Controlling Cost to Improve Organisational Performance

In this section, we will explore the essential concepts of cost accounting, which is crucial for effective management and decision-making. We will cover the purpose and basic terminologies such as direct costs, indirect costs, fixed costs and variable costs.

Understanding these concepts is key to developing cost management strategies. We will also classify costs based on common characteristics to understand cost structures better and examine the composition of costs in services and operations. By the end of the section, you should understand the importance of cost management and control in enhancing organisational performance.

KEY IDEAS

• Cost Accounting is a branch of accounting that focuses on recording, classifying and analysing the costs associated with producing goods or providing services. Its main objective is to control and reduce costs, enhance decision-making and determine product profitability.

• Cost Centre is a segment or area within an organisation where costs are incurred and tracked. It may be a department, machine, a person, time or specific activity.

• Cost Unit is a unit of output or service to which costs can be allocated or measured. It represents the measure of quantity, such as a single product, service, or job, for which cost is calculated.

• Unit Cost is the total cost incurred to produce a single unit of output. It is calculated by dividing the total cost by the number of units produced.

• Element of Cost are the basic categories of costs that make up the total cost of production, typically classified into three elements: materials, labour and expenses.

• Direct Costs are made up of costs that can be directly traced to a specific product, service or cost object. These include expenses like direct materials and direct labour which are linked with the production of a particular good or service.

• Cost Classification is the process of grouping costs based on their nature or purpose, such as direct and indirect costs, fixed and variable costs or product and period costs, to facilitate decision-making and control.

Meaning of cost accounting Cost Accounting is a branch of accounting that focuses on recording, classifying and analysing the costs associated with producing goods or providing services. It records all incurred costs associated with the production of goods or provision of a service and enables businesses to track costs over time.

Cost accounting is a form of management accounting and is the process by which all the costs of a business activity or production are examined to support effective decision making.

Scope of Cost Accounting

Cost accounting includes:

1. Cost classification and analysis

2. Cost estimation and forecasting

3. Cost control and reduction

4. Budgeting and variance analysis

5. Decision making and performance Cost accounting can be applied to various industries and sectors, including manufacturing, service and construction.

Functions of Cost Accounting

Cost accounting is used by businesses to:

1. Provide important information to management; this is done by collecting and sharing financial and business data to help them make good decisions.

2. Help management plan, check progress and control activities. This involves setting goals, tracking how things are going and making sure everything matches the company's plans.

3. Assign costs to products and services by calculating how much each product or service costs so the company can see which one is more profitable.

4. Collect costs by gathering all the data on expenses in an organised way for analysis.

5. Set budgets and standards. This involves creating financial plans and goals to guide the business.

6. Help them to evaluate the performance of different departments to see if they are working efficiently and effectively.

Activity 4.1 Nature, Scope and Functions of Cost Accounting

1. In pairs or small groups, think about things you or your family buy regularly (for

example, bread, soap, phone data).

a. Write down 3–5 of these items and their prices.

b. Share your list with another pair/group.

c. Discuss what these costs mean for you and how they might be recorded in a business.

2. Talk about what cost accounting means using examples from the previous activity.

Use these questions to guide your discussion:

a. What does cost accounting involve?

b. Why might a business need it?

c. Explain five functions of cost accounting

3. Write down your explanations in your own words.

4. Present your explanations to other pairs/groups.

5. Listen to their presentations and write down any points you did not know before.

Basic Cost Accounting Terminologies

To understand cost accounting, it is necessary to explain the terminology that is used.

Some of the basic terms are explained below:

Cost Cost is the measurement of expenses incurred in the production of goods or services. It is the monetary value or expense incurred to produce, acquire or maintain a product or service. It involves all the expenses involved in the process, including materials, labour and other expenses.

Understanding cost is essential for pricing, budgeting, and financial analysis within any organisation or project.

Cost Centre

Cost centres allow businesses or departments to organise their accounts based on their specific activities. Each cost is assigned to a cost centre to enable monitoring or performance and control over expenditure.

A cost centre could be

1. a location, e.g. a department or a sales area of the business.

2. a person e.g. a salesman or machine operator.

3. an item of equipment e.g. a delivery van or a machine.

Cost Unit / Cost Object A cost unit is defined as a product, service or time to which cost may be expressed. Cost unit refers to the product or service that a company produces for example: a tin of milk, a car, a bag of rice, etc.

Unit Cost

A unit cost refers to the cost incurred per unit of output. It is the cost price of a product.

It is measured as total cost divided by the total number of units produced.

Cost Sheet

A cost sheet is a detailed statement that shows all the costs involved in producing a product or providing a service. It helps businesses understand how much it costs to make something by listing all the costs involved.

Profit Centre

A profit centre is a part of a business that is responsible for its own revenues and expenses.

It operates somewhat independently, and its performance is measured by the profit it generates. For example, a specific store or product line within a larger company can be a profit centre.

Direct Cost

Direct costs are expenses that can be directly traced to the production of a specific good or service. Examples include raw materials and wages of workers who make the product.

Indirect Cost

Indirect costs are expenses that cannot be directly linked to a specific product or service.

They are shared costs, such as rent, electricity, or salaries of administrative staff, which support the overall business.

Prime Cost

Prime cost is the sum of direct costs involved in production, mainly direct materials, direct labour and direct expenses. It represents the basic cost of making a product before adding indirect costs.

