Cost and Management

Management Accounting
Chapter 1
The nature and purpose of

management accounting
The nature and purpose of

management accounting
Data and information.
Planning, decision making and
control.
Responsibility centres.
The role of management accounting.
Data and information

Data and information are different.
Data consists of numbers, letters,
symbols, raw facts, events and
transactions which have been recorded
but not yet processed into a form
suitable for use.
Information is data which has been
processed in such a way that it is
meaningful to the person who receives it
(for making decisions).
Good information
The ACCURATE acronym:
A Accurate
C Complete
C Cost-effective
U Understandable
R Relevant
A Accessible
T Timely
E Easy-to-use!
Planning, decision making

& control
Strategic, tactical and operational

planning
Example
Solution
Responsibility Centres
An individual part of the business whose manager has
personal responsibility for its performance.
Cost Centre
Profit Centre
Responsibility Centre
Investment
Centre
Revenue Centre
Managers to plan & control areas of performance on which they

are measured.
Responsibility Centres
Responsibility centres Examples
Practice questions
1. The part of an organisation which generates
revenues and for which costs are also collected is
called:
A)A cost centre
B )A revenue centre
C )A profit centre
2. A support department in an organisation, for which
costs are collected, is called:

A) A cost centre
B )A revenue centre
C )A profit centre
Management Accounting vs.

Financial Accounting
Financial accounting
Financial accounting is mainly a method of
reporting the results and financial position
of a business.
It is not primarily concerned with providing
information towards the more efficient
running of the business.
Cost Accounting and Management

Accounting

Cost accounting
Cost accounting is concerned with the
following.
Preparing statements (e.g. budgets, costing)
Cost data collection
Applying costs to inventory, products and
services
Cost accounting is part of management
accounting.
Cost accounting provides a bank of data for
the management accountant to use.

Management Accounting
Management accounting is the process of measuring and
reporting information about economic activity within
organizations, for use by managers in planning,
performance evaluation, and operational control:
Planning: For example, deciding what products to make,
and where and when to make them.
Performance evaluation: Evaluating the profitability of
individual products and product lines.
Operational control: For example, knowing how much
work-in-process is on the factory floor, and at what stages
of completion, to assist the line manager in identifying
bottlenecks and maintaining a smooth flow of production.

Management
Accounting
Information
Internal users, e.g.
mainly produced Managers and
for
employees
External users e.g.

Shareholders, creditors,
lenders, banks, government
Purpose of
information
To aid planning, control

and decision making
To record financial
performance and position in
a period
Legal
requirements
No
Yes (limited companies)
Formats
No set format
managers decide on
content & presentation
Limited companies must

produce financial accounts
Nature of
information
Financial & nonfinancial
Mostly financial
Time period
Historical & forwardlooking
Mainly an historical record
Chapter Summary
Chapter 2
Types of cost and cost behaviour
Total product/service costs

The total cost of making a product or
providing a service consists of the following:
Cost of materials
Cost of wages and salaries (labour
costs)
Cost
of
other
expenses
(rent,
depreciation, electricity bills)
Slide 21
Slide
21
Direct and indirect costs

A direct cost is a cost that can be traced in
full to the product, service or department that
is being costed
Direct costs are made up of direct materials,
direct labour and direct expenses
An indirect cost is a cost which cannot be
traced directly to the product, service or
department. Indirect costs are also known as
overheads
Examples are indirect materials, indirect labour,
indirect expenses, administration overhead,
selling/distribution overhead
Slide 22
Slide
22
Direct Costs-Direct material

Direct material is all material
becoming part of the product
(unless
used
in
negligible
amounts and/or having negligible
cost).
Examples of direct material are as
follows.
(a) Wood in the production of a
table or fabric in a shirt.
(b) Primary packing materials like
Direct Costs-Direct labour

Direct wages are all wages paid for labour
(either as basic hours or as overtime)
expended on work on the product itself.
Examples are as follows.
(a) Workers engaged in altering the
condition or composition of the product.
(b)
Inspectors,
analysts
and
testers
specifically required for such production.
(c) Foremen, shop clerks and anyone else
whose wages are specifically identified.
Direct Costs-Direct expense

Direct expenses are any expenses which are
incurred on a specific product other than
direct material cost and direct wages
Direct expenses are charged to the product
as part of the prime cost.
Examples of direct expenses are as follows.
The hire of tools or equipment for a particular
job
Maintenance costs of tools, fixtures and so
on, Royalty on production, Import duty, Excise duty
Total direct costs are known as prime cost
Indirect costs
An indirect cost is a cost which
cannot be traced directly to the
product, service or department.
Indirect costs are also known as
overheads
Examples are indirect materials,
indirect labour, indirect expenses,
administration overhead, selling &
distribution overhead
Indirect costs
Indirect materials which cannot be traced in
the finished product. e.g. material used in
negligible amounts
Indirect wages, meaning all wages not
charged directly to a product. e.g. Wages of
non-productive
personnel
in
the
production
department e.g. supervisors
Indirect expenses (other than material and
labour) not charged directly to production,
e.g. Rent, rates and insurance of a factory,
depreciation, fuel, power, maintenance of plant,
machinery and buildings
Example
Suppose that a furniture maker is
determining the cost of a wooden table.
The manufacture of the table has involved the
use of timber, screws and metal drawer handles.
These items are classified as direct materials .
The wages paid to the machine operator,
assembler and finisher in actually making the
table would be classified as direct labour costs .
The designer of the table may be entitled to a
royalty payment for each table made, and this
would be classified as a direct expense .
Example Cont
Other costs incurred would be classified as
indirect costs .
They cannot be directly attributed to a particular
cost unit, although it is clear that they have been
incurred in the production of the table. Examples
of indirect production costs are as follows:
Cost incurred
Cost
classification
Lubricating oils and cleaning materials
Salaries of supervisory labour
Factory rent and power
Indirect material
Indirect labour
Indirect expense
Direct and Indirect costs

Direct costs : costs which can be directly identified with a specific
unit or cost centre
Total of direct costs =
Direct Materials + Direct labour + Direct expenses =
Prime Cost
Indirect costs : costs which can not be directly identified with a
specific unit or cost centre
Indirect costs =
Indirect Materials + Indirect labour + Indirect expenses =
Overheads
Functional costs
Costs can also be classified according to their function
(a) Production or manufacturing costs. These are costs
associated with the factory. Cost of oils used to lubricate
production machinery, Protective clothing for machine operatives,
Depreciation of factory plant and equipment, Salary of security guard in raw
material warehouse
(b) Administration costs. These are costs associated with

general office departments. Salary of the secretary to the
finance director, Cost of typewriter ribbons in the general office
(c) Marketing, or selling and distribution costs. These are
costs associated with sales, marketing, warehousing and
transport departments. Fees to advertising agency, Motor vehicle licenses
for lorries
Classification in this way is known as classification by

function. Expenses that do not fall fully into one of these
classifications might be categorized as general overheads or
even listed as a classification on their own (for example
research and development costs).
Slide 31
Slide
31
Fixed and Variable Costs

A fixed cost is a cost which is unaffected by
changes in the level of activity
Such as rent of a building, business rates, salary of
a director
A variable cost is a cost which tends to vary with
the level of activity
Such as direct materials, direct labour, sales
commission
Costs may also be semi-fixed or semi-variable
Such as an telephone bill which has a fixed
standing charge and a variable cost per calls made
Slide 32
Slide
32
Cost Behaviour variable

The
way in which costs vary at different levels
cost
of activity
A cost that varies with the level of activity, e.g. Material cost
Cost behaviour Fixed Costs

A cost that, within certain output and sales revenue limits, is
unaffected by changes in the level of activity.
Cost behaviour Fixed Costs

Stepped Fixed Costs : A fixed cost which is only fixed within a
certain level of activity. Once the upper level is reached, a new
level of fixed costs becomes relevant. Warehouse costs(as more
space is required, more warehouse must be purchased or rented).
(a) Rent is a step cost in situations where accommodation
requirements increase as output levels get higher.
(b) Basic pay of employees is nowadays usually fixed, but as
output rises, more employees (direct workers, supervisors,
managers and so on) are required.
(c) Royalties.
Cost behaviour Semi variable

costs
A cost with a fixed and a variable element, e.g. telephone charges
with fixed line rental and charge per call
Cost behaviour Hi-low

method
Costs are analysed into variable & fixed

elements using the hi-low method.
Step1 :
Select high and low activity levels and their associated costs.
Step 2 :
Variable Cost per unit
=
cost at high level of activity-cost at low level of activity / High level of activitylow level of activity
Step 3 :
Find fixed cost by substitution using either the high or low activity level
Fixed cost=Total cost at activity level Total variable Cost
Analysis of cost into fixed and variable

elements
Example
a)
b)
c)
d)
Output (units)
Total costs ($)
200
7000
300
8000
400
9000
Find the variable cost per unit
Find the total fixed cost
Estimate the total cost if output is 350 units
Estimate the total cost if output is 600 units
Example: The high-low method

DG Co has recorded the following total costs during the last
five years.
Year
Output volume
Total cost
Units
$
20X0
65,000
145,000
20X1
80,000
162,000
20X2
90,000
170,000
20X3
60,000
140,000
20X4
75,000
160,000
Required
Calculate the total cost that should be expected in
20X5 if
output is 85,000 units.
High/low method with stepped fixed costs

