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5. Cost Accounting
What affects the price?
In setting prices, a business will be aiming at an adequate level of profit.
Prices may be affected by the following factors:
-
The benefits which customers receive and the value they attach to them.
How much are costs to make the product?
The degree of competition in the marketplace
The prices of substitute products
There are many kinds of pricing policies:
1. Competition oriented policy
Some firms may adopt a skimming policy, pricing high for maximum short-term
profits until competition arrives.
Other firms may set prices much lower from the outset to achieve a greater market
share and deter possible competitors from entering the market. They may also rely
on the cost falling.
2. Demand oriented policy
This policy means that the price is high when the demand is high, and the price is
low when the demand is low. So, the price depends on what the customers are
ready to pay for the product.
3. Cost oriented pricing
3a) Full cost pricing
Full cost pricing aims to attribute all business costs to a particular product (direct
costs and part of indirect costs). The price is the sum of the full cost and profit.
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full cost
+ profit
= price without VAT
+ VAT
= price including VAT
Unlike direct costs, however, indirect costs (overheads), by definition, cannot be
directly identified with particular products. Hence, there is first a need for apportion
indirect costs to cost centers; and then for attributing the total costs of each of the
cost centers to the various products which pass through them.
A cost center is a part of a business in respect to which costs can be identified and
aggregated. It may be a whole factory, a part of a factory, department, or even a
single machine. Different cost centers may be appropriated for different levels of
management decision.
Example 1
ABC Ltd makes trousers. There are three cost centers: stock, production and
management and marketing.
D
Direct material costs 200 000
Direct labour costs 180 000
Indirect
costs:
18 000
Stock
Total
costs
578 000
Products
60 000
Production
120 000
Profit
50 000
Management
and
marketing
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Overhead rates (overhead cost increments):
Stock
100* indirect stocking costs
direct material costs
100 * 18 000 = 9 %
200 000
Production
100* indirect production costs
direct labour costs
100 * 60 000 = 33,33 %
180 000
Management and marketing
100* indirect management and marketing costs
production value
100 * 120 000 = 26,20 %
458 000
Profit
100* profit
full cost (=total costs)
100 * 50 000 = 8,65 %
578 000
Price of trousers:
Direct raw material costs
Overheads of stock 9% * 77
Direct labour costs
Overheads of production 33,33% * 30
Production value
Overheads of management and marketing
26,2 % * 123,93
Full cost
Profit 8,65% * 156,40
Price without VAT
VAT 24% * 169,93
Price including VAT
77
6,93
30
10
123,93
32,47
156,40
13,53
169,93
40,79
210,75
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Exercises:
1. There are three cost centers in Roberts company: stock, production and
management and marketing. The costs are as follows:
D
Direct material costs 180 000
Direct labour costs 70 000
Indirect
costs:
16 200
Total
costs
387 580
Stock
Products
59 500
Production
61 880
Management
and
marketing
a) Define the overhead rates.
b) How much is the price including VAT of the X-product, when the direct
material costs are 920,- and direct labour costs 370,-?
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2. DC Ltd makes many kind of machines. There are three cost centers: stock,
production and management and marketing.
D
Direct material costs 320 000
Direct labour costs 150 000
Indirect
costs:
27 900
Total
costs
885 000
Stock
Products
241 100
Production
146 000
Management
and
marketing
a) Define the overhead rates.
b) How much is the price including VAT of the Y-machine, when the direct
material costs are 1 920,- and direct labour costs 2 370,-?
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3. DEF Ltd produces various antennas for radios and televisions. The following costs
have been budgeted for the next year:
Direct material costs
Direct labour costs
Indirect stocking (storage costs)
Indirect production costs
Indirect management and marketing costs
Budgeted profit
900 000
800 000
200 000
150 000
300 000
130 000
a) How much is the price including VAT of the TV-antenna, when the direct
material costs are 80,- and direct labour costs 70,-?
b) How much is the price including VAT of the TV-antenna, when the direct
material costs are 170,- and direct labour costs 140,-?
4. XYZ Ltd produces various parts for cars. The following costs have been budgeted
for the next year:
Direct material costs
Direct labour costs
Indirect stocking (storage costs)
Indirect production costs
Indirect management and marketing costs
Budgeted profit
3 220 000
900 000
700 000
740 000
1 060 000
90 000
a)How much is the price including VAT of the X-product, when the direct
material costs are 120,- and direct labour costs 40,-?
b)How much is the price including VAT of the X-product, when the direct
material costs are 30,- and direct labour costs 20,-?
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Example 2
In retail shops costs of goods are direct costs. The other costs are indirect.
Overhead rate= 100 * (indirect costs + profit)
direct costs
Ladies Fashion’s cost budget for the following year is as follows:
- goods
- salaries
- rent
- office
- advertising
- depreciation
- interest
- other overheads
132 000
65 000
15 000
5 000
7 100
4 100
3 900
1 900
The budgeted profit for the following year is 35 000 euros.
