Thursday 29 December 2022

Cost classification

Costs can be classified in 4 ways - by function, by element, by nature and by behaviour.


Classification of costs by function:

Production costs- this is also known as “cost of sales”. This category would include production labour costs, materials, factory supervisor salaries, factory rent. These are any costs which are directly linked with organisations production process. 

Selling & distribution costs- this will include any selling and distribution costs incurred by the organisation in getting the products to its end users. This category would include sales team commission, delivery costs. 

Administration costs- this will include any other costs that are incurred in the organisations operations. This category would include all other head office costs, IT support, HR support


Classification of costs by element:

Materials- these will include raw materials for a manufacturer, costs of goods to be resold in a retail organisation or service items or consumables to be used within a business operation. 

Labour- these will include all salary and wages costs to employees, including overtime, commissions and bonuses. 

Other expenses- this will include any other costs that are incurred in the organisations operations, such as, electricity, depreciation, rent, telephone. Most of these types of expenses are usually known as “overheads


Classification of costs by nature:

Direct costs- This is an item of cost that is traceable directly to a unit of production produced by a manufacturing organisation or a unit of service delivered by a service delivery organisation. The total of all direct costs is known as the “prime cost” per unit. These will include cost of raw materials used for production. 

Indirect costs- This is an item of cost that cannot or cannot be easily identified directly with any one finished unit. Expenses that do not relate directly to production (nonproduction costs) will all be classified as indirect costs and these are usually known as “overheads”. These will include HR costs, IT support, selling & distribution.


Classification of costs by behaviour:

Variable costs- these are costs that vary with the level of production or activity. It is usually assumed to vary in direct proportion to production. For example, if you make twice the number of chairs then the assumption is that the amount of wood used would be doubled. 

Fixed costs- these are costs that are not affected by changes in the level of production or activity, hence costs that don’t vary. For example, rent costs for a factory. It is assumed that if production increases, the factory rent cost would not be increasing based on the production volume. 

Semi-variable costs- these are costs that have a fixed element and a variable element. This means that if production were to double, the cost of production will not double because of the fixed cost element in the production cost, which will remain the same. For example, the cost of electricity for the factory has a fixed element relating to lighting and a variable element relating to power used in the production line. 

Stepped costs- these are costs that remain fixed up to a particular level of activity, but which rise to a higher (fixed) level, if activity goes beyond that range. For example, a firm may pay £40,000 per year to rent a factory in which they can produce up to 1 million units of product per year. However, if demand increases to more than 1 million units, a second factory may be required, in which case the cost if factory rent may step up to, say, £80,000 per year and then be constant until we want to make 3 million units.



Wednesday 14 December 2022

Net wages, gross wages and wages expense

A crucial part of nailing any payroll journal question is being able to calculate the wages expense, gross wages and the net wages due to the employees. 

Use the chart below to help - and remember to play close attention to and differentiate between employee and employer contributions!



Friday 2 December 2022

Economic Order Quantity (EOQ)

EOQ is the most economic re-order quantity of inventory which helps the business both ensure that the business is not holding too much inventory (which ties down working capital) and that they don't keep so little inventory, which can interrupt the production process. 

These two situations can prove to be costly to the business and both situations will need to be avoided as much as possible. Increasing the inventory quantity ordered will increase the holding costs to the business and will reduce the ordering costs due to fewer orders being placed through the year. 

In an ideal operating condition, a mathematical model can be used to determine the optimum order quantity that will help minimise these two costs to the business. The formula involves:

1. Ordering costs- administrative costs of placing each order. This does not include the cost of the materials. It will include costs like stationery, postage, telephone etc.

2. Annual usage- quantity of inventory in units used per year or the annual demand.

3. Inventory holding costs- cost of holding one unit of inventory per year. This will be the total cost of keeping and maintaining the inventory by the business. It will include costs like rent, insurance, wages, deterioration, etc. 

The formula is as follows:

Assumptions of EOQ:

 Demand and lead time are constant and known

 Purchase price is constant

 No buffer inventory is held 


The economic order quantity chart will be as below; 


Illustration: A company operates a 300-day year and it uses 30 units of inventory each day. For any orders placed, it incurs administrative charge of £40 and its inventory holding cost is £4.00 per unit per year. Calculate the EOQ. 

