NATURE OF COST & COST CLASSIFICATION

PROFESSOR WILLIAM COFFIE

HEAD OF DEPARTMENT OF ACCOUNTING
EMAIL: wcoffie@ug.edu.gh
ROOMS G4 & G8

Prof. William Coffie Slide 1

 Session Overview

Lesson Objectives:
By the end of this session you should be able to:
• Distinguish between private sector organizations and public
sector organizations.
• Identify factors that inhibit profit maximization of businesses.
• Explain management information system within a business
setting.
• Nature of cost and cost classification.
• Elements of cost for various purposes.

Prof. William Coffie Slide 2

 Reading List
• S. Andoh-Kwofie, Cost and Management Accounting. Gpak
Publishing House, Accra. Chapter 1 (pages 1-17)
• W. Coffie, Cost & Management Accounting Questions
&Answers Bank, DigiBooks, Tema
• D. Hansen & M. Mowen, Management Accounting,(8th
Edition), South-Western College Publishing, USA

Prof. William Coffie Slide 3

Overview of Business Organizations
There are two types of Organizations namely:
• Private Sector (Business) Organizations and
• Public Sector (Governmental Organizations)

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  BUSINESS GOVERNMENTAL
Ownership It is owned by individuals or equity owners It is owned by the State. No individual can claim
ownership.
Establishment It is established by Registration with the Registrar General It is established by an Act of Parliament.
Department.
Motive It has a profit motive Non-profit in motive
Funding It is funded by the contributions made by owners known It is funded from the Public Fund (Article 175 of
differently as sole proprietors, partners and shareholders 1992 Constitution)
(i) Consolidated Fund
(ii) Contingency Fund
(iii) Any other Fund established by Act of the
Parliament.

Regulatory Frame work It is regulated by: It is regulated by:

(i) Business Registration Act (i) Constitution
(ii) Incorporated Private Partnership Act 1962, Act 152 (ii) Financial Administration Act (Act 654) &
(iii) Company Code 1963 Act 179 Legislative Instrument 1802.
(iv) Any Act, Legislation, Statutes established specifically (iii) Internal Audit Agency Act 658
for the industry it operates e.g. Banking Act, Insurance (iv) Public Procurement Act 663
Act etc. (v) Periodic Directories from the Government.
Slide 5
Performance Evaluation It is evaluated for Performance, Financial It is evaluated for VFM
Criteria Statues and Investment Potential. (i) Efficiency
(ii) Effectiveness
(iii) Economy and

Form It is takes the form of It takes the form

(a) Sole Proprietorship
(b) Partnership
(c) Limited Liability Companies
(i) Ministries, Departments and Agencies
MDA)
(ii) Metropolitan, Municipal and District
Assemblies (MMDA).
(iii) Public Boards and Corporation
(iv) Educational and Research
Institutions

Slide 6
 Business Organizations are sub-divided by virtue of what they engage in:

a) Production Organization – involve in production of physical goods. They could be found in:
I. Extractive Industries – engaged in extractions or exploiting of Natural Resources e.g. Timber, Quarry, Oil
and Gas, Farming and Fishing etc.

II. Manufacturing Industries – engaged in converting raw materials into finished goods.

b) Commercial Organization – they buy and sell finished goods.

c) Service Organization – they neither produce nor buy and sell finished goods but render
services to other industries. They are aids to Production and Commerce e.g. Banking,
Insurance, Transportation, Hospitality etc.

Prof. William Coffie Slide 7

 Inhibiting factors to profit maximization
• In all of these, they are set up primarily to make profit to
increase or maximize the wealth of the owners (sole
proprietors, partnership, shareholders) etc.
• The owners’ wealth are increased by providing them with
adequate return on (dividend) etc. and of (increase in share
price) investment.
• There are however certain factors that can inhibit or constrain
a business organization to make unlimited or adequate profit to
maximize the wealth of the owners. These factors are:

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 Inhibiting factors to profit maximization

Non Controllable Factors Controllable Factors

Political External – competitors
Economic - Customers
Social Internal – corporate governance
Technological - Capacities and capabilities
- Costs

Prof. William Coffie Slide 9

 • The foregoing means business
organizations have six (6) main concerns
that they seek to address on daily basis.
These have come to be known as 6cs of
management which are:

Prof. William Coffie Slide 10

 Capital Providers – adequate returns

Competitors – better and good practices

Customers – quality products at affordable
prices
Corporate governance – good management
team
Capacities and Capabilities – constant
improvement
Costs – effective and efficient in their operations
Prof. William Coffie Slide 11
 • To achieve these objectives, management must undertake
certain activities which include:
Sales,
Production,
Procurement,
Recruitment and Training,
Research and Developing.
The organization consumes resources which has come to
be known as the 4m’s (men, money, machine, materials)
when undertaking these activities. These resources must be
managed (i.e. their use must be planned and controlled).

