Accounting & Finance 3A

1. Accounting & Finance 3A Cost Accounting & CVP

2. Lesson 1 • Review • What is financial accounting? • Primarily for external users such as shareholders, creditors, customers, government agencies & investors. • Involves the production of general purpose financial reports that are produced on a regular basis to show profits or losses and inventories in accordance with accounting standards.

3. Management (Cost) Accounting • Used in all types of organisations. • Users of management accounting reports are usually internal to the organisation. • Management accounting reports are special purpose reports such as sales forecasts or planning & production cost reports. These special purpose reports do not need to comply with accounting standards.

4. Differences between Management & Financial Accounting

5. Manufacturing • A manufacturing business needs to know what it costs to make its products to ensure they are sold at a profit. • A manufacturing business involves production,selling, administrative functions these are all costs associated with the production of a service or saleable item. • Manufacturers commence the process with raw materials which they convert to saleable products.

6. Why Calculate costs? • You might want to know whether it is cheaper to manufacture yourself or import from China? • Should you invest in high technology such as robots and fully automated plant or stay with your workforce of 300 people? • Are you working at full capacity or full efficiency – do you need to increase output / or decrease output to improve profitability?

7. What can you cost? • Well just about anything, think about the pizza you buy from the shop or a subway roll. Some costs would be bread and fillings, staff wages, shop rent, advertising, electricity and admin costs. • What about a holiday in Phuket? What costs can you think of that will make up the total cost? • Do you think we can cost the erection of the big wheel (Perth Eye) on the foreshore?

8. Cost Object • A cost object is defined as any activity where a specific cost measurement is required.

9. Worksheet • Please complete worksheet 1

10. Lesson 2 • Review • What can you cost? • What is a cost object?

11. Types of Costs in a manufacturing business • There are three distinct types of costs • Direct Materials • The cost of materials that can be directly traced to the finished product. The bread and fillings In our previous example of Subway • Direct Labour • Wages paid to staff members which can be directly traced to the finished product. This will be our staff wages serving the customers • Factory Overhead Cost – Indirect Cost • All factory costs except direct materials and labour required in the production process – Rent, insurance etc

12. Factory Overheads explained • Sometimes known as manufacturing overhead, indirect manufacturing or factory burden costs. • Includes costs such as electricity, rent, depreciation, insurance. • Cannot be traced to a single product and therefore an allocation of cost is made.

13. Factory Overhead cont • BEWARE • Sometimes rent depreciation or insurance for example may not be attributable to manufacturing costs, they may belong to admin or sales functions – Only use the manufacturing portion in Factory Overhead calculation.

14. Direct & Indirect Costs • Direct Costs • Can be traced directly to the product or service in an economically feasible way • Indirect costs • Are related to the product or service but cannot be traced in an economically feasible way and therefore need to be allocated.

15. Cost Behaviour • Cost Behaviour relates to how a cost reacts to changes in levels of manufacturing activity. • There are two main types • Fixed Cost • Variable costs • A hybrid called mixed costs, being part fixed and part variable can also exist. i.e. electricity

16. Fixed Costs • A fixed cost remains the same no matter what level of output or efficiency has been attained. • For example factory rent may be $2000 per month. This figure does not fluctuate in response to changing production amounts, it is static (fixed) at $2000. Adapted from Hoggett & Edwards Accounting in Australia 4th edition

17. Variable Costs • Variable costs are production costs which vary directly with the volume of production. • Direct Materials & Direct Labour are variable costs because as production rises more material and labour will be required. Adapted from Hoggett & Edwards Accounting in Australia 4th edition

18. Cost Drivers • A cost driver is any activity which causes costs to be incurred • Examples; • Number of phone calls made • Number of units produced • Number of machine hours • Number of advertisements made • Number of customers

19. Product & Period Costs • Product Costs – also known as inventoriable costs. A specific type of cost that can be capitalised and recorded as an asset in the stock or inventory ledger account. • Period Costs – recorded as an expense in the period in which they occur. • The matching principle influences the classification of these costs

20. Worksheet • Please complete worksheet 2

21. Lesson 3 • Review previous lesson • Fixed costs • Variable costs • Mixed Costs • Cost Objects • Cost Drivers • Cost Behaviours

