MAC2601 STUDY NOTES.

MAC2601 STUDY NOTES.

,Study Guide One
Part 1 : Valuing inventories using basic techniques
Topic 1 : Nature and behaviour of costs
Study Unit 1 : Cost objects, classification and behaviour

 Cost objects and traceability :
 Cost object: is any activity, unit or phenomenon for which cost can be accumulated
and measured.
 Direct cost: can be traced easily or physically to a particular cost object.
 Indirect cost: cannot be traced easily or physically to a particular cost object.
 Classification of costs according to their nature of origin :
 Manufacturing cost: factory costs; production costs
 Non-manufacturing cost: Marketing costs; Administration costs
 Further classification of manufacturing costs according to its components :
 Direct materials
 Direct labour
 Manufacturing overheads:
 Indirect materials
 Indirect labour
 Other manufacturing costs (rent, depreciation, electricity etc)
 Prime cost: total of all the direct material.
 Conversion cost: total cost when converting new material into finished products.
 Figure 1.1: The relationship between the components of manufacturing cost: Page 9
 Classification of costs according to cost behaviour :
 Fixed cost: cost that remains constant, in total, regardless of changes in the level of
activity or volume.
 Variable cost: cost that varies, in total, in direct proportion to changes in the level of
activity or volume.
 Semi-variable cost: contains both fixed and variable cost.
 Semi-fixed (stepped) cost: certain kinds of fixed costs increase or decrease only in
fixed increments or in steps.
 A closer look at relevant range and specific time frame :
 Relevant range: defined by the production capacity within which the organisation
normally operates.
 Specific time frame:
 In the very short term (eg in the next month), almost all cost (excluding
direct material) is fixed.
 In the short term (eg the next year), most of the fixed cost will remain fixed
monetary terms.
 In the medium term (two to three years), significant changes in the level of
fixed cost can be implemented.
 In the long term, all cost becomes variable.
 Classification of cost as product or period cost :
 Product (manufacturing) cost: cost incurred in the manufacturing of a product.
 Period (expenses) costs: costs that are not included in production costs.

,Study Unit 2 : Estimation techniques and the linear equation

 The linear equation :
 Cost equation based on linear equation : y = a + b x
 y = total cost; the dependent variable
 a = total fixed costs; the intercept on the y-axis
 b = variable cost per unit of activity; the slope of the straight line
 x = activity level; the independent variable
 Figure 2.1: Total cost graph: Page 21
 The high-low method :
 Variable cost per unit (High-low method):
𝑡ℎ𝑒 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑐𝑜𝑠𝑡𝑠 𝑎𝑡 𝑡ℎ𝑒 ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑛𝑑 𝑙𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦
𝑡ℎ𝑒 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑛𝑑 𝑙𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦
 Fixed costs: total fixed costs for related activity level – (variable cost per unit x related activity level)
 The scatter diagram :
 Formula : y = a + b x
 The fixed cost (a) is equal to the intercept on the y-axis.
 The variable cost (b) is computed by taking two points on the y-axis and x-axis and
calculating the difference per unit of activity in the same way as the high-low
method.
 Simple regression analysis (least squares method) :
 The linear equation can be used to determine the fixed and variable portions of
manufacturing overheads.
 Simple regression can be used to determine the relationship between the
dependent and independent variable.
 The values for “a” and “b” can be found by simultaneously solving the following
equation:
∑xy = a∑x + b∑x2……………………………..①
∑y = an + b∑x…………………………………..②

, Study Unit 3 : Cost-volume-profit analysis

 What is the cost-volume-profit analysis?
 It investigates the change in profit that results from changes in:
 Activity levels (units produced and sold)
 Per unit selling price
 Per unit variable costs
 Total fixed costs
 It is a powerful tool that management uses for short-term decision-making and
planning to investigate the impact of decisions on profit.
 Assumptions of the cost-volume-profit analysis :
 The selling price per unit is constant, irrespective of the sales volume.
 All costs are linear and can be accurately divided into variable and fixed elements.
 Variable costs are constant per unit; fixed costs are constant in total over the
relevant range.
 The sales mix is constant in multiproduct organisations.
 Inventory levels do not change, units sold is equal to units produced.
 Cost-volume-profit analysis applies to the relevant range only.
 Relevant range: upper and lower levels of production (= sales) activity levels.
 Contribution :
 The amount remaining after the deduction of all variable cost from sales.
 Contribution = sales – total variable costs
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
 Contribution ratio = × 100%
𝑠𝑎𝑙𝑒𝑠
 Breakeven analysis :
 Breakeven point: point where the total contribution is equal to total fixed costs
(point where profit is zero).
 y = bx – a :
 y = net profit
 b = contribution per unit
 x = number of units sold
 a = total fixed cost
𝑡𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡
 Breakeven point in units: 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
 Breakeven value = breakeven units x selling price per unit
Or
𝑡𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
 Breakeven value = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜
 The effects of price and cost changes on the breakeven point :
 Activity 3.4: Pages 39 – 42
 Margin of safety :
 Margin of safety = total sales – breakeven sales
𝑚𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦
 Margin of safety ratio % = 𝑡𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠
× 100%
 Target profit analysis :
𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠+𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡
 Sales units = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠+𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡
 Sales value = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜
 Breakeven graph :
 Figure 3.1: Page 45