chapter 8

Step costing aims to provide a more complete cost breakdown by gradually calculating the surplus in steps, allowing for a detailed understanding of contribution margins at different levels.

CM1 is calculated as the contribution margin per product (per liter) using contribution costing, which is the difference between revenue and specific costs for each product.

CM3 represents the total contribution margin for product groups, calculated by taking the total contribution margin from each product group and subtracting their specific costs.

The expenditure is recorded in the company's bookkeeping system, and at the same time, the income is recorded for the supplier.

A cost is recognized when the resources are consumed in the company's production of a product that has been sold and delivered to a customer.

Expenditure is recorded when an invoice is received or paid, while cost is allocated to a future period when the resource is consumed.

Challenges include determining the quantity of materials used for a specific product, hours spent on production, and the reliability of reported data.

The term is 'cost of goods sold'.

As activity volume increases, variable costs also increase. They are directly related to the level of production or output, meaning that the more products produced, the higher the variable costs incurred.

Step costs are a type of fixed cost that remains constant within a certain range of activity but can increase to a higher level when the activity exceeds that range. For example, if a manufacturing plant expands due to increased production, the fixed costs will jump to a new level, creating a new relevant range where they remain fixed again.

In linear variable costs, total variable costs increase linearly from 0 to 40,000 as the number of units produced increases from 0 to 400, while the unit cost remains constant at 200.

In progressive variable costs, total variable costs increase exponentially from approximately 0 to 40,000 as the number of units produced increases from 0 to 400, while the unit cost increases from approximately 100 to 400.

In regressive variable costs, total variable costs increase logarithmically from 0 to approximately 40,000 as the number of units produced increases from 0 to 400, while the unit cost decreases from approximately 200 to 100.

A break-even chart illustrates the relationships between total revenues and total costs (both fixed and variable), showing how revenues are proportional to activity volume and how total variable costs relate to production levels.

The break-even point, or critical volume, is where total revenues exactly equal total costs, indicating no profit or loss.

Total costs are calculated using the formula: Total costs = Fixed costs + (Variable costs/unit * Volume).

The safety margin represents the difference between real volume and critical volume, indicating how much sales can drop before reaching the break-even point.

In the break-even chart, total revenues and total variable costs are linearly dependent on volume, although real-world scenarios may show a regressive revenue curve with increased sales volume.

Common costs must be subtracted from the total contribution margins to calculate company profit.

Direct costs are costs that can be traced directly to specific cost units, such as raw materials, production components, and labor for production employees. They are easily identifiable and directly linked to the manufacturing processes of products.

Indirect costs, also known as overhead costs, are costs that cannot be traced directly to specific cost units. They arise from departments or functions (cost centers) and include expenses for administration, sales, product development, machinery, and buildings. These costs must be allocated to cost units in a systematic manner.

Cost units refer to the goods or services produced by a company, while cost centers are the departments or functions where costs are incurred. Direct costs are traced from cost types to cost units, while indirect costs are allocated from cost centers to cost units, often using standardized overhead charges.

Specific costs are costs incurred as a result of specific actions, such as beginning production of a new product or processing an order for a particular product. In contrast, common costs are costs that are not affected by specific actions, such as machinery costs that remain unchanged regardless of production decisions.

Specific revenue refers to revenues that are affected by a specific action, particularly in product costing, it pertains to a product's sales price, which represents the additional revenue generated from the sale of that product.

A cost may be classified as a common cost in one situation and as a specific cost in another, depending on whether it is incurred as a result of specific actions or decisions being made.

A cost unit is the object (such as a product, project, department, or machine hour) for which a cost calculation is made.

Product costing helps a company determine the cost to produce a good or service, which is essential for setting prices and assessing profitability. It also aids in decisions regarding production methods and make-or-buy choices.

Contribution costing is a method where only specific costs are allocated to cost units, allowing for the calculation of each unit's contribution margin. This differs from other methods that may allocate all costs, including common costs, to the cost units.

Contribution margin (CM) = Specific revenue for the object - Specific costs for the object.

Business hotels may charge lower rates on weekends, where the revenue from renting a room at this lower rate can cover the room's specific costs (like cleaning) and contribute towards covering the hotel's common costs.

The total contribution margin should cover total common costs and ideally provide a profit.

Project 3 has a negative contribution margin of -50,000 SEK.

The total contribution margin for all projects is 1,250,000 SEK.

Specific costs at a particular level of the company can be common costs at a lower level; for example, costs associated with a product group may be considered specific for the company but common if viewed from a product level.

CM4 is the total contribution margin that the Beverage Division contributes to the company, calculated by summing the CM3 of all product groups and subtracting the Division's specific costs.

SEK 15

CM1 for Green is SEK 11, while CM1 for Black is SEK 25, indicating that Black has a higher contribution margin.

MSEK 9.63

SEK 30

750,000 liters

MSEK 5.21

The main disadvantage of contribution costing is that it only allocates specific costs to cost units, making it impossible to determine if all costs are covered at a certain price for the goods and services produced.

In full costing, direct costs are traced directly to cost units, while indirect costs (overhead) must be allocated among the cost units.

The full cost of a product is the sum of all costs until the product is delivered and payment is received.