Sometimes fixed costs are only fixed within
certain level of activity and increase in steps as
activity increases.
The high/low method can still be used to estimate the

fixed and variable costs.
Adjustments need to be made for the fixed costs

based on the activity level under consideration .
Example: The high-low method

with stepped fixed costs
The following data relate to the overhead expenditure of
contract cleaners (for industrial cleaning) at two
activity levels.
Square meters cleaned
12,750
15,100
Overheads
$73,950
$83,585
When more than 14,000 square meters are industrially
cleaned, there will be a step up in fixed costs of $4700
Required
Calculate the estimated total cost if 14,500 square meters
are to be industrially cleaned.
Solution
Before we can compare high output

costs with low output costs in the
normal way, we must eliminate the part
of the high output costs that are due to
the step up in fixed costs:
Total cost for 15,100 without step up in
fixed costs = $83,585 $4,700 =
$78,885
We can now proceed in the normal way
using the revised cost above.
Solution
Sq Met
$
High activity 15,100 Total cost
78,885
Low activity 12,750 Total cost
73,950
2,350
4,935
Variable cost = $4,935
2,350
Solution
Before we can calculate the total cost for 14,500
square metres we need to find the fixed costs. As the
fixed costs for 14,500 square metres will include the
step up of $4,700 we can use the activity level of
15,100 square metres for the fixed cost calculation:
$
Total cost (15,100 square metres)
(this includes the step up in fixed costs)
Total variable costs (15,100 x $2.10)
Total fixed costs
83,585
31,710
51,875
Solution
Estimated overhead expenditure if
14,500
square metres are to be industrially
cleaned:
$
Fixed costs
51,875
Variable costs (14,500 X$2.10)
30,450
High Low method with changes in the variable

cost per unit
Same data as the previous question.
Additionally, a round of wage negotiations
have just taken place which will cost an
additional $1 per square metre.
High Low method with changes in the variable

cost per unit
Estimated overheads to clean 14,500 square metres.
Per square
metre
$
Variable cost
2.10
Additional variable cost
1.00
Total variable cost
3.10
Cost for 14,500 square metres:
Fixed
Variable costs (14,500 X $3.10)
$
51,875
44,950
96,825
Example
An organization has the following total costs at two activity
levels:
Activity levels (units)
Total costs ($)
16,000
135,000
22,000
170,000
Variable cost per unit is constant within this range of

activity but there is a step up of $5,000 in the total fixed
costs when the activity exceeds 17,500 units.
What is the total cost at an activity of 20,000 units?
,
Equation for the total cost function

Cost equations are derived from historical cost data.
Once a cost equation has been established (using
methods such as the high/low method which will be
revised later in the course) it can be used to estimate
future costs. In the exam, cost functions will be linear
y = a + bx
a is the fixed cost per period (the intercept)
b is the variable cost per unit (the gradient)
x is the activity level (the independent variable)
y is the total cost = fixed cost + variable cost
(the dependent variable).
Equation for the total cost function
Question 1: Total Cost

Functions
If y = 8,000 + 40x
Please find the followings:
(a) Fixed cost
(b) Variable cost per unit
(c) Total cost for 200 units

Functions
If the total cost of a product is given
as:
Y = 4,800 + 8x
(a) The fixed cost is ?
(b) The variable cost per unit is ?
(b) The total cost of producing 100
units is ?

Functions
Consider the linear function y = 1,488 +
20x and answer the following
questions.
(a) The line would cross the y axis at the
point
(b) The gradient of the line is
(c) The independent variable is
(d) The dependent variable is
Question 4: Total Cost Function

Fixed costs $100,000.
Variable costs per unit $5 for volumes up to
1,000 units.
Volumes above 1,000 units receive 5%
discount on all units.
Required:
Derive the two equations for the total
cost
function.
Cost Units
A unit of product or service in relation to

which costs are ascertained .
Cost units can be developed for all kinds of
organizations, whether manufacturing,
commercial or public-service based.
Industry sector
Cost unit
Brick-making
1,000 bricks
Electricity
Kilowatt-hour
Professional services
Chargeable hour
Education
Enrolled student
Cost Object
A cost object is often a product or department for
which costs are accumulated or measured. For
example, a product is the cost object for direct
materials, direct labor and manufacturing
overhead. The factory maintenance department is
a cost object for the cost of the maintenance
employees and the maintenance supplies. Later
the factory maintenance department costs will be
assigned to products, which are also cost objects.
A cost object can also be a customer, a machine, a
group of machines, a group of employees, etc.
Cost Card
Chapter 3
Business Mathematics
Expected Values
The weighted average of a probability distribution, used in
simple decision-making situations.
EV = px
Where
p = probability of outcome occurring

x = outcome.
When using Expected Values :

Only accept projects if EV is positive
With mutually exclusive options, accept the one with the
highest EV.
Expected Values - Example
Expected Values Limitations

Expected values :
Use past data and estimates, which may be inaccurate
Are not always suitable for one-off decisions as they are longterm average. The expected value might never occur for any
single result
Do not take into account the time value of money
Do not take into account the decision makers attitude to risk.
Regression
If x is the independent variable and y the dependent variable, least
squares regression finds the line of best fit through the scatter diagram.
y = a + bx
Where a is the y value when x is 0, and b is the change in y when x

increases by one unit.
Regression
In the context of cost estimation :
y represents the total cost
x represents the production volume in units
a represents the total fixed costs
b represents the variable cost per unit
(Given)
Correlation Coefficient
r measures the strength of a linear relationship between two variables.
-1 < r < 1
If r = 1 perfect positive correlation
If r = 0, no correlation
If r = -1, perfect negative correlation.
(Given)
Correlation does not prove cause and effect it merely suggests

it.
Coefficient of determination
r shows how much of the variation in the dependent variable is
dependent on the variation of the independent variable.
E.g. If r = 0.95, r = 0.90 or 90%

This means that 90% of the variation in y (costs) is explained by
the variation in x (level of output).
Chapter 4
Accounting for Materials

Ordering and Accounting for
Inventory
Inventory control-Ordering,
Receiving and issuing materials
Inventory control-Ordering,
Receiving and issuing materials
Inventory control-Paperwork
Document
Completed
by
Sent to
Information
included
Purchase Requisition form
Production department
Purchasing department
Goods required
Managers authorisation
Purchase order form
Purchasing Department
Supplier
Accounting (copy)
Goods receiving
department (copy)
Goods required
Delivery note
Supplier
Goods Receiving
Department
Check of goods delivered

against order form
Goods Received Note
Goods receiving
department
Purchasing department
Verification of goods
received to enable payment
Materials requisition note
Production department
Stores
Authorisation to release
goods
Update stores record
Materials returned notes
Production Department
Stores
Details of goods returned to

stores
Update stores record
Materials Transfer notes
Production Department A
Production Department B
Goods transferred between

departments
Update stores records
Inventory control-Double
entry
Inventory control
Inventory levels can be recorded in a variety of
different ways
Bin cards - shows the level of inventory of an item
at a particular stores location and is kept with the
inventory
Stores ledger accounts shows amounts
received, amounts issued, amounts returned and
the current balance in quantity
Free inventory - what is really available for
future use
Free inventory is calculated as materials in
inventory + materials on order materials
requisitioned but not yet issued
Slide 71
Slide
71
Inventory control
Perpetual inventory is an inventory recording
system where the records are updated for each
receipt/issue of inventory
Actual quantities of inventory may not agree to
records therefore inventory counts required
Periodic inventory count - all items counted on
specific date, usually the end of the accounting
period
Continuous inventory count each item
counted at least once a year, generally requires a
specialised team
Slide 72
Slide
72
Inventory levels
Inventory is held for a number of reasons

To ensure any unexpected demands can be met
To meet any future shortages
Bulk purchasing discounts available
Slide 73
Slide
73
Chapter 5
Order Quantities and Reorder

Levels
Holding & Ordering Costs
Minimise total of holding, ordering and stock-out costs
Economic Order Quantity

The EOQ minimises the total of holding, ordering & stock-out
costs
EOQ =
2C0D
Ch
Where :
D = demand p.a.
C0 = Cost of placing one order
Ch = cost of holding one unit per year
Total Annual Cost = PD + (Co X D/Q)+ (Ch X Q/2)
EOQ
EOQ
A company uses components at the rate of 500 units per month, which are bought at a cost
of $1.20 each from the supplier. It cost $20 each time to place an order, regardless of the
quantity border.
The total holding cost is 20% per annum of the value of inventory held.
Required:
How many components company should order and what will be the total annual cost ?
EOQ with discount:

A company uses components at the rate of 500
units per month, which are bought at a cost of
$1.20 each from the supplier. It cost $20 each
time to place an order, regardless of the
quantity border.
The supplier offers a 5% discount on the
purchase price for order quantities of 2000
units. The current EOQ is 1000 units
The total holding cost is 20% per annum of the
value of inventory held.
Required:
Should the discount be accepted?
Economic Batch Quantity

The EBQ is primarily concerned with determining the number of
items that should be produced in a batch.
EBQ =
2C0D
Ch(1D/R)
Where :
Q= Batch size
D = demand p.a.
R=Annual production rate
C0 = Cost of setting up a batch ready to be produced
Ch = cost of holding one unit per year
EBQ
The following is relevant to item X:
Production at a rate of 500 units per week.
Demand is 10,000 units per annum, evenly
spread over 50 working weeks.
Set up cost is $2,700 per batch.
Storage cost is $2.50 per unit for a year.
Required:
Calculate the economic batch quantity (EBQ)
for item X.
Solution
Annual production rate, R=500 x 50
=25,000 units
Annual demand rate = 10,000 units
Cost per setup Co = $2,700
Cost of holding one item in inventory per
year, Ch = $2.50
EBQ = 2 x 2,700 x 10,000
2.5 (1-10,000/25,000)
EBQ = 6,000 units
Inventory control levels

Inventory control levels can be
calculated in order to maintain
inventories at the optimum level.
The three critical control levels are
reorder level, minimum level and
maximum level.

