Cost behaviour

The costs and activity of a business can be related to each other under various levels of behaviour. This behaviour is
useful to management in:
(a)Cost identification- Certain costs arise only after a certain level of activity.
(b)Cost determination – The amount of costs can be determined.
(c)Cost control – Comparison of actual and budgeted costs.
(d)Decision making – Production ,sales etc.

Factors affecting cost behaviour

-Activity
-Bargaining power
-Economy
-Type of market in which operating

Some basic definitions

Costs objects- it is anything against which a separate measurement of cost is desirable(also termed cost objective)

Cost unit- Unit of product or service in relation to which costs are ascertained (e.g per ton ,per brick, per mile)

Cost center- a location, function o item of equipment in respect of which costs may be ascertained and related to cost
units for control purpose.
(Production,service,process cost centers)

Classification of costs
• By function –production costs, selling costs, administrative costs.
• Direct and indirect-Direct cost or traceable costs are those costs which can be identified to a product or
service while indirect costs or common costs are those which cannot be specifically identified to a cost object.
• Product and period costs-product costs are those which can be included in the inventory(e.g material) while
period costs are charged against the revenue of a period in which they are incurred.
• Controllable and uncontrollable costs-Controllable costs are those which can be inflenced by the action of a
specified member of an undertaking while uncontrollable costs are those which cannot be influenced by such an
action.
• Avoidable and unavoidable costs-Avoidable costs are those that may be saved by adopting a given alternative
(materials,rent for a new branch) while unavoidable costs are those that cannot be saved by adopting an
alternative e.g depreciation of an existing equipment.
• Fixed and variable costs – variable costs are those which tend to follow the level of activity while fixed costs
are those which accrue with the passage of time and are unaffected by fluctuatuions in the level of activity up to
a certain level.

Costing methods
Specific order costing
o Job order costing-each job is unique and require different resources for execution-E.g A painting
o Batch costing-Similar or identical items are manufactured as a batch in large quantities e.g bakery
o Contract costing-Job order which spans over an accounting period e.g (Road constructions)
Process costing- method suitable for industries manufacturing goods using a series of continuous processes

Behaviour of costs
See - diagrams
Materials
Basic elements relating to material control
Materials should be purchased only when required and properly authorised from suppliers who represent an
appropriate balance between quality, price and delivery. On delivery, the materials should be properly received and
recorded to ensure physical checks regularly and minimum discrepancy and loss.

Transaction relevant to materials and associated documents

Transacti Document Issuing Sent to Other
on department associated
tasks
Request Purchase Store or Purchas
for Requisition production e dept
purchase dept
Purchase Purchase Purchasing Supplie Supplier
Order dept rs search,
tender etc
Receipt of Goods Material Purchas Verificatio
goods Received Reception/ e Dept n of
Note Store quality,
returning
non-
specified
materials
Request Materials Relevant cost Store
for Requisition centre
materials
from store
Issue of Material Store Cost
materials issue centre
note(alterna
tively MR
retained)
Materials Materials Cost centre Store
returned return note
to store

Materials control
Causes of material shortage or excess
• Errors
• Pilferage
 • Evaporation
• Breaking bulk / Cutting
• Handling wastage
• Contamination/process loss
Measures taken for control and avoiding wastage and losses
• Authorisation of all transactions
• Internal control
• Perpetual inventory system with continuous stocktake
• Regular reconciliation of book and physical stock

Materials control account or Stores ledger control account

Interlocking accounts or non-integrated accounts

(a)Financial ledger (not relevant)

(b) Cost ledger

Stores ledger control account

Details $ Details $
Balance b/d 150000 General ledger 10000
adj(Returns)
General ledger 1000000 WIP ledger 1040000
adj(Purchases) control(issues)
Production overhead 5000
ledger control
account(shortage)
Bal c/d 95000
1150000 1150000

Integrated accounts
Stores ledger control accounts- Materials control account
Details $ Details $
Balance b/d 150000 Creditors(returns) 10000
Sundry 1000000 WIP ledger 1040000
creditors(purchases) control(issues)
Production overhead 5000
(shortage)
Bal c/d 95000
1150000 1150000

Labour
Direct wages – That proportion of the wages of production employees directly attributable to production (ascertained
from job cards/time sheets).It is charged to the job or operation in which the employee is engaged and the total for that
period is charged to the department’s work in progress.

