Download Assignment 1 is compulsory and due

1
COST ACCOUNTING AND CONTROL
Study Unit 1 (text book unit 1.1 – Function & Environment of Cost and Management Accounting)
Cost accounting = process and procedures used to obtain, record and report cost data. Used with other accounting
info by management when planning and controlling activities of the entity.
Cost control = comparing the actual results with the expected results, determining the causes of deviations and making
management decisions to ensure that planned results are achieved, or to amend the initial plan because of the changed
conditions.
Cost & Management Accounting pg 4
Cos of new international business environment management needs relevant and timely accounting info for accurate
product cost info. Also essential to have accurate costing info when making pricing decision.
Users of financials made up of :
 management of entity
 shareholders of entity & other interested parties (creditors, staff and government)
So need to have info for all these people either :
 financial accounting – provides financial info bout entity by general purpose financials and used by parties NOT
involved in day-to-day management of entity (parties outside the entity). General purpose financials give report of
how management has handled the activities of the enterprise for period that has already happened (so financials
are historical). Prepared in accordance with GAAP and financials MUST be objective so DOESN’T show personal
view of preparer of financials.
Aim of financial accounting – provide external reports by means of general purpose financial statements
 management accounting – process of identifying, measuring, analysing, interpreting and communicating info that
is in line with entity’s goals, so therefore involves planning and control. Cos for internal decision-makers and will
influence decisions in future, the management accounting reports are future-orientated (although still use historical
data for planning and decisions). No external criteria so management accounting reports are subjective, but future
estimates normally based on historical data.
Management decides the type and extent of info that is needed e.g. :
 is info relevant to question on hand?
 does info equip management to make better decisions?
 is info timely?
 does info provide all possible variables?
NOT of general nature – management accounting reports contain SPECIFIC INFO.
Differences between financial accounting and management accounting :
Financial accounting
Management accounting
Users
External users e.g. stockholders, SARS,
creditors or investors
Internal users e.g. decision-makers, budget controllers
Purpose
GENERAL PURPOSE financial
statements
SPECIFIC PURPOSE statements and reports
Timeliness
Reports on historical financial events
Current and future orientated reports
Restrictions
Must conform to external standards e.g.
GAAP
Not subject to external standards. Management needs info
in format that meets strategic, operational, planning and
controlling needs
Type of info
Financial measures only
Financial measures as well as customer, business
processes and organisational learning perspectives
Nature of
info
Objective,
precise
Scope
Highly aggregated reports on entity
reliable,
consistent
and
Subjective, judgmental, valid, relevant and reasonably
accurate
Disaggregated internal reports for managers and decision
makers
Although financial and management reports use historical data, the financial accountants report on historical costs and
income, while management accountants use the historical info and estimate future costs and income, but both use cost
accounting (where current data is collected and assimilated to provide info.)
Place and function of cost accounting
2
Cost accounting = process of compiling costs of producing products, providing services or undertaking activities.
Management uses cost info for decision making. Easier to measure and determine production costs, but more difficult
to determine cost of non-manufacturing activities like marketing and admin.
Essential for non-profit organisation – can only be effective if can determine cost of products and services that they buy
and render e.g. church, schools etc.
Function of management accounting
Management accounting = planning and control decisions :
 planning decisions – setting of goals for entity and designing actions that will attain that goal. Normally needs
estimates of future costs and future income and will use historical data as start for future orientated estimates.
 control decisions – comparing the actuals with expected results and imposition of accountability for deviations
from original standards. Also entails further management decisions to ensure that planned results are achieved or
that initial plan is changed cos of current conditions (so choosing between possible alternative actions).
Financial accounting
External reporting based on GAAP
Internal reporting based on relevance
Cost accounting
(common data base)
Planning
Management accounting
Control
Cost accounting systems
Set of systematic processes and procedures used to measure, record and report on cost accounting data :
 cost determination – data collected to determine the costs of specific product or activity, using info (like hours
worked, materials used etc) that has been collected from different departments of entity
 cost recording – cost accounting system is part of basic accounting system of entity which gathers accounting info
used for both management and financial accounting. Info needed is taken from various source documents e.g.
wage sheets or supplier invoices
 cost analysis – cost accounting system provides large amounts of info, but will only be useful or meaningful if info
is analysed by people who know how to use cost accounting methods
 cost management – preparation of info in a different report format for requirement of management to effectively
manage the enterprise. e.g. cost accountant uses cost analysis to make meaningful recommendations for cost
management (e.g. saving on costs) and therefore strategically helps with allocation of scarce resources in entity.
To get meaningful info accountants collect, analyse and report the costing info in different way.
 cost reporting - process by which relevant info is given to decision makers using detailed internal cost reports.
Relevant info = accounting info of the entity which is needed by a particular manager for making a specific decision.
Cost accounting system must provide relevant and necessary info timeously to anyone who needs it.
Ethical conduct
Managers and accountants sometimes take actions that are not in line with entity’s goals mainly cos of inappropriate
performance measures e.g.
 if performance is measured by return on assets (i.e. net income / total assets) then managers won’t want to replace
inefficient equipment cos will reduce the return on investment
 may keep redundant or obsolete inventory in the books to avoid showing lower profit
 may purchase goods from friend rather then getting competitive quotes
 may allocate costs to different projects rather then go over budget on a specific project
 could base budget on over optimistic sales forecasts.
Must have ethical standards and anyone breaking these, or failing to report unethical behaviour, could loose career.
summary of Standards of Ethical Conduct of Practitioners of Management Accounting and Financial
Management are on pgs 10/11 of text book.
Chartered Institute of Management Accountants (CIMA) promotes professionalism and competence in management
accountants in SA.
Cost accounting = assimilation and evaluation of cost data
3
Management accounting = use of this cost data in internal planning, control and decision-making.
3 primary uses of cost data :
1. allocation of costs between cost of sales and finished goods inventory to calculate profit
2. cost data for long and short-term decisions
3. cost data for planning and control decisions
Summary :
 cost accounting = process of calculating cost of products and services or an activity
 cost accounting system = part of basic accounting system that accumulates accounting info for use in
management and financial accounting
 cost analysis = evaluation of cost data
 cost management = preparation of info in a report to adhere to requirements of management to effectively manage
the entity
 cost recording = updating the entity’s double entry accounting system using source documents
 cost reporting = process by which relevant info in the form of a report is given to decision-makers
 financial accounting = financial info about the entity given to external stakeholders by means of general propose
financials
 management accounting = process of identifying, measuring, analysing, interpreting and communicating info in
pursuit of entity’s goals
Management accountants use accounting and other info to prepare specific reports to be used by internal users for
planning, controlling and decision making
Study Unit 1 cont. (text book unit 1.2 – Cost Classification and Terminology)
Thorough understating of cost accounting entails understanding :
 nature of costs
 cost terminology
 cost classification
Expenses = value offered where it is not determined if the expenses will be applied effectively
Cost = if expenses are applied effectively
Wastage / loss = if expenses aren’t applied effectively. So difference between total expenditure and the effective
expenditure
Expenses must be applied as effectively as possible to obtain resources i.e. the minimum expense must be applied to
obtain the best possible advantage, but effectiveness must be measured economically NOT technically (so replacing
obsolete computer that is still functioning adequately is effective cos new equipment can result in cost saving).
Effectiveness of application of resources must be measured in terms of economical results and NOT technical results.
If materials are used effectively then unused pieces aren’t wastage, so wastage is a loss, but NOT all losses are
wastage. Other causes of wastage = ineffective admin, working methods, bad marketing etc.
Wastage = all expenses not necessary for processing a product or delivering a service.
Costs = expenses that are economically unavoidable and technically essential for production of goods or service. Each
specific expense has a norm and if expense = norm then it is a cost, BUT known wastages are NOT costs.
To measure costs accurately and satisfy management’s needs for specific type of cost report then need a careful
description and identification of product to be reported on.
Costs are necessary sacrifices to deliver a product or service. Unnecessary expenditures NOT taken into
account as part of cost of product or service.
Cost objectives
To determine the cost of product or activity must first define cost objective which is any product activity or project
requiring that costs must be measured. Cost objectives NOT actual costs – just products.
Services, departments, divisions etc that require the costs that must be determined.
In manufacturing entity products are primary cost objective but also includes marketing costs and cost of admin.
Classification of costs :
Expired and unexpired costs – outlay of cost represents offer made to obtain economic benefit. Can have already
received the benefit (e.g. payment for past rent) or for benefit useful in future, and then until time that benefit is used
then it is a deferred or unexpired cost (e.g. prepaid insurance, raw material stock on hand and net book value of
equipment). All deferred / unexpired costs are assets in Balance Sheet and represent future benefits.
4
If benefit has been received then outlay is expired cost and is in the Income Statement.
If no benefit will arise from the outlay then it is an expired cost and is a loss in the Income Statement
Balance Sheet
Deferred / unexpired
Outlay or
expenditure
Expense / cost
Income Statement
Loss
Expired cost
Costs = total resources used to achieve specified aims
Classification of costs by their nature
Cost = monetary measure of resources given up to acquire goods or services that will benefit the enterprise at present
or future date. Either :
 manufacturing costs – sum of costs incurred in manufacturing process, direct materials, direct labour and
manufacturing overheads
 commercial costs :
 marketing costs – including all costs with promotion of product, acquisition of orders, admin of marketing
function and delivery of finished goods. Costs for obtaining orders for and delivery of manufactured products
 administrative costs – relate to executive, organisational and clerical costs of enterprise, but EXCLUDING
costs for manufacturing and marketing functions. All costs relating to day-to-day function of entity.
Total operating costs
Manufacturing costs
Commercial costs
Marketing costs
Administrative costs
Period costs = costs associated with given accounting period rather then given product e.g. marketing and admin costs
are incurred to generate income in specific period but not related to sale of given number of units. Also rent paid for
shops to market goods are not influenced by the volume of sales.
In accounting match costs against income earned during the same period.
Deferred costs = unexpired period costs and shown as asset in Balance Sheet (cos haven’t received benefit of outlay
yet – so can’t be expensed against income for that period).
Product costs = associated with products that are manufactured and can be either expired cost or unexpired cost.
Unexpired cost = when product hasn’t been sold e.g. cost of finished goods on hand. Shown as asset in Balance
Sheet.
Expired cost = if the product has been sold and is COS and in Income Statement.
If no sales take place in month then amount of purchased goods for resale is shown as stock in BS and only when sales
occur is the sales and corresponding purchases taken to the IS so that can calc profit made on those items.
Balance of unsold items will be shown as unexpired cost in BS (as stock on hand) cos of matching concept in financial
accounting.
Total costs
Period costs
Expired
(items sold)
Charged in period during which
product was sold / cost expired
Unexpired
(items unsold)
Costs in
Income Stmt
Production costs of total
products produced
Expired
(items sold)
Unexpired
(items unsold)
Inventory still on hand
/ prepaid costs
Assets in
Balance Sheet
5
Cost classification in relation to product
Cost of goods in manufacturing entity determine by knowing which are product costs in entity and also having an
understanding of the flow of costs through the accounts of entity.
Production costs classified as :
 direct material – primary materials and easily traced to manufacturing of goods or services rendered. Integral part
of end product and normally in predetermined measurable quantities proportional to the volume of production
usages. Direct material forms cost element on its own!
 indirect material = secondary material that isn’t part of the end product and quantity used is not directly related to
volume of production and can’t be linked directly to particular product. Not part of cost element and normally
under manufacturing overheads.
 direct labour – cost of all essential labour physically expended on manufacturing the product and traced
conveniently to manufacture of goods or services rendered. Indirect labour costs can’t be directly linked to
particular cost objective and are classified under manufacturing overheads
 manufacturing overheads – refers to all other costs expended in manufacturing process, EXCLUDING direct
material and direct labour costs, but INCLUDING indirect material and indirect labour costs. e.g. depreciation,
insurance costs etc. So basically they occur during course of production, but can be attributed directly to the
production unit and amount applied to specific unit can only be estimated by determining total of the overheads for
the period and allocating all those cost to the units manufactured in that period.
see example and explanation pgs 22/23 of text book
Primary cost = total of direct material and direct labour costs
Conversion costs = total of direct labour costs and manufacturing overheads (so total cost of converting the raw
material to a finished product).
Total operating costs
Manufacturing costs
Direct
material
Primary costs
Direct
labour
Commercial costs
Manufacturing
overheads
Marketing
costs
Administrative
costs
Conversion costs
Direct costs = cost that can be accurately traced to a particular cost objective even if not only direct materials or labour,
but rather something that is directly related to the objective
Indirect costs = cost that is not direct so can’t be accurately traced to specific cost objective. Normally part of the
common costs relating to more then one cost objective and can’t be traced individually to products or processes.
Summary
Costs necessary sacrifices to deliver products and services. Any unnecessary expenditure not used as part of cost of
product or service is wastage. Cost object is not actual costs, but rather any product, service, activity or project which
must be measured.
Expired costs (expenses) are when benefit has already been received – shown in Income Statement.
Unexpired costs are deferred costs and shown as assets in Balance Sheet.
Manufacturing costs = direct materials, direct labour and manufacturing overheads.
Commercial costs = total of marketing and administrative costs.
Period costs = costs associated with given accounting period NOT a specific product.
Product costs = any cost associated with a specific product.
Primary costs = total of direct materials and direct labour costs
Conversion costs = direct labour costs and manufacturing overheads.
Variable cost is constant per unit, but changes in proportion to number of units made
Fixed costs do not change in relation to the output charges
Direct costs are costs that can be traced to particular cost objective
Indirect costs cannot be accurately traced to a specific cost objective.
Administrative costs exclude costs relating to manufacturing or marketing functions.
6
Cost objectives are products, services, departments, divisions or any other activity or object where costs must be
measured.
If expense is applied effectively it is a cost.
Indirect costs are any costs, other then direct costs, that cannot be allocated to a specific cost objective.
Manufacturing costs = direct materials + direct labour + manufacturing overheads
Manufacturing overheads = all costs expended for efficient continuation of the manufacturing process, excluding
direct material and direct labour costs.
Product costs = all costs associated with the products that are manufactured
Relevant range = range of production levels in which fixed cost remains fixed in total.
do exercises on pgs 29 to 31 of text book
Study Unit 1 cont (text book unit 2.1 – Material)
Cost & Management Accounting pg 36
Material, labour and overheads are cost elements and used for grouping of all costs.
Material is all costs relating to physical raw materials used in manufacturing process as well as all costs and activities
associated with making a finished product.
Primary / direct material = basic raw material that is converted to finished product e.g. wood into furniture.
Secondary / indirect material = material used in manufacturing process that contributes to conversion of primary
material, but doesn’t normally form part of the finished product e.g. sandpaper used on wood to make furniture
Work in progress / incomplete work = primary material which has entered manufacturing process but isn’t complete
and so can’t be called finished product. Normally portion of labour and overheads already allocated to it.
Finished goods = finished product converted during manufacturing process from primary material
Commercial inventories = finished products obtained from factories or wholesalers for resale purposes. So no raw
materials, work in process or finished goods stock – only commercial inventory
Inventory = all material (primary and secondary), work in progress and finished goods at a given moment. If
commercial entity then only commercial inventory.
Inventory piling
Normally timing difference between purchasing material and using it, so held as inventory in meantime. Must have
material available when needed to prevent unnecessary costs or losses.
Normal inventory – material in stock for necessity cos it is in process of production, about to enter production or has
finished production.
Buffer inventory – where keeping a stock of this inventory is a buffer between production and erratic usage of the item.
Safety inventory – more then just buffer inventory and normally kept to ensure that entity can continue with production
if there is a shortage of a specific material or if it is not delivered within the correct lead-time (normal delivery period).
Basically extra inventory carried to prevent a stock-out.
Stock-out – when material is not available for production purposes or when there is a demand for a product that is not
available
Strategic inventory – when more quantity is purchased then normal in order to cope with possible unavailability in
future. So kept for strategic reasons
Speculative inventory – held for economic reasons e.g. expecting huge price increase and so purchase more just
before it goes up
Inventory-in-transit – inventory that has been purchased but not yet received.
Technical inventory – inventory that is physically in the entity’s possession
Economic inventory – amount of inventory after all adjustments have been taken into account e.g. adjusted for
inventory-in-transit or inventory sold but not yet delivered
Overstocking – when amount of inventory held is not justified by volume of production
Under stocking – when amount of inventory held is too low for volume of production
Maximum inventory – greatest possible inventory. Normally more then the order size and safety inventory and
normally when an order is delivered earlier then the normal delivery period.
Average inventory – either calculated the average inventory precisely or use :
average inventory = (opening inventory + closing inventory)
2
or
average inventory = (order size) + safety inventory
2
Study Guide pg 3
Must always be sufficient material available to ensure constant flow to the production process. Normally use printed
prenumbered forms to exercise control over the purchasing procedure. Person acquiring the stock has to sign forms to
isolate responsibility.
Documentation of material purchases :
7
 bill of quantities – used by engineers or planning departments to work out necessary material specifications and
states quantity and quality of the material needed for specific job. Gives storekeeper advance notice of what
material will be needed
 purchase requisitions – used by storekeeper or production department to purchase material or equipment that
isn’t in stock. Written document authorises purchasing department to purchase the material needed – must have
accurate description and exact number of items needed.
Cost & Management Accounting pg 39
Inventory piling activities are :
 acquisition
 storage
 distribution and consumption
 inventory value
Acquisition function – normally done by purchasing department and problems include :
 if too little purchased then entity runs out of inventory
 if too much purchased then too much capital invested in inventory and storage space is wasted
 if wrong material purchased then unnecessary losses can result
 if material not received timeously then unnecessary losses
Specifications must be prepared before purchasing can proceed – must indicate quality, dimensions and combination of
material needed. How much of what is required when?
Cycle of inventory levels of material with constant usage :
100
normal maximum inventory
normal
delivery
period
80
60
see pg 40/41 of
text book for
explanation
order point
40
20
0
safety stock
2
4
6
8
10
12
Time in weeks
Safety inventory = maximum usage x (maximum lead time - normal lead time)
Order point = (order period x normal usage) + safety inventory
Order size is made up of :
 cost of placing the order
and
 cost of holding inventory
But need to find balance cos of amount of capital involved. If reduce cost of one then will increase cost of another.
Use formula
EOQ
C
U
H
=
=
=
=
economic order quantity
cost of placing an order
yearly usage
inventory-holding cost per unit
But also have to take the cost of the inventory into account. Either interest paid if money borrowed to pay for stock or
interest received that is lost as the money had to be used for stock instead.
EOQ =
EOQ
C
2 x C x U
(P + i) + H
= economic order quantity
= cost of placing an order
8
U
H
P
i
=
=
=
=
yearly usage
inventory holding cost per unit
cost per unit
interest rate
If high interest rate then should place smaller orders more often that that will reduce capital in investment.
Ordering – once have order quantity and order point then place written order. Must take into account which supplier is
most favourable but also most reliable. Must be control over purchase function and only authorised person can sign.
Must keep record of all orders placed and check that goods delivered in agreed period of time and are correct.
Study Guide pg 6
To calc number of orders that should be place annually :
no. of annual orders =
total annual demand
economic order quantity (EOQ)
.
Cost price of material
Cost price – obtained from supplier’s invoice and must make adjustments for discounts, packing and transport costs
etc
Trade discount – price that wholesalers supply to retailers less trade discount. NOT shown in books of either seller or
buyer
Quantity discount – bulk discount. Subtracted from invoice price to get cost price
Cash discount – if paid within certain time. This is income NOT reduction of cost price
Packing and transport costs – paid for separately, but should be taken as part of purchase price.
Stock systems :
 perpetual stock system – continuous record kept of movement of stock and every time items received or issued
then stock figures are adjusted. So stock figure in GL will always show the actual stock on hand. Still do stock-take
but system is just control over the perpetual stock records
 periodic stock system – systematic and physical count made of each item in stock at least once a year
Cost & Management Accounting pg 44
Storage
Once stock received and checked then GRV issued and goods stored in warehouse. Design of warehouse mustn’t
hinder efficient flow of inventory and must take into account :
 orderly way of storing according to predetermined classification policy of stock
 safety for certain products
 unique characteristics of each product e.g., perishable or dangerous goods etc
 easy access to inventory near entrance that is regularly issued
 entrances to warehouse to be kept to minimum
 only authorised staff to have access to warehouse.