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 • To effectively manage these resources, when
undertaking activities towards the attainment
of the objectives to address the concern of the
6c’s, management needs information.
Information is powerful and it reduces risk

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 • To obtain information therefore management puts in
place a system that will gather this information. This
system is called Management Information System.
It consist of people, equipment, procedures that are
used to gather, sort, evaluate, distribute, timely,
complete, needed and accurate information to users
for informed or right decisions.

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 • Accounting system is part of management
information system just like Production, Marketing,
Procurement system etc.
Accounting as part of information system
therefore basically is to provide information for
users for informed and right decisions.

Prof. William Coffie Slide 15

 Cost Accounting as part of the Accounting System

a) Importance of cost

Cost is the aggregate monetary value of the resources that

are used up or sacrificed or consumed in the process of
producing the product (goods and services).

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 Importance of cost
Cost is used to determine the selling price (revenue) of products (goods, services

and work).

Profitability, which remains the cardinal aim of every organization is

determined by Revenue – Cost = Profit. Revenue in the equation has two

variables which are Quantity demanded and Price. These two variables are

exogenous to the organization. i.e. (Q x P = Revenue)

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 Importance of cost
• Note that quantity demanded of a product is of a function (fx) (income,
taste, preference, degree of substitution etc). These are outside the
control of the organization.
• The determination of price as part of the equation; Further apart from
cost is competitor’s reaction and consumers affordability or acceptance.
• Therefore the only variable controllable by the organization as the profit
equation is Cost.

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 Importance of cost
Michael Porter, a strategic writer postulated that in this business environment of
global competition, shorter product lifecycles and discerning customers, Porter
says that for organizations to survive, they must adopt three generic strategies.

These are:
(i) over all cost leadership

(ii) differentiation and

(iii) focus

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 DEFINITION OF COSTING TERMS

•In view of the importance of cost which we have defined as the

aggregate monetary value of all resources that were sacrificed or used up
in producing the product (goods and services), organizations must put in
place a sub accounting system that will generate cost information
(product cost) for management.

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 DEFINITION OF COSTING TERMS

• The process of determining the cost of the product i.e.

accumulation and assignment of cost is costing.
• The product (goods and services) for which cost is
being determined is called Cost object or Cost unit.
• The place, department or activity for which cost is
accumulated and assigned or charged to cost object is
known as the Cost Center.
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DEFINITION OF COSTING TERMS

Industry sector Cost unit

Brick-making 1000 bricks

Electricity Kilowatt-hour

Professional services Chargeable hour

Education Enrolled student

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DEFINITION OF COSTING TERMS

Type of cost center Examples

Service location Stores, canteen

Function Sales representative

Activity Quality control

Item of equipment Packing machine

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Cost accounting as a sub system provides cost information to both Financial
Accounting and Management Accounting.

a) To Financial accounting, it provides product information for

stock valuation for the determinations of income or profit.
b) To Management accounting, it provides information for
(i) Planning e.g. budgeting
(ii) control e.g. standard costing
(iii) decision making e.g. make or buy, discontinuation, further
processing decisions etc.

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 Relationship between Cost Accounting Financial and
Management Accounting

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 CLASSIFICATION OF COST

Behavior of cost in
Time when
relation to fluctuation Management
computed. (Time in activity level (Cost
Degree of averaging
Function
Period) Behavior).

Manufacturin
Historical Variable cost Total cost
g costs
Cost
Fixed cost Unit cost Selling costs
Budgeted or
predetermin Semi- variable Administrative
ed Cost Average Cost
(mixed) cost cost

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 CLASSIFICATION OF COST
Time of charging cost
Extent of controllability
Ease of traceability of against revenue
by management Decision Significance
cost to product (Accounting
(Managerial Control).
Treatment).