Reorder level
When inventories reach this level, an order should
be placed to replenish inventories. The reorder level
is determined by consideration of the following.
The maximum rate of consumption
The maximum lead time
The maximum lead time is the time between
placing an order with a supplier, and the inventory
becoming available for use
Reorder level = maximum usage x maximum
lead time

Minimum level/Buffer Level
This is a warning level to draw management attention to the
fact that inventories are approaching a dangerously low level
and that stock outs are possible.
Minimum level = reorder level (average usage x average
lead time)
Maximum level
This also acts as a warning level to signal to management that
inventories are reaching a potentially wasteful level.
Maximum level = reorder level + reorder quantity
(minimum usage x minimum lead
time)

Reorder quantity
This is the quantity of inventory
which is to be ordered when
inventory reaches the reorder level.
If it is set so as to minimize the total
costs associated with holding and
ordering inventory, then it is known
as the economic order quantity
Question- Maximum inventory level

A large retailer with multiple outlets maintains a central
warehouse from which the outlets are supplied.
The following information is available for Part Number SF525.
Average usage
350 per day
Minimum usage
180 per day
Maximum usage
420 per day
Lead time for replenishment
11-15 days
Re-order quantity
6,500 units
a) Based on the data above, what is the re-order level
and maximum level of inventory?
b)
Based on the data above, what is the approximate
number of Part Number SF525 carried as buffer
inventory?
Answer
Maximum inventory level = reorder level +
reorder quantity (min usage x min lead time)
=6,300 + 6,500 (180 x 11)
=10,820units
Buffer inventory = minimum level
Minimum level = reorder level (average usage
x average lead time)
= 6,300 (350 x 13)
= 1,750units
Chapter 6
Accounting for Labour
Direct or Indirect Costs?

Type of worker
directly involved in making

products
Direct Labour
cost
Make up part
of prime cost of
a product,
Basic Pay
Overtime
Premium on
specific job, at
customers
request
Indirect Labour
cost
General O/T
premiums
Bonus payments
Idle time
Sick pay
Time spent on
indirect jobs
Indirect workers
(Maintenance staff,
supervisors, Canteen
Indirect Labour cost
ALL COSTS
Direct and Indirect Labour
Vienna is a direct labour employee who works a

standard 35 hours per week and is paid a basic
rate of $12 per hour. Overtime is paid at time and
a third. In week 8 she worked 42 hours and
received a $50 bonus.
Please find Basic pay for standard hours (DLC)
Basic pay for overtime hours (DLC)
Overtime premium (IDLC)
Bonus (IDLC)
Example
A company operates a factory which employed 40
direct workers throughout the four-week period just
ended. Direct employees were paid at $4 per hour
for 38 hours week. The total hours of the direct
workers in the four- week period were 6,528.
Overtime, which is paid at premium of 35%, is
worked in order to meet production requirements.
Employees deduction total 30% of gross wages. 188
hours of direct workers time were registered as idle.
Calculate:
Gross Wages, deductions, net wages, direct labour
cost and indirect labour cost for the four-week
period.
Solution
Solution
Remuneration Methods
Time Based Schemes
Total Wages =
(hours worked * basic pay/hour) + (o/t hrs worked * o/t
premium/hour)
Higher quality if workers are happy to spend longer on units to get
them right; However, no incentive to improve productivity.
Piecework Schemes
Total Wages =
Number of units completed * agreed rate per unit.
May involve a guaranteed minimum wage;
May use a higher rate per unit once productivity target achieved
Higher productivity at the expense of quality?
Other Schemes e.g. Flat salary + bonus
Bonus Schemes (individuals or groups)
Piecework Schemes
A company operates a piecework system of
remuneration,
but
also
guarantees
its
employees 75% of a time-based rate of pay
which is based on $19 per hour for an eight
hour working day. Three minutes is the standard
time allowed per unit of output. Piecework is
paid at the rate of $ 18 per standard hour.
If an employee produces 200 units in eight hour
on a particular day.
What is the employee guaranteed wages
and gross pay for that day?
Example
A company operates a premium bonus scheme
for its employees of 50% of the time saved
compared with the standard time allowance for a
job, at the normal hourly rate. The data relating
to job 999 completed by an employee is as
follows:
Allowed time for the job 999- 12 hours
Time taken to complete job 999 10hours
Normal hourly rate of pay is $15.
Required
What is the total pay of the employee for job
for 10 hours
spent on job 999?
Remuneration methods examples
Question Weekly pay

Penny Pincher is paid 50c for each towel
she weaves, but she is guaranteed a
minimum wage of $60 for a 40 hour week.
In a series of four weeks, she makes 100,
120, 140 and 160 towels.
Required
Calculate her pay each week, and the
conversion cost per towel if production
overhead is added at the rate of $2.50 per
direct labour hour.
Solution
Labour Turnover
Labour Turnover
At 1st January a company employed
3,641 employees and at 31 December
employees numbers were 3,735.
During the year 624 employees
choose to leave the company.
What was the labour turnover rate for
the year?
Labour Related Ratios

Labour Efficiency Ratio=
Expected hours to make actual output
Actual hours taken
Labour Capacity Ratio=
Actual hours worked
Hours budgeted
Labour Production Volume Ratio=
Expected hours to produce actual output
Hours Budgeted
Example: Labour activity ratios

Rush and Fluster Co budgets to make
25,000 standard units of output (in four
hours each) during a budget period of
100,000 hours.
Actual output during the period was 27,000
units which took 120,000 hours to make.
Required
Calculate the efficiency, capacity and
production volume ratios.
Solution
Efficiency ratio
=
(27,000u x 4h) 108,000 x
100 = 90%
120,000h
Capacity ratio
=
120,000 hours x 100 =
120%
100,000hours
Solution
Production volume ratio
= (27,000u x 4h) 108,000h x 100
= 108%
100,000
The production volume ratio of 108%
(more output than budgeted) is explained
by the 120% capacity working, offset to a
certain extent by the poor efficiency (90%
x120% = 108%).
Labour Related Ratios
Chapter 7
Accounting for Overheads
Absorption costing
Step1 : O/H allocated
or apportioned to
cost centres using
suitable bases
Step 2 : Service cost
centres
reapportioned to
production cost
centres
Step 3 : Overheads
absorbed into units of
production
Cost Unit x
Overheads
Overhead is the cost incurred in the course
of making a product, providing a service or
running a department, but which cannot
be traced directly and in full to the
product, service or department.
Overhead is actually the total of the
following
- Indirect materials
- Indirect expenses
- Indirect labour
Overheads
The total of these indirect costs is usually
split into the following categories.
Production
Selling and distribution
Administration
In cost accounting there are two schools of
thought as to the correct method of
dealing with overheads.
- Absorption costing
- Marginal costing
Absorption costing: an introduction

The objective of absorption costing is
to include in the total cost of a product an appropriate
share of the organization's total overhead.
An appropriate share is generally taken to mean an
amount which reflects the amount of time and effort
that has gone into producing a unit or completing a
job.
An organisation with one production department that
produces identical units will divide the total overheads
among the total units produced.
Absorption costing is a method for sharing overheads
between different products on a fair basis.
Absorption costing
A business needs to know
the cost per unit of goods and
services
- to value stock
- to fix a selling price
- to analyze profitability
Absorption costing
In principle, the unit cost of material and
labour should not be a problem, because
they can be measured.
Problem?
It is overheads that present the real
difficulty-in particular fixed overheads.
e.g. If the factory cost $100,000 p.a. to rent,
then how much should be included in the
cost
of
each
unit?
Absorption costing
Allocation
Allocation is the process by which whole
cost items are charged direct to a cost unit
or cost centre.
Apportionment
Apportionment is a procedure whereby
indirect costs are spread fairly between cost
centers.
Overhead absorption
Overhead absorption is the process
whereby overhead costs allocated and
apportioned to production cost centers are
Example: Overhead allocation

Consider the following costs of a company.
Wages of the foreman of department A
$200
Wages of the foreman of department B
$150
Indirect materials consumed in department A
$50
Rent of the premises shared by departments A and B
$300
The cost accounting system might include three overhead cost
centers.
Cost centre:
101
Department A
102
Department B
201
Rent
Overhead costs would be allocated directly to each cost
centre, i.e $200 + $50
Absorption costing-Absorption of
overheads
Example 1 (One product in a factory)
X Plc produce desks.
Each desk uses 3kg of wood at a cost of
$4 per kg, and takes 4 hours to
produce.
Labour is paid at the rate of $2 per
hour.
Fixed costs of production are estimated
to be $700,000 p.a..
The company expects to produce
50,000 desks P.a.
Absorption costing-Absorption of
overheads
Example 2(more than one product)
X plc produce desk and chairs in the same factory.

Each desk uses 3 kg of wood at a cost of $4 per
kg and takes 4 hours to produce.
Each chair uses 2 kg of wood at a cost of $4 per
kg, and takes 1 hour to produce.
Labour is paid at the rate of $2 per hour.
Fixed cost of production are estimated to be
$700,000 p.a..
The company expects to produce 30,000 desks
and 20,000 chairs p.a..
Overheads are absorbed on labour hours basis
Calculate cost per unit of desks and chairs
Blanket absorption rates and

departmental absorption rates
A blanket overhead absorption rate is an
absorption rate used throughout a factory
and for all jobs and units of output
irrespective of the department in which
they were produced.
Example, if total overheads were $500,000
and there were 250,000 direct machine
hours during the period, the blanket
overhead rate would be $2 per direct
machine hour and all jobs passing through
the factory would be charged at that rate.

