# Cost centres and cost behaviour

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1 2 Cost cetres ad cost behaviour this chapter covers... I this chapter we look i more detail at how the basic priciples of costig that we explaied i the last chapter are used i a costig system. We will start by describig cost cetres. These are sectios of the orgaisatio that costs ca be charged to ad we will use the idea of fuctioal aalysis (ie differet areas of the orgaisatio) that we examied i Chapter 1. We will also examie profit cetres ad ivestmet cetres, ad see how they differ from cost cetres. Next we will itroduce the idea of codig systems by first idetifyig the three mai types of codig that are used i costig. We will the use the various forms of classificatio of costs that we have already studied to see how costs could be aalysed ad coded to help with costig. The third mai topic covered i this chapter is cost behaviour. This term relates to the way that costs react to chages i output or activity levels. Some costs remai the same i total ( fixed costs), others chage directly with chages i output ( variable costs), while others cotai a elemet of each of these behaviours ( semi-variable costs). We will lear about the features of these differet cost behaviours, ad will be able to idetify the behaviour of a variety of costs for differet orgaisatios. We will the see how this kowledge of cost behaviour ca be used to help calculate total costs ad uit costs i a rage of situatios.

3 2 8 i t r o d u c t i o t o c o s t i g t u t o r i a l w h e r e d o e s t h e i f o r m a t i o c o m e f r o m? The sources of iformatio for the aalysis of costs iclude: purchase orders ad purchase ivoices, for materials ad expeses costs payroll schedules, for labour costs bills ad cash receipts, for expeses costs The amouts of each cost are the aalysed to the cost cetre which has icurred the cost. The diagram below shows how this process works. A firm s policy maual should give details of which costs are to be charged to which cost cetre. costs aalysis cost cetres materials purchase orders purchase ivoices productio admiistratio labour payroll schedule costs charged to cost cetres huma resources expeses purchase orders purchase ivoices bills receipts fiace sales/marketig P R O F I T C E N T R E S For some sectios of busiesses the cost cetre approach of aalysig costs is take to a further level by also aalysig sales icome to cetres. As sales icome less costs equals profit, such cetres are called profit cetres. Note that the source of iformatio o sales comes from sales orders ad sales ivoices. Profit cetres are sectios of a busiess to which costs ca be charged, icome ca be idetified, ad profit ca be calculated.

6 c o s t c e t r e s a d c o s t b e h a v i o u r 3 1 We have also leart that cost cetres, profit cetres ad ivestmet cetres ca be used to idetify sectios of a busiess. A codig system ca use these ways of classifyig costs ad classifyig icome. For example, a clothig maufacturer might use a codig system where the first part of the code deotes the profit cetre or cost cetre, ad the secod part of the code (the sub-code) deotes a sub-classificatio based o whether the data is sales icome, direct cost, or idirect cost. If this code system was alpha-umeric, the amout of icome from the sales of dresses could be coded to: B10 if B related to the profit cetre dresses ad 10 was the sub-code for sales icome The cost of machiists wages i the sewig sectio could be coded to: H30 if H related to the cost cetre sewig sectio ad 30 was the sub-code for direct cost Remember that the codig system will be desiged to suit the eeds of each idividual orgaisatio. The above example is quite a simple oe, but demostrates how a codig system could work. We will ow use a Case Study to illustrate i more detail how a codig system works. Case Study C L A S S Y L I M I T E D : U S I N G C O S T I N G C O D E S s i t u a t i o Classy Limited is a educatioal compay that rus courses for accoutacy traiees ad other office staff. It uses a codig system for the elemets of cost (materials, labour ad expeses), with further classificatio ito direct ad idirect costs. The codig used is as follows: Elemet Code Nature Code Materials 100 Direct X Idirect Y Labour 200 Direct Idirect X Y Expeses 300 Direct Idirect X Y

7 3 2 i t r o d u c t i o t o c o s t i g t u t o r i a l r e q u i r e d Idetify codes for the followig costs: wages of tutor ret of classroom hadouts ad statioery for studets use power, light ad heat i classroom wages of maager isurace of equipmet s o l u t i o wages of tutor ret of classroom hadouts ad statioery for studets use power, light ad heat i classroom wages of maager isurace of equipmet 200X 300Y 100X 300Y 200Y 300Y Note: for a example of a alterative codig system, see Activity 2.3 o page 45. C O S T B E H AV I O U R So far i this chapter we have see how we ca classify costs accordig to the mai elemets of materials, labour ad expeses. We ca classify the ature of costs as direct or idirect, ad also accordig to their fuctio. We ca use cost cetres to help with this aalysis. Oe further way that costs ca be classified is based o the way that costs chage whe the level of output chages. This is kow as cost behaviour. w h a t d o e s c o s t b e h a v i o u r m e a? What we mea by cost behaviour is the way i which costs alter with chages i the level of output or activity. For example: for a maufacturig orgaisatio, the quatity of items produced for a service orgaisatio, the volume of services provided Whe the output of a orgaisatio chages, some costs will stay the same, while others will chage. There are three mai ways that costs may behave: fixed costs variable costs semi-variable costs Remember that we are oly iterested here i the way that costs chage because of chages i output or activity ot because of chages i price or ay other reaso urelated to output or activity.