Relevant Costs
Direct costs Product cost Controllable
Irrelevant Cost

Sunk Cost
Uncontrollabl
Indirect cost Period cost
e Opportunity Cost

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 ELEMENTS OF COST
The Cost component of a product to an organisation depends upon
the use for which the product is to be put in the organisation. A
product could be
(a) procured for its final use e.g. stationary, lubricant.
(b) Procured for resale.
(c) manufactured by converting raw materials procured to finished
goods.
(d) procured to facilitate or used in furthering the activities of the
organization e.g. Capital items like Plants, Vehicles
Prof. William Coffie Slide 28
 Cost of a Product for final use
•The Total Cost is the Cost of Purchase price plus all expenditure
incidental to or Cost of Purchase necessary in bringing the product to
use.
• The cost components of Cost of Purchase are Pre-Acquisition,
Acquisition and Post Acquisition Cost.

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 (a) Pre-Acquisition Cost
(i) Preliminary Cost e.g. preparation of requisition, vendor selection
(tendering) negotiation etc xxxx
(ii) Placement cost e.g. order placement, stationary, postage xxxx
(iii) Post placement cost e.g. accounting, expediting (progressing) etc. xxxx xxxx
(b) Acquisition Cost
(i) Price (Invoice, FOB, CIF) less any rebate, discount etc xxxx
(ii) Import duties, levies, taxes etc xxxx
(iii) Other directly attributable cost e.g. containers xxxx xxxx
(c) Post Acquisition Cost
(i) Handling Expenses (Inspection, stocking etc) xxxx
(ii) Transportation xxxx
xxxx
Cost of Purchase xxxx

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 • The incidental expenditure to bring the goods to a
usable point are the General and Administrative
Expenses e.g. Holding Cost like Rent, Security
Expenses, Salaries and Wages, Stocking etc.
Total Cost is therefore:
(a) Cost of Purchase xxxx
(b) Add General & Administrative Expenses xxxx
Total Cost xxxx

Prof. William Coffie Slide 31

 Cost of Goods for Resale
The Total Cost is the Cost of Purchase plus all incidental expenditure necessary
to bring the goods to a saleable point or condition.
(a) The Cost of Purchase is as detailed above.
(b) The incidental expenditure to bring the goods to saleable point are:
(i) General and Administrative Expenses e.g. Holding Cost like Rent of
warehouse, Security Expenses, Salaries and Wages etc.
(ii) Selling and Distribution Expenses like Advertising and Publicity, Sales
commission, Distribution etc.

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 Total Cost is therefore:
Cost of Purchase xxxx
Add: General & administrative Expenses xxxx
Selling and Distribution xxxx
Total Cost xxxx

To determine Selling Price, profit is added i.e.

Total Cost xxxx
Add: Profit xxxx
Selling Price xxxx

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 Cost of a Manufactured Product
• The Total cost of a manufactured product is the “cost of
Purchase of the Raw material to be used in producing
the product as in (a) above Plus cost of conversion as
are appropriate to that location or condition”. Other
incidental expenses may have to be incurred.
• Cost of Purchase is as detailed above.

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 Cost of Conversion

A/. Cost of Conversion is the cost of converting the raw material into finished products.
The details are:
(i) Direct Labour xxx
(ii) Direct Expenses (Royalties, Copy right) xxx
(iii) Production Overheads
(a) Indirect Materials (Lubricants) xxx
(b) Indirect Labour (Supervisor’s Salary) xxx
(c) Indirect Expenses (Utilities, depreciation, Rent) xxx xxxx
(iv) Other attributable Overheads (in bringing
product or Service to its present location xxxx
Cost of Conversion xxxx

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 While the manufactured goods are awaiting to
be sold or despatched. Certain incidental
expenses have to be incurred e.g. warehouse
These are General and Administrative
Expenses.
Selling and Administrative Expenses are all
incurred when manufactured goods are being
sold.

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 (i) The foregoing means the Total Cost of a manufactured product becomes:
Cost of Purchase xxxx
Cost of Conversion xxxx
Cost of Production xxxx
Add: (i) General and administrative Expenses xxxx
(ii) Selling and Distribution xxxx
Total Cost of Production xxxx
Add Profit xxxx
Selling Price xxxx
Prof. William Coffie Slide 37
 Diagrammatically the Total Cost of a manufactured
Product is:

Prof. William Coffie Slide 38

 SUMMARY

In this Session, you have learned:

• The difference between private sector organizations and
public sector organizations.
• The factors that inhibit profit maximization of businesses.
• About the management information system within a
business setting.
• About cost classification.
• The elements of cost for various purposes

Prof. William Coffie Slide 39