Blanket overhead rates are not
appropriate in the following
circumstances.
There is more than one department.
Jobs do not spend an equal amount
of time in each department.

If a single factory overhead absorption rate is
used, some products will receive a higher
overhead charge than they ought 'fairly' to
bear, whereas other products will be undercharged.
If a separate absorption rate is used for
each department, charging of overheads
will be fair and the full cost of production
of items will represent the amount of the
effort and resources put into making them.
Example: Blanket absorption

rates and departmental
absorption rates
The Old Grammar School has two production departments, for

which the following budgeted information is available.
Departments
A
Total
Budgeted overheads
$360,000
$560,000
Budgeted direct labour hours 200,000 hrs
240,000 hrs
B
$200,000
40,000 hrs
Required:
Find a single factory overhead absorption rate and
departmental overhead absorption rate?
Solution
If a single factory overhead absorption rate is
applied, the blanket rate/factory rate is:
$560,000/240,000h = $2.33 per direct labour hour
If separate departmental rates are applied,
Dep A=$360,000/200,000h =$1.80 per direct labour
hour
Dep B =$200,000/40,000h = $5 per direct labour hour
(Department B has a higher overhead rate of
cost per hour
worked than department A)
Example-Cont
Now let us consider two separate jobs.
Job X has a prime cost of $100, takes 30 hours in
department B and does not involve any work in
department A.
Job Y has a prime cost of $100, takes 28 hours in
department A and 2 hours in department B.
What would be the factory cost of each job, using
the following rates of overhead recovery?
A single factory rate of overhead recovery
Separate departmental rates of overhead
recovery
Example-Cont
Single factory rate
Job X
Job Y
$
Prime cost
100
Factory overhead (30 x$2.33)
70
Factory cost
170
100
70
170
Example-Cont
Separate departmental rates
Job X
Job Y
$
$
Prime cost
100
100
Factory overhead: department A
0
50.40
department B
(30 x$5) 150
10.00
Factory cost
250
160.40
(28x$1.80)
(2x$5)
Example-Cont
Using a single factory overhead absorption rate, both jobs
would cost the same. However, since job X is done entirely
within department B where overhead costs are relatively
higher, whereas job Y is done mostly within department A,
where overhead costs are relatively lower, it is arguable
that job X should cost more than job Y. This will occur if
separate departmental overhead recovery rates are used to
reflect the work done on each job in each department
separately.
If all jobs do not spend approximately the same time in
each department then, to ensure that all jobs are charged
with their fair share of overheads, it is necessary to
establish separate overhead rates for each
department.
More than one department in the

factory
In this situation we need first to

allocate and apportion overheads
between each department. We can
then absorb the overheads in each
department separately.
Example 3 (more than one department)

X plc produces desk and chairs. The factory has
two departments, assembly and finishing.
Each desk take 3kg of wood at $4 per kg and
takes 4 hours to produce-3 hours in assembly and
1
hour
in
finishing.
Each chair uses 2kg of wood at $4 per kg and
takes 1 hour to produce-1/2 hour in assembly and
in
finishing,
All labor is paid at the rate of $2 per hour.
Fixed cost of production are estimated to be
$700,000 pa, of this total , $100,000 is the salary
of
the
supervisors-$60,000
to
assembly
supervisor and $40,000 to finishing supervisor.
The remaining overheads are to be split 40% to
assembly
and
60%
to
finishing.
The company expect to produce 30,000 desks
Bases of apportionment
Overheads
Basis
Rent, rates, heating Floor area occupied by
and light, repairs and
each cost center
depreciation
of
buildings
Depreciation,
insurance of
equipment
Personnel office,
canteen, welfare,
wages and cost offices,
first aid
Cost or book value of

equipment
Number of employees,
or labour hours worked
in each cost centre
Overheads Allocation and Apportionment

Example 4
X plc, production overheads costs for the period
$
Factory rent
20,000
Factory heat
5,000
Processing Dep-Supervisor
15,000
Packing Dep-Supervisor
10,000
Depreciation of equipment
7,000
Factory Canteen expense
18,000
Welfare cost of factory employees 5,000
There is also direct labour cost of $20,000.
Cubic space (m)
NBV equipment
No. of employees
Processing Dep
50,000
$300,000
50
Packing Dep
25,000
$300,000
40
Canteen
5,000
$100,000
10
Allocate and apportion production overheads costs

amongst the three departments using a suitable basis.
Reapportionment of service
cost centre overheads
Example 5
Reapportion the canteen cost in
example 4 to the production cost
centers.
Question- Apportioning service

department overheads
Spaced Out Co has two production departments (F and G) and two
service departments (Canteen and Maintenance). Total allocated and
apportioned general overheads for each department are as follows.
F
G
Canteen
Maintenance
$1,25000
$80,000
$20,000
$40,000
Canteen and Maintenance perform services for both production
departments and Canteen also provides services for Maintenance in
the following proportions.
F
G
Canteen
Maintenance
% of Canteen to
60
25
15
% of Maintenance to
65
35
Required:
What would be the total overheads for production
department G once the service department costs have been
apportioned?
Fast Inc has two production departments (A and B) and two service departments
(maintenance and stores). Details of next years budgeted overheads are shown
below.
Central Heating
Direct labour
General Repair costs
Machinery Depreciation
Rent and rates
Canteen
Machinery insurance
Direct Material
Details of each department are as follows.
A
B
Total
Floor area (m2)
6,000
4,000
15,000
Machinery book value ($000) 48
20
80
Number of employees
50
40
120
Allocated overheads ($000)
15
20
52
Total ($)
19,200
8,000
9,600
54,000
38,400
9,000
25,000
20,000
Maintenance
Stores
3,000
2,000
20
10
12
.Service departments services were used as follows
A
B
Maintenance
Stores
Total
Maintenance hours worked
5,000
4,000
---1,000
10,000
Number of stores requisitions
3,000
1,000
------4,000
Required
a) Allocate and apportion production overheads costs amongst the
four departments using a suitable basis and reapportion the
service department cost to production departments and finds the
total overheads of production
. departments
B) In FAST incorporation there are two production departments A
and B. Both departments are machine intensive. Department A use
10,000 machine hours and department B uses 12,000 machine
hours. Find OAR for department A and B?
Example: The basics of absorption

Athena Co makes two products, the Greek
and the Roman. Greeks take 2 labour
hours each to make and Romans take 5
labour hours. Athena Co estimates that the
total overhead will be $50,000. Athena Co
estimates that a total of 100,000 direct
labour hours will be worked
Required:
What is the overhead cost per unit
for Greeks and Romans respectively if
overheads are absorbed on the basis
of labour hours?
Example 7
X plc produces one product-desk
Each desk is budgeted to require 4 kg of wood at $3 per
kg, 4 hours of labour at $2 per hour, and variable
production overheads of $5 per unit.
Fixed production overheads are budgeted at $20,000 per
month and average production is estimated to be 10,000
units per month.
The selling price is fixed at $35 per unit.
There is also a variable selling cost of $1 per unit and
fixed selling cost of $2000 per month.
During the first two months X plc expects the following
level of activity
January
February
Production
11,000 units
9,500 units
Sales
9,000 units
11,500 units
a) Prepare a cost card using absorption costing?
b) Set out budgeted profit statement for the
month of Jan and Feb?
Over and under absorption of

overheads
The rate of overhead absorption is based
on estimates (of both numerator and
denominator) and it is a quite likely that
either one or both of the estimates will not
agree with what actually occurs.
Reasons of under-/over absorbed

overheads
The overhead absorption rate is predetermined from
budgeted estimates of overhead cost and the expected
volume of activity. Under or over recovery of overhead
will
occur in the following circumstances
Actual overhead costs are different from budgeted
overheads.
The actual activity level is different from the
budgeted activity level.
Both actual overhead costs and actual activity level
are different from budget.
Hourly absorption rate

Y plc budgets on working 80,000 hours per month
and having fixed overheads of $320, 000. During
April, the actual hours worked are 78,000 and the
actual fixed overheads are $315,000.
Calculate:
a) the overhead absorption rate per hour.
b) the amount of any over or under
absorption of fixed overheads in April.
Marginal Costing
Variable production costs are included
in cost per unit(i.e. treated as a
product cost).
Many businesses only want to know the variable cost of the units
they make, as fixed costs treated as period cost. The variable
cost is the extra cost each time a unit is made, fixed cost being
effectively incurred before any production is started.
Fixed costs are deducted as a period cost in the profit statement
Variable production cost of a unit is made up of
$
Direct material
X
Direct Labour
X
Variable production OH X
Marginal Cost of a Unit X
Contribution
It is the difference between selling price and all variable costs,
including non-production variable costs.
Example 8
X plc produces one product-desk
Each desk is budgeted to require 4 kg of wood at $3 per
kg, 4 hours of labour at $2 per hour, and variable
production overheads of $5 per unit.
Fixed production overheads are budgeted at $20,000 per
month and average production is estimated to be 10,000
units per month.
The selling price is fixed at $35 per unit.
There is also a variable selling cost of $1 per unit and
fixed selling cost of $2000 per month.
During the first two months X plc expects the following
level of activity
January
February
Production
11,000 units
9,500 units
Sales
9,000 units
11,500 units
a) Prepare a cost card using marginal costing?
b) Set out profit statement for the month of Jan
and Feb?
A company commenced business on 1st March making one

