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    Lecture 8 Cost Classification

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    Cost classification for businesses

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    Lecture 8 Cost Classification

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    shaan.fernando
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    Cost classification for businesses

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    Lecture 8 Cost classification

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    Cost classification for businesses

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    Download as docx, pdf, or txt
    2 views8 pages

    Lecture 8 Cost Classification

    Uploaded by

    shaan.fernando
    Cost classification for businesses

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 8

    Lecture 8 – Cost classification and cost behaviour

    Management accounting – Decision making for managers

    What is cost behaviour?


     Study of how the activities of an organisation affect its costs
     Marginal cost (Variable) – Variable cost of producing one more unit, this categorises
    costs by the way they behave they can either be variable or fixed

    Cost Analysis

     Direct cost – Incurred for specific purposes directly related to the product
     Indirect – Costs which cannot easily be identified with a product
     Fixed costs – Remain fixed in short/medium term irrespective of activity
     Variable costs – vary with level of activity (Increase production = increase VC)
     Semi variable cost – e.g. electricity such as a standing charge every day then charged
    on how much you used

    Total Costs graph

    Total Costs

    VC – Change according to output

    Fixed Overheads – Remain the same despite output


    Sales Revenue Graph £ against volume

    Total Revenue

    Total Costs

    PROFIT

    Margin of
    Safety

    Fixed costs

    BREAK EVEN UNITS Current Sales

    Where Total revenue cross total cost = break even – further from that point the business
    make a profit

    If the fixed costs decreases causes shift to the left meaning business can sell less and still
    break even

    The different between current sales and break even units shows the margin of safety

    How to work out the break even point?


    Break even = fixed overhead/ contribution per unit

    Contribution is = Sales – variable cost of sales

    Contribution per unit = Selling price – VC


    A street vendor selling newspaper pays £45 per day for the stand. This is a fixed cost and must
    be paid each day regardless of whether any papers are sold or not. The vendor pays £0.15
    each for the Newspapers, which are then sold for £0.40.
    1. How much is the contribution?
    2. How many papers must be sold to break even

    Contribution = 0.40 – 0.15 = 0.25 contribution per newspaper

    Break even = Fixed costs/contribution per unit. =. 45/0.25 = 180 newspapers to break even

    What is profit volume ratio?

    P/V Ratio = Contribution per unit/selling price

    0.25/0.40 = 62.5% or 0.625

    We can use this value to work out a break even point for revenue

    Fixed costs/PV = Revenue for break even

    45/0.625 = £72 of revenue needed to break even

    What is a margin of safety?


    This is the amount sales can fall by before the business begins to make a loss.

    MOS = Current sales – Break even sales/current sales volume

    A street vendor selling newspaper pays £45 per day for the stand. This is a fixed cost and
    must be paid each day regardless of whether any papers are sold or not. The vendor pays
    £0.15 each for the Newspapers, which are then sold for £0.40.
    If the vendor is currently selling 400 papers per day what is the margin of safety

    400 – 180/400 = 55% is the margin of safety for the business

    How to work out sales required to reach a target?


    If the business knows the contribution per unit which is Sales – variable cost of sales it can
    work out how much volume to sell to meet a goal.

    Target Volume = Fixed Costs + Required profit/contribution per unit

    What is a semi variable cost?


    Mixture of fixed and variable areas, whereby FC stays the same but VC changes with activity.

    Total VC = Variable cost per unit x No of units

    Total costs = FC + VC

    FC = Total Cost – TVC

    What is the relevant range?


    How many units does this hold true for, firms normal range of production

    Absorption costing – Method which included apportionment of


    overhead into the calculation of unit cost
    In this method you want to calculate the full cost to do so unit cost must have DC and some
    overheads

    Full/Absorption cost = DC + Share of overheads

    To find overhead per unit need to find the overhead absorption rate (OAR)

    OAR = Budgeted overheads/Budgeted volume

    Marginal costing – Categorises costs according to their behaviour,


    only treats variable costs as product cost
    Variable cost are treated as costs of the products and fixed costs are treated separately under
    Period cost

    Contribution = Sale price – VC

    Total contribution = Contribution per unit x sales volume

    Profit = Total contribution – Fixed overheads


    The following data relate to questions 1-4

    Sales Volume (units) 3,000


    £
    Sales Revenue £60,000
    Variable Costs:
    Raw Materials £18,000
    Direct Labour £12,000
    Other Variable costs £6,000
    Total Variable Costs £36,000
    Contribution £24,000
    Fixed Overheads £15,000
    Net Profit £9,000

