Assignment 2 – Step 2 I’m still going

Ok so I have been going over and over chapter 6 and feel that I have finished this step. It’s still a struggle but I’m happy with what I have written. Any feedback would be great.

Step 2:

Chapter 6: Understanding key cost relationships

The concept of linking a company’s costs to cost objects as explained by Martin made a lot of sense to me as I have been responsible for costing expenses to their correct cost code in my previous role at TCEO. Having to do this for 4 small schools was tricky at times as schools incur a huge amount of costs that need to be correctly coded for budgeting purposes. For example, each class had their own budget for general resources. Once they had exhausted their budget, no more resources were to be purchased. This made it very important for the coding to be correct.

I haven’t actually worked with the costing of products before, so the example Martin used of Cadbury’s chocolate production was a great way for me to understand how indirect costs work or would be allocated to each product. Although I’m still a bit confused as to why you would allocate costs like electricity, rates, etc to each product. Wouldn’t that just be a company or overhead cost?

Reading about cost objects made me realize that the use of cost objects in the company I have been given – Novogen Limited, would be extremely important as it is with every other company. I believe they would need to keep their fixed costs to a minimum as their revenue comes from grants and government funding. No revenue is being generated from actual customers or consumers at this stage.

Functional based and activity-based costing systems:

Overhead absorption rate =

Total overheads of a production department/Level of activity

Reading about the functional based costing system was interesting although I found that it seemed logical with the way it allocated overhead costs.

The concept of predetermining overhead costs also seemed logical to me as no one can predict the future so assumptions or estimates using previous year costs would be required. This was a process that I have used in my previous position as a Finance Officer. Each month I was required to print reports that had budgets (figures from previous years were used) versus actuals to determine how each cost center was progressing throughout the year. If any changes were to be made – in the case of cost centers being inaccurate, then I would talk to the school accountant to make a change if it looked like the budget was too low for that particular cost. This didn’t happen very often though as the budget forecast was usually accurate from using the previous year’s figures.

I really enjoyed reading the section on fixed and variable costs. Martin’s explanation by using his son’s band assisted my understanding of this concept. It showed me that fixed costs can vary depending on the amount of production or services that are produced. Determining the fixed costs and also the variable costs is necessary to calculate the break-even point of the product or service being produced. Any sales above that figure is a bonus and brings important profit to the company.

It seems interesting to me to think about how this would affect Novogen Limited. As they are a research and development company, a lot of their costs would be fixed I believe. Although with the production of treatments to be trialed I guess the variable costs would depend on how many patients are to be involved in the clinical trials. I’m sure this would be a fixed number.

Contribution Margin = Sales – Variable Costs

After reading chapter 6 I feel that the contribution margin is an important concept to a business. Calculating this figure shows how the fixed costs effect the company’s sales and how they could improve by reducing these costs where possible.

I am looking forward to reading about budgeting in Chapter 7.