Either centralised or decentralized warehouse – decided by nature of enterprise and product that has to be stored.
Cos computers more in use can have greater classification and codification of inventory and numerical code of item can
tell what it is from the classification, but still need “bin card” (record of quantity of each type of material in warehouse,
showing all receipts, issues, order points, order quantity and safety inventory), but can now be on computer which
makes it faster and more efficient. (If use continuous / perpetual stock then bin card is control over daily ordering).
Ledger card used to calculate the value of stock items.
At least once a year MUST do physical count and compare bin cards and inventory ledger cards to the stock and then
differences must be investigated and adjusted.
Issuing of inventory – must ensure control over issues from warehouse using requisitions as base document.
Requisition provides authorisation for storekeeper and is the source document for accounts. Must show reason for
issuing of stock.
Inventory valuation – purchased material is valued at cost price, but if materials are stored then used later purchase
price will change (due to inflation, exchange rates, etc). Then must ensure valuation method used kept for ENTIRE
year and not changed from year to year. Valuation methods either :
 FIFO – first in first out – stock used in order it was received. So if received first then issued first at the price that
was paid for that stock
 LIFO – last in first out – material received last is issued first.
9
 AVCO – weighted average cost – uses actual average purchase prices weighed by the applicable qualities to calc
the issue price, BUT means have to calc new price after each receipt
 standard price – uses predetermined standard unit price and all price differences between predetermined price
and actual price paid are price variances
 market price – uses ruling market price as basis for issue price of inventory.
When valuing inventory must :
1. Prepare ledger card using 4 columns showing date, receiving, issuing and balancing columns each with
quantity, unit price and total amount
2. Stock received transactions must be entered into receiving columns and stock issuing in the issued column
3. After each transaction must update unit and total amount balances, so that have stock balance after each
transaction
4. Cost of sales value is sum of the issuing column
see example of card and also how to use FIFO, LIFO and AVCO on pgs 47/48 of text book
Study Guide pg 7
In big entity normally 3 copies of GRN – 1 each for purchases department, 1 for creditors department and 1 for person
who submitted requisition.
GRN – written confirmation of quantities and kinds of goods delivered by the supplier
Material returns vouchers – gives proof of goods that are returned
Coding – each item in warehouse is marked with commodity number so that identification is easier. Speeds up
dispatch of material to correct section of warehouse and also helps with counting and recording stock.
If materials need for specific job and know quantities and just standard material then use material schedule not
requisitions. So materials are ordered in bulk by requisition, but only drawn in accordance with material schedule.
Method of stock valuation effects cost price and selling price of item as well as the value of the finished and unfinished
products, raw material and profit made by enterprise. All stock must be valued as accurately as possible at end of
accounting period so profit is calculated as precisely as possible.
FIFO – any stock on hand at end of financial year is valued at price of the last purchases.
Advantage = easy to calculate stock value cos valued at purchase values
Disadvantages :
 if periodic system followed then stock value in BS may be too high if prices rise and unrealised profits are made on
old stock on hand. Or stock value too low in BS if prices drop (and if prices drop below cost price then stock is
valued at net realisable value)
 IS can be misleading cos unrealised profits on stock are taken into account
LIFO – material is issued at prices as close as possible to the prevailing market prices. LIFO will show a smaller profit
then FIFO if there are rising prices, and will show bigger profit if there are falling prices.
Advantages :
 profits conductive to greater stability cos net profit determined according to most recent cost prices
 stock values more conservatively shown in BS then with FIFO method
Disadvantages :
 if large quantities stock are kept and seldom issued then when is eventually issued it will be at “old” prices
 no guarantee that issue price is in accordance to current economic values
AVCO / weighted average method – if large price fluctuations then this is best option for dealing with price highs and
lows, but average price is fictitious and may never be related to actual market price.
Standard price method for each stock item
Advantages :
 interim profits calc is simplified
 acceptable for year end valuations if standard prices is conservative and in line with price from previous year
Disadvantages :
 standard prices can be radically different from actual prices at the end of the year and must adjust the difference
using Stock Valuation Adjustment Account in IS
Market price method
Disadvantage – system is not conservative and not in line with normal cost concepts. Not really accepted basis for
stock valuation unless make year-end adjustments.
10
Cost & Management Accounting pg 44
Just in Time (JIT) inventory holding – stock received just before it is to be used so not much inventory on hand.
Advantages :
 inventory holding limited to minimum
 capital investment in inventory minimised
 less storage space used
But needs very careful planning and scheduling of production activities. Must determine exactly time that inventory
must be ordered and make sure that orders are placed in time and that supplier will deliver on time.
Disadvantages :
 increased ordering and handling cost cos of increase in deliveries must be compared to saving of holding less stock
and storage space that is saved
 may not be able to rely on suppliers to deliver on time. Late deliveries will increase costs.
Study Guide pg 11
Efficient planning means can have low stock levels by using JIT stock system. Basically only raw materials for one day
are carried and products completed are sent to clients immediately so there is little or no stock being carried. So raw
materials are received just in time for production and products are completed just in time for dispatch!
Then no stock kept and no need for warehouse. Also material delivered is by fixed price and no material left over after
production so there is no stock valuation.
Can improve delivery service cos fewer suppliers and so can place long-term orders, so JIT strengthens purchasessupplier relationship (cos supplier assured of long-term sales) and leads to better quality product.
Also said that holding stock involves wastage and also increases inefficiency and that JIT reduces ordering costs (cos
long-term). see calc’d example pg 13 of study guide
Although use bin cards in warehouse need to have GL account for stock control of materials, uncompleted work and
completed work.
In separate system control accounts are in the costs ledger
In integrated system control accounts are in the GL.
Cost transactions
When purchases made then entered into Purchases Journal and allocated as materials and then allocated to material
control account and actual material account in ledger at end of month. Invoices or credit purchase invoices are the
source documents.
Can also use a stock ledger card which is not T-account, but rather subsidiary ledger which is controlled by the Material
Control Account in GL.
Materials returned are recorded in Return-out Journal and effect the same accounts only as a reversal.
Materials issues (out of stores)
Would then credit specific materials account in the materials ledger and debit the unfinished goods account with the
amount of the materials that were issued.
If are materials issued and returned, then will use material returns requisition and reverse above transaction.
see example of these ledgers and the flow of materials & docs on pgs 15, 17 & 18 of study guide
see example of accounting entries on pgs 49 to 51 text book
Stock adjustments
Differences between current and periodic stock counts must be recon’d and theoretical stock MUST ALWAYS be
adjusted to physical stock.
Done against manufacturing overheads if :
 relatively small differences
 if reason for difference hasn’t been established and cause is economically unavoidable
Done against account in Income Statement if :
 relatively large differences
 if reason for difference has been established and the cause is negligence or something similar.
Cost & Management Accounting pg 56
Labour control
Productivity = ratio between output and input. Can compare ratios of different period and note the trend which gives
benchmark of productivity.
Labour productivity = output to labour hours worked (input). But difficult to determine standard productivity level cos
varies from person to person and circumstances affect productivity.
Personnel functions closely related to cost control :
 determining labour requirements
11
 employment procedures
 job description
 job evaluation
 time and motion studies
 resignation.
Labour control comparison between what must be done and the labour time allowed for it / what was done and the
labour time taken to do it.
read balance of info unit 2.2 sections 1 to 9 in text book pgs 56 to 65
Cost & Management Accounting pg 66
Labour remuneration
Remuneration = compensation for labour done
Direct labour costs = costs to compensate production employees for time they worked to convert materials into
finished goods. Costs are allocated to specific products
Indirect labour costs = costs to compensate employees who do not work in production but who support the production
process e.g. cleaners, supervisors & storekeeper etc. Cannot be accurately allocated to specific products or production
lines so overheads.
Idle time = when production ceases to operate and direct laborers are idle. Overheads
Manufacturing costs = all manufacturing costs EXCEPT direct materials and direct labour costs e.g. indirect labour,
idle time, overtime premium and PAYE, UIF etc
Learning curve – any one who does something over again will make less mistakes and take less time to complete the
task. Will take less time until reaches optimum speed. Use learning curve effect to estimate the number of labour hours
(cos labour hours will decrease in fixed pattern as laborer gains experience and becomes competent when completing
task).
Learning curve effect works on :
 new activities or activities with new production methods
 new employees not experienced with specific task
 usage of new type of material
 short production runs, prior to subsequent activities.
Learning curve effect used for :
 calc of prices to be quoted
 determination of labour standards
 compiling of budgets
 control (actual hours worked are compared to learning curve to evaluate labour output).
see explanation, examples and graph on pgs 74 to 76 of text book
read balance of info unit 2.3 sections 1 to 12 in text book pgs 66 to 81
Study Guide pg 19
Job cards – used to keep record of worker’s activities in factory. Shows the time a job is started and when the job is
finished as well as telling worker exactly what to do. Gets new card for each new job and once finished gives card to
supervisor to record time of completion. If can’t continue cos of delay on production line or something like breakdown,
then doesn’t use job card, but fills in idle time card instead
Timesheets – job cards reconciled and then summary of clock cards and job cards made on timesheet every day or
every week. Use timesheets to allocate labour costs to cost centers, products or jobs
Wage sheet – info on clock cards summarised onto wage sheet / register and then used to calc total wages owed.
If worker permanently employed on one job then can allocate labour costs directly from wage sheet, but if different jobs
then have to draw up wage sheet showing direct / indirect labour, admin wages etc.
see example of wage sheet and wage analysis sheet on pgs 21 & 22 of study guide
Cost & Management Accounting pg 82
Classification of manufacturing overheads
Overheads divided into :
 manufacturing overheads – all manufacturing costs necessary for efficient continuation of production process
excluding direct material and direct labour costs e.g. :
 hire of factory premises
 maint of machinery and equipment
 depreciation
 supervision
 quality control
12
 administrative overheads
 marketing costs
Problems with overheads – largest problem is how to proportion manufacturing overheads to the different products.
Must allocate the cost on the basis of causal relationship between products i.e. the cause (cost) is linked to the effect
(product)
Classification of manufacturing overheads :
 fixed manufacturing overheads / period costs– costs that are constant in total for certain time and NOT linked to
number of units manufactured during that time. So basically cost of being in business or costs incurred for the
capacity (the production line) e.g. factory rental. So fixed cost remains constant in total and NOT changed by
number of units produced BUT if calc’d the cost per unit will decrease as the volume of production increases. Fixed
costs are fixed for period only and given capacity level (relevant range or minimum and maximum limits within which
the fixed costs won’t change, but if manufacturing capacity is expanded to level more then relevant range then
amount of fixed costs will also increase e.g. if increase production to more then there is space in current factory
then will have to rent additional factory and therefore fixed cost of rental per month will increase
 variable manufacturing overheads / direct overheads – direct bond with, and vary directly in relation to number
of units produced cos the cost per unit is only constant. Also incurred in utilisation of the available capacity i.e. also
part of costs of doing business.
 semi-fixed manufacturing overheads – have a variable and a fixed element e.g. transport cos if have truck then
can carry certain number of units, but if want to increase number of units transported, then must either buy new
truck or make two trips
 semi-variable manufacturing overheads – have a variable and a fixed element e.g. cost of running emergency
generator cos must make provision for petrol used by generator, so more generator is used the more the cost of
petrol will be
Total manufacturing overheads and linear function
Cos can use linear function to show the variable and fixed overheads, can also use this linear function to solve for ;
T = a + bx
Total manufacturing overheads = fixed costs + (variable costs x volume in units)
total overheads
C
osT
tso
t
a
l
variable overheads
fixed overheads
Production volume
c
Study Guide pg 23
o
Handling overheads in cost accounting
system :
n
 collection – collecting andsposting expenses from financial or suspense accounts to the cost accounts
 allocation – analysing the uvarious expenses so that they can be placed in the cost groups where they belong :
m
 manufacturing overheads
p
 service overheads
t
 marketing overheads i
 distribution overheads o
 administration overheads
n
 apportionment – post overheads of the service and admin sections to the following cost recovery groups :
s
 manufacturing overheads
 marketing overheads p
 distribution overheads e
n
 recovery / absorption ofdoverheads – costs that have been allocated over the period to products or jobs (cost
bearers) are bought into account
and recovered.
i
n
g
Cost & Management Accounting
pg 87
Techniques for dividing manufacturing overheads
Must divide manufacturing overheads into fixed and variable elements cos easier for control purposes.
13
Fixed variable overheads quite easy to control cos the total amount is constant – if amount is exceeded then there is
wastage or ineffective use of funds and can determine the cause
Variable manufacturing overheads can be controlled cos the cost per unit is constant. Then can calc total variable
manufacturing overheads by taking variable costs per unit and multiplying by number of units manufactured, and that
can be used to determine if there is any wastage or if ineffective usage has taken place.
Can be easy to divide some manufacturing overheads into fixed and variable elements, but in some cases impossible to
divide and must then use either :
 regression analysis
 high-low method
 simple regression
 multiple regression
Regression analysis
Draw scatter diagram on graph of the number of units manufactured (XY-axis
axis) against the total manufacturing overheads (Y axis) and then draw
Total costs
a straight line between the different points. Then draw line from where
the line between the points intersects the Y-axis parallel to the X-axis
Costs
and that will give you a graph representation of the fixed and variable
elements of the total manufacturing overheads. The intersection of the
fixed overheads
“fixed overheads” line then gives you the amount that is the fixed cost
0
and can divide by the number of units to get the variable cost per unit.
Production volume
Disadvantages : not accurate cos could estimate line through points
with different gradient and that would mean that could be different fixed and variable amounts, but is still acceptable for
control purposes.
High-low method
Basically uses the same basis as regression analysis BUT only uses the highest and lowest volumes. So would then
take the manufacturing overheads of the highest number of units made and subtract the manufacturing overheads of
the lowest number of units made and that will give you a difference total of units made with a difference total of
manufacturing overheads. Divide the manufacturing overheads by the number of units and that will give you the cost
per unit and so that is then the variable amount (cos we used cost per unit).
To calc the fixed costs just take the highest volume of units and working with the total overhead figure calc the variable
cost by multiplying the highest volume by the variable cost per unit that we have worked out above and then subtract
that from the total overheads and that will give you the fixed costs. Do the same with the lowest volume figures.
Cannot be used if highest and lowest volumes are very different as then will be unrealistic amount for fixed costs.
Simple regression
Instead of using scatter profile and drawing line which can have different totals if different people draw it, use the simple
regression (least squared method) which gives the relationship between one fixed and one variable factor.
see formula and explanation on pgs 90 / 91 of text book
Multiple regression
Shows the influence of fixed component and two or more variable components – using formula :
Y = a + bx + b1x1 + ……… bnxn
Total costs = fixed costs + variables with influence on Y & values of the variables to n level
e.g. x might be the man hours or machine hours and b would be the rate per man hour / machine hour
see example pg 91 of text book
Cost & Management Accounting pg 97
Budgeted manufacturing overheads
Budgeted overheads = estimated amount of future overheads. Must be calc’d carefully so that are close to actual
situation, but also must be guideline for expenditure without concealing wastage and spillage. Done by dividing each
overhead item into fixed and variable elements and then determining the expected production volume (used in
allocation tariff calc) and taking into account the economic trend.
Applied overheads – amount of overheads that were applied to the production process according to a predetermined
rate which is based on the budgeted overheads. Basically the amount of overheads received during the year and
bought into account when determining the cost price and total production costs.
Actual manufacturing overheads = what it has actually cost. But only available after processing in books are finished
and so is then not valuable for price determination.
Applied manufacturing overheads
14
Overheads allocated to production process and / or products manufactured during production according to
predetermined rate based on budgeted overheads and expected capacity utilisation.
Calc of predetermined rate :
allocation rate = budgeted manufacturing overheads
suitable basis
When calc’ing predetermined overhead allocation rate must choose suitable basis for the rate – either :
 product unit basis – when calc’d will give a price per unit and that is the amount of overheads that will allocated to
the manufacturing process for each unit. Then after budgeted production of units is met the budgeted overheads
for the year will have been recovered. Best used in entity which only produces a single type of product
allocation rate = budgeted manufacturing overheads
budgeted number of units produced
 labour hour basis – when calc’d will give you an allocated rate of labour per hour. Must then multiply by the labour
hours taken to make each unit and that will give you a unit cost. Used in entity which is very labour intensive or
where a wide range of products are produced
allocation rate = budgeted manufacturing overheads
budgeted labour hours
 labour cost basis – must be calc’d as a % using budgeted labour costs and the will give you a % of the direct
labour costs which will be your applied overhead. But if used in very labour intensive entity where there is little or
no machinery then overheads (normally depreciation or maintenance of machinery) using labour costs will be higher
then they should be
allocation rate = budgeted manufacturing overheads x 100
budgeted labour hours
1
 machine hour basis – use budgeted machine hours and give you a price per machine hour. Used for entity which
is very mechanised and also gives output of the machinery, but must remember to take into account the
maintenance, repair and adjustments of machinery as well as idle time
allocation rate = budgeted manufacturing overheads
budgeted machine hours
 material cost basis – also calc’d as % and gives % of material costs, but not very accurate as there isn’t really a
connection between material costs and overheads
allocation rate = budgeted manufacturing overheads x 100
budgeted material cost
1
 primary cost basis – uses budgeted material costs and budget labour costs but also not very accurate cos no real
connection between material cost and overheads, but more accurate then material cost basis
allocation rate =
budgeted manufacturing overheads
x 100
budgeted material costs + budgeted labour costs
1
 combination of above
Normally composition of products and the way that they are manufactured will determine the basis used for the calc of
the predetermined overhead rate. Must use most logical and accurate method with greatest connection between costs
and product.
Actual manufacturing overheads only calc’d after product is finished and sold so NOT anything to do with allocation rate.
Study Guide pg 24
Requirements for good basis of overhead apportionment :
 system should be easy to calculate
 cost of applying it should be reasonable
 basis used should be related to the time factor of fixed overheads
 it should be possible to do the calcs on the departmental basis so that causes of deviations can be ascertained
 apportionment should be fairly accurate so that under application / over application of overheads are kept to
minimum
Cost & Management Accounting pg 102
Actual manufacturing overheads – amounts actually spent as in financials.
Cost items under manufacturing overheads :
 depreciation of machinery and equipment – either :
 reducing balance method – as per book value
 straight line method – set amount as per cost price
15
fixed installment method – value of machinery is written off over its expected useful economic life (period for
which asset can be profitable employed). Can deduct scrap value at end of contract and then depreciation is
reduced by that amount
 interest on capital – if machine purchased on credit interest normally capitalised and recovered in depreciation,
but if machine purchased by cash or on credit then interest received is sacrificed and should be classified as
overhead
 indirect material usage
 indirect labour
 rental and maintenance of factory buildings
Normally keep an Overhead Control Account to which all manufacturing overheads are coded

Over applied / under applied manufacturing overheads
Difference between the applied manufacturing overheads and the actual manufacturing overheads.
To calc if over / under applied overheads :
 determine overheads rate at beginning of the period :
predetermined overheads rate = budgeted manufacturing overheads
estimated units
 apply the manufacturing overheads during the period :
manufacturing overheads applied = predetermined overhead rate
actual units
 determine if over / under applied overheads at end of period :
under / over applied overheads = manufacturing overhead applied - actual overheads
Over applied overheads = when applied manufacturing overheads exceed actual manufacturing overheads. If at end
of year more of the overheads are recovered then must correct at the end of the year (by cr COS and reducing account
by the amount that was over applied during the year)
Under applied overheads = when applied manufacturing overheads are below actual manufacturing overheads. If at
end of year all the overheads are not recovered then must apply the under applied overheads at the end of the year (by
dr COS and therefore increased COS by the amount that was under applied during the year)
see example pgs 104 / 105 of text book and pgs 26 / 27 of study guide (USE METHOD IN STUDY GUIDE)
Causes for over / under applied overheads :
 incorrect predetermined overhead rates
 actual overheads that are more / less then budgeted figs
 more / less activity in the base that the overheads were applied to
Cost & Management Accounting pg 108
Departmentalisation of manufacturing overheads
Can’t use only one overhead recovery rate for all departments of the same factory cos some divisions generate more
overheads then others. Must therefore have accurate allocation rate for each department separately.
