01. Different types of costs

(a) Direct Cost.

Direct costs are those which have direct relationship with a unit of operation like manufacturing a product, organizing a process or an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs is related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is also called as “Traceable Costs”.

(b) Indirect Cost.

Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department. Like the direct costs indirect costs, do not vary i.e., they may or may not be variable in nature. However, the nature of indirect costs depends upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.

(c) Opportunity Cost.

Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return from the second best use of the firms’ resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input.

(d) Incremental Cost.

Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be avoided by not bringing any variation in the activity the activity, they are also called as “Avoidable Costs” or “Escapable Costs”. More ever incremental costs resulting from a contemplated change is the Future, they are also called as “Differential Costs”

Example: Change in distribution channels adding or deleting a product in the product line.

e) Relevant cost.

Relevant cost is a managerial accounting term that describes past or sunk costs that are not used to make current business decisions. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision making process. As an example relevant cost is used to determine whether to sell or keep business unit.

Different types of costs relating to the Munchee Biscuits (PVT) Ltd.

Generally this company is introduced new biscuit to the market in every year or less. Therefore I would like take Munchee Sun Cracker which was introduced recently for identify different type of costs relating to that product.

Different types of Costing Methods

Methods of costing for ascertainment of actual cost may be identified in many names according to the variation of procedure adopted to determine cost for different types of product. Broadly there are two group of costing method specific order, costing. Specific order or job costing is applicable for specific jobs, batches or contracts each of which is undertaken by specific order or contract job costing. Batch costing and Contract costing are included in this group.

Job Costing.

Job costing is concerned with the finding of the cost of each job or work order. This method is followed by these concerns when work is carried on by the client request, such as printer general engineering work shop etc. under this system a job cost sheet is required to be prepared find out profit or losses for each job or work order. Costing technique used to ascertain cost of a job or work-order is called job costing.

One of example for job costing is a customer gives order to a carpenter for making a bed on his personal requirements so this job is separated from other jobs of carpenter

Process Costing.

Some products are to pass through different stages of production before their completion. The different stages of production are called ‘process’ and each process is distinct and well defends. Output of one process is used as raw material for the next process. It may be in a saleable state. It is necessary to ascertain total cost of each of such processes and cost per unit at each process. So a separate account for each process is maintained and that method of maintaining record and ascertaining cost of production is known as process costing. Sometimes, it is also referred as ‘average’ costing. It is used in case of textile, chemical, paints, food product, paper, sugar, etc.

Batch Costing.

Batch costing is a form of specific order costing. Job costing refers to costing of jobs that are executed against specific orders whereas in batch costing items are manufactured for stock. A finished product may require different components for assembly and may be manufactured in economical batch lots. When orders are received from customers there are common products among orders; then production orders may be issued for batches, consisting of a predermined quantity of each type of product. Batch costing method in such cases to calculate the cost of each such batch.

The examples for Batch costing: This method is mainly applied in biscuits manufacture, garments manufacture, spare parts and component manufacture, pharmaceutical enterprises etc.

Task 02.

01._Absorption costing method

“000”

Sales (14000*25) 350

Production cost

Variable (15000*15) 225

Fixed 12

237

(+)Opening stock –

237

(-)Closing stock (W1) (16)

Production cost of sales 221

Under/over absorbed overhead (3)

(W2) ___

Total cost 218

Gross profit 132

Other costs

Variable (30+15) 45

Fixed (6+18) 24 69

Net profit 63

_Marginal Costing method

“000”

Sales (14000*25) 350

Cost of sales

Variable cost (15000*15) 225

(+) opening stock __

225

(-) closing stock (W1) (15)

210

(-) variable selling & so on (45) 165

04

Contribution 185

(-) Fixed cost: Production 12

Selling & so on 24 36

Net profit 149

Workings

1. Closing Stock

Production units 15000

Sold units 14000

Remain 1000

Absorption cost valuation 1000*16 = 16000

Marginal cost valuation 1000*15 = 15000

1. under/over absorption

Actual production 15000

Budgeted production 12000

Over production 3000

Fixed production over-

Head per unit 1/=

Over (3000)

