Cost sheet basics & Absorption Costing

8/13/2019 Cost sheet basics & Absorption Costing

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The Winning Edge Compiled by Chhaya SehgalA WRITE UP ON COSTS

Analysis of Costs. There are three methods adopted for cost analysis.

1. Direct and Indirect Costs method

2. Variable, Fixed and Semi Variable Costs method

3. rod!ction, "dmin, Sales # Finance Costs method

Direct Cost is the cost $hich is directly related to a partic!lar acti%ity. In con%erse $ay it is the

expendit!re $hich can be a%oided if the partic!lar acti%ity is not !nderta&en. '(. The ra$ material

!sed for man!fact!rin( an item. If a partic!lar item is not man!fact!red, the ra$ material and

conse)!ential cost of ra$ material is sa%ed*not spent.

Indirect Cost is that cost $hich is not directly related to acti%ity. In other $ords it is the cost $hich

may still ha%e to be inc!rred irrespecti%e of acti%ity pro(ressin( or not. S!ch costs normally co%erm!ch $ider ran(e of acti%ities li&e "dministrati%e costs.

Variable Costsare the costs $hich chan(e in direct proportion $ith the )!ant!m of acti%ity or $ith

sales. In s!ch cases there is direct fixed relation bet$een )!ant!m of acti%ity and the cost inc!rred.

'.(. F!el expendit!re of yo!r car $hich is directly proportional to the !sa(e of the car. "nother

example co!ld be, ima(ine that a boo&shop b!ys in boo&s for an a%era(e price of +s. 1 each. It

then resells the boo&s for a hi(her price. For the boo&shops the %ariable cost is +s. 1 per !nit.

Total costs are fo!nd by addin( to(ether fixed and %ariable costs.

Fied Costs are the cost $hich remain constant -s!bect to a pre/specified maxim!m limit of

acti%ity, or $ith sales after $hich it $ill chan(e0 irrespecti%e of the )!ant!m of acti%ity. '(.

Depreciation cost of achinery, Ins!rance and finance cost of yo!r %ehicle $hich remain constant

irrespecti%e $hether the %ehicle is r!n or not. "nother example is, one of the fixed costs of a hi(h

street shop is the rent paid for the property. The rent is still the same $hether the shop sells one item

or tho!sands.

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The Winning Edge Compiled by Chhaya SehgalSe!i Variable Costsare the costs $hich do chan(e as the acti%ity le%el chan(es b!t the %ariation is

not in direct proportion to the acti%ity le%el %ariation chan(e $ith %ol!me, b!t in increments.. This

is basically s!m of a fixed cost element and a %ariable cost element. 'xample hirin( of a car $hich

has a fixed daily hirin( char(es and in addition, per &ilometre r!nnin( char(es applicable.

r for a hotel b!siness, if ho!se&eepin( staff can clean no more than 1 rooms each, a co!nt of 41

(!ests $o!ld re)!ire six staff. If nine more (!ests arri%e to brin( the total co!nt to 5, the

n!mber of ho!se&eepin( staff needed is still only six. The next (!est after that $ill re)!ire

(oin( to the next 6step7, or se%en staff.

Total Costs

TC = F + VCq

where

F => Fixed cost ,

VC => Variable Cost, q=> Quantity Produced

Econo!ies of Scale

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The Winning Edge Compiled by Chhaya Sehgal

In partic!lar, econo!ies of scaledescribe sit!ation $hen the total costs rise less than proportionally

to prod!ction increases, as yo! see in the follo$in( dia(ram

Dis"econo!ies of scale represent the opposite sit!ation

Constant ret#rn to scaleis the intermediate sit!ation in $hich the (ro$th in prod!ction is exactly

matched by the same percenta(e increase in total costs, i.e. elasticity of costs to prod!ction le%els

is

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The Winning Edge Compiled by Chhaya Sehgal

In t$is case% &rod#cti'ityis constant

Con'ertin( Variable to Fied Costs

8hen a b!siness is (ro$in(, it is often better to con%ert %ariable to fixed cost. " smaller hotel may

pay for la!ndry at a rate per po!nd to an o!tside %endor. "s it (ro$s, it may be $orth ma&in( a one/

time p!rchase of $ashin( machines. If %ol!me is declinin(, it is best to con%ert fixed cost into

%ariable.

