DAY- 1

Revision- MA Topics -:
• Cost Classification

• Costing Techniques

• Budgeting

• Variance Analysis

Uses of Cost per Unit:

Value Inventory
Used to value inventory in the Statement of Financial Position (Balance Sheet)

Record Costs
Cost are recorded in the Statement of Profit or Loss

Price Products
Helps in pricing products.
E.g., Cost = $0.30 → Price = $0.50 → Profit = $0.20

Make Decisions
Used to decide which products to make and in what quantities

Formulae: Management Accounting

Prime Cost
= Direct Material Direct Labour Direct Expense

Production Cost
= Prime Cost Production Overheads

Total Cost
= Production Cost Non-Production Overheads

Conversion Cost
= Direct Labour Direct Expenses Production Overheads
 Standard Costing:
Standard costing is a technique that assigns pre-determined (standard) costs to products or services.

Types of Standards:

1. Ideal Standard
Based on perfect operating conditions
No allowance for wastage, no scrap, no idle time, no breakdowns, no inefficiencies
No motivation, but not realistic as a result employee feel impossible to acheive

2. Attainable Standard
Based on efficient but realistic performance
Includes normal losses & delays
Most commonly used in businesses, motivate employees to work harder

3. Basic Standard
Set for long-term use which remain unchanged over period of time.
Rarely changed, may demotivate employees if, over time, become too easy to achieve,
Used for measuring trends over time

4. Current Standard
Based on current working conditions
Updated regularly
Useful for short-term planning and control, useful when current conditions are abnormal,

Purposes of Standard Costs

1. Cost Control
Compare standard vs actual costs to identify variances

2. Planning-Budgeting
Used as a basis for preparing budgets

3. Performance Evaluation
Measures efficiency of workers, machines, and departments
 4. Inventory Valuation
Standard costing helps companies fix a cost (example: $10 per unit) for all products.
So when a company wants to know how much their stock is worth, they just multiply:

Standard cost × Number of units

5. Accounting Simplification
Instead of recording actual cost of every unit (which may be different every time), company
uses standard cost in their accounting.

Standard Costing is Most Suited to:

Mass Production of homogenous products
Less human intervention
Repetitive Work

Why? : Repeated production helps determine average resource usage.

Less Suited to:

non-homogenous products
High human intervention or customization
Changing processes or small-scale production

Terms in Budgeting:

1. Fixed Budget
Prepared before the period
For one level of activity only
Does not adjust for actual output

2. Flexible Budget
Also prepared before the period
Prepared for multiple activity levels
Requires splitting costs into fixed & variable

3. Flexed Budget
Prepared after the period ends
Based on actual output
Gives a realistic comparison between budgeted & actual results

Notes: Compares actual results vs budgeted results, difference is known as Variance

Types of Variance:

Favourable Variance (F)

Actual results are better than expected
E.g., Higher revenue or lower cost

Adverse Variance (A)

Actual results are worse than expected
E.g., Lower revenue or higher cost
 Traditional Costing Methods:

1. Marginal Costing (MC)

Only variable costs are included in unit cost
Fixed costs are treated as a period cost charged against contribution (not included in inventory)
Helps understand cost behavior & decision-making (cost control, which product to produce in case of limited resources, Make or Buy Decisions & special order)

Profit depends only on sales volume, not inventory. Profits will increase as sales volume rises.
Closing inventory value = Lower (no fixed cost included)
 2. Absorption Costing (AC)
All costs (fixed + variable) are included in unit cost
Fixed production overheads are absorbed into inventory
Used for financial reporting
Profit is affected by change in inventory levels
Higher closing inventory = Higher profit

Note: Direct Costs (i.e Direct Materials & Direct Labour) is Easy to estimate but Production Overheads is Hard to estimate. So,
need a method to absorb overheads into each unit.

Overhead Absorption Bases:

• Units produced
• Labour hours
• Machine hours

Key Assumption:
Overhead costs are linked to production volume
 Under- and Over-Absorption:
An estimated rate that we calculate in advance to apply overhead costs to each unit of production
known as OAR.

Why we use OAR?

1. Smooth out seasonal fluctuations

➤ Some overhead costs (like electricity, heating, maintenance) go up in winter or down
in summer.
➤ Instead of changing the unit cost every month, we use one average rate for the whole
year.
➤ This makes costs more stable and consistent.
 2. Enable unit cost to be calculated quickly
➤ Since the rate is already set, we don’t wait for actual costs each time.
➤ We can calculate product cost immediately — useful for pricing, budgeting, and
decision-making.

If either or both of the actual overhead cost or activity volume differ from budget, the use of this rate is
likely to lead to under absorption or over-absorption of overheads.

Under-absorption
Overheads absorbed < actual overheads
Costs underestimated
Leads to understated product cost

Over-absorption
Overheads absorbed > actual overheads
Costs overestimated
Leads to overstated product cost
 Advantages and Disadvantages of Absorption Costing
Advantages:
Includes fixed overheads in inventory values (IAS 2)
Useful for analysing under/over absorption of overheads (cost control)
Best for small organisations to estimate job costs and profits

Disadvantages:
More complex than marginal costing
Does not provide useful info for decision making like marginal costing

Advantages and Disadvantages of Marginal Costing

Advantages:
Contribution per unit is constant (unlike profit, which changes with sales volume)
No under/over absorption of overheads → no adjustment in profit or loss
Fixed costs treated as period costs → charged fully in the period
Helps in decision-making
Simple to operate

Disadvantage:
Closing inventory not valued as per IAS 2
Fixed production overheads are not included in inventory cost