02. The difference in profits reported under the two costing methods is due to the different inventory valuation methods used.

a) If inventory levels increase between the beginning and end of a period, absorption costing will report the higher profit because some of the fixed production overhead incurred during the period will be carried forward in closing inventory (which reduce s cost of sales) to be set against sales revenue in the following period instead off in full against profit in the period concerned.

b) If inventory levels decrease ,absorption costing will report the lower profit because as well as the fixed overhead incurred, fixed production overhead which had been carried forward in opening inventory is released and also included in cost of sales.

05

03. Break even analysis or cost-volume-profit analysis is the study of the interrelationship between cost, volume and profit at various levels of activity.

The break-even point occurs when there is neither a profit nor a loss and fixed costs equal contribution.

Hence the BEP for above organization is calculated bellow.

BEP = Fixed Cost

Contribution for unit

= 36000

7

=5142 units

In revenue, BEP = 5142*25

=Rs.128550.00

• Contribution = 25 – 18 = 7
• Fixed cost = 36000

Sales above Rs.128550 will result in profit of Rs.7/= per unit of additional sales below Rs.128550 will mean a loss of Rs.7/= per unit for each unit by which sales fall short 5142 units. In other words profit will improve or worsen by the amount of contribution per unit.

Task 03

Purposes and Objectives of Budgeting process

• Ensure the achievement of the organization’s objectives.
• Compel planning
• Communicate ideas and plans
• Coordinate activities
• Provide a framework for responsibility accounting
• Establish a system of control
• Motivate employees to improve their performance
• Evaluate of managerial performance

Zero-Based Budgeting

The principle behind the zero based budgeting is that the budget for each cost Centre should be made from “scratch” or zero. Every item of expenditure must be justified in its entirety in order to be included in next year’s budget.

There is a three step approached to ZBB.

• Define decision units
• Evaluate and rank packages.
• Allocate resources

ZBB rejects the assumption inherent in incremental budgeting that this year’s activities will continue at the same level or volume next year, and that next year’s budget can be based on this year’s costs plus an extra amount perhaps for expansion and inflation.

Zero based budgeting involves preparing a budget for each cost center from a zero base. Every item of expenditure has then to be justified in its entirety in order to be included in the next year’s budget.

Preparation of budgets.

Sales budget

07

“000”

Production budget

Material Purchase budget

08

Direct Labour Cost

Cash Budget

Task 04

Direct materials cost variance

Price Variance = 270000 (Adverse)

Usage Variance = 50000 (Favorable)

Direct labor cost variance

Wage ate variance = 2600 (Favorable)

Efficiency variance = 14400 (Adverse)

Variance overhead cost variance

V / O / H /E / variance = 8600 (Adverse)

V / O / H /E / efficiency variance = 3600 (Favorable)

F / O / H Variance

F / O / H expenditure variance = 1600 (Adverse)

F / O / H volume variance = 1800 (Favorable)

Sales value variance

Reconciliation of budgeted & actual profit

Statement

 References

(Prime Minister’s Strategy Unit. 2004)

Return-on-investment calculator, developed by the NHS Institute of Innovation and

Improvement:

http://www.institute.nhs.uk/quality_and_service_improvement_tools/quality_and_service

_improvement tools/Return_on_Investment_ (ROI) _calculator.html

Coates, J.B., Richwood, C. and Stacey, R.J. (1996) Management Accounting for Strategic and Operational Control, Oxford, Butterworth-Heinemann.

Davenport T.H. and Prusak, L (1997) Working Knowledge, Boston, MA, Harvard Business School Press.

Professional Accountants in Business Committee (2009). Evaluating and Improving Costing in Organizations (International Good Practice Guidance). International Federation of Accountants. p. 7. ISBN 9781608150373.

“Cost Management”. Thomson Reuters.( 2011). Retrieved November 12, 2011