28/11/2024

Costing Principles

Elements of Cost
Manufacturing a product
incurs different types of
costs. These costs are as
follows:
-Raw Materials
-Direct Labour
-Factory Overheads
Raw materials and direct
labour are Direct or Prime
Costs.
Factory Overheads are
Indirect Costs.

Other expenses incurred by

the entity are
-Administrative
expenses (salaries,
office expenses etc.)
-Selling and Distribution
expenses (advertising,
 depreciation of delivery
vehicles, sales staff
salaries, etc.)

The total cost of production

or manufacturing is
determined as follows:
$
Direct materials
xxx
Direct Labour
xxx
 Direct expenses
xxx
PRIME COST
xxx
Add: Factory
Overheads xxx
Total Production
Cost xxx
Cost Classification: Fixed
and Variable Costs
Costs can be classified as
either fixed or variable.
Fixed costs are those costs
which do not change as
output changes, for
example, rent. Conversely,
variable costs change as
output changes, for
example, direct materials
and direct labour.

Cost Centre
Cost centres are individual
parts of the business to
which costs can be
charged, i.e. the different
departments which make
up the entity. To ensure
operational efficiency of
each cost centre, a manager
is hired to oversee its’
operations on a day to day
basis, for example, a
human resource manager.

Unit Cost of production

The cost of production per
unit is calculated as
follows:
 Unit cost of production
= Total production cost
No. of units
produced

E.g. (pg. 352)

$
Direct materials
45000
Direct Labour
42000
 Direct expenses
9000
Prime Cost
96000
Add: Factory
O/heads 24000
Total Prod. Cost
120000

Production cost per

unit = Total Production
Cost
 No. of units
produced
= $120000
8000
= $15

Cost Plus Pricing

Cost plus pricing refers to
the costing method for
determining the selling
price of goods/services
where a mark up % is
added to the total cost of
production of the goods to
arrive at a selling price.
This is done as follows:
i) Calculate the total cost
of production
ii) Calculate the mark up
based on the preferred
mark up %
iii) Add the values from (i)
and (ii)
iv) Divide the result from
(iii) by the no. of units
 produced to determine
the selling price per
unit

E.g. (pg. 353)

$
Direct materials
200
Direct labour
250
Factory Overheads
100
 Total production cost
550 Cost of Goods
Sold
Mark up @ 20%
110 Gross Profit
660 Sales

S.P. per unit =

$660
100
=
$6.60
Absorption Costing
Direct costs are easily
traceable to each unit of
product, however, indirect
costs are not. Given that
indirect costs are not easily
traceable to each unit of
product, these costs are
shared amongst the cost
centres to which they are
attached.
Allocation of overheads
If an overhead cost is
related to a specific cost
centre, then that overhead
is said to be allocated to
that cost centre only. This
means that the overhead
cost will only be included
in the calculation of the
cost of that specific
department or cost centre.
Apportionment of
overheads
If an overhead cannot be
allocated to a specific cost
centre, then that overhead
is shared or apportioned
across the various
departments it is related to.
The basis of apportionment
for each overhead is
determined by the type of
organization and by
management. Different
methods of apportionment
are used for different
overheads. Some examples
are as follows:

Overhead
Basis of Apportionment
Rent and rates
Square footage (area
occupied)
Depreciation
Cost of asset/net book
value
 Electricity
Square footage (area
occupied)
Supervisor’s salaries
No. of employees
supervised

E.g. (pg. 355)

Ace Components make and
supply components to the
electronic market. The
company operates two
production departments A
and B, department B being
smaller than department A.
Details of each department
are shown below:
Total Dept. A
Dept. B
Floor area (square metres)
800 500
300
No. of employees
20 14
6
N.B.V. of machinery
$80000 $60000
$20000

At the end of the financial

year the overheads that
were allocated or
apportioned were as
follows:
Rent and rates
$16000
Supervisors’ salary
$25000
 Insurance of
machinery $2400
Dep’n of machinery
$6000
Building insurance
$3000
Heating and Lighting
$5000
Canteen
$10000
You are required to
determine the total
overhead cost of each
department.

Working Paper:

Apportionment of
overheads
i) Rent and rates
($16000) - Floor area
Dep’t A:
500/800 x
$16000 =
$10000
 Dep’t B:
300/800 x
$16000 =
$6000
ii) Supervisor’s Salary
($25000) – No. of
employees
Dep’t A:
14/20 x
$25000 =
$17500
 Dep’t B:
6/20 x $25000
= $7500
iii) Insurance of
Machinery ($2400) –
NBV mach.
Dep’t A:

$60000/$8000
0 x $2400 =
$1800
Dep’t B:
 $20000/$8000
0 x $2400 =
$600
iv) Dep’n of machinery
($6000) – NBV mach.
Dep’t A:

$60000/$8000
0 x $6000 =
$4500
Dep’t B:

$20000/$8000
 0 x $6000 =
$1500
v) Building Insurance
($3000) – Floor Area
Dep’t A:
500/800 x
$3000 =
$1875
Dep’t B:
300/800 x
$3000 =
$1125
vi) Heating and Lighting
($5000) – Floor Area
Dep’t A:
500/800 x
$5000= $3125
Dep’t B:
300/800 x
$5000 =
$1875
vii) Canteen ($10000) –
No. of Employees
Dep’t A:
14/20 x
 $10000 =
$7000
Dep’t B:
6/20 x
$10000 =
$3000

