Basic cost manual

Manufacturing Cost: Other elements are incorporated into the manufacturing or transformation process. Here, an additional process is generally added to the raw material and a different product is obtained from the one that had been purchased. Each company, when making its own products, then has the Manufacturing Cost, which is generated in the production process of a certain product.

3.2           Elements of Cost

The cost elements of a product or its components are materials, labor, and manufacturing overhead. This classification provides management with the information necessary for measuring revenue and pricing the product.

Materials: They are the main resources used in production, these are transformed into finished goods with the addition of direct labor and indirect manufacturing costs. The cost of materials can be divided into direct and indirect materials, as follows:

Direct materials: They are all those that can be identified in the manufacture of a finished product, are easily associated with it, and represent the main cost of materials in the production of the product. An example of a direct material is the lumber used in the manufacture of a bunk bed.

Indirect materials: They are those involved in the production of a product, but they are not direct materials. These are included as part of manufacturing overhead costs. An example is the glue used to build a bunk bed.

Labor: It is the physical or mental effort used in the manufacture of a product. Labor costs can be divided into direct labor and indirect labor, as follows:

Direct Labor: It is directly involved in the manufacture of a finished product that can be associated with it easily and that represents a significant cost of labor in the production of the product. The work of machine operators in a manufacturing company is considered direct labor. OR Person who polishes the wood and assembles the bunk.

Indirect labor: It is involved in the manufacture of a product that is not considered direct labor. Indirect labor is included as part of manufacturing overhead costs. The job of a plant supervisor is an example of this type of labor. (Shift Manager in the furniture store)

Overhead Manufacturing Costs: Used to accumulate indirect materials, indirect labor, and other overhead manufacturing costs that cannot be directly identified (in the final product) with the specific products. Examples of other manufacturing overhead costs are rent, power, heating, and depreciation on factory equipment.

Example: A company incurs the following costs in the manufacture of wooden tables.

Materials:

Oakwood                                                                           $150,000

Pinewood                                                                             $110,000

Glue                                                                                   $800

Screws………………………………………………………….        $1,000

Total……………………………………………………..        $261,800

Labor:

Woodcutters                                                                  $180,000

Table assemblers…………………………………….. $190,000

Sanders…………………………………………………………. $170,000

Supervisor…………………………………………………….. $20,000

Goalkeeper…………………………………………………………       $10,000

Total…………………………………………………………      $570,000

Others:

Factory lease……………………………………………… $70,000

General factory services……………………………… $20,000

Office lease………………………………………………. $16,000

Office salaries………………………………………………. $80,000

Factory equipment depreciation……………………………… $21,000

Office equipment depreciation………………………………       $8,000

Total…………………………………………………………      $215,000

Grand Total…………………………………………………….       $1,046,800       

product elements

                                                            Materials Labor Indirect Costs Total Cost

                                                                      Direct from Manufacturing                                        Production

Oakwood $150,000 $150,000

Pinewood $110,000 $110,000

Glue $800 $800

Screws $1,000 $1,000

Woodcutters $180,000 $180,000

Table assemblers $190,000 $190,000

Sanders $170,000 $170,000

Supervisor $20,000 $20,000

Goalkeeper $10,000 $10,000

Factory lease $70,000 $70,000

General factory services $20,000 $20,000

Factory equipment depreciation    $21,000 $21,000                                                                                                      

      Total                                                $260,000          $540,000            $142,800       $942,000

Conclusion

Based on the above figures, the cost of direct materials would be $260,000.-, direct labor $540,000.-, and indirect manufacturing costs $142,800.-. These figures represent the product elements, as detailed above. Office lease, office salary, and depreciation of office equipment are not included as product costs because they are not product cost elements. They usually appear as deductions from gross profit on the income statement as Selling and Administrative Expenses. The $942,000.- of the total cost of the product will appear as the main component in a manufacturer’s statement of cost of goods manufactured.

The classification of the cost that is based on the relationship with the product will change as the product and/or service varies. For example, lumber is a direct material cost when used in the manufacture of wooden furniture. However, sawn lumber is an indirect material cost when used in packaging for the shipment of equipment. The maintenance personnel (porter, watchman) of a manufacturing plant is an indirect labor cost, their function is not directly related to production. However, in a company that provides maintenance service to other people, maintenance personnel is considered a direct labor cost.

