2. Definition Chartered Institute Of Management Accountants ( CIMA London ) “ Costing is the technique and process of ascertaining cost”
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4. Cost Accounting It provides information for both management accounting and financial accounting. It measures and reports from financial and non financial data.
16. Costs in a Manufacturing Company Inventoriable (Product) Costs Direct Material Purchases Work in Process Inventory Cost of Goods Sold Revenue Gross Margin Marketing and Administrative Costs Operating Income Period Costs Income Statement Balance Sheet Materials Inventory Direct Labour Indirect Manufacturing Costs Finished Goods Inventory
28. Why is Standard Costing Used? A standard is a preestablished benchmark for desirable performance. A standard cost system is one in which a company sets cost standards and then uses them to evaluate actual performance. A variance is the difference between actual performance and the standard.
29. Favorable versus Unfavorable An unfavorable variance occurs when actual performance falls below the standard. A standard is a preestablished benchmark for desirable performance.
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31. Quantity and Price Standards What can cause a cost to increase? Quantity used Price paid
32. Ideal versus Practical Standards A standard that allows for the normal inefficiencies of production is called a practical standard. A standard that allows for no inefficiencies of any kind is an ideal standard.
33. The Standard Costing Process Gather information and set standards. Compare actual performance to standard and prepare performance reports. Determine which variances to investigate. Investigate the cause of variances. Take corrective action. Determine if corrective action is needed.
34. Problems With Standard Costing Employees may try to set low standards to make them easier to achieve. Using historical data to set standards may build in past inefficiencies. Managers might focus on the “ numbers” to the exclusion of other important factors.
35. Problems With Standard Costing Focus on unfavorable variances may result in ignoring the favorable variances. Managers may lose sight of the big picture.
36. Comparison of Cost Systems Cost Classification Actual Cost System Normal Cost System Standard Cost System Direct Material Direct Labor Manufacturing Overhead Actual Actual Actual Actual Actual Estimated Estimated Estimated Estimated
38. Analysis of Variance may be done in respect of each element of cost and sales: 1.Direct Material Variance 2.Direct Labor Variance 3.Overhead Variance 4.Sales Variance Analysis of Variance
39. Material Variances Material Cost Variance: (Standard Price x Standard Rate) - ( Actual quantity x Actual Rate )
40. Direct Materials Variances There are two variances calculated for material cost variance. The material quantity variance (also called the usage variance) is a measure of the amount of materials used. The material price variance is a measure of the cost to buy the various materials that were purchased.
41. Material Variances Material price variance: Material quantity variance: ( Standard material price – Actual material price) × Actual material quantity ( Standard material quantity – Actual material quantity) × Standard unit price
42. Direct Materials Variances Again Material Qt variances can be divided into two varainces The material mix variance . The material Yield variance
43. Material Mix Variances Standard Cost of Standard Mix – Standard Cost of Actual Mix Std. Unit cost (SQ – AQ) Actual weight do not differ
44. Material Mix Variances Actual weight differ Total wt. Of actual mix X Std. Cost - Std. Cost Total wt. Of standard of Std. Mix of actual mix mix
45. Material Variances Material yield variance: Standard Rate (Actual Yield – Standard Yield ) {If std. & actual mix are same} Standard Rate = Std. Cost of Std. Mix Net Std. Output (Gross output – Standard loss)
46. Material yield Variances {Standard Rate (Actual Yield – Revised Standard Yield ) If std. & actual mix are not same} Standard Rate = Std. Cost of Revised Std. Mix Net Std. Output (Gross output – Standard loss)
47. Labor Variances The labor cost variance is the difference between actual cost of hour worked and the standard cost allowed. The labor rate variance is the difference between the actual direct labor cost incurred and the standard cost for the actual hours worked.
48. Labor variance: St. Cost of labor – Actual cost of labor Rate variance =Actual Time Taken (Standard Rate – Actual Rate) Labor Cost Variance Labor Rate Variance
49. Standard Rate (Standard time for actual Output - Actual time Paid for) Total Labor Efficiency Variance
50. Labor Variances Total Labor efficiency variance are of two types Labor Efficiency Variance Labor Idle Time variance
51. Labor Variances Labor Efficiency Variance Labor Efficiency Variance = Standard rate(Standard time for actual output - Actual time worked)
52. Labor Variances Labor Idle Time variance = Abnormal Idle Time x Standard Rate Labor Idle Time variance
53. St. Cost of St Composition (Actual time taken)– Standard cost of actual Composition ( Actual time worked) Labor Mix Variance Labor Variances
54. Standard Rate (Actual Yield –Revised Standard Yield) Labor Yield Variance Labor Variances
55. Overhead cost variance can be defined as the difference between the Standard cost allowed for the actual output achieved and the actual overhead cost incurred. Overhead Variance:
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64. (A) Variable overhead (spending) expenditure variance = (Actual hours worked x standard variable overhead rate) – Actual variable overheads (B) Variable overhead efficiency variance = Standard variable overhead rate(standard Hours for Actual output – Actual Hours)
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67. Using Standard Cost Variances A performance report should be prepared on a periodic basis for the managers who are responsible for the standard cost variances. The management by exception concept would then be used by the managers to focus their attention on the most significant cost variances.
