COST BEHAVIOUR

Cost behaviour refers to the way in which total costs or costs per unit are affected by fluctuations
in the level of activity. Understanding cost behaviour is essential for forecasting or budgeting,
and for controlling costs and monitoring performance.
Factors Affecting Cost Behaviour
There are several major factors which affect cost behaviour either singly or in combination.
Some of these are:
1. Volume of output or the level of activity: Many costs are influenced by the level of activity
which can be one of the following: Number of units produced, value of items sold, number of
items sold, number of invoices issued, number of units of electricity consumed etc.
2. Nature of the Cost: The nature of a particular cost will also affect predicting its amount. For
example, if depreciation cost is based on production units per year, then it is a variable cost. If
the depreciation charge is based on straight line or reducing balance method, then depreciation
cost is a fixed cost. Similarly, by their nature, electricity and telephone costs are mixed costs,
having a fixed element or standing charge and a variable element based on volume of usage.
3. Nature of the production process: If the production process is fully automated then a higher
proportion of production cost will be fixed. However, in a highly labour-intensive operation, a
high percentage of production will be a variable cost.
4. The existence of spare capacity: If an organization is working below the installed capacity,
an increase in output may result in little change in costs. But where an increase in output
involves a change in capacity, then all costs will be affected.
5. The effect of learning: The degree of efficiency or otherwise of workers may affect cost, for
example, labour cost per unit might fall as workers become more practiced and faster at making
units of production.
Problems Associated With Cost Behaviour
i. Oversimplification: It is conventionally assumed that all variable costs vary according to a
single activity usually production volume (under a manufacturing outfit). But the truth of the
matter is that different costs will vary with different activity indicator.
ii. Definition of Cost Unit: It is possible to standardize what constitute cost unit or cost per unit
in a manufacturing outfit. However, few problems will emerge if same approach is adopted in a
service-oriented establishment.
iii. Use of Statistical Methods: More frequently, the nature of available data together with the
major factors influencing cost must be considered in selecting an appropriate statistical method.
iv. Linearity Assumption: The assumption that the relationship between a variable cost and
production volume is linear may be for the purpose of easy analysis and computation.
v. Classification based on Convention: There is a tendency to classify costs, without any
emphasis on their actual behaviour as fixed or variable.
 PROCESS COSTING
In some organizations, the output produced emerges from a continuous process. Examples are
processed food production, palm oil required for food and petroleum oil. Crude oil in a raw state
is input and subjected to a process of purification, refined oil emerges at the end of the process.
Thus, problems that will arise in such situations include the attribution of materials costs and
conversion costs to units of finished output, and the occurrence of losses during the process
(spoilt or lost production).
Definition and Meaning of Process Costing
Process costing is a costing method used where it is not possible to identify separate units of
production or jobs usually because of the continuous nature of the production processes
involved.
When standardized goods or services result from a sequence of repetitive and continuous
operations or process, it is useful to work out the cost of each operation or process. Then,
because every unit produced may be assumed to have involved the same amount of work, costs
for a period are charged to processes or operations and unit costs are ascertained by dividing
process costs by the quantity of output units produced. This method of costing is known as
process costing. It is common to identify process costing with continuous production such as the
following: -Oil refining, paper, foods and drinks, chemicals, cans and tins.
Terminology Associated with Process Costing
a. Normal loss: This is the amount of loss expected from the operation of a process. This
expectation is based on past experience and is considered to be unavoidable. They are usually
expressed on the input volume. Such losses will usually have no value.
b. Abnormal loss: The extent to which the actual loss exceeds normal loss is referred to as
“normal loss”. It is the difference between expected units of raw materials and actual output unit
of raw material in a particular process. i.e. actual units is less than expected unit where:
Expected unit = Input unit – Normal loss
c. Abnormal gain: This is the extent to which the actual loss is less than the normal loss. It
occurs where the actual unit (output) is greater than the expected. The treatment is usually by
transferring the balance to the profit and loss account.
d. Scraps: These are losses of some recoverable value even though relatively minor; they
represent part of raw materials no longer required either because they are out of date (expired) or
they are useless as a result of process.
e. Waste: These are those aspect of raw materials with low measurable recoverable value.
f. Defective units: These are units of production that does not meet quality standard and
therefore re-worked.
g. Spoilage units: These are those units of production that does not meet the quality standard
and therefore sold-off.
h. Partially processed units: At the end of a period, there ma be some units which have been
started but have not been completed. These are regarded as closing work in process unit.
i. Equivalent units: Once processing has started, on a unit of output to the extent that it remains
in an incomplete state, it can be expressed as a proportion of a completed unit, e.g., 100 units of
half complete out can be regarded as 50 equivalent units that are complete.
Feature of Process Costing
a. The output of one process becomes the input to the next until the finished product is made in
the final process.
b. The continuous nature of production in many processes means that there will usually be
closing work in progress which must be valued.
c. There is often a loss in process costing due to spoilage, wastage, evaporation and so on.
d. Output from production may be a single product, but there may also be a by-product or joint
products.
Single Process Accounts
In process costing, costs are averaged over the units produced. The costs relating to a process for
a period are collected and divided by the number of units produced during the period. This
costing process can be executed in four steps:
i. Have a separate process account for each process. The amount is used to build up the costs of
the process and work out the value of items produced from the process.
ii. Charge the process account with the direct costs incurred. Debit the account with the direct
costs.
iii. If absorption costing is being used, charge the process account with absorbed production
overheads. If marginal costing is being used, charge with variable production overheads only.
iv. Divide the total costs by the number of units produced to calculate the cost per unit and so
value the output of the process. The cost of output is credited to the process account.
Question 1
JAMES Chemicals Limited makes many products including Gloss Paint. For December, the
following information is available.
Gloss Paint Production:
Material used
A. 1200 kg at ₦2.00
B. 1000 kg at ₦3.00
C. 600 kg at ₦4.00
Labour:
Four workers operate the mixing machine. Their wages are ₦100 per week and they work 40
hours a week each.
Output: 2000 litres
Calculate the cost per litre using:
a. Marginal costing
b. Total absorption costing with a manufacturing fixed overhead absorption rate of ₦5.00 per
labour hour.
SOLUTION
a. Marginal costing
Gloss Paint Process Account
Units Rate Amount Units Rate
Amount
Materials Kg ₦ ₦ ₦ ₦
A 1200 2.00 2,400 Output 2,400 4.70 9,400
B 1000 3.00 3,000 (W1)
C 600 4.00 2,400
Labour (₦100x4
X4 weeks) 1,600
9,400 9,400

(W1) Cost per litre = ₦9,400/200 ltrs = ₦4.70

b. Total Absorption Costing
Gloss Paint Process Account
Units Rate Amount Units Rate
Amount
Materials Kg ₦ ₦ ₦ ₦
A 1200 2.00 2,400 Output 2,000 6.30 12,600
B 1000 3.00 3,000 (W1)
C 600 4.00 2,400
Labour (₦100x4
X4 weeks) 1,600
Overheads (₦5x4 3,200
x40x4weeks)
12,600 12,600

(W1) Cost per litre = ₦12,600/2000 = ₦6.30