Must first divide factory into cost centers where the activities performed in each cost centre have approx the same
exposure to overheads (i.e. approx the same use of same machinery, degree of uniformity and share proportionally in
overheads of cost centre).
Cost carrier = product or job in process of manufacturing which accumulates costs near completion and against which
overheads are allocated according to a pre-determined tariff.
Departmentalisation of overheads divided into :
 primary departmentalisation / primary allocation – where manufacturing overheads are divided among all
departments / cost centers (including service departments). Must have suitable basis that used to divide costs e.g.
number of employees. Each item must be analysed separately to determine which basis is best
 secondary allocation – where costs of service departments are allocated to production departments. Cannot
allocate costs directly to final product so have to divide them first amongst the production departments and then to
the final product or jobs. Can be possible to allocate costs directly according to worksheets or timesheets
Tariff or rate at which overheads of production departments are calc’d and applied (normally basis used is labour hours
or machine hours). MUST departmentalise budgeted overhead first and then calc predetermined overhead rates. Then
must departmentalise actual manufacturing overheads and calc if under applied or over applied overheads.
see example pgs 109 to 111 of text book and pgs 27 to 33 of study guide
Cost & Management Accounting pg 112
Activity based costing (ABC)
16
Doesn’t use allocation of fixed costs by fixed tariff per labour hour or % of direct labour cost, rather assumes that
activities that cause cost and that products are created by those activities, so the costs are allocated on the basis of the
utilisation of activities.
Activity based costing allocates costs to final product by :
 identifying the most important activities of the company
 identifying the factors that influence the cost of the activities (cost drivers are factors that determine the extent of the
cost of the activities)
 create a cost centre for each activity (to accumulate the cost of each activity)
 allocate the cost center (cost of each activity) to the products according to the extent that the products used the
activities – use cost drivers to determine the extent to which the activities are used. Allocate costs by allocating :
 cost to the cost centres
 the cost centres to the products with the cost drivers as basis.
3 types of activities :
 unit level activities – activities each product is subjected to e.g. machine – all the costs for machining would be
allocated to that specific product
 batch level activities – activities each batch is subjected to e.g. setting machinery for production run. Costs aren’t
allocated to individual product but to the actual production line
 product support activities – activities aimed at supporting the different products that are part of the product range
e.g. admin, financial services, management or factory lighting. All considered general costs and written off against
income of all production lines.
So basically have to calc a contribution :
 per product
 each production line
and
 for the whole product range that is being manufactured
Study Unit 2 (text book unit 5.1 – Product Orientated Cost Systems)
Study Guide pg 36
Job costing
Costing system is specific method according to which the manufacturing costs of product or group of products are
accumulated, processed and reflected.
Costing systems – production costings systems developed to calc unit cost of products. If unit cost of product
or products are known then can calc value of stock, cost of sales and net profit.
Also need unit cost to prepare the budget cos complied using expected cost at various production levels.
Also need to distinguish between types of production costing systems, either :
 job or product oriented systems – costs are accumulated separately for each job / product and then added
together in offer to obtain the total manufacturing costs for the period e.g. building industry with different
products
 process oriented systems – total cost calc’d for each process then divided by number of units in order to
obtain the cost per unit e.g. chemical industry or canning factory using identical products
see diagram 5.1.1 on pg 206 of text book
Method of calc cost per unit (unit costing) used where goods manufactured according to client’s specs when different
products manufactured using same production facilities e.g. garage where repair on diff vehicles and each job card
calc’d separately.
Service enterprises cost per activity e.g. accountant billing each client for job done.
Consultants cost per project.
Cost & Management Accounting pg 205
Most important aim of product costing is to calc unit manufacturing costs – vital for financial reporting and for valuation
of inventory and determination of cost of goods sold.
Absorption approach / total cost approach – provides for absorption of all manufacturing costs (fixed and variable)
by the units produced
Types of product costing systems :
 job costing systems – used where different (heterogeneous) production using same manufacturing facilities e.g.
shipbuilding, engineering repair shops
 process costing systems – large range of identical (homogeneous) products using same manufacturing facilities
e.g. oil refinery, sawmill. Here total costs incurred in production process calc’d first and then cost per product calc’d
by dividing total costs of process by number of units manufactured
Normal overheads are allocated to the job by pre-determined overheads rate.
17
Job description – done by production planning department before job is begun and shows execution of job (special
order or repeat orders). Copies of job description with other specs sent to all manufacturing sections to ensure have
required material, labour, tools etc
Study Guide pg 38
Expansion of accounts
Costs of direct materials, direct labour and manufacturing overheads are collected separately for every job (either single
product or group of identical products, or specific service).
If job costing used then must be adjusted to record the cost per job. Separate ledger account is opened for each job
and cost of that job dr to that account.
(subsidiary ledger)
GENERAL LEDGER
Cost ledger is subsidiary ledger and has all different jobs and then shown in GL as Production Account which is control
account (summary) of cost ledger
Job costing system documents :
REQUISITION
Initiates work to be done on job
PRODUCTION ORDER
MATERIAL REQUISITION
DIRECT LABOUR TIME CARD
OVERHEADS ALLOCATION STATEMENT
Job card forms basis for calculation
of unit costs, valuing closing stock
and cost of goods sold
JOB COST CARD
Accumulates production costs
in accounts department
Flow of manufacturing costs through
GL accounts when using costing system :
18
Cost & Management Accounting pg 207
Inventory ledgers in job costing system comprises of :
 control accounts :
 Raw Material Control account
 Production account / Incomplete Work / Work In Progress account
 Finished Goods Control account / Completed Goods
 subsidiary ledgers – supporting ledger that has detailed accounts & ties up to the balances in the control account :
 materials ledger – quantities and unit costs of each type of material recorded on separate ledger card
see example pg 208 of text book
 cost ledger – job cost card kept for each job. Is supporting record for work in progress and shows cost of
direct material, direct labour and applied overheads relevant to the job. When job is completed the total costs
are divided by the number of units to get the unit cost
see example pg 208 of text book
 finished goods ledger – every card identified by item number and description of the product and shows
quantities, unit costs and total costs
see example pg 209 of text book
Supporting ledger is kept up to date when used, but control account are only updated periodically.
see example of T-accounts pg 209 of text book
Example of job costing system
 recording of material costs – material purchase is shown on relevant material inventory card and at end of period
total of material purchases are posted from purchases journal to the Material Control account (balance in Control
account must agree with total on various cards in the Material Ledger account). When materials are requested
(using material requisition) the issues are recorded on Inventory Cards and in Control account. Requisitions for
direct materials are recorded on relevant job cards and debited to the Production account, while indirect material is
debited to the Overheads account
 recording of labour costs – use time cards to determine time spent by employees on various jobs and also to
identify labour costs for specific jobs. Normally use hourly wage rate to determine the labour costs for each job.
Details are transferred periodically from the time cards to the job cards.
Time card will show direct labour cost (time employee work on particular job) and indirect labour (time taken to
repair a machine). Daily time sheets of all employees are totaled on labour summary sheet and analysed so that
can be apportioned properly.
 recording of manufacturing overheads – indirect materials and indirect labour charges are recorded in the
production overheads account. Other overhead items are transferred to production overheads account from
account where they were allocated when expenses.
Direct material and direct labour costs are allocated by material requisition forms and time cards directly to the
products, but can’t allocate the indirect manufacturing costs directly to cost of particular product so use
predetermined overheads rates for allocation of indirect manufacturing overheads
19
As actual manufacturing costs arise they are debited to overheads control account
Overheads allocated to products during the period are debited to production account (and job cards) by using
overheads rate and applied overheads account is credited.
Once all overheads have been entered onto the job care it contains all the cost elements incurred in respect of each
job to date. Must then dr / cr the under / over applied overheads to Cost of Sales Account.
Balance of Overheads account has bearing on incomplete goods still in inventory as also cost of goods sold – if
balance is material then can be allocated to each of categories using reasonable basis.
 recording of completed / finished goods – when job completed then unit cost of items for that job are obtained by
dividing the total costs by the number of units produced. Job cards can be removed from production ledger and are
filed and must make entries to the Finished Goods Ledger on applicable inventory cards to show quantity, unit costs
and total costs. At end of period must dr Finished Goods Accounts and cr Production Account.
When goods are sold then must be recorded on inventory cards and at end of period cr Finished Goods Account
and dr Cost of Goods Sold Account with cost price of the goods that have been sold.
Various supporting records contain detailed analysis of total amounts and balances of control accounts in GL
Selling of finished goods means that must make entries for the cost price and also selling price of the goods.
see comprehensive example pgs 210 to 221 of text book
and example on pgs 42 & 43 of study guide
Raw Materials & Materials Stock
o/b of raw material andDirect raw material
materialstransferred to production
Purchases of raw materialIndirect material used in
and materialsfactory
Finished Goods Stock
o/b stock of finishedCost of finished
goods on handgoods sold
Production Account
Manufacturing Overheads
Indirect materials usedProduction overheads
in factoryallocated to
production
Other overheads
e.g. elect / deprec
Indirect labour costs
o/b of incomplete workTotal costs of goods
completed
Raw materials put into
production process
Cost of goods
completed
Overheads allocated
to production
Direct labour used in
production process
Cost of Goods Sold
Transfer from finished
goods
Production Wages
Total wages payableIndirect labour wages
(including direct and
indirect labour)Direct labour wages
Study Guide pg 44
Spoilt units
Goods that aren’t up to scratch and don’t make quality standards – called spilled products. If can reprocess spilt
products then they can be sold as finished goods (costs relating to the re-processing are either recorded and disclosed
according to either process or job related methods). If very badly defective and can’t be sold then wasted units
Waste / losses either :
 normal (unavoidable)
 abnormal (avoidable)
If scrap or waste material can be sold then the actual overheads must be reduced by the money received from the sale
of the scrap or waste.
Cost & Management Accounting pg 222
Shrinkage and evaporation
Wastage occurs with units that aren’t up to standard and then either sold for scrap or re-processed and sold as finished
goods, but also have to worry about shrinkage and evaporation. Here no spoilt product, but rather case of more
materials are needed to complete a job or process products.
Changes in temperatures can cause evaporation during chemical process and so lower units produced.
20
Normal wastage - wastage that is inherent in product or manufacturing process so anticipated wastage and occurs
repeatedly. So must make provision in planning of the production and normal wastage is part of the cost of production
and is allocated to acceptable units that are manufactured.
Abnormal wastage - not anticipated and could be avoided (so should be controllable). Cos not anticipated have to
write it off as loss in Income Statement.
Scrap – waste material that arises from the manufacturing process. Has little value and not shown in inventory as
asset. If sold then dr Cash or Debtors and credit Actual Overheads Account (this will then be part of the calc for
overheads recovery rate).
Accounting for spoilt work in job costing systems :
 general manufacturing cost – normal wastage expected if jobs for clients to their specs cos have to use the same
machinery and labour for all the jobs even if they are not the same. MUST associate the costs of normal wastage
with ALL the tasks carried out and so NOT for one specific task, so should provide for normal wastage in the
predetermined overheads rate. So must estimate the cost of the normal wastage at the beginning of the period for
the entire period and include that estimate as part of the total estimated overheads and use it to calc the overheads
rate. Actual cost of normal wastage dr to Actual Manufacturing Overheads Account cos estimated normal wastage
already cr to same account and then allocated to Production account as part of the overheads rate.
see example pg 224 of text book
 job related normal wastage – if specific job and know going to have extra waste then that must be build into the
cost and can calc the cost of this wastage and add it to the cost of the units that are “normal” and can be sold. So it
will then increase the average cost of the units and will be an additional cost of completing that specific job
see example pgs 225 / 226 of text book
 re-processing costs – can sometimes re-process some of spoilt units so that they are up to standard although this
will mean additional costs for materials, labour and overheads. Can treat these costs by :
 dr to Actual Manufacturing Overheads Account if they are process related and then allocated to the total
production costs for the year by using the overheads rate
 dr to the Production Account for that specific job if the costs are job related (so caused by special requirements
of the job.)
Study Guide pg 44
Summary – job costing is method of cost accumulation normally used by entity that manufactures products according to
the user’s specs.
In job costing system material and labour are accumulated per job – overheads are first accumulated per department
and then allocated to the various jobs.
Normal and abnormal wastage has to be accounted for.
see example & solution on pgs 44 to 48 of text book
Study Unit 3 (text book unit 5.2 – Contract Cost Accounting)
Cost & Management Accounting pg 233
Contract costing is form of job costing used to account for cost of contract for the construction of asset e.g. construction
of bridges, building, ships. Either :
 fixed price contract – client agrees to pay a fixed price (can be escalation clause)
 cost plus contract – contractor is reimbursed for defined costs plus a certain percentage
NOT IN EXAM
Cos major construction takes time and so start and finish normally in different accounting periods have to find way to
allocate contract revenue and costs to the accounting period when the work is done.
Study Guide pg 51
Accounting
Separate records are kept for each contract and the results of each contract are calc’d separately.
Account is opened for each contract – all costs debited to this account and all goods or writing back of costs is cr.
At end of contract account is cr with amount of the contract price. If contract is incomplete the cost price of the work
completed plus profit on the contract (or loss) is cr to contract account at year-end.
If only direct costs (materials and labour) then it is a gross profit, but want net profit so have to include actual or total
cost so have to calc the overheads / indirect costs.
Costs to be accumulated against construction contracts :
 costs that directly relate to contract (direct contract costs) e.g. :
 materials issued – either purchased from suppliers or issued from entity’s stores. Dr contract accounts
21
returns of materials – excess materials returned to stores. Cr Contract account and dr Store account. If
materials transferred from one contract to another must cr contract supplying the materials and dr the contract
receiving the materials
 sale of material – CONTRACT COSTS ARE REDUCED BY INCOME FROM SALE OF EXCESS MATERIAL
(INCIDENTAL INCOME). If part of material sold then cr contact account with SELLING price of material
 cost of subcontract work – if subcontract hired to do part of work (e.g. electrician to do the wiring) then
subcontractor will supply his own materials and labour and then contractor must pay him directly. This
influences primary cost of contract and so must dr contract account
 site labour costs (incl supervision) – wage book written up from wage cards showing hours worked and the
contract number and direct wages for each contract must be calc’d directly and dr to contract account
 machinery and plant costs – cost of hiring machinery and equipment can be either :
 hiring equipment – normally per hour and full price will be dr to contact account
 depreciation of machine and equipment used – if contractors own equipment then deprec according to
GAAP and then dr to contract account cr to deprec account in GL, based on period that the equipment was
used on the contract (so deprec for periods not used on contract is just general expense for contractor)
 revaluation of equipment – machinery taken to the site is valued and total value of machinery is dr to
the contract account and cr to machinery account. At end of yr the machinery is revalued and value of
machines is cr to contract account and so difference in value from start to yr-end is the depreciation for that
time of construction. Revalued amount is opening bal for contract account in next financial yr. at end of
contract machinery is revalued and cr to contract acc and dr to machinery account or, if transferred to
another contract, then dr to that contract account. If machinery or equipment is sold then that is incidential
income and will be cr to contract account with FULL amount of sale price
 moving machinery and equipment to site – direct cost so dr to contract account
 indirect costs / costs relating to contract activities in general and have to be allocated to contracts – costs
not directly related to one specific contract but generally associated with all contract activities must be allocated
systematically and rationally and constantly applied. Either :
 in accordance with ratio of total cost of this contract to the total cost of all contracts. Can be done like this
easily, but then calc of profit or loss on completed contracts only done at yr-end and better to know contract
profit when it is completed
 allocate costs using the cost of labour as basis
 use any other ratio that suits contractor as basis for cost
 transport
e.g. of general contract costs are :
 storage costs
 insurance
 design costs and cost of technical assistance not specifically for one contract
 cost of preparing / processing the salaries and wages for the construction staff
 charges that are specifically charged to customer in terms of the contract

Costs that are NOT related to contract activities – or costs that can’t be allocated to specific contract are
EXCLUDED from cost of contract and written off in IS as expense. e.g. :
 general research and developments cost
 head office cost
 general admin expenses
 advertising cost
 financing other then for specific contracts
 depreciation on machinery and equipment that has been standing idle (down time)
Extras / variations – contract normally has specifications laid down by contractor and client and if need to change
specs on client’s request then contractor needs to be paid for this extra materials. Just added directly to cost of the
contract and contract will evaluate and revise the estimate of the contract income and costs as agreement is added to.
Estimated cost of variations will be included in estimated total costs of contract completion and the initial contract price
will increase by the amount of the extras to get a total contract profit.
Retention money – certain portion of the progress payments that is withheld until all the conditions of the contract
have been compiled with or all the defects have been corrected. If any other defects occur within certain period
specified in contract then contractor has to repair them at his own cost.
So when contract is completed the contractor doesn’t transfer full amount of profit to IS – the retention amount is either
b/d as cr bal in that Contract account or is cr to Provision for Defects Account. If provision becomes a dr balance cos of
very high expenses then show in IS as Loss as Result of Latent Defects.
If at end of specified date there are no claims against this provision account then this is transferred to IS as additional
profit.
22
Cost & Management Accounting pg 234
Contract revenue = initial amount agreed in agreement as well as changes in contract work, claims and incentive
payments. Amount can increase or decrease from one period to another cos of :
 variation on claims that increase or decrease contract revenue in subsequent period as per agreement in contract
 amount of revenue in fixed price contact can increase cos of escalation clauses in the agreement
 amount of contract revenue can decrease cos of time penalties set on date of completion
 if fixed price contract involves fixed price per unit of output then contract revenue will increase as the number of
units is increased
Duration of project is normally from date the contract is signed until the project is substantially completed and handed
over to client. Cost incurred before contract is signed normally period costs, but if cost can be identified with future
contract and reasonably certain that contract will proceed then pre-contract costs are contract costs.
Costs incurrent normally by construction entity are normally either :
 contract costs – divided into either :
 direct contract costs – for a specific project e.g.
 material bought specifically for that project or material charged out from stores to specific project
 site or project wages including supervision
 subcontract work
 costs of hiring plant and equipment
 depreciation of plant and equipment used on contract
 cost of moving plant and equipment to and from contract site
 financing costs if borrowed specifically for that project
 costs of design and technical assistance directly related to the contract
 indirect contract costs – general project activities that are allocated to individual projects using systematic and
rational method. e.g. :
 warehouse costs
 insurance
 transport
 cost of design and technical assistance not for specific contract
 construction overheads including preparation and processing of construction personnel payroll
 costs specifically chargeable to the client under terms of the contract
 general costs – incurred by entity to function and not allocated to specific contract. e.g. :
 general admin costs
 head office costs
allocated to IS as period cost and
 selling costs
NOT contract cost, but should still be
 financing costs except for specific contracts
taken into account when determining
 research and development costs
price or tender cos effects entity’s
 depreciation of idle plant and equip not used on specific contract
final profit
Separate account opened in contracts ledger (supporting ledger), where account is dr with all contract costs and cr with
the contract price. So each contract account becomes separate profit and loss account for that specific contract.
Characteristics of contract cost accounting :
 contract number assignment to each contract
 material ordered specifically for contract is dr directly to the contract from the supplier’s invoice – materials
requisition used to draw material from warehouse stores
 most other costs are also direct costs e.g. labour and subcontractors
 machinery and equipment costs charged to contact either :
 on rental basis normally per machine hour
 revalued at end of each financial year, and then difference between beginning and end of financial period is the
depreciation for that period.
 using normal depreciation to write off cost over time specifically used for that contract
Total estimated costs = most recent estimation of the total cost to complete the whole contract. Is costs incurred to
date and the estimated additional cost of completing the contract.
