Accounting & Finance 3A
Cost Accounting & CVP
Lesson 1
•
•
Review
What is financial accounting?
•Primarily for external users such as
shareholders, creditors, customers,
government agencies & investors.
•Involves the production of general purpose
financial reports that are produced on a
regular basis to show profits or losses and
inventories in accordance with accounting
standards.
•
•
•
Management (Cost)
Accounting
Used in all types of organisations.
Users of management accounting reports are
usually internal to the organisation.
Management accounting reports are special
purpose reports such as sales forecasts or
planning & production cost reports. These
special purpose reports do not need to comply
with accounting standards.
Differences between Management &
Financial Accounting
Management
Assists internal users in decision
making process
Financial
Assists external users in decision
making process
Consider pricing,product choices,
investment and make or buy
decisions
Although some decisions follow
GAAP, management accounts can
be produced to suit individual
needs.
All accounts subject to GAAP and
accounting standards. No
deviance from these standards
are permitted
Has a future perspective, focuses
on budgets and forecasts for
future performance.
Takes a historical perspective,
reports focus on what happened in
the past
Manufacturing
•
•
•
A manufacturing business needs to know what
it costs to make its products to ensure they are
sold at a profit.
A manufacturing business involves
production,selling, administrative functions
these are all costs associated with the
production of a service or saleable item.
Manufacturers commence the process with raw
materials which they convert to saleable
products.
Why Calculate costs?
• You might want to know whether it is
cheaper to manufacture yourself or import
from China?
• Should you invest in high technology such as
robots and fully automated plant or stay with
your workforce of 300 people?
• Are you working at full capacity or full
efficiency – do you need to increase output /
or decrease output to improve profitability?
What can you cost?
• Well just about anything, think about the pizza you
buy from the shop or a subway roll. Some costs
would be bread and fillings, staff wages, shop rent,
advertising, electricity and admin costs.
• What about a holiday in Phuket? What costs can
you think of that will make up the total cost?
• Do you think we can cost the erection of the big
wheel (Perth Eye) on the foreshore?
Cost Object
• A cost object is defined as any activity where
a specific cost measurement is required.
Worksheet
• Please complete worksheet 1
Lesson 2
• Review
– What can you cost?
– What is a cost object?
Types of Costs in a
manufacturing business
• There are three distinct types of costs
– Direct Materials
• The cost of materials that can be directly traced to the
finished product. The bread and fillings In our previous
example of Subway
– Direct Labour
• Wages paid to staff members which can be directly traced
to the finished product. This will be our staff wages
serving the customers
– Factory Overhead Cost – Indirect Cost
• All factory costs except direct materials and labour
required in the production process – Rent, insurance etc
Factory Overheads explained
• Sometimes known as manufacturing
overhead, indirect manufacturing or factory
burden costs.
• Includes costs such as electricity, rent,
depreciation, insurance.
• Cannot be traced to a single product and
therefore an allocation of cost is made.
Factory Overhead cont
• BEWARE
– Sometimes rent depreciation or insurance for
example may not be attributable to
manufacturing costs, they may belong to admin
or sales functions – Only use the manufacturing
portion in Factory Overhead calculation.
Direct & Indirect Costs
• Direct Costs
– Can be traced directly to the product or service
in an economically feasible way
• Indirect costs
– Are related to the product or service but cannot
be traced in an economically feasible way and
therefore need to be allocated.
Cost Behaviour
• Cost Behaviour relates to how a cost reacts
to changes in levels of manufacturing
activity.
• There are two main types
– Fixed Cost
– Variable costs
• A hybrid called mixed costs, being part fixed
and part variable can also exist. i.e.
electricity
Fixed Costs
• A fixed cost remains the same no matter what
level of output or efficiency has been attained.
• For example factory rent may be $2000 per
month. This figure does not fluctuate in response
to changing production amounts, it is static (fixed)
at $2000.
Number of units
produced
Monthly rent
Rent allocated per unit
produced
1
20
$2000
$2000
$ 2000
$100
Adapted from Hoggett & Edwards Accounting in Australia 4th edition
Variable Costs
• Variable costs are production costs which vary
directly with the volume of production.
• Direct Materials & Direct Labour are variable
costs because as production rises more material
and labour will be required.
Number of units
produced
Direct labour cost per
unit
Total direct labour cost
1
25
50
$40
40
40
$ 40
1000
2000
Adapted from Hoggett & Edwards Accounting in Australia 4th edition
Cost Drivers
• A cost driver is any activity which causes costs to
be incurred
• Examples;
– Number of phone calls made
– Number of units produced
– Number of machine hours
– Number of advertisements made
– Number of customers
Product & Period Costs
• Product Costs – also known as inventoriable
costs. A specific type of cost that can be
capitalised and recorded as an asset in the
stock or inventory ledger account.
• Period Costs – recorded as an expense in
the period in which they occur.
