NOTES: Management Accounting 1 for Business
WEEK 1
Overview of this week
• Introduction to key concepts
Direct and indirect costs
Fixed and variable costs
• Cost allocation
Cost pools and allocations bases
• Job costing: for individual products and services
Dealing with differences in expected and actual volumes
• Process costing: for large amounts of identical products and services
Dealing with input price changes
What does it cost? Costs and cost objects
• The cost of something is the amount of money that you have spent to achieve that
something
• This can be quite straightforward
If you buy a specific product or service, the cost is the price you pay for it (for
example if you buy something from the supermarket)
• But what if it is something more complex?
An automobile that is produced by a car manufacturer
An operation performed in a hospital
A three-year study by a student
• We call the something we want to know the cost of the cost object
This can be anything: products, services, employee activities, organizational units...
→ Typically, organisations use big instalations which are paid by operation.
Direct and indirect costs
Direct costs
• Direct costs can be linked directly to a cost object
• For a bicycle manufacturer, producing an extra bike requires two extra tyres
• For a hospital, performing an operation requires surgeon and nursing hours
• Often, these are variable costs (but not always!) Variable costs: costs that change
when the volume of products or services changes
Indirect costs
• Indirect costs are related to the cost object but cannot be linked directly
• Or this direct link would not be economically feasible because it requires too much
registration and administration: that is, it would cost too much
• The plant of the bicycle manufacturer is used to produce both regular and e-bikes
, • The hospital’s operating rooms and equipment are used for many different
operations
• Many fixed costs are indirect (but again, not always!) Fixed costs: costs that do not
change with a variation in the number of products or services
Example
• A health care provider offers one type of eye laser treatment
• Next year’s plans are the following:
• Fixed costs
- Lease of building: € 200,000
- Laser equipment: € 1,000,000
- Wages: € 400,000
• Variable costs
- Supplies: € 50,000
• What is the cost object? → treatment
• What are the direct and indirect costs?
• There is only one type of treatment
- Every treatment is the same
• The cost object is the treatment
• This also means that all costs are incurred for a single cost object: the laser treatment
- No need for distributing the costs among different types of treatment
• When there is only one cost object, there are no indirect costs
- But what are the costs per treatment?
- So what is the unit cost?
Unit costs depend on volume
The expected volume of treatments is 5,000 (this is how many patients are expected to
be served)
- This is estimated by the laser clinic
Total fixed costs: € 1,600,000
Variable costs: € 50,000
- Variable cost per unit = variable costs/expected volume
- 50,000/5000=10), so the (expected)
variable costs per unit are € 10
• Unit costs: (€1,600,000 (total fixed costs) / 5,000 (expected volume) + € 10 (variable
costs per unit) = € 320 + € 10 = € 330
- Unit costs = total fixed costs / expected volume + variable cost per unit
• What if the actual volume of treatments turns out to be 4,000?
- Unit costs: (€ 1,600,000/ 4,000) + € 10 = € 400 + € 10 = € 410
- Variable costs change with volume, but per unit they are constant, so still € 10
, → The volume (activity level) impacts the unit costs
- The expected volume is the most important number in planning and control
What if there are multiple types of treatments?
• Let’s assume that each patient is unique
• What are the cost objects?
- Treated patients
• We can trace the use of supplies to each treatment
- So, supplies are direct costs
• But now we do have indirect costs
- There is no way to identify which part of the equipment and building costs are
made specifically for a specific patient
- Wages are for employees on a permanent contract
Costing of products and services: job and process costing
1. JOB COSTING
• When an organization generates individual units with varying characteristics, we use
job costing
» Repair jobs, consultancy jobs, building jobs, manufacturing jobs
2. PROCESS COSTING
• When an organization generates similar units, we use process costing
» Process industry: chemicals, foods
» Large scale manufacturing
1. Job Costing
Job costing in the eye laser clinic
• Patients in the eye laser clinic have different requirements
• Some will require more use of laser equipment
• Some will require more support and attention from nurses
• Two patients
• Achraf gets a treatment requiring 2 hours of equipment use and 4 hours of
labor; additionally, € 20 supplies are used
, • Birgit gets a treatment requiring 4 hours of equipment and use and 3 hours of
labor; additionally, € 10 supplies are used
• How can we allocate the indirect costs of € 1,600,000 to these treatments?
! We identify the following groups of costs:
• Building and equipment: € 1,200,000
• Wages: € 400,000
Cost pools
• What are good ways to link these costs to patients?
• For building and equipment: hours use of equipment
• For wages: labor hours Allocation base
» To allocate the indirect costs to a treatment, we need to know what the expected
volume is of the hours of use and labor
• The clinic administration shows the following
• Expected hours of equipment use: 14,000
• Expected hours of labor: 22,000
Activity volume
• With this we can calculate a cost per unit of the allocation base
- Building + equipment: € 1,200,000/ 14,000 (expected hours of equipment use)
= € 85.71
- Wages: € 400,000/ 22,000 (expected hours of labor) = € 18.18
→ So we now have an allocation rate for each cost driver
B+E Wages
Cost pool 1,200,000 400,000
Units of allocation base 14,000 22,000
Cost per unit 85.71 18.18
SO:
• Achraf’s treatment requires 2 equipment hours, 4 labor hours and € 20 supplies
» Indirect costs: 2 * € 85.71 + 4 * € 18.18 = € 171.42 + € 72.72 = € 244.14
» Direct costs: € 20
» Treatment (job) costs: € 244.14 + € 20 = € 264.14
