4.4.1 Identify and classify costs (3)
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1.
A small business produces handmade jewellery. They currently make two types of necklaces: beaded necklaces and silver necklaces. The cost data for each necklace type is as follows:
- Beaded Necklace: £5 in materials, £2 in labour.
- Silver Necklace: £10 in materials, £4 in labour.
The business sells beaded necklaces for £15 and silver necklaces for £30. The business has a limited amount of time available for production. Explain how the business could use this cost data to decide which product to produce and justify your answer.
The business can use the cost data to calculate the profit margin for each necklace type. This involves calculating the total cost per necklace (materials + labour) and then subtracting that from the selling price.
Beaded Necklace:
Total Cost = £5 (materials) + £2 (labour) = £7
Profit = Selling Price - Total Cost = £15 - £7 = £8
Silver Necklace:
Total Cost = £10 (materials) + £4 (labour) = £14
Profit = Selling Price - Total Cost = £30 - £14 = £16
Based on this cost data, the silver necklace has a higher profit margin (£16 compared to £8 for the beaded necklace). Therefore, the business should focus on producing silver necklaces. This is because it generates more profit per unit sold. The limited time available for production should be allocated to the silver necklace production to maximize overall profitability. The business should also consider the market demand for each product. If demand for beaded necklaces is very high, it might be worthwhile to produce some, even with a lower profit margin, to meet customer needs and maintain sales. However, the primary focus should be on the more profitable silver necklace.
2.
Explain the difference between fixed costs and variable costs. Give an example of each that a retail business might incur.
Answer:
Fixed costs are costs that do not change with the level of production or sales. They remain the same regardless of how much a business produces. An example for a retail business is the rent on the shop premises. The rent is a fixed amount each month, even if the business sells a lot or very few items.
Variable costs are costs that change directly with the level of production or sales. As production increases, variable costs increase, and as production decreases, variable costs decrease. An example for a retail business is the cost of goods sold (COGS). The more items the business sells, the more it has to pay for those items.
3.
A small bakery sells cakes, pastries and bread. In a particular week, the bakery’s fixed costs were £1,500. Variable costs were £8 per cake, £5 per pastry and £2 per loaf of bread. The bakery sold 200 cakes, 150 pastries and 300 loaves of bread during the week. Calculate the total variable costs incurred by the bakery during the week.
Answer:
Total variable costs = (Number of cakes x Variable cost per cake) + (Number of pastries x Variable cost per pastry) + (Number of loaves of bread x Variable cost per loaf of bread)
Total variable costs = (200 x £8) + (150 x £5) + (300 x £2)
Total variable costs = £1600 + £750 + £600
Total variable costs = £2950