Study unit 19

Job order costing means

- Accumulation of costs by specific jobs, contracts, or orders. - This costing method is appropriate when direct costs can be identified with specific units of production.

Calculation of contribution margin

- All variables (and only variable) costs, both manufacturing and selling and administrative, are subtracted to arrive at contribution margin.

Difference between contribution margin and gross margin

- CM seeks to separate out variable costs from fixed costs (not included in the contribution calculation) - gross margin is determined using accounting standards. E.g. production line with positive CM should be kept even it causes negative total profit, when CM offsets part of the fixed cost.

Purpose of contribution margin

- Contribution margin analysis is a measure of operating leverage: it measures how growth in sales translates to growth in profits. - This calculation is often used for internal (managerial) reporting purposes.

Rework

- Correcting of defective, failed, or non-conforming item, during or after inspection. Rework includes all follow-on efforts such as disassembly, repair, replacement, reassembly, etc. - Actual or standard cost of correcting defective work.

Cost of goods sold

- Cost of goods sold represents the sum of the costs of all goods which have been sold during the accounting period. - Theses are expired costs, and thus are actual expenses for the year.

Accounting treatment for normal spoilage

- Costs of normal spoilage are allocated to the remaining good units in inventory. - It is treated as a product cost that is, it is absorbed into the cost of the good output (i.e. cost of goods produced).

Contribution margin or marginal income

- Difference between sales and the variable costs - It is the marginal profit per unit sale and the intermediate figure when variable (direct) costing is used. - It is the amount of money available to cover fixed costs and generate profits.

Direct Costs

- Direct costs are costs that can easily be associated with a particular cost object in an economically feasible way. - E.g. Direct material, Direct labor

Fixed costs

- Fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. - For example, a retailer must pay rent and utility bills irrespective of sales.

Indirect Costs

- Indirect costs are costs that cannot be associated with a particular cost object in an economically feasible way. - E.g. Indirect materials

Semi-variable cost or Mixed cost

- It contains both a fixed-cost component and a variable-cost component. - The fixed cost element needs to be paid irrespective of the level of activity and variable component of the cost is payable proportionate to the level of activity.

Benefit of Back-flush costing

- It eliminates the detailed tracking of costs, work-in-process and journal entries to inventory accounts may be delayed. - It is best suited to companies that maintain low inventories because costs then flow directly to cost of goods sold.

Total Absorption Costing or Full Costing

- It is a method of accounting cost which entails the full cost of manufacturing or providing a service. - It includes not just the costs of materials and labour, but also of all manufacturing overheads (whether 'fixed' or 'variable').

Direct labor cost

- It is a part of wage-bill or payroll that can be specifically and consistently assigned to or associated with the manufacturing. - It is the cost of the work done by those worker who actually make the product on the production line.

Characteristics of fixed cost

- It is not dependent on the level of goods or services produced. - It tend to be time related - It is not permanently fixed; it will change over time, but is fixed in relation to the quantity of production for the relevant period.

Calculation of Gross margin

- It is the difference between revenue and cost before accounting for certain other costs. - Generally, it is calculated as the selling price of an item, less the cost of goods sold (production or acquisition costs, essentially).

Gross margin (also called gross profit margin or gross profit rate)

- It is the intermediate figure between sales and operating income under absorption (full) costing. - All manufacturing (and only manufacturing) costs, both variable and fixed, are subtracted to arrive at gross margin.

characteristics of variable costs

- Its cost per unit remains constant in the short run regardless of the level of production. - It is the sum of marginal costs over all units produced. - It vary directly and proportionally with changes in volume.

Non manufacturing costs

- Non-manufacturing Costs are those costs that are not directly incurred to manufacture a product. - Examples of such costs are salary of sales personnel and advertising expenses.

Period costs

- Period costs are expense as incurred, i.e. they are not capitalized in finished goods inventory. - They are excluded from cost of goods sold.

Job costing vs Process costing

- Process costing is used when products are homogeneous in nature conversely, Job costing assign costs to distinct production jobs that are significantly different.

Product cost or inventory cost

- Product cost or inventory cost is a component of cost of goods sold. - They are capitalized as part of finished goods inventory.

