Book Title BookBook Title Student’s Student’s Book FET FIRST Level 3

NATEDFET Series FIRST Author Level

3

COST AND MANAGEMENT Author ACCOUNTING N5 Student's Book

T. Lakhan

FET FIRST NATED Series Cost and Management Accounting N5 Student’s Book © T. Lakhan, 2012 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, photocopying, recording, or otherwise, without the prior written permission of the copyright holder or in accordance with the provisions of the Copyright Act, 1978 [as amended]. Any person who does any unauthorised act in relation to this publication may be liable for criminal prosecution and civil claims for damages. First published 2012 by Troupant Publishers [Pty] Ltd PO Box 4532 Northcliff 2115 Author: Tanuja Lakhan Copy editing by Adrienne Pretorius Proofreading by Moira Richards Cover design by René de Wet Typesetting by Golden Pear Desktop Publishing Distributed by Macmillan South Africa [Pty] Ltd

ISBN: 978-1-430800-80-4, eISBN: 978-1-430802-20-4 It is illegal to photocopy any page of this book without written permission from the publishers. While every effort has been made to ensure the information published in this work is accurate, the authors, editors, publishers and printers take no responsibility for any loss or damage suffered by any person as a result of reliance upon the information contained therein. The publishers respectfully advise readers to obtain professional advice concerning the content.

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Contents SYLLABUS GRID 

v

Module 1: INTRODUCTION

1

Unit 1.1: Fields of accounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Unit 1.2: Management functions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Unit 1.3: Cost classification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Unit 1.4: Cost systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Unit 1.5: Unit, fixed, and variable costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Module 2: Materials

39

Unit 2.1: Terminology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Unit 2.2: Stock transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Unit 2.3: Accounting entries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

Module 3: LABOUR

66

Unit 3.1: Influences on labour productivity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 Unit 3.2: Cost of labour. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Unit 3.3: Wage control. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Unit 3.4: Accounting entries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Module 4: MANUFACTURING OVERHEADS

89

Unit 4.1: Classification of manufacturing overheads . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Unit 4.2: Budgeted manufacturing overheads. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 Unit 4.3: Basis of allocation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Unit 4.4: Actual manufacturing overheads. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 Unit 4.5: Recovery of manufacturing overheads. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 Unit 4.6: Accounting entries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

Module 5: ACCOUNTING SYSTEMS

113

Unit 5.1: Accounting systems used by manufacturing organisations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Unit 5.2: The flow of transactions in an integrated system. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Module 6: FINANCIAL STATEMENTS

128

Unit 6.1: Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

Glossary138 BIBLIOGRAPHY141

Syllabus Grid: Cost and Management Accounting N5 Page in SB

Learning Content

Learning Objectives On completion of this module the student must be able to:

MODULE 1: INTRODUCTION 2

1.

The different fields of accounting

1. describe the different fields of accounting and to identify the most important differences

2

1.1

Financial accounting

1.1

to put financial accounting as well as the place and function of cost accounting in perspective

2

1.2

Management accounting

4

1.3

The place and function of cost accounting

4

2.

The management functions

6

2.1 Definitions: the four basic management functions that are common to all production activities, namely planning, organising, leading and control

2.1

define the four basic management functions that are common to all production activities, namely planning, organising, leading and control

7

2.2

Information needed for management decisions

2.2

identify information needed for management decisions, both quantative and qualitative

8

2.3

Setting of goals for decision making

2.3

set objectives for both short- and long-term decisions

9

2.4

Organisation chart

2.4

compile an organisation chart for a production concern

9

3.

Cost classification

9

3.1

Definition of cost

3.1

describe the term cost

3.2

Methods of accumulating and allocating of cost data •• Function •• Elements •• Product •• Department •• Income •• Volume

3.2

describe the mentioned methods of accumulating and allocation of cost data

9 9 10 10 10 10 12

3.3

Prime product cost

3.3

describe the term prime product cost

13

3.4

Conversion cost

3.4

describe the term conversion cost

18

4.

Cost systems

18

4.1

Periodic system

4.1

describe the periodic system briefly

18 18 18

4.2

Perpetual system •• Job costing •• Process costing

4.2

describe the job costing system and process costing system briefly

20

5.

Unit cost

5.

describe the term unit cost

20

6.

Fixed cost

6.

describe the term fixed cost

20

7.

