Management accounting

Part A

CHAPTER 4
COST CLASSIFICATION
 ˊ

Selling price: ￥43 per customer

Material cost: ￥ 16.3 ( 37.9%)

Labour cost: ￥ 12.94 ( 30.1%)

Distribution cost: ￥ 2.37( 5.5%)

Other cost: 26.5%

• Rent, Electricity and gas bills
• Depreciation
• Marketing and advertisement
• Financing cost

Loss: ￥2.84 per customer

Framework
1. Direct costs and indirect
costs 和间接成本
直接成本

2. Functional costs
Cost classification
3. Production and
non-production costs 产和 成本
产

4. Cost behaviour

5. Cost codes
6. Cost units and cost
objects

7. Responsibility centres
 1. Direct cost and indirect cost
1.1 Analysis of total cost

Materials = Direct Materials + Indirect Materials

+ + +

Labour = Direct Labour + Indirect Labour

+ + +

Expense = Direct Expense + Indirect Expense

Total cost Direct cost Indirect cost
 1. Direct cost and indirect cost
1.2 Direct cost (prime cost) 直接成本
Explanation Examples
Component parts
Direct
All material becoming part 零部件
of the product (or providing Part-finished work
Material 半成品
a service). Primary packing materials包装
直接材料
All basic wages paid for Basic pay of direct workers
Direct direct labour (either as (basic hour and overtime)
Basic hn 8 07 2hr
labour
(wages)
basic hours or as overtime)
expended on work on the Specific request of an
基础 individual customer
最
07 Bfffǚ笈
151W
product itself. 直接 劳动 的
直接 䲜
器器器
Direct Incurred on a specific
The hire of tools or
expense product other than direct
equipment for a particular
(chargeable material cost and direct
job
D
expenses) wages.

直接费
Illustration 1
Two trends may be identified in direct labour costs

• The ratio of direct labour costs to total product cost is falling as

the use of machinery increases, and therefore depreciation
run 折旧费
charges increase.
-

• Skilled labour costs and subcontractors’ costs are increasing as

direct labour cost decrease.
 1. Direct cost and indirect cost
1.2 Indirect cost
Indirect materials Indirect wages Indirect expenses

Examples
• Consumable stores, e.g. material used in negligible
amounts
Production • The basic pay of indirect workers, e.g. supervisors
overhead • Rent, rate and insurance of a factory;
• Depreciation, maintenance of machinery and
产费 buildings
• Depreciation of office buildings and equipment
Administration • Office salaries (directors, secretaries and
overhead accountants)
• Rent, rates, insurance, lighting, telephone charges
管理 费
 1. Direct cost and indirect cost
1.2 Indirect cost
Indirect materials Indirect wages Indirect expenses

Examples
• Printing and stationery, such as catalogues and
price lists
• Salaries and commission of salespeople,
Selling
representatives and sales department staff
overhead
• Advertising and sales promotion, market research
销售费 • Rent, rates and insurance of sales offices and
showrooms, bad debts and so on
• Cost of packing cases
Distribution • Wages of packers, drivers and despatch clerks
overhead • Insurance charges, rent, rates, depreciation of
运输费 warehouses
Illustration 2
Classify the following labour costs as either direct or indirect cost
a) Basic pay of direct workers (basic hour and overtime) Direct cost
b) Overtime premium to both direct and indirect workers Indirect cost
except:
If overtime is worked at the specific request of a
customer to get his order completed, the overtime
premium paid is direct cost of the order.
c) Bonus payments Indirect cost
d) Social / National insurance contributions (NIC) Indirect cost
e) Idle time of direct workers Indirect cost
Capital cost of 成本
的资本
f ) Work on installation of equipment
the equipment
设备
 Practice 1
Direct labour cost A direct labour employee's wage in week 5
consists of the following
$
(a)Basic pay for normal hours worked, 36 hours at $4 per hour= 144
144124 168
(b)Pay at the basic rate for overtime, 6 hours at $4 per hour= 24
(c) General overtime shift premium, with overtime paid at time
6
and a quarter 1/4 x 6 hours x $4 per hour=
(d)A bonus payment under a group bonus (or ‘incentive’)
i 30
scheme-bonus for the month=
Total gross wages in week 5 for 42 hours of work 204

What is the direct labour cost for this employee in week 5?