Standard Cost

Standard cost is a predetermined or estimated cost of producing a product or providing a service, based on efficient operations. It serves as a benchmark to compare actual costs and help control expenses.

Budget A budget is a financial plan that estimates income and expenses over a specific period. It helps businesses plan their activities, control spending, and achieve financial goals.

Activity 4.2 Basic Terminologies used in Cost Accounting

1. In groups complete the table below by writing the appropriate costing terminologies for the following definitions.

Definition Terminology

1 A predetermined or estimated cost of producing a product or providing a service, based on efficient operations. It serves as a benchmark to compare actual costs and help control expenses 2 Expenses that cannot be directly linked to a specific product or service. They are shared costs, such as rent, electricity, or salaries of administrative staff, which support the overall business.

3 A detailed statement that shows all the costs involved in producing a product or providing a service. It helps businesses understand how much it costs to make something by listing the costs involved.

A financial plan that estimates income and expenses over a specific period. It helps businesses plan their activities, control spending, and achieve financial goals.

5 A product, service or time to which cost may be expressed. Cost unit refers to the product or service that a company produces for example: a tin of milk, a car, a bag of rice, etc.

6 The monetary value or expense incurred to produce, acquire, or maintain a product, service, or resource 7 Expenses that can be directly traced to the production of a specific good or service. Examples include raw materials and wages of workers who make the product.

8 The cost incurred per unit of output. It is the cost price of a product.

It is measured as total cost divided by the total number of units produced.

9 The sum of direct costs involved in production, mainly direct materials, direct labour and direct expenses. It represents the basic cost of making a product before adding indirect costs.

10 Part of a business that is responsible for its own revenues and expenses. It operates somewhat independently, and its performance is measured by the profit it generates. For

example, a specific store or product line within a larger company can be a profit centre.

2. Make a presentation of your responses using a flip chart to share with the wider class.

Extension task Answer the following question to support the review of your learning.

Describe the difference between:

1. An indirect and direct cost

2. Cost unit and unit cost

3. Cost centre and profit centre Write up your response in your workbook and share with your teacher for feedback.

Cost Accounting System

A cost accounting system is a method or process used by organisations to record, analyse, and monitor the costs associated with producing goods or providing services. Its primary purpose is to determine the cost of products or services accurately, enabling management to make informed decisions related to pricing, budgeting, cost control and financial planning.

An effective cost accounting system can streamline the cost accounting process within a business. The system should suit the environment of the business and should be simple, economical and practical.

Factors a business should consider when planning to implement a cost accounting system include.

1. Organisational objectives and needs: Understand the specific information required for decision-making, control and planning. Determine whether the system should support product costing, pricing, budgeting or performance evaluation.

2. Nature of products or services: Consider the diversity and production processes of the products or services offered. For example, batch production may require different cost allocation methods than mass production.

3. Cost structure and types of costs: Identify fixed, variable, direct and indirect costs to determine appropriate cost classification and allocation methods.

4. Cost data availability and accuracy: Assess the existing data collection systems for completeness, accuracy and timeliness. Ensure that the data sources can support the required level of detail in cost reporting.

5. Choice of costing method: Decide on suitable costing techniques such as job costing, process costing, activity-based costing or standard costing based on operational needs.

6. Integration with existing systems: Evaluate how the new cost accounting system will integrate with financial accounting, inventory management and other systems.

7. Cost of implementation and maintenance: Analyse the resources (time, personnel, financial) required to implement and sustain the system. Balance the benefits against the costs involved.

8. Organisational structure and responsibilities: Define roles and responsibilities for data collection, processing and analysis. Ensure staff are trained to use the system effectively.

9. Management support and commitment: Secure buy-in from top management to facilitate smooth implementation and utilisation.

10. Flexibility: Ensure the system can adapt to changes in production processes, product lines, or organisational growth.

Type of information produced by a cost accounting system A good cost accounting system produces various types of valuable information essential for effective management and decision-making. These include:

1. Cost of Goods Sold (COGS): Accurate calculation of the direct costs attributable to production help assess profitability.

2. Product costing data: Detailed information on direct materials, direct labour and manufacturing overhead for each product or service.

3. Work-in-Progress and finished goods inventory values: Valuation of inventory at different stages, aiding in financial reporting and inventory management.

4. Budget variance reports: Comparison of actual costs with budgeted costs to identify variances and control expenses.

5. Cost control data: Insights into areas where costs can be reduced.

6. Profitability analysis: Data on the profitability of individual products, departments or segments.

7. Pricing information: information to support setting or adjusting product prices based on cost structures.

8. Cost behaviour patterns: Understanding fixed and variable cost relationships to forecast and plan effectively.

9. Decision-making data: Information supporting decisions like product discontinuation, process improvements, or investment opportunities.

Activity 4.3 Factors to Consider When Installing a Cost Accounting System

1. In groups, consider the scenario below and answer the questions that follow:

Nyamekye has been running a bakery for two years. He has not been recording all the costs associated with producing his products, such as bread, chips, and doughnuts. He recently hired an accounting graduate to assist him, who recommended implementing a cost accounting system to record, analyse, and monitor the costs associated with producing goods. As a student of cost accounting.

a. Explain to him the factors he should consider when setting up the cost accounting system

b. Describe the types of information this system will generate.