product only, the cost card of which is as follows
$
Direct labour
5
Direct material
8
Variable production overheads
2
Fixed production overheads
5
20
Fixed production overheads figure has been calculated on the
basis of a budgeted normal output of 36,000 units per
annum. The fixed production overhead incurred in March was
$18,000 each month.
Selling, distribution and admin expenses are
Fixed
$10,000 per month
Variable
15% of the sales value
The selling price per unit is $35 and units produced and sold
were:
Production in March 2000 units
Sales in March 1500 units
Prepare the absorption costing and marginal costing
income statement for March.
Example: Marginal and absorption costing

compared
Big Woof Co manufactures a single product, the Bark, details of which are as follows.
Per unit $
Selling price
180.00
Direct materials
40.00
Direct labour
16.00
Variable overheads
10.00
Annual fixed production overheads are budgeted to be $1.6 million and Big Woof
expects to produce 1,280,000 units of the Bark each year. Overheads are absorbed
on
a per unit basis. Actual overheads are $1.6 million for the year.
Budgeted fixed selling costs are $320,000 per quarter.
Actual sales and production units for the first quarter of 20X8 are given below.
January March
Sales
240,000
Production 280,000
There is no opening inventory at the beginning of January.
Prepare income statements for the quarter, using
(a) Marginal costing
(b) Absorption costing
Absorption costing
Step1 : Allocation is the charging of overheads directly to specific departments
where they can be identified directly with a cost centre or cost unit.
Apportionment is the sharing of overheads which relate to one department
between those departments on a fair basis.
Step 2 : Service department costs need to be reapportioned to the production
departments, using a suitable basis linked to usage of the service.
Step 3 : Costs within production cost centres are charged to a cost unit, using
Overhead absorption rates (OAR) based on :
Labour or machine hours
% of direct labour cost
....
OAR
=
Budgeted overheads / Budgeted level of activity
Re-apportionment
Over- or under-absorption of
overheads
Overheads Absorbed
=
Actual labour hours * OAR per labour hour
Actual Overheads Incurred
Overhead under- or over-absorbed
Actual overheads
different from
budget
Actual activity
level different from
budget
Ledger Accounting
Chapter 8
Marginal and Total Absorption

Cost
Contribution
Absorption & marginal costing and

profits
ABSORPTION COSTING
MARGINAL COSTING
Valuing units
Total production cost
Marginal (variable)
production cost
Valuing inventory
Opening and closing stock

valued at total production cost
OS and CS valued at
marginal cost
Fixed production
overheads
Carried forward from one period

to the next as part of the
closing / opening stock
valuation. Only hit profit when
units are sold.
FC charged in full
against profit in the
period in which they are
incurred
Adjusting for overor under-absorption
Yes in the income statement
None needed
Impact of increase
in inventory levels
Gives higher profit
Gives lower profit
Impact of decrease
in inventory levels
Gives lower profit
Gives higher profit
Inventory level
constant
Same profit under both systems
Profit Statements
*
*
*
Reconciliation
MARGINAL COSTING PROFIT
Increase in inventory * Fixed OAR
ASORPTION COSTING
PROFIT
Absorption Vs Marginal
Breakeven or CVP Analysis
Breakeven or CVP Analysis

Cost-volume-profit(CVP)/Breakeven
analysis is study of the effects on future
profit of changes in fixed cost, variable
cost, sales price, quantity and mix .
CVP analysis is a particular example of
what if? analysis. A business sets a
budget based upon various assumptions
about revenues, costs, product mixes and
overall volumes.
Breakeven Point
The breakeven point which is the activity
level at which neither profit nor loss.
Breakeven Point
Cost
(in terms of number of units sold)
Total Fixed
Contribution per
unit
Breakeven Point
Cost
(in terms of sales revenue)
Total Fixed
C/S Ratio
Example
The following information relates to product X
$
Selling price per unit
20
Variable cost per unit
12
Fixed cost
100,000
Required:
a) Calculate the breakeven point in
terms of number of units sold
b) Calculate the breakeven point in
terms of sales revenue.
C/S ratio/PV ratio/Contribution margin

ratio
C/S ratio= Contribution PU
=
Contribution
Selling price PU
revenue
Total
Total sales
Example
The following information relate to product B.
$
20
12
Fixed cost
100,000
Calculate the contribution to sales ratio.
Margin of safety and target profits

The margin of safety is the difference in units between the
budgeted sales volume and the breakeven sales volume. It
is sometime expressed as a percentage of the budgeted
sales volume.
It may also be expressed as the difference between the
budgeted sales revenue and breakeven sales revenue
expressed as a percentage of the budgeted sales revenue.
Margin of safety = Budgeted Sales Breakeven point
sales
(in terms of no. of units)
Margin of safety = Budgeted Sales Breakeven sales
Budgeted Sales
(as a % of budgeted sales)
Example
The following information relates to product X
$
20
12
Fixed cost
100,000
Budgeted sales for the period are 16,000 units.
Required:
a) Calculate the margin of safety in terms
of units.
b) Calculate the margin of safety as a % of
budgeted sales.
Target profit
Sometime an organization might wish to
know how many units of a product it
needs to sell in order to earn a certain
level of profit or target profit.
Sales volume to
=
(fixed cost +
required profit)
achieve a target profit
contribution
per unit
Example
Arrow ltd manufactures product A and
wishes to achieve a profit of $20,000, the
following information relate to product A
$
20
12
Fixed cost
100,000
Budgeted sales for the period are 16,000
units.
Required:
Calculate the sales volume required to
achieve a profit of $20,000.
Example
the following information relate to product A
$
100
56
Fixed cost
220,000
Budgeted sales are 7,500 units.
Required:
a)Calculate the C/S ratio.
b) Calculate the breakeven point in terms of
units sold.
c) Calculate the breakeven point in terms of
sales revenue.
d) Calculate the unit sales required to achieve
the target profit of $550,000.
e) Calculate the margin of safety (expressed as
a percentage of budgeted sales).
Breakeven Chart
The Breakeven point can also be determined
graphically using a breakeven chart.
The breakeven chart plots total costs and total
revenues at different levels of output.
A breakeven chart has the following axis
A horizontal axis showing the budgeted/actual
sales/output (in terms of units)
A vertical axis showing $ for sales revenues and
costs
Drawing a breakeven chart

The breakeven chart is constructed as follows
1) Plot the fixed cost line as a straight line parallel to the
horizontal axis.
2) Plot the sales revenue line from the origin.
3) the total cost line is represented by fixed cost plus
variable
costs.
4) Note the point at which the breakeven point and margin
of
safety occurs.
5) Breakeven point is the point where sales revenue is equal
to
the total costs.
6) Margin of safety is the difference between the breakeven
point and the budgeted or actual sales.
Example
A restaurant selling 600 meals at $24.
The meals cost $8 each to prepare.
The restaurant also pays fixed cost such
as rent of $8500 a week.
Draw a breakeven chart?
Quantity
Fixed
Cost
Variable
cost $8
each
Total
cost
Revenue
$24 each
$8500
$8500
600
$8500
$4800
$13,300
$14,400
Breakeven Chart
Example
The budgeted annual output of a factory is
120,000 units. The fixed overheads amounts to
$40,000 and the variable costs are 50c per unit.
The sales price is $1 per unit.
Required
Construct a breakeven chart showing the
current breakeven point and profit earned
up to the present maximum capacity.
Contribution Breakeven Chart

A variation on the traditional breakeven
chart is the contribution breakeven chart.
The main difference between the two charts
are as follows,
a) The tradition breakeven chart shows the
fixed cost line whereas the contribution
chart shows the variable cost line.
b) Contribution can be read more easily
from the contribution breakeven chart than
the traditional breakeven chart.
Contribution Breakeven Chart
P/ V Chart
Chapter 9
Relevant Costs
Relevant Costs
Relevant Cash Flows

Relevant costs are future costs. A decision is
about the future and it cannot alter what has
been done already. Costs that have been
incurred in the past are totally irrelevant to any
decision that is being made 'now'. Such costs
are past costs or sunk costs.
Costs that have been incurred include not only
costs that have already been paid, but also
costs that have been committed. A committed
cost is a future cash flow that will be incurred
anyway, regardless of the decision taken now.
Relevant Cash Flows

Relevant costs are cash flows.
Only cash flow information is
required. This means that costs
or charges which do not reflect
additional cash spending (such
as depreciation and notional
costs) should be ignored for the
purpose of decision-making.
Relevant Cash Flows

The cost associated with one
additional unit of production. also
called marginal cost.
Incremental cost is the overall
change that a company experiences
by producing one additional unit of
good.
Differential costs and opportunity

costs
Relevant costs are also differential costs and
opportunity costs.
Differential cost is the difference in total
cost between alternatives.
An opportunity cost is the value of the
benefit sacrificed when one course of
action is chosen in preference to an
alternative.
For example, if decision option A costs $300 and
decision option B costs $360, the differential
cost is $60.
Example: Differential costs and

opportunity costs
Suppose for example that there are three options,
A, B and C, only one of which can be chosen. The
net profit from each would be $80, $100 and $70
respectively.
Since only one option can be selected option B
would be chosen because it offers the biggest
benefit.
Profit from option B
100
Less opportunity cost (ie the benefit from the most
profitable
alternative, A)
80
Differential benefit of option B
Relevant Cash Flows-Sunk costs

-
A sunk cost is a past cost which is not directly

relevant in decision making.
Example:
An example of a sunk cost is development costs which
have already been incurred. Suppose that a company has
spent $250,000 in developing a new service for
customers, but the marketing departments most recent
findings are that the service might not gain customer
acceptance and could be a commercial failure.
The decision whether or not to abandon the development
of the new service would have to be taken, but the
$250,000 spent so far should be ignored by the decision
makers because it is a sunk cost.
Relevant Cash Flows

