Topic 10

Cost Accounting and Management

Learning Objectives

1. Cost behaviour analysis - variable, fixed and mixed cost behaviour.

2. Explain the costs involved in manufacturing activities – direct material, direct labour and overhead.

Cost Behaviour Analysis

Cost behaviour analysis:• Examines how costs behave when levels

of business activity change:– Some costs change– Some costs stay the same

• Helps in planning and choosing between alternatives.

• Starts with identification of key activities and their relationships with various costs.

Variable Costs

• Variable costs change in total with increases and decreases in activity level.– e.g. direct materials, direct labour, COGS,

freight costs, fuel• They are identified on a per-unit basis• Variable costs stay the same per unit as

activity level changes.• Total variable costs change in proportion

to change in activity level.

Variable Costs (cont’d)

Fixed Costs

• Fixed costs do not change with increases and decreases in activity level.– e.g. rates, rent, insurance, supervisors’

salaries• Fixed cost per unit = total cost divided by

units of activity level.• Total fixed costs stay the same.• Fixed cost per unit changes as activity

level changes.

Fixed Costs (cont’d)

Mixed Costs

• Mixed costs are also called semi-variable costs.

• Mixed costs includes a fixed cost component plus a variable cost according to activity level. e.g. telephone (fixed line charge plus

charge per unit consumed)• Mixed costs are often separated into fixed

and variable components at end of period.

Mixed Costs (cont’d)

Importance of Identifying Costs

• Identification of costs as fixed or variable is important for business decisions:1. Effect on profitability of reduction in sales

price.2. Effect on activity level when expenses

increase per unit to keep current profitability.3. Minimum level of sales to cover costs.4. Costs of maintaining level of production for

different manufacturing methods.

Manufacturing costs consists of: Direct material: material and parts used

directly during the manufacturing process.

Direct labour: the work of factory employees that are directly involved in producing the product.

Manufacturing overhead: costs that are indirectly associated with the manufacturing of the finished goods. Eg. Indirect material, indirect labour, depreciation on factory buildings.

All costs

Product costs(Manufacturing costs)

Period costs(Non-manufacturing costs)

Direct materials

Direct labour

Manufacturing overhead

Selling expenses

Administrative expenses

Prime costs

Conversioncosts

Product Costs – costs that are necessary and integral part of producing the finished product.

Direct labour and manufacturing overhead are incurred in converting raw materials into finished goods, these costs elements are often referred to as conversion costs.

Period costs – costs that are identified with a specific time period rather with a salable product. These costs relate to non-manufacturing costs and therefore are not inventorial costs.

Manufacturing Costs in Financial Statements

Format Manufacturing AccountsABC Manufacturing Company

Manufacturing account for the year ended December 2007

Direct Materials RMRMRaw material as at 1 January 2007 xxAdd: Purchases of Raw Material xx Carriage Inward xx Import Duty xxTotal Raw Material Available for Use

xxx(-) Raw material as at 31 December 2007 (xx)DIRECT MATERIAL USED

xxxDirect Labour

Wages xxxDirect ExpensesxxxPRIME COSTSxxx

Continue..PRIME COSTS xxx

Overhead CostsIndirect Labor xxFactory repairs xxDepreciation – factory machine xxTOTAL OVERHEAD COSTS xxx

TOTAL MANUFACTURING COSTS xxxAdd: WIP – Opening xxLess: WIP – Closing (xx)

COST OF GOODS MANUFACTURED XXX

ABC Manufacturing CompanyIncome Statement for the year ended December 2007

RM RMSales xxxLess: Cost of Goods Sold:Finished goods – 1 Jan xxAdd: Cost of goods manufactured xxGoods Available for Sale xxLess: Finished goods – 31 Dec (xx)COST OF GOOD SOLD xx

GROSS PROFITXX

Less: Operating ExpensesSelling and Distribution ExpensesxxAdministrative Expenses xx

NET / LOSS XX

Mutiara Ltd incurs the following manufacturing costs and expenses during the month of May.1. Assembly line wages2. Raw materials used directly in product3. Depreciation on office equipment4. Property taxes on factory building5. Rent on factory building6. Sales commissions7. Depreciation on factory equipment8. Factory utilities9. Wages for factory maintenance workers10. Advertising11. Indirect materials used in production12. Factory manager's salary

Complete the following matrix by placing an X mark under the appropriate headings.

Cost item Directmaterial

Direct labour

Manufact.overhead

Prime costs Conversion costs

Period costs

Wages

Raw material

Depreciation office equip.

Property taxes

Sales commissions

Depreciation on factory equipment

Factory utilities

Wages for factory maintenance workers

Advertising

Indirect materials

Factory manager's salary