A. $144 B. $168 C. $198 D. $204

Answer : B
 2. Functional costs
2.1 Classification by function Direct material

Direct cost Direct labour

Direct expense
Production costs
Indirect material
Production
Indirect labour
overhead
Administration costs Indirect expense

Selling costs

Distribution costs
Research and development costs
Financing costs
财务费
 2. Functional costs
2.2 Full cost of sales
In costing a small product made by a manufacturing organisation, direct costs
are usually restricted to some of the production costs. A commonly found build-
up of costs is therefore as follows:
$
Production costs
Direct materials A
Direct wages B
Direct expenses C
Prime cost Directcost A+B+C
Production overheads D
Full factory cost
Fullproductioncost A+B+C+D
Administration costs E
Selling and distribution costs F
Full cost of sales A+B+C+D+E+F
 Practice 2
1. Cost of oils used to lubricate production machinery Cost Reference number
classification
2. Depreciation of factory plant and equipment
Production
3. Cost of chemicals used in the laboratory costs 1 27 8 11 12

Ǘiii
4. Commission paid to sales representatives Selling &

5. Salary of the secretary to the finance director

distribution 4 6 9
6. Trade discount given to customers
Administration
5
R&D
7. Holiday pay of machine operators 3 10
8. Salary of security guard in raw material warehouse
9. Rent of finished goods warehouse
成品仓库租
Él
10. Salary of scientist in laboratory
11. Salary of supervisor working in the factory
12. Protective cloth for machine operators
 3. Production and non-production costs
For the preparation of financial statements, costs are often classified at
as production costs and non- production costs.

Production costs are costs identified with goods produced or

Sales
COS last of ǜi
Grossprofit
purchased for resale GP
Non-production are costs deducted as expenses during the
Periodcost
costs current period Non赢 unioncost

Production costs are all the costs involved in the manufacture of Netprofit
goods. In the case of manufactured goods, these costs consist of
direct material, direct labour and manufacturing overhead. 相当于
Non-production costs are taken directly to the statement of profit or
loss (income statement) as expenses in the period in which they are
incurred; such costs consist of selling and administrative expenses.
 4. Cost behaviour
4.1 Introduction of cost behaviour
Cost behaviour is the way in which the costs are affected and changes
in the volume of output or the level of activity.
• Number of units produced
• Value of items sold

The level of activity • Number of items sold

• Number of invoices issued
• Number of units of electricity consumed

Basic principles: as the level of activity rises, costs will usually rise.
 4. Cost behaviour
4.1 Introduction of cost behaviour

Decision making

Cost behaviour Cost control

Budgeting
 4. Cost behaviour
4.2 Cost behaviour patterns

4.2.1 Fixed costs 固定成本

4.2.2 Step costs
步骤成本
4.2.3 Variable costs 变动成本
Patterns
4.2.4 Semi-variable costs半变动成本
4.2.5 Non-linear or curvilinear
variable costs 线性或曲线可变成本

4.2.6 Others
 Cost behaviour
4.2 Cost behaviour patterns
4.2.1 Fixed costs
To be unaffected by increases or decreases in the volume of output

Examples:
Total cost
$ Gluwt
• The salary the managing
director
Fc
Total fixed cost
• The rent of a single factory
building

• Straight line depreciation

Volume of output (level of activity) uni

 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.2 Step costs
Fixed in nature but only within certain level of activity
Examples: Total cost
$
• Rent is a step cost in situation
where accommodation
requirements increase as out
levels get higher.