2. Present your work for discussion to the larger class.

Cost and financial accounting are related but different branches of accounting.

To recap Section 1, financial accounting is a branch of accounting that focuses on recording, summarising, and reporting an organisation's financial transactions over a specific period. Cost accounting is a subset of management accounting and focuses on identifying, measuring and controlling costs of producing goods and services.

The differences between the two types of accounting reflect the different user group which they address. The main areas of comparison are summarised in the table below.

S/N Aspect Financial Accounting Cost Accounting

1 Legal requirements Financial reports, for many organisations are subject to accounting regulations which try to ensure that they are produced in conformity with a standardised format. These regulations are imposed by law and accounting professional bodies. In effect, financial accounting information is determined by concepts, standards and legal provisions.

Cost accounting reports are not guided by any such regulations from external sources dictating the form and content.

Management reports are for internal use only and can be tailored to meet the needs of a particular management.

Cost accounting information is therefore, determined by management on the basis of relevance and cost benefit considerations.

2 Nature of

the reports produced Financial reports tend to be general- purpose reports. That is, they contain financial information that can be useful for a wide range of accounting users as well as decisions rather than being specifically developed for the needs of a particular group or set of decisions.

Cost and management accounting reports are often designed for specific purpose. They are designed either with a particular decision in mind or for a specific level of management.

3 Level of

details Financial accounting reports provide users with a broad overview of proposition and operational performance of the business for a defined period. Consequently, information is generally aggregated and presented at a high level rather than in granular detail.

Cost accounting reports, however, often provide management with considerable details to help them with a particular operational decision.

4 Reporting intervals and frequency For most businesses, financial accounting reports are produced on an annual basis. However, large companies may produce semi-annual reports and a few also produce quarterly reports.

Cost accounting reports may be produced as frequently as required by management. In most businesses, management teams are provided with certain reports on a weekly or monthly basis which permit constant review of operational performance.

5 Time horizon Financial accounting reports reflect the operational performance and financial health of the business for the past period. In short, financial accounting reports are historical information or derived from past

activities. Financial statements do not incorporate future expectations.

Occasionally, businesses do issue financial forecast reports to other users in order to raise additional capital or to fight off possible take-over bid.

Cost accounting reports, on the other hand, often provide information concerning future costs and revenues as well as past activities.

6 Range and

quality of information Financial accounting reports concentrate on information which can be quantified in monetary terms. Financial accounting reports place much premium on the use of objective, verifiable evidence when preparing annual reports.

Cost accounting reports also produce such reports, but they are also more likely to include information of a non-financial nature such as measures of physical quantities of stocks and output. Cost accounting reports may use information which is less objective and verifiable in order to provide managers with information which they require.

7 Precision of

information Financial accounting information must be more precise. There is usually an audit by independent external auditors to confirm the reliability of information.

In cost accounting, approximations are permitted due to uncertainties in making estimates, but must be precise and accurate.

8 Objectives Financial accounting information is required to satisfy the stewardship function of management i.e. account for the use of resources entrusted to management (Principal-Agency relationship) Cost accounting information is meant to aid planning, control, decision making and performance evaluation.

Activity 4.4 Cost Accounting and Financial Accounting

1. Your teacher will arrange you in small groups of no more than five. Read the following scenario and answer the questions that follow:

You are the manager of Aba Klewiah Company that makes traditional woven mats. Your team is considering whether to switch to a new, more efficient weaving process to produce more mats in less time. Before making the decision, you need to understand the financial implications of the change based on. To do this you gather the following information from the finance department:

a. Data on the costs involved in making mats:

i. cost of threads, dyes, etc.

ii. wages paid to weavers.

iii. electricity, equipment maintenance, etc.

b. Reports that show the financial position of the company for stakeholders like government agencies, banks or investors;

c. The total revenues from sales and the total expenses (costs)

d. Income Statement

e. Balance Sheet.

These statements show whether the company made a profit or loss over a certain period, but they don’t go into the detailed cost analysis of the new process.

2. In your groups, discuss the importance and uses of both the financial and cost accounting information gathered in this scenario and how they might influence decision making

3. Discuss the difference between cost accounting with financial accounting.

4. Ensure everybody in your group gets the opportunity to contribute to the discussion.

You could choose to role play aspects of the discussion, for example with ne person acting as the manager of the company and another as the accountant.

5. Record the outcomes of your discussion on flip chart paper.

6. Present your answers to the teacher and the rest of the class for feedback.

Cost classification Cost classification refers to the process of grouping costs according to their common features or characteristics. This ensures effective reporting and communication of costs.

Different Methods of Classifying Costs

₁. Classification according to nature of cost Under this method, a cost can be described as direct or indirect.

a. Direct costs are those costs that are traced or conveniently identified with a particular cost centre or cost unit. For example, the cost of wood used in making a table.

b. Indirect costs are those costs which cannot be traced to any particular cost centre.

They are general costs that are incurred for the benefit of a number of cost centres.

Examples are insurance, rent and managerial salaries.

2. Classification according to behaviour Here, cost is classified as fixed or variable.

a. Fixed costs are those costs that remain constant in total over a range of activities for a period of time. That is, a fixed cost does not change as output changes. For

example, rent, depreciation and insurance on vehicles.

b. Variable costs are those costs that tend to vary in direct proportion to output. That is, as output rises, variable cost also increases and vice versa. For example. cost of raw materials.

