Controlling Cost to Improve Organisational Performance

This section is designed to help you gain the knowledge, skills and tools needed to control costs effectively, improve your organisation's performance, reduce unnecessary expenses, and increase profitability. By working through this lesson, you will learn how to recognise what makes up a cost accounting system and the type of information it provides, understand what inventory is, how inventory control works, and how to calculate inventory levels, explain the concept of labour and related terms as well as how to calculate employee remuneration, and finally, prepare an overhead analysis sheet and work out overhead absorption rates.

These topics are essential for you as a cost accounting student. By mastering them, you’ll discover how effective costing systems supply reliable data, helping businesses set prices, manage production, make investment choices, and assess their own performance. Ultimately, you’ll be equipped to spot areas where improvements can be made and support better decision-making within an organisation.

KEY IDEAS

• Inventory refers to goods or materials that a business owns or intends to sell or use for production purposes.

• Inventory control involves the processes and procedures for managing and regulating inventory levels efficiently.

• Inventory level is the quantity of inventory a business holds at any given moment.

• Labour is the work carried out by employees to produce goods or deliver services.

• Overhead analysis ensures that indirect costs are allocated fairly and appropriately across different departments or products.

• Remuneration is the compensation employees receive for their contributions and work.

Material Control Process

The term “materials” refers to all commodities that are consumed in the production process. Materials can be grouped into direct and indirect materials.

Direct materials are those whose consumption can be identified with the specific product or service, for example, raw materials.

Indirect materials are those that cannot be conveniently identified with a product or service, for example, sandpaper, lubricants and cardboard.

The Purchasing Process

When a business buys materials from a supplier, it’s important to keep a record of the purchasing process. The reasons for documenting materials include the following.

1. To make sure the steps for ordering, receiving, and paying for the materials are done correctly;

2. To confirm that the ordered goods were delivered and match in quantity and quality;

3. To keep a record of the materials bought for financial purposes;

4. To provide information on material costs for the cost accounting department.

Procedures and documents ₁. The department that needs materials (like the Production Department) sends a request

note to the Stores Department, asking for the materials they need.

2. If the Stores Department does not have the materials in stock, they send a request to the Purchases Department to buy the materials. This request must be approved by the Stores Manager.

3. The Purchasing Officer asks suppliers for prices (quotations). After comparing the quotes, they chose the best one. Then, they send a purchase order to the selected supplier, specifying what is needed, how much, the quality and the price.

4. When the supplier delivers the materials, they include a Goods Delivery Note that shows what was sent and how much. One copy stays with the Stores, and another copy is kept by the supplier.

5. The Stores Department then makes a Goods Received Note to record the materials they received, including details like the item code and quantity. This process helps ensure that materials are bought and received properly, keeping everything organised.

6. Copies of the Delivery Note and the Goods Received Note are sent to the Accounts Department, where they are matched with the Purchase Order.

7. The Accounts Department reviews the invoice details and compares them with the Purchase Order and the Goods Received Note before paying the supplier.

Storage of Materials

Storage means keeping materials in a safe and secure way, making sure they are protected from loss, theft or damage. The Stores Department should keep track of how much and what quality of materials they have. For each type of material, there should be a Bin Card that shows how much was received and how much was issued. This Bin Card can be a physical card or a digital record on a computer.

Classification and Coding of Materials

Classification is when we organise items based on what they are or what they are used for.

It means putting similar items together into groups.

A code is a set of numbers or symbols used to label a group of items. This helps us quickly identify, organise, and analyse them. Items that are alike are grouped and given a specific code (name and number) so we can easily find and distinguish them.

Coding can be done in the following ways.

a. Alphabetically: this is where letters are used to represent materials. For example, SDC can be used to represent sodium chloride.

b. Numerical: Numbers are used to codify materials. For example, 456 represents sodium chloride.

c. Alphanumeric: this is where a combination of letters and numbers is used to codify materials. For example, SD45C represents sodium chloride.

The goal of classification and coding

1. Make it easy to identify materials quickly.

2. Reduce the need for long descriptions of items in the stores.

3. Improve the storage and distribution of materials.

4. Keep track of the levels of materials available.

Advantages of classification and coding

1. It helps to speed up the recording of information about the materials.

2. It minimises errors in stock taking and valuation of materials.

3. It simplifies clerical work in the material control system.

4. Coding is essential in computerised accounting systems.

Features of a good coding system

1. Unique: Each code should be different from another and should be used for only one item.

2. Clear symbolisation: coding should follow a consistent format, i.e. it should either be alphabetical, numerical or alphanumerical.

3. Brevity: codes should be as short and brief as possible. This will ensure that it can be easily remembered and is consistent with the requirements of classification.

4. Uniformity: Codes should be equal in length and of the same structure. This helps to identify any missing letters or figures.

5. Ambiguity: Coding should avoid the use of similar characters and numbers. For

example, the letters O and I are normally not used in coding since they look like zero (0) and one (1).

Activity 4.1 Procuring Business Materials

1. With a partner, describe the step-by-step process a business follows when purchasing materials.

2. Talk about the specific documents and procedures used at each stage of the purchasing process.

3. Consider the impact of a good material coding system. Why is it important for a company to have a well-organised system for identifying materials?

