Delivery in day(s): 5
Classification of Cost can be made in a number of ways. For different classifications manufacturing & service providing units use different costing techniques.
The different costing classification can be summarized as under:
Materials: Materials can be broadly classified as:-
Direct Material & Indirect Materia
Wages: - Wages can be classified as:
Direct wages & Indirect Wages
Direct Expenses & Indirect Expenses
Function Wise Classification:
Variable overheadare the expenses which proportionately vary with production units such as indirect material, indirect labour, indirect expenses which cannot be directly allocated to a specific product. Fixed Overheads are the expenses which remains fixed irrespective of the production volumes which consist of rent and rates, depreciation on factory equipment,insurance, office expenses etc. The expenses which partly remains fixed and partly variable with the production output is called Semi Variable or Semi Fixed overhead.
The following formula can be used for calculating Semi-variable overhead: Y = a + bX
Where Y = total mixed cost
Some examples of semi variable overheads are telephone expenses, salary inclusive of bonus etc.
Marginal Costing distinguishes between the fixed and the variable cost of a product. The cost of producing one additional unit is termed as marginal costing. In producing one additional unit there is no change in the fixed cost. It is to be noted that the fixed and variable cost are short term concept. In the long run all costs are variable.
Classification of cost can also be made in relation to Accounting Period. The benefit which is derived in future periods is termed as Capital cost. Such costs have to be amortised in a number of years. On the other hand, the costs which are incurred solely for a particular year are called Revenue Costs. It forms the part of the Total Cost which is incurred solely for that particular year. Classification of Cost can also be made according to the decision-making process such as opportunity cost, sunk cost, controllable &uncontrollable cost, joint cost, differential cost etc.
Standard costs are associated with the manufacturing companies cost of direct material, direct labour &direct expenses. Variance analysis is an important part of Standard costing which shows the actual differences between the actual cost and the standard cost. Some of the major variances are volume variation, material cost variation, labour cost variation, etc.
Value of Classification:
The following are the value of classification which are given as under:
Suitable classification of costs for Launch break Ltd.
Launch Break ltd is a bakery company. The suitable costing method for this organization is the processing costing. As most of the cost expenses are managed by various departments it is accounted as direct cost for the organization except few items of expenses which has to be apportioned. In this process of accounting the organization follows the various type of production cost obtained by the department, to measure cost on production and per units. So, this is process of accounting is far better than job accounting.
The different type of process used department wise:
a) Calculation of Cost of Job no. 336
b) Costing Methods
There are various methods for computing cost of production, cost of sales, unit cost etc. The organization or the company has the right to choose what kind of methods they are going to adopt for their production depending upon the output. These types of methods can be classified as listed below.
a) First In First Out
Stores Ledger Account(FIFO)
Closing Stock 25000 units=£4050
b) Direct Labour Cost
Direct Labour Cost:
Standard hours for production 11250 hrs.
Actual hours worked 10750 hrs.
Hours saved11250-10750 500 hrs.
Cost of Direct Labour
Normal wages = 10750*8 £86000
Bonus = .75*8*500 3000
50% of over-time premium
=50% of 2*2400 2400
c) Overhead Analysis
d) (i) Budgeted Fixed Overhead absorption Rate
d) (ii) Distinction between Costing Method and Costing Techniques:
Methods indicate an integrated system applied depending upon the manufacturing technique. The term refers to the cost ascertainment of different methods of costing by different industries. The following are the some important methods of Costing:
Another name of job costing is terminal costing or specific order costing. Costs are accumulated according to the job or work order. The material, labour and overhead costs are allocated through respective abstracts which are charged on a predetermined basis. Job Costing can be further classified as under:
2. Process Costing:-
The continuous operation of a product through different processes is termed as process costing. This costing method is applicable where the product passes through different process and converted into finished product.Process costing method is mainly applicable in cement industry, sugar industry, textile industry etc.Process costing can be broadly classified into 1) Operation Costing; 2) Operating Costing; 3) Output Costing; 4) Multiple Costing.
