20240126financesem4 Lesson 1 No Explanation

Academy Engineering and Automotive
BM: Financial
Management Semester 4Lecturer: H. van der Zee
Lesson 1 Costs and Costallocation
05-04-2024 © HAN-Automotive
1
Naam: drs. H. (Harold) van der Zee
Opleiding:
 Master Business Economics Rijks Universiteit Groningen
Working Experience:
 Management Trainee Pakhoed
 Controller Avia Presto
 Sales Manager Paktank
 Manager Finance&Logistiek M.L.S.
 Controller EDON/ESSENT
 Controller SCA Hygiene Products Gennep
 Financial Director SCA Hygiene Products Benelux
 Director Backoffice Koops Furness
 Lectorer HAN Automotive
Personal:
 Motorbiking and travel
 football, Tennis
 61 years, married, 3 suns, 1 foster daughter, 4 grandchildren, and living in Apeldoorn
Subjects
 See Onderwijs Online
– Cost allocation, different methods

– Investment Selection methods
– Budgeting and variance analysis
– Financial Statements
– Financial KPI’s
– Video bankruptcy Kroymans
3
Programme
 See Onderwijs Online

– weekly lessons (1,5 hours)
– preparations before the lessons
– Sometimes individually, sometimes in groups
– Exam: Open Book + advice (3 hours)
• Self study crucial for succes!!
 Material: Book: Basics of Financial
Management
4
EXAM
5
EXAM
6
Programme lesson 1 and 2
 Classification of costs
 Allocation of indirect costs
– Overhead application rates:

• simple
• multiple
• Cost Centre method
• ABC Costing method
8
Why do we want to know the costs?
1. In order to calculate the profit:

Turnover – Costs = Profit
2. In order to compare:
Do it ourselves or outsource it
3. In order to deal with the following:

Lower/compare costs and cost efficiency
4. Budgeting
5. In order to find out the cost price

05-04-2024 Necessary in order to determine© the sales price and the margin
HAN-Automotive
9
Classification of costs
1. Variability
Constant and variable costs
2. Attributability
Direct and indirect costs
3. Cost type
For example raw materials, labour and depreciations
4. Department
For example Purchasing, production, sales
10
Ad 1. Variability
 Constant cost: independent on level of business activity

For example: depreciation, rent, salaries for permanent personnel
 Variable costs: dependent on level of business activity

For example: raw materials, maintenance costs of tooling, hiring of personnel
 Mixed costs: partly fixed/partly variable

For example: energy, maintenance
11
Example 1: Variable and fixed costs
A car manufacturer Month Production Total costs
produces in the first 6 (cars) (1000€)
months according the
schedule in the table at
the right. January 4,500 185,000
What is the cost February 5,000 200,000

function C = F + v.Q? March 3,500 155,000
C=total costs per month April 2,000 110,000

F= fixed costs per month May 1,500 95,000
v = variable costs/product
q = number of products Jun 4,000 170,000
[1] p. 226
12
Ex. 2 : Two production techniques
For the production of a particular car, the car manufacturer
can choose one of the following two techniques:
Technique Constant costs/year Variable costs/car
A € 2,000,000,000 € 40000
B € 4,000,000,000 € 30000
Normal production and sales of 300,000 products/year.
The production capacity of the two available techniques is more than
enough to generate normal sales.
Exercise:
1. Determine the indifference point for these two techniques
2. Draw a diagram of the indifference point)
3. Indicate which technique this company should choose for
business reasons
4. Which technique is most sensitive to the actual sales?
[1] page 227
13
Ad 2. Attributability
 Direct costs
Directly related to the product. Attribution is therefore not necessary. Example??
 Indirect costs (overheads)

An attribution must be performed here. Various methods are available for this attribution.
Examples for a car manufacturer:

– direct/variable: raw material
– Direct/constant: machine for just one product
– Indirect/variable: paper costs incurred by administration
– Indirect/constant: salary for administration employee
14
Indirect costs
Examples:
 Costs of management
 Costs of administration
 Building and technical services, etc.
 Salaries and bonuses
 Insurance
 Marketing, PR and advertising
 Etc.
Remarks:
 The more the indirect costs exceed the direct costs, the more
accurate the allocation must be to be able to calculate a proper
costprice
 Risk of a top-heavy organisation

15
Examples of classifying costs, company producing multiple
different products
Costs Variability Attributability
Variable Fixed Direct Indirect

Depreciation building
Paper photocopier
Depreciation production
machine
Salary for permanent adm.
employee
Salary for temporary prod.
employee
Packing materials
16
Link between costs and products
[1] page 270
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Importance of allocating indirect costs
Incorrect cost allocation can lead to wrong management decisions, such as:
- whether or not to retain products or even departments
- whether or not to accept orders, and so on.
The aim is, where possible, to translate the costs to the products for which they were
incurred!
Complications:
 The distribution of indirect costs has a subjective element, but they must be
covered in order to make a profit
 For the short term, variable costs are more relevant than the fixed, often indirect,
costs
19
Methods for allocating indirect costs
In ascending order of accuracy:
1. Equivalent Unit method
2. Overhead application rates:

- simple (or primitive)
- multiple
3. Cost centre method
05-04-2024 4. Activity-based costing (ABC)

