COST ACCOUNTING

TOPIC 1: INTRODUCTION
In order to determine the meaning and importance of cost
accounting, first we have to define how it is defined and related to
other types of “accountings” firms use.
 Financial accounting: deals with the performance of the
company, so it measures and records business transactions and
provides financial statements. Everyone has access to it, and
legislation makes financial accounting homogeneous throughout
different firms.
 Management accounting: it represents any type of inside
created information that is considered in management
decisions. Basically it reports information that managers use in
order to intervene in the decision-making process.
 Cost accounting: supports both management and financial
accounting. It consists on collecting and analyzing cost data.
Since cost accounting is
important in a lot of
decisions, some situate
its position as an
intersection between
financial and
management
accounting. However,
others prefer to bundle
cost accounting into
management
accounting.

Moreover, we have to note that what makes financial accounting clear

is regulation, whereas both management and cost accounting has no
constraints as long as it is relevant and in time.

Differences between an expense, a cost and a payment

We have to have clearly defined which of the former types of
elements is used for.
 Expense: it is a financial accounting costs. It represents a
decrease in owners’ equity, accompanied by a decrease on
assets or an increase on liabilities. It is included in the income
statement.
 Cost: belongs to managerial accounting. A cost stands for the
expenses that participate in the production of a good or service.
Examples could be tax on corporate profits or an impairment of
an asset.
 Payment: it refers to cash outflows, or in other words,
reductions in cash. For instance, a depreciation is not a
 payment, but it represents both a cost and expense for the
firm. Conversely, a purchase of the PPE is, at the moment of
the purchase, a payment.
 Investment: refers to assets (=’unexpired costs’)

Cost Terms and Classifications

We can classify costs depending on its objective. If our objective is
cost calculation, we have different subcategories. Otherwise, if our
objective is decision making, we have another kind of
subcategories. The objective of this course is the former

Objective: Cost calculation

We have the following categories. Recall this is the focus of this
course.

Cost by Nature
It refers to the standard I’m paying for: material costs, labor costs,
financial costs, etc.

Cost by (Business) Function

Depends on the functional area (like we will do in full costing): design
costs, production costs, marketing costs, etc.

Direct versus Indirect Costs

The classification depends on the cost object. Cost object is basically
what the company wants to know its associated cost. It can be a
product, a service, a project, a customer, etc. Whether costs are
direct or indirect will depend on the cost object. Regarding this, we
have the two types:
 Direct cost: cost that can be assigned (or traced) to the cost-
object easily.
 Indirect cost: those costs that cannot be assigned directly to
the cost object.
An example of indirect cost would be the insurance of the office
building where tables are produced.

Now consider for instance amortization. It can be both a direct cost

(if we are calculating the amortization for machinery directly related
to the production of a product)
or an indirect cost (if we are
depreciating the headquarters
offices of the company).

The same happens with a lot

of costs, such as marketing
costs. The classification
depends on whether
marketing, in this case, is
general to the firm or specific to a given product.
Product versus period costs
Product costs are the sum of costs assigned to a product. We have
a broader definition of cost here. This is not manufacturing costs only
considered to the production -the so-called COGS-. Intuitively, we
may consider more costs depending on the company decisions
(remember we have no legal framework to follow).

Opposite to this, we have period costs, which are the costs incurred
on a given and definite interval of time, normally the business cycle.

The definitions of both will vary depending on financial accounting or

management accounting perspectives.

Example
Suppose we have the following information regarding a company:
 Manufacturing costs:
o Direct labor: 400,000
o Direct materials: 200,000
o Manufacturing overheads: 200,000
 Non-manufacturing costs: 300,000
 Sales: 910,000
 We also have this information:
o 70% of costs are assigned to finished goods, which were
sold in period 1.
o 20% are finished goods that remain in stock, and the
final 10% represents unfinished goods.
Design the income Statement for period 1.
First of all, we have to note that Costs of Goods Produced is equal to
800,000 (the sum of direct labor, direct material and manufacturing
overheads). From this number, 560,000 (=70%) are COGS, 160,000
(=20%) are finished goods that become stock, and finally 80,000
(=10%) that belong to work in progress goods (WIP).
Income Statement
Sales 910
- COGS (560)
Gross Margin 350
- Non-manufacturing costs (300)
Margin 50

Variable versus Fixed Costs

Variable costs are those costs that vary as the level of activity
changes, whereas fixed costs do not change in total when activity
levels change within the relevant range, such as high proportion of
personnel costs, depreciation of factory building or plant insurance.
Step Fixed versus Semi-Variable Costs
Step fixed costs are those that are fixed within specified activity
levels, but eventually increase or decrease by a constant amount at
various critical activity levels, such as personnel costs when
additional employees are
hires.

Semi-variable costs are those

costs that include a fixed and
a variable component, such
as telephone costs which
have a fixed rate and a
variable rate per phone-
minute used.

Step-Fixed costs and associated relevant ranges

Summary of costs – Example

Cost Terms for Decision Making

Those include relevant costs, incremental costs, sunk costs,
opportunity costs and controllable costs, but those are out of the
scope of our analysis.

Summary of the course

1. Introduction. Here we are.
2. Partial costing. Only some costs are allocated, like direct or
variable costs.
3. Cost Volume Profit (CVP) Analysis. It deals with break-even
point analysis, on the perspective of variable costs
4. Full Absorption. It deals with the full allocation of costs to the
cost object. It includes job costing, section costing or activity-
based costing (ABC).
5. Full Absorption (or Full Costing) II.
 6. “Standard” Costing. Until topic 5, we are going to compute
costs “ex-post”. In this topic, costs will be calculated in
advance. We could think of it as a forecast.
7. Variance Analysis. Should it better be called variation
analysis.
Summary of the topic
What we must underline of this topic are the different types of cost
that will be useful for our analysis.

Types of cost:
o Changes with the level of activity: Variable or Fixed cost.
o Can the cost be traced to the product? Direct or Indirect
cost.
o Another classification (depends on costing method):
product or period costs.

Exercise 1.1.1 Classify the costs

Cost Classification
Consumption of materials Always a product cost. Variable and
Direct
Salaries and social of the Fixed cost and indirect
administrative personnel and
management
Consumption of office material Probably fixed and indirect
Commercial discounts to clients Not really a “cost”
Commissions to sales personnel Variable and fixed costs
Gas Probably fixed and indirect
Outsourcing of production activities Direct and variable, for the case of
transportation. Depends
Advertising Brand: variable and indirect
Product: variable and direct
Financial costs Depends on cost object
Oil for production machinery Direct and variable. You may also
consider it indirect
Telephone Same as “gas”
Miscellaneous costs (also sundry We don’t know
costs)
Rent Fixed and indirect
Depreciation of production machinery Variable, direct and related to
product

Additional Exercise: Costs and Valuation of Inventory

Calculate the associated income statement for the following
information using (1) Weighted-Average Method and (2) FIFO for
inventories.