Committed cost
A cost which has not yet been paid, but an
agreement, such as a purchase order or
contract, has been made that the cost will be
incurred.
Discretionary fixed costs, for example,
advertising and research and development
costs can be thought of as being controllable
because they are incurred as a result of
decisions made by management and can be
raised or lowered at fairly short notice.
Relevant Cash Flows
Relevant Cash Flows Materials
Relevant Cash Flows Labour
Relevant Cash Flows Labour
Other Relevant Costs

The Relevant cost of overheads is only that which varies as a
direct result of the decision taken.
Fixed Assets
Relevant costs are treated as if related to materials
If P+M is to be replaced, then relevant cost = current
replacement cost
If P+M not to be replaced, then relevant cost is higher of :
Sales proceeds (if sold)
Net cash inflows arising from use of the asset (if not
sold).
Chapter 10
Dealing with Limiting Factors
Single Limiting factor

A limiting factor is a factor
that prevents a company
achieving the level of
activity it would like to.
Scarce resources are

where one or more of
the manufacturing
inputs needed to make
a product are in short
supply.
Multiple Limiting factor

Linear
Programming is
the technique
used to establish
an optimum
product mix when
there are two
more resource
constraints.
Finding the solution

Method 1
Finding the solution

Method 2
Chapter 11
Job. Batch and Process Costing
Job Costing
PROFIT can be a
mark-up on cost, or
a margin (%).
Batch Costing
PROFIT can be a
mark-up on cost, or
a margin (%).
Introduction to process costing

Process costing
It is a costing method used where it is not
possible to identify separate units of production,
or jobs, usually because of the continuous nature of the
production processes involved.
It is common to identify process costing with
continuous production such as the following.
Oil refining
Foods and drinks
Paper
Chemicals
Process costing may also be associated with the
continuous production of large volumes of lowcost items, such as cans or tins.
Features of process costing

The output of one process becomes the
input to the next until the finished
product is made in the final process.
The continuous nature of production in many
processes means that there will usually be
closing work in progress which must be
valued. In process costing it is not
possible to build up cost records of the
cost per unit of output or the cost per unit of
closing inventory because production in
progress is an indistinguishable
homogeneous mass.
Features of process costing

There is often a loss in process due to
spoilage, wastage, evaporation and so
on.
Output from production may be a single
product, but there may also be a by-product
(or byproducts) and/or joint products.
Framework for dealing with process

costing
Process costing is centered around four
key
steps.
Step 1 Determine output and losses
Step 2 Calculate cost per unit of
output, losses and WIP
Step 3 Calculate total cost of
output, losses and WIP
Step 4 Complete accounts

costing
Step 1
Determine output and losses.
This step involves the following.
Determining expected output
Calculating normal loss and
abnormal loss and gain
Calculating equivalent units if there
is closing or opening work in progress

costing
Step 2
Calculate cost per unit of output,
losses and WIP. This step
involves calculating cost per unit
or cost per equivalent unit.

costing
Step 3
Calculate total cost of output,
losses and WIP. In some
examples this will be
straightforward; however in cases
where there is closing and/or opening
work-in-progress a statement of
evaluation will have to be
prepared.

costing
Step 4
Complete accounts. This step
involves the following.
Completing the process account
Writing up the other accounts
required by the question
Losses in process costing
Introduction
Losses may occur in process. If a
certain level of loss is expected,
this is known as normal loss. If
losses are greater than expected,
the extra loss is abnormal loss. If
losses are less than expected,
the difference is known as
abnormal gain.
Normal loss is the loss expected during

a process. It is not given a cost.
Abnormal loss is the extra loss resulting
when actual loss is greater than normal or
expected loss, and it is given a cost.
Abnormal gain is the gain resulting
when actual loss is less than the normal
or expected loss, and it is given a
'negative cost'.
Since normal loss is not given a cost, the

cost of producing these units is borne by
the 'good' units of output.
Abnormal loss and gain units are valued at
the same unit rate as 'good' units.
Abnormal events do not therefore affect
the cost of good production. Their costs
are analyzed separately in an
abnormal loss or abnormal gain
account.

Example: abnormal losses and gains
Suppose that input to a process is 1,000

units at a cost of $4,500. Normal loss is
10% and there are no opening or closing
stocks. Determine the accounting entries
for the cost of output and the cost of the
loss
if actual output were as follows.
(a) 860 units (so that actual loss is 140 units)
(b) 920 units (so that actual loss is 80 units)
Solution
If actual output is 860 units and the actual loss is 140
units:
Units
Actual loss
140
Normal loss (10% of 1,000)
100
Abnormal loss
40
Step 2 Calculate cost per unit of output and losses
The cost per unit of output and the cost per unit of
abnormal
loss are based on expected output.
Cost incurred
= $4,500 = $ 5 pu
Expected output
900 units
Solution
Step 3 Calculate total cost of output
and losses
Normal loss is not assigned any cost.
Cost of output (860 x$5)
Normal loss
Abnormal loss (40 x $5)
$
4,300
0
200
4,500
Solution
PROCESS ACCOUNT
Units $
Units
$
Cost incurred 1,000 4,500
Normal loss
100
0
Output
(finished
goods a/c)
860 ($5) 4,300
Abnormal loss
40 ($5)
200
1,000 4,500
Solution
ABNORMAL LOSS ACCOUNT
Units $
Units
$
Process account 40 200
Income statement
40
200
.
40
40 200
200
Example: Abnormal losses and

gains again
During a four-week period, period 3, costs of input

to a process were $29,070. Input was 1,000 units,
output was 850 units and normal loss is 10%.
During the next period, period 4, costs of input were
again $29,070. Input was again 1,000 units, but
output was 950 units.
There were no units of opening or closing inventory.
Required
Prepare the process account and abnormal loss or gain
account for each period.
Solution
Period 3
Actual output
Normal loss (10% x 1000)
Abnormal loss
Input
Units
850
100
50
1,000
Solution
Period 4
Units
Actual output
950
Normal loss (10% x 1000)
100
Abnormal gain
(50)
Input
Solution
Step 2 Calculate cost per unit of
output and losses
For each period the cost per unit is
based on expected output.
= Cost of input
Expected units of output
= $29,070/ 900 units = $32.30pu
Solution
Step 3 Calculate total cost of output and losses
Period 3
$
Cost of output (850 x $32.30)
Normal loss
Abnormal loss (50 x $32.30)
27,455
0
1,615
29,070
Period 4
Cost of output (950 x$32.30)
Normal loss
Abnormal gain (50 x $32.30)
30,685
0
1,615
29,070
Solution
PROCESS ACCOUNT
Period 3
Units $
Units
$
Normal loss
100
0
Output (finished
goods a/c
@$32.30)
850
27,455
Ab Loss @$32.30
50
16,15
Solution
PROCESS
Period 4
Units $
Units
$
0
Abnormal gain a/c
@$32.30
50
1,615
950
ACCOUNT
Normal loss
100
Output (finished
goods a/c
@$32.30)
30,685
Ab Loss @$32.30
1,050 30,685
Solution
ABNORMAL LOSS ACCOUNT
Units $
Units
$
Period 3
Period 4
Abnormal loss 50 1,615
Abnormal gain in
50
1,615
in process A/c
process A/C
.
50
50
1,615
1,615
Solution
A nil balance on this account will be
carried forward into period 5.
If there is a closing balance in the
abnormal loss or gain account when the
profit for the period is calculated, this
balance is taken to the income statement.
an abnormal gain will be a credit to the
income statement and an abnormal loss
will be a debit to the income statement.
Losses with scrap value

Scrap is 'Discarded material having
some value.'
Loss or spoilage may have scrap value.
The scrap value of normal loss is
usually deducted from the cost of
materials.
The scrap value of abnormal loss (or
abnormal gain) is usually set off
against its cost, in an abnormal loss
(abnormal gain) account.

As the questions that follow will show, the three
steps to remember are these.
Step 1 Separate the scrap value of normal loss
from the scrap value of abnormal loss or
gain.
Step 2 In effect, subtract the scrap value of normal
loss from the cost of the process, by crediting it to
the process account (as a 'value' for normal loss).
Step 3 Either subtract the value of abnormal
loss scrap from the cost of abnormal loss, by
crediting the abnormal loss account.

3,000 units of material are input to a
process. Process costs are as follows.
Material $11,700
Conversion costs $6,300
Output is 2,000 units. Normal loss is 20%
of input.
The units of loss could be sold for $1 each.
Required:
Prepare appropriate accounts.

