CIE As Level Business | 5.4 Costs - Finance & Accounting

Direct costs

These costs are clearly identified with *each unit of production* and can be allocated to a *cost centre*.

Indirect costs (Overheads)

Costs that *cannot* be identified with a unit of production or allocated accurately to a cost centre.

Fixed costs

Costs that *do not vary with output* in the short run.

Variable costs

Costs that *vary with output*.

Semi-variable costs

Costs that include both a *fixed + variable* element.

Cost Centre

A part of a business such as a department, machine, or store where costs are *collected + monitored*.

Profit Centre

A part of a business such as a department, product line, or branch that is responsible for *generating revenue* and whose *profits* can be *measured separately*.

Average cost

The total cost divided by number of units produced.

Formula for *average costs*

Total cost / quantity of output

Marginal costing

The additional cost of producing *one more unit* of output.

Formula for *marginal cost*

Change in total cost / change in quantity

What are the 2 commonly used *methods of costing*?

- Full costing

- Contribution costing

Full costing

A method of costing in which all *direct + indirect* costs are allocated to the products, services or divisions of a business.

What are the *advantages* of *full costing*?

1. *Includes all costs*

→ Both fixed and variable costs are accounted for

→ ✅: Supports *pricing decisions* → reduces risk of *making a loss*

2. *Useful for profit calculation*

→ Shows overall cost of production

→ ✅: Helps assess true *profitability* → useful for decisions about *growth/expansion*.

What are the *disadvantages* of *full costing*?

1. *Difficult to allocate fixed costs*

→ Overheads must be estimated

→ ❌: May lead to *inaccurate costing*

2. *Not useful for short-term decisions*

→ Makes fixed costs unavoidable in short run

→ ❌: Can lead to poor *decision-making* (e.g. rejecting orders) → *missed opportunities*

3. *Time-consuming*

→ Complex calculations needed

→ ❌: Increases *administrative effort*

3. *Higher-pricing*

→ Accounting for fixed costs increases unit cost

→ ❌: *Higher prices* → *less competitive*

Contribution costing

Costing methods that allocates *only direct costs* to cost centres and profit centres — *NOT* overhead costs.

Formula for *contribution per unit*

Selling price - variable costs

What are the *advantages* of *contribution costing*?

1. *Shows contribution per unit*

→ Helps identify *profitable products*

→ ✅: Improves *decision-making* (discontinue or invest more).

2. *Supports break-even analysis*

→ Key for calculating break-even

→ ✅: Aids *planning + forecasting* → can set *clear goals* on units needed to be produced / sold to avoid loss.

3. *Useful for pricing decisions*

→ Helps decide *minimum price*, ensuring prices still cover variable costs.

→ ✅: Improves decision-making, especially for *special orders*.

What are the *disadvantages* of *contribution costing*?

1. *Ignores fixed costs per unit*

→ Focus on contribution only

→ ❌: Overlooks *total profitability* → misleading for *long-term pricing* decisions.

2. *Assumes constant variable costs*

→ Costs may change in reality

→ ❌: Reduces *accuracy*

2. *Special order decisions*

→ Generally lower priced

→ ❌: Existing customers may *demand similar prices* / harm *luxury brand image*.

Break-Even Point

The total level of output of which *total costs = total revenue*, when neither a profit nor loss is made.

Margin of Safety

The amount by which the current output level exceeds the break-even level of output.

Formula for *break-even point*

Fixed costs / Contribution per unit

What are the *advantages* of *break-even analysis*?

1. *Helps planning*

→ Shows level of output needed to cover costs

→ ✅: Supports *target setting*

2. *Simple and visual*

→ Can be shown on graphs

→ ✅: Easy to *understand + use*

3. *Supports decision-making*

→ Shows impact of cost/price changes

→ ✅: Improves *business decisions*

What are the *disadvantages* of *break-even analysis*?

1. *Assumes costs and revenue are constant*

→ In reality they can change

→ ❌: Reduces *accuracy*

2. *Ignores qualitative factors*

→ Only focuses on numbers

→ ❌: May lead to *incomplete decisions*

3. *Makes no allowance for inventory levels*

→ Assumes all output is sold (inaccurate)

→ ❌: Does not reflect true *profitability* → poor decision-making