Date Concept Units Total Unit price

Value
1/1 Initial Stock 100 2000 20
3/1 Purchases of Stock 300 6150 20.50
4/1 Consumption of Stock 320
9/1 Purchase of Stock 420 9534 22.70
11/1 Consumption of Stock 200

In addition, we are provided this information:

o Direct Costs: 15,000
o Indirect costs: 4,100
o Sales: 30,000
o No final stock

Inventory Valuation – Weighted Average Method

Concept In Out Balance

Units Value Units Value Units UC Total
Value
Initial Stock 100 2000 100 20 2000
Purchases of 300 6150 400 20.375 8150
Stock
Consumption 320 6520 80 20.375 1630
of Stock
Purchase of 420 9534 500 20.375 11,164
Stock
Consumption 200 4465.6 300 22.328 6698.4
of Stock

Total initial + purchases: 17,684

Total out: 10,985.6 (=COGS)
Final valuation = Total initial + purchases – Total out = 6698.4

Income Statement (W.A. Method)

Sales 30,000
- Raw Materials (10,985.6)
- Direct Costs (15,000)
Gross Margin 4014.4
- Indirect Costs (4100)
EBIT (85.6)

Inventory Valuation – First In First Out (FIFO)

Concept In Out Balance

U Value U Value U UC Total Value
Initial 100 2000 100 20 2000
Purch. 300 6150 400 100@20 8150
[email protected]
Consm. 100@20 6520 80 20.5 1640
[email protected]
Purch. 420 9534 500 [email protected] 11,174
[email protected]
Consm. [email protected] 4465.6 300 22.7 6810
[email protected]
Total initial + purchases: 17,684
Total out: 10,874 (=COGS)
Final valuation = Total initial + purchases – Total out = 6810

Income Statement (FIFO method)

Sales 30,000
- Raw Materials (10,874)
- Direct Costs (15,000)
Gross Margin 4126
- Indirect Costs (4100)
EBIT 26

From this exercise we can infer that if the cost of inventory is

intensive in sales, and if stock prices are pretty volatile, valuation
process and costing systems may make a difference. So, whenever
regulators give margin to choose in legislation, firms will use the
most favorable method for them.
 TOPIC 2: PARTIAL COSTING

What is a costing method?

A costing method are the set of techniques and procedures used to
calculate the cost of costs objects. This allows us to calculate the
result of a period and also to provide the information required for
management.

There are several costing methods (mentioned in the summary of the

course in page 4). The characteristics of a company, the industry, the
type of product, the information available, and other not-so relevant
factors influence the choice of a costing method.

We can differentiate costing methods depending on which parts of

costs we assign to the cost objects. From this point of view, different
costing systems such as partial costing (the one we are going to deal
with now) or full costing.

The calculation can be based on real or budgeted data, that is, using
historical costs and making an ex post analysis, or working with
budgeted data and performing an ex ante prediction.

In addition to that, we also have a separation depending on whether

the firm uses job-costing methods (thus assigning different costs to
different units, such as consulting or house constructing firms) or a
process-costing method (for firms that produce masses of similar and
standardized products).

Unit Cost Calculations

Uni-product company

As we can see in the

example on the left,
calculation of unit costs
in uni-product company
is pretty straightforward
and entails trivial
calculations.
Multiproduct company
In the case of a multi-product company, it is more difficult to decide
which cost are traced to each of the products. Also, a costing method
decision has to be made.

Costing Method: Direct Costing

This costing method assigns the direct costs (direct material, direct
labor, …) to the cost object, which become the product costs. For its
part, indirect costs are considered period costs. The figure below
provides us with a clear image of this.

In order to provide this

information, we will use as a
convention the income
statement, where the direct
costs and gross margin of each
product will be provided, as
well as the total result of the
period.
This is easily pictured through
an example below.

We have also provided the calculation of direct costs based on units

sold*unit costs. It is convenient to mention that the gross margin
tells us the profit of each of the products.

Costing Method: Variable Costing

This costing method assigns the variable costs (direct materials,
direct labor, packaging…) to the cost object which become the
product costs. Conversely, fixed costs are considered period costs.
The figure below provides us with a clear image of this. As before,
we’ll also use the Income
Statement for this method.
This case is very similar to
the direct costing. However,
the key difference is that
here the gross margin is
called contribution margin.

Exercise 1.2.1 Company AB (1st part)

We are asked to compute the costs per unit as well as the income
statement, using the Direct Costing and Variable Costing systems.

a) Direct Costing
Product 1 Product 2
Direct materials

Direct Labor

Unitary Direct Cost 12 9

Income Statement
Product 1 Product 2 Total
Sales 14400 800 15200
- COGS (10800) (900) (11700)
Gross Margin 3600 (100) 3500
- Indirect costs (5850)
Profit/Loss (2350)
 b) Variable Costing
Product 1 Product 2
Variable materials

Variable Labor

Variable Indirect Costs

Variable Unitary Costs 11.62 16.8

Income Statement
Product 1 Product 2 Total
Sales 14400 800 15200
- COGS (10460) (1680) (12140)
Contribution Margin 3940 (880) 3060
- Fixed cost of labor (1760)
- Fixed indirect costs (3650)
Profit/Loss (2350)

Note that the indirect costs were allocated 50-50 to each of the
products.

Evolved Systems
We may also encounter systems that arise from tracing more costs to
the cost object rather than only direct or variable. Thus, we can
differentiate two of these systems:
 Evolved Direct Costing: direct
costs plus the variable part of
indirect costs are assigned to the
cost object. In contrast to this,
the fixed part of the indirect costs
is considered as period costs.
 Evolved Variable costing:
variable costs plus the direct part
of fixed costs are assigned to the
 cost object, which are considered the product costs.
Conversely, the indirect part of fixed costs is considered as
period costs.

Exercise 1.2.1 Company AB – Example with Evolved Direct

Costing

First of all, we are going to note the unit costs for each product and
then we are going to allocate.
Product 1 (n=900) Product 2 (n=100)
Direct materials 10€/u 5€/u
Direct labor 2€/u 4€/u
Indirect variable 1.22€/u (= 11€/u (=
costs

The allocation of indirect variable costs stems from the following

calculation:

After this, we arbitrarily allocate 50% of this quantity to each of the

products, that is, 1100 per product. Note that the procedure of
allocation of Indirect Costs shows uncertainty.

The associated income statement will be as follows:

Income Statement (Evolved Direct Costing)
Product 1 Product 2 Total
Sales 14400 800 15200
- COGS (11900) (2000) (13900)
Contribution Margin 2500 (1200) 1300
- Period costs (3650)
Profit/Loss (2350)

Since all products are sold (no inventories left), the costing systems
does not affect the final profit. However, if there are inventories left,
the choice of costing system has an incidence on the final profit.

Partial costing: some applications

Partial costing methods are usually intended to make decisions
related to quantity (variable costing) or product mix (direct costing).
However, pricing decisions also can be taken with the information
provided by partial costing analysis, but then some assumptions will
need to be made about how the period costs are related to sales
price.

In order to this, we usually need some data on the amount of period

costs and desired profit relative to the amount of product costs.

You can see an example of this in 2_PartialCosting’s slides 15-24.

Exercise 1.2.2. Sun S.A. (1st part). Computing the selling pri

We have to consider the following equation:

Now let’s compute the direct costs:

So the total direct cost will be the sum of all of the above = 1655€

Finally, we only have to modify the following equation:

This would be the minimum selling price at which the new product
could be sold according to the company’s pricing policy.