4. Present your responses to another pair and then to your teacher for feedback.

Stocktaking Stocktaking is the process of physically counting the materials in the store/shop. It is a system of physical verification of inventories in the store. The two main methods of stocktaking are periodic stocktaking and continuous stocktaking.

Periodic Stock taking is where stock taking is done at regular intervals during the year.

The store may be closed down for the counting to be done.

Advantages of Periodic Stocktaking

1. Normal work of the stores is not disrupted during the stock count since it is closed down.

2. It is less costly in terms of time and money since stock count is at specific periods.

3. Stock figures are more accurate than the figures obtained from continuous stocktaking.

4. There is less clerical work to be done.

5. Staff from other departments can be called to take part in the stock taking.

Disadvantages of Periodic Stocktaking

1. There can be late detection of fraud or errors committed.

2. Since the store is closed down for stock counting, production may be disrupted.

3. Discrepancies, losses and damaged items are not easily detected.

Continuous stocktaking is where an item of stock is counted daily or weekly to ensure that all items in the store are counted at least once within the year.

Advantages of Continuous Stocktaking

1. It avoids disruptions and closure of the store during the year for a major stock count.

2. Discrepancies, losses, deterioration and slow-moving items are detected early.

3. The regular checking of items helps to reduce the occurrence of fraud.

4. It helps to determine closing stock values easily and enables the preparation of interim financial statements.

5. Proper inventory control can be exercised since stock levels are monitored and kept within authorised levels.

Disadvantages of Continuous Stocktaking

1. It is costly in terms of time and money, especially with the use of experienced staff during the stocktaking.

2. There are frequent interruptions within the areas of the store where stocktaking is taking place.

Issuing and Returns of Materials

The Store Department needs to record the quantities and cost of items or materials that are issued to user departments and the quantities that may be returned unused to the Stores.

The following documents are key in this process:

Material Requisition Note

This is a formal document from a user department to request materials from the Stores.

A material requisition note is used to record:

1. the details of the quantity of materials issued

2. the user department that received the item

3. the cost of the items issued.

Material Returns Note

This is used to record items that have been returned to Stores by a User Department.

Monitoring of physical inventory There may be times when inventory records in the Cost Accounting system do not agree with the physical quantities actually held in the Store.

Reasons for this may include the following.

1. Errors in recording and calculation of receipts, issues and returns.

2. Incorrect coding of items causes wrong items to be issued or charged.

3. Omissions in recording of receipts, issues and returns.

4. Theft and pilferage leading to physical loss.

5. Damage to and deterioration of items due to improper handling.

Activity 4.2 A School Store Case Study

1. Go to the school store with a group you form with your classmates.

2. Using a checklist of questions provided by your teacher, interview the storekeeper to understand their process for issuing materials.

3. Look closely at how items are stored and labelled. Pay attention to the organisation of the stock and the records that are kept.

4. Each group will present their findings to the class, sharing what they observed during the visit.

5. As a class, discuss the following questions:

a. Which method of stocktaking is best for a school, and why?

b. How does improper stock management affect teaching and learning?

c. What can students and staff do to help prevent inventory loss or damage?

Meaning of Inventory

Inventory refers to goods or materials available in the business for sale, production, or resale. These are products or materials a business owns and plans to sell or use.

Types of Inventory

What constitute stocks depends upon the organisation. The types of inventory in manufacturing organisations are outlined in the table below.

Type of

inventory Description Examples Raw materials and components Materials are basic substances or resources used to produce goods or products.

Components are pre- made parts or materials used to assemble a final product.

• Timber (for furniture)

• Cotton (for clothing)

• Wheat (for bread).

• Engines (for cars)

• Batteries (for electronic devices)

• Fabric (for clothing).

Products in an

intermediate stage of production or completion Goods or materials that are partially completed and still undergoing processing or manufacturing.

Work–in – progress Partly manufactured goods Consumable stores Goods or materials used in business operations that are used up quickly, not reused or resold and are essential for daily operations.

• Detergents

• Paper

• Pens

• Toner

• Fuel Finished goods Completed products are ready for sale or distribution. They are fully manufactured, complete, functional and ready for customer use.

Meaning of Inventory Control

Inventory control is the management and regulation of inventory levels, including tracking inventory quantities, monitoring inventory movement, maintaining inventory levels and minimising inventory cost.

Why is inventory control important?

The objectives of inventory control are shown in the figure below.

Figure 4.1: Illustration of objectives of inventory control.

Benefits of Inventory Control

₁. Inventory control prevents understocking of materials. Understocking leads to material running out earlier than expected. These can lead to stoppages and delays in production, which can lead to loss of profits, customer goodwill and panic buying.

2. Inventory control prevents overstocking of material. Overstocking is when there are more materials than necessary. This results in capital being locked up in stocks, a higher cost of storing stocks and a higher rate of spoilage and pilfering.

3. Inventory control ensures economy in purchasing. Stock control ensures that purchases of materials are done at the right time, in the right quantities and at the most favourable prices.

4. Proper Inventory control will ensure that quality materials are purchased. Inferior materials result in poor quality of goods.

5. Inventory control provides adequate information on the types of materials in the Store Room. There will be data on the quantity, quality or prices of stocks.

6. Inventory Controls ensures that there is minimal wastage of materials. Losses of materials occurred due to obsolescence, pilferage/stealing, evaporation and deterioration.