3. Classification according to function A cost item can be described based on the functional areas of the business. In this regard, cost may be classified as:

a. Production cost: these are the indirect cost of manufacturing a cost unit. It comprises of indirect materials consumed in the factory, indirect factory wages and other indirect expenses incurred in connection with production. For example, cost of raw materials, indirect labour.

b. Administration cost: these are the costs of formulating policy, directing and controlling operations not related directly to production, selling, distribution or research and development. For example, salaries of management, stationery.

c. Distribution cost: these are the costs incurred in making the finished goods ready for dispatch and the delivery of the product to customers. For example, cost of carriage outwards.

d. Selling cost: these are marketing costs incurred in securing orders. For examples sales promotion cost, salaries of salesmen.

4. Classification according to profit determination Under this method, a cost can be classified as a product cost or a period cost.

a. Product costs are costs that are necessary for the production of goods. Such costs are not incurred when there is no production. They include the cost of raw materials and direct labour.

b. Period costs are those costs that are made even when there is no production. They include rent, insurance, salaries of management, etc. Period costs are written off as expenses in the period in which they are incurred.

5. Classification according to element of cost Costs can be classified by element. There are three basic elements of cost: material, labour and expenses/overheads.

a. Material Costs: These are the costs of materials introduced into product or consumed in the operations of an organisation. In other words, they are the cost of materials input into the production of goods and services.

For example, the cost of: raw materials, component parts, work in progress, primary packing materials, lubricating oil, consumable tools, stationary, cleaning materials.

b. Labour Costs: These are the cost of employee remuneration. In other words, payments made to and on behalf of employees for offering labour services in the production function.

c. Expenses: These are all other costs other than material cost and labour costs. For

example, the cost of: hiring special equipment and maintaining such equipment, royalty payments, copyrights and patent payments, utilities such as electricity and water, rent, etc.

In addition to these cost classifications, costs may also be seen as:

1. Relevant cost refers to any cost that can be changed by a management decision. It is a cost that differs among decisions. Such costs are necessary for a particular decision.

2. Irrelevant cost is any cost that does not change in the decision-making process. For

example, in deciding to increase the number of goods in the warehouse, the salary of the storekeeper is an irrelevant cost but the price of the product is relevant.

3. Sunk cost is a past or previous cost that cannot be changed by any decision. It refers to the cost of resources already acquired and the total cost shall be unaffected by the choice between two alternatives. For example, the cost of a machine purchased five years ago.

4. Opportunity cost values the cost of a forgone alternative or a sacrificed choice of action.

Where there is no alternative use for a resource, then the opportunity cost is zero.

5. Avoidable cost is any cost that management can choose not to incur. Management can decide to do away with such expenses. Examples are advertising, overtime allowances, medical bills of staff, etc.

6. Incremental /differential cost is the difference in total relevant cost between two alternatives. It is a cost that differs as a result of changing levels of activities.

7. Marginal cost refers to the additional cost of producing one extra unit of a product.

8. Conversion cost is the cost of transforming raw materials, direct labour and overheads into finished goods. It is the amount of direct labour and overheads that are required to turn raw materials into finished products.

Importance of cost classification The importance of cost classification lies in its ability to enhance managerial decision- making, control, and planning within an organisation. Reasons why cost classification is important are that it:

1. Facilitates cost control: Classifying costs helps management identify and monitor different expense categories, enabling better control over spending and resource allocation.

2. Aids in cost analysis and decision-making: Understanding which costs are fixed, variable, or semi-variable allows managers to analyse profitability, forecast profits, and make informed decisions regarding pricing, production, and budgeting.

3. Enables accurate costing and pricing: Proper classification ensures that products or services are accurately priced by considering the relevant costs, leading to competitive and profitable pricing strategies.

4. Supports budgeting and planning: Cost classifications assist in preparing detailed budgets, setting financial targets, and planning for future activities.

5. Assists in cost control and reduction: By identifying specific cost components, organisations can focus on reducing or controlling unnecessary expenses in targeted areas.

6. Enhances financial reporting: Cost classification aligns with accounting standards, providing clear and meaningful financial reports to stakeholders.

7. Facilitates performance evaluation: Enables performance measurement of departments, products, or projects, fostering accountability and efficiency.

Activity 4.5 Cost Classification and its Importance

1. Arrange yourself in small groups to discuss the basis of cost classification. Answer the following questions through your discussion:

a. What is meant by cost classification?

b. What different methods could a business use to classify their costs?

c. Why is cost classification important?

2. Record the outcomes of your discussion on flip chart paper and be prepared to present your work to the rest of the class.

3. Record the core definitions In your workbook so that you can refer back to them later.

Activity 4.6 Cost Classification in Practice

1. In pairs, arrange to visit any shop/food vendor in the community or school.

Alternatively, you could arrange to interview a business owner or research a chosen business online.

2. For your chosen business find out the types of cost they incur in producing the goods or services they deliver.

3. Group these costs and identify the relevant classification.

4. Explain why you have classified each cost in this way and why it is important.

5. Compile your research and present it to the wider class for discussion and feedback. You could choose to do this as a short presentation or poster.