Exercise 1.2.3. Mini Case Study: True Fittings

We are asked to calculate the gross margin of each order and the
total profit.

Regarding the information given so far, we may compute first of all

the wages of for production and installation (=direct labor)
associated with each order. Therefore, if we take the 90 cost of
wages and divide between the joint hours worked for each of the
orders, 40, we get that the cost per hour is 2.25. Then, we only have
to multiply this number with the associated hours of each order, and
we’ll get the direct labor.

Income Statement
Orders 1 2 3 4 Total
Sales 50 20 70 40 180
- Direct cost (25) (12) (30) (13) (80)
- Direct labor (18) (33.75) (11.25) (27) (90)
Gross margin 7 (25.75) 28.75 0 10
- Other wages (20)
- Structural costs (40)
Profit/Loss (50)

TOPIC 2A: JOB COSTING

A job costing system

differs from the typical
process costing systems
in the sense that in the
former case, the
products or services are
customized, so the costs
for each job are
collected, whilst in the
process costing system,
products or services are
produced in an
standardized manner, so costs are accumulated and finally the
average unit cost is calculated.

Companies which work by

order may use different
costing methods. In the
case of partial costing,
they may use direct
costing or evolved direct
costing (allocating indirect
manufacturing costs) or
full costing.

If indirect costs (all or

only manufacturing) are
going to be allocated to
the jobs/orders, the
company will need to decide a basis for cost allocation.

Allocating Indirect Costs – Various Options

  No assignment of Indirect costs -> Classic partial costing
 Assignment of Indirect Manufacturing Costs -> Evolved partial
costing
 Assignment of All Indirect Costs -> Full Costing

Job Costing System under Evolved Partial Costing System

Allocation of Indirect Costs – How to Do IT

The cost allocation base or rate is rather subjective and arbitrary, so

you may decide which benchmark you use to attribute costs: units
produced, machine hours, direct labor costs…

General Approach to Job Costing

1. Identify the job or cost object

 2. Identify both the direct costs and indirect cost pools associated
with the job
3. Most important: select the cost-allocation bases for
allocating each indirect cost to the job.
4. Calculate the rate per unit of the cost-allocation bases used to
allocate indirect costs to the job
5. Assign the costs to the cost object by adding all direct and
indirect costs.

It’s not easy to select the cost-allocation base. You have to decide
how to allocate through products, deciding which makes more
sense for your internal decisions.

1. Product costs with direct labor hours-IC rate

Since we have two products, we have to calculate twice the product
costs.

For product A, the direct costs are:

Direct cost of A is 4000 + 2000 = 6000.

For product B, the direct costs are:

Direct cost of A is 2000 + 3000 = 6000.

Now, we have to compute the indirect cost rate:

So the allocation of indirect costs goes as follows:

So, if we sum this allocated costs with the original costs, we have
that the total cost of each of the order will be:

Parts 2 and 3 are pretty straightforward, so let’s focus on part 4.

4. Product costs with different IC allocation rates

Indirect labor cost is allocated depending on Direct Labor Cost.

Energy and amortization are allocated depending on raw materials.
Auxiliary materials are needed depending on units produced.

First of all, we have to allocate indirect labor:

Now, it’s time to allocate energy and amortization:

And finally, we allocate auxiliary materials:

We can finally find the total cost of each product:

More on Slides +14 on 2A. JOB COSTING.

Extra Exercise. Job Costing Service Industry. Law Firm.

Keating & Associates is a law firm specializing in labor relations and
employee-related work. It employs 25 professionals (5 partners and
20 associates) who work directly with its clients. The average
budgeted total compensation per professional for 2011 is $104,000.
Each professional is budgeted to have 1,600 billable hours to clients
in 2011. All professionals work for clients to their maximum 1,600
billable hours available. All professional labor costs are included in a
single direct-cost category and are traced to jobs on a per-hour basis.
All costs of Keating & Associates other than professional labor costs
are included in a single indirect-cost pool (legal support) and are
allocated to jobs using professional labor-hours as the allocation
base. The budgeted level of indirect costs in 2011 is $2,200,000.

1. Prepare an overview diagram of Keating’s job-costing system.

 2. Compute the 2011budgeted direct-cost rate per hour of
professional labor.
3. Compute the 2011 budgeted indirect-cost rate per hour of
professional labor.
4. Keating & Associates is considering bidding on two jobs:
a) Litigation work for Richardson, Inc., which requires 100
budgeted hours of professional labor
b) Labor contract work for Punch, Inc., which requires 150
budgeted hours of professional labor Prepare a cost estimate
for each job.

Part I
The diagram would consists in professionals tracing the direct labor to
the cost object, whereas the other indirect costs such as legal support
would be allocated to the cost object on the basis of labor hours.

Therefore, the costs per lawyer are 104000€ per each one of them,
and the total hours they work is 1600. This is direct labor.

Indirect costs are legal support, which account for a total of 2,2M€.

Part II
The direct-cost rate per hour of professional labor is:

Part III
The indirect-cost rate per hour of professional labor is obtained by
dividing the total indirect labor costs by the total of hours that are
worked by the 25 lawyers. Hence,

Part IV. Estimate the cost for each of the jobs

Job A involves 100 hours of direct labor whilst Job B involves 150
hours of direct labor. So let’s estimate the costs for each job:
 Job Costing and Unfinished Contracts
When you are dealing with unfinished contracts, you should make
and equivalence with respect firms that produce in mass. Whatever
you produce but do not sell ends up as inventory. The treatment in
this case will be similar.

Both from financial accounting and cost accounting perspective, we

will treat unfinished contracts as final stock, we will consider it as an
asset. However, you can also estimate how much of the value of the
job you accomplished within the period and account for it. We have
one example on the slides, but we will work with another one.

Example: Stock valuation and analytic income statement

Note: This
example was
formerly in the
midterm, so be
careful. We’ll use
the Weighted
Average method,
so you can do FIFO
at home and see
how it changes.

First of all, let’s locate all operations that use raw materials:

Raw materials
In Out Balance
U Value U Value U UC Value
Opening Balance 1500 3000 1500 2 3000
Purchase 4500 9000* 6000 2 12000
Production 4000 8000** 2000 2 4000
Ending Balance 2000 2 4000
***
*applying discount, ** RM cost of production
*** Balance sheet as store of Raw materials

Finished Goods
In Out Balance
U Value U Value U UC Value
Opening Balance 4000 16000 4000 4 16000
Production 8000 39200 12000 4.6 55200
Sales 8800 40480 3200 4.6 14720
Ending Balance 3200 4.6 14720
Where the production costs stem from the following:

So if we compute the unit cost of per unit produced, we get 4.9

euros.

The income statement would be:

Income Statement = Sales – COGS = 8800 * 6.5 – 8800 * 4.6
= 16720 as a profit.

