Lecture 8 – Cost classification and cost behaviour
Management accounting – Decision making for managers
What is cost behaviour?
Study of how the activities of an organisation affect its costs
Marginal cost (Variable) – Variable cost of producing one more unit, this categorises
costs by the way they behave they can either be variable or fixed
Cost Analysis
Direct cost – Incurred for specific purposes directly related to the product
Indirect – Costs which cannot easily be identified with a product
Fixed costs – Remain fixed in short/medium term irrespective of activity
Variable costs – vary with level of activity (Increase production = increase VC)
Semi variable cost – e.g. electricity such as a standing charge every day then charged
on how much you used
Total Costs graph
Total Costs
VC – Change according to output
Fixed Overheads – Remain the same despite output
Sales Revenue Graph £ against volume
Total Revenue
Total Costs
PROFIT
Margin of
Safety
Fixed costs
BREAK EVEN UNITS Current Sales
Where Total revenue cross total cost = break even – further from that point the business
make a profit
If the fixed costs decreases causes shift to the left meaning business can sell less and still
break even
The different between current sales and break even units shows the margin of safety
How to work out the break even point?
Break even = fixed overhead/ contribution per unit
Contribution is = Sales – variable cost of sales
Contribution per unit = Selling price – VC
A street vendor selling newspaper pays £45 per day for the stand. This is a fixed cost and must
be paid each day regardless of whether any papers are sold or not. The vendor pays £0.15
each for the Newspapers, which are then sold for £0.40.
1. How much is the contribution?
2. How many papers must be sold to break even
Contribution = 0.40 – 0.15 = 0.25 contribution per newspaper
Break even = Fixed costs/contribution per unit. =. 45/0.25 = 180 newspapers to break even
What is profit volume ratio?
P/V Ratio = Contribution per unit/selling price
0.25/0.40 = 62.5% or 0.625
We can use this value to work out a break even point for revenue
Fixed costs/PV = Revenue for break even
45/0.625 = £72 of revenue needed to break even
What is a margin of safety?
This is the amount sales can fall by before the business begins to make a loss.
MOS = Current sales – Break even sales/current sales volume
A street vendor selling newspaper pays £45 per day for the stand. This is a fixed cost and
must be paid each day regardless of whether any papers are sold or not. The vendor pays
£0.15 each for the Newspapers, which are then sold for £0.40.
If the vendor is currently selling 400 papers per day what is the margin of safety
400 – 180/400 = 55% is the margin of safety for the business
How to work out sales required to reach a target?
If the business knows the contribution per unit which is Sales – variable cost of sales it can
work out how much volume to sell to meet a goal.
Target Volume = Fixed Costs + Required profit/contribution per unit
What is a semi variable cost?
Mixture of fixed and variable areas, whereby FC stays the same but VC changes with activity.
Total VC = Variable cost per unit x No of units
Total costs = FC + VC
FC = Total Cost – TVC
What is the relevant range?
How many units does this hold true for, firms normal range of production
Absorption costing – Method which included apportionment of
overhead into the calculation of unit cost
In this method you want to calculate the full cost to do so unit cost must have DC and some
overheads
Full/Absorption cost = DC + Share of overheads
To find overhead per unit need to find the overhead absorption rate (OAR)
OAR = Budgeted overheads/Budgeted volume
Marginal costing – Categorises costs according to their behaviour,
only treats variable costs as product cost
Variable cost are treated as costs of the products and fixed costs are treated separately under
Period cost
Contribution = Sale price – VC
Total contribution = Contribution per unit x sales volume
Profit = Total contribution – Fixed overheads
The following data relate to questions 1-4
Sales Volume (units) 3,000
£
Sales Revenue £60,000
Variable Costs:
