A2 Accounting

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A2 Accounting

• Unit 1 Lesson 1
• Classification of Costs

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By the end of this lesson
You will
Be able to
Classify costs in relation to output and time, or
product
Know why firms need to understand their costs
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Why do firms need to understand costs?
-

Revenue
Costs
Profit
So, firms need to understand their costs if they
wish to improve their profit
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Costs can be classified in relation to
Product
Output and Time
Long run Scale of operations can be changed
Do change with production
Short run Scale of operations cannot be changed
Direct Can be directly related to product or
service
Indirect Can be directly related to product or
service
Variable Do vary directly with output in the
short run
Fixed Do not vary with output in the short run
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Revising Manufacturing Accounts
Cost of materials consumed direct costs (e.g.
labour/power)
Prime Cost
Cost of finished goods
Prime cost factory indirect (or overhead)
expenses or adjustment for work in progress
In costing the product, the main way in which
costs are analysed above is direct and indirect
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Costs, revenue and profit
Fixed Cost variable cost
Total Cost
Profit total revenue total costs
Profit total revenue (fixed costs variable
costs)
There are a number of costing techniques that use
fixed and variable costs.
Break even analysis
Absorption costing
Marginal Costing
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Fixed Cost shown by graph
Cost in
FC
0
Number of items made (Output)
As the level of output increases, the fixed costs
stay exactly the same
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Activity-1
Sarah Reavenall operates two hairdressing salons,
one in Bromsgrove and the other in Redditch
In your book, write down 4 examples of costs that
are likely to be fixed for this business
Rent Insurance Cleaning Staff salaries could all
be fixed costs Explain why!
Do fixed costs stay the same irrespective of the
level of output, even where there is a massive
rise in the level of output? Think in terms of
the Rent cost for Sarahs business
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Step change in Rent Costs
Cost in
FC
0
Number of items made (Output)
As the salon becomes more popular, additional
accommodation needs to be rented. This will
cause a step in the rent cost. Further
popularity can result in another step etc
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Variable Cost shown by graph
Cost in
VC
0
Number of items made (Output)
As the level of output increases, so does the
variable cost
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Activity-2
Sarah Reavenall operates two hairdressing salons,
one in Bromsgrove and the other in Redditch
In your book, write down 2 examples of costs that
are likely to be variable for this business
Lotions and other materials used Laundry costs to
wash towels could all be variable
costs Explain why!
In some cases, costs have both an element of
fixed and variable cost about them e.g.
electricity may be fixed for heating/lighting but
variable for power to hairdryers
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For Sarahs Salon
For a hairdressing business most costs will be
FIXED. However, there will be some variable
costs.
Total Costs fixed costs variable costs
This can be shown by graph on the next slide
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Sarahs Salon
2. What is the total cost of 2000 hair dos?
3. What is the variable cost of 2000 hair dos?
Cost in
TC
40 000
FC
30 000
0
2000
Number of hair dos (Output)
1. Why does Sarah have a fixed cost of 30 000
at zero output
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For Sarahs Salon
Once we know the TOTAL COSTS we can find Sarahs
BREAK EVEN POINT (BEP)
Sarah will break even when sales (total revenue)
equals total costs
This can be shown by graph on the next slide
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Sarahs Salon Break Even Point
2. What is Sarahs break even output?
Cost in
TR (sales)
50 000
TC
40 000
FC
30 000
0
2000
1500
Number of hair dos (Output)
1. Why does Total Revenue (Sales) start at zero
output?
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For Sarahs Salon
Sarahs break even point can be worked out not
only by CHART but also by CALCULATION
There are 2 formulae needed to work out Sarahs
BEP
First we need to find the CONTRIBUTION made
towards the FIXED COSTS and PROFIT of Sarahs
business
Contribution Selling price Variable cost
Once we know the contribution, we can calculate
BEP
Break Even Point (BEP) Fixed
Costs Contribution
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Calculate Sarahs BEP
If Sarah charges 25 per hair do, has fixed costs
of 30 000 and variable costs of 5 per hair do.
How many hair dos will she need to break even.
Using the 2 formulae on the previous slide show
your calculation of Sarahs BEP
How does your answer compare with that given on
the graph you looked at earlier?
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Homework
Please do the 3 questions from A2 Unit 7
Worksheet 1 for our next lesson Make sure all the
activities in this lesson have been completed
before you do the homework This includes the
Lesson summary on the final slide
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Summary

• Work with your partner on any question you are
  not sure of otherwise write your answer in your
  book
• Define fixed cost and variable cost
• What is a semi-variable cost?
• Under what circumstances could total cost be
  40000 at zero output?
• How much profit is earned at the BEP?
• What does CONTRIBUTION mean?
• Give the formula to calculate the BEP