78. Cost-Volume-Profit Assumptions and Terminology 1. Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold. 2. Total costs can be divided into a fixed component and a component that is variable with respect to the level of output.
79. Cost-Volume-Profit Assumptions and Terminology 3. When graphed, the behavior of total revenues and total costs is linear (straight-line) in relation to output units within the relevant range (and time period). 4. The unit selling price, unit variable costs, and fixed costs are known and constant.
80. Abbreviations SP = Selling price VCU = Variable cost per unit CMU = Contribution margin per unit CM% = Contribution margin percentage FC = Fixed costs
81. Abbreviations Q = Quantity of output units sold (and manufactured) OI = Operating income TOI = Target operating income TNI = Target net income
82. Breakeven Point Sales Variable expenses Fixed expenses – = Total revenues = Total costs
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87. Essentials of Cost-Volume-Profit (CVP) Analysis Example Assume that the Furniture Shop can purchase Chairs for Rs32 from a local factory; other variable costs amount to Rs10 per unit. The local factory allows the Furniture Shop to return all unsold Chairs and receive a full Rs32 refund per pair of Chairs within one year. The average selling price per pair of Chairs is Rs70 and total fixed costs amount to Rs84,000.
88. Essentials of Cost-Volume-Profit (CVP) Analysis Example How much revenue will the business receive if 2,500 units are sold? 2,500 × Rs70 = Rs175,000 How much variable costs will the business incur? 2,500 × Rs42 = Rs105,000 Rs175,000 – 105,000 – 84,000 = (Rs14,000)
89. Essentials of Cost-Volume-Profit (CVP) Analysis Example What is the contribution margin per unit? Rs 70 – Rs 42 = Rs 28 contribution margin per unit What is the total contribution margin when 2,500 pairs of Chairs are sold? 2,500 × Rs 28 = Rs70,000
90. Essentials of Cost-Volume-Profit (CVP) Analysis Example Contribution margin percentage (contribution margin ratio) is the contribution margin per unit divided by the selling price. What is the contribution margin percentage? Rs28 ÷ Rs70 = 40%
91. Essentials of Cost-Volume-Profit (CVP) Analysis Example If the business sells 3,000 pairs of Chairs, revenues will be Rs 210,000 and contribution margin would equal 40% × Rs 210,000 = Rs 84,000.
92. Equation Method Rs70Q – Rs42Q – Rs84,000 = 0 Rs28Q = Rs 84,000 Q = Rs84,000 ÷ Rs28 = 3,000 units Let Q = number of units to be sold to break even (Selling price × Quantity sold) – (Variable unit cost × Quantity sold) – Fixed costs = Operating income
95. Target Operating Income (Fixed costs + Target operating income) divided either by Contribution margin percentage or Contribution margin per unit
96. Target Operating Income Assume that management wants to have an operating income of Rs 14,000. How many pairs of Chairs must be sold? (Rs84,000 + Rs14,000) ÷ Rs 28 = 3,500 What sales are needed to achieve this income? (Rs84,000 + Rs14,000) ÷ 40% = Rs245,000
97. Target Net Income and Income Taxes Example Proof: Revenues: 4,822 × Rs70 Rs337,540 Variable costs: 4,822 × Rs42 202,524 Contribution margin Rs135,016 Fixed costs 84,000 Operating income 51,016 Income taxes: Rs51,016 × 30% 15,305 Net income Rs 35,711
98. Alternative Fixed/Variable Cost Structures Example What is the new contribution margin? Decrease the price they charge from Rs32 to Rs25 and charge an annual administrative fee of Rs30,000. Suppose that the factory the Chairs Shop is using to obtain the merchandise offers the following:
99. Alternative Fixed/Variable Cost Structures Example Rs70 – (Rs25 + Rs10) = Rs35 Contribution margin increases from Rs28 to Rs35. What is the contribution margin percentage? Rs35 ÷ Rs70 = 50% What are the new fixed costs? Rs84,000 + Rs30,000 = Rs114,000
100. Alternative Fixed/Variable Cost Structures Example Management questions what sales volume would yield an identical operating income regardless of the arrangement. 28x – 84,000 = 35x – 114,000 114,000 – 84,000 = 35x – 28x 7x = 30,000 x = 4,286 pairs of Chairs
101. Alternative Fixed/Variable Cost Structures Example Cost with existing arrangement = Cost with new arrangement .60x + 84,000 = .50x + 114,000 .10x = Rs30,000 x = Rs300,000 (Rs300,000 × .40) – Rs 84,000 = Rs36,000 (Rs300,000 × .50) – Rs114,000 = Rs36,000
102. . Financial accounting income statement emphasizes gross margin. Contribution income statement emphasizes contribution margin.
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110. Customer Profitability Analysis Keep Drop Account Account Difference Relevant revenue Rs1,200,000 Rs800,000 Rs(400,000) Relevant costs: Cost of goods sold 920,000 590,000 330,000 Material-handling labour 92,000 59,000 33,000 Marketing support 30,000 20,000 10,000 Order/delivery 32,000 20,000 12,000 Decline in operating income if drop account Rs(15,000)