Elements of cost are the components that make up the cost of a product or service. The main elements of cost are materials, labour and other expenses (overhead).

Materials These are all the ingredients, or inputs that go into the production process before the final product or service is provided. Material cost is made up of direct materials and indirect materials.

Direct material cost This is the cost of raw materials that go into production to be transformed through the manufacturing process to become finished products or services. For example, leather used for shoes, cement used for building, palm oil used for soap and cassava used for gari.

Indirect material cost This is the cost incurred on physical components that do not form part of the final product.

Indirect materials cannot be easily traced to a particular product or service. For example, cleaning materials, lubricants used in machines and packaging materials.

Labour This is all the human effort (physical or mental) used in the production of goods and services. Labour cost is made up of direct labour and indirect labour and can be made up of wages, salaries, bonuses, overtime, etc.

1. Direct labour – this is the remuneration paid to workers whose services can be identified directly with a particular product or service. For example, the wages of a mason building a house and, the salaries of a machine operator, carpenter or a tailor.

2. Indirect labour – this is the remuneration paid for services that cannot be easily traced to a product or service. Examples are salaries of supervisors, cleaners and security men.

Expenses Expenses are all costs incurred other than materials and labour. They are the costs of services paid or unpaid, rendered to an organisation.

1. Direct expenses – these are expenses that can be easily traced to or identified with a particular product or service. For example, royalties paid on patents and mining, the cost of hiring a special machine, fees of architects or consultants and experimental costs.

2. Indirect expenses – these are expenses that cannot be easily traced or identified with a particular product or service. For example, rent and rates, telephone bills, depreciation and insurance.

The diagram below illustrates the breakdown of the different elements of cost.

Activity 4.7 Composition of Cost of Products, Services and Operations

1. Working in groups, discuss the following elements of cost and write down your agreed definitions.

a. Material cost

b. Labour cost

c. Other expenses

2. For each of these components of cost, give three examples of:

a. Direct cost

b. Indirect cost

3. Present your responses on manila cards. You could use a table such as the one shown below to record your responses.

4. Share your response with another group for feedback and discussion.

Definition Type Examples

Direct 1.

2.

3.

Indirect 1.

2.

3.

Labour Direct

1.

2.

3.

Indirect 1.

2.

3.

Other expenses Direct 1.

2.

3.

Indirect 1.

2.

3.

Extension activity Answer the following question to support the review your learning.

Explain labour as a component of cost and its importance to production.

Record your answer in your workbook and share with your teacher for feedback.

In this section, you will explore how businesses determine the cost of producing goods and services, which is important for setting prices and making informed decisions.

You will learn about overheads, including the terms used in overhead analysis and the different types of overheads. The section also covers specific order costing methods such as job, batch and contract costing, helping you understand how costs are calculated in different situations. You will examine processing organisations and their operations, as well as service organisations and the nature of the services they provide. By the end of this section, you should be able to explain how different cost determination methods are used in various types of organisations. This understanding will support your knowledge of pricing control and strategic business decisions. The content also connects with other subjects like finance, business management, and economics, showing the role of cost accounting in the wider business environment.

KEY IDEAS

• Overheads are indirect costs needed to keep a business running.

• Overhead analysis helps share indirect costs fairly across departments or products.

• Specific Order Costing is a method used to calculate the cost of products or services that are produced only when a customer places an order. It is applied in job, batch and contract costing.

• Process costing is a method used to calculate the cost of products that are mass- produced in a continuous and consistent way.

• Service costing is a method used to calculate the cost of providing services, rather than manufacturing physical products. It is used by businesses and organisations that offer intangible services in areas such as transport, education, and healthcare.

Overheads Overheads are the total indirect costs a business spends that cannot be linked directly to a particular product or service. These costs are incurred to ensure the continuation of an organisation. Overheads include indirect materials, indirect labour and indirect expenses.

Types of Overheads

1. Factory Overheads (Production Overheads): These are indirect costs that occur in a factory during the production of goods. These costs do not include direct materials or wages of workers who make a product, but those that are still incurred to produce goods. Examples are factory rent, lubricants, depreciation of machines, factory power/ electricity and factory supervisor’s salary.

2. Administration Overheads: These are indirect costs from the office or management section of a business. The costs are not related to production but help to run a business and make decisions.

Examples of administration overheads are office rent, office electricity, stationery, salaries of administrative staff, depreciation of office equipment.

3. Selling and Distribution Overheads: These are costs that help a business to promote, sell and deliver its goods or services.

a. Selling Overheads: These costs are used to encourage people to buy the product.

Examples are advertising, salespeople’s salaries or commission, samples or promotional items.

b. Distribution Overheads: These are costs involved in getting the product from the factory to the customer. Examples include carriage outwards, delivery van maintenance and storage costs.

4. Financial Overheads: These are indirect costs related to financing the activities of a business, for example in taking loans. Financial overheads are not linked to making or selling products but affect how money is managed. Examples of financial overheads are bank charges, interest on loans, discount allowed.

5. Variable Overheads: These are overheads that change depending on the level of production. If a firm produces more goods, these costs increase; if production drops, they decrease. Examples are packaging materials, factory electricity, lubricants.

6. Fixed Overheads: These are overheads that stay the same even if production increases or decreases. Fixed overheads are incurred even if no goods are produced. Examples of fixed overheads are rent, insurance, salaries of permanent staff.

