complies with
flow position
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IAS2 for external
School
Product Costing in
Services
Many services have high
proportion of overheads.
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School