Activity 4.3 Understanding Inventory Types

This activity will help you and your classmates research and understand the different types of inventory that organisations manage. You will use digital tools or textbooks to find answers to key questions about your assigned inventory type and present your findings to the class. Your teacher will put you in groups for this activity.

1. Using digital tools like a laptop or tablet, or textbooks, research the types of inventory you have been assigned.

2. For your specific type of inventory, answer the following questions:

a. What are the main characteristics of this inventory type?

b. Provide some real-world examples.

c. Explain why organisations choose to keep this type of inventory.

3. Prepare your answers and present your work in the format provided by your teacher or the example below for a class discussion and feedback.

Type of inventory Description Examples Purpose

Activity 4.4 Improving Inventory Control at MFS Clothing

Form a group with some classmates for this activity to analyse the inventory problems of a clothing company, MFS Clothing, and propose solutions to help them improve their performance.

1. Read and discuss the case study about MFS Clothing. Identify the problems the company is facing due to poor inventory management.

2. Prepare an explanation for the management of MFS Clothing on the following:

a. Inventory control: What is it, and why is it important?

b. Objectives of inventory control: What are the main goals of a good inventory system?

3. Propose Solutions: Discuss and list specific ways that MFS Clothing can improve its inventory management. Think about the issues mentioned in the case study, such as overstocking and stockouts.

4. Present Your Findings: Write your answers on a flip chart and present your findings to the class.

Reasons for Holding Inventory

₁. Inventory is held to meet normal production and sales requirements.

2. Inventory may be held to cater for uncertainties in demand. For example, an unexpected increase in demand can require an increase in production and sales levels.

3. Inventory is held for fear of increases in prices or shortages. Management can decide to hold more inventory if prices are expected to rise.

Cost Associated with Inventory

₁. Acquisition Cost: This is the cost of purchasing and transporting the goods to the stores.

2. Ordering Cost: This is the cost incurred anytime a fresh delivery of goods is required.

It includes the cost of preparing a Purchase Order, the cost of receiving deliveries, telephone calls, etc.

3. Holding/Storage Cost: This is the cost of keeping inventory in the warehouse. It includes insurance costs, storage costs, cost of pilfering, cost of obsolescence, etc.

Inventory control levels are shown in Figure 4.2 below.

Figure 4.2: Inventory control levels Explanation of Inventory Control Levels Importance of Inventory Controls ₁. Effective inventory control is important and helps to:

a. minimise the amount of money tied up in stock.

b. lower the costs of storing and managing inventory

c. keep production and sales running smoothly

d. reduce the expenses of buying and stocking inventory

e. minimise waste and losses due to expired, damaged or spoiled goods

2. Effective inventory management supports stock control and prevents organisations from having too much or too little stock than is needed, both of which can be problematic.

Consequences of Overstocking

₁. Increase in inventory storage costs: renting more warehouse space, increased utility bills, higher labour costs, etc.

2. Physical damage or decay: materials losing quality, getting damaged, rotting, etc.

3. Materials becoming outdated: materials no longer in demand, etc.

4. Theft or unauthorised taking by employees.

Consequences of Under-stocking

₁. Decrease in sales as a result of the storage of materials.

2. Loss of customers.

3. Under use of machines and personnel.

4. Unplanned expensive orders to cover the shortfall when customers demand the materials.

Re-Order level

Activity 4.5 Understanding inventory control levels

1. Working in your groups from Activity 4.6, study the case study below and answer the questions that follow.

JOEKEB, a company dealing in stationery with three stores in the Eastern Region of Ghana, has faced challenges with its inventory management over the past six months. Customers visiting their shops often leave empty-handed due to items being out of stock.

JOEKEB’s suppliers have been delivering goods late, and items remain unsold for long periods when the quality deteriorates, and they cannot be sold.

Explain the following to the business to help them improve the management of their inventory and stock control processes:

a. The different inventory control levels.

b. The importance of inventory control levels in effective stock management.

c. The consequences of overstocking and understocking.

2. Write down your responses on a flip chart.

3. Present your work to another group for feedback.

In the previous lesson, we looked at inventory control levels and why they are important in effective stock management.

In this lesson, we will look at how you can calculate different stock levels. You may find it useful to go back and re-read the definitions of each level as you look at the formulas.

Formulas Used in Computing the Various Stock

Levels ₁. Re-order level Re–order Level = Maximum Lead Time x Maximum Consumption during lead time.

2. Maximum Stock Level

Maximum Stock Level = Re- order level +Re-order Quantity - [Minimum usage x minimum lead time]

3. Minimum Stock Level

Minimum Stock Level = Re-order level – [Average consumption x Average lead time]

4. Average Stock Level

Average Stock Level = (Maximum stock level + Minimum Stock level) 2

Note that lead time is the time (days, weeks or months) it takes for ordered goods to arrive.

Factors that Affect Lead Time ₐ. Availability of goods for sale.

b. Consistency of the supplier.

c. Means of transport.

d. Processing/Production time of the material.

e. Inventory inspection time.

f. Waiting time at loading and off-loading points.

Activity 4.6 Factors affecting lead time Pair with a friend and do the following.

1. Identify factors that affect lead time.

a. Consistency of the supplier b.

c.

