Professional Documents
Culture Documents
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Cost definition
• What are costs?
• Resources given up to achieve a particular
objective
• In financial accounting
• if the benefit extends beyond the current accounting
period these costs are classified as assets
• If the benefit is used up in the generation of revenue,
the costs are classified as expense
• Measured in monetary terms
Emphasis on costs
• Why do management accountants pay so much attention
to costs?
• Historic focus on production costs—to value inventory
and cost of goods sold for external reporting
• Ready availability of cost data within the transaction-
based accounting system
• Importance of cost information in managers’ decisions
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Cost classifications
“different classifications for different purposes”
Cost classifications
• according to function: production costs and period
costs
• according to identifiability/traceability with cost
units: direct costs and indirect cost
• according to their behaviour/variability: variable
costs, fixed costs or mixed costs)
• according to controllability: controllable cost and
uncontrollable cost
• Classification on the basis of time: historical cost
and pre-determined cost
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Classifying costs according to
function/financial reporting
Manufacturing costs are incurred within the
factory area. This is the cost of the sequence of
operations which begins with supplying
materials, labour and services and ends with
completion of production. They appear on the
income statement as cost of goods sold and on
the balance sheet as inventory.
Period costs are non-manufacturing costs. This
is the cost of resources used during accounting
period that are not assigned to products. They
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appear as operating expense on the income
statement.
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Classifying costs according to
function/financial reporting
Manufacturing/Production costs/Product costs
• Direct material costs
Direct material costs are the costs of raw materials or parts that go
directly into producing products. For example, if Company A is a toy
manufacturer, an example of a direct material cost would be the plastic
used to make the toys.
• Direct labor costs
Direct labor costs are the wages, benefits, and insurance that are paid to
employees who are directly involved in manufacturing and producing
the goods – for example, workers on the assembly line or those who use
the machinery to make the products.
• Manufacturing overhead costs
Manufacturing overhead costs include direct factory-related costs that 9
are incurred when producing a product, such as the cost of machinery
and the cost to operate the machinery. Manufacturing overhead costs
also include some indirect costs
• Conversion costs
• The total of direct labour cost and manufacturing
overhead cost
• The cost of converting material into a product
• Prime costs
• The total of direct material cost and direct labour
cost
• The major cost associated with producing a 10
product
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Classifying costs according to
function/financial reporting
Manufacturing/Production costs/Product costs
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Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost
• Administration Cost:
This is general administrative cost and includes
all expenditure incurred in formulating the policy,
directing the organization and controlling the
operations of an undertaking, which is not directly
related to production, selling and distributions,
research and development activity of function.
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Classifying costs according to
function/financial reporting
Period costs
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Example 2: The following data for 20X1 relates to Heartstrings
Pty. Ltd
Direct material used in production £550,000
Cost of finished goods inventory on hand £57,500
Rental of office space for sales personnel £7,500
Fringe benefits for production supervisor £ 4,500
Direct workers overtime premiums paid £27,500
Advertising expense £60,000 Direct workers £290,000
Depreciation on factory building $ 57,500 Indirect workers £85,000
Service-department costs £50,000 Cost of idle time £20,000
Production supervisor’s salary $ 22,500 Promotion costs £5,000
Administrative costs £75,000 Sales commissions £2,500
REQUIRED: Calculate each of the following costs for 20X1.
A. total prime costs. B. total manufacturing overhead costs.
C. total conversion-costs. D. total product costs.
E. total period costs.
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2 3 4
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Classifying costs according to traceability with cost units
Direct and indirect costs
A cost object is something for which a cost is
compiled, such as a product, service, customer, project,
or activity.
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Classifying costs according to identifiability with cost units
Discussion
Choose a manufacturing company
1. Determine manufacturing costs for goods
produced
2. Analyze impacts of manufacturing costs to
financial statements with assumption of suitable
data of costs
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Classifying costs according to traceability with cost units
Example 3: overtime and idle time
Given below are the labour costs incurred by a
manufacturing business for the week commencing 23
July 20X5.
Direct production workers 1,200 hours @ $6.40 per hour
Direct production workers overtime hours 200 @ $9.40
per hour
Indirect workers 400 hours @ $5.20 per hour
Indirect workers overtime hours 50 @ $8.00 per hour
Of the hours paid to the direct production workers 40 of
these were idle time hours.
1. What types of costs above that classifying according
to function? 21
2. What is the total for direct labour and indirect labour
for the week?