Solution: Annual usage = 300 days x 30 units = 9,000 units EOQ = £4.00 2 x £40 x 9,000 = 424 units



Friday 16 September 2022

In Remembrance: Her Majesty Queen Elizabeth II (1926 - 2022)


Last week we received the saddening news that Her Majesty The Queen had passed away peacefully at Balmoral Castle in Scotland.

The Queen ascended to the throne in 1952 after the death of her father, King George VI. 2022 marked her Platinum Jubilee - 70 years on the throne. This makes her the longest reigning monarch in the history of our country, surpassing the 63 year reign of Queen Victoria. 

She had presided over Britain in times of great triumph and equal despair - with her messages during the latter offering the nation hope of better days to come. 

Her constant presence in our lives reminded us of our rich and storied history, with the values she put at the forefront of her life - class, dignity, stoicism, resolve and duty - showing us what every Briton should aspire to be. 

In 1947, speaking to the United Kingdom and the Commonwealth, a 21 year-old Elizabeth said:

‘My whole life, whether it be long or short, shall be devoted to your service’.

And for 75 years, she steadfast kept her promise.

For that, we say thank you Ma'am. May you rest in peace.


Monday 14 March 2022

A basic test on prepaid income

 

A basic test on prepaid income:

 

You are working on the accounting records of a business for the year ended 31 March 20X7. You are looking at the rent income for the year and this includes receipts for the following periods:

 

Apr 20X6 – Mar 20X7

£5,040

Apr 20X6 – Jun 20X7

£5,625

 

Identify the prepaid income that need to be posted into the accounts?

 

Account name

Amount (£)

Dr/ Cr

 

 

 

 

 

 



A basic test on accrued income


A basic test on accrued income:

 

You are working on the accounting records of a business for the year ended 31 March 20X7. You are looking at the rent income for the year and this includes receipts for the following periods:

 

Apr 20X6 – Jan 20X7

£5,900

Apr 20X6 – May 20X7

£6,720

 

Identify the accrued income that needs to be posted into the accounts?

 

Account name

Amount (£)

Dr/ Cr

 

 

 

 

 

 



Wednesday 9 March 2022

A basic test on prepayments

 

A basic test on prepayments:

 

You are working on the accounting records of a business for the year ended 31 March 20X7. You are looking at the rent expense for the year and this includes payments for the following periods:

 

Apr 20X6 – May 20X7- Office 1

£5,040

Apr 20X6 – Jan 20X7- Office 2

£5,500

Jul 20X6 – Jun 20X7- New Office

£7,380

 

Identify the prepayments that need to be posted into the accounts?

 

Account name

Amount (£)

Dr/ Cr

 

 

 

 

 

 



Monday 21 February 2022

A basic test on accruals

 

A basic test on accruals:

 

You are working on the accounting records of a business for the year ended 31 March 20X7. You are looking at the rent expense for the year and this includes payments for the following periods:

 

Apr 20X6 – May 20X7- Office 1

£5,040

Apr 20X6 – Jan 20X7- Office 2

£5,500

 

Identify the accruals that need to be posted into the accounts?

 

Account name

Amount (£)

Dr/ Cr

 

 

 

 

 

 



Wednesday 16 February 2022

Prepaid Income

 

Prepaid income is an amount received in advance for a sundry income which relates to an accounting period after the year end.

 

In accounting for prepaid income, the effect that needs to occur will be to reduce the overpayment in income in an attempt to account for only the income earned in that accounting period and then to increase the liability in that accounting period, recognising that the business acts as a custodian of that amount paid in advance, so it should not be accounted for as income, rather it is a liability in the hands of the business until it earns that amount of money.

Example:

You are working on the accounting records of a manufacturing business for the year ended 30 June 20X6. You are looking at the rental income for the year and this shows receipts for the following periods:

 

July 20X5 – July 20X6

   £1,105

July 20X5 – September 20X6

   £1,590

 

Calculate the value of the adjustment required for the rental income account as at 30 June 20X6 and show the journal entry needed for the relevant adjustment.

