Cost Concepts

Class 2

Learning Objectives
Cost

Methods & Cost Techniques Systems/Methods

Costing Cost Cost

Classification Sheet

Cost Methods & Cost Techniques

Cost Methods 1. Job Costing 2. Contract 3. Batch 4.Process( continuous) 5. Service( Operating)

Cost Techniques 1. CVP Analysis 2. Standard Costing 3. Budgetary Control 4. ABC 5. Relevant Costing 6. Target Costing

Costing Systems/Methods
Historical Absorption Direct Marginal Standard Uniform

COST CLASSIFICATION

Elements Behaviour Functions Normality Control Decision Making

Elements

MATERIAL LABOUR EXPENSES

MATERIAL
Direct: traceable to one particular process, job or product identified with each unit of product Example: manufacturing an apparel Cloth, collar, buttons, cufflinks, thread Primary packing material (e.g., carton, wrapping, cardboard, boxes, etc.) Fuel, lubricating oil etc for operating & maintenance of machine Small tools Materials used for repairs & maintenance

LABOUR

Inspectors Supervisors Internal transport staff Storekeeper, maintenance staff

EXPENSES Expenses leading to a job or contract Traveling expenses for negotiation Special pattern, design Special tools for executing the contract

Rent Insurance Canteen, hospital, power , lighting, maintenance

Behaviour
Fixed
in short run & long run

Variable

Varies with volume and constant per unit

Semi-variable

A cost could be variable for one level of activity whereas it could be fixed for another. Not inherently fixed or variable Many costs are semi-variable in nature

Fixed Cost
Committed Fixed Costs consists largely of those fixed costs that arise from the possession of planti, equipment and a basic organizational structure. For example, once a building is constructed and plant is installed, nothing much can be done to reduce the costs such as depreciation, property taxes, insurance and salaries of the key personnel, etc., without impairing the organization's competence to meet the long-term goals. Discretionary Fixed Costs : set at fixed amount, for specific time periods by the management, in the budgeting process. These costs directly reflect top management policies and have no particular relationship with volume of output. These costs can therefore be reduced or eliminated entirely, if the circumstances so require. Examples of such costs are: research and development costs, advertising and sales promotion costs, donations, management consulting fees, etc. these costs are also termed as managed or programmed costs.

Functions
Production Cost Administration Cost Selling Cost Distribution Cost

Normality
Normal Abnormal

Control
Controllable & Uncontrollable

Planning & Control

Budgeted Cost: estimate of expenditure for different business operations Standard Cost: for prescribed set of operating conditions, labour, material and overheads are predetermined; budget translated into actual operation through standard costs

Decision Making
Marginal vs. Absorption Costing (with fixed cost and without FC) Sunk - irrelevant Committed pre committed Opportunity Incremental / Differential Avoidable & Unavoidable controllable / uncontrollable

Relevance
Relevant Irrelevant

Cont..
Irrelevant cost: not relevant for decision making Example: Sunk costs: Sunk cost is the cost of abandoned plant less salvage value. Not relevant for decision making. Imputed (Notional cost): Actually not incurred (interest on own capital, rent on owned building, etc.) Taken into account in capital budgeting decisions. Replacement cost: Cost of replacing at current market price.

Cont..

Avoidable and unavoidable cost: Cost that can be avoided by eliminating a product or department is avoidable and that which cannot be, is unavoidable. Ex. Rent of factory is unavoidable if a product is discontinued.

Other costs:

Future costs: cost to be incurred in future Programmed cost: Cost incurred as per policy of top management. Ex.- Donation to charity. Joint cost: cost of joint or by-products incurred before separation, which cannot be traced to particular products. Conversion cost: cost of converting raw material to finished goods = Production cost- direct material. Discretionary cost: not essential for decision on hand. Ex.- Training expenses of workers, R&D cost. Committed cost: Costs incurred due to past decisions and are not within control in the short run at present. Ex.- Depreciation on Plant, Rent, etc.

INVENTORIABLE COSTS AND PERIOD COSTS

Inventoriable cost/ product cost is that cost which is regarded as asset when incurred, but becomes a part of cost of goods sold when the product is sold. For MUL, all manufacturing cost is inventoriable cost. (Raw material to WIP to Finished goods) For a service sector unit, absence of inventory means all are period costs. Period costs (non-product cost): all costs in P&L account except cost of goods sold. So, in a mfg. sector unit, all non-manufacturing costs are period costs. (Ex. Distribution cost, design cost, R&D costs, Marketing costs, customer-service costs, etc.)