7. Semi-variable Overheads (Mixed Overheads): These are overheads that have both fixed and variable parts. A part of the cost stays the same, but the rest changes depending on the level of the activity. Examples are electricity bills, water bill and telephone/internet bills.

Activity 5.1 Types of Overheads

1. Your teacher will arrange you in small groups and provide a series of flashcards, or a list, with types of overhead written on them.

2. In your groups, discuss each type of overhead and consider:

a. How this type of overhead might be classified

b. How you would define it

c. Examples of this type of overhead

3. Summarise the main points of your discussion on flip chart paper. You may want to use a table such as the one below.

4. Make presentation to the class for discussion and feedback.

Group Type of Overhead Description of Overhead Examples of the overhead Overheads Analysis This is the process of examining and organising indirect costs — these are costs that cannot be directly linked to a single product or service but are still important for running a business. These costs include things like electricity, rent, salaries of cleaners or security services. Businesses look at these costs to know where they are coming from, how they are used and how they can be controlled or reduced.

Overheads analysis involves:

1. Collecting all indirect costs,

2. Grouping them into categories like production, office (administration), and sales

3. Assigning each cost to the correct department (e.g. the cleaning cost to the department it is meant for),

4. Sharing costs that are used by all departments (like rent) fairly,

5. Re-allocating the cost from support areas like the canteen or maintenance to the departments that actually produce goods to know the total indirect costs that should be added to the cost of each unit produced.

Purpose of Overheads Analysis

Overheads analysis is important in order to:

1. Understand how indirect costs affect total production cost.

2. Allocate overheads fairly across departments, products, or services.

3. Identify cost-saving opportunities.

4. Assist in budgeting and pricing decisions.

Terminologies used in Overheads Analysis Allocation of Overheads This is when the whole amount of a cost is given to one department because it belongs only to that department. For example, the salary of a cook in the canteen will be given fully to the canteen department.

Apportionment of Overheads

This is when costs are shared between different departments because it benefits all of them. For example, if a company pays rent for a building that has three departments, the rent will be shared fairly among the three departments.

Re-apportionment of Overheads

This is when the costs of service departments (like maintenance or canteen) are shared to the main production departments that use their services. This is done because service departments do not make products directly.

Absorption of Overheads (Overhead Recovery)

This is when the total overhead cost of a production department is added to the products made. This is done using a rate, such as cost per machine hour, cost per unit or a percentage of direct materials.

Activity 5.2 Terminologies in Overheads Analysis

1. Copy the task below into your book and draw lines to match each description to the right term used in overheads analysis.

2. Share your answer with a colleague for discussion Terms Description Overheads Analysis A process of examining, grouping, and assigning indirect costs to cost centres before distributing them to products or services.

Apportionment of Overheads Transferring service department costs to production departments after initial distribution.

Reapportionment of Overheads Charging the total cost of an expense directly to the cost centre that incurred it without sharing.

Absorption of Overheads

Adding overhead costs to the cost of each unit produced so that they are included in the product’s total cost.

Allocation of Overheads Sharing common overhead costs among different cost centres based on a fair and logical basis.

Activity 5.3 Overheads Analysis

1. Working in the same groups as for Activity 5.1, revisit the types of overhead you identified.

2. For each example, discuss how that type of overhead would be allocated or apportioned. For example, in each case would the cost be allocated to one function of the business or split? Where and how would this apportionment work?

3. Present your work to the class for discussion and feedback.

Extension Activity

To develop your learning, answer the following question:

How does overhead analysis inform pricing decisions?

Write a short explanation in your workbook and share with your teacher for feedback.

Job Costing

Job costing is a way of finding the cost of a particular job or order made to a customer’s request. In job costing, each job is different and done according to the customer’s instructions. The customer places an order for the work, and the price is usually agreed before the job begins. Examples might include sewing a wedding dress, building a special

table or designing a logo for an organisation.

Characteristics of Job Costing

1. Every job is different from another.

2. Production follows the customer’s exact instructions.

3. The selling price is agreed with the customer before starting.

4. The price is based on cost estimates.

5. A separate record is kept for each job.

6. All costs for a job are recorded on a job card.

Advantages of Job Costing

1. Profit for each job can be worked out separately.

2. It gives a detailed breakdown of all costs for each job.

3. Job costing is useful in estimating costs for future jobs.

4. Helps compare estimated costs with actual costs.

5. Helps identify which jobs are profitable or not.

6. Allows accurate quotations for customers.

Disadvantages of Job Costing

1. Job costing requires more paperwork and record-keeping.

2. It is difficult to prevent unnecessary costs during production.

3. There is no fixed method for estimating costs.

4. It is not suitable for fast and mass production.

5. Controlling costs can be challenging.

Batch Costing

Batch costing is used when producing a set of similar or identical products together. The batch is treated as one job for costing purposes. Each batch is allocated a number and all costs are collected for the whole batch. The cost per unit is found by dividing the total batch cost by the number of units made. Examples include producing 2,000 identical chairs, baking bread in batches or manufacturing medicine.