Raw Materials £18,000
Direct Labour £12,000
Other Variable costs £6,000
Total Variable Costs £36,000
Contribution £24,000
Fixed Overheads £15,000
Net Profit £9,000
1. What is the company’s Break-Even Point in volume terms?
Break even point= Fixed overheads/ Contribution cost
Contribution = Sales prices – Variable cost of sales
60,000 – 36,000 = 24,000 = Total contribution
Contribution per unit = 24,000/3,000 = £8 per unit
15,000/ 8 = 1,875 units need to break even
2. What is the company’s Margin of Safety?
MOS = Current Sales – Break even sales/Current sales volume
3000 – 1875/3000 = 37.5%
3. What is the company’s Profit-Volume Ratio?
PV ratio = Contribution per unit/selling price
Selling price = Sales revenue/sales volume = 60,000/3,000 = £20
8/20 = 0.4 or 40%
4. If the company is aiming to make a profit of £18,000 what is its target volume?
Target volume = Fixed costs + Required profit/contribution per unit
15,000 + 18,000/8 = 4,125 units to make 18k profit
5.The following data relate to an outpatient’s department in a hospital:
Number of consultations (patients) 5,750
Total Fixed Cost (£) 25,875
Calculate the overhead absorption rate (OAR) per consultation.
OAR = Budgeted overhead/budgeted volume
25875/5750 = £4.5
1. Draw cost curves depicting each of the following independent sets of circumstances,
assuming that x and y are similarly scaled.
1. Fixed cost
2. Variable cost
3. Semi-variable cost
4. Step-costs (semi-fixed costs)
January 2018 Exam - Section A/Q7 – 6 marks
Year ended 31 March 2018: -
Fixed costs £150,000
Variable costs £300,000
Sales (50,000 units) £500,000
Required: Using the above information calculate the following: -
a) Contribution per unit
i. Contribution = Sales price – Variable cost price
ii. 500,000 – 300,000 = 200,000
iii. 200,000/50,000 = £4 per unit
b) Break-even point in units
i. BEP = Fixed Overheads/Contribution
ii. 150,000/4 = 37,500 units to break even
c) Margin of safety as a percentage
i. MOS = Current sales - Break even sales/Current sales
ii. 50,000 – 37,5000/50,000 = 25%
January 2018 Exam - Section A/Q8 – 6 marks
Briefly explain the following management accounting terms and provide an example for
each one: -
a) Fixed cost – A fixed cost is a cost that stays the same regardless of sales volume for
example this could be rent for a factory
b) Variable cost – A variable cost is a cost that fluctuates with the amount of volume a
business has produced this could be raw materials
c) Semi -variable cost – A semi variable cost is a cost which has a fixed period for an
initial output but then has a positive correlation with output this could be a basic wage plus
a commission wage
January 2019 Exam - Section A/Q7 – 6 marks
Year ended 31 March 2018:-
Sales (35,000 units) £560,000
Variable costs £175,000
Fixed costs £77,294
Required: using the above information calculate the following:
a) Contribution per unit
i. Contribution = Sales price – Variable cost price
ii. 560,000 – 175,000 = 385,000
iii. 385,000/35,000 = £11 per unit
b) Profit-volume ratio (expressed as a percentage)
i. PV ratio = Contribution per unit/selling price
ii. Selling price = 560,000/35,000 = £16 selling price
iii. 11/16 = 0.6875 or 68.75%
c) Target volume required to make a profit of £19,000
i. Target = Fixed costs + profit/contribution
ii. 77,294 + 19,000/11 = 8754 units
January 2018 Exam - Section B/Q1 (TOTAL 20 MARKS)
Recruit Highway Ltd can deliver three different types of service (3 star, 4 star and 5 star)
using the same staff. Various estimates for next year have been made as follows:
Service 3 star 4 star 5 star
Selling price (£/unit) 25 35 42
Variable material cost (£/unit) 11 16 20
Other variable costs (£/unit) 5 8 10
Share of fixed cost (£/unit) 3 6 9
Staff time required (hours) 1 2 3
Fixed cost for next year is expected to total £35,000.
Required:
(a) If the business were to deliver only the 3-star service next year, how many units of the
service would it need to provide in order to break even? (2 marks)
BEP = Fixed overheads/Contribution
Contribution = Sales price – variable cost
25 – 16 = 9 per unit
35,000/ 9 = 3,889
(b) If the business has limited staff hours available next year, in which order of
preference would the three services come? (12 marks)
(c) The maximum market for next year for the three services is as follows:
3 star 3,500 units
4 star 1,800 units
5 star 5,400 units
(d) Recruit Highway Ltd has a maximum of 12,000 staff hours available next year. What
quantities of each service should the business provide next year and how much profit
would this be expected to yield?