The full cost to manufacture one chair is SEK 150, calculated by dividing the total costs of SEK 6,000,000 by the number of chairs produced, which is 40,000.

When a company manufactures multiple products, it becomes complex to conduct a cost analysis, requiring a systematic cost allocation method due to the difficulty in tracing costs to individual products.

SEK 800,000

Indirect costs for materials handling are calculated as 40% of SEK 400,000 for Easy Chairs (SEK 160,000) and 60% of SEK 400,000 for Office Chairs (SEK 240,000).

SEK 128.65

40% for Easy Chairs and 60% for Office Chairs.

SEK 540,000 for Easy Chairs and SEK 660,000 for Office Chairs, calculated as 45% and 55% of SEK 1,200,000 respectively.

SEK 3,427,000

The main components include:

Indirect administrative costs, also known as administrative overhead (AO), are costs associated with management and financial issues. They are often combined with sales costs and referred to as Sales and Administrative overhead (S&A).

Determining a basis for cost allocation is crucial as it helps to find a link between each cost and each cost unit, aiming to match the consumption of resources to each product as closely as possible.

Direct manufacturing costs are costs that can be directly attributed to specific products, such as equipment costs used exclusively for those products. Indirect manufacturing costs (overhead), like wages of equipment operators, must be allocated based on time worked per machine.

The absorption method for full cost allocation assumes that the relationships between direct and indirect costs for the company as a whole are also valid for each individual product, using the same overhead charges and bases for overhead charge across all products.

A company can calculate a materials overhead (MO) charge using the formula: MO charge = Total indirect material costs / Total direct material costs. For example, if total indirect material costs are 400,000 and total direct material costs are 2,000,000, the MO charge would be 20%.

Indirect manufacturing costs (overhead) can be expressed as a percentage of total direct labor costs. For example, if total indirect manufacturing costs are 1,200,000 and total direct labor costs are 2,000,000, the MgO charge is calculated as follows:

MgO charge = Total indirect manufacturing costs / Total direct labor costs = 1,200,000 / 2,000,000 = 60%.

The S&A charge is calculated using the formula:

S&A charge = Total indirect Sales & Administrative costs / Total Cost of Production.

For example, if total indirect S&A costs are 400,000 and total Cost of Production is 5,600,000, then:

S&A charge = 400,000 / 5,600,000 = 7.2%.

Manufacturing overhead costs are usually allocated based on direct labor costs (as a percentage of direct labor), but can also be allocated based on direct labor time or machine time.

Traditional costing methods are criticized for treating too many costs as indirect costs, which can lead to misallocations, especially when costs are allocated routinely to cost units.

ABC focuses on identifying and assigning costs based on activities rather than treating all indirect costs as varying with production volume, allowing for a more accurate reflection of resource consumption.

Costs should be allocated to cost centers where the bases for the overhead charge best reflect how the resources are consumed, avoiding automatic allocations.

ABC is based on a company's activities rather than its departments. Costs are incurred when activities are performed, not by organizational units.

Cost drivers in ABC are the dimensioning factors that determine the costs of activities at each cost center, such as the number of manufacturing orders or change orders.

The total indirect manufacturing costs of SEK 10 million are allocated based on the total direct labor hours. The MgO charge is SEK 1,000 per hour, which translates to 500% of direct labor costs.

The direct labor cost per chair for both Junior and Senior chairs is SEK 10, calculated from 0.05 hours of direct labor at a wage of SEK 200 per hour.

Junior is 135% more expensive than Senior when using ABC calculations.

Traditional costing allocates manufacturing overhead costs to all products by the same percentages, which can lead to high-volume products subsidizing low-volume products. In contrast, ABC allocates costs based on specific activities and their cost drivers, revealing significant differences in product costs.

Companies often find it difficult to make a complete breakdown of the costs of all activities and their cost drivers. Many retain parts of their direct cost allocations and allocate remaining indirect costs in a traditional manner.

Critics claim that there are no significant differences between traditional costing methods and ABC, arguing that ABC merely introduces more cost allocation bases and is a refined method of allocating indirect costs.

The choice of costing methods is determined by the decision situation, which dictates the most logical cost unit for the calculation. Companies may need to calculate profitability for different markets, segments, or product designs, and the appropriate cost allocation base may vary depending on the activity, such as time or machine hours.

The change in cost allocation principles led to:

1. Increased costs: Research activities requiring large floor space became more expensive.
2. Reduced usage: Fewer researchers utilized facilities due to higher costs.
3. Shift in research focus: Researchers turned to projects that required less physical space, prioritizing theoretical simulations over practical research.

Follow-up costing is used to check the accuracy of cost estimates by comparing actual costs incurred during production with the estimated costs. It requires detailed information from the company's cost accounting system regarding resource consumption and performance analysis.

Efficiency analyses require data on the number of units produced and the estimated material costs per unit to determine how efficiently resources were utilized during production.

The possible explanations for the cost differences include:

1. Production problems such as untrained staff or machinery malfunction leading to material damage or waste for Easy Chairs.
2. Incorrect cost estimates due to overly optimistic assumptions about materials usage or time required for manufacturing.

A disadvantage of the contribution costing method is that not all costs are allocated to the cost units, which may lead to incomplete cost assessments.