Here, we only subtract COGS since all costs are allocated to the
product since we used a full costing method. At the end of the period,
there will be a stock value of 14400 (raw materials) and 14720
(finished goods).
Now, let’s think what would happen if we did direct costing instead of
full costing. What we would encounter is that amortizations and
supplies would be considered an indirect cost. So finally, our income
statement would look as follows:

I/S
Sales 57200
 COGS (33733)
Gross Margin 23467
 Period Cost (9200)
Profit 14267

Where final balance of production would be a stock of raw materials

of 4000 euros, a stock of finished goods of 12667 euros (3.83*3200
units) and a profit of 14267.
 TOPIC 3: BREAKEVEN POINT. COST-VOLUME-PROFIT
ANALYSIS

In the CVP analysis we analyze the behavior of total revenues, total

cost and profit, when the level of output, unit selling price, unit
variable cost or fixed costs change.

Since we care about variable vs. fixed cost, our analysis will be
related with variable costing.

Important terminology here:

 Operating profit = Total revenues – Total costs
 Net profit = Operating profit – Income Taxes
 CM % = contribution margin percentage

The main assumptions regarding the CVP model are:

 Total cost can be divided into fixed part and variable part
depending on level of output.
 Total revenues and total costs are linear in relation to output,
within the relevant range
 USP, UVC, FC are known
 Analysis for a single product or constant product mix
Derivation of the formula for equation method

First of all, we consider the operating profit formula:

We substitute revenues and variable cost for USP*Q and UVC*Q:

We take common factor of Q and assume we want OP to be equal to

0:

Therefore, the quantity that makes the firm cover all its cost is given
by the following formula:

For instance, one interpretation of this formula is that if you fixed

costs increase, then you have to produce more quantity to reach the
ideal breakeven point (Q*).

Moreover, profit will be given by:

Now let’s see how it varies with (1) changes in VC and (2) changes in
FC and VC:

Sensitivity Analysis – Margin of Safety

Sensitivity analysis stand for a “what-if” technique examining how a
result will change if the original predicted data are not achieved or if
an assumption changes.

Margin safety indicated by how much sales may decrease before

resulting in a loss. Calculation can be done in two ways:



Exercise 1.3.1. Automobile Auxiliary

The expected units are

 a) We can start calculating the breakeven point. But for that, first
we have to find the unit variable cost:

Now we can proceed to the calculation of the breakeven point:

This means that even if you sold 28% less than E(U), you’d still be
making profit.

b) We calculate the breakeven revenues by using the formula:

( )

We can also use q* x USP = Rev*.

The Breakeven Point in a multiproduct situation

There is no unique breakeven number of units for a multiple-product

situation. Two possible methods are:
 Assume a constant mix of sales (bundle)
 Use the lowest and highest UCM product to give a range of
sales

Method II: Range of Sales

Assume we have Pn products, with UCMn
contribution margins, therefore:
 Take the product with the lowest UCM
and calculate the highest breakeven sales.
 Take the product with the highest
UCM and calculate the “lowest breakeven
sales”.
The breakeven sales with typical mix of
sales will be in that range.

Assume we only sell pens and pencils, and

UCM pencils < UCM pens.
Method I: Constant mix of sales
We combine n products in a single bundle. We have an example on
slides 15-18 from Topic 3.

Operating Leverage
It is useful to express relationships between variable and fixed costs.
Operating leverage basically consists on:

Example:

Exercise from Blackboard

a) We have UVC of 19.50 as raw materials and 1.50 as sales

commission, and a fixed cost of 3600. Moreover, the price of
the product is 30.

b) Which is the profit if we sell 350 units?

c) Calculate the breakeven if there’s an increase of commissions

of 0.3 euros per unit sold:

d) Suppose now that instead of paying a fixed commission, we pay

a salary of 810 to the sales man. Now, what would happen?
Exercise 1.3.4. Ateneu Editors

Breakeven points are easily calculated. Let’s switch to (2):

Income Statement
Q=10.000 Q=20.000 Q=30.000
Revenues 300.000 600.000 900.000
- VC -210.000 -420.000 -630.000
Contr. Margin 90.000 180.000 270.000
- FC -90.000 -110.000 -130.000
Profit 0 70.000 140.000

Exercise: Sales mix and TV Cable

Suppose we have an hotel with 80 rooms. Rooms can be
accommodated to be single or double. The price of a double room is
100 euros a day whilst the price of a single room is 80 euros a day.
Moreover, daily costs are 11 and 8 euros, respectively. The fixed
costs amount up to 1420000 euros a year.

The expected ratio of rooms is that 80% will be single and 20% will
be double.
 a) Compute the breakeven point and the margin of safety
using a constant sales mix and assuming the occupancy
throughout the year is 90%.

We have to calculate the average unit contribution margin:

The breakeven point will be calculated as follows:

Taking proportions, 10 rooms will be double and 42 will be singles. In

addition, the occupancy rate will be:

Hotel needs an occupancy rate of 65% to cover costs. We can also

calculate the margin of safety:

b) Calculate the breakeven point using the max-min range

method.
Recall that:

If I only sold doubles, my BEP would be:

If I only sold singles, my BEP would be:

This means that

If I rent less than 44 rooms a day, I’ll have losses for sure.
Otherwise, If I rent more than 54 rooms per day, I’ll have profits for
sure.

Additional Exercise 5
Let’s compute separately:

We are going to assume a constant mix of sales of 2 to 1.

The margin of safety will be:

Additional exercise 3

Additional exercise 4
Additional Exercise 2
 TOPIC 4: FULL COSTING

In the previous topic we introduced partial costing, which is useful in

organizations where direct or variable costs represent a high
proportion of total costs. It is simple and cheap.

Now, we are going to focus on full costing. Full costing provides

better information on the indirect costs. The main idea here is that
indirect manufacturing costs are always assigned to the cost
objects. It is more complex than partial costing and is used typically
in companies with highly homogenous products and standardized
processes.

We have two options here:

Cost Allocation Base

A cost allocation base is a factor that is the common denominator for
linking an indirect cost (or a group of indirect costs) to a cost object.
Examples are: units produced, machine-hours, direct labor hours,
etc.

Cost-allocation base is the cost driver when a cause-and-effect

criterion is used.

Implementation of A Full Costing System by Departments

1. Define the cost object
2. Divide the total costs of the company into direct and indirect
costs of the cost object.
3. Divide the company into departments (or cost centers). Two
kinds of departments:
a. Operating departments: directly intervene in the
production process.
b. Support departments: support the operating
departments.
4. Assign the indirect cost of the cost object to the different
departments.
 5. Assign the supports department costs to the operating
departments
6. Select the ost-allocation bases for allocating the operating
departments costs to the cost object.
7. Calculate the rate per unit of the cost-allocation bases (“cost
rate”)
8. Assign to the cost object by adding all direct costs and indirect
costs via indirect-cost rate of the operating departments.

Operating Department and Support Departments

 Operating Department
o Adds value to a product or service that is observable by a
costumer.
o Examples: production, marketing.
 Support Department
o Provides services that maintain other international
departments.
o Examples: legal department, HR department.