Step 1 Determine output and
losses
Input
3,000 units
Normal loss (20% of 3,000)
600 units
Expected output
2,400 units
Actual output
2,000 units

Step 2 Calculate cost per unit of output and
losses
$
Scrap value of normal loss
600
Scrap value of abnormal loss
400
Total scrap (1,000 units x $1)
1,000
Cost per expected unit = $(11,700-600)+ $6,300
2,400
= $7.25

Step 3 Calculate total cost of
output and losses
$
Output (2,000 x $7.25)
14,500
Normal loss (600 x$1)
600
Abnormal loss (400 x $7.25)
2,900
Solution
PROCESS ACCOUNT
Period 3
Units $
Units
$
Normal loss
100
0
Output (finished
goods a/c
@$32.30)
850
27,455
Ab Loss @$32.30
50
16,15
Solution
PROCESS
Period 4
Units $
Units
$
0
Abnormal gain a/c
@$32.30
50
1,615
950
ACCOUNT
Normal loss
100
Output (finished
goods a/c
@$32.30)
30,685
Ab Loss @$32.30
1,050 30,685
Process Costing - Features
FIND A COST PER UNIT
VALUE CLOSING STOCK
Process Costing Losses &

Gains
Steps for answering

questions
WIP Equivalent Units
WIP Equivalent Units

AVCO
Opening Inventory
Values are added
to current costs to
provide overall
average cost per
unit
2 Methods
FIFO
Opening WIP Units

are completed
first.
Process Costs in
the period
allocated
between :
Opening WIP
units
Units started &
completed in
Losses part way through production
Joint and by-products
Joint and by-products
Accounting
Treatment
Chapter 12
Service and Operation Costing
Service & operation costing
Suitable Cost Units
Service
Possible Cost Unit
Hotel
Cost per guest per night
Transport
Cost per passenger mile
College
Cost per student
Hospital
Cost per patient day / cost per

procedure
Service Cost Analysis
Labour may be the

only direct cost
OH likely to be
absorbed using labour
hours
Chapter 13
Budgeting
Budgets and Budgeting
A quantitative expression of a plan of

action prepared in advance. It sets out
the costs and revenues that are expected
in future periods.
Budgeting is a process to construct a
quantitative model of how our business
might perform financially if certain
strategies, events and plans are carried
out.
Purpose
Communication of
targets
Co-ordinating
Activities
Purpose
Purpose of
of
Motivatio
n
Budgeting
Budgeting
Planning for the

future
Controlling Costs
Performance
Evaluation
Authorisation of
expenditure
Components of the Budget
Planning for The Future
It can provide the basis for detailed

sales targets.
It can provide staffing plans.
It can be a document to buy and
maintain inventory levels
it can be use to set production Plans
It
can
be
used
for
cash
investment/borrowing,
capital
expenditures (for plant assets, etc.),
and on and on
Performance Evaluation
Budgets provide benchmarks against
which to compare actual results and
develop corrective measures.
Controlling Costs
It can be used to control costs because
standards are set in advance for each
expenditure and managers are aware
about the limits.
Authorization of Expenditure
Budgets give managers pre
approval " for execution of spending
plans.
Communication of Targets
A budget document is a best way to
communicate
targets
to
the
departments of organization
Like:
sales,
Purchase,
Finance,
manufacturing, Store and so on
Co-ordinating
Activities
A comprehensive budget usually
involves all segments of a business.
As a result, representatives from
each unit are typically included
throughout the process.
Motivation
It gives a forward looking guidance
to managers and employees
Budgets don't guarantee success,

but they certainly help to avoid
failure.
Without a budget, an organization
will
be
highly
inefficient
and
ineffective.
Functions of a budget 1
A budget has two main roles to compel planning
and to establish a system of control
Planning
Force management to look ahead
Establish formal system of communicating plans
and ideas usually
Co-ordinate activities
Quantify an organisations objectives
Slide 251
Functions of a budget 2
Control
Compare with actual results
Provide a framework for responsibility accounting
Motivate employees to improve their performance
Slide 252
Computers and budgeting 1

Computers are used in budgeting to process large
amounts of data and recalculate changes in key
variables
They can also be used to evaluate different options
and carry out what if analysis
Spreadsheets and programs are used
Slide 253

Spreadsheets
Advantages
Forecasting different projections can be input
Tax the tax associated with various options can be
easily calculated
Profit projections figures can be changed to deal
with a variety of options and their associated profit
Easy to use Excel can be learnt quickly and is
easy to share with others in the organisation
Slide 254

Spreadsheets
Disadvantages
Danger of corruption of data or variables
Cannot incorporate qualitative factors
Minor errors can creep in the output is only as
good as the input
Slide 255
Flexible budgets 1
Fixed budgets are budgets which are set for a
single activity level.
Master budgets are fixed budgets
Flexible budgets are budgets which, by
recognising different cost behaviours patterns,
change as activity levels change
Slide 256
Flexible budgets 2
To prepare a flexible budget:
Decide whether costs are fixed, variable or semivariable
Split semi-variable costs using the high/low method
Calculate the budget cost allowance for each item
= budgeted fixed cost* + (number of units
variable cost per unit)**
* nil for variable cost ** nil for fixed cost
Slide 257
Behavioural effects of
budgets/motivation 1
Budgets as targets
Can standards and budgets, as targets, motivate
managers to achieve a high level of performance?
There are a number of ways in which
standards can be set:
Ideal standards are de-motivating because
adverse efficiency variances are always reported.
Low standards are de-motivating because there is
no sense of achievement in attainment, no impetus
to try harder.
Slide 258
budgeting/motivation 2
A target must fulfil certain conditions if it is to
motivate employees to work towards it:
Sufficiently difficult to be challenging
Not so difficult that it is not achievable
Accepted by employees as their personal goal
Slide 259
Decision making
Organisational goals = employees goals
Goal congruence
If managers goals organisational goals leads to
dysfunctional decision making
A well-designed control system can help to
ensure goal congruence
continuous feedback prompting appropriate
control action should steer the organisation in the
right direction
Slide 260
There tend to be three budget setting styles:
Imposed (from the top down)
Participative (from the bottom up)
Negotiated
Slide 261
Imposed approach
Advantages
Enhance co-ordination between strategic plans and
divisional objectives
Less time-consuming
Disadvantages
Imposed so can be de-motivational
Lower-level initiatives may be stifled
Does not suit some employees
Slide 262
Participative approach
Advantages
More realistic budgets
Co-ordination, morale and motivation improved
Increased management commitment to objectives
Disadvantages
More time-consuming
Budgetary slack may be introduced
Does not suit some employees
Slide 263
Behavioural aspects of
In practice final budgets are likely to lie between
what top management would really like and what
junior managers believe is feasible
Slide 264
An important source of motivation to perform
well (to achieve budget targets, to eliminate
adverse variances) is being kept informed
This will mean being kept informed about how
actual results are progressing compared with
target.
The information feedback about actual results
should have the qualities of good information.
Clear and comprehensive reports
Significant variances highlighted for
investigation
Timely reports
Slide 265
Example
A production manager may be encouraged to
achieve and maintain high production levels and to
reduce costs
Particularly if a bonus is linked to these factors.
Such a manager is likely to be highly motivated.
The effect on the organisation, with the need to
maintain high production levels, could lead to slowmoving inventory
This could result in an adverse effect on cash flow
Slide 266
Principal Budget Factor

The first thing is to decide where to start. For
most companies starting point will be a sales
budget. Once it has been decided how many
units the company expects to sell it is then
possible to produce a production budget and
so on.
However this will not always the starting point.
Suppose a company produce desks for which
wood is the main material.
Suppose also that in the coming year there
will be limited supply of wood. In this case
starting point will be to budget the amount of
wood available, then production budget and
then sales budget.
Principal Budget Factor

In general terms, the first budget to be
prepared should be whatever factor it is
that limit the growth of the company. It
may be level of demand or may be
availability of raw material.
This factor that limits the company is
known as the principal budget factor.
The management accountant needs to
identify the principal budget factor and it
is this factor that will be budget first.
Preparing Budgets
Different types of budgets

The Master Budget includes the budgeted
income statement, the cash budget and budgeted
statement of financial position (Balance Sheet).
A continuous budget is prepared for a year (or
budget period) ahead, and is updated regularly by
adding a further accounting period (month,
quarter) when the first accounting period has
expired ( Rolling Budgets).
Functional budgets
Functional budgets
Functional budgets
The XYZ company produces X, Y, Z. For the coming

accounting period budgets are to be prepared using
the following information.
Budgeted Sales of Product X 2000 Units at $100 ,
Product Y 4000 units at $130 and Product Z 3000 units
at $150
Usage: X use 5kg (pu) of wood, 2liters (pu) of
varnish, Y use 3kg (pu) of wood, 2 liters(pu) and Z 2kg
(pu) of wood and 1liter (pu) of Varnish. Standard cost
of wood is $8/kg and Varnish is $4 per liter
Inventories of finished goods
X
Y
Z
Opening
500u 800u
700u
Closing
600u 1000u
800u
Inventories of raw material
Wood (kg)
Varnish (liters)
Opening
21,000
10,000
Closing
18,000
9,000
Example
Prepare the following budgets
1) Sales Budget (quantity and value)
2) Production Budget (units)
3) Material Usage Budget(quantities)
4) Material Purchase Budget(quantities and
values)
5) Labour budget(hours and values)
Example 2
A ltd manufactures three products. The expected
sales of each product are shown below.
Product 1 Product 2 Product 3
Sales in units
3000
4500
3000
Opening inventory is expected to be
Product 1 500u
Product 2 700u
Product 3 500u
Management have stated their desire to reduce
inventory level and closing inventor is budgeted as
Product 1 200u
Product 2 300u
Product 3 300u
Prepare the budget for the number of units to
.be produced of Product 1, 2 and 3
C ltd manufactures three products. The expected

production of each product is shown below.
Product 1
Product 2 Product 3
Budgeted production in units
2700
4100
2800
The three type of material are used in varying
amount in the manufacture of the three products.
Material requirement are shown below
Product 1
Product 2 Product 3
Material M1 (kg)
2
3
4
Material M2 (kg)
3
3
4
Material M3 (kg)
6
2
4
The opening inventory of material is expected to be
Material M1 (kg)
4300
The closing inventory of material is expected to be