Indirect wages- Wages of non productive employees e.g storekeepers, inspectors, labourers but also includes overtime
and shift bonuses and these are included in the overheads.

Recording of labour(process of allocating input cost to jobs or works)

Daily and weekly time sheets
• Each worker fills the time allocation between jobs and a summary is made daily or weekly of the time spent on
each job and the appropriate charge is made to that job.
Job cards
• Each job is allocated a card and the time spent by employees on that particular job is entered therein and
appropriate entry is made in the wages control account.

Operation cards
• Also known as piecework tickets used for each operation in a job{cutting, stitching etc]

Accounting entries relating to labour costs

Journal entries
Payments of wages
$ $
Dr Cr
Wages ledger control 50000
account
Cash(net) 40000
Paye 4000
Insurance 3000
Pension 3000
Being wages cost accounted

Allocation of jobs to costs

$ $
Dr Cr
Work in progress 31000
Overheads 19000
Wages ledger control 50000
account
Being apportionment of wages into direct and
indirect wages

Ledger entries
Interlocking accounts
Wages ledger control account
$ $
Financial ledger control 5000 WIP 31000
account 0
Production ohds 19000
5000 50000
0

Integrated accounts
Wages ledger control account
$ $
Bank 4000 WIP 31000
0
PAYE 4000 Production ohds 19000
Insurance 3000
Pension 3000
5000 50000
0

Labour turnover
Labour turnover represents the movement of workers from one job to another.A reasonable level of turnover is good
but a high turnover of workers causes decrease in morale , increased costs and reduce productivity.

Reasons for labour turnover:

• Redundancy
• Dissatisfaction
• Lack of training
• Personal problems(marriage, pregnancy etc)
• Retirement
• Emigration

Costs associated with labour turnover:

• Leaving costs
• Replacement costs
• Training costs
• Learning costs

Labour turnover = Number of employees replaced per period

Average total number of employees in the period

Information for Management

Data – raw material from which information is obtained. Information and Information sytems

Data – raw material from which information is obtained.

E.g.- cost of fabric in a pant.

Information- Output from a system where data ha been processed.

E.g –Total sales in a particular month.

Data is information for someone and yet it is data for others.

E.g Price of a product on shelf is data for the supermarket but information for the customer.

Information

Importance -For controlling activities

-For decision making
-To survive in a competitive environment
Sources -Internal(Management accounts, analysis of
debtors, etc)
-External(Market survey, Government
policy, customer complaints.)
The relevance of the sources will determine
the quality of information generated
Qualities Applicable-Timely, up-to date.
Clear- understandable, concise.
Worthy-relevant, cost-effective , accurate,
complete
Management Information system
A management information system is described as a computer ystem which collect and preents information to
management relating to a business in order to facilitate control.Alternatively it can be described as ue o available
resources to provide such information to management a to enable them make timely and effective decisions.

Accountants and MIS

Accountants may use MIS to make decisions relating to Investments, Financing, working capital management.

MIS and cost accountants

Costs accountants will use a MIS for planning,controlling and Decision making

Financial accounting v/s Cost and Management accounting

Financial Accounts Cost and management accounts

Gives indication of Help in planning ,controlling and
performance and state of decision making
affairs
Legal requirement for No legal requirements
limited companies
Prescribed format No prescribed format
Will be prepared for Focus on specific areas
whole business
Monetary nature May provide certain information in
quantities
Historical info Past and future info

Objectives ,Strategy and Planning

Objectives refer to the long term plans of a business
Strategy refer to the mean adopted to attain the set objactives
Planning refers to the process of establishing objectives and selecting appropriate strategies to achieve those
objectives.