2. How do these factors impact stock availability?

3. Write your answers in your workbook and share with another pair for feedback.

This lesson should be dedicated to learners applying their knowledge of inventory control and working through practical examples of how to calculate various stock and inventory control levels.

Activity 4.7 Calculating Stock Levels

1. Form a group with a few classmates to review the information provided for Tunga Manufacturing PLC from scenario 1. Then, calculate the following.

a. Re-order level

b. Maximum stock/inventory level

c. Minimum stock/inventory level

d. Average stock/inventory level Scenario 1 Tunga Manufacturing Plc buys materials from Odumase. 3,000 kg of materials are purchased in one order, and it takes 3 – 5 weeks for the ordered supplies to arrive. Weekly consumption is between 350 kg and 550 kg.

e. Record your workings and final answers on a flip chart and share them with another group to compare your results.

2. Next, review the data for the company purchasing its materials from Asuboa (Scenario 2). Calculate the following:

a. Re-order level

b. Re-order quantity

c. Minimum stock level Scenario 2 A company purchases its materials from Asuboa. It has set its maximum stock level at 80,000 units. Lead time for delivery of supplies is from 5 to 8 weeks. Weekly consumption is between 4,000 units and 5,000 units.

d. Write your calculations and answers on a separate flip chart and share them with another group.

3. Extension Task: Work on the final scenario for ENOLEX Manufacturing Plc.

Calculate the re-order level, maximum stock, minimum stock, and average stock.

Record your answers in your workbook and share them with your teacher for feedback.

What is Meant by Labour?

Labour is the human effort – physical or mental - employed in the production of goods and services.

Labour is the work that people do, whether it is physical tasks like lifting or mental tasks like thinking, to create goods and services. It's the effort people put into making things or providing services that others need Labour remuneration/cost It is the money given to workers for the work they do. This payment can come in different forms, such as wages or salaries (regular pay), allowances (extra money for specific needs), commission (extra pay based on sales or performance) and bonuses (additional rewards for good work).

Bases of labour remuneration ₁. Time rate

2. Piece rate Time Rate This method of remuneration is a method where workers are paid based on the time worked in hours, days or weeks.

It is calculated as the rate multiplied by the time worked.

Time rate = Hours worked X rate per hour/day Conditions for using the time rate method

1. When it is difficult to measure the amount of work done or the worker's performance.

2. When the job requires careful attention and dedication.

3. When workers prefer to be paid based on time rather than output.

4. When the worker has limited control over the results, such as in research work.

Example

Hours worked = 45 hours Rate per hour = GH¢120 Gross Wage = 45hrs x GH¢120 = GH¢5,400 Advantages Disadvantages Quality goods are produced because workers are not under time pressure.

Close supervision is required to reduce idle time.

There tends to be less wastage of materials because workers are not under a time pressure to produce.

A keeping system must be introduced to check attendance.

An employee can easily calculate his/her income.

Inefficient workers will be rewarded with equal pay as the hard-working workers.

Workers have the option to earn more by working extra hours for overtime pay.

There is little or no incentive to produce more since the salary is guaranteed.

It provides a guarantee of a basic salary for workers.

Output cannot be easily measured or evaluated.

Piece Rate

This method of remuneration is a way of paying workers based on how much they produce. Workers earn money for each unit they complete, and the payment is calculated by multiplying the rate per unit by the total number of units produced. The main types of Piece Rate methods are listed below.

1. Straight Piece Rate

2. Differential Piece Rate

3. Piece Rate with a guaranteed minimum wage Conditions for using the piece rate method

1. When it is easy to measure the amount of work completed.

2. When workers have control over how much they produce.

3. Where little or no supervision is needed during production.

4. Where work is uniform and standardised.

Advantages

1. Workers have control over their earnings, as they are paid based on the amount they produce.

2. Workers are encouraged to work more since increased output results in higher wages.

3. There is an increase in production since workers are encouraged to produce more.

4. There is fair treatment of workers since payment is based on performance.

Disadvantages

1. Excessive wastage of materials may occur due to the desire /pressure to produce more.

2. There is a problem of fixing the piece rate of remuneration.

3. It requires detailed records of the production of each worker.

4. Poor quality goods may be produced since workers want to produce more.

5. The desire to produce more may have health implications for employees.

Straight Piece Rate

Under this method, the amount earned is based on the number of units produced multiplied by the rate per unit.

Example 4.1

No. of units produced: = 500 units Rate per unit: = GH¢15 Gross Wage: = 500 units x GH¢15 = GH¢7,500 Differential Piece Rate Under this method, the rate per unit of output changes at different levels of production.

Example 4.2

GH¢10 per unit for the first 100 units of production GH¢20 per unit for the output between 101 and 200 units GH¢30 per unit for the output above 201 units Therefore, if a worker produces 90 units, they are paid 90 x GH¢10 = GH¢900 If they produce 131units they are paid 131 x GH¢20 = GH¢2,620 And if they produce 210 units, they are paid 210 x GH¢30 = GH¢6,300 Piece Rate with a guaranteed minimum wage This system is adopted to compensate employees for low production during a period.

To prevent workers from earning low wages, businesses may put in place a guaranteed minimum wage. This is paid to any worker who is not able to produce the required output.

