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2-1

Cost Accounting and Cost Concepts

Lecture by :
Hosne Jahan
BUET

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Cost Classification from Manufacturing

Point of View
A.Manufacturing Cost
B.Non-Manufacturing Cost

Identify and give examples of

manufacturing cost & non-
manufacturing cost categories.

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A. Classifications of Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product

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Direct Materials
Raw materials that become an The materials that go
into the final product are
integral part of the product and called raw materials.
that can be physically and
conveniently traced directly to
it. This cost can be identifiable
to a cost unit easily.

Examples:
• A radio installed in an automobile
• Four wheels installed in an automobile

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Direct Labor/Wages
Those labor costs that can be easily
identifiable and traceable to individual Labor cost is the
cost unit of a product. It is called as remuneration of the
touch labor. Direct labor workers workers.
typically touch the product where it is
being made.

Example: Wages paid to automobile assembly workers

Examples for other organization: Carpenter, machine operator, productive workers etc.

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Manufacturing Overhead
Manufacturing costs that cannot be easily
identifiable and traceable directly to specific unit of a product.
(Overhead means all the indirect costs)
Examples: Indirect materials and indirect labor

Materials used to support the
production process and cannot be
easily identifiable to a cost unit.
Examples: lubricants and cleaning
supplies used in the automobile
assembly plant.
Other Examples: cost of glue used in a
lather bag or shoe, thread used in a bag
etc.
Wages paid to workers who are not
directly involved in production work
and cannot be easily identifiable to
a cost unit.
Examples: wages of maintenance
workers, janitors/cleaners, and
security guards, lift operators,
material handlers etc.

Other Examples of Manufacturing Overheads:

Factory rent, supervisor’s salary, repairing cost on the production equipment, utilities
(elect. Gas, heat light, water bill), phone bill, transportation cost, property taxes,
depreciation, insurance on manufacturing facilities etc. All other costs occurring in
the production process.

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B. Non-manufacturing Costs
Marketing/Selling
and distribution Administrative
Costs Costs

All costs necessary to secure All executive,

the customer’s orders and
deliver the product or services
to the customers
Examples: Order receiving and order filing
cost, advertisement, shipping and
transportation cost, rent for the showroom,
wages of cleaners, guard, lift operator of the
showroom, utilities (elect. gas, heat light,
water bill), phone bill, transportation cost,
salesman salary and commission etc.
organizational, and clerical
costs associated with
general management.
Examples: Salaries of executives,
officers, accountants, support staffs, rent
for the office, wages of cleaners, guard,
lift operator of the office. utilities (elect.
gas, heat light, water bill), transportation
cost, phone bill, public relation related
cost etc.

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* Non-manufacturing Costs

Marketing/selling & Distribution cost and Administrative cost are

completely indirect cost in nature, because they cannot be easily
traceable or identifiable to a cost unit of a product.

That is why these costs are called as overhead cost, namely

Marketing/selling & Distribution Overhead
and
Administrative overhead.

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Product costs and period costs

Distinguish between product costs and

period costs and give examples of each.

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Product Costs Versus Period Costs

Product Cost Period cost
All other costs that are not included in
Cost of producing or acquiring a the Product costs
product
Product costs include direct materials, direct labor, Period costs include all selling costs and
and manufacturing overhead. administrative costs. These are treated
For example: as expenses in the period in which they
Units Produced= 10,000 units
Units Sold (Cost of goods sold) = 8,000 units
are incurred.
Units at hand (Inventory) = 2000 units

Inventory Cost of Goods Sold

(2000 units) (8000 unit)
Expense

Balance Income
Sheet Statement Income
(As asset) (As expenses)
Statement

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Manufacturing costs are often

classified as follows:
Direct Direct Manufacturing
Material Labor Overhead

Prime Conversion
Cost Cost

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Cost classification for predicting cost

behaviour

Understand cost
behavior patterns
including variable costs,
fixed costs, and mixed
costs.

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Cost Classifications for Predicting Cost Behavior

Cost behavior means how a cost will react to the
changes in the level of business activity.
Different organization may have different types of business activity.
• In manufacturing organizations – unit produced,
• in hospital – number of bed or patient,
• in transportation organization – mile driven etc.
Nature of cost behaviour:
With the increase or decrease in the level of activity some cost will
increase or decrease directly, some cost will remain unaffected while
others will change but not in direct proportion to the changes in the
level of activity. On the basis of these cost behavior, cost can be
classified as :
• Variable cost
• Fixed cost and
• Mixed cost

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Variable Cost
Which have a tendency to vary in total in direct
proportion to the change in the level of activity.
Example: Direct Materials, Direct Labour ( which can be
easily identifiable to a cost unit). Other cost which vary in
total in direct proportion but cannot be easily identifiable
to a cost unit.
Example: cost of glue etc.
Y
cost

Characteristics of Variable cost:

• Variable cost vary in total in direct proportion

X • Per unit variable cost remains constant

O Level of activity • (other cost remaining the same)

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Fixed Cost
That remains constant in total regardless of changes in
the level of activity. Fixed costs are not affected by the
changes in the level of activity.
(Within the given level of time and activities, these costs
will normally remain fixed.)
Example: Rent, Property taxes, Supervisor salary, depreciation etc.

Y
Characteristics of Fixed cost:
Cost

Fixed cost line

• Remain fixed in total
• Per unit fixed cost vary with
the change in activity – with
the increase in level of activity
O per unit fixed cost decreases
Level of activity X
and vice versa.

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Characteristics of Variable Cost and Fixed Cost

at a Glance

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Mixed Costs
(also called semivariable costs)
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost like
Y telephone bill, electricity bill etc.
Cost

Variable
Cost

X Fixed Cost
Activity

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Linear cost equation to predict total mixed

cost at different level of activity

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Mixed Costs – An Example

If your fixed monthly utility charge is Tk. 40, your
variable cost is Tk. 0.03 per hour, and your monthly
activity level is 2,000 hours, what is the amount of
your utility bill?

Y = a + bX
Y = Tk. 40 + (Tk0.03 ×2000)
2,000)
Y = Tk.100
This cost equation can also be applied to predict the total cost of production
at different level of activity.

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Determination of Fixed Cost and Variable Cost Elements

from a mixed cost for the preparation of linear cost
equation by using the high and low point method:

According to the high and low point method:

Cost Difference
Variable cost per unit =
Activity Difference

Fixed cost in total = Total cost – Total variable cost

= TC – VC per unit x level of activity

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The High-Low Point Method: Example

The variable cost

per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.

$2,400
= $6.00/hour
400

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The High-Low Method – An Example

Total Fixed Cost = Total Cost – Total Variable Cost

Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
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The High-Low Method – An Example

You can get
the same
result with
any other
level of
activity also.
Here is the
example.

Total Fixed Cost = Total Cost – Total Variable Cost

Total Fixed Cost = $7,400 – ($6/hour × 450 hours)
Total Fixed Cost = $7,400 – $2,700
Total Fixed Cost = $4,700
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The Linear Cost Equation for Maintenance

Y = $4,700 + $6.00X

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