Planning process
 Assess

Assessment External The The future Expectation

Stage Environment organisation

Objective Evaluate corporate objectives

stage
Evaluation stage Consider alternatives

Corporate plan Agree corporate plan

Long term srategic planning

It is also known as corporate planning and involves selecting appropriate strategies to prepare a long term plan to attain
objective.

Short term tactical planning

Conversion of long term plans into everal hort term plans.

Operational planning
Further breakdown of the plans into daily,weekly,or monthly plans and targets.

Control
Control can be broken down into two stages:
• Comparison of actual and standards- Identify deviations and take corrective measures.
• Review corporate plan in light of comparisons made.

Role of IT in Management information

A computer system is made up of hardware and software.
Hardware- Refer to the equipments used in a computerized system. Its basic components are:
 Input devices e.g Keyboard
 Procesing device e.g CPU
 External storage device – Floppy disks
 Output devices – Printers,screen
Software is made up of programs running the computer system e.g Windows

Methods for capturing data

 Keyboard
 Cursor
 WIMP-Windows,icons,Mouse,Pull down menu as in a Graphic uer interface where communication take place
through images rather than text in order to make the application more user friendly.
Storage devices
 Floppy disks
 CD
 DVD etc
Output devices
  Printers
 Computer output microform

Marginal costing is the costing principle where all cost units are valued at Variable
production costs (Direct costs+ Variable production overheads) and fixed costs are charged to the P&l a/c.
Under M.C. finished goods are valued at Marginal (variable) Production cost i.e.
 Direct materials
 Direct labour
 Variable production overheads
Contribution refers to the difference between sales revenue and the variable cost of sales

Absorption costing is the costing principle where all cost units are valued at full costs including absorbed fixed costs.
Advantages of absorption costing
1. Realistic-Includes all costs
2. Stock valuation –In compliance with SSAP 9
3. Avoids fluctuation of profits in years of no sale
4. Pricing decisions are made easy

Advantages of Marginal costing

1. Simple to operate
2. Avoids need to apportion fixed costs
Absorption Marginal 3 .Avoids under /over absorption
costing costin 4. Provides relevant information for decision
g making

Example
Sales revenue 15000 15000
Details for product X
Selling price per unit -$15
Cost of production Variable production cost per unit - $8
Normal level of activity 1200 units
Variable costs 10400 10400 Budgeted /actual fixed production overheads
for the period - $3600
Fixed costs 3900 Actual production –1300 units
(3×1300) Actual sales – 1000 units

14300 10400

Less :Closing (3300) 8×300 (2400)

stocks
(8+3) ×300 Revenue statement

11000 8000

Unadjusted profit 4000 Contribution 7000

overabsorbed 300 Less:Fixed 3600

costs

Profit 4300 3400

Reconciliation of profit : $
Profit per absorption costing 4300
Less :Fixed production costs in closing stock (900)
($3×300)
3400

Inventory and issues valuation methods

What is the standard price of material?
This standard price of material of material is set by the buying department based on forecast costs.
• Material price
• Allow for quantity discounts
• Ignore VAT(refundable)
• Ignore cash discounts
• Allow for carriage and packing charges
Methods for valuing stocks and issues
• FIFO
• AVCO
Perpetual inventory
Under this system book values of stocks are updated after each transaction and is supplemented by a continuous
stocktake.
Continuous stock take
Stock take is done continuously covering the whole range of stocks over a given period of time(say monthly or 2-
monthly)
Periodic inventory
Under this method the whole stock is taken physically and book value calculated after a particular period ( e.g monthly)
Example
Balance at 1 Jan 2005 - 2000 units at $30
Receipts – Jan 5 1500 units at $ 35
Jan 8 1600 units at $37
Jan 22 1200 units at $39