22. Job Order Costing • There are two types of costing systems • Job order • Process • We will cover only job order in this course • A job order costing system accumulates production costs on a job by job basis

23. Unit Cost (Average Cost) • Calculated by dividing total cost by number of units produced. • A river cruise for year 12 students has been booked at a cost of $3600 (flat fee all inclusive). If 60 students want to attend the event, what would the unit cost (individual ticket price) be? • Total Cost = $3600 • No Units 60 • Unit Cost = $60 per ticket

24. Question • What happens to the unit cost (individual ticket price) of the river cruise if another 20 students decide to attend? • $3600 • 80 • = $45 per ticket

25. Some things to ponder…. • How do you decide what price you should sell your product at? • How many units can your factory produce on a daily/weekly/monthly/yearly basis? • Do my material costs vary each time I purchase? • Does my labour always cost the same amount per hour? Even on a Public Holiday or weekend? • What if we double our production, will we double our profit?

26. Breakeven Point • We know what it means for a business to make a profit. Basically revenue is greater than expenditure. • We know what it means to make a loss. This is when our expenses exceed our revenues. • What about breakeven? Think for a moment do you think you can create an equation for it? • Revenues – Variable costs – Fixed Costs = 0

27. Cost volume profit analysis • The answers to the questions on the previous slide can be found using CVP. • Four factors affect CVP • Selling Price • Sales Volume • Sales Mix • Costs of Materials • CVP shows us how profits are affected by changes in activities.

28. Limitations to CVP • Unit sales price remains constant • Costs can be identified • Variable cost is proportional to output • Fixed costs remain constant • Efficiency is not affected

29. Worksheet • Please complete worksheet 3

30. Lesson 4 • Review • Variable costs • Fixed Costs • Revenue • Breakeven point

31. Contribution Margin • The contribution margin is used frequently in management accounting. It is quite simply, • Revenue – Total Variable Costs • The contribution margin is the amount left over to firstly absorb any fixed costs, and once these fixed costs are satisfied it starts to contribute towards profits.

32. More equations • Total costs = Fixed costs + Variable costs • Profit = Revenue – Total Costs • Contribution Margin = Revenues – Total Variable Cost • Contribution Margin Ratio = Contribution Margin / Sales

33. Target Net Profit • Once you understand breakeven analysis you are able to take this one step further. • By using breakeven analysis as a planning tool and rearranging the equation we are able to calculate required sales to produce a profit of x dollars. • If Revenues – Variable costs – Fixed Costs = 0 • Then Sales Target = VC + FC + Target net profit

34. Margin of Safety • The amount by which sales can decrease before a loss occurs. • The margin of safety is the excess of actual or expected sales over breakeven sales. • Adapted from Hoggett & Edwards Accounting in Australia 4th Edition

35. Cost Accounting Systems • We now know that if we calculate our direct material and labour costs, as well as our indirect factory overheads, we can calculate the cost of a product. • This is extremely useful as it allows us to accurately calculate our inventory, however there are limitations. • We can also calculate a sales price by using a mark up.

36. Limitations • Historical or actual cost information represents what did happen and not necessarily what should have happened. • Efficiency evaluations do not consider optimal efficiency only trend analysis.

37. Worksheet • Please complete worksheet 4

38. Lesson 5

39. Cost decisions • Often management is faced with the need to make decisions which affect output levels. • Some decisions can have short term gains but long term effects that are not always positive. • CVP is an essential tool enabling management to investigate options such as Make or Buy, Special Order or Product Mix.

40. Make or Buy Make or buy decisions face Corporate Australia on a daily basis. You will constantly hear about companies forced to source overseas materials so they can remain competitive Remember labour costs are considerably cheaper in Asia. But also quality of materials can be of a lower standard Consider Bonds a great Australian company brought into the spotlight during 2009 with its decision to close its manufacturing operations in Australia.

41. Special order Do we accept or reject a ‘one time only’ special order? Sometimes these orders are for large quantities at reduced prices If idle capacity exists then this could be a good decision for the company If the company does not have an alternative use for the assets of the business and the order will not impact negatively on the business then the order should be accepted.

42. Product Mix If a business manufactures more than one product it must determine the optimal production amounts of each in order to maximise profitability. Constraints of the business impact on product mix such as Availability of space, availability of raw materials and labour, profitability and demand all play an important part in this decision making process.