9 3 4 i t r o d u c t i o t o c o s t i g t u t o r i a l v a r i a b l e c o s t s Variable costs chage i proportio to the level of output or activity. For example, if the output doubles the the total of a variable cost would also double. The total cost of wood for chairs that are made i a furiture factory will deped o the umber of chairs that are made. If more chairs are made, the total cost of wood will be greater. We would expect the cost of wood to make 200 chairs to be twice as much as the cost of wood to make 100 chairs. This is because the wood for each chair will cost the same, ad more chairs meas more wood. We ca igore issues like quatity discouts whe cosiderig cost behaviour at this stage of our studies. Suppose that the cost of wood for each chair is 20. That meas that if 100 chairs are made the total cost of wood will be 20 x 100 = 2,000. If 200 chairs were made the total cost of wood would be 20 x 200 = 4,000, ad so o. A graph of the total cost of wood would look like this: Wood for chairs 25,000 Total cost of wood () 20,000 15,000 10, Number of chairs made Total variable costs will always look like this o a graph. The cost lie starts i the bottom left corer where there is zero output ad zero cost. The poits the form a straight lie as the total cost rises i proportio to the output.

10 c o s t c e t r e s a d c o s t b e h a v i o u r 3 5 Whe the output icreases variable costs per uit do ot chage. I our example the cost of wood per chair remaied 20 regardless of the umber of chairs made. Cotrast this with fixed costs that stay the same i total, but reduce as a cost per item whe the output rises. s e m i - v a r i a b l e c o s t s Semi-variable costs cotai both a fixed elemet ad a variable elemet. Whe output (or activity) chages, part of the cost will remai fixed, ad part of the cost will chage i proportio to the activity. This meas that if output doubled a semi-variable cost would icrease, but it would ot double the icrease would be less tha that because the fixed costs stay the same. Suppose that i a furiture factory a perso was employed as a assembler - to fit the parts of the chairs together. If the assembler was paid a basic salary of 1,000 per moth, plus a bous amout of 1 for every chair that he or she assembled the the cost of employig this perso would be a semi-variable cost. The basic pay would ot chage o matter how may chairs were assembled this part would represet a fixed cost. The bous based o the umber of chairs assembled would represet a variable cost as is would chage i proportio to the umber of chairs assembled. Together the total would be a semi-variable cost. The total cost of employig the assembler for a moth will look like this o a graph: Cost of employig a assembler for a moth 2,000 2,000 Total cost () 1,500 1, Number of chairs made per moth

12 c o s t c e t r e s a d c o s t b e h a v i o u r 3 7 Examples of semi-variable costs are: labour paid o a weekly wage basis plus a productio bous power for productio machiery if charged at a flat rate plus a charge based o amout used We will ow use two Case Studies, each based o a differet type of orgaisatio, to practise idetifyig the way that costs behave. Case Study 1 J E A N S J E A N S : I D E N T I F Y I N G C O S T B E H AV I O U R s i t u a t i o You work i the costig sectio of Jea s Jeas, a compay that makes clothig. You have bee asked to idetify how each of the costs show below is likely to behave, as a prelimiary part of a cost plaig exercise. Costs material for clothes factory ret power for sewig machies i factory (charged per uit of electricity) factory supervisors wages (paid a flat rate plus a productio-based bous) packagig materials telephoe (charged at a flat rate plus a amout per call; more calls are made whe more clothes are beig produced) office rates delivery drivers pay (paid a flat rate plus a bous per package delivered) factory heatig r e q u i r e d Complete the followig table by isertig the costs ito the most appropriate colum. Fixed Costs Variable Costs Semi-variable Costs

