Costing

 evaluate the importance of costing in production;

 Classification of Cost of Production (direct/indirect variable/fixed).
 Break-even analysis:- break-even point, (definition, uses, advantages and
disadvantages, simple calculation of the following: BEP for Output and
Sales, Contribution Margin Sales for a desired Profit, Output for a
desired profit and Margin of safety).
 construction of break-even charts.
 Direct vs Indirect Costs
Direct Costs Indirect Costs
Expenses which are easily traceable General expenses which are difficult
to a product and incurred for an to assign to specific product and can
identifiable product be allocated to many departments or
products
 Those involved in the
actual production of the
good/service
 Fixed Costs vs Variable Costs
Fixed Costs Variable Costs

Independent of output – remains Change with level of output

same regardless of how much
produced

Arises even when no output Become zero when no output

produced produced

Supplementary costs Prime costs

Rent = $50,000
5,000 pairs of jeans

Rent per pair of jeans = 50,000/5,000 = $10 per pair of jeans

10,000 pair of jeans

Rent per pair of jeans = 50,000/10,000 = $5 per pair of jeans
 Let’s Practice
The following information relates to a firm manufacturing calculators:

A firm manufactures 100 calculators per period. Selling price: $100 per unit
Fixed costs: $3400
Variable costs: $15 per unit.

1. Construct a Table of Values for the information above.

Ensure that you have the following: Sales (Units), Sales (Revenue), Fixed Costs, Variable Costs, Total Costs.

2. Draw and label a corresponding graph showing the following curves: Fixed Costs, Variable Costs, Total Costs and
Total Revenue.

Be sure to label each curve.

* Be sure to consider the range of data before choosing an appropriate scale.

 Table of Values
Sales (Units) Revenue Fixed Costs Variable Costs Total Costs

0 0 3,400 0 3,400

20 2,000 3,400 300 3,700

40 4,000 3,400 600 4,000

60 6,000 3,400 900 4,300

80 8,000 3,400 1,200 4,600

100 10,000 3,400 1,500 4,900

Sales Revenue Fixed Variable Total
Units Costs Costs Costs

0 0 3,400 0 3,400
20 2,000 3,400 300 3,750
40 4,000 3,400 600 4,000
60 6,000 3,400 900 4,300
80 8,000 3,400 1,200 4,600
100 10,000 3,400 1,500 4,900
Profit Loss
 Break Even Point
 Level of sales where Total Revenue = Total Costs

(Net Income = 0)

 Total Revenue = Total Expenses

 No Profit No Loss Zone

Fixed Costs

Selling price per unit – Variable costs per unit

i.e. Contribution per unit

 Break Even Point
 volume of sales business needs to cover costs

 work out the contribution made from the sale of each unit

 amount of money each unit sold contributes to pay for

fixed and indirect costs

Contribution = Selling Price - Variable Cost per unit

 Example: Break Even for Output (Units)
Fixed costs

Contribution per unit

A product sells for $15 and has variable costs per unit of $11.

Contribution = $15 - $11 = $4

Each unit sale therefore makes a contribution of $4 towards fixed costs

If business had fixed costs of $20,000, it would need to sell 5,000 units to break even

$20,000/4 = 5,000 units

 Let’s Practice
Stanley Bostitch Inc. manufactures and sells staplers. The annual

fixed expenses to run the business are $15,000 and variable

expenses are $7.50 per unit. The selling price of the staplers is $15

per unit.

Calculate the number of staplers they must sell in order to break

even.
 Solution
15,000
7.5 = 2,000 units

Therefore Stanley Bostitch Inc. must sell 2,000 staplers in order to break
even.

2,000 x $15.00 = $30,000

Stanley Bostitch Inc. must earn $30,000 in sales revenue in order to break
even.
Break Even: Sales Revenue

Fixed Costs x Price Per Unit

Contribution per unit

 Let’s Practice

KBC Ltd produces cakes involving variable

costs of $2. Each cake is sold for $6. Fixed costs

amounted to $200,000.

Calculate break even in terms of sales revenue.

Solution
$200,000 x $6

$4 = $300,000

Therefore KBC Ltd must sell $300,000 in cakes in

order to break even.
 Margin of Safety
Actual/Current/Planned Output – Break Even Output

Actual/Current/Planned Sales – Break Even Sales

 Planned sales were thought to be 6,000 units

 Break even output = 5,000 units

MOS = 6,000 units – break even 5,000 units = 1,000 units.