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Controllable and uncontrollable costs
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Cost behaviour, cost drivers, and cost
estimation
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• Cost behaviour
• The relationship between a cost and the level of
activity or cost driver
• Cost estimation
• The process of determining the cost behaviour of
a particular cost item
• Cost prediction
• Using knowledge of cost behaviour to forecast
the level of cost at a particular level of activity
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Cost drivers
• A cost driver
• An activity or factor that causes costs to be incurred
• The higher the correlation between the cost and the
cost driver, the more accurate is the description and
understanding of cost behaviours
• Conventional approaches
• Variable costs are assumed to vary in proportion
to the level of production or sales volume
• Fixed costs remain unchanged as production
volumes increase or decrease
• Volume-based cost drivers include units
produced, direct labour hours, direct labour cost 29
and machine hours
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Cost drivers (cont.)
• Unit level costs
• Relate to activities performed for each unit
produced
• Use conventional volume-based cost drivers
• Batch level costs
• Relate to activities performed for a group of
product units, such as a batch or a delivery load
• Product (or product-sustaining) level
• Relates to activities performed for specific
products or product groups
• Facility level
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• Costs incurred to run the business, not caused by
any particular product
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Activities that cause costs to be incurred are called COST DRIVERS
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Machining operations Machine hours
Setup Setup hours
Production scheduling Manufacturing orders
Inspection Pieces inspected
Purchasing Purchase orders
Shop order handling Shop orders
Valve assembly support Customer Requisitions
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Cost behaviour patterns
• Cost behaviour
• The relationship between a cost and the level of
activity (or cost driver)
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• Cost behaviour patterns
• Variable costs
• Fixed costs
• Step-fixed costs
• Mixed costs: Semi variable costs and
curvilinear costs
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3-38
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3-40
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Cost
Y =x a
Y = ax +b
Y = logx
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Examples?
Example
The following table shows the costs during a month if 600
mufflers are replaced
Number of muffler replacements 500 600 700
Fixed Costs 84000 (a) £ 84 000 (b) 84000
Variable costs 50000 (c) £ 60 000 (d) 70000
Total costs 134000 (e) £ 144 000 (f)
154000
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Fixed costs Variable costs
Level of
activities
Total Unit Total Unit
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Y = ax + b
Y = ax + b
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2.4
Y = ax + b
Cost
Y = ax + b
Y=ax
Y=b
Activity level
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Mixed cost-Semi-variable costs
Step 1: Determine cost driver and total costs at:
Highest activity point and Lowest activity point
Step 2: Calculate Variable cost per unit (coefficient a)
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Warmth Co. produces towels. The following data shows the
company's activities during the last six months:
The company uses the high-low method to estimate the
variable cost per unit and the fixed cost component of mixed
costs. Month Total Production (Units) Total production Cost (£) variable cost
=(105000-55500)/(9500-4000)
=9
January 4,000 55,500
February 6,000 84,000 Fixed cost = 105000-(9500*9)
March 9,000 98,000 = 19500
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3.
In £ ‘000
1. Revenue (1000 units) 2.000.000
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3.
In £’000
1. Revenue 2.000.000
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Jan Feb Mar
COGs 462,000 548,000 711,000
- Direct materials costs
240,000 300,000 420,000
- Direct labour costs 132,000 158,000 201,000
- Manufacturing overheads costs 90,000 90,000 90,000
Selling costs 127,000 142,000 166,000
- Advertising costs 45,000 52,000 60,000
- Building renting costs 40,000 40,000 40,000
- Wages 32,000 40,000 56,000
- Others 10,000 10,000 10,000
Administration costs 180,000 180,000 180,000
Level of activities (units) 8000 10.000 14.000
1. Classify the above costs into variable costs, fixed costs and
mixed costs
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2. Prepare an Managerial Income statement of March, the
revenue in March was £1,500,000
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In £’000 Jan Feb Mar
- Direct materials costs 210.000 260.000 300.000
- Direct labour costs 140.000 180.000 220.000
- Manufacturing overheads 80.000 80.000 80.000
- Advertising cost 42.000 54.000 66.000
- Selling stores renting cost 30.000 30.000 30.000
- Selling wages 38.000 42.000 58.000
- Administration cost 150.000 150.000 150.000
Number of products sold 7.000 9.000 11.000
(units)
1. Classify the above costs into variable costs, fixed costs and
mixed costs. Use high-low method to separate variable and
fixed components in the mixed costs.
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2. Prepare an Managerial Income statement in April. The
estimate revenue in April is £2,000,000,000, and the sales
volume is expected to be 14,000 units
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