Total estimated profit = total contact prices less total estimated costs
Certified work – progress payments made after supervising architect / engineer issues certificates of progress (specify
the contract value of the approved work completed to the date of the certificate). Contractor then requests progress
payments from his client for the certified work according to the contract agreement. Stage of completion is in terms
of the contract price, NOT in terms of the contractor’s costs
23
Uncertified work – certified work is done in terms of the contract and at times agreed upon, but not normally at yearend so normally there is a portion of the contract at year-end that has been done after the last certificate was issued.
This uncertified work costs must be determined at the year-end as part of work in process at year-end.
Material at site – with incomplete contracts there is unused material on hand at yr-end ordered specifically for the
contact. These are valued at cost price and carried over to next financial year.
Study Guide pg 58
Methods of recognition of profit on construction contracts – if contract is begun and completed in one financial
year then can determine total costs and total income easily. But if over more then one year then can calc profit using :
 completed contract method – USED ONLY IF FINAL OUTCOME OF CONTRACT (PROFIT AFTER
COMPLETION) CAN’T BE ESTIMATED RELIABLY. Profits are only regarded as being realised when the contact
has been completed or is almost completed (i.e. if there is only minor work left). Uses actual costs and not
estimates that may be incorrect cos of unforeseen expenses or possible losses, so no risk that profit that might be
showing profit that hasn’t been earned. Disadvantage is that the reported profit only refers to the result of projects
competed during that year and so not accurate reflection of ALL the activities of the year
 percentage of completion method – USED IF FINAL OUTCOME OF CONTRACT (PROFIT AFTER
COMPLETION) CAN BE ESTIMATED RELIABLY. Recognises profits on basis of stage of completion of contract
work at end of each accounting period and profits are bought into account as the contract work progresses. Calc
costs incurred to attain the level of completion and match them to the contract income earned to that stage and will
give profit / loss of the portion of work that has been completed by that stage. So are showing the contract profit in
the financial year when the work was done.
Only used if :
 total contract profit can be determined reliably
 cost of completing the contact and stage of completion of the contract can be estimated reliably at BS date
 cost attributable to the contract can be clearly identified so that actual costs can be compared with prior
estimates.
Use following methods to determine the stage of completion which must be applied when calc the contract profit
for the financials :
 proportion of cost incurred to date to the total contract cost – so contract profit is calc’d up to the end of
the accounting period as
contract profit =
.
cost to date
x estimated total profit
estimated total cost
1
or
contract profit =

actual cost to end of financial year
x total contract price - total estimated cost
latest estimated total cost of completing contract
1
So profit up to end of financial year is added to contract cost up to the date and that is the value of incomplete
work at end of accounting period.
certified surveys of work executed by professional advisors – architect / engineer will inspect the progress
periodically and issue certificate which is value of completed portion relative to full contract price. (Progress
payments are dr for work done on a contact even if they are not paid by client).
Cos certificates won’t be dated at year-end, must also calc the COST price of work done but not yet certified
and this must be added to certified work for total cost of the year.
contract profit = contract value of certified work + cost price of work not certified x 100
total contract price
1
or
contract profit = value of work certified
contract price
x
estimated total profit
1
So certified work is at CONTRACT price, but estimation of work completed but not certified is at COST price.
Can use different methods for different contracts – but must be used consistently.
Cost & Management Accounting pg 238
Profit determination for contracts
Completed contract method – no profit bought into account until project is completed no matter how long the contract
takes to be done. Conservative method of profit calc and there is no doubt about the profitability of the profit since
income and costs that are brought into account have all been realised, so no need to estimate or adjust figs cos f
unforeseen costs or losses. Only used when can’t reliably estimate the profit at completion.
24
see example pgs 239 / 240 of text book
Percentage of completion method – profits calc’d on work done and the total profit on the contract is divided over the
accounting periods in relation to the work completed. So income and profits are brought into account when they are
earned and so costs are incurred when the income is earned.
Stage of completion is measured by either :
 proportion between costs incurred to date and the estimated total costs of the project – so calc proportion of
costs to date at end of financial year to total estimated costs to complete the contract (using the latest calc’s). costs
that have been incurred but not utilised NOT included (e.g. materials not used, advances to subcontractor for work
that isn’t done yet, undepreciated value of machinery and equipment if cost of machinery and equipment have
already been dr to contract account).
 proportion of value of work certified to the total contract price – stage of completion calc’d as proportion of
work certified to end of financial yr by client’s engineer / architect to the total contract price of the project. If project
ongoing for many years then should review profits already reported because of changing circumstances. May have
to make adjustments to prior year profits / losses and then the current year’s reported profit will be combination of
current year and adjustment for previous years.
 project contracted in stages – if project is completed, delivered and invoices in stages then each of these stages
can be viewed as a separate project without having to make provision for expected losses in the next stages.
see example pgs 241 / 243 of text book
Study Guide pg 58
Reserve for contingencies
Cos always risk of over estimating profit and also cos of changing circumstances best not to transfer full amount of profit
to IS – normally keep portion in reserve account. Management decides policy and portion in reserve will only be
transferred to IS when contract is complete.
Called realised portion of the calculated profit and calc’d :
 by taking fairly high percentage of calc’d profit to IS and then balance to Reserve for Contingencies e.g. 33.3% or
25%
 by using cash received in relation to cash receivable (i.e. the amount payable by the client to date). Determined by
provisions of the contract and certificates issued by client’s architect / engineer :
contingency reserve = cash received
x estimated profit to date
cash receivable
1
or
contingency reserve = progress payments received
progress payments receivable
x
estimated profit to date
1
Provision for loss
if estimates indicate that the contract cost will exceed the contract income, then TOTAL expected loss must be provided
for as expense.
Amount to be provided for the loss determined irrespective of :
 contract work has already started or not
 stage of completion
 amount of expected profit on other contracts.
Loss must be provided it is probable will occur and it can be estimated
see example pgs 246 / 247 of text book
see examples pgs 63 to 79 of study guide
Study Unit 4 (text book unit 6 – Process costing systems)
Study guide pg 81
Process costing system used to accumulate, process and reflect manufacturing costs of identical products that are
manufactured in bulk and the products pass through different consecutive processes during manufacture e.g. paint,
chemicals and textiles. Average cost per unit must be calc’d by dividing total manufacturing cost for the process by the
number of units manufactured during the period.
Cost per unit = cost price of the final product which is taken into the inventory system.
Must have 2 kinds of data :
 total manufacturing costs for each separate production process
for a certain period
 number of units manufactured for the various processes
25
Cost & Management Accounting pg 258
Job costing = @ client’s specs and only starts after client places an order. Jobs aren’t identical and costs are per job
and finalised after completion of the job. Use job card for cost for each job. Manufacturing can be over more then one
financial year, so then costs after 1st year become incomplete work and accumulated costs transferred to the next
period.
Process costing system = products manufactured continuously according to standard specs. Products are
manufactured in large quantities and are identical (so each unit needs same quantity of material, labour and
manufacturing overheads). Costs are collected for fixed period. Costs are collected by departments or processes for a
specific period. Number of units also determined by department or process and cos each process has a standard
product then
total manufacturing costs (for that specific period)
average cost per unit of specific dept for specific period = no. of units manufactured (in that specific period)
So 1st have to divide the manufacturing process into different departments / processes and these are cost collection
points – either divided into small cost centres for single activities (smaller entity) or into large group of activities (larger
entity).
Responsibility for process costs is responsibility for :
 costs
 quantities
Study guide pg 82
Product and cost flows
Cos product has to go through various consecutive processes can have materials added during 1st process and then
any of the following processes as well. So output of one process will be the input for the following process. Conversion
costs (labour and overheads) occur in each process and so costs accumulate as the product moves through the
processes.
Process costs uses principle that unit cost for each process is separately calc’d and then all the unit costs are added
together as the products move through the manufacturing process.
see diagram pg 83 and example pgs 84 / 85 (showing journals) of study guide
Cost & Management Accounting pg 259
After processing in first phase with materials, the product moves to the next phase and more conversion cost occur and
possibly more materials. Unit costs calc’d for each department and total cost accumulates as product moves down the
line. Can use production diagram to analyse and organise data for process costing.
see diagrams pg 260 to 262 of text book
Study guide pg 85
Process cost reports
Basic process costs reports have 3 sections :
 quantity / production statement – summary of the number of units entering the process and what happens to
them. Number of units as input should be equal to number of units as output.
see example pg 86 of study guide
 production cost statement – summary of all production costs incurred during the period – shown in total per
cost element and calc’d per unit.
 cost allocation statement – costs recorded in production statement linked to units indicated in the output or
production part of quantity statement.
Cost & Management Accounting pg 263
Process cost report shows summary of total and unit costs for each department in steps :
Step 1: Quantity or production statement
Shows how many units were received in department and how they were dealt with i.e. transferred to next
department or if incomplete work – so is physical flow of units and also the stage of completion they are at.
Units in the quantity statement are in measurements of the department’s finished product (litres / kgs) – all units
must be in the same standard. If not all completed then must calc equivalent production.
Step 2: Establishment of production costs
Total production costs incurred by department in accounting period determined in cost statement of the report.
Costs for any period can be from :
 incomplete units that were still in the process of being completed at beginning of financial year (i.e.
units and unit costs transferred from previous period)
 if second department or more down the production line then costs from previous departments will be
received when units are transferred to this department
 each process gets more labour and manufacturing overheads and sometimes materials
26
Step 3: Calculation of unit costs
Units costs NOT for production as a whole, but for each separate department PLUS costs from previous
departments and costs in current department
Step 4: Allocation of costs
Once total costs are determined then must give account of them i.e. costs from :
 units transferred to next department or to finished goods
 units still being processed by department
 lost units
Step 5: Proof that all costs are accounted for
must recon steps 2 and 4 (i.e. the full production costs that were established against the allocation of the costs)
Process costing methods either :
 single product : single process
 single product : multiple processes
 multiple products : single / multiple processes
Single product : single process
Only have single process cost statement for each accounting period. Costs of material used in departments obtained
from material requisitions and labour costs from salaries department / wage analysis statements. Overheads allocated
by applying the appropriate rate.
Production account / Work in Progress account in GL is opened for each department or process and shows the costs of
material, labour and overheads and also the transfer of completed units made.
see example pgs 265 / 266 of text book
Jnls from cost statement :
Dr
Cr
Production account
xxxxx
Material control
xxxxx
Production Account
Labour control
xxxxx
Material control Finished goods
Labour control
Overheads control
xxxxx
Overheads control
(production costs for the month)
Dr
Cr
Finished goods
xxxxx
Production account
xxxxx
(trsf of completed units – xxxx units @ R … each)
Single product : multiple processes
If more then one department then the costs incurred in EACH department are collected and accounted for in the same
way as in single process. So total costs in each department (including the costs transferred from the 2nd department
onwards) will be divided by the production of that department to get the unit cost for that department.
see example pgs 267 to / 270 of text book
Study guide pg 86
Equivalent Completed Units (ECU)
Cost for certain period is linked to number of units manufactured during same period in a specific department. If there
are partly completed units on hand at the beginning and end of a period then have to convert them into equivalent
completed units.
Normally stage of completion is separately determined for each cost element
see example pg 88 of study guide
Cost & Management Accounting pg 272
Cos there is continuous production will always be partially processed products at year-end – so have to allocate the
costs for that department to both completed and incomplete units, so use equivalent completed units (ECU) of
product. Done by taking the number of units entering the department and subtracting the number of units that were
completed and transferred to next department, to get the units that were still being processed at period end. Now must
determine how much work was done on the incomplete units by inspecting them and deciding what percentage of work
has been done to those units – materials, labour and overheads. (i.e. what percentage of the total resources necessary
to complete the units has been expended on the incomplete units). Then use that percentage to calc
ECU = units still in process at end of period x percentage of work done on unfinished units
Then the unit cost will be calc’d :
total manufacturing costs (for that specific period)
.
27
cost per unit = completed units + ECU (unfinished units x % of work done)
Use of resources
Resources used 2 ways in production :
 continuously during the process (then assume that use occurs evenly)
 in lots at specific stages in the process
Normally assumed that labour and overheads are used continuously and evenly during the production process and that
materials are used at the stage that they enter the process.
How resources are used effects the calc’s of the unit costs :
 if resources are used continuously and evenly then equivalent production deemed to be directly in proportion to
completeness of product (in %)
 if resources are added to production line at certain stages then equivalent completed units (ECU) are the ones that
have already passed the stage at which the resource was used.
e.g. if know that labour and overheads are used continuously and evenly and material is added at the beginning of the
production and that units are 70% complete at the end of the period then calc of equivalent production.
Cos we know that the units have moved past the stage when the material was added (cos at start and already 70%
complete), then material equivalent completed units is 100% while the labour and overhead charges are only 70%
Closing inventory of incomplete work on 20 000 units :
direct materials = 20 000 x 100% = 20 000 units
labour and overheads = 20 000 x 70% = 14 000 units
see example pgs 274 / 275 of text book
labour costs + overheads = conversion costs
Incomplete units in closing inventory
If production department gets products from previous department as input and then processes it further then there are 3
types of costs to be taken into consideration :
 costs from the previous process (don’t have to be broken into materials, labour and overheads – just use it as total
cost of process)
 direct material added to this process
 conversation costs incurred in the process
see example of complete process cost report with opening inventory pgs 275 to 277 of text book
Incomplete units in the cost allocation section ALL THREE of the cost groups are brought into account at the
equivalent unit costs – cos if not then the Cost Statement and Cost Allocation sections won’t reconcile.
Study guide pg 89
Incomplete units in opening stock
Cos of rising costs of materials can have problem when unit costs of products manufactured in different periods differ.
Then what happens with value of stock if manufacturing began in 1 period and is completed in the next? Which period’s
costs are used to value the product when it is finished?
When costing stock normally use :
 weighted average method
 FIFO method
When there are incomplete units on hand in closing stock then portion of the cost gets allocated to the incomplete units
(on basis of equivalent completeness). If use weighted average or FIFO method doesn’t make any difference to value
of the closing stock at the end of the period.
Difference between weighted average or FIFO stock values only apparent at beginning of following period when
closing stock at year-end becomes opening stock in new financial year.
Weighted average method – cost incurred during previous period for partially completed units is added to cost incurred
during the current period to give the total cost. This is then divided by total number of equivalent units to get the
weighted average cost per unit. Incomplete units at end of previous financial year plus the equivalent units completed
during the current period give the total equivalent units.
FIFO method – cost of the partially completed units in opening stock is recorded separately from the cost of the units
started in the current period. Then cost incurred in the current year for completing the opening stock is added and a
separate unit cost is calculated for opening stock.
Cost & Management Accounting pg 278
Incomplete units in opening inventory
Weighted average method – cost of the opening inventory is added to the cost of the current period so that all
the units that are completed have the same unit cost.
28
Units in the opening inventory are treated same way as the units which are started and completed in the current year.
Previous year’s
costs allocated
to incomplete
work at the start
+
Current period
manufacturing
costs on all units
in process
Total
cost for
the
period
=
Valuation of completed products
/
(divided
by)
and
Equivalent
production
for period
=
Average
cost per unit
used for :
Valuation of incomplete units at yr-end
FIFO – costs of the units in opening inventory which are finished in following year are kept separate from the costs of
the units which are begun and completed in the current period.
Costs of goods which are completed and transferred are made up of cost of the units which were :
 completed which were in the opening inventory
and
 started and completed in the current period.
Closing inventory of incomplete work is valued at unit cost of current production (determined by dividing the production
costs incurred in current period only by the equivalent units manufactured during the current year).
ECU calc (weighted average method)
So total costs evenly attributed to 2
production groups (competed units
and incomplete units at end of period)
Step 1: units completed and transferred
PLUS
Step 2: units completed and on hand @ 100%
see example pg 280 of text book
& weighted average example pgs
280 / 281 of text book
PLUS
Step 3: incomplete units in closing inventory @ % of completion
PLUS
Step 4: units lost @ % of completion at time the loss is ascertained
ECU calc (FIFO method)
Step 1: units completed and transferred @ 100%
PLUS
Step 2: units completed and on hand @ 100%
PLUS
Step 3: incomplete units in closing inventory @ % of completion
So total costs evenly attributed to 3
production groups :
 Group 1 - units in opening inventory
 Group 2 - units that were started and
completed during the period
 Group 3 - units which were still
incomplete at the end of the period
PLUS
Step 4: units lost @ % of completion at time the loss is establishedsee example pg 280 of text book & FIFO
method example pgs 284 / 285 of text
MINUS
book
Step 5: opening inventory @ % of completion
Previous years costs allocated to
opening incomplete work
COST
GROUPS
+
Costs incurred in the
current period
=
Total
costs
Portion of current period costs
attributable to completion of
opening incomplete work
Portion of current period costs
attributable to units begun and
completed in the period
Portion of current period costs
attributable to incomplete units
at the end of the period
Group 1 – cost of units in
opening inventory completed
during the period
Group 2 – cost of units in begun
and completed during the period
Group 3 – cost of incomplete
units on hand in process
at end of period
In Quantity Statement - opening stock plus units added during the month are used to calc the equivalent production
and the average cost per unit.
29
In Cost Allocation Statement the total is equal to the cost of the incomplete work at the beginning of the month plus all
the costs that have incurred during the month.
Also cos the total costs are from different cost groups (materials, process and conversion costs), must now calc the
average unit costs for EACH of these so can calc the value of the incomplete units at the end of the period.
So in FIFO Group 1 will be the costs for the units in opening inventory plus the costs incurred in the current period to
complete the units. Groups 2 & 3 will be the other costs incurred during the period i.e. cost input of units received
during the month from the previous department (complete and incomplete units), but equivalent unit costs are ONLY for
costs incurred in the current period.
Study guide pg 91
If product is manufactured in 2 consecutive processes then must do Quantity Statement, Production Statement and
Cost Allocation Statement for both processes separately.
see example pgs 91 to 98 of study guide
Cost & Management Accounting pg 293
Increase in costs due to addition of material – when material is added to process then the unit cost will
increase.
If material is added evenly during the course of the process then the degree of completeness for the equivalent
production for material will be the same as the conversion costs.
But sometimes when material is added it increases the number of units in the process as well. Then cos materials have
been mixed and can’t be distinguished from each other, the total cost must be divided by the increased units.
In weighted average cost method and equivalent production basis then the cost of the increased units is carried by all
the units that were processed during the period. In the Cost Allocation Statement the cost is divided between the
completed goods and work in progress in the closing inventory.
see example weighted average cost method pgs 294 to 296 of text book
In FIFO method the cost of the work in process of opening stock isn’t used in calc of current period’s equivalent unit
costs. In both methods the addition of material means that the number of units will increase, and because normally the
material will be added at the beginning of the department’s process then the increase in the number of units will be on
new products ONLY.
see example FIFO method pgs 297 / 298 of text book
If the increase in units takes place cos the material is added continuously throughout the process then the increase in
the number of units will effect the new production and the opening inventory.
In FIFO DON’T add the value of the opening work in process like in weighted average method.
In Cost Allocation section of Process Cost Report must remember :
 cos the opening stock is only part processed must use more cost elements to opening work in progress so that
opening stock can be completed
 in FIFO method the completed goods that are transferred are groups 1 and 2 (opening inventory that has now been
processed and units from the current years production that are completed)
 closing inventory of work in process has 3 cost elements and must use equivalent production to allocate them at the
applicable unit cost.
Summary - adding material and labour from previous process increases the unit costs – if material added evenly during
the process then will determine the equivalent production according to conversion costs calc
If weighted average cost method (on equivalent production basis) then cost of the units is carried by the units that were
processed during the period. In Cost Allocation statement the cost is divided between the completed goods and work in
process in the closing inventory.
In FIFO method – the cost of work in process of opening inventory isn’t brought into account in calc of current period’s
equivalent unit costs.
Cost & Management Accounting pg 300
Spoilt units
Cos in process costing there is mass production of standardised product, there is no job-related wastage so in process
costing system all waste is either normal wastage (to do with the process (e.g. evaporation) or abnormal wastage.
In job costing system the expected cost of normal wastage is included in overheads recovery rate, but in process
costing cost of normal wastage is calc’d at end of accounting period and allocated to work in process and completed
units (depending on how much is completed when the wastage is detected). Cost of normal wastage allocated ONLY to
completed units that have already past the inspection point or wastage point.
