Learn costing by doing it

Bookkeeping records what was spent. Costing asks what it was spent on: which product, which job, which part of the business. It starts by sorting every cost, in more than one way.

By element

materials, labour or overheads. Overheads are every other running cost, such as rent, electricity and insurance

By whether it can be traced

a direct cost can be traced to one unit of the product. An indirect cost is shared by everything that is made

By behaviour

a variable cost rises and falls in step with output. A fixed cost stays the same in total. A semi-variable cost has a fixed part and a variable part

Teasel Bags makes one product, a canvas bag that sells for £27.50. Each bag uses £8.75 of materials and £6.75 of direct labour, so its variable cost is £15.50. Fixed costs are £8,640.00 a month.

The variable cost of a bag does not change. The fixed costs are spread over more bags, so the cost of each bag falls from £24.50 to £22.25.

Each bag sold adds £12.00 towards the fixed costs. That figure is its contribution: the selling price less the variable cost. The break-even point is £8,640.00 divided by £12.00, which is 720 bags. At 960 bags, sales can fall by 240 bags before the business makes a loss. That gap is the margin of safety.

• Sort a cost as materials, labour or an overhead, as direct or indirect, and as fixed, variable or semi-variable.
• Split a semi-variable cost into its two parts with the high-low method.
• Build and read a cost code, and code costs and income to the right centre.
• Value issues and closing inventory with FIFO and with weighted average cost, and keep an inventory record card.
• Work out gross pay on time rate, with an overtime premium, on piecework and with a bonus, and the labour cost of one unit.
• Allocate and apportion overheads, work out an absorption rate, and find the over or under absorption.
• Build the full cost of a job on a job cost card.
• Work out contribution, the break-even point, the margin of safety and the sales needed for a target profit.
• Flex a budget to the actual output, and label each variance favourable or adverse.

Costing needs arithmetic, not double entry, so it can be learnt before the bookkeeping topics or beside them. These are the modules to take, first to last.

1. Cost classification. The elements of cost, direct and indirect costs, fixed and variable costs, cost per unit, and cost, profit and investment centres.
2. Coding costs and income. How a cost code is built, coding materials, labour, overheads and income, and checking coded entries.
3. Inventory valuation. Why the value of inventory changes profit, FIFO, weighted average cost, the two compared, and the inventory record card.
4. Labour costs. Time rate, overtime premium, piecework, bonus schemes and labour cost per unit.
5. Overheads. Allocation and apportionment, choosing a basis, absorption rates, over and under absorption, and the full cost of a job.
6. Marginal costing. Contribution, the break-even point, the margin of safety, sales for a target profit, and marginal profit against absorption profit.
7. Budgets and variances. What a budget is for, actual against budget, favourable and adverse variances, flexing a budget and reporting a variance.

Marginal costing counts only the variable costs as the cost of a unit. Fixed costs are treated as a cost of the month. It answers questions about volume: how many units must be sold to break even, and what a fall in sales does to profit.

Absorption costing adds a share of the fixed production overheads to the cost of every unit made. It gives the full cost of a job, which is the starting point for a price.

The absorption rate is budgeted overheads divided by budgeted hours, and it is set before the year starts. So the overheads absorbed are compared with the actual overheads at the year end. Under absorption is charged to the statement of profit or loss as an extra expense. Over absorption is credited to it.

The two methods report different profits when inventory changes in the period, because absorption costing carries some fixed overhead forward inside closing inventory.

• Inventory rises in the period: absorption profit is higher.
• Inventory falls in the period: marginal profit is higher.
• Inventory does not change: the two profits are the same.

• Treating all labour as direct. A supervisor's salary is labour, but it cannot be traced to one unit, so it is an indirect cost.
• Saying a fixed cost is fixed for each unit. It is fixed in total, so the cost for each unit falls as output rises. A variable cost is the other way round: it changes in total and is the same for each unit.
• Calling the whole overtime payment a premium. The premium is only the extra part, on top of the basic rate. The basic rate for an overtime hour worked on the product is still direct labour.
• Pricing a FIFO issue at the newest cost. FIFO issues the oldest items first, so it is the closing inventory that is valued at the newest cost.
• Working out a new weighted average after an issue. An issue does not change the average. A receipt at a different cost does.
• Setting the absorption rate from actual figures. It is set from the budget, because jobs must be priced before the year is over.
• Comparing actual costs with the original budget when the output was different. Flex the budget to the actual number of units first. Fixed costs stay at the original figure.
• Reading a variance by its direction alone. Income above budget is favourable, and a cost above budget is adverse.

Ledger Drill teaches costing through questions, with no videos. A task is a few lines of reading and a table of figures for one invented business, then questions on it.

• Sort a month of costs into direct and indirect, or fixed and variable.
• Type the cost of an issue from the store, and the value of the inventory that is left.
• Type an absorption rate, a break-even point or a variance.
• Find the one wrong line on an inventory record card, a job cost card or a variance report.
• Put the steps of a working in order.

Every answer is marked at once, with the working behind it.

The modules and rooms are listed below, in order. A room that costs nothing carries a Free tag.