Support Department Cost-Allocation Methods

1) Direct allocation method (Direct method): it is the

most used because of simplicity. It allocates the costs of
each support department directly to the operating
departments.
2) Step-down allocation method: services rendered by
support departments to other support departments are
partially recognized. Procedure is:
a. Support departments must be ranked
b. Costs in the first ranked support department are
allocated to the other support departments and to
the operating departments.
c. Accumulated costs in the second ranked support
departments are allocated to those support
departments not yet allocated and to the operating
departments.
3) Reciprocal allocation method: includes mutual
services provided among support departments. Procedure
is:
a. Express support department costs and reciprocal
relationships in linear equation form.
b. Solve the system of simultaneous equations to
obtain the complete reciprocated costs of each
support department.
c. Allocate the complete reciprocated costs of each
support department to all other departments.
Exercise 1.4.1

First of all, we are going to show the indirect manufacturing costs:

Production department 1 3000

Production department 2 1500
Support department A&M 1350
Total cost 5850

Using the data above, we are going to allocate the costs of the
supporting department to the product departments. Note that costs
of the support departments are allocated to the production
departments proportionally to their indirect costs:

Prod. Department Prod. Department Support

1 2 department
IC Allocation 3000 1500 1350
Allocation S.D. (1350)

Total IC 3900 1950 0

Hence, we can compute the total costs of product 1 and 2. However,
we have to have in mind how the indirect costs of the production
departments are allocated. This is done using the hour consumption:

Product 1 Product 2
Basis for allocation 300h 100h
Rate L/h 13€/h 19.5€/h

We can finally compute the total costs of each of the costs objects,
having into account the number of hours that each product needs to
go through in each department:

Product 1 Product 2
Prod. Department 1 0.32 0.09
Prod. Department 2 0.09 0.3

Therefore:

Product 1 Product 2
Direct Cost 10 5
Material + Labor 2 4
Indirect Costs
- Production Dept. 1 0.32*13=4.16 0.09*13=1.17
- Production Dept. 2 0.08*19.5=1.56 0.3*19.5=5.85
Total Unit Cost 17.72 16.08

Finally, the income statement:

P1 P2 Total
Sales 900*21=18900 100*12=1200 20100
- COGS 900*17.72 100*16.08 (17550)
Gross margin 2952 (402) 2550
- Period Costs (4000)
Profit/Loss 1450

Additional Exercise: Support Departments Allocation Methods

Suppose we have the following scenario:

P1 P2 S1 S2
I Cost 1000 2000 500 400
S1 Alloc. 30% 40% --- 30%
S2 Alloc 50% 40% 10% ---
We are going to see how to distribute costs with each of the support
departments allocation methods:

a) Direct method
We will not account for the interrelation between support
departments. Hence:
P1 P2 S1 S2
S1 Alloc. -500 ---

S2 Alloc --- -400

TJC 1436.50 2463.49 0 0

b) Step-down allocation method

We will take into account only the allocation of the more relevant %.
So we will first allocate S1, because it allocates a 30% to S2, and
then allocate S2 to the rest.
P1 P2 S1 S2
S1 Alloc. 150 200 (500) 150
IC 1150 2200 0 550
S2 Alloc (550)

TJC 1455.55 2444.45

c) Reciprocal Allocation
In the reciprocal allocation case both departments do allocate
between each other. Thus, we will construct a system of equations to
determine how much each other allocates to the other one:

And now do the allocation:

P1 P2 S1 S2
S1 Alloc. 167 223 (557) 167
S2 Alloc 285.5 226.5 57 -567
TJC 1450.5 2449.5 0 0

BOTTOM LINE

Recall that the process for full costing is the following:

1. Distinguish direct and indirect costs
2. Trace direct costs to products
3. Allocate indirect costs to departments
4. Allocate support dept. costs to production departments.
 5. Allocate productions departments costs to products.

Additional Exercise 4.1.

We are going to start with the step-down allocation method:

PD X PD Y PD Z SD 1 SD 2
IC 48000 42000 30000 14040 18000
Allocation 7200 3600 3600 3600 -18000
of SD2
Allocation -17040
of SD1

Total 59120 53440 39480 0 0

The result is pretty straightforward: this is the final allocation of the

support departments onto the production departments. If we switch
to the reciprocal (equation) allocation method:

PD X PD Y PD Z SD 1 SD 2
IC 48000 42000 30000 14040 18000
Allocation 3600 7200 5400 (18000) 1800
of SD1
Allocation 7920 3960 3960 3960 (19800)
of SD1
Total 59520 53160 39360 0 0

Additional Exercise 4.2.

2. (Based on Drury, pg. 95). A company has a production process with three production departments
(machine centers X and Y and the assembly center) and two support departments (materials procurement
and general factory support). The (indirect manufacturing) costs
are:

And we also know the following:

Total materials issued to the production departments are 4,000,000

(Machine center X), 3,000,000 (Machine center Y) and 1,000,000
(Assembly).

Questions are:

a) Compute the indirect costs allocated to each department using reasonable bases for allocation of the
different indirect costs.

b) The costs of Materials Procurement are distributed to the production departments on the basis of the
value of materials issued to each production department; the costs of General Factory Support are
distributed on the basis of direct labor hours. Compute the final indirect costs allocated to each production
department.

c) Compute the indirect cost rates of each production department using machine hours for the two
machine centers and direct labor hours for assembly as the bases for allocation.

d) The company produces two products (A and B) with the following production data (per unit of the
product):

Compute the total unit costs for each product based on full absorption of indirect manufacturing costs.

e) Redo all the above considering that Materials procurement issued, apart from the data known already,
2,000,000 worth of materials to General factory support and that Materials procurement also received
 support from General factory support (direct labor hours in Materials procurement are 500,000).

Let’s start with exercise A.

Production Departments Support

Department
Cost X Y Assembly MP GFS Total
Indirect Wages 1000 1000 1500 1100 1480 6080
Indirect Materials 500 805 105 - 10 1420
Lightning 100 50 150 150 50 500
Property Tax 200 100 300 300 100 1000
Insurance machine 80 50 10 5 5 150
Depr. Machine 800 500 100 50 50 1500
Insurance building 50 25 75 75 25 250
Other Salaries 240 160 240 80 80 800

The references for cost allocation are (subjective to opinion):

- Lightning and heating: area occupied.
- Property tax: area occupied
- Insurance machinery: book value of machinery
- Depreciation machinery: book value of machinery
- Insurance of building: area occupied
- Other salaries: number of employees.

The total sum of each of the departments costs is the final response to a).

Now, in order to solve b), we have to perform a full costing allocation of indirect
costs to the production departments. We will use a direct allocation method, and it
will be as follows:

Production Dept. Support Dept.

Step X Y Assembly MP GFS Total
IC 2970 2690 2480 1760 1800 11700
Allocation of MP

Allocation of GFS

Total 4300 3800 3600 0 0 11700

The solution of part C will involve distribution the costs using machine hours in case
of the production departments X and Y and direct labor hours in case of assembly.
Thus:

Machine Center X: {

Machine Center Y: {

Assembly: {
Finally, we can use all the information given above in order to compute the total
unit cost for each product:

Product A Product B
Direct Costs 100 170
IC Machine X 5*2.15=10.75 15*2.15=32.25
IC Machine Y 10*3.8=38 15*3.8=57
IC Assembly 12*1.8=21.6 25*1.8=45
Total Unit Cost 170.35€/unit 304.75€/unit

PROBLEMS OF COST CALCULATION

We have mainly two problems here:
 Costs of sub-activity and benefits of over-activity.
 Valuation of WIP

Costs and benefits of sub-activity

Costs of sub-activity arise when:
 FC (in a specific period) are greater than expected
 Production (in a specific period) is lower than expected

Benefits of over-activity arise when:

 FC (in a specific period) are lower than expected
 Production (in a specific period) is greater than expected.