Variable cost

7.

describe the term variable cost

DIDATIC GUIDELINES Students should know and understand the basic cost and management accounting principles. EVALUATION Short tests are necessary to confirm the basic concepts but should not replace complete semester tests.

v

Page in Learning Content SB

Learning Objectives On completion of this module the student must be able to:

MODULE 2: MATERIAL 40

1. Introduction

1.

define the cost elements, namely material, labour, and manufacturing overhead

40 40 41 42 41

2. Terminology •• Direct material •• Indirect material •• Incomplete work •• Finished products

2.

describe the following concepts, namely direct material, indirect material, incomplete work, and finished products

42 43 47 47 54 54 55

3.

3.

define the different stock transactions namely purchase, receipts, stock keeping, storage, issue, and valuation

43 43 45 45 46

3.1 Purchase •• Order point •• Order size •• Economic order quantity •• Order

3.1

calculate the order point, order size, and economic order quantity

47

3.2

3.2

calculate the average stock and maximum stock and define the following concepts, namely normal stock, buffer stock, safety stock, and stock in transit

54

3.3 Storage

3.3

name the factors that should be taken into account at the outlay of a warehouse

54

3.4 Issue

3.4

name two reasons for the use of a requisition as a document at the issuing of stock

55

3.5 Valuation

3.5

compile a stock ledger card according to two methods, namely FIFO and weighted average

62

Stock transactions •• Purchase •• Receipts •• Stock keeping •• Storage •• Issue •• Valuation

Receipts and stock keeping

4.

Flow charts

4.

illustrate the flow of material through an organisation by means of a flow chart

5.

Accounting entries

5.

do the accounting entries for material in a fully integrated financial system.

DIDACTIC GUIDELINES 1. Students should visit a manufacturing concern and attention should be paid to the different stock transactions. The visit should be planned in detail providing students with questions in advance in order to point out specific matters that should be evaluated after the visit. 2. Students should know all given formulas and be able to apply them in practice. EVALUATION 1. Short tests are necessary to confirm the basic concepts. 2. An assignment or test can be used for evaluation purposes after the visit to the manufacturing concern. 3. Students should be able to apply all formulas. Application questions may be asked. 4. The accounting entries for stock should be confirmed by a number of short exercises.

vi

Page in SB

Learning Content

Learning Objectives On completion of this module the student must be able to:

MODULE 3: LABOUR 66

1. Introduction The human and external factors that influence productivity

1.

briefly discuss the human and external factors that influence productivity and calculate labour turnover

70

2.

2.

calculate the remuneration of an employee

70 71 72

2.1 Classification •• Time rate •• Piece rate

2.1

distinguish between direct labour and indirect labour as well as between time rate and piece rate

Labour cost

73

2.2 Overtime

2.2

calculate the cost of overtime

74

2.3

Fringe benefits

2.3

calculate the cost of fringe benefits

75

3.

Wage control

75

3.1

Staff records

3.1

name the most important items that form part of the staff records

76

3.2

Clock card

3.2

describe the purpose of a clock card

76

3.3

Job card

3.3

describe the purpose of a job card

77

3.4 Payroll

3.4

compile a payroll

82

3.5

Production report

3.5

compile a production report

85

4.

Accounting entries

4.

do the accounting entries for labour cost in a fully integrated financial system.

DIDACTIC GUIDELINES 1. Students should know the theory of labour administration in a manufacturing concern and be able to apply it in practice. 2. Students should know the content of, and be able to use ,the different documents, statements and reports applicable to the labour of an organisation. Lecturers should use examples of the different documents, statements, and reports being used in practice. EVALUATION 1. Short tests are necessary to confirm the basic concepts. 2. Students should be able to compile a payroll and production cost statement. 3. The accounting entries for labour should be confirmed by a number of short exercises.

vii

Page in SB

Learning Content

Learning Objectives On completion of this module the student must be able to:

MODULE 4: MANUFACTURING OVERHEAD 89

1. Introduction The concept manufacturing overhead

1.

define the concept manufacturing overhead

90

2. Classification

2.

classify manufacturing overhead according to its fixed and variable characteristics

90

2.1 Fixed

2.1

describe fixed manufacturing overhead by means of an example and a graphic representation

90

2.2 Variable

2.2

describe variable manufacturing overhead by means of an example and a graphic representation

91

2.3 Semi-fixed

2.3

describe semi-fixed manufacturing overhead by means of an example and a graphic representation

91

2.4 Semi-variable

2.4

describe semi-variable manufacturing overhead by means of an example and a graphic representation

92

3.