Overhead rate = 100 *(102 000 + 35 000) = 103,79%
132 000
The price of the jacket:
Direct costs
Indirect costs + profit 103,79%*200
Price without VAT
VAT 24 % * 407,58
Price including VAT
200
207,58
407,58
97,82
505,40
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Exercises:
5.Lasse has an ice-cream stall. The budgeted costs for the following year are as
follows:
- material (ice-cream, chocolate…)
- rent
- salaries
- depreciation
- interest
- other overheads
a)
b)
c)
45 000
23 320
79 300
5 400
6 100
2 900
How much is the overhead rate (without profit)?
How much is the overhead rate, if the expected profit for the following
year is 10 000 euros?
How much should the price of an ice-cream serving be, if the direct costs
are 1,20 euros. Use the overhead rate of b)?
6. Delicatessen shop sells salads and ice-creams. The costs for the following year are
as follows:
- material
- salaries
- social costs
- depreciation
- rent
- interest
- light, heat
- maintenance
- other overheads
a)
b)
c)
65 900
63 600
26 600
7 100
7 900
4 200
2 800
2 400
1 900
How much is the overhead rate (without profit)?
How much is the overhead rate, if the expected profit for the following year is 9 500
euros?
How much should the price of a salad serving be, if the direct costs are 1,80 euros. (Use
the overhead rate of b)?
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7.
Anna has a shop. She sells underwear. She has estimated the costs for the
following year:
- goods
- salaries
- social costs
- rent
- advertising
- depreciation
- interest
- other overheads
600 000
190 000
80 000
36 000
20 000
12 000
15 000
10 000
The profit should be 160 000 euros next year.
a)
b)
8.
How much is the overhead rate?
How much should the price of stockings be, if the direct costs are 10
euros?
Sport shop’s budget for the following year is as follows:
Sales
- Goods
= Contribution
- Rent
- Advertising
- Depreciation
- Interest
- Other overheads
= Profit
a)
b)
300 000
213 000
87 000
21 000
3 000
3 000
6 000
6 000
48 000
How much is the the overhead rate?
How much should the price of a bicycle be, if the direct costs are 280
euros?
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Example 3
In the service sector part of salaries are often direct costs. Other costs are indirect
costs.
Overhead rate 1 = 100 * (indirect costs + profit)
direct salaries and social costs
or
Overhead rate 2 = indirect costs + profit
total direct working hours
In Advertising Company there are 10 workers whose working time can be allocated
to the commissions. Their annual salaries and social costs are as follows:
Advertising manager
Art director
Copywriter
Assistant
Direct costs
3 * 55 000 = 165 000
2 * 50 000 = 100 000
2 * 42 000 = 84 000
3 * 34 000 = 102 000
451 000
The indirect costs per year are 382 000 euros and the expected profit per year
120 000 euros.
Overhead rate 1 = 100 * (382 000 + 120 000 = 111,31 %
451 000
Yearly working hours are 1408 hours per worker.
Price/ hour:
Direct salaries
Indirect
Price/hour
and social
costs+profit
costs/hour
/hour
39,06
43,48
82,54
111,31 %*39,06
35,51
39,53
75,04
Advertising
manager
Art director
55 000/1408
Copywriter
42 000/1408
29,83
33,20
63,03
Assistant
34 000/1408
24,15
26,88
51,03
50 000/1408
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Overhead rate 2 = 382 000 + 120 000 = 35,65 euros/hour
14080
Price/hour
Advertising
manager
Art director
Direct salaries
Indirect
Price/hour
and social
costs+profit
costs/hour
/hour
39,06
35,65
74,71
35,51
35,65
71,16
Copywriter
29,83
35,65
65,48
Assistant
24,15
35,65
59,80
Costs of an advertisement, witch takes 1 hour advertising manager’s, art director’s,
copywriter’s and assistant’s working time:
1. 82,54 + 75,04 + 63,03 + 51,03 =
+ VAT 24 % * 271,64
Price with VAT
271,64
65,19
336,83
2. 74,71 + 71,16 + 65,48 + 59,80 =
+ VAT 24 % * 271,15
Price with VAT
271,15
65,08
336,23
Exercises
9. In Auditing Company there are 10 workers whose working time can be allocated
to the commissions. Their annual salaries and social costs are as follows:
Auditor
Accountant
Assistant
Direct costs
2 * 56 000 = 112 000
5 * 43 000 = 215 000
3 * 24 000 = 72 000
399 000
The indirect costs per year are 189 000 euros and the expected profit per year
20 000 euros.
Yearly working time is 1496 hours/worker.
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a)
b)
c)
How much is the overhead rate 1 ?
How much is the overheat rate 2 ?
How much should the price (with VAT) of a commission be, if it takes time
as follows:
Auditor
Accountant
Assistant
2 hours
8 hours
3 hours