2. Cost Concepts

8/3/2019 2. Cost Concepts

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2-1

Cost Concepts &Cost Concepts &

ClassificationClassification2


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Process of Management

Decision

MakingDirecting

ControlPlanning

Managers need cost information to

perform each of these functions.


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Cost and Cost Terminology

Costis a resource sacrificed orforgone to achieve

a specific objective.

Anactual costis the cost incurred (a historical cost)as distinguished frombudgeted costs.

A cost objectis anything for which a separatemeasurement ofcostsis desired.


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Cost and Cost Terminology

CostAccumulation

Cost Object

Cost Object

Cost Object

CostAssignment

Tracing

Allocating


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Cost Classification

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Purpose ofCost Classification

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Cost Classification by Behaviour

Cost behavior is the way a cost will respond to

changes in the level of an organizations

business activity

Fixed Cost

Variable Cost


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Total Fixed Cost

Yourmonthlybasic telephone bill isprobably fixed anddoesnot change whenyoumake more local calls.

Number of Local Calls

Monthly

Basic

Telephon

eBill

Costs that remain constant in total within therelevant range as the level ofactivity driver varies


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Total Fixed CostTwo production lines can process 10,000 computers peryear

each. The workers on each line are supervised by aproduction-line manager who i s paid Rs 24,000 per year.For production up to 10,000 units, only one supervisor isneeded. When production is between 10,001 and 20,000computers being produced, two supervisors are required.

Supervision

Computers

Processed

Unit

Cost

` 24,000 4,000 ` 6.00

24,000 8,000 3.00

24,000 10,000 2.40

48,000 12,000 4.00

48,000 16,000 3.00

48,000 20,000 2.40

Days Computers, Inc.


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2-10

1

4,000 8,000 12,000 16,000 20,000

Rs48,000

24,000

Supervision

Cost

F= Rs48,000

Fixed Cost Behavior

NumberofComputers Processed

Total Fixed Cost


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Fixed Cost Per Unit

Number of Local CallsMonthlyB

asicTelepho

ne

Billpe

rLocalCall

The fixed cost perlocal call

decreases asmore local callsare made.

Costs that ver y inversely with activity. Asvolume increases, unit cost declines.

Supervision

Computers

Processed

Unit

Cost

` 24,000 4,000 ` 6.00

24,000 8,000 3.00

24,000 10,000 2.40

48,000 12,000 4.00

48,000 16,000 3.00

48,000 20,000 2.40



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Total Variable Cost

Your total long distancetelephone bill isbased on

how manyminutesyoutalk.

Minutes Talked

TotalLong

Distance

Telepho

neBill

Costs that vary in total directly and proportionatelywith changes in the activity level.


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Total Variable Cost

A 3-inch disk drive is added to each computer at a

cost of$30 per computer. The total cost ofdiskdrivesfor each level ofproduction varies.

Total Cost of Number of Unit Cost of

Disk Drives Computers Produced Disk Drives

` 120,000 4,000 ` 30

240,000 8,000 30

360,000

12,000

30

480,000 16,000 30

600,000 20,000 30



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2-14

4,000 8,000 12,000 16,000 20,000

Rs600

120

Cost

VYV = Rs 30X

Variable Cost Behavior

(in thousands)

480

360

240

NumberofComputers Processed

Total Variable Cost


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Variable Cost Per Unit

Minutes Talked

PerMinute

TelephoneCharge

The cost perminutetalked is constant.For example, 10

paise perminute.

Costs that remain the same perunit at every level ofactivity.

Total Cost of Number of Unit Cost of

Disk Drives Computers Produced Disk Drives

` 120,000 4,000 ` 30

240,000 8,000 30

360,000 12,000 30

480,000 16,000 30

600,000 20,000 30



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Cost Behavior of Fixed & variable Costs


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Merchandisers

Cost of Goods Sold

ManufacturersDirect Material, DirectLabor, and Variable

Manufacturing Overhead

Merchandisers andManufacturers

Sales commissions andshipping costs

Service Organizations

Supplies and travel

Examples of normally variable costs

Examples of normally fixed costsMerchandisers, manufacturers, and

service organizations

Real estate taxes, Insurance, Sales salariesDepreciation, Advertising


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Whether a cost is variable orfixed with respect

to a particular activity dependson the time span.

More costs are variable with longer time spans.


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Mixed Costs

Costs comprised ofboth fixed and variablecost components

Example: Electricity costsmaybe based on afixed minimummonthly charge plus a variable

cost for each kilowatt-hrin excessofspecifiedminimumusage.