Issues – Jan 7 1700 units at $60

Jan 15 2200 units at $65
Jan 24 1100 units at $70
Required : Prepare trading account using (i)FIFO, LIFO,AVCO
Periodic and perpetual methods of stockvaluation

FIFO Receipts
(periodic Jan 1(o.s) Jan 5 Jan 8 Jan 22
&perpetual)
2000 1500 1600 1200
Issues
Jan 7 (1700)
Jan 15 (300) (1500) (400)
Jan 24 (1100)

C/stock - - 100 1200

$37 $39
$3700 $46800

AVCO
Perpetual Periodic
Date QTY AVCO Amount($) Qty Avco Amount
Jan 1 2000 30 60000 Receipts 2000 30 60000
Jan 5(rec) 1500 35 52500 1500 35 52500
3500 32.14 112500 1600 37 59200
Jan 1700 54643 1200 39 46800
7(issue)
1800 32.14 57857 Isuses 6300 34.6 218500
8
Jan 8(rec) 1600 37 59200 (1700 (58960)
)
3400 34.42 117057 (2200 (76302)
)
Jan 2200 34.42 75743 (1100 (38151)
15(issues) )
1200 41314
Jan 22 1200 39 46800
receipt C/stock
2400 36.71 88114
Jan 1100 36.71 40386
24(issue)
 Closing 1300 47728 1300 45087
stock

Overheads
Direct expenses- are those expenses which are directly incurred and can be specifically identified with a product
,process or job. e.g. royalty, cost of drawings etc also known as chargeable expenses.
Overheads consist of indirect material, indirect labour and indirect expenses.
Indirect expenses – are those which cannot be conveniently identified to a job, product, or process e.g. Maintenance,
supervision, rent, rates and taxes.
Since indirect production expenses (production overheads) cannot be identified to a job, it has to be distributed to cost
units in an equitable manner. This distribution is a 3-stage process:
(1) Allocation of overheads-the charging of discreet , identifiable items of cost to cost centres or units. E.g. wages
of storekeeper to stores dept
(2) Apportionment of overheads-The allotment of 2 or more cost centres of proportions of common items of cost
on the basis of benefits received
(3) Reapportionment of service cost centre overheads to production depts.
Bases of reapportionment
(i)Direct redistribution method
(ii)Step distribution method
(iii)Reciprocal method
• Simultaneous equation
• Repeated distribution
Simultaneous equation method
Example: Production dept Service
dept
A B C 1 2
$80 $70 $50 $23 $30
0 0 0 4 0
Overhead distribution table
1 20% 40% 30% 10%
2 40% 20% 20% 20%
Let X represent the total amount of overheads of service department 1
Let Y represent the total amount of overheads of service department 2
Then: X = 234 + 20% Y And Y = 300 + 10% X
Solving the equations we get X = 300 and Y = 300
Production
departments
A B C
$80 $700 $500
0
Reapp 1 60 120 90
2 132 66 66
992 886 656
Repeated distribution method – Easier where there are more than 2 service departments.
Production dept Service dept
A B C 1 2
$80 $700 $500 $234 $300
0
1 46 92 72 (234) 24
2 129 64 64 67 (324
)
1 13 27 20 (67) 7
 2 4 1 1 1 (7)
1 1 (1)
992 885 657

Absorption of overheads
o Blanket rate-It is a single OAR used throughout a factory to absorb overheads into units produced.
Is applied where (i)All products spend nearly the same time in each cost centre
(ii)The factory produces only one product or all products are similar.
The drawbacks of using a blanket rate are that:
(i)Distorts the value of WIP-costs not yet used are charged
(ii)Impossible to evaluate the performance of each dept
o Departmental rates- or Multiple OAR –where each dept or centre has its own rate for absorbing overheads.
These are more accurate because:
(i)Some products pass only through a few centres
(ii)Each cont centre has different features(packing and stitching not same)
(iii)Time span is different in each centre.
o Actual OAR
Actual OAR is calculated as follows:
Actual overheads
Actual activity
This can only be calculated at the end of a period when actual figures become available. However it causes a delay
in ascertaining cost figures.

o Predetermined OAR is calculated as follows:

Budgeted overheads
Budgeted activity
With the use of a predetermined OAR:
(i)Product costs can be calculated on a timely basis
(ii)Product prices can be fixed in advance
(iii)Target will be set and worked upon.