Exercise: Chocolates Chip Company uses the following costs to produce its chocolate chip cookies. Determine direct and indirect materials, direct and indirect labor, and manufacturing costs, also shown as elements of a product.

White flour $25,000.- Sugar $20,000.- Chocolate flakes $18,000.- Solvent to clean machines $5,500.- Pastry Chef $15,000.- Partially hydrogenated soybean oil $4,500.- Machine lubricants $1,200.- Assistant Pastry chef $6,000.- Eggs $10,000.- Stickers for cookie boxes $4,000.- Local rent $45,000.- Machine depreciation $15,000.- Skimmed milk $7,500.- Local vendor $9,000.-

Materials:

$

$

$

$      

Total……………………………………………………..        $ 

Labor:

$

$

$

$

$ 

Total……………………………………………………      $ 

Others:

$

$

$

$

$

$ 

Total……………………………………………………      $ 

Grand Total…………………………………………………….       $

product elements

Materials Labor Indirect costs Total cost

        Direct from Manufacturing          Production

Total                                   $                          $                             $                       $                  

3.3 Types of Costs

Relationship with Production: Costs can be classified according to their relationship with production, this classification is closely related to the cost elements of a product and the main objectives of planning and control.

The two categories, based on their relationship to production, are prime costs and conversion costs.

Prime Costs: Direct materials and direct labor. These costs are directly related to production.

Conversion costs: These are those related to the transformation of direct materials into finished products. Conversion costs are direct labor and manufacturing overhead costs.

Relationship to Volume: Costs vary according to changes in production volume. Understanding their behavior is vital in almost all aspects of product costing, performance evaluation, and managerial decision-making. Costs concerning volume are classified as variable, fixed, and mixed.

Variable Costs: These are those in which the total cost changes in direct proportion to changes in volume, or production, within the relevant range, while the unit cost remains constant.

Fixed Costs: These are those in which the total fixed cost remains constant within a relevant range of production, while the fixed cost per unit varies with production.

MIXED COSTS: These costs have the characteristics of fixed and variable, along various relevant ranges of operation. There are two types of mixed costs: semi-variable costs and step costs.

Semi-variable costs: The fixed part of a semi-variable cost usually represents a minimal charge for making a certain item or service available. The variable part is the cost charged for actually using the service. For example, most charges for telephone services consist of two elements, a fixed charge for allowing the user to receive or make telephone calls, plus an additional or variable charge for each telephone call made.

Example: A company rents a delivery truck with a constant charge of $2,000.- per year plus $0.15 for each km traveled. If it travels 10,000 km in a month, the total annual cost of the delivery truck will be calculated as follows:

Fixed charge (fixed component)……..…………………………………… $ 2,000.-

Charge per km (variable component) (10,000 x $0.15)…………     $1,500 .-

Total Cost…………………………………………………………    $3,500 .-

Step cost: The fixed part of step costs changes abruptly at different levels of activity since these costs are acquired in indivisible parts.

Example: The salary of a supervisor is $30,000.- for every 10 workers. If 15 workers are employed, two supervisors will be needed, however, if the number of workers is increased to 23, three supervisors would be needed.

Workers Supervisor Step cost

10 1 $30,000.-

15 2 $60,000.-

17 2 $60,000.-

21 3 $90,000.-

24 3 $90,000.-

ABILITY TO ASSOCIATE COSTS

According to the degree of intervention in manufacturing processes, two types of costs are distinguished:

Direct Costs: They are those that the company can associate with specific items or areas, and are directly involved in the production process. The direct materials and direct labor costs of a given product.

Indirect Costs: These are those that are not directly identified with the production process, but that are necessary for the product to be finished.

PERIOD IN WHICH THEY ARE CHARGED UPON INCOME

They can also be classified based on when they are charged against income. The two categories used are product costs and period costs.

Product costs: These are those that are directly and indirectly identified with the product. These are direct materials, direct labor, and manufacturing overhead costs. These costs do not provide any benefit until the product is sold, therefore, they would be invented until the completion of the product. When products are sold their total costs are recorded as an expense, called the cost of goods sold. (Cost of sale). The cost of goods sold is matched against revenue for the period in which the products are sold.