13 3 8 i t r o d u c t i o t o c o s t i g t u t o r i a l s o l u t i o Fixed Costs Variable Costs Semi-variable Costs Factory ret Material for clothes Factory supervisors wages Office rates Power for sewig machies i factory Telephoe Factory heatig Packagig materials Delivery drivers pay Case Study 2 B L O W N A W AY: I D E N T I F Y I N G C O S T B E H AV I O U R s i t u a t i o You work for Blow Away, a compay that provides hot air balloo rides. Each trip is for two passegers ad a pilot, with a recovery vehicle followig o the groud. You have bee asked to idetify how each of the costs show below is likely to behave, as a prelimiary part of a cost plaig exercise. Costs isurace (charged per year, regardless of umber of flights) fuel for balloo pilot s pay (a basic amout plus a bous per flight) car tax (vehicle excise duty) for recovery vehicle pay for recovery vehicle driver (paid per flight) refreshmets for passegers after every flight advertisig costs aual ret of take-off site fuel for recovery vehicle aual subscriptio to weather forecastig service use of mobile telephoe for cotact betwee pilot ad recovery vehicle driver (paid at a flat rate plus a charge per call)

14 c o s t c e t r e s a d c o s t b e h a v i o u r 3 9 r e q u i r e d Complete the followig table by isertig the costs ito the most appropriate colum. Fixed Costs Variable Costs Semi-variable Costs s o l u t i o Fixed Costs Variable Costs Semi-variable Costs Isurace Fuel for balloo Pilots pay Car tax for recovery vehicle Wages of recovery vehicle driver Use of mobile telephoe Advertisig costs Ret of take-off site Subscriptio to weather forecastig service Refreshmets for passegers Fuel for recovery vehicle C O S T B E H AV I O U R C A L C U L AT I O N S Now that we have studied cost behaviour ad are able to idetify fixed, variable, ad semi-variable costs we ca use this kowledge to carry out calculatios. Study the worked example o the ext page.

16 c o s t c e t r e s a d c o s t b e h a v i o u r 4 1 I summary: to calculate total costs: multiply variable costs per uit by the output, ad add to the fixed costs to calculate uit costs: divide the fixed costs by the output, ad add to the variable costs per uit We will ow use a Case Study to make sure that we ca deal with similar calculatios whe they are preseted i a slightly differet way. Case Study B E H AV E! C O S T B E H AV I O U R C A L C U L AT I O N S s i t u a t i o Behave! is a dog traiig service that provides hour-log sessios to help owers cotrol their pets. A uit of output for this orgaisatio is oe sessio. The followig table cotais accurate data based o oe moth, ad eeds to be completed for various activity levels. Sessios Fixed Costs Variable Costs Total Costs Uit Cost 100 2,000 2,000 4, r e q u i r e d Complete the table, showig fixed costs, variable costs, total costs ad uit cost at the differet activity levels (umbers of sessios). Show all amouts to the earest. s o l u t i o Sessios Fixed Costs Variable Costs Total Costs Uit Cost 100 2,000 2,000 4, ,000 3,000 5, ,000 4,000 6, ,000 5,000 7,000 28

18 c o s t c e t r e s a d c o s t b e h a v i o u r 4 3 Key Terms cost cetre a sectio of a orgaisatio to which costs ca be charged. The umber ad type of cost cetre would deped o the requiremets of the orgaisatio profit cetre a sectio of a orgaisatio to which costs ca be charged, icome ca be idetified, ad profits ca be calculated ivestmet cetre a sectio of a orgaisatio to which costs ca be charged, icome ca be idetified ad ivestmet ca be measured codig system a way of usig uique headigs to aalyse data. They ca also be used to place the data i logical order if required umeric code a code made up etirely of umbers alphabetic code a code made up etirely of letters of the alphabet alpha-umeric code a code made up of a combiatio of umbers ad letters cost behaviour the way that costs alter with chages i the level of output or activity fixed cost a cost that does ot alter whe the level of output or activity chages variable cost a cost that chages i proportio to the level of output or activity semi-variable cost a cost that cotais both a fixed elemet ad a variable elemet

19 4 4 i t r o d u c t i o t o c o s t i g t u t o r i a l Activities 2.1 Idetify which oe of the followig lists could be used as cost cetres for a compay that maufactures widows. (a) (b) (c) (d) Materials; Labour; Overheads Frame Costructio; Glazig; Admiistratio; Distributio Direct Costs; Idirect Costs Prime Cost; Maufacturig Overheads; No-Productio Overheads Aswer (a) or (b) or (c) or (d) 2.2 Cliff Beach Limited is a compay that ows two shops i a seaside tow. Oe shop is called Clifftop, ad the other is called Beachside. Each shop is a ivestmet cetre. Admiistratio for the shops is carried out i a separate cost cetre. The followig is a extract from the codig maual used by the compay. Ivestmet or Cost Cetre Admiistratio Beachside Shop Clifftop Shop Code A B C Reveue, Cost, or Ivestmet Code Shop sales reveue 100 Shop purchases for resale 200 Labour costs 300 Overheads 400 Ivestmet i shop assets 900 Each code cosists of a letter followed by a 3 digit umber. Complete the followig table with the appropriate codes. Trasactio Sales i Beachside shop Cost of payig wages of shop staff at Clifftop Purchase of ew display shelvig for Beachside Purchase of goods for resale at Clifftop shop Cost of electricity at Clifftop shop Cost of payig wages of compay admiistrator Code