Wastage normally detected at fixed inspection points in the process, but can occur at beginning, any stage during or at
end of process. if at beginning or during process then the cost of normal wastage is absorbed by :
 units manufactured and transferred to the next process or to finished goods
 work in process (closing)
30
 abnormal losses.
If wastage occurs during or at the end of the process and there is incomplete work in process which hasn’t reached the
wastage point – then no normal wastage cost is allocated to incomplete work. Then normal wastage is absorbed by :
 compete units
and
 abnormal losses
Study guide pg 99
Some losses in manufacturing process can’t be avoided – called normal / unavoidable losses and take place as part of
the manufacturing process (e.g. waste materials in textile industry). These losses are absorbed by the completed units
that do meet quality requirements.
But also losses that can be avoided – called abnormal / controllable losses e.g. using inferior raw materials. Cost of
wastage that exceeds normal losses have to be separately calc’d and show in the IS.
Wastage is identified at inspection points and MUST know if the products being inspected have already moved past the
point or not.
Losses at the BEGINNING of the process (opening and closing work in process has already passed through the
wastage point) :
Beginning of the production process
Wastage point
Opening work in process
Closing work in process
End of production process
If closing work in process has already passed the wastage point then the cost of the normal loss is ABSORBED
by :
 units manufactured and transferred to the following process or to finished products
 work in process at the end of the process
 abnormal losses
Losses DURING the process (opening work in progress still has to pass the wastage point, but the closing work in
progress has already passed this point) :
Beginning of the production process
Opening work in process
Wastage point
Closing work in process
If closing work in process has already passed the wastage
point then the cost of the normal loss is ABSORBED by :
 units manufactured and transferred to the following
process or to finished products
 work in process at the end of the process
 abnormal losses
End of production process
Losses DURING the process (opening work in progress passes the wastage point but closing work in progress has
NOT yet reached the wastage point) :
Beginning of the production process
Opening work in process
Closing work in process
Wastage point
End of production process
If closing work in process has not yet reached the
wastage point and where losses take place at the end of
the process then the cost of the normal loss is
ALLOCATED to :
 units completed and transferred to the following
process or transferred to the finished products
 abnormal losses
31
Losses at END of the process (both opening work in progress and closing work in progress still have to pass the
wastage point) :
Beginning of the production process
If closing work in process has not yet reached the
wastage point and where losses take place at the end of
the process then the cost of the normal loss is
ALLOCATED to :
 units completed and transferred to the following
process or transferred to the finished products
 abnormal losses
Opening work in process
Closing work in process
Wastage point
End of production process
Inspection during manufacturing process :
Inspection point
for wastage
Opening
stock / work
in progress
Normal loss
Completed &
transferred units
PRODUCTION
LINE
Input during
the period
Abnormal loss
Incomplete
units
Cost of the normal loss is absorbed by the completed units, incomplete units and abnormal loss.
Inspection at end of manufacturing process :
Opening
stock / work
in progress
Cost of the normal loss is absorbed by the
completed units, incomplete units and
abnormal loss
Inspection point
for wastage
Normal loss
Input during
the period
Incomplete
units
Completed &
transferred units
Abnormal loss
Cost & Management Accounting pg 302
Accounting for wastage using the weighted average method
see example of normal wastage at the beginning of process pgs 302 / 303 of text book
If normal wastage at the beginning of process then :
 normal wastage DOESN’T influence on the total production cost
 normal wastage DOES influence unit cost cos the normal wastage is absorbed by the approved units
 cos normal wastage is inherent in manufacturing process the number of wasted units is left out of the calc of the
equivalent units
BUT cos actual wastage is never equal to estimated normal wastage normally have abnormal wastage.
see example of normal wastage and abnormal wastage at the beginning of process pgs 303 / 304 of text book
see example of wastage at the beginning of process & incomplete work at the end of the process pgs 304 to
306 of text book
see example of wastage during the process pgs 306 to 310 of text book
Calculation of equivalent completed units for the spoilt units is based on the state of completeness that the products
have received when the wastage occurs. Cos this is at the end of the process the full applicable amount of material and
conversion costs are allocated to the spoilt units.
Cos using weighted average costing method the cost (in Cost Statement) of opening inventory of work in process is
added to the costs incurred in the current period, and divided by the equivalent units of the relevant cost components to
obtain and average cost per unit.
Journal will then be :
Dr
Cr
32
losses in respect of abnormal wastage
finished goods
production account
xxxxxx
xxxxxx
xxxxxx
Study guide pg 105
see example of wastage at end of the process pgs 105 to 110 of study guide
see example of wastage at beginning of and during the production process pgs 110 to 113 of study guide
Accounting for wastage using the FIFO method
Will be different to the weighted average method cos now have the opening stock in incomplete units forming a
separate cost group.
see example pgs 114 to 122 of study guide
Cost & Management Accounting pg 310
see examples pgs 310 to 316 of text book
Cost & Management Accounting pg 286
Combined Process Cost Report - can present process Cost Report as combined quantity & Production Cost
Statement
Combined Quantity and Production Cost Statement for ….. 2011
Quantity
Incomplete work (opening)
Received from previous process
Production during the month :
Material
Conversion costs
xxxxxx
xxxxxx
Total input
xxxxxxx
Value
R
xxxxxx
xxxxxx
xxxxx
xxxxxx
xxxxxx
xxxxx
xxxxx
xxxxxxx
xxxxx
Completed and transferred :
xxxxxx
From opening inventory
Previous period costs
Costs in current period to complete those units
xxxxxx
Units begun and completed in current period
Completed and transferred :
Incomplete work (closing) :
Costs from previous process
Material
Conversion costs
xxxxxx
xxxxxx
xxxxx
xxxxx
Unit Price
R
xxxxx
xxxxx
xxxxx
xxxxx
xxxxxx
xxxxx
xxxxx
xxxxxxx
xxxxxxx
xxxxx
Study Unit 5 – Joint Products and By-Products (text book unit 6.6)
Study guide pg 126
When use common raw material or joint production process then can have more then one different products from same
production process. So a joint process can produce 2 different products.
The products yielded by the joint processes are either :
 joint products – if both products are more or less equivalent in importance, quantity and value to the other
products which arise from the same manufacturing process & make a material contribution to the market value of all
the outputs of manufacturing process
 by-products – if one product is subordinate to the joint products in importance, quantity and value. By-product has
a sales value but it is incidental to the manufacturing process. Some by-products don’t have a value at all.
Contribute relatively small amount to the total market value of all the outputs of a process
Good quality meat
Ox
Slaughtering
process
Carcass
Hide
Butcher buys
carcass &
processes it into
joint products
Bad quality meat
Bones
33
by-product
Joint costs
When processing the joint products and by-products there are labour and overheads for all 3 products. In
manufacturing process there will be a point when can’t identify individual products. Up to that point (when can still
identify individual products) is split-off / separation point.
All the costs incurred before the split-off point is reached are joint costs (so will include all materials, labour and
overheads incurred to process the products up to the split-off point.)
Additional processing costs
If joint product is not sold directly after the splitting off point, but still processed further then the additional processing
costs must be allocated directly to the respective products by job or process costing system. THESE COSTS AREN’T
PART OF JOINT COSTS, BUT ARE APPORTIONED TO THE SPECIFIC PRODUCT AFTER THE SPLIT-OFF POINT.
Cost & Management Accounting pg 324
Costs incurred up to split-off point are joint costs and include all material, labour and overheads to get the product to the
spilt off point.
Additional processing costs for each product after the split-off point are separate costs cos are allocated to that product
by either job or process costing system.
Product A
Materials
Split-off
point
Materials
Labour
Overheads
– joint
products
are
processed
further so
they can
be sold
Labour
Overheads
Applied joint costs
and separable costs
Product B
Materials
Labour
Applied joint costs
and separable costs
Overheads
Separable costs
Total cost of products
Study guide pg 128
NO joint costs are allocated to by-products – allocated only to the joint products based on one of the following :
 physical standard method (units produced in either quantity or weight). This will always produce the same
cost per unit for each joint product. Sales values are left out of the account when allocating joint costs – so costs
allocated to the product could exceed the income from that product.
 market value at the split-off point method (selling price / market value). So assume that higher selling prices
will mean higher costs and if there is a joint product with a higher selling value then it will bear higher costs then a
joint product with a lower selling value. If the products are sold at the split-off point then the products will both have
the same gross profit percentage.
 relative market value of the final product method (all additional processing costs after split-off point, selling and
distribution costs are deducted from the market value of the final product to find the estimated market value at the
split-off point). Work backwards from market value of the final product to get estimated market value at the split-off
point.
 reverse costing method – use the amounts that must be absorbed by each product. Management decides on
minimum rate of return (profit) percentage and use that to calc the estimated net income for each product
separately using estimated net income as basis, and then counting back the income and additional costs and also
the portion of the joint costs that have to be carried (absorbed) by each product.
Can use method of drafting Income Statement for products at both split-off point and after additional processing to
determine which product should be sold at split-off point and which products should have further processing.
see example of calcs using butcher scenario pgs 128 to 135 of study guide
see examples pgs 327 to 331 of text book
Study guide pg 135
Costing methods for by-products
Proceeds of sale of by-product used to REDUCE the joint cost of the joint products. Shown in IS as :
 reduction of joint production costs
34
 “other income”
 reduction in the cost of the goods sold
see example of calcs using butcher scenario pgs 135 to 140 of study guide
Cost & Management Accounting pg 332
Can calc the net market value of by-product and use it to reduce joint production costs
see examples pgs 332 / 333 of text book
When no joint costs are allocated to by-products then the sale of the by-products is shown directly in the income
statement.
see examples pgs 333 / 334 of text book
Waste materials AREN’T by-products, but any sale of waste materials must be used to reduce the cost of the main
product that is being produced.
Study guide pg 140
NO joint costs are allocated to by-products.
see examples pgs 141 to 149 of study guide
Study Unit 6 – Direct and Absorption Cost (text book unit 4.3)
Cost & Management Accounting pg 154
Recovery of fixed costs done either by :
 direct costs :
 marginal costing
 variable costing
 absorption costing
Direct costing method – total fixed costs are written off against the income of the number of units that were sold during
the period. No fixed costs allocated to the units that are still in inventory. Inventory is only valued at variable costs
(direct materials, direct labour and variable manufacturing overheads). Direct costing recognises fixed manufacturing
overheads as period costs.
So difference between fixed and variable costs are emphasised – direct costing uses ONLY variable manufacturing
costs (i.e. direct materials, direct labour and variable manufacturing overheads). Fixed costs are viewed as cost of
capacity and so is not included in inventory, but rather seen as expired costs and written off in the IS.
Absorption costing method – fixed costs are allocated to the number of units manufactured (units sold PLUS units in
inventory). So fixed costs related to the units that are in inventory are transferred to inventory to be sold in the next
financial period and are included in the opening inventory of the next period. Inventory is valued as production costs
(variable costs plus fixed manufacturing costs), so absorption method recognised fixed manufacturing overheads as
product costs.
Different methods will mean different amounts reflected in the financials in the short term, but as all fixed costs are
eventually recovered in long term, the two different methods will eventually give the same results.
Absorption costs ALLOCATE all manufacturing costs to the product (i.e. direct materials, direct labour, variable
overheads and fixed overheads).
Fixed manufacturing overheads are allocated to the product using pre-determined fixed overhead rate and only
expensed when the product is sold - i.e. they are inventory costs.
Direct costing
Absorption costing
Inventory valuation
Product costs
Direct materials
Direct labour
Variable overheads
Period costs
Fixed overheads
Selling expenses
Admin expenses
Direct materials
Direct labour
Variable overheads
Fixed overheads
Selling expenses
Admin expenses
35
If all the products are manufactured and sold in the same period then there will be no difference between the net profit
for each method. BUT if there is product left at the end of the reporting period then it will be valued differently using the
different methods and will result in a different profit in the IS.
see example pgs 156 / 157 of text book
Income statement
see example pgs 157 to 159 of text book
Using the absorption method the closing inventory will have a higher value as it includes the fixed costs, so will result in
a higher absorption cost.
Fixed and variable selling and admin costs are NOT allocated to the product under either method – but are rather period
costs and so NOT shown in inventory.
Revenue / production / income relationship
Variable costing income higher then absorption costing income if more products are sold then manufactured (cos more
products flow out of finished goods inventory then the inflow).
Absorption costing units from the finished goods inventory can have fixed manufacturing overheads from previous
period as well as the fixed overheads of the current period as well, so the fixed manufacturing overheads in COS will be
higher then the fixed manufacturing overheads moving out of inventory.
Absorption costing income will be lower then variable costing income by fixed overheads that are coming out of finished
goods inventory.
If revenue and production are the same then there is no difference between the income using the direct costing and
absorption method cos there will be no fixed manufacturing overheads coming into or going out of inventory.
production GREATER then revenue
production LESS then revenue
production EQUAL to revenue
THEN
absorption net income GREATER then variable net income
absorption net income LESS then variable net income
absorption net income EQUAL to variable net income
If production is GREATER then revenue then inventory has increased
If production is LESS then revenue then inventory has decreased
If production is EQUAL to revenue then opening stock is same as closing stock.
see example pgs 160 to 164 of text book
Reconciling direct costing profit with the absorption costing profit
1. Record the direct costing net incomes
2. Calc fixed manufacturing cost (number or production units x fixed manufacturing overheads per unit)
3. Calc fixed manufacturing part of the absorption COS (revenue units x fixed manufacturing overheads rate per
unit)
4. Absorption costing net income = step 1 + step 2 - step 3
see example pg 164 of text book
Study guide pg 151
In project costing, very important to allocate the total manufacturing costs incurred during a period to the total number of
units manufactured during that period, so that can calculate manufacturing cost per unit.
total manufacturing cost for period
manufacturing cost per unit = number of units manufactured in period
.
Once have unit cost then can calc the allocation of manufacturing cost to units that are still in stock and to units that
have been sold, in order to calc the net profit.
Direct costing / variable costing / marginal costing uses only the variable cost in manufacturing cost of the product.
Only variable manufacturing costs (direct materials, direct labour and variable manufacturing overheads) are used to
calc the manufacturing cost per unit or in total, but when calc marginal income then ALL the variable costs are taken
into account.
Fixed manufacturing overheads are written off against income as a period cost during the period in which they occur.
Absorption costing includes both fixed and variable costs in the total manufacturing cost of a product (so the product
is “absorbing” the variable and fixed manufacturing cost). The larger the number of units that are manufactured then the
lower the unit cost will be (cos same amount of fixed costs are being divided by larger number of product units).
Fixed manufacturing costs are recovered on the basis of the number of units of a product that are MANUFACTURED
during the period.
36
If the number of units produced and the number of units sold are the same (i.e. no stock on hand) then Income
Statements for the direct or absorption costing methods will have the same net profit.
If there is stock on hand then the difference in net profit can be reconciled by taking into account the difference between
opening and closing stock used in the two methods.
see example pgs 154 to 157 of study guide
Absorption costing – Income Statement :
Direct costing - Income statement :
Sales
xxxxx
less variable costs :
Direct material
Direct labour
Variable manufacturing overheads
Other variable costs :
Selling expenses
Administrative expenses
= marginal income
less fixed costs :
manufacturing cost
selling cost
administrative cost
xxxxx
xxxxx
xxxxx
xxxxx
Sales
xxxxx
less manufacturing costs :
Direct material
Direct labour
xxxxx
xxxxx
xxxxx
xxxxx
Manufacturing overheads :
Variable
Fixed
xxxxx
xxxxx
xxxxxxx
= gross profit
xxxxxxx
xxxxxx
= net profit
xxxxx
xxxxxx
xxxxx
xxxxx
xxxx
less other costs :
Selling costs
(fixed & variable)
Administrative costs
(fixed & variable)
xxxxxxx
= net profit
xxxxxxx
xxxxx
xxxxx
Cost flow of manufacturing costs according to direct costing method :
Direct material
Direct Labour
Variable
manufacturing
overheads
Cost
price
of goods
in stock
Debited
against
income when
goods are sold
Fixed
manufacturing
overheads
Debited
against
income in
that period
Cost flow of manufacturing costs according to absorption costing method :
Direct material
Direct Labour
Variable
manufacturing
overheads
Cost
price
of goods
in stock
Debited
against
income when
goods are sold
Fixed
manufacturing
overheads
Difference in net profit between direct costing method and absorption costing method is the difference between the fixed
manufacturing costs that are included in the closing stock in the absorption costing method.
see example pg 159 of study guide
37
Stock either valued by FIFO or weighted average method. How the opening and closing stock is valued will mean a
difference depending on which method was used.
see example of weighted average valuation method pgs 160 to 163 of study guide
see example of FIFO valuation method pgs 163 to 165 of study guide
Direct costing – advantages
 easier to control different elements of cost cos variable
costs are controlled per unit and fixed costs are
controlled in total
 operating results can be presented in understandable
and synoptic form
 operating results important to management for :
 effects of changes of output volume and product
mix on the profitability of the entity
 determination and adjustment of selling prices
 fixing of entity’s policy cos distinction made
between variable and fixed costs
 significance of fixed cost as percentage of total
cost
 can be applied in conjunction with standard costing and
budgetary control
 eliminates dangers of overcosting and undercosting of
fixed overheads to certain products
 no allocation of fixed costs
Direct costing - disadvantages
 relationship between fixed cost can be directly attributed
to the manufacturing of some products and the marginal
income from these products isn’t calc’d, or is calc’d on
arbitrary basis
 in reality all variable costs don’t vary in direct proportion
to volumes so direct costing is more complicated
 can be semi-variable costs that create complications
 SARS doesn’t recognise inventory, work in progress and
finished goods valuations according to direct costing
method
 risk that people try to compare the relative profitability of
groups of products that can’t be compared e.g. products
made using extensive manual labour against machine
made products would have very different marginal
incomes and can’t be compared
 shouldn’t be used if variety of products are manufactured
– rather used as guideline but not basis for pricing
Absorption costing – advantages
 recognises the importance of fixed costs
 prevents reporting of fictitious losses – if entity has seasonal sales and builds up production during off-season periods
and the costs were shown in IS during the off-season period, but there were no sales then there would be large losses
out of season and large profits in season (cos of high sales and very small fixed variable costs if the direct costing
method was used)
 valuation of work in progress and finished goods is recognised by SARS
see example pgs 168 to 172 of study guide
Study Unit 7 – Activity Based Costing (text book unit 4.4)
Cost & Management Accounting pg 170
Based on fact that products are created from activities and so costs are allocated to these activities.
Traditionally overheads were allocated in two stages :
 overheads allocated to departments
 cost of departments overheads allocated to products
If fixed costs allocated inaccurately then the cost prices will reflect inaccurate unit costs, mainly due to :
 incorrect application of unit-based cost drivers. Some fixed overheads aren’t related to production volume but
rather other factors – called non-unit based cost drivers e.g. number of setups, material handling hours and
inspection hours. So can’t use unit based cost drivers for these costs as won’t be allocated accurately.
 degree of product diversity – when products consume overheads in different proportions e.g. can have the same
number of machine hours per unit, but one product could have a quicker set up time for the machines and could be
manufactured in larger batches so should have lower costs then another product that has longer set up times.
Distortion factors :
 allocated based on unit related measures
 differences in relative consumption ratios
see example of traditional costing on pgs 171 / 172 of text book
ABC costing reduces the distortions cos use the actual cost driver for each activity in production to allocate the costs
directly to the product used.
