Costs and cost behaviour

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Cambridge International AS & A Level Accounting 9706

Costs and Cost Behaviour

The big idea: Before a business can price a product or decide whether to make it, it has to know what the product costs and how those costs move when output changes. This chapter sorts costs two ways: by whether they can be traced to a unit (direct or indirect) and by how they behave as activity changes (fixed, variable, semi-variable, stepped).

Summary — What This Chapter Covers

Labour is paid by time rate, piece rate or with a bonus; basic pay of production workers is a direct cost, while an overtime premium is normally an indirect cost.
Materials issued to production are valued using FIFO or AVCO, on a perpetual (after every movement) or periodic (end of period) basis.
Direct costs can be traced to a cost unit: direct materials + direct labour + direct expenses = prime cost. Indirect costs are overheads.
Fixed costs stay the same in total as output changes; variable costs change in proportion; semi-variable costs have both parts; stepped costs are fixed over a range and then jump.
The high–low method splits a semi-variable cost into its fixed and variable parts.
Just in time (JIT) buys or makes goods only when they are needed, keeping inventory close to zero.

1. Accounting for Labour Costs

Syllabus 2.1.1 · AS Level · Papers 1 & 2

Time rate, piece rate, overtime and bonus

Labour cost is the gross pay of employees plus any employer’s costs. How the pay is earned decides how it is calculated, and the type of worker decides whether it is a direct or an indirect cost.

Method	How pay is worked out	Advantages	Disadvantages
Time rate	Hours worked × rate per hour	Simple; workers are not rushed, so quality is protected	No reward for working faster; needs supervision
Piece rate	Units produced × rate per unit (often with a guaranteed minimum)	Rewards output; labour cost per unit is fixed	Quality may suffer; output must be counted and checked
Bonus scheme	Time rate plus a share of the time saved against a standard time	Encourages efficiency while protecting basic pay	More complex; may cause disputes over standards

Direct or indirect? Wages of workers who make the product (machine operators, assemblers) are direct labour. Wages of supervisors, cleaners, storekeepers and maintenance staff are indirect labour and become production overheads. Overtime is split: the basic rate for all hours is direct labour, but the overtime premium (the extra half in “time and a half”) is an indirect cost, because it is caused by the general workload and not by the unit that happened to be made in the evening. The one exception is overtime worked at a customer’s request for a specific job: then the premium is charged to that job as a direct cost. Idle time and holiday pay are also treated as overheads.

Worked Example

Mariam is a machine operator paid $15.00 an hour for a 40-hour week, with overtime at time and a half. Last week she worked 46 hours. Calculate her gross pay and show how much is direct labour.

Practice Question 1

Workers are paid $1.40 per unit with a guaranteed minimum of $600 a week. Calculate the pay of (a) Faisal, who made 520 units, and (b) Omar, who made 380 units.

Practice Question 2

2. Fixed, Variable, Semi-variable and Stepped Costs

Syllabus 2.1.1 · AS Level · Papers 1 & 2

How costs behave as output changes

in total

Behaviour	In total

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Also in the full note

Can the cost be traced to one unit?
Perpetual and periodic methods
Inventory arrives only when it is needed

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Costs and cost behaviour