Solution:

 

 

Prepaid income

July 20X5 – July 20X6

   £1,105

£1105/13x1= £85

July 20X5 – September 20X6

   £1,590

£1590/15x3=£318

Total prepaid income adjustment needed

 

£1068+£330=£403

                      

Account name

Amount (£)

Dr/ Cr

Rental income

403

Dr

Prepaid income

403

Cr



Prepaid Income - YouTube

Tuesday 8 February 2022

Accrued Income

Accrued income is a sundry income amount outstanding and yet to be received by the end of an accounting period, so has not been entered into the ledger accounts.

 

In accounting for accrued income, the effect that needs to occur will be to increase the relevant income in an attempt to account for the total income due to the business in that accounting period and then to increase the asset- accrued income which is like debtors in that accounting period, recognising that the business is owed that amount.

Example:

You are working on the accounting records of a manufacturing business for the year ended 30 June 20X6. You are looking at the rental income for the year and this shows receipts for the following periods:

 

July 20X5 – March 20X6

£990

July 20X5 – December 20X5

   £1,068

 

Calculate the value of the adjustment required for the rental income account as at 30 June 20X6 and show the journal entry needed for the relevant adjustment.

Solution:

 

 

Accrued income

July 20X5 – March 20X6

£990

£990/9x3= £330

July 20X5 – December 20X5

   £1,068

£1068/6x6=£1068

Total accrued income adjustment needed

 

£1068+£330=£1398

                      

Account name

Amount (£)

Dr/ Cr

Accrued income

1,398

Dr

Rental income

1,398

Cr


Accrued Income - YouTube

Tuesday 1 February 2022

Prepayments

 

A prepayment is an amount paid in advance for an expense which relates to an accounting period after the year end.

In accounting for prepayments, the effect that needs to occur will be to reduce the relevant expenditure in an attempt to account for the transactions which have been overpaid and then to increase the asset in that accounting period, recognising that the business could be owed that amount.



Example:

You are working on the accounting records of a business for the year ended 31 January 20X7. You are looking at the business rates expense for the year and this shows payments for the following periods:

                                                 

Feb 20X6 – Mar 20X7- Office 1

   £1,568

Feb 20X6 – Feb 20X7- Office 2

   £1,287

 

Calculate the value of the adjustment required for the business rates account as at 31 January 20X7 and show the journal entry needed for the relevant adjustment.

Solution:

 

 

Prepayments

Feb 20X6 – Mar 20X7- Office 1

   £1,568

£1568/14x2= £224

Feb 20X6 – Feb 20X6- Office 2

   £1,287

£1287/13x1=99

Total prepayments adjustment needed

 

£224+£99=£323

                      

Account name

Amount (£)

Dr/ Cr

Prepayments

323

Dr

Business rates

323

Cr


Prepayments - YouTube

Monday 24 January 2022

Accruals

 



An accrual is an amount outstanding for payment by the end of an accounting period, so has not been entered into the ledger accounts.

 

In accounting for accruals, the effect that needs to occur will be to increase the relevant expenditure in an attempt to account for the outstanding transactions which may not have been paid for and then to increase the liability in that accounting period, recognising that the business owes that amount.


Example:

You are working on the accounting records of a business for the year ended 31 January 20X7. You are looking at the business rates expense for the year and this shows payments for the following periods:

 

February 20X6 – September 20X6- Office 1

£980

February 20X6 – December 20X6- Office 2

   £1,054

 

Calculate the value of the adjustment required for the business rates account as at 31 January 20X7 and show the journal entry needed for the relevant adjustment.

Solution:

 

 

Accruals

February 20X6 – September 20X6- Office 1

£980

£980/8x4= £490

February 20X6 – December 20X6- Office 2

   £1,054

£1054/11x1=95

Total accruals adjustment needed

 

£490+£95=£585

                      

Account name

Amount (£)

Dr/ Cr

Business rates

585

Dr

Accruals

585

Cr