COSTING OF APPAREL PRODUCTS

Session II

Relationship of cost, price and profit

Manufacturing costs + Operating Expense + Profit = Manufacturers price MC + OE + P = MP Manufacturers price = Retailers' Cost MP = RC Retailers Cost + Operating Expenses + Profit = Retailers Price RC + OE +P = RP

Income Statement
A financial statement that relates revenue (sales) to costs to determine profit.
It is also called profit and loss statement.

It is a summary of revenue and expenses for a specific period of time.

Sections of the Income Statement

Revenue - is the amount of total sales Cost of Goods Sold expenses associated with the manufacturer of the product line including material costs, labor costs, and overhead expenses. The Gross profit Margin (also called gross profit or gross margin) is the amount of income remaining after cost of goods sold is covered. Contribution or Contribution margin is the revenue remaining for covering overhead and profits after variable costs have been deducted from total sales. When General Operating Expenses are deducted from the gross profit, the bottom line becomes profit or loss.

A Simple Income Statement

Sales $ 10,500,000 Cost of goods Sold $ 6,300,000 Materials Costs Direct Labor Overhead Gross Profit Margin $ 4,200,000 - General Operating Expenses $ 3,150,000 Net Profit or Loss (+ or -) $ 1,050,000 100% 60%

40% 30% 10%

Relevance of Income Statement

The different parts of the income statement identify basic areas of profit potential Careful examination of an income statement can help identify where improvements or change need to be made in order to improve profits

For Example
An increase in sales without an increase in COGS or OE May be attained by increase in price
A reduction in the COGS without a change in sales. COGS may be affected by changes in cost of materials, labor, and/or overhead

A reduction in in GOE would result in larger profits if income and COGS remains constant. May be attained by reduction in Admin. Salaries or Expenses of cleric & record keeping services.

But Remember..
Though
Income statement is useful in identifying the overall status of the firm but. Sources of profit or costs among the products of the firm cannot be ascertained Hence.. Each style needs to be evaluated separately on its contribution to profit

OBJECTIVE OF COSTING
Costing helps in periods of trade depression and trade competition Aids in Price Fixation Helps in estimate Helps in channelising production on right lines Wastages are eliminated Costing makes comparison possible Provides data for periodical profit and loss accounts Aids in determining and enhancing efficiency Helps in inventory control Helps in cost reduction Assists in increasing productivity

Classification of costs
Fixed, variable, semi variable and steps costs
Prime cost - Overheads Products costs and period costs Direct and Indirect Costs Shut Down and Sunk Costs Opportunity Costs Production, Administration, Selling & Distribution costs Relevant and irrelevant costs

Fixed, Variable, semi variable Costs

The concept of fixed and variable costs holds good in short run and hence it is more of a theoretical concept. Hence those costs which tend to vary with output or have major relation with output should be termed as variable costs

If a cost varies more than proportionality, then also it is a semi variable cost

STEP Costs
Fixed cost can further be classified into: i) Committed fixed Costs ii) Discretionary Fixed costs Certain costs remain fixed over a range of activity and then jump to a new level as activity changes. Such costs are treated as Step Costs These cost may also be taken as type of semi variable costs

Shut Down and Sunk Cost

When a Manufacturer shuts down his operations temporarily, he still has to incur expenditure on depreciation, rent, maintenance etc. Such costs of the idle plant are called as Shut Down costs.
Sunk costs are historical or past costs which have been created by a decision that was made in the past that cannot be changed by any decision that will be made in future.

Opportunity, Relevant & Irrelevant Costs

Which has been foregone on account of not using the facilities in the manner originally planned The term Opportunity cost refers to the alternative revenue foregone
Relevant costs are those which will be changed by managerial decisions while irrelevant costs cannot be affected and hence may be ignored

Methods of Differentiation
Methods of costing
Job Costing - Items of prime cost are traceable to specific orders Process Costing Where identity of prime cost is lost in operations

Techniques of Costing
Marginal Cost Allocation of expenditure on manufacturing is restricted to variable expenses Direct Costing Indirect costs are written of against profits Absorption Costing Charging all costs, variable or fixed Uniform Costing standardized principles and methods of costing are employed Activity Based Costing Apportionment of overheads are identified with each activity

Need for Differentiation

Manufacturing Industries Marginal Costing To control costs and identify profitable orders Activity Based Costing
Where production is not repetitive Job Costing Where large quantities of the product are being made Process Costing

Class exercise..
Record different costs which may be incurred in apparel manufacturing Unit

Classify these costs in different categories.