Everything needed is in slides 23-42 of Topic 4.

Additional Exercise 4.3

The process of production entails production itself and painting
afterwards. We also have to note that we work with monthly data.

Production Painting
Materials 200 100
Indirect Labor 500 300
Opening WiP 0 5 units (cc=10%)

A conversion cost of 10% means that we have only processed 10% of

the 5 units; in other words, we just did 10% of the painting process.
Moreover, of those 5 units, we have a cost of 30 in materials
(production plus painting) and a indirect labor cost of 30 (production
+10% painting).

In addition, during August, production department started 100 units

and completed 90. The remaining units are completed at a CC=40%.

Production
Initial WiP for production is 0 units. And it has started 100 units, 90
of them which are completed, and 10 are work in process, with a
CC=40%, meaning that 40% of indirect labor has been applied.
Since the cost of production is 200 in materials plus 500 in indirect
labor… How much of them go to stock and how much to WiP?

200€ are already incorporated in the materials, so

Then, 500€ are allocated to the 90 units completed and a 40% to the
10 units. This implies that only 94 units are “theoretically” been
produced. If we compute the costs per unit:

Given the information above we can calculate the stock valuation:

Now the same process for painting:

Painting

As we can recall, initial WiP is 5 units (valued at 60€) but 10%

finished regarding indirect labor (CC=10%). So, as the exercise tells
us, the painting department is dealing with 80 units valued all at
240€. At the end of august, we will have 55 completes units (5 of the
90% IL) and 50 (100% IL and materials), and 30 units WiP (full
materials and 50% of IL).

Let’s compute:

Then, the stock of (painting) finished goods will be:

where the first term is the initial valuation, the second is the
materials, and the third is the indirect labor applied.

If we sum both quantities:

Now, let’s compute the stock of WiP:

This is the valuation of the stock at the end of the period, as if you
had to close the books.

Notice that next period we’ll have an initial value of 30 units valued at
192.3€ and CC=50%.
Appendix: Income Effects of Alternative Inventory Costing
Methods

Depending on the costing method that a company uses, the result of

the period can vary substantially. The two most commonly
encountered methods of inventory costing are variable and full
costing.

While the variable costing only takes as product costs those variable
manufacturing costs, both indirect or direct, the absorption (full)
costing traces to product all manufacturing (production) costs, and
non-manufacturing costs are treated as period costs.

Example
Let’s first of all compute the unit manufacturing cost, P&L and
inventory using direct costing.

Unit Cost Calculation

Product N Product U
Direct Materials 5000 6000
Direct Labor 9000 10000
Direct Depreciation 4000 7000
Total Direct Costs 18000 23000
Units produced 4000 8000
Unit Direct Cost 4.5€/u 2.875€/u

After this, we can calculate the profit and loss for the period.

Profit and Loss

Product N Product U Total
Sales 22650 42000 64650
- COGS (13500) (17250) (30750)
Gross Margin 9150 24750 33900
- Period Costs (33000)
Profit 900

We considered COGS = Units sold * UDC.

We can calculate the value of inventory (assuming no initial value):

It’s time to do the same procedure for absorption (full) costing and
see the difference:

Unit Cost Calculation

 Product N Product U
Direct Materials 5000 6000
Direct Labor 9000 10000
Direct Depreciation 4000 7000
Rent 8000 3000
Insurance 1000 2000
Total “Full” Costs 27000 28000
Units produced 4000 8000
Unit “Full” Costs 6.75€/u 3.5€/u

Profit and Loss

Product N Product U Total
Sales 22650 42000 64650
- COGS (20250) (21000) (41250)
Gross Margin 2400 21000 23400
- Period Costs (19000)
Profit 4400

A difference on inventories of 3500. The exact difference between

profits. The total value of the inventory is higher in the second case
because we allocated also the indirect costs. This is what happens
when you use different cost systems: valuations of inventories
differ. The consequence is that you shift costs of inventories across
time, and thus profits too.

In the Full Costing Method, the next period COGS will be higher
(inventories are worth more), so profit will be lower, if we assume we
will sell at the same price.

This basically means that cost systems will have an effect in profits
and inventories if and only if there are inventories, in which the costs
will shift from one period to the following one.
 TOPIC 5: ACTIVITY BASED COSTING

Imagine a scheme in which the indirect costs are allocated to the

departments, and those taking as reference basis for allocation and
creating allocation rates finally allocate their value to the cost
objects.

This approach may be a bit too simplistic. A refinement of the scheme

mentioned above is pictured below. This is what we call ABC Costing:
The next graph provides a visual example of what ABC consists in:

The goal here is to locate different activities of your production

process and take them as a reference for the allocation of indirect
costs.

Implementing Activity-Based Costing

1. Divide the company into departments.

2. Assign indirect costs to departments.
3. Identify the major activities performed by the departments and
the costs of each activity.
4. Determine the cost driver of each major activity and estimate
the quantity of each of them
5. Compute the rate per unit of each cost driver
6. Calculate the cost rate per unit of each cost object:
a. Direct Costs + Costs of activity required by the cost
object.

Let’s see an example.

 Additional Exercise 5.2. (Drudry, 319)

Dept X. Dept. Y Assembly MP GFS

Assigned 2970 2690 2480 1760 1800
IC
Activities Machine Machine Assembly Purchases Receiving Disburs. Sched. Set up Quality
hours X hours Y
Cost Machine Machine DL Hours Number Number Prod. Prod. Set- Number of
drivers hours hours of PO of Recpts runs runs up Inspections
hours
# Cost 2000 1000 1000 10.000 5000 2000 2000 12000 1000
Drivers
Activity 1.485€ 2.69€ 1.24€ per 96€ per 120€ per 100€ 500€ 50€ 200€ per
Cost rate per m.h per m.h DLH order receipt per per per inspection
prod. prod. set up
run run hour

Check the costs for order A, which has 100u of product A:

Type of cost Operation Total
Direct Costs 100u*100€ 10000€
Indirect Costs
Machine hours X 5hr*100u*1.485€/hr 743
Machine hours Y 10hr*100u*2.69€/hr 2690
Assembly 12hr*100u*1.24€/hr 1488
Purchases 1 order * 96€/order 96
Receiving 1 receipt * 120€/receipt 120
Disbursement 5 prod. Runs*100€/run 500
Scheduling 5 prod. Runs*500€/run 2500
Set up machinery 50 setuphr*50€/stuphr 2500
Quality inspection 5 prod. Run * 200€/inspection 1000€
Total 20837€

This is the result for order A. You can check B at home, the result is
54241€.

