12ACC Unit 1: Costing

Purpose of Costing

To provide information to aid in pricing decisions, to calculate profitability, and to control expenditure.

Cost Unit

A unit of production, a unit of service, a job for a specific client, or a production patch.

FIFO

First in, first out; oldest items are sold first.

AVCO

Average cost; average recalculated after each purchase.

LIFO

Last in, first out.

Advantages of FIFO

Closing inventory is valued on current price values, inventory valuations are based on actual prices paid, and it is logical as older stock is used first.

Disadvantages of FIFO

Inflates profits in rising prices, conflicting with prudence, identical items from different batches may have different costs, making job quotations unreliable.

Advantages of AVCO

Identical items of inventory are given at the same cost, reduces price variations in production, improves cost comparisons over time, and keeps inventory values close to recent prices.

Disadvantages of AVCO

Requires recalculating after each purchase; the average price does not represent any price actually paid for inventory.

Effect of Inventory Valuation on Financial Statements

FIFO gives a higher inventory value than AVCO during rising prices, profit using FIFO will therefore be higher, but long-term profit will remain the same.

Rule for Valuing Inventory

Inventory should be valued at the lower cost AND net realisable value.

Net Realisable Value

Selling price less any costs to restore it to a salable condition. This follows our prudence concept, which is to prevent overvaluing assets and profits

Just In Time - Inventory System

Supplies are received exactly when needed in the production process and do not need to be stored by the business beforehand. It is difficult to eliminate inventory altogether. Achieving this requires reliable suppliers to deliver the goods on time Eg. Toyota

Advantages of Just In Time

Less cash tied up in inventory, lower storage cost, and lower chance for inventory to be stolen or damaged.

Piece Rate

A wage rate paid to workers based on the number of units produced.

Overtime Payment

Extra pay to an employee for working beyond contracted hours.

Bonus Payment

Additional payment to an employee for producing goods more quickly than the time allowed.

Overtime Premium

Extra percent paid to employees on top of regular wages for overtime.

Unit Cost

Refers to the cost of producing a single unit of a product or service, including overhead costs from the cost center. Helps in planning, cost control and pricing.

Unit Cost Formula

For a single product type, unit cost = total factory cost / units produced.

Absorption Costing

A method of allocating overheads to cost units to determine the total cost per unit.

Cost Centre

A production or service location whose costs may be attributed to cost units, such as a department, which helps to control expenditure.

Production Cost Centres

Cost centres directly involved in producing goods, e.g., factory, packaging, painting.

Service Cost Centres

Provide services for the production cost centres, e.g., stores for inventory, canteen, building and plant maintenance.

Allocation of Costs

Charging overheads directly to the cost centre(s) that can be clearly identified with them, e.g., metal and plastic to the production department, food to the canteen.

Appointment of Costs

The process of charging costs that can't be identified with specific cost centres to cost centres using a suitable basis, e.g., heating, lighting, rent, insurance of the building to the floor area.

Overhead - Basis of Apportionment

Rents, rates - Floor Area; Heating costs - Volume/Floor area; Admin labour - No. of employees; Indirect labour - Proportion to direct labour; Insurance & depreciation - Value of the assets used; Canteen - No. of personnel.

Overhead Absorption Rate

= Budgeted department overhead in dollars / Budgeted department machine hours or direct labour hours.

Machine Hours

Used if the cost centre or department is machine intensive, which relies heavily on machinery.

Direct Labour Hours

Used if the department or cost centre is labour intensive, which is mainly labour being used.

Under-absorption

An actual expenditure is higher than budgeted expenditure, and/or the actual production level is less than the planned level, not enough overhead has been charged to production.

Over-absorption

An actual expenditure is lower than budgeted expenditure, and/or the actual production level is more than the planned level, too much overhead has been charged to production.

Continuous Operations

A single type of good is produced and the cost units are identical through continuous or repetitive operations.

Specific Order Operations

Production based on special orders received from customers and may be classified either as individual jobs, or batches of identical units for a customer.

Job Costing

A costing method that calculates the cost of meeting a specific customer order or job.

Batch Costing

A costing method to find the cost of a batch of items produced.

Benefits of Absorption Costing

Useful for long-term decisions by ensuring fixed costs must be covered if it is to be profitable; Inventory can be valued for financial statements; Straightforward to calculate where there is only one product.

Limitations of Absorption Costing

The bases of apportionment are often generalised; Under-absorption and over-absorption of overheads can arise, affecting profit accuracy; Less useful for short-term decision making.

Marginal Costing

The cost of producing one additional unit of output. Only variable cost increases, while fixed cost remains unchanged. Marginal cost = Variable cost per unit.

Variable Cost

A cost that changes directly with output levels, e.g., raw materials, direct labour, packaging.

Fixed Cost

A cost that remains unchanged within a certain level of activity or output, e.g., rent, materials.

Stepped Cost

Fixed costs that are only fixed within certain limits and will increase to a higher level when that limit is reached, e.g., supervisor salaries increasing when a new production shift is added.

Semi-variable Cost

A cost that has both fixed and variable components, e.g., a telephone bill: fixed monthly fee + extra charges based on usage.