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Questions and Answers
What is the cost of raw materials used in the production or service process?
What is the cost of raw materials used in the production or service process?
What is the total of Material Cost, Labour Cost, and Direct Expenses?
What is the total of Material Cost, Labour Cost, and Direct Expenses?
Which of the following is an example of Indirect Labour Cost?
Which of the following is an example of Indirect Labour Cost?
What is the final calculation to determine the price at which the goods must be sold to make a profit?
What is the final calculation to determine the price at which the goods must be sold to make a profit?
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What is the term for indirect costs that are sub-divided into production, administration, and selling and distribution overheads?
What is the term for indirect costs that are sub-divided into production, administration, and selling and distribution overheads?
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What happens when a second supervisor is necessary?
What happens when a second supervisor is necessary?
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What is the term used to describe costs that are a mixture of fixed and variable costs?
What is the term used to describe costs that are a mixture of fixed and variable costs?
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What is an example of a stepped fixed cost?
What is an example of a stepped fixed cost?
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What is the cost of two supervisors in the numerical example?
What is the cost of two supervisors in the numerical example?
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What happens to the fixed costs as the production level increases?
What happens to the fixed costs as the production level increases?
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Study Notes
Classification of Costs
- Costs are classified into different categories according to their nature, which is important for the control function to identify problem areas.
- Examples of functions by which costs can be classified include Production, Administration, and Selling and Distribution.
Cost Centres and Cost Units
- Cost Centres are locations such as departments, individual employees, or machines.
- Cost Units are sub-divisions of cost centres, which can be a single job, batch, contract, or product group, depending on the business type.
Example of Cost Centres and Cost Units
- A firm producing leather goods has four departments, each producing a different type of product (shoes, gloves, handbags, and wallets), making each department a cost centre.
- Within the handbag department, each batch of 100 bags produced is a cost unit.
Elements of Production Cost
- The cost unit can be broken down into three elements of production cost:
- Material Cost: the cost of raw materials used in production.
- Labour Cost: wages, salaries, and bonuses incurred in production.
- Direct Expenses: rare, but may include the hire of equipment necessary for the process.
- These three elements combined are called the Prime Cost of Production/Service.
Indirect Costs
- Any cost that cannot be directly allocated to production or service provision is an indirect cost.
- Indirect costs are apportioned to the cost centre and absorbed into the cost unit.
- Examples of indirect costs include:
- Indirect Labour Costs: wages and salaries of typists, salesmen, and accountants.
- Indirect Material Costs: stationery.
- Indirect Expenses: gas and electricity.
Overheads and Total Cost
- Indirect costs are called overheads and are sub-divided into production/factory overheads, administration overheads, and selling and distribution overheads.
- Factory overheads include supervisors' salaries, factory gas and electricity, and rent and rates.
- Administration overheads include stationery, typists' wages, and employee insurance.
- Selling and Distribution overheads include salesmen's commission, advertising, and sales department costs.
- Once all costs have been collected, allocated, and absorbed, the price at which the goods must be sold to make a required profit can be calculated.
Fixed Costs
- Fixed costs are incurred by an organisation regardless of the level of activity.
- Examples of fixed costs include rates on the factory, rent, and insurance costs.
- These costs are often termed 'period costs' since they are incurred on a time basis as opposed to an output basis.
- Fixed costs will only be fixed over a relevant production scale.
- If the scale of production changes, the fixed cost may also change, but it will remain fixed at the new level.
Variable Costs
- Variable costs vary directly with activity.
- If the level of output or service is doubled, the variable costs will also double.
- However, this will only be the case over a relevant production scale.
- Large increases in provision may lead to economies of scale, which can result in discounts.
Semi-Variable Costs
- Semi-variable costs change when the level of output changes but not directly.
- Indirect labour costs are an example of a semi-variable cost.
- Semi-variable costs are a mixture of fixed and variable costs and are often described as 'stepped costs'.
- Examples of semi-variable costs include a photocopier with a monthly charge plus a charge per copy, or a landline with a line rental plus a charge per call minute.
Step Fixed Costs
- Step fixed costs are a type of fixed cost that is only fixed within certain levels of activity.
- Once the upper limit of an activity level is reached, a new higher level of fixed cost becomes relevant.
- Examples of stepped fixed costs include warehousing costs and supervisors' wages.
- Numerical example: for production of up to 50 widgets, one supervisor is required, but if production is between 50 and 100 widgets, two supervisors are required, resulting in a step increase in fixed costs.
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Description
Learn how management accountants categorize costs into different categories according to their nature. This is crucial for identifying problems in specific areas. Classification is done by function, cost centre, and cost unit.
