Revision Notes
Revision Notes: Cost Accounting
Condensed revision notes for Chapter 7 Cost Accounting, covering types of cost and Work in Progress, preparing the Manufacturing Account, and Break-Even Analysis by calculation and graph.
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Concept of Cost and Types of Cost
- Cost is the monetary value of economic resources sacrificed to produce a good or service.
- Direct cost can be traced directly to the product (e.g. direct material, direct labour); indirect cost cannot be traced directly (e.g. factory rent, machine depreciation).
- Total fixed cost stays the same whatever the output (e.g. rent, supervisor salary); variable cost changes with output quantity (e.g. raw materials, per-unit wages).
- Overhead cost is all indirect factory costs: indirect materials, indirect labour and indirect expenses.
Components of Production Cost and Formulas
- Direct Material Cost = Opening raw material stock + Raw material purchases + Carriage inwards − Closing raw material stock.
- Direct Labour Cost is the wages of workers directly involved in production; Direct Expense Cost is any other direct expense such as special machine hire or royalties.
- Prime Cost = Direct Material Cost + Direct Labour Cost + Direct Expense Cost.
- Production Cost = Prime Cost + Overhead Cost (then adjusted for Work in Progress).
- Remember the order: Direct Material → Prime Cost → add Overhead → adjust WIP → Production Cost.
Work in Progress (WIP)
- Work in Progress is goods that are still partly finished on a given date: production has started but is not yet complete.
- Opening WIP is the partly finished balance at the start of the period; Closing WIP is the partly finished balance at the end of the period.
- Adjustment: add Opening WIP and deduct Closing WIP after Prime Cost + Overhead to obtain Production Cost.
- Reason: Opening WIP is completed within this period (so added), while Closing WIP is not yet finished (so deducted).
Manufacturing (Production) Account
- The purpose of the Manufacturing Account is to determine the total production cost of finished goods in an accounting period.
- It can be prepared in 'T' form (debit = costs, credit = transfer) or statement format (vertical, top to bottom).
- The Production Cost obtained is transferred to the Trading Account in place of 'Purchases' for a manufacturing firm.
- Justifying the allocation: factory-related costs go to the Statement of Production Cost; selling, administrative and finance costs go to the Income Statement.
Break-Even Analysis: Concepts
- Break-Even Point (BEP) is the sales level where Total Revenue = Total Cost, i.e. the firm makes neither profit nor loss.
- Contribution Margin is what remains of sales revenue after deducting variable cost; it is used to cover fixed cost and generate profit.
- Total Cost = Fixed Cost + Variable Cost; Variable Cost = variable cost per unit × quantity; Total Revenue = selling price per unit × quantity.
- Contribution Margin per Unit = Selling Price per Unit − Variable Cost per Unit.
Contribution Margin Method and Target Profit
- BEP (units) = Total Fixed Cost ÷ Contribution Margin per Unit.
- Quantity for target profit = (Fixed Cost + Target Profit) ÷ Contribution Margin per Unit.
- Profit = (Quantity sold × Contribution Margin per Unit) − Fixed Cost.
- If one component changes (selling price, variable cost or fixed cost), recompute contribution margin per unit first, then recompute BEP.
- A higher selling price or lower variable cost raises the contribution margin and lowers the BEP (units).
Graphical Method of Break-Even Point
- The horizontal axis (x) represents quantity (units); the vertical axis (y) represents money value (RM) for revenue and cost.
- Draw three lines: the Fixed Cost line (horizontal), the Total Cost line (starting from fixed cost), and the Total Revenue line (starting from zero).
- The BEP is where the Total Revenue line intersects the Total Cost line; read the quantity on the x-axis and the value on the y-axis.
- The area to the right of the BEP (revenue above cost) is the profit zone; the area to the left (cost above revenue) is the loss zone.
- Profit at any quantity = the vertical gap between the Total Revenue line and the Total Cost line at that quantity.
| Item | RM | RM |
|---|---|---|
| Direct Material Cost | ||
| Opening raw material stock | 5,000 | |
| Add: Raw material purchases | 30,000 | |
| Less: Closing raw material stock | -4,000 | |
| Direct Material Used | 31,000 | |
| Direct Labour Cost | 20,000 | |
| Direct Expense Cost | 3,000 | |
| Prime Cost | 54,000 | |
| Add: Overhead Cost | 16,000 | |
| 70,000 | ||
| Add: Opening WIP | 8,000 | |
| 78,000 | ||
| Less: Closing WIP | -6,000 | |
| Production Cost | 72,000 |
The Production Cost of RM72,000 is transferred to the Trading Account.
Why is Opening WIP added but Closing WIP deducted in computing Production Cost?
Opening WIP is partly finished work completed within this period, so its cost must be included (added). Closing WIP is not yet finished at period end, so its cost is removed (deducted) from the cost of finished goods produced.
How is the BEP calculated using the Contribution Margin Method?
First find Contribution Margin per Unit = Selling Price per Unit − Variable Cost per Unit. Then BEP (units) = Total Fixed Cost ÷ Contribution Margin per Unit. For example, if fixed cost is RM20,000 and contribution margin per unit is RM5, the BEP = 4,000 units.
What is the difference between the cost and revenue lines in a BEP graph?
The Total Revenue line starts at the origin (0,0) because no sales means no revenue. The Total Cost line starts at the Fixed Cost level on the y-axis because fixed cost is incurred even at zero output. The intersection of the two lines is the BEP.
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