Budgeted manufacturing overhead

3.

define the concept budget manufacturing overhead

93

4.

Basis of allocation

4.

describe the concept allocated manufacturing overhead and illustrate how it differs from budgeted manufacturing overhead

96

4.1

Material cost

4.1

calculate the rate of allocation and the total manufacturing overhead cost with material cost as a basis

96

4.2

Labour hour

4.2

calculate the rate of allocation and the total manufacturing overhead cost with labour hour as a basis

97

4.3

Labour cost

4.3

calculate the rate of allocation and the total manufacturing overhead cost with labour cost as a basis

97

4.4

Machine hour

4.4

calculate the rate of allocation and the total manufacturing overhead cost with machine hour as a basis

98

4.5

Product units

4.5

calculate the rate of allocation and the total manufacturing overhead cost with prime cost as a basis

98

4.6

Prime cost

4.6

calculate the rate of allocation and the total manufacturing overhead cost with prime cost as a basis

98

4.7 Combination

4.7

calculate the rate of allocation and the total manufacturing overhead cost with a combination of methods as a basis

viii

103

5.

Actual manufacturing overhead

103

5.1

Indirect material

103

5.2

Indirect labour

103

5.3 Rent

104

5.4 Maintenance

104

5.5 Depreciation 5.6

5.

describe the concept actual manufacturing overhead referring to the most important items in this respect, namely indirect material, indirect labour, rent, maintenance, and interest on capital

5.5

calculate the following methods of depreciation, namely straight-line method, diminished balance method, and production unit method

Interest on capital

106

6. Recovery

6.

describe the concept recovery

107

6.1 Under-recovery

6.1

name the reasons for an under-recovery

107

6.2 Over-recovery

6.2

name the reasons for an over-recovery

109

7.

7.

do the accounting entries for manufacturing overhead cost in a fully integrated financial system.

Accounting entries

DIDACTIC GUIDELINES 1. Students should understand the concept manufacturing overhead and be able to distinguish between the fixed and variable components thereof. 2. Students should be able to determine an appropriate allocation tariff as well as the analysis of an underrecovery and over-recovery. EVALUATION 1. Short tests are necessary to confirm the basic concepts. 2. Students should know and be able to apply all the formulas. Application questions may be asked. 3. The accounting entries for manufacturing overhead should be confirmed by a number of short exercises.

ix

Page in SB

Learning Content

Learning Objectives On completion of this module the student must be able to:

MODULE 5: ACCOUNTING SYSTEM 113

1. Introduction The two basic types of accounting system being used by manufacturing concerns

1.

briefly discuss the two basic types of accounting system being used by manufacturing concerns

114

2.

2.

compile an integrated financial system of a manufacturing concern in a ledger

Integrated systems

DIDACTIC GUIDELINES Students should be able to do the entries in the ledger for the flow of direct material, direct labour, and manufacturing overhead in the case of an integrated system. EVALUATION 1. The accounting entries are confirmed by a number of exercises. 2. A test on this part is essential.

x

Page in SB

Learning Content

Learning Objectives On completion of this module the student must be able to:

MODULE 6: FINANCIAL STATEMENTS 128

1. Introduction Aim of financial statements 2.

Production cost statement

3.

Income statement

4.

Balance sheet

1.

compile a basic statement, income statement, and balance sheet for a manufacturing concern.

DIDACTIC GUIDELINES 1. Students should be able to compile the financial statements of a manufacturing concern. 2. Students should be able to make adjustments (refer to annexures). EVALUATION 1. A number of exercises on the compiling of financial statements are necessary. 2. A test on this part is essential.

xi

Module 1 INTRODUCTION At the end of this module, you must be able to: • Describe the different fields of accounting and identify the most important differences. • Demonstrate an understanding of the place and functions of: – Financial accounting – Cost accounting – Management accounting. • Define the four basic management functions. • Identify qualitative and quantitative information needed for management decisions. • Set objectives for short- and long-term decisions. • Compile an organisational chart for a production concern. • Describe the term ‘cost’. • Describe the methods of accumulating and allocating cost data. • Describe the terms: – Prime product cost – Conversion cost. • Describe the periodic system briefly. • Describe the perpetual system briefly. • Describe the terms: – Unit cost – Fixed cost – Variable cost.