Period costs: These costs, which are not directly or indirectly related to the product, are not inventoried. Costs for the period are written off immediately since no cost-revenue relationship can be determined. The following are examples of the costs of the period, the salary of an accountant (administrative expenses), Electricity, Water, Telephone (general expenses), etc.

Exercises to do in Classes

No. 1) Sony SA produces car radios. The following cost information is available for the period ending December 31, 2003.

120. a) Materials used in production: $120,000.- of which $80,000.- were for direct materials.

90. b) Factory labor costs for the period: $90,000.-, of which $25,000.- were for indirect labor.

40. c) Indirect manufacturing costs for general services: $40,000.-
41. d) Selling, general and administrative expenses: $60,000.-

Calculate Prime Costs, Conversion Costs, Product Costs, and Period Costs.

Development:

Prime costs:

direct materials                                                              $

Direct labor $

Total prime costs                                                    $

Conversion costs:

Direct labor $

Manufacturing overhead                                         $

Total Conversion Costs                                        $

Product costs:

Direct material costs                                             $

Direct labor cost                                           $

Indirect manufacturing costs:

indirect materials                 

Indirect labor             

General services                                                       $

Total product costs                                           $

Costs of the period:

Selling, general and administrative expenses.                              $ 

Nº 2) Soprole presents the following information: the relevant range of the factory is 10,000 to 50,000 gallons of yogurt per month.

Monthly production (gallons)

January                                                                    $10,000

February                                                                 $15,000

March                                                                   $20,000

April                                                                      $22,000

May                                                                    $27,000

June                                                                     $40,000

Variable cost per gallon $5

The fixed monthly cost of $ 100,000.-

Calculate Total and unit variable cost, Total and unit fixed cost.

Nº 3)  Todo Pieles SA manufactures wallets and the following cost information is available for the period ending on December 31, 2003.

Materials used in the production of $82,000.- of which $78,000.- were considered direct materials.

Labor for the period was $71,500.- of which $12,000.- corresponded to indirect labor.

Indirect manufacturing costs due to the depreciation of the factory are $ 50,000.-

Selling, general and administrative expenses for $62,700.-

Calculate Prime Costs, Conversion Costs, Product Costs, and Period Costs.

3.4 Allocation Methods or How They Should Be Allocated to the Product 

To carry out a correct allocation of costs, it is necessary to keep in mind the aforementioned concepts, that is, those direct and indirect costs, and even more so the exhaustive separation that exists between cost and expense, which will be explained below.

– Cost:          Disbursement that is recovered with the sale of the product, since its elements have to be included in the sale price.

 -Expense:         Disbursement that is not recovered (loss), since it is a concept that does not constitute a cost element. For example, the cost of a telephone. 

Assignment of Materials: They must be assigned to the cost of the product through the acquisition price, that is, its cost will be the purchase cost, plus freight and other disbursements until it is made available for production.

Manpower Assignment: Manpower must be assigned using man-hours, which will be calculated from the total paid to each production person, divided by the hours worked in the month. This result gives us the value of work hours per worker. Then the total time spent in manufacturing will be multiplied by the hourly value and the labor cost will be obtained. This element becomes very relevant when proceeding to quote a product that involves a long period of work.

Assignment of Indirect Costs: These are difficult to qualify since their consumption is not truly accurate. But the same criterion of labor will be followed, therefore its allocation will be through the hour of work or consumption. Thus, the value per machine hour and the value per hour of energy and rents will be determined. 

ALLOCATION OF COSTS AND EXPENSES TO THE RESULTS OF THE COMPANY

(See PDF)

3.5 Cost of a kilo of ordinary bread.

Materials

It is based on the production of a quintal of flour with an average yield of 67 kg -in one hour of work.

Materials: It is valued according to the recipe: (Example)

1 qq. Flour $5,300

Salt $500

Butter                                                                                   $2,000

Total Materials                                                                     $7,800

Labor  (working time 72 hours)

Masterman cost 1 x $469 $469

Cost of assistant man 1 x 417                                       $ 417

Total Labor                                                                $ 886

Indirect Costs   (working time 72 hours)

Depreciation $260 x 1 hour $260

Electricity $31 x 1 hour                   $31

Total Indirect Cost                                                            $291

Total Cost of the Mix $ 8,977

Unit cost $8,977 / 67 $134

 Calculation of the Marketing margin

Sale price $ 360
( – ) Total cost                                                                             $ (134)

Utility $226

Marketing Margin in % 169 % Formula: Profit x 100

Total cost

In this hypothetical case, a margin of 169% of the cost has been determined, but in practice, it was possible to calculate a margin of 70% for ordinary bread and 69% for Easter bread.

