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Costing and Management Accounting |
Management accounting |
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A company has direct and indirect costs, and centres within the company that are cost centres and profit centres.
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A profit centre earns revenue (from sales) and generates its own costs. A cost centre simply generates costs.
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How do we work out whether the profit centres are profitable? The company as a whole has to pay for the costs generated by the cost centres. Therefore, the costs of the cost centres have to be attributed to the profit centres. The profit centres have to absorb these costs.
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For example, a company has two products, A and B with separate production facilities and sales teams. Each product represents a profit centre. However, the company also has a head office which manages both products. The head office is merely a cost centre. The costs generated by the cost centre have to be attributed to the profit centres, A and B.
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This process of dividing the costs of the cost centres between the profit centres is called management accounting.
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One approach would be to take all the costs of the cost centres and divide them equally between the profit centres. But this might be deemed to be unfair to some profit centres. For example if the sales of product A are ten times those of product B it is not “fair” to B to attribute half the costs of the non-profit making centres of the company to B.
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This shows that management accounting involves decisions that may ultimately be arbitrary in nature. There are several approaches to attributing costs.
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Full and absorption costing |
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These techniques attempt to identify all costs associated with a particular activity. Both direct and indirect costs are ascribed to each activity.
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In full costing there is a formula by means of which the overhead costs are divided between the various cost centres.
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In absorption costing the various types of overhead are apportioned to each cost centre in distinctive ways.
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For example, rent and rates may be apportioned on the basis of the area taken up by the activity.
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Heating costs may be apportioned according to volume.
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Costs of personnel administration may be apportioned according to the number of employees engaged.
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Indirect labour used may be apportioned according to the proportion of direct labour.
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Fire insurance and depreciation may be apportioned according to the value of the capital.
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Marginal costing |
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The marginal cost is the addition to total cost that results from the production of one further unit of the product or service. Marginal costing focuses on variable costs and ignores fixed costs. It focuses on the contribution made by the sale of one more unit. Contribution is the sales revenue (price) less the variable cost per unit.
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Marginal costing is appropriate in cases where
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| (1) | | The selling price is greater than the marginal cost, so the sale of one more unit produces a contribution. |
| (2) | | Spare capacity exists, so the production of one more unit causes no addition of costs. |
| (3) | | No other business is available. |
| (4) | | It is possible to segment the market so that other customers do not seek to buy at a lower price. |
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Standard costing |
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Standard costs are costs worked out on the basis of what costs ought to be — in other words, on what costs would be expected to be should efficient methods of production be used.
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