Example 4.3

DORKAY employs four workers who produced the following in a particular month:

Each worker is expected to produce 150 units. Workers are paid at GH¢15 per unit, but the company sets their guaranteed basic salary at GH¢2,000.

Kyei produces 150 units and is therefore paid GH¢2250.

Frempong produces 180 units and is therefore paid GH¢2700.

Kumba produces 120 units and is paid GH¢2000.

If the piece rate is less than the guaranteed salary, then workers will be paid the minimum guaranteed salary.

Activity 4.8 Labour and labour remuneration

1. Pair with a friend, and discuss the concepts of labour and labour remuneration.

2. Write down your definitions of both on sticky pads.

3. Share your answer with another pair for feedback. Do you need to adjust your original definitions?

Activity 4.9 Methods of labour remuneration

1. Work with 3 of your classmates in a group, and identify and discuss the methods of remuneration.

2. Write down the conditions for using each method of remuneration.

3. Present your answers to the larger class.

You could use the table below to present your answers.

Method of

remuneration What does this mean? Circumstances under which this method would be used.

What is an Incentive?

An incentive is an additional payment given to motivate workers to produce more or to reward workers for extra or exceptional performance.

Types of Incentive Schemes

₁. _(Overtime)

2. Bonuses Overtime Premium

Is the extra pay given to workers for working beyond their regular working hours. The payment rate for overtime is higher than the usual hourly rate. Overtime premiums are normally expressed as time plus a fraction, or in multiples of time. For example,

a. time and a half

b. time and a fifth

c. time and a quarter

d. double time

Example 4.4

A company employs 4 workers, and they work in a month as follows:

Dokua 170 hrs Esinam 150 hrs Chidi 200 hrs Kumba 120 hrs Each worker is expected to work for 150 hrs. Workers are paid at GH¢15per hour, and overtime is paid at time and a half.

Therefore, Dokua’s wages for the month will be calculated on the following basis:

(150 x GH¢15) + (20 x (GH¢15 x 1.5)) GH¢2250 (base rate) + GH¢450 (overtime premium) = GH¢2,700 Bonus Schemes It is a payment method where workers receive extra compensation based on the time they save or the targets they meet. Bonuses can be awarded where there have been cost savings through improved performance, or where agreed targets have been met within a given period.

Terms

1. Time Allowed – this refers to the expected time to be spent or used on a piece of work.

2. Time taken – this is the actual hours used in performing a piece of work

3. Time saved – this is ascertained when the time taken is less than the time allowed.

It is the excess of time allowed over the time taken.

4. Bonus Premium – this money is paid to the worker for saving time.

For example, the expected production is 200 units, and the time allowed is 4 hours. If the time taken is 3 hours, then the time saved will be 1 hour.

Example 4.5

A company has 3 workers who produced the following units in a day.

Odum 25 units Asor 35 units Kwaku 45 units Each worker is expected to work for 8 hours a day and use 12 minutes to produce one unit of the product.

Taking Asor as an example, the total time taken to produce their 35 minutes is 7 hours ((35 x 12) / 60); therefore, they save 1 hour.

The advantages and disadvantages of incentive schemes are summarised in the following

table.

Advantages of incentive schemes Disadvantages of incentive schemes Incentive schemes reward hardworking employees for their efficiency.

Some incentive schemes can be costly to manage.

Incentive schemes lead to increased production.

It can be challenging to set clear performance levels and determine appropriate payment rates.

Incentive schemes help reduce employee turnover.

The pressure to produce more may affect the health of workers.

Workers can earn more income for putting in extra effort.

The focus on producing more may lead to a decrease in the quality of goods produced.

Incentive schemes attract skilled and high-quality workers to a job.

Labour Turnover

Labour turnover refers to the number of employees who leave an organisation over a specific period, either voluntarily or involuntarily and are replaced by new workers Causes of labour turnover

1. Death or Retirement

2. Redundancy

3. Dismissal

4. Seeking greener pastures

5. Poor working conditions

6. Movement to join spouse/partner Idle Time Idle time refers to periods when a worker is being paid but is not actively working, through no fault of their own.

Causes of idle time

1. Machine breakdown

2. Power outage

3. Shortage of materials

4. Time spent commuting between departments

5. Routine maintenance of machines

6. Natural disasters like floods

Activity 4.10 Exploring Incentive Schemes

You will work with your partner to discuss various incentive schemes, their examples, and their pros and cons.

1. Form a group with a few friends or classmates to discuss the following:

a. The different types of incentive schemes used by businesses.

b. Specific examples for each type.

c. The advantages and disadvantages of using incentive schemes.

2. Write down your answers, and then share and present your work to the class for discussion and feedback. You can use the provided table format to organise your answers.

You could use a table such as the one below to present your answers.

Types of incentive schemes Examples Advantages of incentive schemes Disadvantages of incentive schemes

Activity 4.11 Labour and Time Management

This activity will help you and your classmates understand key concepts related to workforce management. You'll discuss the meaning and causes of both labour turnover and idle time in a business.

1. Form a group with a few friends or classmates.

2. In your group, discuss the meaning and causes of both labour turnover and idle time.

3. Write down your answers on sticky pads.

4. Present your answers to the rest of the class for discussion and feedback.

Explanation of Overheads

Overhead costs are all the indirect costs an organisation incurs. These include indirect materials, indirect labour and indirect expenses. Overhead costs are expenses that do not come from specific departments or activities but support the organisation as a whole Types of Overheads ₁. Production/Factory Overheads These are all the indirect costs involved in producing goods in a factory. They include indirect materials, indirect wages and indirect expenses like machine insurance, factory rent, lubricants, depreciation on equipment and electricity. These costs are also called manufacturing overheads.

