Chapter 2

Calculating unit costs (Part 1)

Phuong Thao NGUYEN

NEU - SAA
 Identifying direct and indirect
costs for cost units

Chapter 2 Inventory valuation

For the purpose of chapter 2 and 3: the cost object is a cost unit
Identifying direct and
indirect costs for cost 1
units
 Direct and indirect costs

Direct material
Prime
Direct wages/ labour cost
cost
Direct expenses

Indirect Costs
Infographics
1.1. Direct material cost

All material becoming part of the cost unit

(unless negligible amount/cost)
Component parts overhead
Or
purchased for a particular product, service, job….
Infographics

Primary packing materials

(cartons/ boxes)
Infographics
 1.2. Direct wages/ labour cost

Basic hours
All wages paid for labour
Overtime

Can be identified with cost unit:

Alter the condition, conformation or composition of the product
Specifically required for such production
Infographics
 1.2. Direct wages/ labour cost
NOTEs

Overtime:
- Basic pay: treated as direct labour (can be traced to specific
cost unit)
- Premium: treated as overhead (unless for a specific cost unit)

Idle time: treated as overhead

 1.3. Direct expenses

Any expenses that incurred on a specific cost unit other than

direct material cost and direct wages

Examples:

Designs/ drawings/ layouts

Particular job
Hire of tools/ equipment

Infographics
 1.4. Indirect costs
Costs that cannot be traced in full to a specific cost unit

Rent

Insurance

Depreciation
Infographics
 Example
Garage service:

Direct material cost:

Replacement parts used

Direct labour cost:

Wages paid to the mechanics

Indirect costs:
Rent, building insurance,
Infographics depreciation…
Inf
 NOTES

• Direct costs are not necessarily bigger in size than indirect costs
• Indirect costs are not less important than direct cost

• Direct costs Often variable

Maybe fixed

• Indirect costs Maybe variable => variable overheads

Maybe fixed
Infographics
 example
Identify direct/ indirect costs of a particular car repair in a garage

The salary of the garage’s accountant An overtime premium paid to the

The cost of heating the garage
A can of engine oil used in the repair
A smear of grease used in the repair
mechanic carrying out the repair
An idle time payment made to the
mechanic while waiting for a delivery of
parts for a number of jobs
The wages of the supervisor overseeing
the mechanic carrying out the repair
Inventory valuation 2
 Inventory valuation
Charging units of inventory to cost of production or cost of sales
FIFO
Infographics
Pricing LIFO
methods
Cumulative
AVCO
Infographics

Periodic
 2.1. FIFO
Logical method
represents what is physically happening
Advantages Easy: understand & explain
Inventory value: near to replacement cost
Cumbersome
need to identify each batch separately
Difficult: compare costs & make decision
Disadvantages
(variation in price)
High inflation:
issue prices => lag behind current market value
 2.2. LIFO
Inventory issue: Close to current market value
Advantages
Managers => aware of
Recent cost
Cumbersome
- need to identify each batch separately
- several batches: only part-used
Disadvantages Difficult: compare costs (variation in price)
Difficult: explain to managers
(often opposite of what is physically happening)
 2.3. Cumulative AVCO

Easier to make decision

Advantages Smooth out fluctuations in prices
Easier to administer
No need to identify each batch separately

Resulting issue price

- rarely an actual paid price
Disadvantages - run to several decimal places
Gradual inflation:
Issue price: lag behind current market value
 2.4. Periodic AVCO

Single average:
Calculated at the end of period

Unless stated to the contrary, assume the cumulative method is

required in an exam question
 2.5. Inventory valuation and profitability

FIFO
LIFO Different profit - temporary
AVCO

Inequalities even out – long run