BASIC COSTING PRINCIPLES

OBJECTIVES

1. To determine the cost of a unit

2. To determine the selling price of an item using cost plus pricing
3. To differentiate between allocation and apportionment of overheads
4. To apportion overheads
5. To calculate total indirect costs (overheads)
6. To define overhead absorption overheads
7. To calculate OARs
8. To calculate total and unit cost of products using OARs

DETERMINING THE COST PER UNIT

Direct materials 4000

Direct labour 6000

Overheads/Indirect costs 10000

Total for 100 units 20000

Cost per unit $20000 / 100 units = $200 per unit

COST PLUS PRICING IN DETERMINING THE SELLING PRICE OF A PRODUCT

$ A $ B $ C

Direct materials 8000 14000 6000

Direct labour 12000 20000 8000

Overheads/Indirect 30000 12000 10000

costs
Electricity
Security
Depreciation

Total cost 50000 46000 24000

Units produced 25 units 100 units 60 units

Units sold 20 units 80 units 50 units

Mark up % 50% 20% 40%

 Cost per unit $50000/25 =$2000 $46000/100= $460 $24000/50=$480

Selling profit Cost = $2000 Cost = $460

Mark up 50% x Mark up 20% x $460
$2000 = $1000 = $92
Total $3000 Total $552

Total gross profit No. of units sold x No. of units sold x

mark up mark up
20 units x $1000 = 80 units x $92 =
Total $20,000 Total $7,360

ABSORPTION COSTING
In a business all costs must be taken into consideration in the determination of the cost of a
product. This is necessary to ensure that correct selling prices are determined in order to be
both profitable and competitive.

COSTS are divided into the following:

DIRECT traceable INDIRECT non traceable OVERHEADS

Materials Materials

Labour Labour

Expenses Expenses

COST CENTRES
Many businesses manufacture products that pass through several departments. In tracing
costs to these departments, they are referred to as cost centres.

ALLOCATION AND APPORTIONMENT OF OVERHEADS

In tracing costs to cost centres, some costs can be easily attributed to those
departments.This means the costs are specific to that department and as such are
ALLOCATED to that department. Examples of allocated costs are the salary of a supervisor
and depreciation of machinery used in a department.

Some expenses relate to the entire business and as such must be shared or apportioned to
departments.This is done by using a base to share the cost fairly to each department.

EXAMPLE 1
The following costs were incurred in FASS Limited for the year 2022. Costs that were
specific to assembly were supervisor salary $4000 and depreciation of machinery $6000. In
the finishing department,specific costs were supervisor salary $7000 and depreciation of
machinery $2000. Rent for both departments were $15000 and electricity costs were $20000
in total for the business.
The following information can be used to apportion rent and electricity.

Assembly Finishing

Rent Floor space sq. metres 3000 1500

Space in department/ 3000/4500 x $15000 1500/4500 x $15000

Total space x overhead = $10000 = $5000

Electricity Kilowatt hours 32000 8000

Kilowatt hrs in 32000/ 40000 x 8000/ 40000 x

department/ $20000 = $16,000 $20000 = $4,000
Total kilowatt hrs x
overhead

Calculate the total costs (allocated and apportioned) for FASS Limited.

ASSEMBLY FINISHING TOTAL

Supervisor salary 4000 7000

Depreciation of 6000 2000

machinery

Rent 10000 5000

Electricity 16000 4000

TOTAL 36000 18000

OVERHEAD ABSORPTION RATES

If a business manufactures only one product in one department then the total manufacturing
cost is divided by the number of units produced to calculate cost per unit.

When a business manufactures one product that passes through several departments
before it is completed then it may be necessary to calculate an overhead absorption rate
(OAR) to determine the indirect costs incurred. This also applies to businesses where
several products are manufactured in several departments.

SINGLE PRODUCT WITH MULTIPLE DEPARTMENTS

EXAMPLE 2
A business has the following information:
 $

Direct materials 3,000

Direct labour 1,600

Overheads/Indirect ?
costs

Total cost ?

There are two production departments, assembly and finishing. Total overheads in the
assembly and finishing areas are as follows: $400,000 and $57,600

Machine hours per year Labour hours per year

Assembly 10000 capital intensive 2200

Finishing 2000 4800 labour intensive

It takes the business 5 hours in the assembly area and 4 hours in the finishing area to
make one unit .
1. Calculate the OAR in each department.
2. Calculate the overhead costs for each department.
3. Calculate the total cost of the product
4. Calculate the selling price of each item assuming a cost plus mark up of 25%.
5. Assuming the business sold 8 units, what is the total profit.

Assembly- capital Finishing - labour

OAR = Total overhead/ no of $400,000/ 10000 machine $57,600/ 4800 labour

hours hours hours

= $40 per machine hour = $ 12 per labour hour

COST PER UNIT $

Direct materials 3,000

Direct labour 1,600

Overheads/Indirect costs

Assembly 5 hours x $40 200

Finishing 4 hours x $12 48

Total cost per unit 4,848

Mark up 25%
Cost price $4,848
Mark up 25 % x $4848 $1,212
Selling price per unit $6,060

Assuming eight units sold, profit will be 8 x $1,212 = $9,696