Common absorption rates:

(i)Direct labour hour-applicable to labour intensive cost centres
(ii)% of direct labour costs –It is simpler than DLH since no time records will have to be kept but will be relevant
only if wages rate within a dept are uniform.
(iii)%of direct material cost –Simple but not logical –Does not take into account time spent on each job.
(iv)%Prime cost-Simple but not recommended .same disadvantage as (ii)and (iii)
(v)Rate per machine hour –Good method if work is of a capital intensive nature
(vi)Rate per unit of output- Simple but is suitable only if cost centre performs one standard task on all units e.g.
Painting of cars

Overheads
Overheads include manufacturing and non-manufacturing overheads.
Manufacturing or production overheads refer to those indirect costs which are incurred in the course of
manufacturing the product e.g Depreciation of factory machinery, rent of factory etc.
Non-manufacturing overheads , the main components of which are selling and distribution overheads and
administration overheads are those indirect expenses which are incurred after the product has left the factory e.g
Advertising , office staff salary etc

Although sometimes such costs are treated as costs not relevant to the product, and are therefore charged to the profit
and loss as an item of expense, however it is better to include them into the cost of the product to have a better picture
of the total costs that have been incurred in relation to that product.
We need to know certain basic terms in relation to manufacturing overheads
Manufacturing overheads incurred relate to the actual amount of overheads that have arisen in a period.
The journal entries for overheads incurred are given below:
Interlocking accounts Integrated accounts
Indirect material Indirect material
Dr Factory overhead control account Dr Factory overhead control account
Cr Stores ledger control account Cr Stores ledger control account
Indirect wages Indirect wages
Dr Factory overhead control account Dr Factory overhead control account
Cr Wages ledger control account Cr Wages ledger control account
Indirect expenses Indirect expenses
Dr Factory overhead control account Dr Factory overhead control account
Cr General ledger adjustment Cr Cash or creditors

Manufacturing Overheads absorbed (i.e. overhead actually attributed to the product) is calculated as follows:
Actual activity × Overhead absorption rate

Overhead absorption rate = Budgeted overhead

Budgeted activity
Budgeted activity refers to the basis used for absorbing the overhead. It can be labour hours, machine hrs, etc

Non-integrated Integrated
Dr Overhead adjustment Dr Overhead adjustment
Cr Factory overhead control Cr Factory overhead control

Since budgeted and actual results are usually not the same under or over absorption arises as shown below:

Overhead (under) or over absorbed = Overhead absorbed - Overhead incurred.

Non-integrated
Under absorbed
Dr Overhead adjustment
Cr Factory overhead control
Over absorbed
Dr Factory overhead control
Cr Overhead adjustment
Integrated
Under absorbed
Dr Overhead adjustment
Cr Factory overhead control
Over absorbed
Dr Factory overhead control
Cr Overhead adjustment

The same accounting treatment applies to all other types of overheads e.g Administrative and Selling and distribution
overheads.

RELEVANT costing approach to decision making

Concept of relevant costing
The relevant costs and benefits for decision making are those that will be affected by the decision. Costs and benefits
that are independent of the decisions are obviously not relevant and need not be considered when making decisions.
Alternatively it can be said that only future cash flows will be considered or only differential(incremental cash flow
will be considered. Cash flows will be same for all alternatives will be ignored.

Relevant costs for materials

(i)Etimated purchase price if bought
(ii)Future replacement cost if taken from stock.
Relevant costs for labour
(i)In case of spare capacity ,idle labour being used is considered an irrelevant cost.
(ii) In case of hired labour the cost of hiring is relevant cost
(iii)where there is full capacity and a reduction in production resulting from undertaking a separate order will lead to a
reduction in contribution. The relevant cost /hr is the labour hour rate plus the opportunity cost of the contribution per
hour lost .
Deprival value of an asset
This is the amount of money the owner would have to receive in relation to an asset to compensate them exactly for
being deprived of it.