• More employees (direct workers,

supervisors) are required for
more outputs.

• Royalties Volume of output (level of activity)

 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.3 Variable costs
Tends to vary directly with the volume of output.
The variable cost per unit is the same amount for each unit produced.

Graph of variable cost (1)

Total cost
Examples: $

• direct materials
• direct labour
• sale commission variable cost in total

Volume of output (level of activity)

 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.3 Variable costs
Total cost Graph of variable cost (2)
$

Bonus payments for productivity

to employees might be variable
once a certain level of output is Bonus
achieved.

Volume of output (level of activity)

 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.3 Variable costs
Total cost Graph of variable cost (3)
$

If, up to a given level of activity,

the purchase price per unit of
raw material is constant. After
以上全单5折
that point, a quantity discount is
given so the price per unit is 3件
lower for further purchases and
also retrospectively to all units
already purchased.

Volume of output (level of activity)

 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.3 Variable costs

Total cost Graph of variable cost (4)

$

If, up to a given level of activity,

the purchase price per unit of
raw material is constant. After 以上的部
that point, a discount is given so 3件
分85圻
that the price per unit is lower
for further purchases but not for
the units already purchased.

Volume of output (level of activity)

 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.4 Non-linear or curvilinear variable costs
Total cost (a) Total cost (b)
$ $

好
among 企业发展
ofscale 规模经济
Volume of output (level of activity) Volume of output (level of activity)

Each extra unit of output in graph (a) causes a less than

proportionate increase in cost whereas in graph (b), each extra
unit of output causes a more than proportionate increase in cost.
 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.5 Semi-fixed or semi-variable (mixed)
Contains both fixed and variable costs and so is partly by changes in
the level of activity
Examples: Total cost
a) Electricity and gas bills b
giant
$
FC=standing charge
VC=charge per unit of electricity used
b) Salesman’s salary
FC=basic salary
Semi-variable cost
VC=commission on sales made
c) Costs of running a car
FC=road tax, insurance
VC=petrol, oil, repairs Volume of output (level of activity)
 4. Cost behaviour
4.2 Cost behaviour patterns
4.2.6 Other cost behaviour patterns
Total cost (a) Total cost (b)

Volume of output Volume of output

Graph (a) represents an item of cost which is variable with output up

to a certain maximum level of cost.
Graph (b) represents a cost which is variable with output, subject to
a minimum (fixed) charge.
Illustration: Assumptions about cost behaviour

a) Within the normal or relevant range of output, costs are often

assumed to be either fixed, variable or semi-variable (mixed).

b) Departmental costs within an organization are assumed to be

mixed costs, with a fixed and a variable element.

c) Departmental costs are assumed to rise in a straight line as

the volume of activity increases. In other words, these costs are
said to be linear.
 4. Cost behaviour
4.3 High-low method
The fixed and variable elements of semi-variable costs can be
determined by the high-low method.
Total cost = Fixed cost + Unit cost x Units
y = a + b x
Total cost
Assumed total cost

Variable costs

Fixed costs
Units
Low High
 4. Cost behaviour
4.3 High-low method – Example 1
DG Co has recorded the following total costs Step 1: y=a+bx
during the last 5 years. Step 2:
找 变量的最 点 和最低点
High: (90,000.170,000)
Year Output volume Units Total cost $ Low: (60,000, 140,000)
20X0 65,000 145,000 Step 3:
20X1 80,000 162,000 170,000 = a + 90,000b
20X2 90,000 170,000 140,000 = a + 60,000b
Step 4:
20X3 60,000 140,000
b=1
20X4 75,000 160,000 a=80,000 (FC)固定 成本
Step 5: y=80,000+x
Required:
Step 6:
Calculate the total cost that should be
y=80,000+85,000=165,000
expected in 20X5 if output is 85,000 units.
Exam focus point

Remember that the high-low method refers to the highest and

lowest volume and not the highest and lowest cost.
 4. Cost behaviour
4.3 High-low method – Example 2 (With stepped fixed costs)
The following data relate to the overhead expenditure of contract
cleaners (for industrial cleaning) at two activity level.
Square metres cleaned 12,750 15,100
Overheads $73,950 $83,585
When more than 14,000 square metres are industrially cleaned,
there will be a step up in fixed costs of $4,700.