Cost control, cost ascertainment and allocation of expenditure are powerfully achieved through the help of costing techniques. It is helpful in supply of information to the management. The following are the various techniques of costing (a) Uniform Costing; (b) Marginal Costing; (c) Standard Costing; (d) Historical Costing; (e) Absorption Costing.
d) (iii) In case of Launchbreak Ltd any one of the techniques discussed above can be adopted. As only marginal costing and absorption costing differ only in the treatment of fixed production overheads in the accounting records and managing financialstatement.
Statement of Cost for October
In the above statement, the material cost incurred for preparing 45000 units of cake is £17200 which is includes £6880 for flour and £10320 for other materials. The hours worked by labourers in different production department are: Machinig-3800, Baking-2050, Packing-4900, and normal rate for working an hour is £8. Therefore, the labour cost incurred for producing 45000 units of cake is £86000 i.e. 3800+2050+4900=10500*£8=£86000.
Overhead absorption in the product is an important aspect which an account manager needs to know. The overhead absorption rate is derived for each department by dividing the total overhead amount of each department with their labour hours. Hence, the overhead absorption rate for each department is, Mixing department-£4.194/hour, Baking department-£7.027, Packing-£2.62/hour. Therefore, the overhead cost absorbed by each department for producing 45000 units of cake is, mixing department-£15937.2, baking department-£14405.35, packing department-£12838. The total cost incurred for producing 45000 units of cake is £146380.55 and the cost per cake is derived by dividing the total cost incurred for producing 45000 units of cake from 45000 units of cake produced i.e. £146380.55/45000 units of cake = £3.2529 per cake.
a) Challenges in preparing Routine Cost Report
Cost of Production Report (CPR) shows all costs chargeable to a department. At the end of each month journal entries are not only the source for summary at the end of each month or a period, but also an effective means in presenting and disposing of accumulated cost during the period. Managerial purposes will not be solved by only identifying the total cost. . The costs are to be divided in details to facilitate cost control and cost reduction.
b) Cost Report Strategy of Launchbreak Ltd.
Lunch break Ltd has adopted Standard Costing technique along with absorption costing system. Since direct labour is a significant input overheads are being absorbed on the basis of direct labour hour.
a) Target Ratios of Takeaway
b) (i) Comparison of Ratios
b) (ii) Limitations of Use of Ratios
There are some limitations of financial ratios that an analyst should take care of
Launch break Ltd can go away with the decision of purchasing Takeaway Ltd. As the ratios of Takeaway Ltd are quite satisfactory. Even if the profit percentage is not up to the mark it has the scope of cost reduction. In order to earn a greater profit initiative should be taken to reduce the cost. There are some ways of achieving it, by increasing the sales per customer and efficiently utilizing the money spent. Increasing larger returns from sales promotions and advertising. (Hansen and Palmer, 1997)
Sometimes in order to earn a greater profit it is difficult to cut down the expenses. If the sales are increased substantially, the cost per percentage of sales substantially declines.
The Profit and Loss statement provides a summary of expenses and helps in locating expenses that can be cut. Therefore, the information should be as current as possible. For this reason, monthly Profit and Loss Account needs to be prepared
2. Key factor : While making budget there some factors which sets out the limitation in making the quantity produced for sale. This is known as Key factor or limiting factor. The ICWA (UK) defines Key-factor as “the factor the extent of whose influence must first be assessed in order to ensure that the functional budgets are reasonably capable of fulfilment”. From the view point of sales, there are many factors by which a demand is influenced. Say for price, quality of the product, purchasing power of the customers etc. The key factor in production may be plant capacity, availability of labour, availability of raw material.
a) Methods of Budgeting : Budgeting Methods are of two types Fixed Budget & Flexible Budget. As defined by the ICWA London fixed budget is the budget is the budget which is designed to remain unchanged irrespective of the level of activity actually attained. It is employed when budgeted output is close to the actual output. Maximum managerial control can be exercised by making comparisons with actual operating results. (Vatter, 1969)
ICWA, UK defines Flexible budget as “a budget which by recognising the difference between fixed, variable and semi-fixed costs, is designed to change in relation to the level of activity attained”. A flexible budget is prepared for more than one level of activity.