Deprival value
Is the lower of

Higher of

Replacement costs NRV Economic

value
Opportunity costs
It is defined as the value of the next best alternative forgone.
Example
A firm rents a small workshop for $50/week but does not use it. The firm could sublet it for $80/week but are
considering using it for a new project. What is the opportunity cost of the project?
Answer: $80/week that is the alternative use that could have been made.$50 rent paid is historical cost and is therefore
irrelevant.

Sunk costs
Also termed past costs are those costs have already been incurred and therefore are irrelevant or decision making
Research and development cost incurred..

Historical costs
Costs already incurred which are not going to be affected by the decisions taken.

Replacement costs
Until now it has been assumed that items needed are bought. Most of the times however they are taken from stocks. In
such cases the relevant costs would be the future cost of replacing the stock

Budgeting
A budget is defined as a plan.Usually it is prepared for each operation or dept existing in a business and such plans are
known as functional or operating budgets.E.g Sales budget or production budget.It is all then accumulated to provide
the master budget which is the Budgeted Profit and Loss account and Balance sheet.
When preparing budget we have to consider the factor which limits our activity and therfore the budget for that factor
has to be prepared first.This is known as the Principal budget factor and is usually the sales but can be any of the
following:
-Materials
-Labour
-Machinery

Advantages
• Helps to establish a plan
 • Coordination is made easy among dept
• Control will be exercised on the performance of depts
• Communication is facilitated
• Evaluation of performance of each dept is easy
• Creates motivation in different units

Linear programming
This is a mathematical technique used to optimise scarce resources in cases of product mix problems, production
planning, etc
LP can be used if:
• Problem can be stated numerically
• All factors have a linear relationship
• The problem permits a choice
• There must be one or more restrictions
• Solutions must be feasible

The objective function

This is the objective of the problem expressed in a simple mathematical form. it can refer e.g. to the maximisation of
the contribution

Limitations and constraints

These can appear in the form of scarce resources. They must be linear, identified and quantified.

Example
A manufacturer produces two products B and S with contributions of $3 and $4 respectively. The manufacturer wishes
to establish weekly production plan which will maximise contribution.

Production data are as follows:

Per unit
Machine hrs Labour hrs Material kgs
Biss 4 4 1
Soub 2 6 1
Total available 100 180 40

Sales of B are limited to a weekly maximum of 20 units and a minimum of 10 units of S must be produced.
Required: Calculate the number of B and S to be produced.

Solution
 First we identify the objective: Maximisation of contribution
 Next we identify the constraints: Machine hrs, Labour hrs, material qty, B maximum qty, S minimum qty.

We have two unknown variables:

X – Quantity of B to be produced
Y – Quantity of S to be produced

List the constraints

A - 4x + 2y ≤ 100 (Machine hrs constraint)
B - 4x + 6y ≤ 180 (Labour hrs constraint)
C - x + y ≤ 40 (Material constraint)
D- x ≤ 20 (B maximum constraint)
E y ≥ 10 (S minimum constraint)

Above all x ≥ 0 (x cannot be negative)

Production costing
♦ Job Costing
♦ Process costing
 Abnormal gains and losses
 Equivalent units
 Joint costs and by products

♦ Batch costing

Job costing
Specific order costing used when a customer orders a specific job. Each job is unique and priced separately.

