Basic Costing, the subject of this blog, is studied by those following an AAT course for a Level 2 Certificate in Accounting.
It involves understanding how to record or extract data from cost recording systems and analysing how spreadsheets communicate information about actual and budgeted income and expenditure.
What is Basic Costing used for?
Organisations use cost accounting systems to help them make internal management decisions.
Basic Costing systems will vary between different types of businesses and organisations, depending on the sector they operate in. For example, a manufacturing company might have a different system from a retail outlet or a charity.
What are the elements of cost?
The elements of cost are usually categorised as:
- Labour (staff costs)
- Overheads (expenses)
Basic costs can be classified and recorded in different ways and the nature of these costs can be direct, eg a spare part that a garage uses to repair a customer’s car, or indirect, eg staff wages or rental cost of business premises.
Costs can be fixed, variable or semi-variable: for example, a fixed-rate loan payment would be a fixed cost, an electricity bill would be a variable cost and a staff salary with bonus would be a semi-variable cost. Because costs can vary, accountancy students will need to learn how to calculate a variance between budgeted cost and actual cost, and to understand the significance of this variance.
The cost of a product will have an impact on the price it is sold at and this can vary due to fluctuations in the cost of materials. When preparing an inventory, goods can be classified as raw materials, part-finished or finished goods.
When it comes to labour, while some staff may be full-time permanent employees, other labour costs may be for consultants or piecework. The cost of permanent employees can also vary due to such elements as overtime and bonuses.
Overheads can be estimated for financial planning but again, there is likely to be some variation in costs over the financial year.
Basic costing and coding
Businesses use cost codes to identify the type of cost and which profit or cost centre is incurring the cost. The codes will be chosen to suit the way the business operates.
Coding systems can be numeric, alphabetic or alpha-numeric, and codes are usually quoted on order forms and invoices.
An important part of Basic Costing is knowing how to value inventory. The most common methods to do this are: FIFO (First in first out), LIFO (Last in first out) and AVCO (Average Cost) (see our blog on: When is FIFO used in accountancy?).
Any successful business will budget for income and expenditure in order to plan ahead. As well as an overall budget, there may be budgets set for individual departments, eg marketing costs over the financial year. Most companies will use spreadsheets to prepare and analyse their budgets.
Once a student has a clear knowledge of Basic Costing, they will be able to progress to the more complex modules seen in the Level 3 Diploma in Accountancy and Level 4 AAT Diploma in Accountancy.