3.6 Balance Point:

It is that point at which there is no utility, at which point total revenue is equal to total costs.

Then the following equality can be established:

TOTAL REVENUES = TOTAL COSTS

Three main conclusions can be drawn from this:

a) If in a period, there have been revenues of $1,500,000.- and the total costs have been $1,500,000. –, means that absolutely nothing has been won.

IT = CT, then, 1,500,000 = 1,500,000

b) Now if the income continues to be $1,500,000.- and the costs reached $500,000.-, it means that the company has earned $1,000,000.-

1,500,000 = 500,000, so 1,000,000 corresponds to profit.

c) Finally, if the total costs have been $2,000,000.-, our company has lost $500,000.-

1,500,000.= 2,000,000, then 500,000 correspond to a loss.

Determining the break-even point is of vital importance since the employer must keep in mind the volume of sales or minimum income to be generated in a work period.

Breakeven analysis

A simple example will be used to introduce break-even analysis and cost-volume-profit analysis. Mrs. Maria Ramos, a housewife, wants to start a business in which she would sell a cosmetic case, developed and patented by her.

Ms. Maria did a good job of researching to determine if the business would be profitable. Regarding cost, and based on her discussions with real estate agents, she discovered that the cost of renting an office suitable for her business needs would be approximately $1,200 per month or $14,400 per year. The rent will include all the services, except the expenses of the telephone and the furniture of the office. She estimated that the telephone expenses would be about $1,800 per year, this cost does not vary with the level of sales as long as sales do not exceed $100,000 per year. She also estimated that it would cost $13,800 a year to hire one person on Fridays to perform all the secretarial duties and keep the books. An independent manufacturer of cosmetic products has agreed to manufacture your cosmetic kit for $1 per unit. Maria was confident that she could sell each unit for $9.

Maria must now decide whether to start her business or not. Although she has a great talent for cosmetics, she does not trust her ability to make business decisions, so she decided to seek professional help from her nephew Mario, who is an accountant.

She summarized all the information for Mario as follows:

Annual rent $14,400

Annual telephone expenses are $1,800

Employee cost on Fridays is $13,800

Cost per case $1

The sale price per case is $9

Mario was a very skilled accountant, he responded that he could not recommend starting her business without knowing approximately the number of compact cases she expected to sell.

Why?, she said, Mario explained to his aunt that, regardless of the number of cases he sold, he would incur the fixed cost of the annual rent, the telephone cost, and the cost of the employee on Fridays. This total annual fixed cost would be $30,000 ($14,000 rent + $1,800 telephone + $13,800 secretary). Since $9 in revenue would be received from the sale of each case and the cost of buying one unit is $1, this means that a “profit” of $8 would be made for each unit sold.

Profit / Loss = Total Income – Total Cost

Profit / Loss = 9 – 1

Utility = 8

To break even, 3,750 units (30,000 / 8) must be sold to cover the full annual fixed cost value of $30,000.

Break-Even =                               Total Fixed Costs                           

(In units) Sales price per unit – Variable cost per unit

=  30,000

9 – 1

= 3,750 units

 Contribution Margin per unit

It is the surplus available to cover fixed costs and perhaps provide profit after sales have been used to cover variable costs. (Sales price per unit – Variable cost per unit)

To show that 3,750 is indeed the number of units that would not generate a profit, a simple income statement can be developed:

Total income ($9 x 3,750)                                                                          $33,750

(-) Costs:

Total Variable Costs ($1 x 3,750)                    $3,750

Total fixed costs                                                $      30,000

Total Costs                                                                                          $ (33,750 )

Utility                                                                                                      $              0

Ms. Maria was delighted, she was confident that she could easily sell more than the $3,750 cosmetic kits that were required to break even. Mario said, “there is something else we must analyze before you make your decision”.