Example Job No 101

$
Materials 1375
Labour 138
Overheads 242
Other charges 23
1778
Profit 622
Invoice 2400

Process a job order

Sales order → Production order→

♦GRN
♦Material requisition form
♦Direct labour time ticket
♦OAR → Job cost sheet
Batch costing
 Set of identical units
 Each batch different
 E.g footwear, clothing

Process production
Mass production of identical units which involves several processes e.g tins of paint, bars of chocolate.
Process 1 account
Units $ Unit $
s
Mterials 1000 20000 Transfer to 1000 24000
process 2
Labour 3000
Overheads 1000
24000 24000

Process losses
Normal losses occur due to evaporation,wastage of materials,and is expected in any process.
Losses can be sold and generate a revenue called scrap proceeds or scrap value.
Example :
Process 1 data:
Materials input 1000 units costing $10000.
Labour costs $8000
Overheads $6000
Normal loss is 4% of input and is sold as scrap for $12 per unit.
Prepare:
(a) Process 1 account
(b) Scrap account
(c)Calculate the average cost per unit.
Answer
 Process 1 account
Units $ Unit $
s
Materials 1000 10000 Transfer to 960 23520
process 2
Labour 8000 Normal loss 40 480
Overheads 6000
24000

Scrap account
$ Units $
Process 1 480 480

Abnormal losses and gains

This occurs when the actual loss or gain is different from actual gain or loss. Abnormal gain or loss is valued at same
value as good output.

Example :
Materials 1000 units costing $10000
Labour cost $8000
Overheads $6000
Normal loss is 4% of output and is scrapped at 412 per unit.
Actual output is 944 units

Process 1 account
Units $ Unit $
s
Materials 1000 10000 Transfer to 944 23128
process 2
Labour 8000 Normal loss 40 480
Overheads 6000 Abnormal loss 16 392
24000 24000

Scrap account
$ Units $
Process 1 480 480

Average cost = Process cost – scrap value

Units input- Normal loss

Valuation of work in progress: Existence of Opening work in progress

The following methods of valuation can be applied:
(i)FIFO
(ii)AVCO

Example
Opening work in progress in Process 2- 200 units (25% complete) valued at $2500.
800 units received from Process 1 valued at $4300.
840 units were transferred to process 3.
Closing WIP 160 units (50% complete)
Costs for the period were $16580- No scrap units.
Prepare process account for Process 2 using:
(i)FIFO (ii)AVCO methods of valuing WIP.
FIFO method
Units
Completed units transferred 840
+ Closing WIP 160 × 50% 80
- Opening WIP (200×25%) (50)
Effective units for the period 870

Cost per unit = Total cost per period (Process costs + Transfers in)
Effective units of production

= 16580 + 4300 = $24(used for valuing WIP)

870
Process 2 account
Units $ Unit $
s
Opening WIP 200 2500 Process 3 840 21460
Process 1 800 4300 Closing WIP 160 1920
Process costs 16580
1000 23380 1000 23380

AVCO method
Units
Completed units transferred 840
+ Closing WIP 160 × 50% 80
Effective units for the period 920

Period costs = Opening WIP + Transfers in + Process 2 costs

= 2500 + 4300 +16580
=$23380
AVCO = $23380
920
= $25.413
This CPU will be used for valuing closing stock and transfers out.
Closing stock = 160 × 50% × 25.413
= $2033
Transfers to Process 3 = 840×25.413 = $21347

Process 2 account
Units $ Unit $
s
Opening WIP 200 2500 Process 3 840 21347
Process 1 800 4300 Closing WIP 160 2033
Process costs 16580
1000 23380 1000 23380
Service/function costing
“Cost accounting for specific services or functions e.g canteen ,maintenance, personnel. These maybe referred to a
service centers, departments or functions. The service can either be for sale(tpt) or for use within the
organization(canteen).
Typical cost units in a service costing system
Service Possible cost unit
Transport Tonne-mile
Hospital Patient days
Electricity Kilowatt-hrs
Hotels Bed nights

Cost/ unit = Total cot for the period

Number of service units supplied

Example
City Hospital County Hospital
Number of beds 780 500
Number of 23472 8165
inpatients
Average stay 7.5 days 85% occupancy
Number of 216500 63920
outpatients

Cost breakdown

City hospital County hospital

Direct patient care In Out In Out

Supplies, drugs etc 1821520 693620 1551350 285450

Medical staff 8729100 3308950 6832700 1975050

Support services 2210500 2563700 1845380 1591620

Indirect costs

General services 3524470 1721800 1937410 635600

Total 16285590 8288050 1216684 4487720
0 Calculate
(i) Average stay in County hospital
(ii)Bed occupancy % in City hospital
(iii)Cost per patient day for both hospitals
(iv)Cost per outpatient for both hospitals.