Sol’n:
Overhead Basis of App.
Total Dep’t A
Dep’t B
$ $
$
Rent/rates Floor area
16000 10000
6000
Sup. Sal. No. of Empl.
25000 17500
7500
Mach. Ins. NBV Mach.
2400 1800
600
Mach. Dep. NBV Mach.
6000 4500
1500
Buil. Ins. Floor area
3000 1875
1125
Heat./Ligh. Floor area
5000 3125
1875
Canteen No. of Empl.
10000 7000
3000
67400 45800
21600

Overhead Absorption Rate

The overhead absorption
rate for each department is
calculated using the direct
labour method to allow for
the determination of the
overhead cost per unit of
production in each
department. This is done as
shown below.

Overhead Absorption
rate = Total Department
Overhead
 (per direct labour hour)
Total labour hours
worked

E.g. 3 (pg. 357)

Using the information from
the previous example,
assuming that employees
work a 40-hr. week for 48
weeks in the year, calculate
the overhead absorption
rate for Dep’ts A and B.
Working Paper
i) Direct labour hours
worked
Dep’t A: 14
employees x 40
hrs. x 48 weeks
=
26,880 hrs.
Dep’t B: 6
employees x 40
hrs. x 48 weeks
=
11,520 hrs.
Sol’n:
Overhead Absorption
Rate = Total overhead cost
Total labour hours
Dep’t A: OAR per
labour hr. = $45800
26880 hrs.
= $1.70 per dlh

Dep’t B: OAR per

labour hr. = $21600
 11520 hrs.
= $1.88 per dlh

E.g. 4
Using the information from
example 3 above, assuming
that the product
manufactured by Ace
Components uses $100 in
direct materials cost, takes
10 direct labour hours in
Dep’t A and 5 direct labour
hours in Dep’t B, calculate
the unit cost of production
if employees earn $20 per
labour hour worked.

Sol’n:
$
Direct
materials/unit
100.00
 Direct labour
cost/unit
(15 hrs. x $20)
300.00
Overheads:
Dep’t A
($1.70 x 10 hrs.)
17.00
Dep’t B
($1.88 x 5 hrs.)
9.40
Total Cost per unit
426.40
If the target profit for sale
of 100 components is
$5000, what is the selling
price per unit of each
component.

Selling price = CP + Profit

Profit per unit = $5000/100
= $50 profit per unit
S.P. = $426.40 + $50 =
$476.40

Determine the gross profit

margin.
GP/Sales x 100 =
50/476.40 x 100 = 10.5%

30/11/2023
Principles of Accounts
Costing Principles

Homework Corrections
#36.7

Working Paper:

Apportionment of
overheads
i) Rent and rates
($32400) - Floor area
Ladies:
800/1200 x
 $32400 =
$21600
Child.:
400/1200 x
$32400 =
$10800
ii) Insurance of Building
($2400) – Floor Area
Ladies:
800/1200 x
$2400 = $1600
 Child.:
400/1200 x
$2400 = $800
iii) Heating & Lighting
($6000) – Floor Area
Ladies:
800/1200 x
$6000 =
$4000
Child.:
400/1200 x
$6000 =
$2000
iv) Dep’n of equipment
($3000) – NBV equip.
Ladies:

$21000/$3000
0 x $3000 =
$2100
Child.:

$9000/$30000
x $3000 =
$900
v) Supervisor’s Salary
($26000) – No. of
employees
Ladies: 30/40
x $26000 =
$19500
Child.: 10/40
x $26000 =
$6500
vi) Insurance of
equipment ($1500) –
NBV Equip.
 Ladies:

$21000/$3000
0 x $1500 =
$1050
Child.:

$9000/$30000
x $1500 =
$450
vii) Canteen ($12000) –
No. of Employees
 Ladies: 30/40
x $12000 =
$9000
Child.: 10/40
x $12000 =
$3000

Sol’n:
Overhead Basis of App.
Total Ladies
Children
$ $
$
Rent/rates Floor area
32400 21600
10800
Build. Ins. Floor Area
2400 1600
800
Heat/Ligh. Floor Area
6000 4000
2000
Equip. Dep. NBV Equip.
3000 2100
900
Sup. Sal. No. of Empl.
26000 19500
6500
Equip. Ins. NBV Equip.
1500 1050
450
Canteen No. of Empl.
12000 9000
3000
83300 58850
24450

ii) Working Paper

Direct labour hours
worked
Ladies: 30
employees x 38
hrs. x 47 weeks
=
53,580 hrs.
Child. : 10
employees x 38
hrs. x 47 weeks
=
17,860 hrs.
Sol’n:
Overhead Absorption
Rate = Total overhead cost
Total labour hours
Ladies: OAR per
labour hr. = $58,850
53580 hrs.
= $1.10 per dlh

Child.: OAR per

labour hr. = $24450
17860 hrs.
= $1.40 per dlh