Required:
Calculate the estimated total cost if 14,500 square metres are to
be industrially cleaned.
 4. Cost behaviour
4.3 High-low method – Solution

Before we can compare high output costs with low output costs in
the normal way, we must eliminate the part of the high output costs
that are due to the step up in fixed costs:
Total cost for 15,100 without step up in fixed costs
= $83,585 - $4,700 = $78,885
Units $
High output 15,100 Total cost 78,885
Low output (12,750) Total cost (73,950)
2,350 4,935

Variable cost = $4,935 / 2350 = $2.10 per square metre

 4. Cost behaviour
4.3 High-low method – Solution
Before we can calculate the total cost for 14,500 square metres we
need to find the fixed costs. As the fixed costs for 14,500 square
metres will include the step up of $4,700, we can use the activity
level of 15,100 square metres for the fixed cost calculation:

$
Total cost (15,100 square metres) (this includes the step 83,585
up in fixed costs)
Total variable costs (15,100 * $2.10) 31,710
Total fixed costs 51,785
 4. Cost behaviour
4.3 High-low method – Solution
Estimated overhead expenditure if 14,500 square metres are to be
industrially cleaned:

$
Fixed costs 51.875
Variable costs (14,500*$2.10) 30,450
82,325
 4. Cost behaviour
4.3 High-low method – Example 3 (With change in VC/unit)
The following data relate to the overhead expenditure of contract
cleaners (for industrial cleaning) at two activity level.
Square metres cleaned 12,750 15,100
Overheads $73,950 $83,585
When more than 14,000 square metres are industrially cleaned,
there will be a step up in fixed costs of $4,700.

Additionally, a round of wage negotiations have just taken place

which will cost an additional $1 per square metre.
Required:
Calculate the estimated total cost if 14,500 square metres are to
be industrially cleaned.
 Practice 4.1
The Valuation Department of a large firm of surveyors wishes to
develop a method of predicting its total costs in a period. The
following past costs have been recorded two activity levels.

Number of valuations Total cost 8075 95 85

Period 1 420 82,200
Period 2 515 795 90,275 gg
The total cost model for a period could be represented as follows.

ˇ
A. TC= $465,00 + 85V
B. TC= $42,000 + 95V
C. TC= $42,000 - 85V
D. TC= $51,500 - 95V

Answer: A
 Practice 4.2
An analysis of costs has found that fixed costs are $40,000per
变动成本始终保持了
month and variable costs are $4.50 per unit. 单位
y
ms_io
If y=total cost per month in $’000, and x=output in ’000 units, then
which of the following equations is correct? hnns

ftp 000 145X

A. Y = 4.5 + 40x -
40
B. Y = 40 + 0.0045x y
C. Y = 40 + 4.5x
D. Y = 40x + 4.5x

Answer C
 5. Cost code
Once the costs have been classified then a coding system could be
put in place to make an easier to manage the cost data.

Costs are classified Costs are code

Each individual cost should be identifiable by its code.

The characteristics which are normally identified are as follows.
• The nature of the cost (material, labour, overhead)
• The type of cost (direct, indirect)
• The cost centre
• The department
 5. Cost code
5.1 Features of a good coding system

• Easy to use and communicate

• Unique code
• Flexibility
• Index or reference book
• Review regularly to minimise error
5. Cost code
5.2 Types of code
Explanation

The CIMA Official Terminology definition of a code

Composite codes
describes a composite code.

Numbers are given to items in ordinary numerical

Sequence /
sequence, so that there is no obvious connection
progressive codes
between an item and its code.