38
4 steps to ABC system :
Step 1 : Identify activities
Entity must identify all activities (e.g. tasks, actions or unit of work). Activities are classified into 4 categories :
 unit-level activities – relating to individual units produced (i.e. unit level activities have to be performed every time a
batch is produced). Directly related to production volumes e.g. direct material, direct labour, variable manufacturing
overheads
 batch-level activities – performed each time a batch of goods are produced so related to production batches but
NOT to individual products e.g. machine setups, purchasing orders and inspections. Variable cost and will depend
on the number of batches manufactured, but fixed cost is allocated to the number of units in each batch e.g. cost for
processing a sales order, equipment setup, cost to move batch and cost for inspection
 product-sustaining activities – performed to support the different products that are manufactured e.g. cost incurred
to enhance a specific product written off against that product and not dependent on number of units produced e.g.
new bills of materials for modified products, compiling engineering changes and developing new process or product
testing procedure
 facility-sustaining activities – performed to sustain factory’s general manufacturing process. Benefit the whole
manufacturing process and the costs must be written off against total production. Viewed as fixed costs for all
products manufactured in the plant e.g. plan management, security
Step 2 : Identify cost drivers for each activity
Cost drivers are factors that cause different activity costs. Must be measurable and must also be able to be allocated to
products (i.e. must be direct relationship between cost driver and the activities that must be performed)
e.g.’s
Activity
Cost driver
Activity classification
Direct labour hours
Direct labour hours
Unit-level
Setups
Number of batches
Batch-level
Maintenance
Maintenance hours
Product-sustaining
Accounting services
Headcount
Facility-sustaining
Cost driver is the cause of the cost that occur every time an activity is performed.
Step 3 : Cost pool creation
Cost of each activity accumulates into cost pool. Each cost pool has related costs like departmental manufacturing
overheads that are allocated to one or more cost objectives like products, services and activities. One cost driver for
each cost pool.
Number of cost pools determined by :
 activity cost must be material in size in order to justify separate treatment
 cost diver should be most suitable one for the cost pool
Step 4 : Trace activity costs to cost objectives
Activities cause costs and cost objectives. 1st allocate costs to cost pool and then to cost objectives.
Rate to allocate costs calc’d :
activity cost (cost centre cost)
cost centre rate =
cost driver volume
allocated amount = cost centre rate x cost driver volume
see example pgs 175 / 176 of text book and see example pgs 176 178 of study guide
Cost & Management Accounting pg 178
Criteria for use of ABC system :
 non-unit based costs (fixed manufacturing costs) must be high part of total overheads – if aren’t then can use
traditional absorption costs cos will give the same results
 consumption rate of unit-based and non-unit based activities must be very different. If in about the same ratio then
doesn’t matter if unit-based costs are used to allocate all overhead costs or to individual products
 if line managers have doubts about the integrity of product costs from the management accountant
 when marketing department refuses to use reported product costs as basis for pricing the products
 if divisional profit margins are difficult to explain
 if product lines are diverse
 if certain products have suspicious profit margins
 if marketing department suggests that seemingly profitable product should be dropped
 if number of low priced products are increasing while the profits are declining due to undercosting of those products.
Study Guide pg 178
39
Traditional absorption costing systems can measure volume related costs that are consumed in production to the
number of production units, BUT assume that products also use non-unit related costs in the same proportion as
production volumes so will have distorted product costs. Can also be distorted if high level of product diversity.
ABC system 1st traces costs to activities and then to products. Have to identify the activities, identify the cost divers,
create cost centres, and allocate activities costs to products.
ABC system used when non-unit based overhead costs are significant and there is a high level of product diversity.
Study Unit 8 – Cost-Volume-Profit Analysis (text book unit 9.1)
Cost & Management Accounting pg 388
Cost-Volume-Profit analysis is technique for short-term planning and based on fact that any change in either cost,
volume or eventual profit will have an influence on the other two elements.
So CVP is study of relationships between :
 price of product
 volume or level of activity
 variable costs per unit
 total fixed costs
 sales mix
 estimated profit.
Conventional income statement (absorption costing) doesn’t distinguish between fixed and variable costs so can’t be
used for internal management purposes.
Use the info we have on fixed and variable costs to draw up marginal income statement which shows the distinction
between fixed and variable components for ALL expenses. Total variable costs are deducted from sales revenue to
determine the marginal income.
Conventional Income statement :
Marginal Income Statement :
Sales
xxxxx
Sales
xxxxx
less Cost of Goods sold :
xxxxx
less variable costs :
xxxxx
variable production costs
variable marketing costs
variable admin costs
xxxxx
xxxxx
xxxx
Gross profit
xxxxx
Marginal income
xxxxx
less operating expenses :
xxxxx
less fixed expenses :
xxxxx
Marketing
Administration
= net profit
xxxxx
xxxxx
xxxxxxx
fixed production costs
fixed marketing costs
fixed admin costs
= net profit
xxxxx
xxxxx
xxxx
xxxxxxx
CVP analysis used to evaluate changes in selling price, cost or volume on profits.
Must calc the marginal income (balance after variable costs have been deducted from sales revenue). Then take
marginal income and deduct the fixed costs to get the profit for the period (so if there isn’t enough marginal income to
cover the fixed costs then there will be a loss).
So basically if only on item is sold then sales less variable costs = marginal income and less fixed costs will be a loss.
But if additional items are sold then eventually there will be sufficient to cover all the fixed costs and will make a profit.
see example pg 390 of text book
Marginal income = difference between sales value and the total variable costs (marginal costs) of those sales OR
Marginal income = the increase in total costs which arise if an additional unit is manufactured
OR
Marginal income is the aggregate of the variable costs applied to produce or market a single product.
Calc of break-even point using marginal income per unit method
Break-even point = volume (number of units that must be sold) for marginal income to cover all the fixed costs
(minimum quantity of product that must be sold to ensure that all fixed costs are covered and that enterprise doesn’t
make a loss).
total fixed costs
.
40
break-even units (number of products) = marginal income per unit
= number of units that must be sold
Break-even value = sales value of the break-even number of units :
total fixed costs
marginal income ratio
.
break-even value = break-even quantity x selling price per unit
OR
= number of units that must be sold
see example pg 391 of text book
Instead of working out the calcs per unit, can also calc the income variable costs and marginal income as a percentage.
Marginal cost ratio = percentage of variable costs to total sales
Marginal income ratio (or profit / volume ratio) = percentage of the marginal income to total sales
marginal income ratio =
Marginal income x 100
sales
1
OR
marginal income ratio =1
-
variable costs
sales
Marginal income ratio can then be used in different calcs :
break-even value = 1
-
fixed costs
variable cost per unit
sales price per unit
.
OR
total fixed costs
marginal income ratio
.
break-even value =
see example pg 393 of text book
Also use marginal income and marginal income ratio in profit-volume graphs
Expected profit or return
Used to calc the sales value that will produce a specific net profit.
sales volume =
fixed costs + expected profit
marginal income per unit
.
= number of units that will need to be made to make a specific expected profit
.
sales value = expected profit units x selling price per unit
OR
fixed costs + expected profit
marginal income ratio
= number of units that must be sold
see example pg 394 of text book
Margin of safety (M/S)
This is the amount by which the sales value exceeds that break-even value. Can be either in Rands or units :
margin of safety in Rands = total sales - break-even sales
margin of safety in units = total units sold - break-even sales units
see example pg 394 of text book
Margin of safety ratio (as a percentage) – used to show the percentage that the volume of sales can drop before start
to make a loss :
margin of safety value % =
M/S in Rands x 100
total sales
1
sales - break-even sales x 100
41
OR
margin of safety units % =
total sales
1
M/S in units x 100
total sales
1
see example pg 395 of text book
Change in selling price
Increase in the selling price of a product normally results in lower sales. Can use Cost-Volume-Profit analysis to show
how low the sales volume can fall before the planned profit suffers.
Then can use info of the price increase and the planned profit to calc how many units will need to be produced to break
even or to achieve a planned profit.
see example pg 395 of text book
Change in variable costs
Can have a change in variable costs and calc the break-even point and also the number of units that need to be
produced to achieve a certain profit.
see example pg 396 of text book
Change in fixed costs
Can have a change in fixed costs and calc the break-even point and also the number of units that need to be produced
to achieve a certain profit.
see example pg 397 of text book
Product mix
If entity has more then one product then more complicated to find break-even analysis and difficult to get accurate
forecast. Each product will have its own marginal income ratio, so must establish sales mix to calc the marginal income
ratio on a weighted average basis.
see example pg 398 of text book
Change in product mix
If there is a change in the product mix then the break-even point will also change.
see example pg 399 of text book
Change over point
Can change from one Cost-Volume-Profit ratio to another and the change over point is the quantity at which the profit
will be the same.
see example pg 400 of text book
Break-even analysis using graphs
Used to show the relationship between costs, volumes and profit at various sales volumes.
Use Y-axis / vertical axis for monetary values and X-axis / horizontal axis for volume in units.
1. draw the fixed costs line (will be the same for all the volumes), so drawn parallel to the X-axis
2. draw the total costs – fixed costs + (expected sales / sales for the period x variable costs per unit)
3. draw straight line from the origin (0) to the maximum value of the sales (this is the total value of the
proceeds of the sales value x units)
4. break-even point is the intersection between sales line and the total costs line. The break-even value is
point BV, and BU is the break-even volume
5. the vertical distance between the sales line and the total cost line is the profit or loss amount. Using the cost
line – anything below the break-even point is a loss and anything above the break-even point is profit
6. the safety margin is the distance between the break-even point and the units sold (so will be between the 500
and 1000 units)
see example pg 401 of text book
Break-even graph
42
Y
But if want to do a
R 10,000
marginal income graph
then can’t be the same as
R 8,000
the break-even graph as
difficult
to
draw the
R 6,000
different income and costs
lines on the same graph.
But cannot always have a
R 4,000
cost line that is a straight
line as there are changes
R 2,000
in costs.
Variable costs can also
increase
or
decrease
0
500
1000 X
progressively
or
Volume
digressively in relation to
the volume of business.
Selling price per unit can also change and then sales is also not a straight line.
see example pgs 402 to 403 of text book
Use Y-axis / vertical axis for monetary values and X-axis / horizontal axis for volume in units.
1. use the same scale on each axis (e.g. 1 cm = R 1 000)
2. the break-even line will divide the Y axis into positive profit or negative loss, so the portion above the line on
the Y axis is the profit portion and the portion below the line is the loss.
3. the fixed costs are marked on the graph at – R 2 000 and the profit is at + R 2 000 on the profit line (so before
production even starts there is already a total loss of R 2 000.)
4. the break-even point is where the profit line cuts through the break-even line
5. the safety margin is the distance between the break-even point and the R 10 000 sale point
Marginal income
graph
Y
+ R3 000
see example of marginal
income graph when
there is a production
mix on pgs 403 and 404
of text book
+ R2 000
+ R1 000
0
Algebraic / equation
methods of calc’ing
Cost-Volume-Profit
analysis
- R1 000
- R2 000
- R3 000
R 5 000
Value of sales
less
=
less
=
S
V
MI
F
P
less
=
less
=
R 10 000
X
Income
Statement
sales
variable costs
marginal income
fixed costs
profit
So :
Sales = Fixed costs + Variable costs + Profit / Sales = Marginal Income + Variable costs
Variable costs = Sales - Fixed costs - Profit
Marginal Income = Sales - Variable costs
Fixed costs = Sales - Variable costs - Profit / Fixed costs = Marginal Income - Profit
43
Profit = Sales - Fixed costs - Variable costs
OR
Marginal Income x 100
Marginal Income ratio =
Sales
1
Sales - Variable Costs x 100
Sales
1
OR
Marginal Income ratio =
1-
Variable costs x 100
Sales
1
OR
Fixed cost
Break-even quantity = Selling price per unit - Variable cost per unit
Break-even value =
Fixed cost
Marginal income ratio
OR
Fixed cost
Marginal income per unit
.
= break-even quantity x selling price per unit
OR
Break-even value =
1-
Fixed costs
variable cost per unit
sales price per unit
Margin of safety = Sales - break-even value
Margin of safety ratio =
.
OR
(or variable costs)
or (sales)
= sales quantity - break-even quantity
Sales quantity - break-even quantity
sales quantity
x 100
1
OR
= Sales - break-even sales x 100
total sales
1
Minimum subsistence turnover in value = Fixed cost + planned profit + variable cost
OR
= Fixed cost + planned profit
marginal income ratio
Minimum subsistence turnover in quantity = Fixed cost + planned profit
marginal income per unit
Marginal income approach in non-manufacturing activities
see example pgs 407 and 408 of text book
Cost structure and operating leverage factor
Cost structure is the relative relationship between fixed and variable costs in entity. Management must ensure that
fixed costs are used effectively irrespective of the actual level of activity.
Operating leverage used to show how profit reacts to changes in sales volume and also to evaluate extent of how fixed
costs have been utilised.
Operating leverage factor :
Indicates how much influence a percentage change in sales
Marginal income
volume will have on net profit.
Net profit
Specific operating leverage factor is valid for a specific
sales volume and will change as the sales volume changes
44
So in case where two different entities both have the same net profit, they will have completely different cost structures
and operating leverage ratios.
In entity which has larger marginal income and larger fixed costs, then that entity will earn more profit, however if sales
fall then entity that has lower fixed costs will be better off.
So profit will increase or decrease at a higher rate for entity that has a higher operating leverage.
Operating leverage will be reduced in proportion to the increased gap between the sales value and the break-even
point. So can calc the effect of different sales volumes on net income without having to prepare detailed statements.
see examples pgs 409 and 411 of text book
Evaluation of Cost-Volume-Profit analysis
When using break-even analysis which has a fixed ratio of cost, volume and profit must remember that it is limited cos
of assumptions that :
 selling price per unit will remain constant irrespective of the sale volume (so sales are shown graphically as a
straight line)
 all costs and expenses are either variable or fixed
 fixed costs remain constant no matter what the volume of the business while variable costs change in direct ratio
with volume (so can also be shown as straight cost lines on a break-even graph)
 the sales mixes are constant for different types of products
 no change in the variable costs effectiveness in the production factors (also relates to the linear variable costs)
 inventory levels don’t change materially during the period (cos more inventory there is the more fixed costs there
will be in the manufacturing cost of inventory and visa versa.) Cos don’t use the fixed manufacturing costs from the
production costs, CVP analysis doesn’t work out the profit at different inventory levels.
Still useful tool for management for short-term decision making and profit planning.
CVP can be used for short-term investigations and decisions, cos can calculate sales in order to make an expected
profit level and can also be used to evaluate the effect of operating changes on profit (including changes in selling price
and fixed costs).
Summary
Break-even graph = graphical relationship between revenue, variable costs, fixed costs and profit / losses at various
activity levels
Break-even point = point where no profit or loss is made
Break-even quantity = lowest quantity of products that must be sold to ensure total costs are recovered and to prevent
the entity from making a loss
Break-even value = lowest marginal income to earnings to ensure that total costs are recovered to prevent the entity
from making a loss
Change-over point = level of activity at which total costs (and profits) are the same under two alternative CVP
situations
Cost structure = relative relationship between fixed and variable costs in specific entity
CVP analysis = management technique used to examine relationships between total volume, total costs, total revenues
and profits during period
Marginal cost accounting approach = method where all variable costs are deducted from sales to determine the
marginal income
Marginal income = difference between sales and variable costs i.e. the amount available to cover fixed costs and make
a profit
Marginal income ratio (MIR) = marginal income divided through sales and expressed as a percentage of sales
Marginal income statement = management tool to evaluate the influence of changes in the selling price, cost or
volume on profits
Operating leverage = degree of sensitivity of net profit to change in sales volume
Safety margin (monetary) = sales value in excess of the break-even value i.e. states the sales value or sales units that
sales can decrease before the entity starts to suffer a loss
Safety margin (units) = sales units in excess of the break-even units i.e. states the number of sales units that can
decrease before the enterprise starts to suffer a loss and also states the number of units that represent making a profit
Safety margin ratio = expresses the margin of safety as a percentage of sales
Sales mix = relative quantities in which entity’s products are sold
Sales value = sales volume multiplied by the unit cost
Sales volume = number of units sold
see examples pgs 186 and 198 of study guide
Study Unit 9 – Flexible / Variable Budgets (text book unit 11.1)
45
Cost & Management Accounting pg 529
Fixed budgets
Budget = plan of action to achieve a stated goal (so route that must be followed from current period and situation to a
future target). Must be in writing and in realistic quantitative measurable terms. Management must set out a specific
goal for entity and then must spell out plans as to how to achieve the goal using budgets.
Comparison between the budget and actual results used to evaluate performance and take corrective steps.
Budget control = budget is the route that must be followed to achieve specific goal and budget control is used to make
sure that any deviation from the route is noticed, and that the goal is achieved in good time. Done by continuously
measuring the results against the budgeted target and also by determining if what was planned in the budget can be
carried out in practice. Also if there is a difference between the panned and actual results then budget control can
establish the cause, which can then be corrected and the problem averted.
Functions of budgets and budget control :
 budgets = planning function
Study of what must be done, what is necessary to be do it, how it must be done and what the
eventual outcome must be.
 budget controls = controlling and coordinating function
Piecing together of the underlying or subsidiary budgets (e.g. sales, production and labour
budgets), and co-ordinating all the activities and production resources of the entity as a whole.
Control maintained by comparing results achieved against budgeted results. Control will lead to further planning.
Aims of budget control :
 focus on the long term aims of the business
 gather various ideas of all levels of management in preparation of budget
 co-ordinate all the activities of the organisation efficiently
 centralise controls for decentralised activities
 lay basis for future policy when unforeseen situations affect the budget
 plan costs and income in a way to achieve maximum profits
 use capital expenditure in most profitable manner
 use production factors in most economical way
 serve as standard against which actual results can be compared
 establish the causes for variables between actual and budgeted results and advise management how to correct
deviations or take advantage of favourable situations
Advantages of budgets / budget control
 are an aid for achieving the management’s
objectives
 facilitate establishment of standards if standard
costing system is in use
 expenditure of the 3 cost elements in
manufacturing are planned and controlled
 leads to effective management principles and
makes delegation of authority possible
 can determine the relationship between planned
profits and planned employment of capital
 cost variations will expose the weaknesses in the
entity
Disadvantages of Budgets
 can be problems when defining responsible staff
cos some duties can overlap
 forecasts are never 100% accurate and
effectiveness of the budget depends on the accuracy
of the forecast
 degree of willingness and co-operation of
management will determine if it is successful
 budget programme needs additional admin work
and so additional expenses
 cannot prevent some relaxing of the budget
Important aspects for the preparation of budgets :
 human factor – if staff understand the purpose of the budget and are correctly guided and motivated by
management to co-operate with budget programme then it will work
 budget period –strategic plan is long-term (identifies the desired output can be 3 to 5 years or longer) while budget
is short-term (emphasises the inputs that are necessary to achieve the desired output normally for a financial year).
length of budget period :
 seasonal entities – budget period should cover at least one cycle
 should cover the entire production cycle
 budget period should link with financial period so easier to compare actual and budgeted figures
46
 budget personnel – budget committee prepares and administers the budget as well as reviewing, discussing and
co-ordinating all the budget activities. Once all the budgets are reviewed they must be combined in final budget and
submitted to top management for approval
 budget factors – any scarcity factors must be taken into account in determining the entire budget programme e.g.
availability of capital, material or labour shortages etc
Study Guide pg 201
Fixed / prediction budget – when sales and costs are based on estimated turnover that will be manufactured
according to utilisation of estimated and available factory capacity level.
Budget control = comparing the actual results obtained on continuous basis with budgeted targets set, and identifying
the causes of any differences that may be found so that corrective action can be taken.
In practice might be distorted picture when comparing actual and budgeted figures using fixed budget cos if the number
of units that were budgeted for differs from the actual units at the end of the year, then the variances in the budgets
compared to the actual results will b unrealistic.
Can only get a meaningful comparison if the budget figures are based on the same activity level of units produced as
the actual results. see example pg 202 of study guide
Variances calculated by comparing the actual results with the fixed budget are based on number of units actually
produced and not the effectiveness of production.
Cannot use a fixed budget when costs are influenced by change in volume – should rather use variable / flexible budget
which is adjusted to the actual level of activity of entity.
Flexible budget = budget that calculates budgeted income and budgeted costs according to actual production volume
and sets them off against each other to determine the budgeted net profit or loss. Must calc the variable cost per unit.
The budgeted fixed cost will remain the same irrespective of the volume produced so flexible budget can be used as
either :
 unit-based budget
 total budget
Cost & Management Accounting pg 585
Classification of standards :
Must decide at which level of business activity the budgets and standards are going to be based, and can also use more
then one basis for the establishment of a standard for a single cost element e.g. machine hours or labour hours.
If standard hours are basis then is the amount of work that should be completed in an hour.
4 different methods for setting standard level of business activity in entity :
 expected actual level of business activity – level expected for budgeted period based on the prevailing
conditions
 basic level of business activity – level of activity that was set in the past and against which expected and actual
performance will be compare, Very important for statistical purposes
 ideal or theoretical level of business activity – achieved only if all the conditions are ideal i.e. impractical, will
never be ideal conditions
 normal level of business activity – level of business activity that can be achieved with efficient performance under
prevailing conditions. So is average figure which aims to absorb and cover total costs taking into account economic
and seasonal conditions. Especially suited for establishing standard for manufacturing overheads.
Study Guide pg 203
Before budget can be drawn up must decide on the level of production or capacity on which the budget and fixed
manufacturing overheads recovery rate should be based
To determine normal capacity of entity must take into account the physical capacity of the plant and the realistic sales
expectation.
Once normal capacity established then might find that some departments are under-utilised or over-utilised. This can
be corrected by using sub-contractors, purchasing additional material or selling excess machinery.
Study Guide pg 201
Flow of labour costs :
Wage cards are kept for each employee and a
wage sheet is kept for each week showing
gross earnings, deductions and net wages.
47
Once the wages are paid then the bank is
credited and the Wages Due account is
contra’d with a dr.
Then have to divide the labour costs between
direct and indirect labour costs.
Must also allocate the direct labour costs to
the various jobs using the wage sheet :
 total of the wages are dr to the wage
control account
 the manufacturing overheads and
admin costs are dr to expense accounts
 unfinished work allocated to each of
the jobs.
Study Guide pg 203
When drafting flexible budget first need to determine the normal capacity of the entity and then calculate the overheads
recovery rate. Flexible budget must attempt to predict entity’s results within service of capacity levels. Costs at each
capacity level divided into 3 groups :
 fixed costs – don’t change with an increase or decrease in sales volume or quantity of units of product
manufactured e.g. factory rental. But if different number of units manufactured per month then the fixed cost is
divided by those units and so will also differ per month
see example pg 204 of study guide
 variable costs – change in proportion to an increase or decrease in quantity of units manufactured or sold e.g.
direct material costs, direct labour and variable manufacturing overheads which are constant per unit
see example pgs 205 / 206 of study guide
 semi-variable costs – has both fixed cost component and variable cost component, so change in cost per unit isn’t
directly proportional to the change in the level of production. When calc’ing the semi-variable costs for flexible
budget then have to use acceptable method to divide fixed and variable cost component.
Can use either :
 high-low method
 least squares method
 regression analysis using scatter diagram
see example pg 207 of study guide
Drafting flexible budget
Normally few budgets prepared for different production volumes or capacity levels.
see example using direct costing method pgs 208 to 210 of study guide
Once have info of all the expenses and have identified fixed and variable components then can draw up a budget
schedule showing the info that you need to draft a flexible budget.
Flexible budget drawn up using either :
 table method see example pg 211 of study guide
48
 formula method see example pgs 211 to 213 of study guide
 graphical method – used mainly for curved or stepped costs (i.e. costs that vary). Budgeted info is read directly off
the graph for various capacity levels. see example pgs 213 to 215 of study guide
Determine the manufacturing overheads
Fixed costs
Variable costs
Semi-variable costs
Apply high-low method
Fixed costs
Variable costs
Draw up schedule containing budget info :
Capacity
Budgeted allowances
- based on experience
- direct labour costs
- theoretical
- direct labour hours
- practical
- machine hours
- expected / anticipated
- direct material costs
- normal
- units produced
Must have following info :
Direct overheads
Indirect overheads
- fixed
- fixed
- variable
- variable
Cost of service departments
Draft flexible budget
(using either Table, Formula or Graphical method)
Direct costing method
see examples pgs
217 to 223 of study
guide
Absorption costing method
Study Unit 10 – Standard costs (text book unit 12.1)
Study Guide pg 226
Standards are used to give a measure against which actual figures can be measured so that management can identify
factors for the variances, and can then take corrective action (especially if the variances are negative / unfavourable).
If use standard costing system then standards are laid down using historical info as well as info from similar
manufacturing entities and also technical and economic criteria.
Standard cost is calculated cost of product at particular production volume under given set of conditions
Before establish standards need :
 careful selection of raw materials
 systems analysis and time and motion studies to determine the most effective manufacturing methods
 engineering studies on the subjects of equipment design and the provision of facilities
Differences in standards can be cos of policies, cost composition and resources. Must be revised regularly and MUST
be adapted when change in cost component (like material, labour or overheads)
Info on costs either :
 historical / post-calculated – price already paid
 pre-calculated – standard costs
Relationship between standard costing and variable budgets!
Cost & Management Accounting pg 583
Overheads recovery rates give a pre-determined rate based on estimated cost and a normal level of business activity.
Using these rates means can value production when don’t know the actual historical costs.
49
Normal / pre-calculated rates are the EXPECTED cost of business activity and NOT the actual costs at that level of
activity.
Standard rates are the same as many predetermined normal overhead recovery rates – they indicate normal standards
of what costs should be.
Standard costs are the cost of the efficient employment of production resources under current business
circumstances by reasonably competent management.
Standard costing = system where comparison drawn between :
 what should be done at standard costs
and
 what was done at actual costs
Aims
Standard costing should furnish relevant info to management in good time through cost reports. Info should show which
cost centres / departments aren’t functioning efficiently so that management can concentrate on areas where there are
large differences between established standards and actual info.
Improves cost control by :
 establishing standards for each cost element
 determining actual costs for each cost element
 comparing actual costs with standard costs and determining the difference / variances
 analysing variances and facilitating measures to correct them where necessary
Study Guide pg 227
Entity sets standards that reflect the philosophy and mission of entity and this leads to the aim of the entity. Staff must
be continually aware of costs.
Goal of standards will determine how strict and high the standards are – if to cut costs then would be very strict, but if to
value stock and income then standards would be reasonable, and if prices being set then standards would have to be
realistic.
Standard costing system and a budget control system are DIFFERENT things, but one compliments another.
Most important differences :
Budget
 statement that sums up intended, estimated and
desired income and costs at certain capacity level and
serves as guideline for keeping the enterprise on track
 budget emphasises volume and cost levels that
have to be maintained in order to achieve a certain
result
 budget control = comparison of actual results to
budgeted results of all parts of entity for given period
 budgets establish the maximum permissible costs
Standards
 standard reflects what the costs should be when
manufacturing takes place under particular production
conditions, NOT what the costs may possibly be
 standards emphasise the cost level at which the
optimum profitability will be achieved – especially
when break-even analysis is carried out
 standard costing controls = only cost aspect of
the production and distribution of products
 standards establish the minimum allowable costs
Characteristics of good standard costing accounting system :
 standards must be attainable and realistic
 must be room for normal variances
 employees must be informed about the purpose and application of the system and feel motivated to achieve and
maintain the standard
 standard not based on historical results – rather on realistic future costs, results and conditions
 methods followed to achieve the standards must be relevant and attainable
 info from standards must be useful
Cost & Management Accounting pg 584
If there is a standard costing system in use then can facilitate the preparation of budgets, and a budget control system is
great help in controlling costs
Uses of standards and standard costs – normally in homogeneous products (the same) or if entity does piecework /
jobs :
 cost control – standards enable management to draw periodic comparisons between actual and standard costs to
measure efficiency
 stock valuation – if stocks valued at standard costs then can convert them to actual costs for BS purposes
50
 planning for budget purposes – facilitate the preparation of the production, cost and sales budget
 fixing of prices – normally connection between selling price and unit cost of product. Standard unit costs enable
management to achieve the best combination of prices and volumes for a given period
 keeping of records – when standard costing system used together with actual costs then can reduce keeping of
records in detail (e.g. stock registers that show quantities).
Purpose for which the standard costing system is introduced will determine its use i.e. improve control physical stock,
control use of time, to determine the cost price of products more accurately etc.
Classification of standards :
Must decide at which level of business activity the budgets and standards are going to be based, and can also use more
then one basis for the establishment of a standard for a single cost element e.g. machine hours or labour hours e.g. if
standard hours are basis then is the amount of work that should be completed in an hour.
4 different methods for setting standard level of business activity in entity :
 expected actual level of business activity – level expected for budgeted period based on the prevailing
conditions
 basic level of business activity – level of activity that was set in the past and against which expected and actual
performance will be compare, Very important for statistical purposes
 ideal or theoretical level of business activity – achieved only if all the conditions are ideal i.e. impractical, will
never be ideal conditions
 normal level of business activity – level of business activity that can be achieved with efficient performance under
prevailing conditions. So is average figure which aims to absorb and cover total costs taking into account economic
and seasonal conditions. Especially suited for establishing standard for manufacturing overheads.
Type of industry and purpose that the standard costing system is implemented will determine the basis on which
standard costs should be calculated as well as method of establishing standard production capacity.
Advantages of standard costing
 serve as yardstick against which actual costs can be measured
 analysis of variations necessitates consistent control over the
whole production process – so could lead to cost reduction
programmes cos draws attention to aspects that might not be
controlled efficiently
 use of standard costs reduce clerical work cos the value and
quantities of the cost elements of each completed product that
must be manufactured are already available on standard cost
card and so production orders only need to be recorded on
standard forms
 analysis of cost reports by management are simpler and take
less time
 standard costing means better control over costs – object is to
improve work performance and have more efficient material
usages so entity is more cost conscious
 task of valuing raw materials, half complete and completed
production is easier
 standards being established can serve as stimulus to further
planning which leads to greater efficiency
Disadvantages of standard costing
 if prices fluctuate in a period then standards
may not be reliable
 can be costly to implement and modify
standard costing system
 system only useful in manufacturing entity
where mass production or batch processing
take place
 report from system can be long and complex
and won’t be understood by non-financial
managers
 system need continual monitoring and
management
 standards that are set too high can be
negative yardstick.

Cost & Management Accounting pg 586
Before implementation standard costing system must :
 divide production departments into cost centres for greater efficiency and responsibility
 classify accounts so can make provision for actual costs, standard costs and variations
 choose level of business activity to be used as basis for determining standard costs
 establish standard quantities, standard times and costs for each element
In order to establish costing standards for each cost element must have a standard card for each product manufactured
or service provided that shows :
 standard quantities and standard prices of each raw material
 standard labour rate and standard hours
 standard variable manufacturing overheads
 standard fixed manufacturing overheads
 total standard costs allowed
51
MUST take into consideration ALL possible factors that could have any influence when establishing the standards cos
must make sure that they are set with the greatest accuracy possible.
If there are any changes then standards must be changed accordingly (cos must be as accurate and reliable as
possible)
Variances of different elements :
TOTAL VARIANCE
Manufacturing variances
Material variances
Marketing & administrative
cost variances
Labour variances
Sales variances
Overheads variances
Study Guide pg 227
Classifying a manufacturing entity into centres
When standard costing system is implemented then must look at two levels in the organisation :
 info that is based on units
 overall info per cost element in the organisation
Must classify manufacturing entity into centres so that each functional responsibility is represented :
MANUFACTURING ENTITY
Manufacturing
Production
Cost Centres
Administration
Sales & Distribution
Research & Distribution
Production departments are divided into cost centres and classified.
In accounting system accounts classified and grouped according to Expense,
Income, Asset or Liability accounts.
In manufacturing process have to add Cost Accounts, Control Accounts and Production
Accounts.
If Standard Costing System is used then get Standard Costs and Standard Cost Variances.
Service
Standard cost card - needed for each product that is manufactured and for each service that is rendered. Card
must show :
 standard quantities of each raw material
see example of a standard cost card on
 standard unit price of each raw material
pg 233 of the study guide
 standard labour rate
 standard labour hours
 standard manufacturing overheads
 total standard costs allowed according to the standard to manufacture a unit of a completed product
Variances – difference between standard costs and the actual costs of manufacturing the product AND the difference
between the standard selling price and the actual selling price
Must determine the possible cause or reason for the variances and what action is necessary to eliminate similar
variances in the future. Variances are favourable (positive) or unfavourable (negative).
Must understand the basic principles of calc’ing the standard cost variances as needed to determine the exact
origin of the variance.
Standard costs and standard cost variances :
 direct material
 total variance
52
 material purchase price variance
 material quantity variance
 direct labour
 total variance
 labour rate variance
 labour efficiency variance
 overheads
 variable manufacturing overheads
 variable with hours worked
o total variance
o overhead rate variance
o overhead efficiency variance
 variable with production
o total variance
o overhead rate variance
o overhead efficiency variance (always zero)
 variable sales and distribution overheads
 total variance
 expenditure variances
 volume variance (always zero)
 sales price variance
Cost & Management Accounting pg 586
Standard specs must be prepared for establishment of standard material quantities according to size, mass or any other
measure. Must include :
 quantities
 prices
Total material variance
 rates
 quality
 grades
Quantity variance
Price variance
and must also provide for :
 normal scrap
 losses
Purchase price variance
 wastage
OR Issue price variance
 breakages
So when standards are established there will be :
 a price standard for materials (normally based on historical, current and expected future prices)
 quantity standard for materials (quantity specs serve as the basis for determining the standard quantities required to
manufacture one unit of each completed product)
Actual quantity of material used and costs that differ from the standard quantity and costs are variances.
Standard costs
Quantity variance
Actual costs
(difference in quantity @ standard price)
Standard quantity
x
Standard price
Material variances
Actual quantity
+
Price variance
(difference in price x actual quantity)
x
Actual price
= TOTAL VARIANCE
Total cost of material consumed in or purchased for the manufacturing process is :
 unit price paid for the material purchased
 quantity of material issued for consumption or application
 variance between standard material composition and actual material composition (if more then one type of materials
used in manufacturing)
53
So total variance between standard material cost and actual material cost will be variance in one of these.
Actual results are :
 actual units manufactured in period under review
 actual quantity of material used to manufacture the actual units
 actual price paid for material consumed for actual production
Total material variance is difference between the actual quantity of material consumed at the actual price and standard
quantity allowed (standard quantity allowed for units actually produced) at standard price
Total actual costs
less
Total standard costs
allowed for actual
quantity manufactured
difference = total variance
If actual costs > standard costs = unfavourable / negative
If standard costs > actual costs = favourable / positive
see example pgs 236 / 237 of study guide
Total material variance is either :
 material price variance – material purchase price variance based on actual price paid for the material
purchased. Standard price is then the NORM :
 if actual price > standard prices then variance is unfavourable
 if actual price < standard price then variance is favourable
Material purchase price variable is the difference between the actual quantity purchased and consumed at
the actual purchase price and the actual quantity purchased and consumed at the standard price.
CONSTANT FACTOR = actual quantity of material purchased and used
To calc material purchase price variance need :
 material quantity actually purchased and used to manufacture the completed units
 actual price paid for the material
 standard price of the material purchased
 NOT standard quantity of material allowed for actual production cos constant factor = actual
quantity of material purchased and used!!!
see example pg 239 of study guide
Material purchase price variance causes can be :
 entity not taking advantage of rebates on bulk purchases
 poor control over purchases, receipt of stock and timeous payments
 price increases cos of inflation, exchange rates or rise in petrol / transport costs
 faulty standards (errors / mistakes when calc’ing the standards)
 material quantity variances – either :
 volume variance
 efficiency variance
Material quantity variance – difference between the actual quantity of material purchased and consumed at
standard prices, and the standard quantity of material allowed for actual production at standard prices
 if actual quantity > standard quantity then variance is unfavourable
 if actual quantity < standard quantity then variance is favourable
CONSTANT FACTOR = standard material purchase price
To calc material quantity variance need :
 number of completed units actually manufactured
 quantity of material actually consumed in order to manufacture the completed units
 standard quantity of material allowed in order to manufacture the actual completed units
 standard price of material
 NOT actual material purchase price cos constant factor = standard material purchase price!!!
see example pg 241 of study guide
Cost & Management Accounting pg 590
Purchase price variance – when actual price differs from standard price. Variance = difference between actual cost
of the amount purchased and the standard cost (amount purchased x standard price)
54
(AP x AQ) - (SP x AQ)
(actual price x actual quantity purchased) - (standard price x actual quantity purchased)
OR
(AP - SP)AQ
Must use “basket method”
(actual price - standard price) x actual quantity purchased
Cost & Management Accounting pg 591
Material quantity variance – difference between the actual amount of material used at the standard price and the
standard quantity of material allowed at the standard price (standard quantity of material allowed = standard quantity
allowed for the actual production)
(AQ x SP) - (SQ x SP)
(actual quantity of material used x standard price) - (standard quantity of material allowed
for actual production x standard price)
OR
(AQ - SQ)SP
(actual quantity - standard quantity) x standard price
Total material variance
(AQ x SP) - (SQ x SP)
(actual quantity of material used x standard price) - (standard quantity of material allowed
for actual production x standard price)
OR
total material variance = material price variance + material quantity variance
If standard costs > actual cost then variance is favourable
If standard costs < actual cost price then variance is unfavourable
OR
AC > SC = unfavourable
AC < SC = favourable
see example pgs 592 / 593 of text book
Material quantity variances can be attributed to :
 faulty standards (errors made when calc’ing the standards)
 poor controls over the use of material
 poorer quality material resulting in poorer output
 inefficient working conditions, equipment, supervision and skills of staff
Transactions in the GL
Purchases from suppliers : cr Creditors
Transfer material for manufacturing : dr Production Account cr Material
Stock Account and favourable or
unfavourable balance to Material
Quantity Variance account
Transfer of completed units from manufacturing process to completed stock :
cr Creditors, dr Material Stock Account and favourable or unfavourable
balance to Material Purchase Price Variance account.
unfavourable
favourable
unfavourable
favourable
Material Purchase Price Variance account
If material purchase price variance is unfavourable then dr
If material purchase price variance is favourable then cr
Material Quantity Variance account
If material quantity variance is unfavourable then dr
If material quantity variance is favourable then cr
55
Cost & Management Accounting pg 601
Labour standards and variances
Labour rate / tariff and labour efficiency standard are drawn up. Rate standards based on established wage scales paid
for that specific type of labour and time standards, Must include idle time which is unavoidable.
Variances for labour are :
 labour rate variance
Total labour variance
 labour efficiency variance
Study Guide pg 244
Rate variance
Direct labour costs have 2 basic elements :
 rate (or tariff) which is paid for labour per hour
 time required to manufacture the product
Composition (mix) variance
Efficiency variance
Yield variance
To do calc must have :
 actual units manufactured during a period
 actual labour hours worked to manufacture those actual units (normally as total direct labour hours for the period
under review or actual labour hours per unit)
 actual labour rate paid for actual number of hours worked – expressed as R per direct labour hour.
Total labour variance is the difference between the actual hours worked at the actual labour rate per hour and the
standard hours allowed (for actual production) at the standard labour rate per hour.
Total actual labour costs
less
Total standard labour
costs allowed for
actual production
difference = total variance
If actual costs > standard costs = unfavourable / negative
If actual costs < standard costs = favourable / positive
see example pg 245 of study guide
Total labour variance is either :
 labour rate variance – difference between the actual hours worked at the actual rate and the actual hours
worked at the standard rate. Standard price is then the NORM :
 if actual labour costs > allowed labour hours then variance is unfavourable
 if actual labour costs < allowed labour hours then variance is favourable
CONSTANT FACTOR = actual labour hours worked to complete the actual units
To calc material purchase price variance need :
 actual number of labour hours worked to manufacture the completed units
 labour rate paid for the actual labour hours worked
 standard labour rate allowed per hour
 NOT standard labour hours cos constant factor = actual number of hours worked to deliver
the actual production!!!
see example pg 247 of study guide
labour efficiency variance – difference between the actual time worked (in hours) at the standard labour
rate and the stand time (in hours) allowed for actual production at the standard labour rate.
 if actual hours worked @ standard labour rate > standard labour rate then variance is unfavourable
 if actual hours worked @ standard labour rate < standard labour rate then variance is favourable
CONSTANT FACTOR = standard labour rate
To calc labour efficiency variance need :
 number of completed units manufactured
 actual labour hours worked to manufacture the completed units
 standard labour hours allowed for the manufacturing of these units
 standard labour rate per hour
 NOT actual labour rate cos constant factor = standard labour rate!!!
see example pgs 248 / 249 of study guide
56
total variance = labour rate variance + labour efficiency variance
Cost & Management Accounting pg 602
Labour rate variance – multiply difference between the actual and standard rate by the actual hours worked.