2. Administration Overheads

These overheads are related to the administrative side of the business. They are the costs that management incurs to organise and control business activities. Examples include stationery, office rent, electricity, telephone bills, management salaries and depreciation of office buildings.

3. Selling & Distribution Overheads These are overhead costs from the selling and distribution activities of the business.

They are spent to attract customers and deliver goods to them. Examples include sales commissions, advertising, promotions, showroom expenses, sales staff salaries, depreciation of delivery vehicles and catalogue costs.

4. Financial Overheads

These are expenses related to managing the financial responsibilities of a business.

They include costs for obtaining loans, bank charges, discounts given to customers and interest on loans.

Stages of Overhead Analysis

Overhead analysis is a process used by businesses to identify, allocate and manage indirect costs in order to ensure effective resource allocation and to optimise cost efficiency.

The stages of overhead analysis

1. Collection

2. Classification

3. Allocation

4. Apportionment

5. Absorption.

Explanation of Stages

Collection Overheads are collected from various departments as they are incurred. The amounts are recorded using documents like vouchers, invoices, bank statements and other key records.

Classification This is when overheads are grouped based on specific characteristics or features. They can be classified by functional areas such as production, administration, finance, or selling and distribution. Overheads can also be grouped by cost elements, like indirect materials, indirect labour and indirect expenses. Another way to classify overheads is by their behaviour, meaning they can be either fixed or variable.

Allocation This is when a whole overhead cost is assigned to a specific cost centre or department.

Cost allocation is the process of allotting overhead cost to a cost centre or cost unit when the overhead can be conveniently traced to that particular cost centre or cost unit.

Apportionment Apportionment is the process of spreading overhead costs across different cost centres.

When an overhead cost cannot be traced to a particular cost centre, it is shared among various cost centres. The sharing of overhead costs to cost centres is done in proportion to the benefit received by the cost centre. The basis of apportionment becomes the criterion used in apportioning overhead cost to cost centres.

Absorption Overhead absorption is the process of adding overhead costs to the final cost of a product or service. This is done by calculating an Overhead Absorption Rate (OAR) for each production department. The OAR is then used to include the overhead costs in the unit cost of the product or service.

Activity 4.12 Understanding Overheads - meaning and examples of overhead You'll brainstorm together with a group of friends, discuss your findings with other groups, and present your final work to the class.

1. Form a group with a few friends or classmates. Discuss and brainstorm what the term overheads means to you.

2. Write down your group's definition on a sticky pad. Share your definition with another group for comparison and adjust your definition as needed.

3. In your group, list examples of overheads that a business might have. Classify each example by type. For instance, office rent would be an administrative overhead.

4. Write your work on a flip chart and present your ideas to the class for discussion and feedback. You can use a table to help organise your answers.

Definition of overhead Examples of overheads Type of overhead

Activity 4.13 Understanding Costing Terms

1. Form a group with a few friends or classmates.

2. In your group, explain the meaning of the following terms:

a. Allocation

b. Apportionment

c. Absorption

3. Go back to the list of overhead examples you recorded in the previous activity. For each example, decide if its cost would be allocated to a cost centre or apportioned across multiple cost centres. Justify your decision.

4. Write your answers on a flip chart and present them to the class for discussion and feedback.

Preparation of an Overhead Analysis Sheet

An overhead analysis sheet, also called an overhead distribution statement, is used to show how overhead costs are shared among different departments.

The bases of apportionment are the rules used to decide how to divide these overhead costs between the cost centres. The most common bases of apportioning overheads are given below.

Overhead Cost Basis of Apportionment

1 Building expenses, Rent & Rates Floor space or area, value of buildings 2 Electricity / Heating, Power Number of bulbs, floor space or area, kilowatts of electricity, meter reading.

3 Indirect Labour cost, Supervisor`s salary, Canteen cost, Welfare, Medical cost Number of employees 4 Insurance on materials, store expenses, and handling expenses Number of requisitions made by department (dept.); value of materials collected by departments.

5 Depreciation/ Repairs on Machines,

Maintenance cost, Value/Cost of machines, maintenance hours

Example

Given below is the cost data of Mildart Manufacturing Company. The company has two production centres, A and B and two service centres, the canteen and maintenance.

Expenses Total Dept. A Dept. B Canteen Maintenance

Indirect Labour 157,000 55,000 72,000 22,000 8,000

Indirect Material 436,000 200,000 68,000 26,000 142,000

Heat & Light 113,000 Rent & Rates 118,000 Depreciation 400,000 Supervision 360.000 Power 280,000 Additional Information Dept. A Dept. B Canteen Maintenance Total Amount % total Amount % total Amount % total Amount % total Floor Space 12 24 16 32 10 20 12 24 50 Value of machines GH¢ 120,000 50 88,000 36 16,000 7 16,000 7 240,000 No. of Workers 60 50 40 33 0 0 20 17 120 Labour hours 4,000 57 3,000 43 0 0 0 0 7,000 Kilowatts of Electricity 600 43 500 36 200 14 100 7 1,400 To produce the overhead analysis sheet, you need to complete the breakdown of costs using the basis of apportionment for each type of expense (or overhead).