Characteristics of Batch Costing

1. Goods are made in fixed lots or batches, not one by one.

2. All costs are collected for the whole batch.

3. All items in a batch are the same or very similar in quality.

4. The total batch cost is divided by the number of units to get the cost per unit.

5. Suitable for products made repeatedly, such as medicines, garments or packaged food.

Activity 5.4 Job and Batch Costing

1. Choose a partner to work with to discuss the characteristics of job and batch costing.

2. Extend your discussion to consider the advantages and disadvantages of job costing.

3. Summarise your discussion in your workbook and share your answers with another pair.

4. If you are unsure on the concept of either job or batch costing, speak to your teacher.

Activity 5.5 Applying Job or Batch Costing

1. Your teacher will arrange for you to visit a local artisan (e.g., carpenter, builder, seamstress, tailor, etc.) to learn about how they cost their goods or services.

2. Ahead of your visit, plan questions you would like to ask.

3. If you are not able to visit a local artisan, then choose a small business to research or find a documentary video online showing how artifacts are produced and costed.

4. In small groups, discuss what you observed on the trip (or through your own research) regarding duration, location, nature of work and payment methods of the work done by the artisan.

5. Make a poster presentation of how your chosen artisan produces goods to illustrate the job or batch approach to costing.

6. Share with another group for feedback.

Contract Costing

Contract costing is a method used to find the cost of large projects that are carried out according to a customer’s request and usually take a long time to finish. Unlike job or batch costing, contract costing is done mainly at the customer’s site. Often contracts are for construction work such as building roads, bridges, schools or ships.

Characteristics of Contract Costing

1. The work is done according to the customer’s exact instructions.

2. Contracts take a long time to complete.

3. Work is done at the customer’s site or location.

4. Each contract is separate from other jobs.

5. Contracts are usually large projects.

Advantages of Contract Costing

1. Each contract is recorded separately, making it easier to track and control costs.

2. Loss is less likely because most costs are recovered from the contract price.

3. The contractor earns a fixed percentage of profit.

4. Payments are received in stages, which helps cash flow.

5. The customer can monitor the work’s progress through retention money.

6. The contractor can benefit from price increases by including escalation clauses in the contract.

Disadvantages of Contract Costing

1. Time can be wasted if work is delayed or not done according to plan.

2. Costs may rise if there are production delays.

3. Poor record-keeping can lead to wrong profit calculations.

4. The contractor may need to spend money upfront before receiving payments.

Difference between job costing and contract costing S/N Aspect Job Costing Contract Costing 1 Duration Short term period. Takes place over a long-term period.

2 Location of work Work is done in a workshop or factory.

Work is done at the customer’s site.

3 Scope Involves small and individual jobs. Involves large-scale projects.

4 Control of work It is usually internal.

Supervised by the customer’s technical professionals (for example engineer or architect).

5 Mode of payment Payments is mostly done upon the completion of the job.

Payment made in stages, based on work certified.

Activity 5.6 Contract Costing

1. Working in pairs, explain the meaning of contract costing.

2. Discuss the characteristics of contract costing.

3. Summarise four (4) advantages and four (4) disadvantages of contract costing

4. Discuss the difference between job costing and contract costing.

5. Compare your responses with another pair for feedback and discussion.

6. Be prepared to share your responses with the wider class at the end of your lesson as part of a general reflection on these types of costing method.

Process Costing

Process costing is a method of costing used when identical goods are produced on a large scale. It is commonly used in industries where products are made continuously and each unit is the same as the others, so it is not possible to calculate the cost of each individual unit separately. Examples of businesses that might apply contract costing include breweries, oil refineries, chemical factories, food production and water processing plants.

The Main Purpose of Process Costing

1. To find the cost per unit of production.

2. To calculate the average cost of production after each stage.

3. To find the value of work still in progress.

4. To record normal and abnormal losses during production.

5. To compare actual costs with estimated costs.

Characteristics of Process Costing

1. Production is continuous.

2. The products are all the same (homogeneous).

3. The production process is standardised.

4. The output of one process becomes the input for the next process.

5. The final output from the last process becomes finished goods.

6. A separate account is kept for each process.

7. Finished goods are identical and can only be distinguished by batch coding.

Advantages of Process Costing

Advantages of process costing include that it:

1. Ensures costs are spread evenly across all units produced within a specified period of time.

2. Is simpler to use in continuous, standardised production compared to job costing as production processes are standardised and often repetitive.

3. Shows accurate costs for each stage of production, enabling better cost control and decision making.

4. Makes it easy to value work in progress and finished goods inventory at each stage of production.

5. Helps check the performance and evaluate efficiency at each stage of production. This can help management identify areas for improvement.

6. Encourages standardised production, reducing waste and improving quality and efficiency.

7. Tracks costs for each process, making it easier to find cost differences.

8. Helps management control costs by monitoring each stage of production.

Disadvantages of Process Costing

Disadvantages of process costing include that it:

1. Treats all units as identical, so no room for product individuality. This can be an issue in industries where customisation or variation in products is important.

2. Overhead costs may be wrongly allocated, affecting the accuracy of costing information and potentially misinforming decision making.

3. May not give enough detailed cost information for tight control because costs are aggregated at process or department level.

4. Can be time-consuming and requires a lot of record-keeping.

5. Not suitable for small-scale or customised production as it is better suited to industries with large scale and repetitive production processes.