Therefore, the business would be able to sell 1,000 less than planned before they are in
danger of making a loss.
Let’s Practice
The following data relates to OPQ Enterprises for the Month of June 2015.

Sales (3,500 units @ $20/unit): $70,000

Contribution margin per unit: $12
Total fixed expenses for the month: $15,000
There was no opening and closing finished goods inventory in stock

Calculate margin of safety for the OPQ Enterprises.

 Solution
Break-even sales:

$15,000

$12 = 1,250 units

$70,000 – $25,000 (1250 x $20) = $45,000

Therefore, OPQ Enterprises can sell $45,000 less than planned before
they are in danger of making a loss.
 Break Even Charts
 plots the sales revenue, fixed costs, variable costs, total costs and helps identify the break
even point (BEP) and margin of safety.

To Draw:
1. Create Table of Values showing all costs and revenue: Fixed, Variable, Total Costs,
Total Revenue.

2. Label the vertical axis "sales and costs $“ and horizontal axis "sales/production
(units)".

3. On another piece of paper sketch the scales that you want to use given the data,
then use this plan on the chart (refer to table).
 Break Even Charts
5. Plot any two points from sales revenue data for sales revenue line and draw straight line for sales
revenue (assumes that the price per unit does not change) – if the information is not given for sales
revenue, then work out two points, e.g. for 1000 units sold and 1500 units sold. The start of the
line should be through the origin (where the axes meet – zero units sold = zero revenue earned).

6. Draw a horizontal line for total fixed costs starting at point on vertical axis at level of costs.

7. At the same starting point it is possible to draw total costs line. TC= FC + VC.
Work out what TC are for say 1000 units and 1500 units. Draw straight line starting at the same
point as FC started and then through the two plotted points.

8. Where sales revenue crosses the TC line = BEP. Read off the units of sales to give break even level
of sales.

9. Gap between TC line and sales revenue line after BEP represents level of profit.
Table of Values
Sales (Units) Revenue Fixed Costs Variable Costs Total Costs

0 0 3,400 0 3,400
20 2,000 3,400 300 3,750
40 4,000 3,400 600 4,000
60 6,000 3,400 900 4,300
80 8,000 3,400 1,200 4,600
100 10,000 3,400 1,500 4,900

BEP = Fixed Costs/Contribution

Contribution = Selling Price – Variable Costs per unit

3400/(100 – 15) = 40 calculators ($4,000)

Break even
point
 Profits

Break even
point

Loss
 Profits

Break even
point

Loss
Margin of Safety
 Contribution Margin Output/Sale Revenue for Desired Profit

Unit sale for target profit = Fixed Costs + Target Profit

Contribution per unit

Fixed Costs + Target Profit X Selling price

Sales Revenue for target profit =
Contribution per unit
 Question 1
HK company manufactures product X. A unit of product X is sold to customers
for $80. The per unit variable expense and the total expected fixed expenses for
the first quarter of the year 2012 are as follows:

Variable expenses to manufacture and sell a unit of product X: $50

Total fixed expenses for the first quarter of the year 2012: $40,000

The company wants to earn a profit of $80,000 for the first quarter of the year
2012.
 Question 2
GHI Co Ltd. incurs fixed costs of $1m and variable costs of
$5 per unit for each marker they sell. The selling price for
each marker is $10. It is aiming to gain a profit of $200,000.

Calculate the amount of units GHI must produce to gain

this amount of profit.
Question 3
The information below has been extracted from the books of Fruitalicious Ltd:
Sales $20 000
Direct material per unit $20 Question 4
Direct labour per unit $10
Total fixed cost $8,500
100 units of the product were sold in the period.

1. Determine the following:

i. Number of units required for breakeven (3 marks)
ii. Breakeven point in sales (3 marks)
iii. Margin of safety (3 marks)

2. Use the information to plot the breakeven chart. (8 marks)

 2016 Q 2a, c
Edwards’ Air Conditioning must reduce its operating expenses in order to
remain profitable. The production manager is required to keep production
cost at a manageable level. He wants to outsource one of the components of
the manufacturing process. He also wants to determine the indirect costs.

(a) Differentiate between ‘direct costs’ and ‘indirect costs’. [4 marks]

(c) Discuss THREE reasons why it is important for Edwards’ Air

Conditioning to keep its production cost at a manageable level. [12 marks]
 2018 1c

Discuss THREE ways in which the business could reduce the rising indirect
operating costs. (12 m)