An introduction to

cost terms & concepts

-Week 1
Management Accounting
•  It is the application of professional skills and
knowledge in the preparation of financial and
accounting information in a manner in which it
will assist the internal management in the
formulation of policies, planning, and control
of the operations of the firm.
• The basic function of management accounting
is to help the management make decisions.
Classification of Costs
1. General Cost Classifications
2. Cost Classification based on Behaviour
3. Cost Classification for Decision Making
4. Cost Classification for Assigning Cost to Cost
objects
5. Cost Classification on Financial Statements
General Cost Classification
1. Manufacturing Costs(Product Costs)
i) Direct Material
ii) Direct Labour
iii) Direct Expenses
iv) Manufacturing / Factory Overhead
2. Non Manufacturing Costs( Period Costs)
i) Marketing or selling costs
ii) Administrative costs
Costs Based on Behaviour
Cost behavior means how a cost will react to
changes in the level of business activity.
– Total variable costs change when activity changes.
– Total fixed costs remain unchanged when activity changes.

Variable Fixed Mixed

Total Variable Cost Example
Your total cable pay-per-view bill is based on how
many movies you watch.
Total Pay-Per-View Bill

Pay-Per-View
Movies Watched
Variable Cost Per Unit Example

The cost per movie watched is constant. For

example, £4.00 per movie.

Per Movie Charge

Movies Watched
Total Fixed Cost Example
Your monthly cable bill probably does not change when
you watch movies on channels that you have elected to
be paid on a monthly basis (HBO).
Monthly Charge for HBO
Bill

Number of HBO Movies

Watched
Fixed Cost Per Unit Example

The average cost per HBO movie decreases as

more HBO movies are watched.

Monthly HBO Bill per Movie

Watched

Number of HBO Movies

Watched
MIXED
• Semi- Variable Costs: • Semi-Fixed Costs:
• Example: Office space is
• Example: Telephone
available at a rental rate
charges, where there is a of £30,000 per year in
fixed rental charges and increments of 1,000
over that the bill depends square feet. As the
upon the number of calls business grows more
made. space is rented,
increasing the total cost.
 Quiz QUIZ!!!
True or False

1. The total variable cost remains fixed.

False, The total variable cost increases with volume.
2. The variable cost per unit remains fixed.
True, the variable cost per unit remains fixed.
3. The total fixed costs remains fixed.
True, the total fixed costs remains fixed.
4. The fixed cost per unit remains fixed.
False, the fixed cost p.u. decreases with increased volume.
On The Basis Of Managerial Decision Making

1. PERIOD & PRODUCT COSTS

1. OPPORTUNITY COSTS
2. SUNK COSTS
2. MARGINAL COSTS
3. OUT OF POCKET COSTS
3. REPLACEMENT COSTS
4. AVOIDABLE & UNAVOIDABLE COSTS
5. RELEVANT AND IRRELEVANT COSTS
6. DIFFERENTIAL COSTS
Period and Product costs
• Product Cost: Product cost consists only direct
materials, direct labor and factory overheads whether
fixed or variable. i.e. the cost which has been incurred
on the production of product

• Period cost: costs which are associated with the

period for which they have been incurred. These costs
can not become the part of inventory. Office and
selling costs are period costs.
Opportunity Cost
The potential benefit that is given up when one
alternative is selected over another.
­ Example: If you were
not attending college,
you could be earning
Rs20,000 per year.
Your opportunity cost
of attending college for one year is rs20,000.
Sunk Costs

All costs incurred in the past that cannot be changed

by any decision made now or in the future are sunk
costs. Sunk costs should not be considered in
decisions.
– Example: You bought an automobile that cost
120,000 two years ago. The 120,000 cost is sunk
because whether you drive it, park it, trade it, or sell
it, you cannot change the 120,000 cost.
Differential Costs
• If there is a change in costs due to change in
the level of activity or method of production
they are known as differential costs.
• If the change increases the cost, it will be
called incremental cost and if the change
results in the decrease in cost it is known as
decremental cost.
OUT OF POCKET COSTS & REPLACEMENT COSTS

• Out of Pocket Expenses

• Out of pocket expenses are such expenses for which there is
an immediate actual cash outflow. E.g. Purchase of raw
material, payment of electricity bill etc.

Book Costs
• Which do not requires cash payment like depreciation.

Replacement Costs
Costs that would be incurred to replace the asset at market rate.
Avoidable and unavoidable costs
• Cost which can be eliminated by discontinuing any
product or department like cost of raw material.
On other hand if a cost can not be eliminated even
after discontinuation of any product or department
is called unavoidable cost. Like factory rent.
Avoidable costs are those costs that can be saved by
not adopting a given alternative, whereas
unavoidable costs cannot be saved.
Relevant & Irrelevant Costs

• Relevant costs are the costs which play an

important role in the decision making process.
• Irrelevant costs are usually the sunk costs and
the uncontrollable costs.
• Normally all fixed cost are termed as
Irrelevant and Variable as Relevant.
Cost Classification for Assigning cost to cost
objects
1. Direct Cost :- A cost that can be easily and
conveniently traced to particular cost
object under consideration.

2. Indirect Cost:- A cost that cannot be easily

and conveniently traced to particular cost
object under consideration.
COST SHEET
COST SHEET
 
DIRECT MATERIAL
DIRECT LABOUR
DIRECT EXPENSES
 

PRIME COST
ADD
FACTORY OVERHEADS
 
FACTORY COST OR WORKS COST
ADD
OFFICE OVERHEADS
 
COST OF PRODUCTION OR COST OF GOODS SOLD
ADD
SELLING & DISTRIBUTION OVERHEADS
 

COST OF SALES
PROFIT
 

SALES
PROBLEM on COST SHEET
• The following expenses were incurred for the job during the year ended 31 st
December 2011.
• Direct Material 5,000
• Direct Wages 3,000
• Chargeable expenses 2,000
• Factory Overheads 3,000
• Administrative Overheads 4,000
• Selling & Distribution Overhead 3,000
• Selling price for the job was Rs. 25000. You are required to prepare a statement
showing the profit for the year from the job and an estimated price of a job,
which is to be executed in the year 2012. Material, wages and chargeable
expenses will be Rs.8,000 Rs.10,000 and Rs.2000 respectively for the job. The
various overheads will be received on the following basis while calculating the
estimated price.
a. Factory overheads as a percentage of direct wages.
b. Administration and selling & distribution overheads as percentage of factory cost.
c. Profit as a % of costs.
PROBLEM on COST SHEET
• In respect of a company the following particulars have been extracted for the year
2011.
• Cost of Materials 6,00,000
• Wages 5,00,000
• Factory Overheads 3,00,000
• Administration 3,36,000
• Selling Charges 2,24,000
• Distribution Charges 1,40,000
• Profit 4,20,000
• A work order has to be executed in 2012 and the estimated expenses are Materials
Rs.8000; Wages Rs.5000
• Factory overheads are based on wages and administration selling and distribution
overheads on factory cost. Assuming that in 2012 the rate of factory overheads has
gone up by 20%, distribution charges have gone down by 10% selling and
administration charges have gone each up by 15%, at what price should the
product be sold so as the same rate of profit on the selling price as in 2011.