Mario explained to his aunt that 3,750 was the amount needed to break even, but he expected her to be interested in making a profit. Ms. Maria responded that she hoped to earn at least $40,000 a year, or she wouldn’t be justified in wasting time starting this business. How much do I have to sell to get a profit of $40,000 before taxes? Mario explained that the sale of 3,750 units would be necessary to break even, but an additional 5,000 units would have to be sold to generate a profit of $40,000 before taxes. of tax. This means that sales must be at least 8,750 units to generate a profit of $40,000 before taxes.

Therefore, the number of units that must be sold to generate a target profit is as follows:

Sales to Achieve =   Target Profit + Total Fixed Costs

A target profit Contribution Margin per unit

(In units)

Sales to achieve =   $40,000 + $30,000

A target profit of $9 – $1

(in units

= 8,750 units

To show that 8,750 is indeed the number of units that would generate $40,000 of pre-tax profit, a simple income statement can be developed:

Total income ($9 x 8,750)                                                                          $78,750

(-) Costs:

Total Variable Costs ($1 x 8,750)                   $8,750

Total fixed costs                                                $      30,000

Total Costs                                                                                          $ (38,750 )

Utility                                                                                                      $     40,000

Income Tax Adjustments

It is easy to include income taxes in the analysis. The income tax rate constitutes a certain percentage of the profit before taxes. The formulas for the cost-volume-profit analysis presented above can be modified to include income taxes, as follows:

profit after tax

Sales to make a profit =                      1 – % Taxes + Total Fixed Costs

Target after-tax Contribution Margin per unit

(In units)

40,000

=         1 – 0.15 + 30,000

• – 1

= 9,632

To show that 9,632 is indeed the number of units that would generate $40,000 of after-tax profit, a simple income statement can be developed:

Total income ($9 x 9,632)                                                                          $86,688

(-) Costs:

Total Variable Costs ($1 x 9,632)                   $9,632

Total fixed costs                                                $      30,000

Total Costs                                                                                          $ (39,632 )

Profit before Taxes                                                                        $47,056

15% Income tax                                                                    $7,058

Profit after Taxes                                                                   $     39,998

Risk and Utility Analysis

A useful measure for management in profit planning is the maximum percentage by which expected sales can decrease and still generate a profit. This is known as the Margin of Safety and is calculated as follows:

The margin of Safety =   Expected Sales – Break-Even Sales

Expected sales

For example, Mrs. Maria expected to sell 7,000 units. Since the break-even point is 3,750 units, the margin of safety is:

Safety margin =      7,000 – 3,750

7,000

= 0.46 or 46%

therefore, as long as actual sales are not less than 46% of what was expected, Ms. Maria will make a profit.

Exercises to do in class:

Nº 1) ABC asked you to determine the level of sales that must be achieved to cover its fixed and variable costs. The selling price is $5, total fixed costs are $160,000, and variable cost per unit is $3.

Determine the break-even point in units and the simple income statement.

1. What is the break-even point in units?
2. Prepare income statements when sales are $500,000 and $000 (ignore taxes)
3. Determine the number of sales in units so that he earns an after-tax profit of $289,000.
4. What is the margin of safety for the company whose break-even point was calculated if expected sales are 000 units?

#2) A company knows that its variable costs per unit are $0.10 and its selling price is $0.50. Total fixed costs are $50,000.-

1. What is the break-even point in units?
2. Prepare income statements when sales are $31,250 and $750 (ignore tax)
3. Determine the number of sales in units so that he earns an after-tax profit of $30,000.
4. What is the margin of safety for the company whose break-even point was calculated if expected sales are 000 units?

 3.7 What are the costs?

It is important to keep in mind whether the unit costs of the different products are already manufactured or not. They represent only a reference parameter for decision-making, especially in sales prices and discount policies.

The determination of a manufacturing cost must allow the entrepreneur, among other things, the following:

• Set sale prices with certainty.
• Know your marketing margin.
• Know how much you are allocating to finance expenses that are not costs.
• Establish an adequate cost control and reduction policy.
• It allows a correct valuation of inventories of finished products.
• An adequate valuation of its elements for each cost item.

BIBLIOGRAPHY

• Ralp S. Polimeni and Frank J. Fabozzi  COST ACCOUNTING. Third Edition Concepts and Applications for Management Decision Making_____________________