For each type of expense, complete the table using the relevant basis of apportionment, proportionate to each department.

Overhead analysis sheet for Mildart Manufacturing Expense Basis of apportionment Total Dept. A Dept. B Canteen Maintenance Indirect Labour Direct allocation 157,000 55,000 72,000 22,000 8,000 Indirect Material Direct allocation 436,000 200,000 68,000 26,000 142,000 Heat & Light Floor space 113,000 27,120 36,160 22,600 27,120 Rent & Rates Floor space 118,000 28,320 37,760 23,600 28,320 Depreciation Value of machines 400,000 200,000 144,000 28,000 28,000 Supervision Number of workers 360,000 180,000 118,800 0 61,200 Power kW electricity 280,000 120,400 100,800 39,200 19,600 Total 1,864,000 810,840 577, 520 161,400 314,240 Apportionment of Service Department costs Service departments exist to provide support to the production cost centres in the manufacturing of products. Service cost centres are usually not income-generating centres;

therefore, costs of service departments are redistributed to the production cost centres.

The most common bases of reapportioning service cost centre overheads are given below:

s/n Service Cost Centre Basis of Apportionment 1 Canteen Number of employees 2 Maintenance Maintenance hours/ Labour Hours 3 Medical/ Welfare Number of employees 4 Stores Number of requisitions made by dept.; value of materials issued to depts.

5 Transport Number of employees To develop our example for Mildart Manufacturing, we can look at how to apportion the costs for the canteen across the rest of the departments based on the number of employees.

To do this, take the total expenses of the canteen (GH¢ 161,400 ) and add these to departments A and B in a way that is proportionate to their size.

Department Number of

workers Proportion Amount of expenses to be apportioned A 60 60% (161,400 ÷100) x 60 = GH¢ 96,840 B 40 40% (161,400 ÷ 100) x 40 = GH¢ 64,560 Total 100 100% GH¢161,400 You can use this information to calculate the overheads of each department with the apportioned costs of the canteen.

Department Expenses Amount apportioned from the canteen Combined overhead cost A GH¢ 810,840 GH¢ 96,840 GH¢ 907,680 B GH¢ 577, 520 GH¢ 64,560 GH¢ 642,080

Activity 4.14 Bases for Apportioning Overheads

1. Form a group with a few friends or classmates.

2. In your group, discuss the different bases for apportioning overheads. A basis is a method used to divide costs, such as the number of employees, square footage, or machine hours.

3. Identify eight common business expenses and the appropriate basis for apportioning each. For example, rent might be apportioned based on the floor area occupied by each department. Your teacher may provide you with additional examples to consider.

4. Write down the expenses and their corresponding apportionment based on a flip chart. Share your findings with another group for discussion and feedback.

Activity 4.15 Preparation of overhead analysis sheet In your groups from Activity 4.14, discuss the information below and perform the tasks that follow.

SamBoat Manufacturing Company has two production centres and two service centres - Canteen and Maintenance.

Expenses Dept. A Dept. B Canteen Maintenance Total

Indirect Labour 57,000 72,000 20,000 8,000 157,000

Indirect Material 200,000 68,000 26,000 142,000 436,000

Heat & Light 36,000 23,500 15,500 38,000 113,000 Rent & Rates 116,000 Depreciation 380,000 Supervision 350,000 Power 230,000 Additional Information Dept. A Dept. B Canteen Maintenance Total Floor Space 14 18 10 8 50 Value of machinesGH¢ 130,000 98,000 17,000 17,000 262,000 No. of Workers 65 40 0 25 130 Labour hours 4,500 3,500 0 0 8,000 Kilowatts of Elect. 500 600 150 150 1,400 Tasks

1. Prepare an overhead analysis sheet from the above data for the SamBoat company.

2. Reapportion the overheads of the service cost centres to the production departments. Calculate the combined overhead costs for Departments A and B.

3. Write your answers on a flip chart and share with another group for feedback.

Overhead Absorption Rate

Overhead Absorption Rate (OAR) is the rate used to apply overhead costs from cost centres to cost units.

To calculate the OAR, divide the total overhead cost of a cost centre by a suitable activity measure for that cost centre.

OAR = Types of Activity Levels / Bases of Absorption Examples of activities/bases of absorption.

1. Machine hours – this method of absorbing overheads applies when machines play a dominant role in the production of goods. It is calculated as:

OAR =

2. Direct Labour hours - this method of absorbing overheads applies when production is labour-intensive. It is calculated as:

OAR =

3. Product Units (Cost unit) – this formula is based on the quantity of goods produced.

The absorption rate is per item, and it applies where standardised products or jobs are produced.

OAR =

4. Direct Materials Cost percentage – this method is based on the cost of materials incurred. It is calculated as:

OAR = x 100%

5. Direct Labour/Wages cost percentage – this method is based on the cost of direct labour incurred. It is calculated as:

OAR = x 100%

6. Prime cost percentage – this is where overheads are recovered in relation to prime cost.

Prime cost is the total of direct material cost and direct labour cost. It is calculated as:

OAR = x 100%

Activity 4.16 Explanation of overhead absorption rate

1. Working in pairs, explain the overhead absorption rate.

2. Write down your definition and the formula and share with another pair.

3. Working with another pair, identify the different bases for apportionment and how these affect the formula for calculating overhead absorption rates.