Group These are an improvement on simple sequences

classification codes, in that a digit indicates the classification of
codes an item.
 5. Cost code
5.2 Types of code
Explanation
These are a refinement of group classification
Faceted codes codes, in that each digit of the code gives
information about an item.

Significant digit These incorporate some digits which are part of

codes the description of the item being coded.

This is a type of faceted code where each digit

Hierarchical represents a classification, and each digit further
codes to the right represents a smaller subset than those
to the left.
 5. Cost code
5.3 Advantages of a coding system

• Briefer than a description

• A code is more precise than a description and therefore reduced
ambiguity
• Coding facilitates data processing
 Practice 5.1
The overhead expenses of a company are coded using a five
digit coding system, an extract from which is as follows:

Cost centre Code No. Types of expense Code No.

Machining 10 Indirect materials 410
Depreciation of
Finishing 11 420
production machinery
Packing 12 Machine hire costs 430
Stores 13 Indirect wages 440
Maintenance 14 Maintenance materials 450
Depreciation of non-
460
production equipment
 Practice 5.1
The coding for the hire costs of a packing machine is 12,430.
Which is the coding for the issue of indirect material issued from
stores to the machining department?

ˇ
A. 10,410
B. 10,440
C. 13,410
D. 13,440

Answer: A
 6. Cost objects and cost units
成本 对象 成本单位
6.1 Cost objects
A cost object is any activity for which a separate measurement
of costs is desired.
If the users of management information wish to know the cost of
something, this something is called a cost object.

Example:
• The cost of a product
• The cost of a service
• The cost of operating a department
 6. Cost objects and cost units
6.2 Cost units
• Unit of product or service to which costs can be related
• The basic control unit for costing purposes

Examples:
• Patient episode (in a hospital)
• Room (in a hotel)
• Barrel (in the brewing industry)
 7. Responsibility cetres责纠中
Explanation
are collecting places for costs before they are further
Cost centres analysed. Costs are further analysed into cost units
once they have been traced to cost centres.

Revenue are accountable for revenues only. Its managers should

centres normally have control over how revenues are raised.
Profit
are accountable for costs and revenues.
centres
is a profit centre with additional responsibilities for
Investment capital investment and possibly for financing, and whose
centres performance is measured by its return on investment or
return on capital employed.
Illustration 2
Cost centres may include the following:
• A department
• A machine
• A project
• Overhead cost (rent, rates, electricity)
Illustration 2

Responsibility Managers Financial performance

centre responsible for? measures

Cost centre Costs Variances

Revenue centre Revenues only Revenues
Costs and
Profit centre Controllable profit
revenues

Costs, revenues ROI, residual income and

Investment centre
and assets return on equity (ROE)
 Practice 7.1
Which of the following is a characteristic of an investment centre?
A. Managers have control over marketing.
B. Management have a sales team.
C. Management have a sales team and are given a credit control function.
D. Managers can purchase capital assets.
ˇ
Answer: D
 Summary
1. Direct cost and indirect
cost

2. Functional costs
Cost classification
3. Production and
non-production costs

4. Cost behaviour

5. Cost codes

6. Cost units and cost

objects

7. Responsibility centres

2021/11/27
 Part A Summary-1
Quantitative & Qualitative

Classification Internal & External

Primary & Secondary

Data
Probability (5)
Collecting Sampling
None-probablity
method Big data

Qualities of good information

Management Information
accounting Types of information
MA & FA
Tables
Reports Bar charts, Pie charts, Line graphs,
Charts Scatter graphs
Management Planning, Decision making, Control
 Part A Summary- 2
Element: Material, labour,
overheads(expense)

Nature: Direct (Prime), indirect

Classification Functional: Production, non-production

Fixed costs

Step costs High-low

Behaviour Methods:
Variable costs
Cost TC=FC+VC
classification Semi-variable
costs
Cost codes

Cost units and cost objects

Responsibility centres