21 4 6 i t r o d u c t i o t o c o s t i g t u t o r i a l aalysis code reveue or expese 110 pritig 210 basic pay 220 overtime 230 holiday pay 310 authors' royalties 320 rates 330 heatig ad lightig 340 telephoe 350 buildig maiteace 360 vehicle ruig costs 370 advertisig 410 sales to bookshops 420 sales to wholesalers From the codig policy maual extract give, you are to code the followig icome or cost trasactios usig the table below. Trasactio Sales ivoice showig the sale of 14,750 of academic textbooks to Orto Book Wholesalers Limited Code Priter's bill of 22,740 for pritig sports books Payroll summary showig overtime of 840 last moth i the childre's book sectio Paymet of 1,540 for advertisig sports books i the magazie 'Sport Today' Telephoe bill of 1,200 for the admiistratio departmet Royalties of 88,245 paid to childre's book authors Sales ivoice showig the sale of 1,890 of ovels to the Airport Bookshop

23 4 8 i t r o d u c t i o t o c o s t i g t u t o r i a l 2.6 Idetify the followig statemets as either true or false by puttig a tick i the relevat colum of the table below. True False Variable costs always iclude a time period cost Fixed costs are based o a time period ad the amout does ot deped o output Semi-variable costs chage directly with chages i the level of activity 2.7 Idetify the followig statemets as either true or false by puttig a tick i the relevat colum of the table below. True False A variable cost is based o a uit of output ad is the same for each oe A fixed cost chages with chages i the level of activity A semi-variable cost is based o a combiatio of a time period cost ad a per uit cost 2.8 Classify the followig costs as either fixed or variable by puttig a tick i the relevat colum of the table below. Costs Fixed Variable Ret of premises Labour paid per uit produced Staff salaries Packagig materials for goods produced

24 c o s t c e t r e s a d c o s t b e h a v i o u r Classify the followig costs as either fixed or variable by puttig a tick i the relevat colum of the table below. Costs Fixed Variable Isurace of vehicles Heatig ad lightig Materials used i productio Bous paid to productio workers for each extra uit of output 2.10 You work i the costig sectio of Doorcraft Ltd, a compay that maufactures woode doors. Each door is made by cuttig up wood usig a powered saw, ad the wood pieces are screwed together. The door is the machie saded ad fially polished by had. Classify the followig costs icurred by their behaviour (fixed, variable or semi-variable) by puttig a tick i the relevat colum of the table below. Costs Fixed Variable Semi-variable Factory rates Power for saw ad saders i factory (charged per uit of electricity) Factory supervisors wages (paid a time rate plus a productio-based bous) Wood used i the productio process Telephoe (charged at a flat rate plus a amout per call) Office ret Polish for fiishig doors Delivery drivers pay (paid a time rate plus a bous per door delivered) Factory lightig Wages of productio staff who are paid accordig to the umber of doors they make Salary of marketig maager

25 5 0 i t r o d u c t i o t o c o s t i g t u t o r i a l 2.11 The followig table cotais data based o a compay that makes a sigle product, ad eeds to be completed for differet levels of productio. Output (uits) Fixed Costs Variable Costs Total Costs Uit Cost 1,000 30,000 20,000 50, ,500 2,000 3,000 You are to complete the table, showig fixed costs, variable costs, total costs ad uit cost for the differet levels of productio Complete the table below showig fixed costs, variable costs, total costs ad uit cost for the differet levels of productio. Output (uits) Fixed Costs Variable Costs Total Costs Uit Cost 2,000 12,000 4,000 16, ,000 4,000 6, Complete the table below showig fixed costs, variable costs, total costs ad uit cost for the differet levels of productio. Output (uits) Fixed Costs Variable Costs Total Costs Uit Cost 500 8,000 2,000 10, ,000 2,000 4,000

26 c o s t c e t r e s a d c o s t b e h a v i o u r Victoria Ltd is costig a sigle product which has the followig cost details: Variable costs per uit Material 5 Labour 4 Total fixed costs 50,000 Complete the followig total cost ad uit cost table for a productio level of 25,000 uits. Total cost Uit cost Material Labour Overheads Total 2.15 Albert Ltd is costig a sigle product which has the followig cost details: Variable costs per uit Material 10 Labour 8 Total fixed costs 90,000 Complete the followig total cost ad uit cost table for a productio level of 30,000 uits. Total cost Uit cost Material Labour Overheads Total

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