Costing

introduction

 COST
‒ measurement of the use of business resources in order to produce its
output

 Determining all the costs and all the components is a key to

any company’s success
− one missing item or miscalculation from the cost sheet could lead to
the loss of a season’s profit

− and if not realized in time could ultimately lead to the failure of a

company

16-2
Cont.d

 Costing is the technique and process of ascertaining

costs
− It is the process for estimating the total resource investment
required to merchandise, produce, and market a product

− Product costs accumulate from all functional divisions of a

company – R&D, marketing, production, engineering,
finance, purchasing etc

− It is the total amount of money invested in a product

16-3
Cont.d
 Price of a product is the amount of money asked
/received in ex-change for a product
− The difference between the price and the cost of a
product is profit or loss on that product

− It is, revenue minus costs equals profit or loss

− Revenue is the total of all receipts from the sale of the

firm's products during a stated time period

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Cont.d

 Pricing is the process of determining the exchange value

of goods that are made available for sale based on:
− the data produced in the costing process

− the value customers place on the product, and

− the competition in the market

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Cont.d

 Costs, Prices & profits

 All manufacturing companies sell their products to make profit

 Therefore, a product must:

‒ satisfy design specification

‒ be built within pre-set cost criteria

‒ and generate reasonable profit

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Cont.d

 Relationship between cost, price, and profit

‒ Manufacturing costs + Operating expenses + Profit =
Manufacturer's price

MC + OE + P = MP

‒ Manufacturer's price = Retailer's cost

MP = RC

‒ Retailer's cost + Operating expense + Profit = Retailer's price

RC + OE + P = RP

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 Elements of costs

Direct Direct
labour expenses

Factory Office Selling & distributive

overheads overheads overheads

Indirect Indirect Indirect

material labour expenses
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Cont.d
 Material cost
− It is the cost of the substance from which the product is made

− It may be in a raw or a manufactured state

− It can be direct as well as indirect

a) Direct Material – mostly termed as raw material

− Direct material refers to all materials which becomes an integral
part of the finished product and which can be conveniently
assigned to specific physical unit

16-9
Cont.d

 Examples
− All materials specifically purchased, produced or
requisitioned from stores

− Primary packing material (e.g. cartoon, wrapping,

cardboard, boxes etc.)

− Purchased or partly produced components

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Cont.d
b) Indirect Material
− All materials used for purposes ancillary to the business and can’t
be conveniently assigned to specific physical units

− Examples: Consumable stores, oil and waste, printing and

stationery etc

− Indirect material may be used in the factory, the office or the

selling and distribution division

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Cont.d
 Labor cost
− Human effort needed for conversion of materials into finished
goods

− Labor can be direct as well as indirect

a) Direct Labor
− takes an active and direct part in the production of a particular
commodity

− conveniently traceable to specific products eg. Salary of Design

engineer

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Cont.d
b) Indirect Labor
− Labor employed for the purpose of carrying out tasks incidental to
goods or services provided

− does not alter the construction composition or condition of the

product

− It cannot be practically traced to specific units of output

− Examples: Wages of store-keepers, foremen, time-keepers,

directors' fees, salaries of salesmen

− Indirect labor may relate to the factory, the office or the selling
and distribution divisions

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Cont.d
 Expenses - may be direct or indirect
a) Direct Expenses: are expenses which can be directly, conveniently and wholly
allocated to specific cost centers or cost units

 Examples:

− hire or purchase some special machinery required for a particular contract,

− cost of defective work incurred in connection with a particular job or

contract etc

− Also called Directly chargeable expenses

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Cont.d
b) Indirect Expenses
− These are expenses which cannot be directly, conveniently and wholly
allocated to cost centers or cost units

− It is part of an overhead cost

 Overheads
• Overhead costs: costs incurred but which are not directly related to
the production process

• cost of indirect material + indirect labor + indirect expenses

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Cont.d

 Indirect expenses include:

a) Manufacturing (works, factory or production) Expenses

− Expenses incurred in the factory for running the factory or plant

− Expenses related to production management and administration

Examples:
‒ Rent, rates and insurance of factory buildings

‒ power used in factory building, plant and machinery, etc.

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Cont.d

b) Office and Administrative Expenses

− they are related to the management and administration of business

− Expenses incurred on the direction and control of an undertaking

business

Examples are:
‒ Office rent
‒ lighting and heating
‒ postage and telegrams
‒ telephones and other charges
‒ depreciation of office building, furniture and equipment
‒ bank charges, legal charges, audit fee etc

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Cont.d
c) Selling and Distribution Expenses
Expenses incurred for:
‒ marketing of a commodity
‒ securing orders for the articles
‒ dispatching goods sold
‒ and for making efforts to find and retain customers
Examples are:
‒ Advertisement expenses
‒ cost of preparing tenders
‒ travelling expenses, bad debts, collection charges etc.
‒ warehouse charges, packing and loading charges, carriage outwards,
etc.

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Components of Total cost
 Prime cost (basic, first or flat cost)
• costs of direct material + direct labor + direct expenses

• Factory cost (works, production or manufacturing cost)

• prime cost + factory overheads

 Total cost of production

• Production cost + office and administrative overheads

 Total cost of sales

• total cost of production + Selling and distribution overheads

16-19
Cont.d
‒ Materials Consumed = Opening Stock + Purchases – Closing Stock

‒ Factory Cost = Gross Factory Cost/mng cost + Opening WIP –

Closing WIP

‒ Cost of Goods Sold = Total Cost of Production+ Opening Stock of

FGs/cgs – Closing Stock of FGs

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Thank you!