b) Zero base Budgeting : Zero Base Budgeting is the process of traditional budgeting which makes planning and decision making easier for an organization the term Zero Base Budgeting is the practice of budgeting of every unit of income received. Zero Base Budgeting also includes the identification of task and funding resources for the completion of the task.
c) Rolling Budget : Rolling budget is also known as continues budget or perpetual budget in which the budget period automatically extends continuously incorporating the changes in the budget. It adds future accounting periods to replace budgets for an accounting period that has passed.
d) What If Analysis
The other name of what if Analysis is the Sensitivity Analysis which helps in the planning, decision making and managing a business. The management knows the use of what if analysed beforehand and what changes are going to take place in the future and on the basis of that budget are prepared.
a) Production Budget
b) Material Purchase Budget
c) Cost of Material
d) Labour Hour Budget
Labour hour required @ 2 hrs. Per unit
Labour hour available
e) Labour Cost Budget
Add: Cash sales 40% less 10% discount
Collection from debtors
Sale of assets
Purchase of assets
a) Calculation of Various Information
(i). Actual price of material per gram.
= 143000.00/27500=£5.20 per gram.
(ii) Standard usage of material for actual production:
Standard quantity per unit=30gms. Thus standard usage for actual production=30 gms.*900=27000gms.
(iii) Actual labour rate per hour=26040.00/4200=£6.20per hour.
(iv) Standard labour hour for actual production=Standard labour hr. per unit*actual units produced.
(v) Budgeted production overhead=Budgeted output*budgeted overhead per unit of output
b) Variance Calculation
(i) Material price variance
= (Standard price-Actual price)*Actual quantity= (5-5.2)*27500=£5500(A)
(ii) Material usage variance= (Standard quantity-Actual quantity)*Standard price
(iii) Labour Rate variance= (Standard rate-Actual rate)*Actual hours
(iv) Labour efficiency variance
=(Standard hours for actual output-Actual hours)*Standard rate per hour
= (5*900-4200)*6= (4500-4200)*6=£1800(F)
(v) Fixed overhead expenditure variance=Budgeted fixed overhead-Actual fixed overhead
(vi) Fixed overhead volume variance=Recovered overhead-Budgeted overhead
Budgeted overhead=£20000, Budgeted labour hour=4500hrs.
Thus overhead recovery rate per labour hour=20000/4500=£4.44 per labour hr.
Actual hours worked=4200hrs. Thus overhead recovered=4.44*4200=£18667
Thus volume variance=18667-20000=£1333(A)
(vii) Fixed overhead capacity variance=Standard overhead-Budgeted overhead
Standard overhead=Standard rate per unit*Standard output for actual time
Thus Capacity variance=18660-20000=£1340(A)
(viii) Fixed overhead efficiency variance=Recovered overhead-Standard overhead
C) Causes of Variance
Management action: In a Standard Costing system actual results are compared with standard and the variances either favourable or adverse are determined. The reasons for such variances are found and the person/s or department/s responsible are identified and responsibilities fixed. For material cost variances purchase department, production department, stores department, might be responsible. The management takes necessary remedial action. Similarly for labour or overhead variances, responsibilities are fixed, and corrective action like training, motivation of workers, proper sequencing of machinery etc., are resorted to by the management. Similar remedial actions are taken for variances in overhead costs. Variances obtained under standard costing system have to be reported to management as “management by exception” for taking remedial steps and action.
The following points emerge after analysing the variances and operating statement.
Material cost variance is adverse; all the variances under material cost are adverse. The purchase manager might be responsible, as it might so happen that quality of material is not up to the mark, also the purchase price of material is higher than estimated.
Labour rate variance has occurred adverse balance, but labour efficiency variance has ocurred favourable balance. It means although actual labour rate is higher than budgeted, actual productivity of labour is higher than standard.
All overhead variances except overhead efficiency variance are adverse. It is clear that management should take care to rectify the mismanagement in utilizing overhead cost. (Kaplan, 1975, pp. 311--337)