(AR x AT) - (SR x AT)
(actual rate paid x actual hours worked) - (standard rate x actual hours worked)
OR
(AR - SR)AT
(actual rate - standard rate) x actual hours worked
Labour rate variances can be caused by :
 incorrect labour rates being used
 changes in wage tariffs
 poor scheduling of production causing overtime to be paid at higher rate
 use of better qualified staff with higher pay
Labour efficiency variance – difference between the actual hours worked at standard rate and the standard time
hours allowed for the actual production at the standard rate.
(AT x SR) - (ST x SR)
(actual time worked x standard rate) - (standard time allowed for actual production x
standard rate)
OR
(AT - ST)SR
(actual time worked - standard time allowed for actual production) x standard rate
Labour efficiency variances can be caused by :
 incorrect establishment of standard hours
 poorly trained employees
 bad supervision
 use of poor quality material
 problems with machinery and equipment
resulting in longer manufacturing hours
then anticipated
see example pgs 603 / 604 of text book
Transactions in the GL
see example pgs 607 / 608 of text book
Study Guide pg 251
Actual wages paid : dr to Wages Payable account
Actual wages to be paid : cr to Wages Payable for actual number
of hours worked x actual rate, and then
dr to Wage Control account for the
actual number of hours worked x std
rate and the difference cr or dr to the
Labour Rate Variance account.
Wages paid for production : cr Wage Control account with actual
Number of hours worked x standard
Rate and dr production account with
The standard number of hours allowed
x standard rate and the difference cr
or dr to the Labour Efficiency Variance
account.
Study Guide pg 252
Manufacturing Overheads
Secondary cos not always noticeable in end product, but which
unfavourable
favourable
57
contribute to the manufacturing of the product. Unlike direct
materials and direct labour which can been seen in the product
(primary costs), overheads are :
 indirect materials
unfavourable
favourable
 indirect labour (supervisor)
 services (electricity, rates, insurance, rental, telephone)
 cost of manufacturing machines, equipment, land and buildings.
Manufacturing overheads components :
 fixed manufacturing overheads – costs which are fixed for the period and not influenced by the number of units
that are produced. So are variable per unit
 variable manufacturing overheads – costs which are fixed per unit (so increase or decrease in direct proportion to
increases or decreases in production)
 semi-variable manufacturing overheads
Standard fixed manufacturing overheads rated calc’d for fixed manufacturing overheads by using normal capacity as
basis.
Total variable manufacturing overheads variance is either :
 variable manufacturing overheads variance in respect of overheads that vary with hours worked –
e.g. something like electricity. The more hours worked the more electricity will be used and so the higher the
variable manufacturing overheads will be.
Total variable manufacturing overheads variance is calculated as the difference between the actual variable
manufacturing overheads and the standard hours allowed for actual production at the standard variable
manufacturing overheads rate per hour.
 if actual variable manufacturing overheads > standard variable manufacturing overheads then variance is
unfavourable
 if actual variable manufacturing overheads < standard variable manufacturing overheads then variance is
favourable
Actual variable manufacturing
overheads which vary
with hours worked
less
Standard time allowed for
actual production at
standard rate per hour
Standard variable manufacturing overheads rate =
budgeted variable manufacturing overheads
normal capacity
difference = total variance
If actual variable manufacturing overheads > standard
variable manufacturing overheads = unfavourable
If actual variable manufacturing overheads < standard
variable manufacturing overheads = favourable
see example pgs 254 to 256 of study guide
Total variable manufacturing overheads divided into :
 variable manufacturing overheads rate variance – difference between the actual variable
manufacturing overheads incurred and the actual hours worked at the standard variable manufacturing
overheads rate
CONSTANT FACTOR = actual hours worked
To calc variable manufacturing overhead rate variance in relation to hours worked need :
o actual labour hours worked to manufacture the completed units
o actual variable manufacturing overheads incurred
o standard variable manufacturing overheads rate per hour
o constant factor = actual labour rate!!!
see example pgs 257 / 260 of study guide

variable manufacturing overheads efficiency variance that vary with hours worked – monetary
value calculated by difference between the actual hours at the standard variable manufacturing
overheads rate and the standard hours allowed for actual production at the standard variable
manufacturing overheads rate.
To calc variable manufacturing overheads efficiency rate variance in relation to hours worked :
o number of competed units actually manufactured
o actual hours worked to manufacture the completed units
58
o
o
o
standard number of hours allowed to manufacture these units
standard variable manufacturing overheads rate per hour
NOT actual variable manufacturing overheads rate cos constant factor = standard variable
manufacturing overheads rate!!!
see example pgs 258 / 260 of study guide
 variable manufacturing overheads variance in respect of overheads that vary with production –
difference between the actual variable manufacturing overheads and the variable manufacturing overheads
ALLOWED for the actual production during the period.
e.g. machine that has to be reset after has finished one manufacturing line and before the next line can begin, cost
of setting the machines will vary according to the number products manufactured on the line.
 if actual variable manufacturing overheads > standard variable manufacturing overheads allowed then variance
is unfavourable
 if actual variable manufacturing overheads < standard variable manufacturing overheads allowed then variance
is favourable
Total actual variable
manufacturing overheads
for total production
=
Actual variable manufacturing
overheads INCURRED
less
Total standard variable
manufacturing overheads
=
standard variable manufacturing
overheads ALLOWED
Standard variable manufacturing overheads rate =
budgeted variable manufacturing overheads
normal capacity
difference = total variance
If actual variable manufacturing overheads > standard
variable manufacturing overheads = unfavourable
If actual variable manufacturing overheads < standard
variable manufacturing overheads = favourable
see example pgs 262 / 263 of study guide
 variable manufacturing overheads rate variance in respect of overheads that vary with production
– difference between the actual variable manufacturing overheads and the actual production at the
standard variable manufacturing overheads rate.
Also called variable manufacturing overheads expenditure / price / budget / spending variance




To calc variable manufacturing overheads rate variance for overheads that vary with production :
actual number of units manufactured
variable manufacturing overheads incurred
standard variable manufacturing overheads rate per unit
constant factor = number of units manufactured!!!
see example pg 264 of study guide
 variable manufacturing overheads efficiency variance in respect of overheads that vary with
production – difference between the actual variable manufacturing overheads and the actual production at
the standard variable manufacturing overheads rate.
Also called variable manufacturing overheads expenditure / price / budget / spending variance


To calc variable manufacturing overheads efficiency variance for overheads that vary with
production :
number of completed units actually manufactured
standard variable manufacturing overheads rate per unit allowed
 should indicate the variance in quantities, but cos there is NO variable in the actual
number of units produced THE VARIANCE IS ALWAYS ZERO!!!
see example pgs 265 / 266 of study guide
Study Guide pg 266
Transactions in the GL
Variable Manufacturing Overheads
59
Control account is dr with the actual
variable manufacturing overheads.
The Variable Manufacturing Overheads Control account is cr and
the Production Account is dr, and
the difference is taken to the Rate
Variance account.
The Efficiency variances is
ALWAYS ZERO!!
unfavourable
favourable
ALWAYS ZERO!!
Study Guide pg 260
Transactions in the GL
Actual manufacturing overheads
are dr in the Variable manufacturing
Overheads Control account.
Then the standard hours x standard variable manufacturing
overheads rate is dr to the Production account and cr to the
Variable Manufacturing Overheads Control account.
The difference is credited to the Efficiency Variance and Rate
Variance accounts (if favourable) or dr if unfavourable.
Study Guide pg 267
Variable sales and distribution overheads variances
Consist of :
 expenditure variance
 volume variance
Sales and distribution overheads also include admin expenses.
Total variable sales and distribution overheads variance is the difference
between the actual variable sales and distribution overheads INCURRED
and the standard variable sales and distribution overheads ALLOWED for
the units actually sold.
To calc total variable sales and distribution overheads
variance need :
 number of units actually sold
 actual sales and distribution overheads incurred
 standard variable sales and distribution overheads rate
per unit
unfavourable
unfavourable
favourable
favourable
If actual variable sales and distribution overheads > standard variable
sales and distribution overheads allowed then variance is unfavourable
If actual variable sales and distribution overheads < standard variable sales and distribution overheads allowed then
variance is favourable.
see example pgs 268 / 269 of study guide
The total variable sales and distribution overhead variance divided into :
 variable sales and distribution overheads expenditure variance -



To calc variable sales and distribution overheads variance :
number of units actually sold
actual variable sales and distribution overheads incurred
standard variable sales and distribution overheads rate per unit
 constant factor = number of units actually sold!!!
see example pg 270 of study guide
60
 variable sales and distribution overheads volume variance – variance volume is ALWAYS zero cos
there is no difference in volumes.
see example pg 271 of study guide
Study Guide pg 272
Sales price variance
When selling one type of product then variance is the sales price variance.
Actual sales price
for actual units sold
less
difference = total variance
If actual sales price > standard sales price = favourable
If actual sales price < standard sales price = unfavourable
Standard sales price for
actual units sold
see example pgs 272 / 273 of study guide
see case studies pgs 273 to 289 of study guide
Revision / Formulas
EQUVALENT ORDER QUANTITY
Cost of ordering
EOQ =
2 x C x U
(P + i) + H
Cost per unit
Usage yearly
Holding cost p/u of inventory
Interest
rate
If can’t split variable and fixed costs :
HIGH LOW METHOD of dividing manufacturing overheads
mnft o/h highest - mnft o/h lowest = cost per unit of variable
number of units
total o/h - (highest volume units x variable cost p/u) = fixed costs
SIMPLE REGRESSION
Sum xy = a sum x + b sum x2
sum of (production volume x overheads) = a(sum of production volumes) +
b(sum of production volumes)2
JOB
COSTING
JOURNALS
61
Raw Materials & Materials Stock
o/b of raw material andDirect raw material
materialstransferred to production
Purchases of raw materialIndirect material used in
and materialsfactory
Finished Goods Stock
o/b stock of finishedCost of finished
goods on handgoods sold
Production Account
Manufacturing Overheads
Indirect materials usedProduction overheads
in factoryallocated to
production
Other overheads
e.g. elect / deprec
Indirect labour costs
o/b of incomplete workTotal costs of goods
completed
Raw materials put into
production process
Cost of goods
completed
Overheads allocated
to production
Direct labour used in
production process
Cost of Goods Sold
Transfer from finished
goods
Production Wages
Total wages payableIndirect labour wages
(including direct and
indirect labour)Direct labour wages
CONTRACT COSTING ACCOUNTING
Construction Contract account
Dr
Materials issued
Return of materials
Subcontractor fees
Sale of materials (@ selling price)
Site labour costs
Material @ site @ yr-end (@ cost)
Finance costs (specifically for contract)
Sale of machinery or equip
(@ sale price)


Machinery & plant :
Hire costs (full price)
Deprecation (for time on site)
Value of machinery and equip
@ end of contract
Cr
62
If retention money – then held as cr until date of
return has passed, then taken to IS as extra profit
If dr then IS as Loss on Latent Defects
CONTRACT PROFIT
contract profit =
OR
contract profit =
cost to date
estimated total cost
x estimated total profit
1
actual cost to end of financial year
x total contract price - total estimated cost
latest estimated total cost of completing contract
1
CERTIFIED WORK ON CONTRACT
contract profit = contract value of certified work + cost price of work not certified x 100
total contract price
1
OR
contract profit = value of work certified
contract price
x
estimated total profit
1
certified work @ contract price
estimate of completed work NOT CERTIFIED @ cost price
PROCESS COSTING
average cost p/u =
total manufacturing costs
number of units manufactured
.
EQUIVALENT COMPLETED UNITS (ECU)
(percentage completed @ end of period)
ECU = units in process x % of work done on them
Unit cost =
total manufacturing costs
Completed units + ECU of incompleted units
.
Labour + overheads = conversation costs
WEIGHTED AVERAGE
Prev period costs + current period costs = total costs = weighted average cost p/u
equiv units
ECU calc (weighted average method)
63
Step 1:
units completed and transferred
PLUS
Step 2:
units completed and on hand @ 100%
PLUS
Step 3:
incomplete units in closing inventory @ % of completion
PLUS
Step 4:
units lost @ % of completion at time the loss is ascertained
FIFO
Costs of opening stock recorded from current unit costs. Add costs for completing opening stock units and
calc separate unit cost for opening stock.
ECU calc (FIFO method)
Step 1:
units completed and transferred @ 100%
PLUS
Step 2:
units completed and on hand @ 100%
PLUS
Step 3:
incomplete units in closing inventory @ % of completion
PLUS
Step 4:
units lost @ % of completion at time the loss is established
MINUS
Step 5:
opening inventory @ % of completion
PRODUCTION STATEMENT - WEIGHTED AVERAGE
Input
Production
xxxxxxx
Opening work in progress
xxxxxxx
Received from prev process
xxxxxxx
Increase in units
Material %
Labour %
Overheads
%
Completed and transferred
xxxxxxx
xxxxxxx
100
xxxxxxx
100
xxxxxxx
100
Closing work in progress
xxxxxxx
xxxxxxx
100
xxxxxxx
50
xxxxxxx
60
Normal wastage
xxxxxxx
-
Abnormal losses
xxxxxxx
xxxxxxx
xxxxxx
xxxxxx
xxxxxxx
-
-
100
xxxxxx
xxxxxx
COST STATEMENT - WEIGHTED AVERAGE
Work in
Process
Current
costs
Total
Cost per
unit
R
R
R
R
Direct material
xxxxxxx
xxxxxxx
xxxxxxx
x.xx
Labour
xxxxxxx
xxxxxxx
xxxxxxx
x.xx
Overheads
xxxxxxx
xxxxxxx
xxxxxxx
x.xx
xxxxxx
xxxxxx
xxxxxxx
x.xx
64
COST ALLOCATION STATEMENT - WEIGHTED AVERAGE
R
Units completed and transferred
xxxxxxx
Work in progress (opening) :
xxxxxxx
Material
xxxxxxx
Labour
xxxxxxx
Overheads
xxxxxxx
Abnormal loss :
xxxxxxx
Material
xxxxxxx
Labour
xxxxxxx
Overheads
xxxxxxx
Work in progress (closing) :
Material …. units @ cost p/u
Labour
…. units @ cost p/u
Overheads … units @ cost p/u
xxxxxxx
xxxxxxx
xxxxxxx
xxxxxxx
Total
xxxxxxx
PRODUCTION STATEMENT – FIFO
Input
Production
xxxxxxx
Opening work in progress
xxxxxxx
Put into production
Material %
Labour %
Overheads
%
Completed from :
Opening inventory
xxxxxxx
xxxxxxx
100
xxxxxxx
100
xxxxxxx
60
Current production
xxxxxxx
xxxxxxx
100
xxxxxxx
50
xxxxxxx
100
xxxxxx
xxxxx
xxxxx
xxxxx
Wastage :
xxxxxxx
-
-
-
Normal
xxxxxxx
-
-
-
Abnormal
xxxxxxx
xxxxxxx
100
xxxxxxx
50
xxxxxxx
60
xxxxxxx
xxxxxxx
100
xxxxxxx
50
xxxxxxx
50
xxxxxx
xxxxxx
Work in process
xxxxxxx
xxxxxx
xxxxxx
COST STATEMENT – FIFO
Total
Material
Labour
Overheads
R
R
R
R
xxxxxxx
xxxxxxx
xxxxxxx
xxxxx
R x.xx
xxxxx
R x.xx
xxxxx
R x.xx
Work in process
xxxxxxx
Current costs
Costs to allocate
xxxxxxx
xxxxxxx
Equivalent production (units)
Equivalent cost p/u
R x.xx
65
COST ALLOCATION STATEMENT – FIFO
R
Opening inventory :
xxxxxxx
Material
xxxxxxx
Labour
xxxxxxx
Overheads
xxxxxxx
Current production
xxxxxxx
Cost gds completed & trsf'd to fin goods
xxxxxxx
Abnormal wastage :
xxxxxxx
Material
xxxxxxx
Labour
xxxxxxx
Overheads
xxxxxxx
Closing inventory :
xxxxxxx
Material
…. units @ cost p/u
xxxxxxx
Labour
…. units @ cost p/u
xxxxxxx
Overheads …. units @ cost p/u
Total costs allocated
xxxxxxx
xxxxxxx
COST OF WASTAGE only to completed units that have past the inspection point :
@ beginning or during process :
 units mnfd & trsf’d / finished goods
 work in process (closing balance)
 abnormal losses
@ end or during process and if is incomplete work in progress not yet at inspection point :
 completed units
 abnormal losses
Stock valued at either :
DIRECT COSTING :


fixed costs – w/o in IS against income of units sold
variable mnfd costs – only for inventory (direct materials, direct labour, variable manufacturing o/h)
ABSORPTION COSTING :
 fixed costs – to units manufactured (sold and inventory)
So fixed costs of inventory in closing balance are in opening bal of next period.
Direct costing - INCOME STATEMENT :
Absorption costing - INCOME STATEMENT :
Sales
Sales
xxxxx
xxxxx
66
less variable costs :
Direct material
Direct labour
Variable manufacturing overheads
Other variable costs :
Selling expenses
Administrative expenses
= marginal income
less fixed costs :
manufacturing cost
selling cost
administrative cost
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxx
xxxx
Manufacturing overheads :
Variable
Fixed
xxxxxxx
= gross profit
xxxxxxx
xxxxxx
= net profit
less manufacturing costs :
Direct material
Direct labour
xxxx
xxxx
xxxxxx
xxxxx
xxxx
xxxx
less other costs :
Selling costs
(fixed & variable)
Administrative costs
(fixed & variable)
xxxxxxx
= net profit
xxxxxxx
xxxx
xxxx
RECONCILIATION OF DIFFERENCES
Direct costing net income
R
xxxxxxx
add fixed manufacturing costs of production units to inventory
under absorption costing (no of production units x cost per unit)
xxxxxxx
less fixed manufacturing overheads released from inventory under
absorption costing (purchasing units x cost per unit)
(xxxxx)
Absorption costing net income
xxxxxxx
APPLIED MANUFACTURING OVERHEADS
Difference between applied manufacturing o/h and actual manufacturing o/h
To calc if over / under applied overheads :
1. predetermined o/h rate = budgeted manufacturing overheads






budgeted units produced (Product unit basis)
budgeted labiour hours (Labour hour basis)
budgeted labour hours x % (labour cost basis)
If “cost” basis then
budgeted machine hours (machine hour basis)
use % (100/1)
budgeted material cost x % (material cost basis)
budgeted material costs + budgeted labour costs x % (primary cost basis)
2. apply the manufacturing overheads during the period :
manufactured overhead applied = predetermined overhead rate
actual units
3. determine if over / under applied overheads at end of period :
actual mnfd o/h > applied o/h = under applied overheads (diff to COS)
actual mnfd o/h < applied o/h = over applied overheads
67
STANDARD COSTS
Standard cost variances :
 direct material
 total variance
 material purchase price variance
(AP x AQ) > (SP x AQ) = unfavourable
 material quantity variance
(AQ x SP) > (SQ x SP) = unfavourable
 direct labour
 total variance
 labour rate variance (AR x Ah) > (SR x Ah) = unfavourable
 labour efficiency variance
(Ah x SR) > (Sh x SR) = unfavourable
 overheads
 variable manufacturing overheads
 variable with hours worked
o total variance
o overhead rate variance
o overhead efficiency variance
 variable with production
o total variance
o overhead rate variance
o overhead efficiency variance (always zero)
 variable sales and distribution overheads
 total variance
 expenditure variances
 volume variance (always zero)
 sales price variance