1

Introduction Since you started studying accounting at school, you have been studying financial accounting, as contained in the accounting cycle in Figure 1.1 below:

1 Transactions, e.g. Paid rent by cheque

6 Preparation of financial statements Income Statement Balance Sheet Cash Flow Statement

2 Source documents, e.g. receipts, cheque counterfoils, etc.

3 Subsidiary Journals e.g. CRJ, CPJ, etc.

5 Extract a Trial Balance

4 Posting to the: GL DL CL

Figure 1.1: The accounting cycle

UNIT 1.1: FIeLDS oF ACCoUNTING Different fields in accounting focus on different areas. The main fields in accounting are: • Financial accounting • M anagement accounting. Financial accounting focuses on recording and maintaining the financial transactions in a business. Furthermore, it involves the preparation of financial statements (usually at the end of a financial period) to report on the financial results and position of a business. Management accounting is concerned with the provision of information to people within the organisation to help them to make decisions and improve the efficiency and effectiveness of existing operations (Drury, 2004: p. 7).

2

Cost accounting basically focuses on accumulating and calculating the production costs in a business, i.e. how much does it cost a business to produce the products they are producing to sell. It is very important for businesses to know the cost of its production so that it can determine its profit and sales. Cost accounting forms the link between financial accounting and management accounting. It uses the information generated by the financial accounting process to calculate the production costs in a business and presents this information to management, who will use it to make sound decisions regarding the business’s future. In practice, cost accounting and management accounting are treated as a single discipline. Financial accountants determine what the costs and incomes of a business are and what profit or loss the business has made. Cost accountants determine what the costs of production are, i.e. how much it cost the business to produce the amount of finished goods they actually produced. They focus on reducing costs so as to maximise profits. Management accountants will take all this information and make good decisions about the business’s future in order to maximise profits in the future. Users of information Users of financial information can be broken up into internal and external users. Internal users are those who are involved in the day-to-day running of the business, while external users are those who are not. Internal users

External users

Employees

Banks

Managers

Shareholders

Owners

Potential shareholders Creditors Government

Table 1.1: Internal and external users of information

3

Differences between financial accounting and management accounting Financial accounting

Management accounting

Reports are prepared according to standards and GAAP

No conformance to standards or legislation required

Provides information for external users

Provides information for internal use

Reports on a business as a whole, e.g. shows the net profit of the business

Focus on departments/divisions of a business so that decisions can be made about them

Reports on transactions that have already occurred (historical data), e.g. paid rates by cheque

Reports are future-oriented (to make decisions about the business’ s future)

Data must be recorded to the nearest cent (accurate), e.g. the calculation and recording of depreciation

Emphasis is not on monetary values but on other aspects to enable management to make decisions

Prepares ‘general purpose’ financial statements, i.e. a set of financial statements will include all financial details about a business, i.e. its financial results and position and cash-flow position

Prepares reports for a specific purpose, e.g. whether to buy a specific machine or not (capital budgeting/NPV), or a production budget to determine how many units of a product to produce

Table 1.2: Differences between financial accounting and management accounting

UNIT 1.2: MANAGeMeNT FUNCTIoNS Four basic functions of management For any business to be successful, its management must perform various functions. The following figure shows the basic functions of management. Planning Planning involves the formulation of detailed plans and the preparation of various budgets in order to achieve the organisation’s objectives.

Planning

Planning is the starting point of all management functions. Everything starts with a plan. You may have heard of the saying: ‘If you fail to plan, you are planning to fail.’

Control

Management functions

Organising

Leading

So where does planning start? First and most importantly, managers Figure 1.2: Four basic management functions must define their goals and objectives. They must know exactly what they want the business to achieve and in what time frames, for example, in three years, or in five years. So the planning process starts with identifying objectives to be achieved. Thereafter, strategies are formulated to achieve these objectives. Planning is an estimate of what the business wants to achieve in the future.

