ACC2200 Notes Semester 2, 2016 9
ACC2200 Notes Semester 2, 2016 What are Costs? Costs are resources given up to achieve a particular objective. In accounting, they are usually measured in monetary terms. In financial accounting, the focus is on assets and expenses but not on costs. • Costs are incurred to obtain future benefits. If the benefits extend beyond the current accounting period, the costs are recorded as assets. • As the benefits are used, the costs are no longer regarded as assets, but are expenses. • Where benefits from a cost are confined to the current period, the cost is recorded as an expense rather than an asset. • An expense is the cost that is used up in the generation of revenue.
Classifying Costs According to Their Behaviour Management accountants can help managers to understand the way costs behave as the level of activity in the business changes. The level of activity refers to the level of work performed in the organisation. • The activity causes the cost and, for this reason, the level of work performed is the cost driver. • Two common cost behaviour classifications are fixed and variable costs. o Fixed costs: a cost that remains unchanged in total despite changes in the level of activity. o Variable cost: a cost that changes, in total, in direct proportion to a change in the level of activity. Direct and Indirect Costs Costs can be classified as direct or indirect, depending on whether they can be traced to cost objects. A cost object is an item for which management wants a separate measure of costs. • Direct cost: a cost that can be identified with, or traced to, a particular object in an economic manner. • Indirect costs: a cost that cannot be identified with, or traced to, a cost object in an economic manner.
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ACC2200 Notes Semester 2, 2016 Departmental Overhead Rates Departmental overhead rates recognise that overheads in each department may be driven by different cost drivers:
Two-stage Cost Allocation for Departmental Overhead Rates Stage one: overhead costs are assigned to production departments (separate cost pool for each department) - Step 1: Overhead costs are allocated to all departments - Step 2: Support departments costs are reassigned to overhead cost pools in the production departments
Stage two: overhead costs are applied to products. Manufacturing overhead rates are calculated for each production department.
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ACC2200 Notes Semester 2, 2016 CVP analysis provides information about: • Products or services to emphasise • Sales needed to achieve target profit • Revenue required to avoid losses • Whether to increase fixed costs • Budget for discretionary expenses • Sensitivity analysis if costs change The Break-even Point The break-even point is the volume of sales at which the total revenues and costs are equal. At this level of sales, there is no profit or loss. • The break-even point can be calculated for an entire organisation or for individual projects or activities. Profit = Sales Revenue – Variable Costs – Fixed Costs The break-even formula (units):
Expressed in sales dollars ($):
Contribution Margin Ratio Unit contribution margin: the difference between the sales price per unit and the variable cost per unit. Contribution margin ratio: the unit contribution margin divided by the unit sales price. • The proportion of each sales dollar available to cover fixed costs and earn a profit Contribution margin percentage: the contribution margin ratio multiplied by 100. • The percentage of each sales dollar available to cover fixed costs and earn a profit CVP Analysis with Multiple Products When a company sells more than one product, the CVP calculations must be adjusted for the sales mix. The sales mix is the relative proportions of each type of product sold by the organisation. This involves calculating the weighted average unit contribution margin which is the average of the products’ unit contribution margins, weighted by the sales mix. Target Net Profit The break-even point formula can be used to determine the sales units or sales revenue required to achieve a target net profit. A target net profit is a desired profit level determined by management.
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Classifying Costs According to Their Behaviour Management accountants can help managers to understand the way costs behave as the level of activity in the business changes. The level of activity refers to the level of work performed in the organisation. • The activity causes the cost and, for this reason, the level of work performed is the cost driver. • Two common cost behaviour classifications are fixed and variable costs. o Fixed costs: a cost that remains unchanged in total despite changes in the level of activity. o Variable cost: a cost that changes, in total, in direct proportion to a change in the level of activity. Direct and Indirect Costs Costs can be classified as direct or indirect, depending on whether they can be traced to cost objects. A cost object is an item for which management wants a separate measure of costs. • Direct cost: a cost that can be identified with, or traced to, a particular object in an economic manner. • Indirect costs: a cost that cannot be identified with, or traced to, a cost object in an economic manner.
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ACC2200 Notes Semester 2, 2016 Departmental Overhead Rates Departmental overhead rates recognise that overheads in each department may be driven by different cost drivers:
Two-stage Cost Allocation for Departmental Overhead Rates Stage one: overhead costs are assigned to production departments (separate cost pool for each department) - Step 1: Overhead costs are allocated to all departments - Step 2: Support departments costs are reassigned to overhead cost pools in the production departments
Stage two: overhead costs are applied to products. Manufacturing overhead rates are calculated for each production department.
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ACC2200 Notes Semester 2, 2016 CVP analysis provides information about: • Products or services to emphasise • Sales needed to achieve target profit • Revenue required to avoid losses • Whether to increase fixed costs • Budget for discretionary expenses • Sensitivity analysis if costs change The Break-even Point The break-even point is the volume of sales at which the total revenues and costs are equal. At this level of sales, there is no profit or loss. • The break-even point can be calculated for an entire organisation or for individual projects or activities. Profit = Sales Revenue – Variable Costs – Fixed Costs The break-even formula (units):
Expressed in sales dollars ($):
Contribution Margin Ratio Unit contribution margin: the difference between the sales price per unit and the variable cost per unit. Contribution margin ratio: the unit contribution margin divided by the unit sales price. • The proportion of each sales dollar available to cover fixed costs and earn a profit Contribution margin percentage: the contribution margin ratio multiplied by 100. • The percentage of each sales dollar available to cover fixed costs and earn a profit CVP Analysis with Multiple Products When a company sells more than one product, the CVP calculations must be adjusted for the sales mix. The sales mix is the relative proportions of each type of product sold by the organisation. This involves calculating the weighted average unit contribution margin which is the average of the products’ unit contribution margins, weighted by the sales mix. Target Net Profit The break-even point formula can be used to determine the sales units or sales revenue required to achieve a target net profit. A target net profit is a desired profit level determined by management.
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