Exercise 1.5.1. Company AB (3rd part)

First
of all, we compute indirect costs, which amount up to 5850 (the sum
of machine activity, handling orders, customer service and other
indirect costs). Let’s see the info we have:
 Product 1 Product 2
Units 900 100
DMC 10 5
DLC 2 4
Machine hours 0.2952 0.2 (machine hrs/u)
Orders 10 orders 40 orders
Customers 20 customers 30 customers
Selling price 16€ 8€

And now, the activities:

Machine Orders Customers
Indirect 1000 3500 1000
Cost
Cost Machine hours # of orders # of customers
Driver
# cost 900*0.295+100*0,2 10+40=50 20+30=50
drivers =2285.68
IC Rate 3.5€/h 70€/order 20€/customer

So the costs for each product are:

Costs / Product P1 P2
DMC 9000 500
DL 1800 400
Machine hours 929.88 70.12
Orders 700 2800
Customers 400 600
TC 12829.88€ 4370.12€
VC 14.255€/u 43.70€/u

And the income statement:

Income Statement
Product 1 Product 2 Total
Sales 14400 800 15200
(COGS) (12829.88) (4370.12)
Gross Margin 1520.12 (3570.12) (2000)
(Period Costs) (350)
Indirect Non-M
Profit/Loss (2350)

There’s no change of inventories, so the profit is the same.

Exercise 1.5.2. Automobile Components SA

Part A)
In this exercise we allocate costs to each of the customers using the
cost drivers. Hence, for C and F we have:

Customer C Customer F
“Customer 1 1
Activities”
Products Activities 40 20
Components 700 150
Orders 600 30
Set ups 200 30
Direct Costs 1000+800+40+900 3000+2200+140+2600

Total Costs are:

Total Costs Customer C Customer F
Direct Costs 2740 7940
IC - Customer 1*78.33 1*78.33
IC - Product 40*8.88=355.2 20*8.88=177.6
IC - Component 0.13*700= 0.13*15=19.5
IC - Orders 0.22*600=132 0.22*30=6.6
IC - Setups 1.07*200=214 1.07*30=32.1
Total 3610.53€ 8254.13€

Hence, the income statement is as follows:

I/S Product C Product F

Revenue 3100 8900
(Cost of customer) -3610.53 -8254.13
Prawfit -510.53 645.87

Part B)

Indirect Costs are assigned to customers as a proportion of DC. Recall

we have 6 customers. Given that total indirect costs are 3000, we
have a IC rate of 3000€.

Therefore, since total direct costs are 17000, the IC rate will hence
be:

This implies:

Which is the same as:

The income statement will be:

Product C Product F
Revenues 3100 8400
(DC + Allocated -3223.53 -9341.18
IC)
PRAWfit -510.53 -441.8

The different cost system used may change the relative cost
profitability of each product, even though joint profitability is the
same.
Additional Exercise topic 5 NUMBER 1

Truth is I’m pretty lazy right now to copy this one. Because of that,
I’m just going to copy the solutions so you, Future Gabriel, have to
work out throught the ANSWERS

a) Answer B
b) Answer B
c) Answer D
 TOPIC 6: STANDARD COSTING AND VARIANCE ANALYSIS

We should better be called this chapter deviation analysis to not get

confused with what variance truly is (sigma squared).

In this chapter, we mainly work with budgets and compare it with

data.

Variance Analysis – Terminology

a) Static Budget
It is a budget for the planned output volume. It is not adjusted or
altered after it is set. It goes as follows:
Static Budget:
Quantity output (planned)
- Direct Cost (planned)
- Ind Cost Variable
(planned)
- Ind Cost Fixed (planned)
Standard Budget Profit

b) Flexible Budget
This budget is adjusted in accordance with ensuing changed in actual
output volume:
Flexible Budget:
Quantity Output (“Actual”)
- DC (“Actual”)
- IVC (“Actual”)
- IFC (Planned)
Flexible Budget Profit

c) Actual data
We just do the same procedure as in the other budgets but with the
data that really took place.
Then, depending on the results of the variances, which are the
difference between an actual result and a budgeted amount, we will
have:
 Favorable Variance (denoted F): variance that increases
operating income.
o Actual revenues are higher than budgeted
o Actual expenses are lower than budgeted
 Unfavorable Variance (denoted U): variance that decreases
operating income
o Actual revenues are lower than budgeted
o Actual costs are higher than budgeted

1. Variance in Sales Revenue

We have to define two types of sales volume:
 Sales volume variance: differences in budgeted data (here in
revenues) due to the difference between actual and budgeted
output units
 (Selling-)Price Variance: difference in actual and budgeted
revenues due to differences between actual and budgeted
selling price.

Exercise
Q: A company produces product A and plans to sell it at 20€/unit. It
expects to sell 5300 units at 20€ each one. But the real data for the
period is that they sell 5100 units at 22€/unit.
A: As we can see, the difference between total revenues is 112200€
and 106000€ (actual minus budgeted) is 6200€, which is Favorable.

To understand how it works, we may construct a table:

Output P/u Total Revenue
Static Budget 5300 20€ 106000
Flexible Budget 5100 20€ 102000
Actual Data 5100 22€ 112200

The total variance is Actual Data – Static Budget = 6200€ (F)

The sales volume variance is Flexible Budget – Static Budget =

(5100-5300)*20= -4000(U). Or more generally: .
The Selling-Price Variance is Actual Data – Flexible Budget =
(22-20)*5100=10200(F). Or more generally:

2. Variance in Direct Costs

Here we will mainly work with direct costs, which involve direct
materials and raw material. We will assume direct costs are all
variable

We will have to distinguish between:

 Sales Volume Variance: differences in budgeted data due to
difference between actual and budgeted output units.
 Flexible Budget Variances
o Efficiency (Quantity) Variance: Actual input quantity
differs from budgeted
o Price Variance: actual input price differs from budgeted
o Joint Price-Quantity Variance

Flexible-Budget Variance Analysis of Direct Costs

Example

The budget is therefore: raw materials 1 kg per 50€ each kg, is

equal to 50€ per unit of raw materials, and 2h at 500€ euro each
hour, that means 1000 euros of direct materials per unit. Summing
up, we have that each unit costs 1050€. So the budgeted costs are
200.000.

The real data is that we used 4368 kg at 51,35kg each one, and 8524
hours for 4300 units, that is, 542,94€ per hour.

Let’s put it on a table.

Raw Materials Output Qinput/unit Price/unit of Total cost
output
Static Budget

Flexible Budget

Actual Data

Direct Labor Output Qinput/unit Price/unit of Total cost

output
Static Budget

Flexible Budget

Actual Data

Let’s make the variance analysis for Raw Materials:

Total Direct Costs Variance = AD-SB =24297€ (U)

a) Sales Volume Variance=

b) Flexible Budget Variance =

1) Pure q (efficiency)=
2) Pure price variance=
3) Joint Variance=

Here I skipped a class. Nobody provided me the notes.

Variance in Indirect Costs

Variance analysis for indirect costs depends on available information.
 If indirect costs are not divided into its fixed and variable part,
then the analysis must be done at the cost center level globally
or for each cost item, and it’s basically:

 If indirect costs are divided into its fixed and variable part, we
can perform a more detailed analysis.

Variance in Variable Indirect Costs

It represents variances in variable indirect costs, such as energy,
indirect materials, etc.
 Sales volume variance: differences in budgeted data due to
differences between actual and budgeted output units.
  Flexible budget variances
o Efficiency (Quantity) Variance: actual quantities of
allocation base differ from budgeted.
o Spending (Price) Variance: actual indirect costs differ
from budgeted.

