5 BASIC COST CONCEPTS

INTRODUCTION:Understanding of basic cost concepts is necessary because

costing helps in

 Optimum utilisation of resources

 Pricing, Volume, make or buy, replacement, assets acquisition, product

mix, etc.

 performance evaluation

Financial statements and costs-GAAP

Expired costs.
Unexpired cost

7.1.NATURE OF COST - No universal definition-Based on individual needs

Specifc purpose,context.

7.2.MEANING OF COSTS

Cost is a foregoing or sacrifice, measured in monetary terms, incurred or

potentially to be incurred to achieve a specific purpose.

In the food and beverage context if a material is used, wastefully or otherwise,

it becomes cost.

1 Eg a piece of meat may be spoilt thrown away, stolen, becomes a part of the
total cost.

2.Eg labour cost is calculated, the total amount due whether paid not, becomes a
cost .

`Cost' - suffix or a prefix. material, labour, direct, inderect, fixed variable,

job, process, etc.

7.3USES OF COSTS:
 Determination of profits -Historical costing
 Budgeting and planning -Estimated costs
 Controlling -Standard costs
 Pricing -Marginal costs
 Day to day application of plans and policies.
7.4 TYPES OF COSTS:
1.Historical costs/Actual Costs : Actual payments at the time of incurring
- time gap between occurance and reporting-no help to in cost control.

2.Estimated costs - Predetermined costs

3.Standard costs Scientifically predetermined costs-

controlling. - variances analysis.

4.Total costs : Sum of all costs

5.Marginal costs : This is measured by the change in cost due to change in

output by one unit.

6.Differential costs : Extra cost when an alternative chosen. Differ between two
available alternatives.
Eg. Installation of computer at front office to replace the two obsolete posting
machines-costs to be taken-purchase cost computer,and all extra costs associated
with the computer. The costs of labour,electricity etc need not be considered.

7.Replacement cost : This is the current cost of replacing an asset.

8.Opportunity cost - It is a measurable advantage foregone- rejection-alternative

use of resources.
Eg renting place- Florist, hair stylist-managerial decisions.

9.Descretionary costs: top management decisions. Employee training

programmes, research and development, advertisement, sales promotion, donation
etc.

10..Budgeted costs : Plan prepared and approved prior to a predefined period of

time.

11.Direct Costs: Directly and wholly charged to a product,or a cost unit.

Eg for rooms department may include payroll and related expenses,
commissions, contract cleaning, guest transportation,laundry
drycleaning,,linen,operating supplies, reservations, uniforms etc. Undistributed
operating expenses can not be considered.-It all depends on the objective with
which the cost is being ascertained.

12.Indirect Cost: Those costs which cannot be identified but have to be allocated,
eg electricity , insurance, water charges etc. advt expense of the hotel can be an
indirect cost for the rooms department.
7.5 Difference between Cost accounting and Financial Accounting
FINANCIAL ACCOUNTING COST ACCOUNTING
1.Knowing the profits and financial planning operation control and decision
position making
2.GAAP and It Act and Cos Act Kept by the companies on a voluntary
basis (but for some manufacturing cos it
is compulsory)
3.Helps Recording important and not Helps Control of material labour and
control overheads
4.Annual reporting As required
5.Total costs are reflected Costs per unit are reflected
6.Deals with actuals Deals also with estimates
7.Relative efficiencies of cost units not Valuable comparative information is
available available
8.Stocks valued at lower of cost or Actual costs are considered
market price
9.Legal rigidity is found No such legal rigidity

7.6.CLASSIFICATION OF COSTS

Classification of costs can be made according to

Elements
function
behaviour

I.Classification of costs according to elements

COSTS

Material Labour Expenses

Direct Indirec Direct Indirect Direct Indirect

Direct costs: Those costs which can be identified with cost centers or
products. Material, wages, and expenses directly involved in manufacture of
a product

Indirect Costs: Those costs which cannot be identified but have to be

allocated, eg electricity , insurance, water charges etc.
 With respect to a lodging establishment they are related to the operated
departments(profit centers). Like the rooms department, Food and bev department
etc.

MATERIAL

Direct materials cost. Materials are Raw materials -integral part of the
finished product -conveniently assigned to specific physical units is termed as
"Direct Material"

1.Flour used in the making bread.

2.Primary packing material (the paper required to pack the loaf)
Cartons,wrppings,cardboard,boxes etc
3.Partly produced or purchased components (the yeast powder)

Indirect Material:
Materials that are ,used in the manufacturing operations, but do not become
the part of a finished product. cannot identified with them.- cotton waste,
lubricants, grease, oil, Cleaning Material,

LABOUR
The human effort measured in terms of the money paid is known as
LABOUR.
Direct labour money paid to persons who take Direct and active part in the
production - specifically and conviniently traceable - altering the
construction, composition or condition of product
1. Eg. The salary of the baker who is directly involved in making of the
loaf of bread .
2.Salary of the the waiters, involved in F&B service.
3.Pay and allowances of the rooms department

Indirect labour
Carrying out tasks incidental to goods produced or services provided-
does not alter the condition of the product. Cannot be traced to a product.
Eg. Wages of storekeeper,supervisor,managers'salaries , manager, clerks
etc, sales manager etc,.

EXPENSES
Direct Expense
Expenses which can be wholly or directly assigned to a specific product.
Eg.The repairs charges on a machine used exclusively for production of
bread. The cost of wastage or defective work etc. ,commissions, contract
cleaning, guest transportaion etc. factory rent, factory electricity charges any
expenses like rent water charges etc which are directly involved in the
manufacture of a product. Also termed as the factory overheads.
Indirect Expense
Those expenses which cannot be directly, conveniently, and wholly
allocated to a specific cost unit. These form a large chunk of expenses in an
organisation, and are Normally referred to as overheads.

Eg. Rent,lighting insurance charges etc,Interest on loan, repair charges etc.

The Element of costs can be regrouped as follows:
Prime Costs: Direct Material, Direct Labour and Direct Expenses.
Overheads : Indirect materials, Indirect labour, and Indirect Expenses.These
are all costs other than the direct costs incurred by the profit centers. With
reference to a lodging business overhead costs include the undistributed
operating expenses, management fees, fixed charges. These costs are not
related to the profit centers in the income statement. In order to know the
total costs of the departments these indirect costs will have to be allocated to
the profit centers.

II.Classification according to function:

1. Production costs
Prime costs + Factory Expenses
Administration costs
Expenses of running of the place like,salaries of managers, electricity,
water, etc

3.Selling and Distrbution costs

Costs seeking to create and stimulate demand(Selling) and make the
product available for despatch or service costs in case of a restaurant.
Based on the functionwise classification Cost Sheets are prepared for every
product. The Cost sheet gives the bifurcation of costs for every unit and also
the total production. Analysis of total cost for the purpose of cost sheet.

Prime costs + Factory Expenses

---------------------------
Cost of production
+Administration costs
+Selling and Distrbution costs
---------------------------------------
Cost of sales
--------------------------------------

III.Classification of costs according to behaviour.

According to this Costs are classified into Fixed Costs Variable Costs and
Semi-fixed costs.
FIXED COSTS: These are the costs which remain constant irrespective of
the quantum of output within and up to the capacity that has been built
up. Fixed costs are also known as period costs. Examples of such costs are :
rent,insurance,mangement salary. Basically all overheads except the variable
portion can be considered as Fixed costs. Fixed costs are also known as
period costs.

1.Total Fixed Cost(TFC) remains constant what ever be the output

2.Unit Fixed Costs(UFC) are inversely proportional to the volume of output.

Example 1: If Rs 6,000 is the rent for the factory building it will remain
fixed at Rs6,000 at various volumes say 6000 units 7000 units 8000 units etc,.
Where as fixed cost per unit will be Re.1, Re0.85,Re.0.75 respectively.

Variable Costs:
1.Total variable costs(TVC) are directly in proportion to the
volume of output.
2.Unit variable costs remain constant.
These costs are also called as product costs,maraginal costs, direct costs or
prime costs.

Graph
Example 2: If cost of raw materials is Rs.1 per unit. Cost per unit will
remain the same when the output is 1000units,2000units or 3000units.
Where as the total variable cost will be Rs.1,000 Rs2,000 and Rs 3,000
respectively.

Semivariable Costs: These are costs which do vary but not in direct
proportion to the output. These are known as the semi-variable costs or step
costs. These costs contain a fixed element and a variable element. Upto a
certain level of activity they behave like fixed costs and beyond that level of
activity they behave like variable costs(directly proportional to
output)Normally all the overhead expenses are semi variable, they contain
a portion of fixed element and a portion of variable element.
Graph:

Elements
Semivariable costs Fixed Variable
1.Telephone expenses Cost of
system/rental of Cost of calls
system
2.Building lease Fixed cost per Percentage of
square foot of revenue earned in
space taken on addition to the
lease rent fixed amount
3.Automobile lease Fixed cost/day Additional charge
per mile
automobile is
driven
4.Executive remuneration Base pay Bonuses paid on
sales
5.Repair and maintenance Minimum Additional
amount required maintenance
to maintain required with
lodging firm at higher occupancy
low occupancy levels

For the purpose cost analysis, under various decision making, management
accounting tools such as the break even analysis, cost volume and profit
analysis, budgeting etc,the classification of costs according to behaviour is
considered.
Costs are grouped as two types that is fixed and variable costs
Total fixed costs = Pure fixed costs + Fixed portion of SVC
Total Variable cost
= V.C per unit + Variable portion of SVC per unit x no of units

1.A baker has given the following information with regard to production of cakes.
Calculate unit variable cost and total variable cost and total variable cost at 1000 and
1,200 units
Costs per cake:
DM : 5
DL : 3
DE : 1
Present production :1000 cakes; b.Total fixed cost Rs 10,000 Calculate Unit fixed cost and
total fixed at 1000, and 1200 units of production
The selling price per unit is Rs 25
1.Calculate profits at various levels
2.Calculate percentage of profits

Problem 2:The expenses budgeted for production of 10,000 units in a Hotel are
furnished below. Calculate the costs for 8000 and 6000 units
• 1.Selling exps (10% fixed) 13.00
• 2.Distr exps (20% fixed) 7.00
Ans:

Variable portion:
Selling 11.70 1,17,000 11.7 93,600 11.70 70,200
(90 % var)
Distr exps
(80% var) 5.60 56,000 5.60 44,800 5.60 33,600

Fixed portion
Selling 1.30 13,000 1.62 13,000 2.17 13,000
Distr exps 1.40 14,000 1.75 14,000 2.33 14,000

• (13-11.7)x10,000 u= 1.3x10,000=13,000
• 2.Distr Exps given = Rs 7; Variable expenses is 80%.Hence VC=5.60
• Therefore fixed distr exps = (7-5.6)10,000u= 14,000

Question Bank
1. Define costs. Discuss the Classification of costs
according to function how does it differ from the
classification in elements?
2. Explain the meaning of semivariable costs,total and
unit fixed costs,total and unit variable costs costs with
at least five examples
3. Explain the three different classification of costs.
4. What are the uses of costs.
5. Explain briefly, estimated costs, standard costs, total
costs marginal costs Opportunity costs and
discretionary costs.
6. Explain briefly Discretionary costs, Budgeted costs,
Direct Costs: and indirect cost giving examples. Give 5
differences between between Cost accounting and
Financial Accounting
7. Define costs giving at least 3 examples of costs
related to food production.
8. Explain briefly, estimated costs, standard costs, total
costs marginal costs differential costs and opportunity
costs.
9. Explain the classification of costs according to
elements.
10. Explain the classification of costs into functions
11. .Explain the classification of costs into behaviour.
12. . Classification of costs according to function
13. .Explain the meaning of semivariable costs with at
least five examples.
14. .Explain the total fixed costs and unit fixed costs
with examples
15. .Explain the meaning of total variable costs and
unit variable costs with examples
16.The estimated selling and distribution expenditure for a
product is Rs 10,000 (20% fixed). Calculate the following
for 1000 units and 800 units of production
Total variable cost and total fixed cost
Unit variable cost and unit fixed cost and total fixed cost

17.The estimated administration cost for a restaurant is Rs

5,00,000(10% fixed) , with and the estimated sale of 10000
covers. What would be the variable cost per room, fixed cost
per cover and the total cost per cover. With the same cost
structure what would be the unit variable cost, unit fixed cost
and total administration cost for and estimated sales of 9000
covers,

18.The estimated number of units expected to be sold in a

restaurant is 1000. The estimated selling and distribution
expenditure is Rs 10,000(20% fixed). Find out the Unit cost.
What would be the Unit cost if the estimated sales is 800
units.

19.At the present level of production of 10000 the Semi

variable estimated at 80,000(10%) fixed. Calculate the unit
variable cost and total variable costs at 6000 units of
production.