Answer:
(i)Average stay in county hospital
Total bed days in a year = 500×365 = 182500 bed days

Number of patient days = 85% × 182500 = 155125

Average stay = 155125 = 19 days
8165
(ii)Bed occupation % = Actual in patient days
Potential patient days
=23472×7.5 × 100 = 62%
780×365

(iii)Cost per inpatient day = Cost of in patient

no of in patient days

City County
16285590 12166840
23472×7.5 8165×19
=$92.51 = $78.43

(iv) Cost per out patient = Cost of out patients

No o out patients
City County
8288050 4487720
216500 63920
= $38.28 =$70.21
Semi- variable costs/semi- fixed costs

High –low technique

This is a method used to separate variable costs from fixed costs.
See the example below:

Production Costs($)
(units)
Lowest 2000 8000
Highest 4000 12000

Variable cost = Difference in costs = 4000 = $2 per unit

Difference in output 2000

FC = TC – VC = 8000 – 4000 = $4000

Limitation – considers only extremes

Scatter graph method

We plot the different levels of out and costs on a graph and then we draw a line of best fit to represent the most appropriate slope.
The slope will represent the Variable cost per unit and the Y- intercept will represent the fixed cost.

25

20
15
Cost
10
5

0
0 2 4 6 8

Least squares method of regression analysis

This is a statistical technique which calculates variable and fixed costs using a linear function between costs and activity.

Output(000’s) 1 2 3 4 5 6 7
Costs(000’s) 14 17 15 23 1 2 3
8 2 1

Using normal equations of regression analysis

∑y =an +b∑x.......( i)

∑xy = a ∑x +b∑x 2
.........( ii )

Where a is the fixed cost and b is the variable cost per unit.

Output(000’s)- Cost(000’s)-
x y xy X2
1 14 14 1
2 17 34 4
3 15 45 9
4 23 92 16
5 18 90 25
6 22 132 36
7 31 217 49
∑x = 28 ∑y =140 ∑xy = 624 ∑x 2
=140
Solving the simultaneous equations:

140 = 7a + 28 b
624 = 28 a + 140 b

We get a =$ 10.86 and b = $2.286

Using the co-efficient formula

a=
∑y ∑x 2
− ∑x ∑xy
n∑x − ( ∑x )
2 2

n∑xy − ∑y ∑x
b=
n ∑x 2 − ( ∑x )
2

where n=7 (number of observations)

we arrive at the same figures.

Correlation
Once we know that a causal relationship exists evidence of good correlation has to be tested prior to carrying out a least squares calculation.
The coefficient of determination is calculated as follows:

Coefficient of determination = r2

n∑ xy − ∑ x ∑ y
Where r = = 0.839
n∑ x 2 − ( ∑ x ) n ∑ y 2 − ∑( y )
2 2

r2 = 0.8392 = 0.704 i.e 70.4 % that is 70 % of variations in y can be explained by variations in x

n −2
T= 0.839 × = 3.45
1 − ( 0.839 )
2

T at 95% significance level = 2.57 at 99% = 4.03

Therefore at 95 % level there is evidence of real correlation but not at 99%

Output(000’s) Cost(000’ X2 Y2
-x s)- xy
Y
1
1 14 196 14
2 17 4 289 34
3 15 9 225 45
4 23 16 529 92
5 18 25 324 90
6 22 36 484 132
7 31 49 961 217
∑x = 28 ∑ y =140 ∑x 2 =140 ∑y 2
= 3008 ∑xy = 624