4

For example, if the objective of a business is to increase profits by 20% in the next 12 months, then all plans must ensure that this objective is met, for example, by reducing telephone costs in the business by giving only managers codes to use the telephone. What do managers do after they have defined their goals and objectives? They must document ways and means of reaching these objectives. From a financial point of view, they must prepare various budgets. What is a budget? A budget is a financial plan detailing how management plans to achieve their objectives. For example, a sales budget will detail how many units of goods the business plans to sell in order to achieve an increase in profits of 20%. Now think about yourself. Why are you studying at college? Your goal is to get a job, specifically in the financial field. So you realised, or may have been advised, that you have to study a course in the financial field to achieve this. Have you noticed how your plan of studying a course in the financial field will help you to get a job in this field? If you had chosen to study nursing, it would not help you to get a job in the financial field. This is what we mean when we say that your plans must help you to achieve your objectives. Organising Organising involves assembling or arranging an organisation’s activities and all its available resources in the best possible way to achieve its goals and objectives. Resources include human and physical and natural resources. A manager must determine the best or optimal combination of these resources in order to achieve the goals and objectives of management. Leading Leading involves inspiring, influencing and motivating people to share the vision of the organisation and in so doing, achieve its goals and objectives. In leading, a manager will provide the necessary knowledge, information, procedures, and possibly skills to employees. The manager’s personality plays a crucial role in his or her leading function. It is essential for a manager to be an effective leader. Control Control involves comparing budgeted and actual results, investigating variances, and taking corrective action. This is an extremely important function. Managers can have the best plans, organise their resources optimally, and inspire and motivate their staff to achieve these goals and objectives. However, if they do not monitor and exercise control over the entire process, then the organisation can fail dismally! 5

The control function involves managers monitoring actions and activities to determine whether everything is going according to plan in order to achieve the goals and objectives of the business. This is achieved by comparing actual results to planned or budgeted results. If there is a difference, a manager must investigate the cause of, or reason for, the difference. After the manager has determined a difference or variance, he or she must take corrective action. This is extremely important. There is no point in understanding the reason an organisation has not achieved its objectives if action is not taken to correct this. Finally, management must evaluate the results of the control process and adjust their planning if necessary. It is possible that their plans were unrealistic and could not be achieved in the stipulated time frames and therefore need to be adjusted. Look at Figure 1.2, and notice how each management function is linked to another. Also notice how the control function goes back to planning. Information needed for management decisions Quantitative information The word quantitative comes from the word ‘quantity’. If you had to describe the quantity of something, you would describe it in numbers. Therefore quantitative information refers to measuring or calculating something, such as the profit of a business, its total expenses, its depreciation cost for the year, and so on. Management needs this quantitative information to help them in making decisions about various matters in the business.

6

Qualitative information The word qualitative comes from the word ‘quality’. If you had to describe the quality of something, you would describe it in words. Therefore qualitative information refers to descriptive information that helps management to make decisions. This information may refer, for example, to the aftersales service provided by a particular supplier, the reliability and reputation of a supplier, the quality of a product (even if it the cheapest), and so on. Setting of goals for decision-making As you have already noticed, the first function of management is planning. Before planning can commence, management must define or set their goals. To assist in the achievement of goals, we break them up into short-term and long-term goals, i.e. management must define which goals they can achieve in the short-term (taking not too long to achieve this) and which they can achieve in the long-term (this could be anything from nine months, or a year, to many years). Management must therefore take decisions to achieve their short-term and long-term goals. Short-term decisions Short-term decisions entail management making decisions about the business’s day-to-day operations. They are therefore also called operating decisions. Examples of short-term or operating decisions include: • S etting the selling price of products for the next financial period • B udgeting for the next financial period • Th e level of after-sales service that must be provided by the firm. Long-term decisions/strategic decisions Long-term decisions are decisions made by management that commit the business’s resources for a lengthy or longer period of time. Examples of long-term decisions include: • P roducing a new product • E ntering into a new market • O pening new, or closing existing branches.

7

organisational chart An organisational chart is a diagrammatical representation of lines of authority and communications in a business. It clearly shows all employees who their immediate supervisor is (lines of authority) and therefore eliminates any confusion as to whom to report to (it aids in communication). It also shows employees who their peers are (employees on the same level). It usually depicts the various management functions (finance, sales, human resources, production, and so on) and their sub-divisions, as boxes linked by lines along which decisionmaking power travels downwards (from managers) and answerability travels upwards (from people on the lower levels). Names of managers and employees are captured in the relevant boxes so as to customise the chart and provide clarity on line management. example 1.1 Required: Draw the organisational chart of NTN Ltd, which has the following employees: Name of employee