In absorption costing

- Product costs consist of direct material, direct labor, variable overhead and fixed overhead - Period costs consist of selling and administrative costs

Variable costing or Direct Costing

- Product costs consist of variable production (manufacturing) costs - Period costs consist of variable selling and administrative costs and fixed portion of both production and selling and administrative expenses.

Normal Spoilage

- Product deterioration that is expected even under the best operating conditions. - It is inherent and unavoidable in the short run.

Abnormal Spoilage

- Spoilage that is recognized as a loss when discovered. - It is controllable because it is a result of inefficiency. - It is not a cost of good production, but rather it is a loss for the period.

Purpose of gross margin

- To determine the value of incremental sales, and - To guide pricing and promotion decision.

Traditional costing vs Activity-based costing

- Traditional costing is more simplistic and less accurate than ABC. - ABC is more complex and more accurate than traditional costing.

Traditional costing vs Activity-based costing

- Traditional costing typically assigns overhead costs to products based on an arbitrary average rate. - ABC first assigns indirect costs to activities and then assigns the costs to products based on the products' usage of the activities.

Variable costs

- Variable costs are expenses that change in proportion to the activity of a business. - They are volume-related and are paid per quantity produced.

Accounting treatment for abnormal spoilage

-Abnormal spoilage is typically treated as a period cost (a loss) because of its unusual nature. - Costs are assigned to the spoiled units and then credited to work-in-process (WIP) inventory and debited to a loss account.

When process costing is applied?

-For companies that produce a continuous mass of like units through series of operations or process - Also, when one order does not affect the production process and a standardization of the process and product exists.

Methods of arriving at full cost

1) Absorption Costing or full costing and 2) Activity Based Costing

Cost of Goods Sold Statement of Manufacturing Companies:

1) Direct Materials Section 2) Direct Labor Section 3) Factory Overhead Section 4) Work in Process Inventories Section 5) Finished Goods Inventories

Manufacturing costs are often grouped into:

1) Prime cost 2) Conversion cost

Non-manufacturing costs are further classified into two categories:

1) Selling and distribution Costs. 2) Administrative Costs.

Life-cycle costing

A costing approach that focuses on all costs along the value chain that will be generated throughout the entire life of a product.

Relevant cost or Avoidable cost or Differential cost

A relevant cost is a cost that differs between alternatives being considered.

Back-flush costing

A system generally used in a just-in-time inventory environment. Back-flush costing delays process until production of goods is completed. Costs are then "flushed" back at the end of the production run and assigned to goods.

Activity-based costing

Activity-based costing (ABC) is a special costing model that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.

Cost of goods sold is ascertained by

Adding the value of unsold goods at the beginning of the year (opening inventory or stock) to the purchases made during the year and the deducting the values of unsold goods at the end of the year (closing inventory of stock) from the purchases.

Administrative costs

Administrative expense are those costs incurred by a company not directly related to producing or marketing the product. e.g. executive salaries and depreciation

Formula/Equation of Cost of Goods Sold (COGS):

COGS = Opening inventory + Net Purchases + Direct expenses - Closing inventory

Conversion cost

Conversion cost is total of direct labor and manufacturing overhead

Formula/Equation of Cost of Goods Manufactured :

Cost of goods manufactured = Direct materials used + Direct labor used + Factory overhead + Work in process opening inventory - Work in process closing inventory

Cost of goods manufactured is

Cost of goods manufactured is the total cost of goods completed during the period.

Direct materials cost

Direct materials cost is the cost of direct materials which can be easily identified with the unit of production.

Manufacturing overhead costs

Manufacturing overhead costs are all manufacturing costs that are related to the cost object (work in process and then finished goods) but cannot be traced to that cost object in an economically feasible way.

Process costing

Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture.

Scrap

Scrap is the excess unusable material that is left over after a product has been manufactured.

Selling and distribution costs

Selling and distribution costs are those costs incurred in getting the product from the factory to the consumer. e.g. sales personnel salaries

Sunk costs

Sunk costs are retrospective (past) costs that have already been incurred and cannot be recovered.

Waste

Unwanted material left over from a production process, or output which has no marketable value.

Historical cost

historical costs is the original monetary value of an economic item.

Prime cost equals

prime cost is total of direct material and direct labor cost

Purpose of absorption costing

the main reasons for absorbing overheads into the cost of units is for inventory valuation purposes.