Costing: Fixed vs Variable Costs

• Costing determines the cost of a product, service, or activity.
• Costing is a fundamental aspect of cost and managerial accounting.
• Accurate costing is crucial for pricing decisions, profitability analysis, and cost control.

Fixed Costs

• Fixed costs are constant in total, regardless of production or sales volume.
• Examples include rent, salaries, equipment depreciation, and insurance.
• Fixed Costs are constant in total but vary per unit; per-unit cost decreases as production increases.
• Fixed costs are also called period costs.

Variable Costs

• Variable costs change in total, in direct proportion to production or sales volume.
• Examples include direct materials, direct labor, and sales commissions.
• Variable costs are constant per unit but vary in total; total costs increase with more units produced.
• Variable costs are also called product costs.

Cost-Benefit Analysis

• Cost-benefit analysis systematically estimates the strengths and weaknesses of alternatives.
• It determines the best approach to achieving benefits while preserving savings.
• The process identifies and compares all costs and benefits of a project or decision.
• Both tangible and intangible factors are considered in the analysis.
• A cost-benefit ratio provides a quantifiable measure for decision-making.
• A project is financially viable if the benefits outweigh the costs.
• Cost-benefit analysis aids informed decisions by weighing the pros and cons of different options.

Budgeting Techniques

• Budgeting is the creation of a financial plan, generally for a future period.
• It estimates revenues and expenses to achieve specific financial goals.
• Zero-Based Budgeting (ZBB) requires justification of all expenses for each new period starting from a "zero base," analyzing the needs and costs of every function.
• Activity-Based Budgeting (ABB) focuses on budgeting for activity costs necessary to produce and sell, identifying activities, determining costs, and allocating resources based on these costs.
• Rolling Budgeting continuously updates the budget by adding a new period and dropping the oldest, providing an ongoing view.
• Incremental Budgeting uses the previous period's budget as a starting point adjusting it based on expected changes but may not challenge inefficiencies.
• Static Budget: Remains unchanged regardless of the actual volume.
• Flexible Budget: Adjusts to the actual volume of activity.

Activity-Based Costing

• Activity-based costing (ABC) assigns costs to activities based on resource use and then assigns costs to products/services based on activity consumption.
• ABC recognizes that many overhead costs are driven by activities, not production volume.
• ABC Steps:
  • Identify Activities: Determine the major activities performed.
  • Assign Costs to Activities: Assign resource costs to each activity.
  • Identify Cost Drivers: Determine the factors that cause activity costs.
  • Assign Activity Costs to Cost Objects: Allocate activity costs to products/services based on consumption.
• ABC provides an accurate understanding of costs, leading to better pricing and product mix decisions.
• Traditional costing methods often allocate overhead based on volume-related measures, such as direct labor hours, which can distort costs.
• ABC can help identify areas for process improvement and cost reduction.