(1) Budgeted Cost (out of Flexible Budget)

o Budgeted Indirect Cost Rate * Budgeted Units of
Allocation Base
o
(2) Efficiency (Quantity) Variance
o (Actual Units of Allocation Base – Budgeted Units of
Allocation Base1)) * Budgeted Indirect Cost Rate
o –
(3) Spending (Price) Variance
o (Actual Indirect Cost Rate – Budgeted Indirect Cost Rate)
* Actual Units of Allocation Base
o –

Variance in Fixed Indirect Costs in a direct costing system

Fixed indirect costs are costs such as depreciation of the plant, plant
manager’s salary, etc.

In a direct costing system, fixed indirect costs are the costs of the
period, so:
o Sales volume variance: does not exist since fixed costs are
unaffected by changes in sales volume.
 o Total FIC Variance = Spending (Price) Variance: difference
between actual fixed indirect costs and budgeted fixed indirect
costs.

Variance in Fixed Indirect Costs in a Full (absorption) system

In a full absorption system, we need to remember that FIC are
allocated to the products based on a basis for allocation and an
allocation rate per unit of the basis (standard FIC rate).

Therefore, given a level of production we will have allocated

(absorbed) a certain amount of FIC, and this amount will likely
be different from actual FICs and from budgeted FICs.

We now have an additional “production volume variance” in FICs we

need to account for. This volume variance may be separated
into a capacity and an efficiency component.

(Sales) Volume Variance

Now we have a sales volume variance given that the actual quantity
of output sold includes the absorption (cost) of a standard rate of
FICs. In a sense, this variance must be interpreted as affecting the
margin of the excess units sold: this margin is lower because of the
absorption of FICs. The sales volume variance (which is usually
included together with all other sales volume variance as a “margin
variance”) could be computed as

Standard FIC charged to actual production – Budgeted FICs =

(Standard units of basis needed for actual production * standard FIC
rate per unit) – Budgeted FICs

Given this margin variance, we then have to calculate the “true” (we
call it “total”) FIC variance: actual FICs may be different from those
that have been charged to actual production this is the issue of the
costs/profits of subactivity/overactivity from topic 4 (full costing).
Example

Case a)
 Output € of FIC / unit Total FICs

Static Budget 4000 500€/u 2.000.000

Flexible Budget 4300 500€/u 2.150.000

Actual Data 4300 2.100.000

Total FIC = 2100000 – 2150000 = 50.000 (F)

o Spending = Actual – Budget = 2.100.000 – 2.000.000 =
100.000 (U)
o Production Volume=2000000-2150000=-150.000(F)

Case a)

Output m/h units Q. basis Alloc. Rate Total FICs

Static Budget 4000 2 8000h 250€/mh 2.000.000

Flexible Budget 4300 2 8600h 250€/mh 2.150.000

Actual Data 4300 8524h 2.100.000

Total FIC = 2100000 – 2150000 = 50.000 (F)

o Spending = Actual – Budget = 2.100.000 – 2.000.000 =
100.000 (U)
o Production Volume=2000000-(4300*2*250) =-150.000(F)
o Efficiency = (8254-8600) *250=-19000(F)
o Capacity = (8000-8524) *250=-131000(F)
 a) Contribution Margin in variable costing: 20€/u
b) Total Standard Cost = DM + DL + IVC = 68€ + FIC allocated to
products: 3h * 4€/h = 12€
So Full costing version of unit cost = 80€/unit

See that FIC = 120.000, which allocated on basis of direct labor

hours for the period, are 120.000€ / 30.000h = 4€/h

The net margin for the product therefore is 8€/unit

Variance Analysis
One. Variance in Sales Revenue

Q output Price/unit Total Revenue

Standard Budget 10.000 88 880.000
Flexible Budget 9.000 88 792.000
Actual Data 9.000 90 810.000

Total Variance = Actual Data – Static Budget = -70.000 (U)

o Sales Volume Effect:

o Sales Price Effect:

A positive price effect and a negative quantity effect.

Two. Variances in Direct Costs (Direct Mat. A)

Q output Unit output/unit Q input €/unit Total Cost

SB 10.000 2 20.000 10€/kg 200.000
FB 9.000 2 18.000 10€/kg 180.000
AD 9.000 2,11 19.000 11€/kg 209.000

Sales Volume Variance = FB-SB =

Flexible Budget Variance = AD-FB =
o Pure Q (Efficiency) Variance: .
This signals an inefficient use of input.
o Pure Price Variance:
o Joint Effect:
And the solutions for the rest of direct costs variances are:

Direct Materials B
o Sales Volume Variance: 15000 (F)
o Flexible Budget Variance
o Pure Q: 16500 (U)
o Pure P: 9000 (F)
 o Joint: 1100 (F)

Direct Labor
o Sales Volume Variance: 27000 (F)
o Flexible Budget Variance
o Pure Q: 13500 (U)
o Pure P: 16200 (U)
o Joint: 900 (U)

Three. Variable Indirect Cost

Q input Units of Q basis Alloc rate TVC
basis/unit
SB 10.000 3dlh 30.000 2€/h 60.000
FB 9.000 3dlh 27.000 2€/h 54.000
AD 9.000 3.17 dlh 28.500 1.82€/h 52.000

Sales Volume Variance: FB-SB=(9000-10000)*3*2= -6.000(F)

 If we produce less than expected, we have lower costs.

Flexible Budget Variance: AD-FB=-2000(F)

 Efficiency: (28500-2700) * 2=3000 (U)
 Spending Variance: 52000-(28500*2)=-5000(F), or which is
the same: (1.8245-2)*28500=-5000(F)
Notice this one is not really a price variance.

Four. Fixed Indirect Costs (VC style)

The fixed indirect costs under the variable costing are: FICV=AD-SB
=
116000-120000=-4000 (F). Under a VC, nothing else

Four point two. Fixed Indirect Cost under Full Costing

Q out Basis/u Unit of Basis €/u TFIC
SB 10.000 3 30.000 4 120.000
FB 9.000 3 27.000 4 108.000
AD 9.000 28.500 116.000

Sales volume variance is “FB”-SB=-12.000(F)

But total FICV = AFIC – FICS alloc = 116.000-108.000=8000(U)

 Spending Variance: AD-SB=116.000-120.000=-4.000(F)
 Production Volume: SB – FIC allocated to product: 120.000-
108.000 = 12.000 (U)
o Capacity: (30000-28500)*4=6000(U)
o Efficiency: (28500-27000)*4=6000(U)

Five. Comparative Balance Sheet

Budgeted Revenue 880.000
+/- Sales Variance -88.000(U)
+/- Price Variance +18.000(F)

- Budgeted DC -620.000
+/- Sales V. Variance +62.000(F)
+/- Pure Q -40.000(U)
+/- Pure V -25.200(U)
+/- Joint -800(U)

- Budgeted VIC -60.000

+/- Sales variance 6.000(F)
+/- VIC Efficiency -3.000(U)
+/- VIC Spending 5.000(F)

- Budgeted FIC -120.000

+/- FIC Spending 40.000(F)

Actual Profit 18.000

So, Actual revenue=810.000; Actual DC=209.000; Actual VIC=52000

and ACTUAL FIC=116.000

Also note that if you add all Sales Variances, those sum up to
negative 20.000, which is the same as multiplying the units we
haven’t sold per the contribution margin: