Actual and Expected costs
Expected costs are estimates or predictions of what should happen in the
future. They are also referred to as budgets.
Whole organisation budget may be broken down into different
departments: Production, sales, administration and so on.
Budgets for each department may be broken down into different costs:
materials, labour, overheads and so on.
Each cost budget may be broken down into further detail and/or by time:
hours, days, weeks and so on.
Materials costs is the cost of ingredients for the product that you are going
to make.
Labour Costs. Work out how many hours you need, then multiply by the
labour rate per hour.
Overheads are budgeted as part of the overall costs of a business. Fixed
overheads e.g. rent and heating of a building.
What is costing?
Working out the costs for an organisation.
Costs incurred by the business making products or providing services.
The Need for costing?
Set selling prices.
Monitor and control expenditure.
Plan.
Costs are usually worked out for a unit or in total for over a period of time.
Management accounting.
Accounting data for internal use.
Future financial planning.
Budgets and forecasts.
Detailed financial information.
Format set by organisation in line with internal requirements.
Financial Accounting
Accounting data for external use.
Past financial performance.
Formal financial statements.
Summaries of the accounts.
Format required by external rules and regulations.
Elements of Cost
Materials
Labour
Expenses (overheads)
Materials- Physical things that are used to make a product or to provide a
service.
Labour- The cost of paying people to make a product or provide a service.
Expenses- The costs of providing everything that isn’t either material or
labour.
Calculating the cost of one unit of output:
Cost of 1 unit = materials + Labour + Expenses
Direct Costs- Can be identified directly with each unit of output.
Indirect Costs- Cannot be identified directly with specific units of output.
Direct Materials- Go into the manufacture of the product.
Indirect materials- More remote from the final product or service.
Direct Labour- Cost of employing people who are directly involved with
making products or providing services.
Indirect Labour- Cost of employees who are a stage further away from the
product or service.
Indirect Expenses- Relate to the organisation as a whole. Also related to as
overheads.
Direct Materials + Direct Labour = Direct Cost
Direct and indirect costs also apply to service providers.
All examples of expenses are indirect costs.
Function analysis is when the costs are separated into their functions.
Production normally takes place in the factory.
Direct, e.g. the cost of raw materials.
Indirect, e.g. the cost of factory heating.
Non-Production occurs where support functions take place. These Costs
are indirect. Administration, sales and distribution, finance.
Summary:
-Production Costs can be direct or indirect.
- Non-production costs are always indirect.
- Materials and labour costs can be direct or indirect.
-Expenses are nearly always indirect.
Analysing credit.
Identify the appropriate cost centres, profit centres and investment
centres.
Coding Systems.
The use of a series of numbers and/or letters to identify data. E.g. car
registrations, post codes and national insurance numbers. In the business
world, stock codes and cost classification codes.
Revenue centres- sections of a business to which income can be
identified. Only concerned with revenue, not costs.
Cost centres- Need to be monitored to see how much they cost to run.
Profit Centres- Can collect income as well as costs, and work out the profit
for that part of the business.
Investment Centres- Collect income and costs. Record investment in that
part of the business. Can compare the profit with the amount instead.
Absorption overheads.
The indirect production cost of an organisation are added together and
then spread over the units of output.
Three methods of absorbing production overheads:
-units of output method
-Direct labour hours method
-machine hours method.
All use budgeted data to calculate overhead absorption rate.
Units of output method.
Only really suitable for when all the products made are the same or
similar.
Calculation : Budgeted overheads / budgeted units of output= absorption
rate per unit.
Direct labour hours method
Useful when a range of different products are made in a labour intensive
way. Absorption rate is calculated for each labour hour.
Calculation: Budgeted overheads / budgeted direct labour hours =
absorption rate per direct labour hours.
Machine hours method.
Useful when a range of different products are made in a machine intensive
factory. Absorption rate is calculated for each machine hour used.
Calculation: Budgeted overheads / budgeted machine hours = absorption
rate per machine hour.
Cost behaviour
What happens to costs when the level of output changes.
Three Types:
-fixed costs (and stepped costs) The totals stay the same when the output
changes within a range of activity.
-Variable costs. The totals change in proportion to the output.
- Semi variable costs. Part of the cost behaving as a fixed cost. Part of the
cost acting as a variable cost.
Fixed cost behaviour.
Do not vary when the level of output or activity changes within a range.
May ‘step up’ to a different amount outside the range.
Examples include Rent on premises, insurance.
Fixed cost per unit = fixed costs / number of units produced.