Chapter 32 - Costs
Lesson Objective: To understand the basic concepts of costs before learning costing techniques
What are the reasons cost data/information is so important for businesses?
Why should managers have accurate cost data?
Cost data is important for various reasons:
Costs aid on pricing decisions;
Costs are also important for production decisions:
Whether to stop the production of a product;
Whether to increase production;
Whether to implement new methods;
Whether to choose different materials.
Cost is an important measure for comparison:
Comparing different periods;
Comparing with set targets.
We will learn two different costing techniques on this chapter but before going into them we need to clarify some concepts:
Overhead costs are the costs of running a business such as rent, insurance, utilities, etc. They cannot be avoided but should be reviewed frequently to increase profitability. Overheads can be divided into four:
1. Production/Manufacturing Overheads:
2. Selling and Distribution Overheads:
3. Administrative Overheads:
4. Finance Overhead (Interest and Loans)
Other important concepts before costing techniques include:
Unit Cost - The average cost of producing each unit of output
Cost Centers:
Profit Centers - an identifiable part of the business for which is possible to identify revenues and costs and therefore calculate profit (e.g. individual shops in a retail chain, local branches, geographical region, a team or individual responsible for sales):
Businesses make this division (cost and profit centers) for some obvious reasons:
So that targets for managers and workers can be set;
So that performance can be assessed;
So that areas for improvement can be identified;
To aid decision making.
The problems of dividing centers, on the other hand, are:
May create unhealthy competition between centers (loss of organizational purpose/direction);
Inaccuracies as some indirect and overheads costs cannot be allocated to specific centers;
External influences in different centers are not taking into account.
We will soon learn two separate costing techniques:
Full-Costing Technique (a.k.a. Absorption Costing);
Contribution Cost (a.k.a. Marginal Costing).
The major problem with costing methods relates to cost allocation:
Allocating direct labor and direct materials to an individual product is easy...
Overheads and indirect costs, however, are hard to individually allocate making it hard to properly answer the question:
"How much does it actually cost to produce this product?'
To-Do-List:
Chapter 32 - Costs
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