Activity 5.7 Processing operations Part A

1. Your teacher will share with you photographs or short videos showing processing operations in different industries.

2. You may also watch the short films below:

https://www.youtube.com/watch?v=b543tIbjoo8 https://www.youtube.com/watch?v=g5dZpT51IY4

3. Make notes while you watch the films on the types of process operations and the types of costs that would need to be considered for each of these businesses.

4. Share your thoughts as part of a wider class discussion.

Part B (optional)

1. Your teacher may be able to arrange for you to visit a local processing organisation, or have an industry representative come and present to the class on their processing operations.

2. Plan questions to ask during the visit/presentation.

3. Take notes and take part in a wider class discussion on what you have seen/heard.

Activity 5.8 Key Issues in Process Costing

1. Find a partner to work with and discuss the meaning of process costing

2. Summarise four (4) purposes of process costing

3. Identify the characteristics of process costing

4. Write down four (4) advantages and four (4) disadvantages of process costing

5. Compare your responses with another pair for feedback and discussion.

Service Costing

Service costing is the method used to find out the cost of providing services instead of goods. Services are intangible and cannot be stored. Examples of services include the work of teachers, lawyers, pastors, drivers, barbers and hairdressers.

Characteristics of Service Costing

1. No inventory: Services cannot be stored like goods. For example, a haircut today cannot be stored for tomorrow.

2. Expiration: If a service is not used when it is offered, it cannot be saved for later.

3. Inseparability: The service is usually linked to the person providing it. For example, teaching cannot be separated from the teacher.

4. Uniqueness: Every service is different. For example, two lessons by the same teacher may not be exactly the same.

The objectives of Service Costing are to

1. find the cost per unit of service.

2. help decide how much to charge for the service.

3. know whether the service makes a profit or loss.

4. give management information to control costs and improve services.

Organisations that use service costing and units produced Examples of the types of organisations that apply service costing are listed in the table below. For each organisation, examples have been given of how the cost of the service could be broken down (cost unit).

Organisation Cost units Hospitals In-patient days, number of surgeries, number of outpatients attended to Consultancy Client hours or days Schools School hours or days, numbers of learners, types of programmes Canteen/ Restaurants Number of plates of meals served Maintenance services Maintenance hours/days Power generation organisations Kilowatts used Soliciting firms Court days/ hours Hotels Occupied beds/ rooms, conference rooms, subscriptions for use of space and gym centres Library Subscription for use of the library, library days/ hours Transport services Tonnes/ kilometre covered, number of passengers, distance covered Advantages of Service Costing

1. Clear picture of the cost: It shows the cost of each service offered by a business/ organisation, making it easier to set prices.

2. Better use of resources: It helps businesses/organisations to use money, time, and staff more efficiently.

3. Performance evaluation: It helps businesses/organisations to see which services are profitable and identify areas fo improvement or investment.

4. Better decisions: Service costing provides useful information to support decision making, for example related to pricing, outsourcing or improving services.

5. Customer analysis: It helps businesses/organisations to know which customers bring more profit.

6. Comparison: It allows comparison of costs with other organisations to help businesses/ organisation identify the need for cost reviews or to improve efficiency.

Disadvantages of Service Costing

1. Complexity: It can be difficult to undertake when a business offers many different services with different cost structures and revenue streams. It can be difficult to allocate overhead costs and indirect expenses accurately to each service.

2. Intangibility: Services are not physical, so costs are harder to measure and allocate.

3. Subjectivity: Some cost allocations, such as assigning shared resources, depend on judgment which may not always be fair.

4. Difficult measurement: Some services do not have clear cost units which makes it difficult to know how to allocate costs.

5. Different customers: Customers use services differently at different times, making cost allocation harder.

Activity 5.9 Service Operations

1. Click on the link below to watch a short video showing service operations in different industries.

Service Industry Definition, Types & List - Lesson – https://study.com/learn/lesson/video/service-industry-types-list.html

2. Make notes while you watch the films on the types of services and the types of costs that would need to be considered for each of these industries.

3. Share your thoughts as part of a wider class discussion.

Activity 5.10 Nature of Service Costing

1. In pairs or small groups, discuss the meaning of service costing

2. Summarise four (4) objectives of service costing

3. Identify the characteristics of service costing

4. Write down five (5) advantages and five (5) disadvantages of service costing

5. Compare your responses with another pair or group for feedback and discussion.

Activity 5.11 Costing Methods

1. Complete the table below to identify the costing method that might be used to determine the total cost of producing goods or services in the following industries.

S/N Industry Costing Methods

1 Pharmaceutical industry 2 Specialised equipment manufacturing 3 Food processing (e.g., bakery goods) 4 Infrastructure projects (e.g., highways, bridges) 5 Custom furniture manufacturing 6 Cement production 7 Education (schools, universities) 8 Shipbuilding 9 Hospitality (hotels, resorts) 10 Crude oil refining

2. Share your answer with a colleague for feedback

Activity 5.12 Service costing case study

1. Your teacher will arrange you in small groups of no more than five and assign you with a type of service organisation, for example a restaurant or a hospital.

2. In your groups, discuss the primary service offered by your assigned organisation and prepare a list of the cost units that would support the costing of this primary service.

3. You may find it useful to research examples of your assigned organisation, e.g how a restaurant breaks down its services for costing purposes.

4. Make a short presentation of your work to the rest of the class for discussion and feedback.