Marginal/decision costing
Sunk costs and other excluded costs
Activity-based costing
Calculating labour and machine costs
Depreciation and amortisation
Marginal (Decision) Costing
Also known as variable, direct and decision costing
Basic principle: cost = direct costs only
Direct costs:
Salaries/wages
Raw materials
Plant hire
Other costs are generally omitted:
Overheads
Money spent before the project starts (“sunk costs”)
Indirect costs
Marginal Costing Example
4,000 4,000 4,000 4,000 4,000 Overhead 5,400 3,400 7,200 10,500 11,000 Subtotal 600 600 3,000 6,000 5,000 Materials 4,800 2,800 4,200 4,500 6,000 Labour cost 32 28 28 30 30 Rate/hour 150 100 150 150 200 Labour hours Project 2 4,025 2,025 3,500 3,700 3,500 Total Cost 2,000 - 1,000 1,200 1,000 Materials 2,025 2,025 2,500 2,500 2,500 Labour cost 27 27 25 25 25 Rate/hour 75 75 100 100 100 Labour hours Project 1 5 4 3 2 1 Period Marginal costing is usually (though not always) straightforward. Unlike the previous example, we simply ignore overheads.
Marginal Costing: Pros & Cons
Advantages
Simple
Data relatively easy to collect or estimate
Easy to compute
Avoids allocation problem
Forward-looking
Tends to be less controversial with users
Avoids distortions due to incorrect absorption Disadvantages
Ignores many realities, e.g.
Sunk costs
Indirect and knock-on costs
Understates the true cost
Can lead to bad decisions
e.g. “throwing good money after bad”
Basic principle:
cost = direct cost + indirect driven cost
Overhead is allocated according to:
labour hours/costs
machine hours/costs
materials cost
direct costs
ABC is offered as more accurate/meaningful
A better basis for decisions
ABC Versus Absorption
€75.00 €47.50 Cost/unit €25.00 €12.50 Per unit €37,500 €12,500 Overhead allocation 1,500 500 Hours Overhead €50,000 Labour cost/hour €20 1.0 0.5 Labour hour/unit 30 25 Materials/unit (€) 1,500 1,000 Units Y X Illustration using an industrial example
A company produces two products X and Y
Using traditional cost accounting:
ABC Versus Absorption
Number of customers for product € 5,000 Packaging Time required to clean after production €10,000 Plant cleaning Number of inspections €25,000 Quality inspections Number of set-ups €10,000 Machine set-ups Cost driver Cost Task ABC considers what drives the overheads
Assume these are made up as follows:
The following data are gathered:
ABC Versus Absorption
75.00 47.50 Absorption cost/unit 60.33 69.50 Cost per unit 10.33 34.50 Per unit 1,500 1,000 Units 15,500 34,500 Total 4,000 4 1,000 1 1,000 Packaging 2,000 2 8,000 8 1,000 Cleaning 7,500 3 17,500 7 2,500 Inspections 2,000 1 8,000 4 2,000 Set-ups ABC (€) Product Y ABC (€) Product X Cost (€) Activity
Costing Detail: People
Important to cost labour accurately
e.g. how much does an engineer cost per hour?
Total cost includes:
Salary
Social welfare cost
Pension cost
Office costs (if relevant)
Other non-people support costs
Training, etc.
We also need to know time worked, based on:
Standard hours per year
Non-working time: holidays, training time, illness, etc.
Costing People - Example
Joe is paid €36,400 p.a. and works a 35-hour week (1,820 hours/year)
Gives an hourly cost of €20
But:
Joe’s pension, social welfare and perks add another €4,000
Joe works only 1,155 hours a year
4 weeks annual leave plus 10 days of public holiday
one week’s sick leave
one week’s training
and Joe effectively works about 6 hours in every 8
1155 hours @ €40,400 ≈ €35 per working hour
Costing Detail: Machine Hire
Maximum time available Planned time available Available time Normal time available Not worked Planned running time Changeovers Actual running time Machine
down time Obviously, this does not matter if it is a fixed cost.
Depreciation/Amortisation
Rationale
Assets cost money
Physical assets will be used up through wear and tear, depletion, loss of value, etc.
This usage is known as:
“depreciation” (for equipment)
“amortisation” (for wasting assets e.g. mines, quarries)
Basic methods:
Straight line
Declining balance
Sum of digits
Double declining balance
Plant and Machinery Costing
Total cost Depreciation Maintenance
Straight Line Depreciation
€ 0 €50,000 4 € 50,000 €50,000 3 €100,000 €50,000 2 €150,000 €50,000 1 Balance Charge Year Based on no. years over which asset will be written off
Machine press bought for €200,000, written off over 4 years
Therefore, depreciation charge is 25% per year
Pros: simple to compute; writes off assets cleanly (no residual balance problem)
Cons: not always realistic
Declining Balance Depreciation
Year Charge Balance
1 €50,000 €150,000
2 €37,500 €112,500
3 €28,100 € 84,400
4 €21,100 € 63,300 Write off same % of residual balance each year
press may be written off over infinite no. of years
may therefore need a termination year
e.g. write down press over 4 years at 25% p.a.
Pros: relatively easy to compute; realistic for many assets
Cons: Problem of residual balances
Sum of Digits Depreciation
€ 0 €20,000 4 € 20,000 €40,000 3 € 60,000 €60,000 2 €120,000 €80,000 1 Balance Charge Year Combines exponential and a clean write-down
Example: assume 4-year write-down
Add the digits in the no. of years: 1 + 2 + 3 + 4 = 10
Take the write-down in order: 4/10, 3/10, 2/10, 1/10
Pros: Approximates declining balance; no residual balance problem
Cons: More complicated to compute
Double Declining Balance Depreciation
0 0 10 0 0 20,000 20,000 9 920 920 20,000 40,000 8 20,000 21,920 20,000 60,000 7 20,000 41,920 20,000 80,000 6 20,000 61,920 20,000 100,000 5 20,000 81,920 20,000 120,000 4 20,480 102,400 20,000 140,000 3 25,600 128,000 20,000 160,000 2 32,000 160,000 20,000 180,000 1 40,000 200,000 20,000 200,000 0 Charge Balance Charge Balance Year DDB SL Start with a straight line (say four years)
Compute % depreciated (10%) and double it (20%)
Depreciate with declining balance method at this rate until charge is less that it would be using straight line
Use straight line value from there on
Shared Costs
Costs shared with other activities
e.g. Machines used part of the time
Part-time staff
Shared overheads
e.g. Management
Insurance
Not always clear how to account for shared costs
Comments