    1. What is the company’s Break-Even Point in volume terms?

    Break even point= Fixed overheads/ Contribution cost


    Contribution = Sales prices – Variable cost of sales
    60,000 – 36,000 = 24,000 = Total contribution
    Contribution per unit = 24,000/3,000 = £8 per unit
    15,000/ 8 = 1,875 units need to break even

    2. What is the company’s Margin of Safety?


    MOS = Current Sales – Break even sales/Current sales volume
    3000 – 1875/3000 = 37.5%

    3. What is the company’s Profit-Volume Ratio?


    PV ratio = Contribution per unit/selling price
    Selling price = Sales revenue/sales volume = 60,000/3,000 = £20
    8/20 = 0.4 or 40%

    4. If the company is aiming to make a profit of £18,000 what is its target volume?
    Target volume = Fixed costs + Required profit/contribution per unit
    15,000 + 18,000/8 = 4,125 units to make 18k profit

    5.The following data relate to an outpatient’s department in a hospital:


    Number of consultations (patients) 5,750
    Total Fixed Cost (£) 25,875
    Calculate the overhead absorption rate (OAR) per consultation.

    OAR = Budgeted overhead/budgeted volume


    25875/5750 = £4.5
    1. Draw cost curves depicting each of the following independent sets of circumstances,
    assuming that x and y are similarly scaled.

    1. Fixed cost

    2. Variable cost

    3. Semi-variable cost

    4. Step-costs (semi-fixed costs)


    January 2018 Exam - Section A/Q7 – 6 marks
    Year ended 31 March 2018: -

    Fixed costs £150,000


    Variable costs £300,000
    Sales (50,000 units) £500,000
    Required: Using the above information calculate the following: -
    a) Contribution per unit
    i. Contribution = Sales price – Variable cost price
    ii. 500,000 – 300,000 = 200,000
    iii. 200,000/50,000 = £4 per unit
    b) Break-even point in units
    i. BEP = Fixed Overheads/Contribution
    ii. 150,000/4 = 37,500 units to break even
    c) Margin of safety as a percentage
    i. MOS = Current sales - Break even sales/Current sales
    ii. 50,000 – 37,5000/50,000 = 25%

    January 2018 Exam - Section A/Q8 – 6 marks


    Briefly explain the following management accounting terms and provide an example for
    each one: -
    a) Fixed cost – A fixed cost is a cost that stays the same regardless of sales volume for
    example this could be rent for a factory
    b) Variable cost – A variable cost is a cost that fluctuates with the amount of volume a
    business has produced this could be raw materials
    c) Semi -variable cost – A semi variable cost is a cost which has a fixed period for an
    initial output but then has a positive correlation with output this could be a basic wage plus
    a commission wage

    January 2019 Exam - Section A/Q7 – 6 marks


    Year ended 31 March 2018:-

    Sales (35,000 units) £560,000


    Variable costs £175,000
    Fixed costs £77,294

    Required: using the above information calculate the following:

    a) Contribution per unit


    i. Contribution = Sales price – Variable cost price
    ii. 560,000 – 175,000 = 385,000
    iii. 385,000/35,000 = £11 per unit
    b) Profit-volume ratio (expressed as a percentage)
    i. PV ratio = Contribution per unit/selling price
    ii. Selling price = 560,000/35,000 = £16 selling price
    iii. 11/16 = 0.6875 or 68.75%
    c) Target volume required to make a profit of £19,000
    i. Target = Fixed costs + profit/contribution
    ii. 77,294 + 19,000/11 = 8754 units

    January 2018 Exam - Section B/Q1 (TOTAL 20 MARKS)


    Recruit Highway Ltd can deliver three different types of service (3 star, 4 star and 5 star)
    using the same staff. Various estimates for next year have been made as follows:
    Service 3 star 4 star 5 star
    Selling price (£/unit) 25 35 42
    Variable material cost (£/unit) 11 16 20
    Other variable costs (£/unit) 5 8 10
    Share of fixed cost (£/unit) 3 6 9
    Staff time required (hours) 1 2 3
    Fixed cost for next year is expected to total £35,000.
    Required:
    (a) If the business were to deliver only the 3-star service next year, how many units of the
    service would it need to provide in order to break even? (2 marks)

    BEP = Fixed overheads/Contribution


    Contribution = Sales price – variable cost
    25 – 16 = 9 per unit
    35,000/ 9 = 3,889

    (b) If the business has limited staff hours available next year, in which order of
    preference would the three services come? (12 marks)
    (c) The maximum market for next year for the three services is as follows:
    3 star 3,500 units
    4 star 1,800 units
    5 star 5,400 units

    (d) Recruit Highway Ltd has a maximum of 12,000 staff hours available next year. What
    quantities of each service should the business provide next year and how much profit
    would this be expected to yield?

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