• The matching principle influences the
classification of these costs
Worksheet
• Please complete worksheet 2
Lesson 3
• Review previous lesson
– Fixed costs
– Variable costs
– Mixed Costs
– Cost Objects
– Cost Drivers
– Cost Behaviours
Job Order Costing
• There are two types of costing systems
– Job order
– Process
• We will cover only job order in this course
• A job order costing system accumulates
production costs on a job by job basis
Unit Cost (Average Cost)
• Calculated by dividing total cost by number of units
produced.
– A river cruise for year 12 students has been booked at a
cost of $3600 (flat fee all inclusive). If 60 students want to
attend the event, what would the unit cost (individual
ticket price) be?
Total Cost
No Units
=
$3600
60
Unit Cost
=
$60 per ticket
Question
• What happens to the unit cost (individual
ticket price) of the river cruise if another 20
students decide to attend?
• $3600
• 80
• = $45 per ticket
Some things to ponder….
• How do you decide what price you should sell your
product at?
• How many units can your factory produce on a
daily/weekly/monthly/yearly basis?
• Do my material costs vary each time I purchase?
• Does my labour always cost the same amount per
hour? Even on a Public Holiday or weekend?
• What if we double our production, will we double
our profit?
Breakeven Point
• We know what it means for a business to
make a profit. Basically revenue is greater
than expenditure.
• We know what it means to make a loss. This
is when our expenses exceed our revenues.
• What about breakeven? Think for a moment
do you think you can create an equation for
it?
• Revenues – Variable costs – Fixed Costs = 0
Cost volume profit analysis
•
The answers to the questions on the
previous slide can be found using CVP.
•
Four factors affect CVP
1. Selling Price
2. Sales Volume
3. Sales Mix
4. Costs of Materials
•
CVP shows us how profits are affected by
changes in activities.
Limitations to CVP
• Unit sales price remains constant
• Costs can be identified
• Variable cost is proportional to output
• Fixed costs remain constant
• Efficiency is not affected
Worksheet
• Please complete worksheet 3
Lesson 4
• Review
– Variable costs
– Fixed Costs
– Revenue
– Breakeven point
Contribution Margin
• The contribution margin is used frequently in
management accounting. It is quite simply,
• Revenue – Total Variable Costs
• The contribution margin is the amount left
over to firstly absorb any fixed costs, and
once these fixed costs are satisfied it starts
to contribute towards profits.
More equations
• Total costs =
Fixed costs + Variable costs
• Profit
Revenue – Total Costs
=
• Contribution Margin
=
Revenues – Total Variable Cost
• Contribution Margin Ratio
=
Contribution Margin / Sales
Target Net Profit
• Once you understand breakeven analysis
you are able to take this one step further.
• By using breakeven analysis as a planning
tool and rearranging the equation we are
able to calculate required sales to produce
a profit of x dollars.
• If Revenues – Variable costs – Fixed Costs = 0
• Then Sales Target = VC + FC + Target net profit
Margin of Safety
• The amount by which sales can decrease before a
loss occurs.
• The margin of safety is the excess of actual or
expected sales over breakeven sales.
• Adapted from Hoggett & Edwards Accounting in Australia 4th Edition
Cost Accounting Systems
• We now know that if we calculate our direct
material and labour costs, as well as our
indirect factory overheads, we can calculate
the cost of a product.
• This is extremely useful as it allows us to
accurately calculate our inventory, however
there are limitations.
• We can also calculate a sales price by using
a mark up.
Limitations
• Historical or actual cost information
represents what did happen and not
necessarily what should have happened.
• Efficiency evaluations do not consider
optimal efficiency only trend analysis.
Worksheet
• Please complete worksheet 4
Lesson 5
Cost decisions
• Often management is faced with the need to
make decisions which affect output levels.
• Some decisions can have short term gains
but long term effects that are not always
positive.
• CVP is an essential tool enabling
management to investigate options such as
Make or Buy, Special Order or Product Mix.
Make or Buy
• Make or buy decisions face Corporate Australia on
a daily basis. You will constantly hear about
companies forced to source overseas materials so
they can remain competitive
• Remember labour costs are considerably cheaper
in Asia.
• But also quality of materials can be of a lower
standard
• Consider Bonds a great Australian company
brought into the spotlight during 2009 with its
decision to close its manufacturing operations in
Australia.
Special order
• Do we accept or reject a ‘one time only’
special order?
• Sometimes these orders are for large
quantities at reduced prices
• If idle capacity exists then this could be a
good decision for the company
• If the company does not have an alternative
use for the assets of the business and the
order will not impact negatively on the
business then the order should be accepted.
Product Mix
• If a business manufactures more than one
product it must determine the optimal
production amounts of each in order to
maximise profitability.
• Constraints of the business impact on
product mix such as
• Availability of space, availability of raw
materials and labour, profitability and
demand all play an important part in this
decision making process.