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Understanding Cost Accounting Principles for Profitable Operations

Learn how to calculate costs and maximize profits in manufacturing operations. Understand fixed and variable costs, direct materials, labor, and overhead allocations. Explore methods for allocating costs to multiple products to enhance financial management.

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Understanding Cost Accounting Principles for Profitable Operations

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  1. Cost Accounting

  2. The Cost Object TimCo manufactures Chairs, each chair consists of Materials (Wood), Labor (A Carpenter) and Overhead (Rent, Utilities and Managers Wages). The Chairs are sold onto a furniture shop. TimCo’s Strategy is to make a profit on its operations

  3. Planning • The manager asks how many chairs can the company make in a week? • The Manager asks you how much the chair needs to sell for to make a profit?

  4. Costs • Material costs per chair are $10 of wood and nails/glue • It takes a carpenter one hour to make a chair Carpenters are paid $300 per week and there are 40 working hours in each week, the company employs 2 carpenters • Manufacturing Overheads are $1000 per week, this includes rent, heat light and managerial wages

  5. How Many Chairs can be made? • One chair per hour, per carpenter, two carpenters • 40 hours in a week = 40 x 2 = 80

  6. What are the cost of constructing a chair? • Direct Materials $10 • Direct Labour $7.5 ($300/40 hours) • Overhead $12.5 (£1000/80 Chairs constructed in one week) = $30 per chair

  7. What should the company sell the chair for? • Your manager suggests that the company needs to make a Margin of 30% = $30 x 0.30 = $9 • The selling price of the chair is therefore = $39

  8. Review Question ABC Plc manufactures Beds the following information is available • Direct Materials $10 • Direct Labour $5 • Overheads $5 • Units produced in one week 100 • Sales Margin of 25% • What is the Total cost of production? • What is the selling price of one bed? • How much profit will the company make in one week?

  9. Answer • Total Cost of production is $20 (10+5+5) • Selling Price is $25 (20 x 0.25) • Profit for one week is $500 (5 x 100)

  10. Fixed and Variable Costs • Fixed costs are usually the direct costs of producing a Cost Object • Variable Costs are all other associated costs which are assigned to the production of a Cost Object • Fixed and variable costs behave in different ways

  11. Fixed Costs • Fixed costs do not change with the volume of production • Usually fixed costs include all of the running costs of the business apart from the direct materials and labour involved in the physical aspects of the Cost Object

  12. Variable Costs • Variable costs increase as production increases • Variable costs are usually the direct materials and labour of producing the Cost Object

  13. Allocation of Fixed Costs • It is unusual for a company to make only one product, but often many products will be made in the same environment, sharing some portion of Fixed Costs • Often managers will want more information about the difference between Cost Objects and the cost of production • We can do this by allocating overheads in some way

  14. Example • A company makes two products A and B

  15. Further Information

  16. How can we allocate the fixed costs to the Products? • We need more information, assume the following • Product A utilises 30% of the Factory, Product B utilises 70% • Product A utilises 4 Machine Hours per unit, Product B utilises 3 Machine Hours per unit, there are a total of 400 machine hours used per week

  17. Allocation of Fixed Costs • We need to make a choice on how we allocate these costs, given the information available we can assume the following • Allocate the utilities according to the % of space used • Allocate the Machine Costs according to the % total machine time each product uses • Allocate managerial costs using either of these methods

  18. Rent and Utilities • Total Fixed cost $400 • Product A utilises 30%, Product B utilises 70% • Total Fixed Cost allocated to Product A $120 (400 x 0.3) • Total Fixed Cost allocated to product B $280 (400 x 0.7) • Fixed cost per Unit • Product A $2.4 (120/50) • Product B $5.6 (280/50)

  19. Machine Costs • Find Total Machine Hours per Product • Product A Machine Hours Per Unit = 4, Total Units Produced = 50, total machine hours used producing Product A = 200 (4 x 50) • Product B Machine Hours per Unit 3, total units produced 50, Total Machine Hours used producing Product B = 150 (3 x 50)

  20. Machine Costs (ctd) • Find % of cost to allocate to each product • Total Machine Hours= 350 • Product A Machine Hours = 200 • Product A Percentage = 57% (200/350 x 100) • Product B Percentage = 43% (150/350 x 100) • Product A = $114 ($200 x 0.57) • Product B = $86 ($200 x 0.43) • Product A Per Unit = $2.28 (114/50) • Product B Per Unit = $1.72 (86/50)

  21. Managerial Costs • Managerial costs are less clear, we could use either method because there is not enough information, but it is likely that more managerial oversight is required for a bigger area of the factory, so you should use the same methodology as the Rent and Utilities

  22. Managerial Cost Ctd • Total Managerial Costs = $600 • Product A = $180 (600 x 0.3) • Product B = $420 (600 x 0.7) • Per Unit, Product A $3.6 (180/50) • Per Unit, Product B $8.4 (420/50)

  23. Allocated Costing

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