)at$e!atical )odel of Fied and Variable Costs

Sl Ite! *+++ Units ,+++ Units -+++ #nits Re!ars

-a0 Depreciation +s 1*/ +s 1*/ +s 1*/ Fixed Cost

-b0 +a$ aterial

9+s24*/per !nit

+s 4*/ +s 124*/ +s :4*/ Variable Cost

-c0 "d%ertisement +s 2*/ +s 25*/ +s 22*/ Semi Variable cost

Fixed Component +s 15*/ +s 15*/ +s 15*/

Variable Component

9+s2*/per !nit

+s ;*/ +s 1*/ +s 5*/

In case of Fied costs% a!o#nt is constant.In case of Variable costs% #nit rate is constant.

Ea!&le.

" factory can prod!ce 14 !nits per month. The follo$in( is their data for "pril # ay /

Sl Ite! A&r /Units0 )ay /Units0

-a0 Total rod!ction abo!r Cost +s =1*/ +s 1=*/-d0 Depreciation +s 2*/ +s 2*/

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The Winning Edge Compiled by Chhaya Sehgal-e0 rod!ction %erheads +s 34*/ +s ;;*/

-f0 "dmin %erhead +s 14*/ +s 154*/

-(0 Sales %erhead +S 3*/ +s 35*/

The factory is expectin( to prod!ce and sell 1 !nits in ?!n at a sellin( price toearn a profit of 2@ on the cost. repare a cost statement and sellin( price for ?!n.

Cost Analysis State!ent

Sl Ite! A&r )ay 1#n

-a0 Total rod!ction abo!r Cost +s =1*/ +s 1=*/ +s


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The Winning Edge Compiled by Chhaya Sehgal50 Reso#rce costs

'xamples of reso!rce costs are salaries, b!ildin(s, machinery, and comp!ter systems. These costs

$ill chan(e only $ith a chan(e in reso!rce le%els by the cost of these reso!rces. For example, acompany can increase its h!man reso!rce capacity by hirin( more people. These costs, ho$e%er,

exist re(ardless of the prod!ction %ol!me.

*0 Acti'ity costs

"cti%ity costs are inc!rred by performin( a partic!lar acti%ity. These costs may or may not be

independent of the n!mber of !nits prod!ced.

achine set/!p operations, $here additional scrap mi(ht be prod!ced in order to allo$ for steady/

state operation prior to processin( the sched!led parts, is independent of prod!ction %ol!me

This cost is a f!nction of the acti%ity, not of the n!mber of !nits prod!ced. The more set!ps, the

hi(her the scrap cost, $hether no prod!cts are processed d!rin( the prod!ction phase or an infinite

n!mber are processed.

-0 Factor costs

rod!ction costs that increase directly $ith increased prod!ction are called factor costs. Factor costs

are (enerally B b!t not al$ays B material costs.

>abor paid by piece$or& is a factor cost labor paid by the ho!r, $ee&, month, or year is not.

70 )ied costs

Some costs exhibit beha%ior that is similar to both factor and reso!rce costs. "n example is

electricity. The cost to t!rn on the li(hts in the office is independent of the n!mber of !nits

prod!ced and so co!ld be considered a reso!rce cost.

o$e%er, if a machine re)!ires po$er to stamp the n+1st fender, $hich $o!ld not ha%e been !sed

had prod!ction stopped $ith the nth !nit. Therefore, electricity can also beha%e as a factor cost the

difference is in the application. This %al!e sho!ld be incl!ded in the !nit factor cost. 8hereas

traditional cost acco!ntin( $o!ld consider !tilities mixed costs or semi %ariable costs, they can, in

fact, be bro&en do$n into factor and reso!rce components.

Cost S$eet of a Prod#ct

1. rod!ction Cost -a0 Direct Cost -"lso called Pri!e Cost0

/b0 Indirect Cost -"lso called Prod#ction O890 incl!des

indirect material, indirect labo!r, po$er and f!el

depreciation on machinery etc.

2. "dmin Cost is also called "dmin *.

3. Sellin( and Distrib!tion Cost called Sellin( and Distrib!tion *.

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The Winning Edge Compiled by Chhaya Sehgal;. Financial Costs called Financial *. -Eot incl!ded in cost sheet as this cost %aries

bet$een proect to proect and it is diffic!lt to arri%e at a proper fi(!re. !t this cost is f!lly

ad!sted $hile calc!latin( sellin( price to an article or ser%ice0.

P#r&ose of Pre&arin( a Cost S$eet.

1. To find profitability of a prod!ct

2. To fix sellin( price

3. to plan cost of a ne$ prod!ct

;. To control cost of an existin( prod!ct

Cost s$eet is a &rofit and loss acco#nt of a &rod#ct.