Designation/Job title

Mr A.C. Kerman

Managing director

Mr N.R. Hari

Production manager

Ms H.T.K. Buthelezi

Finance manager

Ms F.S. Zwane

Sales manager

Mr T. Singh

Research and development manager

Mr R. Mbatha

Assembly manager

Mr N.N. Botha

Machinery department manager

Mr Z.J. Thwala

Management accountant

Mr S. Shabangu

Financial accountant

Mr C.T. Moloi

Advertising manager

Ms E. Zita

Distribution manager

Ms G. Ray

Research and development assistant manager

Suggested solution

NTN Ltd Organisational Chart

8

Assessment activity 1.1

(Self-assessment)

Cricket Manufacturers manufactures various types of bags. The business employs the following staff members: Name

Portfolio in the company

M. Dhoni

Chief executive officer

C. Gayle

Financial manager

S. Narine

Production manager

T. Dilshan

Financial accountant

R. Ponting

Production supervisor

G. Smith

Cost accountant

R. Cook

Personnel manager Sales representatives

S. Bond

Marketing manager

Required: Prepare the organisational chart for Cricket Manufacturers. Clearly show the names of employees and their portfolios in the company.

Unit 1.3: Cost classification Definition of cost Costs are a necessary sacrifice incurred in order to deliver a product or service (Faul et al, 2001 p. 10). This sacrifice is usually measured in monetary value. Methods of accumulating and allocating cost data How does a business determine or calculate its costs? It must add up all the costs that it has incurred. To make this easy, various methods or approaches can be used to determine the costs in a business. Function In this method, costs for each functional area in a business are added together to get its total costs. Functional areas in a business include the finance, marketing, production, purchasing, sales, human resources, and other departments. Elements Costs are accumulated according to the elements of production cost. Remember the three elements of production cost are: • D  irect or raw materials • Direct labour • Manufacturing overheads. 9

The cost of each element is calculated and added to the others to determine the total cost of production. Direct or raw materials

+

Direct labour

+

Manufacturing overheads

=

Total production cost

Direct materials are all those materials that are used in production and can be seen in, or traced to, the finished products, for example, the wood in a table, or the steel in a car. They are also called raw materials. We will refer to them as direct materials from this point onwards (materials are discussed in detail in Module 2). Direct labour is the wages paid to the labour that is used to make the finished products only, for example, the labour used to make tables (this is discussed in detail in Module 3). Manufacturing overheads are the indirect costs that are associated with production, for example, the cutting blade used to cut the logs of wood into the appropriate size for the tables, sandpaper used to sand down the tables, and so on. These are very important costs. If you did not use them on the product, it would not be complete. However, they are indirect, and you cannot see them in the final product (this is discussed in detail in Module 4). example 1.2 The following information was extracted from OneUp CC: Direct materials R105 000 Direct labour R110 000 Manufacturing overheads R100 000 Required: Calculate the manufacturing or production costs. Suggested solution Production cost = Direct materials + Direct labour + Manufacturing overheads = R105 000 + R110 000 + R100 000 = R315 000 Remember that any expense related to the factory (apart from direct material and direct labour), is a manufacturing overhead. Examples include depreciation on machinery, rent, water and electricity, rates and taxes, insurance, security guard’s wages, telephone expenses, and any other costs involved in running the factory. Remember that any expense related to the office is a selling and administration cost. It has nothing to do with the factory, and is therefore not a product cost.

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example 1.3 The following information relates to North Value Manufacturers. The company is involved in the manufacture of wooden desks. Cost item

Amount

Salary of factory supervisor

R25 000

Insurance: Factory buildings Office buildings

R6 000 R7 000

Sales commission

R3 000

Production wages

R125 000

Depreciation: Office equipment Factory equipment

R2 000 R5 000

Purchases of wood for the desks

R100 000

Rent of office buildings

R60 000

Factory electricity

R50 000

Advertising costs

R35 000

Carriage on sales

R15 000

Salary of factory cleaner

R45 000

Required: Classify each cost item firstly as a production or selling and administration cost; and secondly, if it is a production cost, say whether the cost is direct or indirect. Write the amounts of the each cost item in the relevant column(s). Suggested solution Cost item

Production

Selling and administration

Production Direct

Indirect

Salary of factory supervisor

25 000

 

25 000

Insurance: Factory buildings

6 000

 

6 000

 

7 000

 

Sales commission

Office buildings

 

3 000

 

Production wages

125 000

Depreciation: Office equipment Factory equipment Purchases of wood for the desks Rent of office buildings Factory electricity

125 000

 

2 000

5 000

 

100 000

100 000

 

