Accounting Lecture 8

• Cost object (or cost unit)

  Anything (product, service, activity) for which a separate measurement of cost is required
• Types of costs


  • Variable
  • Fixed
  • Semi-fixed
  • Semi-variable
• Variable costs in a manufacturing organisation

  • Direct materials
  • Energy to operate the machines
• Variable costs in a merchandising company (e.g. a supermarket)

  • Purchase cost of items that are sold
• Fixed costs


  • Depreciation of non-current assets
  • Insurance costs
  • Supervisory salaries
• Semi-fixed costs


  • Depreciation of non-current assets (new assets are needed)
  • Insurance costs (contracts are renegotiated)
  • Supervisory salaries (new supervisors are employed)
• Semi-variable costs


  • Telephone expense for the landline (the cost of a line rental is the fixed component, and the cost of the telephone calls is the variable component)
• Variable costs


  • Vary in direct proportion with activity
• Fixed costs


  • Remain constant over wide ranges of activity
• Semi-fixed costs


  • Fixed within specified activity levels, but they eventually increase or decrease by some constant amount at critical activity levels
• Semi-variable costs


  • Include both a fixed and a variable component
• Classification of costs depends on the time period involved. In the short term some costs are fixed but in the long term all costs change with the level of activity
• Cost-Volume-Profit (CVP) analysis


  Analysis of the relationship between changes in activity, costs, and profit
• Break-even point


  Where revenues cover all costs (therefore profit is zero)
• CVP analysis key assumptions

  • Costs can be accurately divided into their fixed and variable elements
  • Unit variable cost and selling price are constant per unit of output
  • All other variables remain constant (e.g., sales mix, production efficiency, production methods)
• Relevant costs/revenue


  Recap of key components for CVP analysis
• Profit


  Total revenue - Total costs
• Total contribution (C)


  Revenue - Variable cost
• Find break-even point


  1. Profit = 0

  2. C = FC

  3. q = FC / (p-v)

  4. q = FC / C per unit
• Profit Volume Ratio


  Proportion of each £ of sales available to cover fixed costs and provide for profit
• Margin of Safety


  Extent to which expected sales exceed the break-even point (after the break-even point the profit is positive)
• Key cost accounting concepts: budgeting; assigning costs to cost objects; classification of costs for decision making; classification of cost behaviour in relation to activity level
• CVP analysis is a tool for decision making based on restrictive assumptions