Y= Fixed cost + Total variable cost

Y=F+ VX

where

Y= Total cost


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Selling Cost

Per Unit

Mixed Costs


Fixed Cost

ofSelling

Variable Cost

ofSelling

Total Cost Computers

Sold

Rs300,000 Rs 200,000 Rs 500,000 4,000 Rs125.00

300,000 400,000 700,000 8,000 87.50

300,000 600,000 900,000 12,000 75.00

300,000 800,000 1,100,000 16,000 68.75

300,000 1,000,000 1,300,000 20,000 65.00

Mixed Costs


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Mixed Cost BehaviorCost

(in thousands)

Rs1,500

NumberofComputers Sold

Variable Costs

Fixed Cost

500

300

700

900

1,100

1,300

4,000 8,000 12,000 16,000 20,000

1Mixed Costs


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Cost Classification by Degree of Traceability

TraceabilityTraceabilityis the ability to assign a cost to a costobject in an economicallyfeasible waybymeansofa cause-and-effect relationship.

Direct costsDirect costs are those costs that canbe easilyand accurately traced to a cost object.

Example:Example: If a hospital is the cost object, the cost of

heating and cooling the hospital is a direct cost.


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C = P * Qwhere

C = cost ofinput resource

P =price perunit ofresourceQ = quantity (numberofunits) ofresource

Direct costsDirect costs Equation


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Indirect costsIndirect costs are those costs that cannot be easily and

accurately traced to a cost object.

Example:Example: The salary of a plant manager, wheredepartments within the plant are defined as the costobjects.


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Direct

Indirect

Variable Fixed



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Choice ofCost Object Example

Ifthe numberof taxisowned by a taxi company

is the cost object, annual taxi registration andlicense fees would be variable costs.

Ifmiles driven during a yearon a particular taxiis the cost object, registration and license fees

for that taxi are fixed costs.


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All Costs

Cost Classification by Function

An integral part of finished production

Sig portion of totalcost of product

Also calledmfctg ovhds

Cost of convertingmaterial into finished

product

Accumulated ininventory accounts(asset)

Expensed whensold (cost ofgoodssold)

Expensed inperiod incurred


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All Costs


Variable Cost

Generally

Variable Cost

Mixture of Fixed& Variable Cost



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All Costs


Variable Cost

Generally

Variable Cost



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All Costs


Still important (40 to60% in some plants)

Only a small portionof manufacturing cost

Proportionatelyhigher than in past


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Product Costs

MaterialsPurchases

Period Costs

Direct

Labor

FactoryOverhead

Selling andAdministrative

CostsCosts

Balance Sheet

Income Statement

Total CostFlow & Classification


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Balance Sheet

MaterialsInventory

Product Costs

MaterialsPurchases

Period Costs

Income Statement

Direct

Labor

FactoryOverhead


CostsCosts



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Work inProcessInventory

Balance Sheet

MaterialsInventory

Product Costs

MaterialsPurchases

Period Costs

Income Statement

Direct

Labor

FactoryOverhead


CostsCosts



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FinishedGoods

Inventory


Balance Sheet

MaterialsInventory

Product Costs

MaterialsPurchases

Period Costs

Income Statement

Direct

Labor

FactoryOverhead


CostsCosts

Cost ofGoodsManufactured



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Cost ofGoods Sold

FinishedGoods

Inventory


Balance Sheet

MaterialsInventory

Product Costs

MaterialsPurchases

Period Costs

Income Statement

Direct

Labor

FactoryOverhead


CostsCosts

Product costsflowthrough the

balance sheet tothe income

statement



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Cost ofGoods Sold

FinishedGoods

Inventory


Balance Sheet

MaterialsInventory

Product Costs

MaterialsPurchases

Period Costs

Income Statement

Direct

Labor

FactoryOverhead


CostsCosts

Period costsflowdirectly to the income

statement



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Manufacturing Company

MaterialsInventory

FinishedGoods

Inventory

Revenues

Cost ofGoods Sold

INCOME STATEMENT

PeriodCosts

InventoriableCosts

BALANCE SHEET

Equals Operating Income

whensalesoccur

deduct

Equals Gross Margin

deductWork inProcessInventory


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Merchandising Company

INCOME STATEMENTBALANCE SHEET

whensalesoccur

InventoriableCosts

MerchandisePurchases

Inventory

Revenues

deduct

Cost ofGoods Sold

Equals Gross Margin

deduct

PeriodCosts

Equals Operating Income


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Cost Classification by Relevance

Sunk Costs occurred in the past and cannot bealtered by any current orfuture decision.

Irrelevant for decisionmaking.

Example: Youbought an automobile that costRs12,000 twoyears ago. The Rs12,000 cost issunk

because whetheryou drive it, park it, trade it, orsell it,

you cannot change the Rs12,000 cost.


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Differential Costs the difference in a cost itemunder two decision alternatives.

Example: You can earn Rs1,500 per month in yourhometown or Rs 2,000 per month in a nearby city.

Your commuting costs are Rs 50 per month in your

hometown and Rs 300 per month to the city.

What is your differential cost?

Rs300 - Rs50 = Rs250


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Opportunity Cost the potential benefit givenupby choosing a decision alternative.

Example

Opportunity Set = {A, B, C}Alternative Benefits Opportunity Cost

A $88,000 $87,000 =Alternative BB $87,000 $88,000 =Alternative AC $86,500 $88,000 =Alternative A

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2. Cost Concepts