4. Record the formulas in your workbooks.

Activity 4.17 Computation of overhead absorption rates In your groups from the previous activity, study the data below and perform the tasks that follow.

The budgeted cost data for Nimako Productions Ltd is given below:

Total Direct Wages Cost GH¢3,250,000

Total Direct Material Cost GH¢6,000,000

Total Overheads GH¢8,500,000

Additional Information

Labour hours for the year 125,500 hours Total machine hours 305,000 hours Total units produced 50,000 Tasks

1. Calculate the following overhead absorption rates for Nimako Productions Ltd.

Show all of your workings.

a. Machine hours

b. Direct labour hours

c. Product units

d. Direct materials cost percentage

e. Direct labour cost percentage

f. Prime cost percentage

2. Write your answer on a flip chart and present to the larger class.

Overhead Absorption

Overhead absorption is the process of adding overhead costs to the final cost of a product or service. This is done by calculating an Overhead Absorption Rate (OAR) for each production department. The OAR is then used to include overhead costs in the unit cost of the product or service Over Absorption Over-absorption happens when the overhead costs assigned to a product, job or service are higher than the actual overheads incurred. This results in the cost of production being overstated.

Under Absorption

Under-absorption happens when the overhead costs assigned to a product, job or service are lower than the actual overheads incurred. This means the actual overheads are higher than what has been added to the product or service cost, which results in the production cost being understated.

Causes of under- or over–absorption of overheads

1. Difference between estimated overhead expenditure and actual overhead.

2. Difference between estimated production volume and actual production units.

3. Differences between the estimated activity levels and the actual activity levels.

Treatment of under- or over–absorption of overheads

1. Over–absorption of overheads increases the cost of production, and this reduces the net profit of the business. To obtain the correct net profit, the amount of overabsorbed overhead should be added to the profit.

2. Under–absorption of overhead decreases the cost of production, and this increases the net profit of the business. To obtain the correct net profit, the amount of underabsorbed overhead should be deducted from the profit.

Calculating over- or under-absorption To calculate over- or underabsorption, you can follow the following steps:

1. Calculate the overhead absorption rate (OAR)

2. Calculate the overheads absorbed

3. Compare the overheads absorbed with the actual overheads incurred (Overheads absorbed – Actual fixed overhead incurred) If the answer is above zero (positive), then overheads have been overabsorbed; if they are below zero(negative), then they have been underabsorbed.

Activity 4.18 Overhead Absorption: Under and Over

This activity will help you and your partner understand a key concept in cost accounting: overhead absorption. You'll brainstorm together to define the term, and then you'll explain the difference between under- and over-absorption of overheads.

1. Form a group with a few friends or classmates. Discuss what overhead absorption means and brainstorm a definition.

2. Explain the difference between under-absorption and over-absorption of overheads.

3. Write your definitions on separate pieces of paper and exchange them with another pair.

4. Discuss their feedback, and if needed, adjust your definitions. Record your final answers in your workbooks.

Activity 4.19 Computation of overhead absorption rates (over or under) Working in groups, study and discuss the data below and perform the tasks that follow.

The budgeted cost data for Senyo Productions Ltd is given below.

Total Direct Wages GH¢3,250,000

Total Direct Material Cost GH¢6,000,000

Total Overheads GH¢9,500,000

A cost unit was produced by the company with the following details;

Direct Materials Used GH¢2,800

Direct Labour cost GH¢1,900 Machine Hours 12 hours per unit Direct Labour Hours 10 hours per unit Additional Information Labour hours for the year 125,500 hours Total machine Hours 305,000 hours Total Units Produced 50,000 units You are required to do the following after studying the information above.

1. Use this data to calculate the absorption rate

a. Per labour hour

b. Per machine hour

c. Per unit produced

d. Direct materials cost percentage

e. Direct labour cost percentage

f. Prime cost percentage

2. Show your workings.

3. Overheads are recovered at GH¢170 per unit. Compute any over or under absorption of overheads based on each of the six absorption rates.

4. Write your answers on a flip chart.

5. Present your answer to another group for feedback.

Extension task Study the data below and perform the tasks that follow.

The budgeted cost data for Sandy Productions Ltd is given below:

Total Direct Wages GH¢2,250,000

Total Direct Material Cost GH¢5,000,000

Total Overheads GH¢8,500,000

A cost unit was produced by the company with the following details;

Direct Materials Used GH¢2,600

Direct Labour cost GH¢1,700 Machine Hours 10 Direct Labour Hours 8 hours per unit Additional Information Labour hours for the year 122,500 hours Total machine Hours 300,000 hours Total Units Produced 48,000 units Tasks:

1. Use this data to calculate the following absorption rates

a. Per labour hour

b. Per machine hour

c. Per unit produced

d. Direct materials cost percentage

e. Direct labour cost percentage

f. Prime cost percentage

2. If overheads are recovered at GH¢160 per unit, compute any over- or underabsorption of overheads based on each of the six absorption rates.

3. Record your answers, with all of your working, in your workbooks and share with your teacher for feedback.