Overview of Cost Accounting (Grade 10 NSC Matric Accounting): Revision Notes

Overview of Cost Accounting

Introduction to enterprises and cost accounting

Cost accounting is a crucial tool for businesses that manufacture products. Before diving into the details, it's important to understand the different types of enterprises and why cost accounting matters to each one.

Types of enterprises

There are three main types of enterprises you need to know about:

Trading enterprise: This is a business that purchases manufactured products and then sells them to customers at a profit. Trading enterprises don't make the products themselves - they buy finished goods and resell them. In a trading enterprise, we focus on the cost of purchasing stock (bought at a wholesale price) and selling it at a retail price. The difference between these prices, minus expenses, represents the profit.

Service enterprise: This type of business provides services rather than physical products. Service enterprises employ people who use their skills and expertise to help the community. Examples include hair salons, tutoring centres, repair shops, and consulting firms. These businesses focus on labour costs and the expenses needed to deliver quality services.

Manufacturing enterprise: This is a business that transforms raw materials into finished products (also called completed products). Manufacturing enterprises start with basic materials and use labour, equipment, and other resources to create something new that can be sold. Understanding costs in manufacturing is essential because there are many different expenses involved in turning raw materials into finished goods.

Understanding cost concepts

Cost accounting involves tracking and categorising all the money spent on making products. Let's explore the key concepts you need to master.

What is cost?

Cost refers to the monetary value needed to manufacture a product or to provide a service. In simpler terms, it's all the money you must spend to create something that you can sell. Every rand spent on materials, workers, electricity, rent, and other resources contributes to the total cost of your product.

Fixed costs vs variable costs

Understanding the difference between fixed and variable costs is essential for managing a manufacturing business effectively.

Fixed costs are expenses that stay the same no matter how many products you make. Whether you produce 10 units or 1,000 units, these costs don't change. Think of fixed costs as the "baseline" expenses you must pay just to keep the business running. Examples include:

• Rent for the factory building (you pay the same amount each month regardless of production)
• Insurance on equipment
• Salaries for permanent administrative staff
• Depreciation on machinery

Variable costs are expenses that increase or decrease depending on how many products you manufacture. The more you produce, the higher these costs become. Variable costs are directly linked to production volume. Examples include:

• Raw materials (more products = more materials needed)
• Direct labour paid by the hour or per unit
• Electricity used by production machines
• Consumable supplies used in manufacturing

Important formula:

$\text{Total costs} = \text{Fixed costs} + \text{Variable costs}$

Direct costs vs indirect costs

Another way to classify costs is by whether they can be traced directly to a specific product.

Direct costs can be directly linked to specific products, the production process, or a particular section of the factory. These are costs you can measure precisely for each item you make. When you look at a finished product, you can identify exactly how much of these costs went into making it. Direct costs fall into two main categories:

• Direct materials
• Direct labour

Indirect costs cannot be directly linked to a specific product or the completion of a particular task. However, these costs are still necessary for manufacturing to happen. Indirect costs are usually referred to as overheads. They support the production process but can't be traced to individual units. Examples include:

• Factory rent (benefits all products made)
• Supervisor salaries (they oversee all production)
• Cleaning materials
• General factory maintenance

Labour costs explained

Labour costs represent the total amount paid to workers who are directly or indirectly involved in manufacturing products. This includes their wages or salaries plus any worker contributions (such as UIF and pension contributions).

Direct labour costs are payments made to employees who are directly involved in making the product. These workers physically handle the materials and use equipment to transform them into finished goods. Examples include:

• Machine operators
• Assembly line workers
• Cutters and sewers in a clothing factory

Indirect labour costs are payments made to employees who support the manufacturing process but don't directly work on the products themselves. Examples include:

• Quality control inspectors
• Factory cleaners
• Factory supervisors
• Maintenance staff

Material costs explained

Direct material costs refer to all the raw materials and parts used in the production process that become part of the final product. You can physically see and measure these materials in the finished item. For example, in manufacturing a bag, the fabric, zips, and thread are all direct materials because they become part of the bag itself.

Indirect material costs involve materials and parts used in small quantities that cannot easily be traced to individual products. While these items are necessary for production, it would be impractical or too time-consuming to measure exactly how much was used for each unit. Examples include:

• Small amounts of glue
• Cleaning solvents
• Machine lubricants
• Minor consumables

Primary costs

Primary costs represent the most essential, direct expenses of manufacturing. These are the costs that can be specifically traced to each product unit.

Manufacturing costs

Manufacturing costs include all expenses related to making products in the factory. This combines the primary costs with the overhead costs.

Formula:

$\text{Manufacturing costs} = \text{Primary costs} + \text{Overheads}$

In other words:

$\text{Manufacturing costs} = (\text{Direct material} + \text{Direct labour}) + \text{Overheads}$

Work-in-progress

Work-in-progress refers to units that are incomplete - they're still being manufactured. In any production period, you'll have some products that are finished and some that are still being worked on. Work-in-progress inventory can be at any stage of completion, from just started (1% complete) to almost finished (99% complete).

When calculating costs for a specific period, accountants must determine how much to allocate to partially completed units versus fully completed ones. This is important for accurate financial reporting.

Completed products

Completed products (also called completed goods or finished goods) are units that are 100% complete and ready to be sold. These products have gone through all manufacturing stages and are now in inventory waiting to be shipped to customers.

Cost of sales

Cost of sales involves determining the cost of completed units that have actually been sold to customers. This is a key figure for calculating profit because it shows how much it cost to produce the items that generated revenue.

Practical application: Thembi's bag manufacturing business

Let's see how these concepts work in a real-world example. Thembi manufactures designer bags and sells them at a flea market. Here are the costs she incurs:

Thembi's cost structure

Cost item	Amount
Material fabric – 0.75m	R24 per metre
Cotton thread – 50m	R10 per 1,000m
Webbing for handle – 0.75m	R20 per metre
Beads for decoration – 48 beads	R7 per dozen
Labour time – 2.5 hours	R15 per hour
Rent (garage space)	R1,500 per month
Cleaning material	R50 per month
Electricity	R200 per month

Calculating direct material cost per bag

Calculating direct labour cost per bag

Calculating primary cost per bag

Identifying overhead costs

Overhead costs cannot be traced to individual bags but are necessary for production:

• Rent: R1,500 per month (fixed cost)
• Cleaning material: R50 per month (fixed cost)
• Electricity: R200 per month (could be semi-variable but often treated as fixed)

$\text{Total overhead costs} = \text{R}1{,}500 + \text{R}50 + \text{R}200 = \text{R}1{,}750 \text{ per month}$

Understanding cost behaviour

In Thembi's business:

This distinction is crucial for planning. Thembi knows that each additional bag costs R99.00 in primary costs, but her fixed costs of R1,750 per month are spread across all bags produced.

Tips for classifying costs correctly

When you're asked to classify costs in an exam or activity, follow these guidelines:

Common examples:

Cost item	Classification	Reason
Raw materials in finished product	Direct material	Becomes part of the product
Factory workers making products	Direct labour	Directly involved in production
Factory rent	Indirect (overhead)	Cannot trace to specific units
Factory cleaner wages	Indirect labour	Supports production but doesn't make products
Insurance on equipment	Indirect (overhead)	Benefits all production
Maintenance of factory	Indirect (overhead)	Benefits all production

Exam tips

Remember!