Material M1 (kg)
2200
Material M2 (kg)
1300
Material M3 (kg)
2000
Material prices are expected to be 10% higher than
this year and current prices are $1.10/kg for material
M1, $3.00/kg for material M2 and $2.50/kg fort
material M3
Prepare a budget of material usage, material
purchase and value of M1, M2 and M3.
Example
Example - continued
Fixed budgets
Fixed
budgets
remain
unchanged
regardless of the level of activity.
A fixed budget is a budget which is
normally set prior to the start of an
accounting period, and which is not
changed in response to changes in activity
or costs/revenues.
Flexible budgets
A flexible budget is a budget which is
designed to change as volume of activity
changes.
Flexible budgets are prepared using
marginal costing and so mixed costs must
be split into their fixed and variable
components (possibly using the high/low
method).
Fixed and flexible budget

Comparison of a fixed budget with the
actual results for a different level of
activity is of little use for budgetary
control purposes.
Flexible budgets should be used to
show what cost and revenues should
have been for the actual level of activity.
Differences between the flexible budget
figures and actual results are variances.
Example
A ltd manufacture one product and when operating at 100%
capacity can produce 5,000 units per period. But in last few
periods operating below capacity.
Below is the flexible budget prepared at the start of the last
period for three activity levels
Level of activity
70%
80%
90%
$
$
$
Direct material
7000
8000
9000
Direct labour
28000
32000
36000
Production overheads
34000
36000
38000
Admin and selling Overheads 15000
15000
15000
Total cost
84000
91000
98000
In the event, last period turned out to be even

worse than expected with 2500 units
production only. The following cost incurred
Direct material
4500
Direct labour
22000
Production overheads
28000
Admin Expense
16500
Total cost
71000
Required
Use the information given above to
prepare the following
a)A flexed budget for 2,500 units.
b) A budgetary control statement.
Chapter 14
Standard Costing
The purpose of standard

costing
Standard Costing is a control tool
for management.
Standard Costs are collected on a
standard cost card. They may be
based on Absorption Costing or
Marginal Costing.
Advantages & Disadvantages of

Standard Costing
Types of standard
Ideal
What would be expected under perfect operating conditions
Attainable
What would be
expected under
normal operating
conditions
Types of Standards
Basic
A standard left
unchanged from
period to period
Current
A standard adjusted for specific issues relating to the current period
Variance
A variance is the difference between a
planned, budgeted, or standard cost and
the actual cost incurred.
The same comparisons may be made for
revenues.
The process by which the total difference
between standard and actual results is
analysed is known as variance analysis.
Variance
Variances can be divided into three
main groups.
1. Sales variances
2. Variable cost variances
3. Fixed production overhead variances
Variance Calculations
Are we working with a marginal or absorption costing
system?
Sales
Volume
Variance
Marginal Costing
Absorption Costing
(Budgeted Sales Actual

Sales) x standard
contribution/unit
(Budgeted Sales Actual Sales) x

standard profit / unit
Standard Selling Price is not used. When volume changes, so do production costs,
and the purpose of the variance is to show the impact on profit or on contribution
Fixed
MC does not relate fixed o/h to
overhead cost units fixed overhead is a
variances period
cost.
No
fixed
overheads
volume
variance.
Fixed o/h are related to cost units by

using absorption rates.
The Fixed overhead total variance is
equal to the over- or underabsorption of overheads.
The
fixed
overhead
expenditure variance is the The FO Volume variance can be
difference
between
actual further subdivided into efficiency &
expenditure
&
budgeted capacity variances.
expenditure. It is the total
variance.
Sales Price Variance

Sales Price Variance
(Budgeted Sales Price Actual Sales

Price)
X
Actual Quantity sold
Sales Variance
Sales Volume Variance
(Budgeted Sales Actual Sales)

X
Standard profit
Sales Variance
The following data relate to 2008
Actual sales 1000 units @ $650 each
Budgeted output and sales for the year 900 units
Standard selling price $700 per unit
Budgeted contribution per unit $245
Budgeted profit per unit $205
Calculate
sales volume variance (under marginal and
absorption costing) and the sales price
variance.
Direct Material Variances

Direct Material Price Variance
It is the difference between the actual cost
of direct material and the standard cost of
quantity purchased or consumed.
Direct Material Usage Variance
It is the measure of difference between the
actual quantity of material utilized during
a period and the standard consumption of
material for the level of output achieved.
Direct Material Cost

Product X has a Variances
standard direct material cost as
follows.
10 kilograms of material Yellow at $10 per
kilogram = $100
per unit of X.
During period 4, 1,000 units of X were
manufactured,
using 11,700 kilograms of material Yellow which
cost $98,600
Required
Calculate the following variances.
(a) The direct material total variance
(b) The direct material price variance
Direct Labour Cost

Variances
Direct Labor Rate Variance

actual cost of direct labor and the
standard cost of direct labor utilized during
a period.
Direct Labor Efficiency Variance
standard cost of actual number of direct
labor hours utilized during a period and
the standard hours of direct labor for the
level of output achieved.
Direct Labour Cost

The standard directVariances
labour cost of product X is as follows.
2 hours of grade Z labour at $5 per hour = $10 per unit of
product X.
During period 4, 1,000 units of product X were made, and
the direct labour cost of grade Z labour was $8,900 for
2,300 hours of work.
Required
(a) The direct labour total variance
(b) The direct labour rate variance
(c) The direct labour efficiency (productivity) variance
Idle time variances

It occurs when labour is available for
production but is not engaged in active
production. e.g. shortage of work or
material.
The cost of this can be highlighted
separately in an idle time variance, so
that:
it is not hidden in an adverse labour
efficiency variance.
& management attention can be directed
towards the cost of idle time.
Example Idle time variance

Of the 8,722 hours of direct labour paid for, 500
hours were idle because of a shortage of material
supplies. Labour is paid at $6 per hour.
An idle time variance could be calculated as follows:
Idle time variance= Idle hours X standard labour rate per
hour
= 500hors X $6
= $3,000 (A)
Variable Overhead
variances
Variable overhead expenditure variance
It reveals how much of the variable overhead
total variance was caused by paying a different
hourly rate of overhead for the hours worked.
Variable overhead efficiency variance
The variable overhead efficiency variance
reveals how much of the variable overhead total
variance was caused by using a different
number of hours of labour, compared with the
standard allowance for the production achieved.
Variable Overhead
variances
Variable Overhead expenditure

Variance
Actual o/h cost incurred (actual hrs worked X variable OAR

per hour)
Variable overhead efficiency

Variance
(Actual hours worked X variable OAR)
(Actual production in standard hrs X variable OAR per hour)
Variable Overhead
variances
Suppose that the variable production overhead cost of
Product X is as follows.
2 hours at $1.50 = $3 per unit
During period 6, 400 units of product X were made. The
labour force worked 760 hours. The variable overhead cost
was $1,230.
(a) The variable overhead total variance
(b) The variable production overhead expenditure variance
(c) The variable production overhead efficiency variance
Solution
Fixed Overhead Variances

Absorption Costing
Fixed
Fixed Production
Production Overheads
Overheads Total
Total
Variance
Variance
Expenditur
Expenditur
e
e Variance
Variance
Volume
Volume
Variance
Variance
Efficienc
Efficienc
y
y
Variance
Variance
Capacity
Capacity
Variance
Variance

Absorption Costing
UnderUnder- or
or over-absorption
over-absorption of
of
overheads
overheads
Budgeted
Budgeted FOH
FOH
Actual
Actual FOH
FOH
(Actual
(Actual Production
Production
in
in standard
standard hours
hours xx
OAR)
OAR) Budgeted
Budgeted
FOH
FOH
(Actual
(Actual hours
hours
taken
taken
standard
standard
hours
hours for
for
output
output
(Actual
(Actual Hours
Hours
worked
worked
budgeted
budgeted
hours
hours worked)
worked)
xx OAR
OAR

Marginal Costing
Fixed
Fixed Production
Production Overheads
Overheads Total
Total
Variance
Variance
Expenditur
Expenditur
e
e Variance
Variance
Causes of Variances
Causes of Variances

Cost and Management

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Cost and Management

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Management Accounting

The nature and purpose of

The nature and purpose of

Data and information

Planning, decision making

Strategic, tactical and operational

Managers to plan & control areas of performance on which they

Responsibility centres Examples

costs are collected, is called:

Management Accounting vs.

Cost Accounting and Management

Management Accounting vs.

Management Accounting vs.

Management Accounting vs.

External users e.g.

To aid planning, control

Yes (limited companies)

Limited companies must

Financial & nonfinancial

Historical & forwardlooking

Mainly an historical record

Types of cost and cost behaviour

Total product/service costs

Direct and indirect costs

Direct Costs-Direct material

Direct Costs-Direct labour

Direct Costs-Direct expense

Direct and Indirect costs

(b) Administration costs. These are costs associated with

Classification in this way is known as classification by

Fixed and Variable Costs

Cost Behaviour variable

Cost behaviour Fixed Costs

Cost behaviour Fixed Costs

Cost behaviour Semi variable

Cost behaviour Hi-low

Costs are analysed into variable & fixed

Analysis of cost into fixed and variable

Example: The high-low method

High/low method with stepped fixed costs

The high/low method can still be used to estimate the

Adjustments need to be made for the fixed costs

Example: The high-low method

Before we can compare high output

High Low method with changes in the variable

High Low method with changes in the variable

Variable cost per unit is constant within this range of

Equation for the total cost function

Equation for the total cost function

Question 1: Total Cost

Question 2: Total Cost

Question 3: Total Cost

Question 4: Total Cost Function

A unit of product or service in relation to

p = probability of outcome occurring

When using Expected Values :

Expected Values - Example

Expected Values Limitations

Use past data and estimates, which may be inaccurate