Princi&les of a Profit and :oss Acco#nt

1. +elate to a period -an acco!nt is applicable for a specified period only0.2. +elate to a prod!ct -for e%ery indi%id!al and specific prod!ct0

3. +elate to a le%el of acti%ity -rod!ction rate0.

W$ile &re&arin( Cost S$eet of a &rod#ct it is necessary to $a'e o&enin( stoc of6 "

-a0 +a$ aterial

-b0 8or& in pro(ress -i.e. Stoc& of semi finished prod!cts0

-c0 Finished prod!cts

Cost S$eet )odel of a Prod#ct ;

Period6


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The Winning Edge Compiled by Chhaya Sehgal4. Cost of Sales GGGG G

"dd rofit or >oss GGGG G

5. Sales -oney realised thro!(h Sales0 GGGG G

Cost Analysis and Pre&aration of Cost State!ent

-a0 Cost. Cost is all e&endit#re inc#rred to brin( t$e (oods or ser'ices in t$e

&resent condition or location.

/ Implies that all expendit!re is not cost

/ Cost to be calc!lated $ith some reference point

/ There is a chan(e in location or condition or chan(e in both.

-i0 +a$ aterial Stoc& Cost -to be %al!ed at cost0

/ S!pplierMs price

/ >oadin( Char(es

/ Transportation

/ Transit ins!rance

/ Import d!ty or octroi etc

/ Anloadin( char(es

/ Lodo$n char(es G

-a0 Lodo$n char(es are sometimes not considered as cost as there

is no chan(e in location or condition

-b0 Lodo$n char(es are considered only after the item is shifted

from (odo$n. In case of !sin( (odo$n d!rin( the transit, the char(es

are to be incl!ded.

-ii0 Finished Loods Stoc&

/ +a$ material cost

/ 8a(es

/ Factory expenses

-a0 8ater

-b0 'lectricity

-c0 Shed rent

-d0 Depreciation on asset for prod!ction

-e0 Factory taxes/ ac&in(

=


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The Winning Edge Compiled by Chhaya Sehgal/ 'xcise d!ty

/ Sales tax G

/ "d%ertisin( G

-iii0 Semi finished (oods

/ +a$ material

/ 8a(es n proportionate basis

/ Factory expenses

Cost S$eet and Absor&tion costin( Proble!s

?5. 8hen the sellin( price of a prod!ct N Mfor the year 23 $as +s 1*/, the total sales $ere +s

1*/. For the year 2;, the sellin( price has been increased by 1@. The total sales are

expected to increase by 21@.

For the year 23, the materials cost $as ;@, labo!r cost $as 3@ and total o%erheads $ere 2@

of sales.

For the year 2;, the material rates ha%e increased by 1, labo!r rates by 4@ and total o%erheads

by +s 31*/

repare the cost sheet for the year 23 and 2; and find o!t the profitability.

?*." >td company man!fact!res and sells electrical o%ens. The sellin( price of the same for theyear 23, $as +s 24. For the year 23, the material $as ;@, labo!r 3@ and total o%erheads

$ere 3@ of the cost of sales.

For the year 2;, the material rates ha%e increased by 4 @, labo!r rates by 1@ b!t no chan(e in

o%erheads.

If the mana(ement fixes the same sellin( price of +s 24 for the year 2;, there shall be a

red!ction in the profit of 2; by 2@ of s!ch profits. The mana(ement $ants yo! to s!((est s!ch

as price for 2; so that same percenta(e of profit shall be maintained.

?-. G >td has a capacity to man!fact!re 24 !nits per ann!m. For the l year 23, theyprod!ced and sold 2 !nits in domestic mar&et and the data for same is as !nder /

aterial +s 5

>abo!r +s 35

rod!ction %erheads +s 2

-4@ fixed0

"dmn %erheads +s 4

-4@ %ariable0

Sales %erhead +s 1

-:4@ %ariable0

Cost of sales +s 131rofit +s 1


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The Winning Edge Compiled by Chhaya SehgalSales +s 14

For 2;, the domestic demand shall red!ce by 1@ b!t the company is expected to !tilise 1@ of

capacity by exportin( the !nits of balance capacity.

The rates of all the %ariable costs shall increase by 12@ b!t the fixed costs are not expected tochan(e.

The %ariable sales o%erheads rate for the export is expected to be 4@ of the similar rate for

domestic sale.

The company is expected to maintain same le%el of profit also for 2;.

repare the cost sheet for 2; and find o!t $hat sellin( price shall be char(ed for exports if

domestic sellin( price is not expected to chan(e for 2;.

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Cost sheet basics & Absorption Costing

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