60 000

5 000   

50 000

50 000

Advertising costs

 

35 000

 

Carriage on sales

 

15 000

 

Salary of factory cleaner TOTAL

45 000

45 000

 

R225 000

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R131 000

Product In this method, costs are accumulated according to each product being produced. For example, when building houses according to customers’ specifications, the cost of each house would be accumulated separately. If one customer wanted porcelain tiles in his house, the cost of those tiles would be added to the cost of his house only and not to other houses being built without porcelain tiles. Department Costs are accumulated according to the various departments in a business. Think about a factory making shirts. One shirt has to go through the cutting department (where the pattern is cut), then to the sewing department (where the shirt is stitched), then to the quality department (to check if the shirt is of the required quality), and finally to the packaging department. The costs incurred in each department are calculated and added together to determine the total cost for the business as a whole. Income Matching is one of the principles of GAAP, where costs are matched to corresponding income, for example, cost of sales is matched to sales. In this method, costs are matched to incomes and are added up to determine total costs. Volume In the volume method, costs are accumulated and allocated according to the volume produced (the number of units produced). For example, if the cost of producing 100 packets of soup is R1 000, then the costs associated with producing 500 packets of soup will increase accordingly. Prime product cost Think about the words ‘prime’ or ‘primary’. Which school did you first attend? Primary school. So what does prime mean? It means ‘first’. Now think about production costs (direct material, direct labour, and manufacturing overheads).

Prime Cost

To manufacture (make) any 12

=

Direct material

+

Direct labour

product, which two of the elements shown in the diagram below would you need first? Think about making a table. What would you need first? The wood (direct material) and labour to make the table (direct labour). example 1.4 The following information was extracted from OneUp CC: Direct materials Direct labour Manufacturing overheads

R105 000 R110 000 R100 000

Required: Calculate the prime cost. Suggested solution Prime cost = Direct materials + Direct labour = R105 000 + R110 000 = R215 000 Conversion cost Conversion comes from the word ‘convert’, which means to change or transform. What is being transformed? Direct or raw materials are being transformed into finished goods. For example, wood is being transformed or converted into tables. What is needed to convert direct materials into finished goods? Manufacturing overheads and direct labour. Direct labour

+

Manufacturing overheads

=

Conversion Cost

example 1.5 The following information was extracted from OneUp CC: Direct materials Direct labour Manufacturing overheads

R105 000 R110 000 R100 000

Required: Calculate the conversion cost. Suggested solution Conversion cost = Direct labour + Manufacturing overheads = R110 000 + R100 000 = R210 000

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Assessment activity 1.2

(Self-assessment)

The following information relates to NTN Manufacturers: Direct material Direct labour Manufacturing overheads

R100 500 R250 000 R145 500

Required: Calculate the: a) Prime cost b) Conversion cost c) Production cost. example 1.6 Refer to Example 1.3. Required: Calculate the: a) Prime cost b) Conversion cost c) Production cost d) Manufacturing overheads. Suggested solution a) Prime Cost

b) Conversion Cost

=

Direct materials + Direct labour 

=

Direct labour + Manufacturing overheads

=

R125 000 + R100 000 

=

R100 000 + R131 000

=

R225 000 

=

R231 000

c) Production cost

d) Manufacturing overheads

Add up the values in the Production cost column =

R356 000

Add up the values in the Indirect production cost column =

R131 000

Assessment activity 1.3

(Self-assessment)

The following information relates to AA Producers: Direct materials Direct labour Factory rent Insurance of office buildings Factory electricity Indirect materials Indirect labour

R780 000 R800 000 R100 000 R110 000 R90 000 R130 000 R150 000 14

Required: Calculate the: a) Manufacturing overheads b) Conversion cost c) Prime production cost d) Manufacturing cost. Assessment activity 1.4

(Self-assessment)

Berry Ltd revealed the following cost data: Direct labour Direct material Indirect labour Indirect materials Factory rent Office insurance Factory electricity

R125 800 R155 800 R55 000 R45 000 R50 000 R16 000 R34 000

Required: Calculate the: a) Prime cost b) Conversion cost c) Production cost. Assessment activity 1.5

(Self-assessment)

The following information was extracted from the records of Nina Ltd: Conversion cost Prime cost Manufacturing overheads

R80 000 R100 000 R30 000

Required: Calculate the: a) Direct labour cost b) Direct material cost c) Total production cost.

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