© HAN-Automotive
20
Simple overhead application rates
 Basic principle:
indirect costs are expressed as a percentage of one or more constituents of the direct costs
 Question:
With which of the following are the indirect costs most closely related:
- raw material costs?
- salary costs?
- the total direct costs?
This often greatly depends on the sector.
21
Ex. of simple overhead application rate (1)
Contracting firm Annual budget
Costs of materials 750,000
Direct labour costs 500,000
Indirect costs 375,000
1,625,000
Question:
Calculate te cost price for for a small building modification
with:
• direct cost: material € 3,400 and direct labor costs € 1,600

• indirect costs based on a surcharge.
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Cost price 1 in euro’s Surcharge material

costs
Indirect costs/material costs 375,000/750,000 50%
Materials 3,400
Direct labor 1,600
Surcharge for indirect costs 1,700 (50% of 3,400)
6,700
23
Cost price 2 Surcharge direct labor

Indirect costs/direct labour +375,000/500,000  75%
Materials 3,400
Direct labour 1,600
Surcharge for indirect costs 1,200 (75% of 1,600)
6,200
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Cost price 3 in euro’s Surcharge direct costs
Indirect/direct costs +375,000/1,250,000  30%
Materials 3,400
Direct labour 1,600
Surcharge for indirect 1,500 (30% of
costs 5,000)
6,500
25
The multiple overhead application rate
 sometimes KISS is not enough…
 Indirect costs are broken down into:

– indirect raw material costs
– indirect labour costs
– indirect general costs (or: other indirect costs)
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Advantages of the multiple method
 This method provides a more accurate picture of the

actual cost price
 Indirect costs can be monitored more accurately
 It is therefore easier to detect overruns and to intervene,

where necessary
27
Ex. of multiple application rate method (1)
Direct material costs 750,000
Direct labour costs 500,000
Indirect costs 375,000
1,625,000
Indirect costs:
Warehouse costs 60,000
Indirect labour costs 75,000
Equipment and tools 150,000
Other indirect costs 90,000
375,000
Warehouse costs ≈ use of 60,000/750,000 +8%

materials
Indir. labour + equip. and tools ≈ 225,000/500,000 + 45%
dir. labour costs
05-04-2024
Other indir. costs ≈ total dir. costs
© HAN-Automotive
90,000/1.25 mln + 7.2%
28
Ex. of multiple application rate method (2)
Cost price 4 in euo’s
Materials 3,400
Direct labour 1,600
+ 8% of 3,400 (mat.) 272
+ 45% of 1,600 (dir. lab.) 720
+7.2% of 5,000 (dir. costs) 360
Total 6,352
What is the correct cost price: € 6,500, € 6,700, € 6,200 or €

6,352?
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Homework for lesson 2
 Study Chapter Indirect Costs 13 or 14 depending on editions
 For lesson 2: Prepare the 2 cases
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Cases to be handed in next week!!!
 Case 1:
The following data is available of an operator-machine combination:
 machine investment € 600.000
 depreciation period 4 years
 residual value € 200.000
 maintenance € 4.000 variable budgetted costs/yr.
 electricity + water € 2.000 variable budgetted costs/yr.
 operator € 20/hr, 1 man every 2 machines
 supervisor € 30/hr 1 supervisor every 5 operators
 normal production 4.000 hours
 budgetted production 4.000 hours
Calculate the combined man-machine rate in €/hr based on the data above.
31
 Case 2:
The cost allocation table (x € 1,000):
Mana- Main- Production Production

gement tenance A B
Labor costs 60 75 300 300
Materials 30 150 250 150
costs
Machine costs 90 350 100
Total 90 315 900 550
The Management costs are split up over the other departments proportional
to the labor costs of those departments.
Then the costs of the Maintenance department are divided over the 2
production departments proportional to the primary attributed machine costs
of the departments.
The normal production is 30000 products A en 15000 products B (labor and
material costs are also based on the normal production).
Calculate the cost prices of product A and product B.
32

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Academy Engineering and Automotive

Lesson 1 Costs and Costallocation

 See Onderwijs Online

– Cost allocation, different methods

 See Onderwijs Online

 Allocation of indirect costs

– Overhead application rates:

1. In order to calculate the profit:

3. In order to deal with the following:

5. In order to find out the cost price

 Constant cost: independent on level of business activity

 Variable costs: dependent on level of business activity

 Mixed costs: partly fixed/partly variable

What is the cost February 5,000 200,000

C=total costs per month April 2,000 110,000

 Indirect costs (overheads)

Examples for a car manufacturer:

 Risk of a top-heavy organisation

Variable Fixed Direct Indirect

[1] page 270

In ascending order of accuracy:

1. Equivalent Unit method

2. Overhead application rates:

3. Cost centre method

05-04-2024 4. Activity-based costing (ABC)

This often greatly depends on the sector.

• direct cost: material € 3,400 and direct labor costs € 1,600

Cost price 1 in euro’s Surcharge material

Cost price 2 Surcharge direct labor

 sometimes KISS is not enough…

 Indirect costs are broken down into:

 This method provides a more accurate picture of the

 Indirect costs can be monitored more accurately

 It is therefore easier to detect overruns and to intervene,

Warehouse costs ≈ use of 60,000/750,000 +8%

What is the correct cost price: € 6,500, € 6,700, € 6,200 or €

 For lesson 2: Prepare the 2 cases

Mana- Main- Production Production

Calculate the cost prices of product A and product B.

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