direct costing1

7/30/2019 Direct Costing1

1/24


2/24

Cost classification Product vs Period cost

Direct vs Indirect cost

Fixed vs Variable cost

Direct costing Direct costing vs Absorption costing

Income analysis under direct costing and absorption costing

Uses of direct costing Cost controlling

Product pricing

Profit planning

Production planning

Analyzing contribution margin


3/24

Product costAll costs incurred in getting product to saleable condition

Three main elements:

Raw Materials

Labor

Factory overheads

Period costAll costs incurred for a period of time regardless of

production

Sometimes classified into:Marketing expenses

General (administrative) expenses

Financial expenses


4/24

Direct CostsMajor costs that can be directly attributable to the final

product or service

Includes:

Direct materials

Direct labour

Other: subcontractors, tender document preparation

Indirect CostsAll other costs that cannot be directly attributable to the

final product or service. Includes Indirect materials: factory supplies, small items of material

Indirect labour: admin, cleaning or security staff

Factory overheads; rates, rent, insurance, telephone, stationery


5/24

Fixed costsThose costs that in total will remain the same for

a period of time and over a relevant range oroutput

Includes:Rent, rates, insurance, depreciation

Variable costsThose costs that in total will tend to increase as

output level increaseIncludes:Direct Materials and Direct Labour


6/24

Used for External financial reporting

Includes Direct material, Direct labor, variable

factory overhead and fixed factory overhead as a

part of total product cost


7/24

Used for internal planning and decision making

Does not include Fixed factory overhead as a

product cost


8/24

Alternative method of costing

Relatively new

More useful costing method for managementplanning and decision making

Also know as variable costing as most direct

costs are variable with respect to level activities


9/24

Main difference between absorption costing and

direct costing is in the treatment of fixed

manufacturing overhead

Fixed manufacturing costs is not treated as a

product cost instead it is treated as a period cost

That is, it is written off (expensed) in the period in which it

is incurred rather than included as a cost when determining

the cost of inventory


10/24

If fixed manufacturing costs are excluded from the

cost of inventory when using direct costing then

inventory at end of an accounting period will be

lower than the value is using absorption costing

this will effect both the balance sheet and profits


11/24


12/24

Faisal Manufacturing Company has no

beginning inventory and sales are estimated

to be 20,000 units at $75 per unit,

regardless of production levels


13/24

Proposal 1: 20,000 Units to Be Manufactured and Sold

Total Cost Unit CostManufacturing costs:

Variable $ 700,000 $35Fixed 400,000 20

Total costs $1,100,000 $55

Selling and administrative exp.Variable ($5 per unit sold) $ 100,000

Fixed 100,000

Total expenses $ 200,000


14/24

Total Cost Unit CostManufacturing costs:

Variable $ 875,000 $35Fixed 400,000 16

Total costs $1,275,000 $51

Selling and administrative exp.

Variable ($5 per unit sold) $ 100,000

Fixed 100,000

Total expenses $ 200,000

Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold


15/24

Faisal Manufacturing Company

Absorption Costing Income Statements

20,000 Units

Manufactured

25,000 Units

ManufacturedSales $1,500,000 $1,500,000

Cost of goods sold:

Cost of goods manufactured

(20,000 units x $55) $1,100,000


16/24



20,000 Units

Manufactured

25,000 Units


Cost of goods sold:


(20,000 units x $55) $1,100,000(25,000 units x $51) $1,275,000


17/24



20,000 Units

Manufactured

25,000 Units


Cost of goods sold:


(20,000 units x $55) $1,100,000(25,000 units x $51) $1,275,000

Less ending inventory:

(5,000 units x $51) 255,000

Cost of goods sold $1,100,000 $1,020,000

Gross profit $ 400,000 $ 480,000

Selling and administrative expenses

($100,000 + $100,000) 200,000 200,000

Income from operations $ 200,000 $ 280,000


18/24


Direct Costing Income Statements

20,000 Units

Manufactured

25,000 Units


Variable cost of goods sold:

Variable cost of goods manufactured:

(20,000 units x $35) $ 700,000(25,000 units x $35) $ 875,000


19/24



20,000 Units

Manufactured

25,000 Units




(20,000 units x $35) $ 700,000(25,000 units x $35) $ 875,000

Less ending inventory:

(0 units x $35) 0

(5,000 units x $35) 175,000

Variable cost of goods sold $ 700,000 $ 700,000

Manufacturing margin $ 800,000 $ 800,000

Continued


20/24



20,000 Units

Manufactured

25,000 Units

Manufactured

Manufacturing margin $ 800,000 $ 800,000

Variable selling and administrative

expenses 100,000 100,000

Contribution margin $ 700,000 $ 700,000

Fixed costs:

Fixed manufacturing costs $ 400,000 $ 400,000

Fixed selling and administrative

expenses 100,000 100,000Total fixed costs $ 500,000 $ 500,000

Income from operations $ 200,000 $ 200,000


21/24



30,000 Units

Manufactured

Sales $1,500,000



(30,000 units x $35) $1,050,000Less ending inventory:

(10,000 units x $35) 350,000

Variable cost of goods sold $ 700,000

Manufacturing margin $ 800,000

Continued

Suppose 30000 units were manufactured


22/24



30,000 Units

Manufactured

Manufacturing margin $ 800,000Variable selling and administrative

expenses 100,000

Contribution margin $ 700,000Fixed costs:

Fixed manufacturing costs $ 400,000

Fixed selling and administrative

expenses 100,000

Total fixed costs $ 500,000

Income from operations $ 200,000


23/24

Cost controlling

Product pricing

Profit planning

Decision making


24/24

direct costing1

Documents