Cost Slide 03

8/6/2019 Cost Slide 03

1/29

Classification of costClassification of cost

The cost of a product can be classified as follows:Elements of a productRelationship to production

Relationship to volumeAbility to traceAccording to departmentAccording to periodAccording to functionFor managerial decision making


2/29

A. Elements of a product: A. Elements of a product:

Material cost: Cost incurred for transforming raw materials to finishedproducts .

Example:Timber for making a furnitureMaterial cost can be classified into two

types: Direct material cost: Cost of materialsthat can be identified with production


3/29

Indirect material cost: Cost of materials thatcannot be directly identified with production .

L abor cost: L abor cost is the cost of physical or mental efforts given in the production of anyproduct . L abor cost is of two types:

Direct labor cost: Cost of labor that can beidentified with production .

Indirect labor cost: Cost of labor that cannot bedirectly identified with production .


4/29

F actory overhead cost: Indirect material,indirect labor and other indirect costswhich all together form factory overhead . F actory overhead costs are costs thatcannot be identified with productiondirectly .

Example:Cost of supervision in a factory, factory rentetc .


5/29

B . Relationship to production:B . Relationship to production:

A ccording to relationship to production,costs can be classified into broad

categories:Prime cost: Directly relates withproduction .

Prime cost = Direct material + Direct labor Conversion cost: Costs incurred to

transform materials to finished products .


6/29

Conversion cost = Direct labor + F actoryoverhead


7/29

C . Relationship to volume:C . Relationship to volume:

There are four types of costs according tovolume:

Variable costs: Costs which change withthe change in volume, activity or outputwithin the relevant range .

Example:Mobile call, electricity bill etc


8/29

S pecial features of vc: Total variable cost is variable Unit variable cost is fixed

F ixed cost: Costs which remains fixed or constant over the period within a relevant range .

Example:F actory rent, salary to workers etc


9/29

S pecial features of fc: Total fixed cost is fixed Unit fixed cost is variable

S emi-variable cost: S emi-variable cost isnothing but the combination of variable and fixedcosts .

Example:Mobile bill standard line, equipment service


10/29

S tep cost: A step cost is similar to fixedcost within a very small relevant range . S uch costs are constant for a given levelof output and then increases by a fixedamount at a higher level of output .

Example:

S upervisors salaryS emi-variable and step costs are also

known as mixed costs .


11/29

D. A bility to trace:D. A bility to trace:

There are two types of costs based ontraceability:

Direct cost: Costs which can be directlytraceable to production, specific product or department .

Indirect cost: Costs which cannot bedirectly traceable to production, specificproduct or department .


12/29

E . A ccording to department:E . A ccording to department:

Costs can be classified department-wise asfollows:Production department: Costs which are

directly related with the production .Example:

Costs for manual and machine operationS ervice department: These are

departments which are not directly relatedwith production .


13/29

Example:Payroll, factory office, personnel, security

service etc.

F . A ccording to function:Costs can be categorized according tofunction as follows:


14/29

Manufacturing costs: Total cost requiredfor production .

Manufacturing costs = DM + DL

+ FOHMarketing costs: Costs required to

promote a product

Example: A dvertising expense


15/29

A dministrative costs: Costs required to operatea company or business activities .

Example:S alaries paid to employees

F inancing costs: Costs incurred for collectingfinance/fund for a company

Example:B ank loan, lease financing, equity financing etc .

B oth administrative and marketing costs areknown as commercial costs also .


16/29

G . A ccording to period:G . A ccording to period:

Costs may be classified on the basis of whenthey will be charged as revenue as follows:Product costs: Costs which are directly and

indirectly identified with production, not with theperiod . When the product is sold, cost of goodssold are matched with revenue in the period theproducts are sold .

Example:Cost of goods sold


17/29

Period costs: Costs which are not directlyor indirectly related with production, rather related with the period . There is hardly anyrelationship in between these costs andearning revenue .

Example:S alary, rent etc .


18/29

H . F or managerial decisionH . F or managerial decision- -making:making:

They can be grouped into the followingcategories:S

tandard costs: Estimates that are usuallyused for per unit basis to direct material,direct labor and/or factory overhead .B udgeted costs: Estimates that are

usually used for total cost basis .


19/29

A ctually, both standard and budget costs areused for the same purpose . B oth areapplied by management to plan cost for future and to control costs by comparingbetween estimated and actualperformance .


20/29

Replacement costs: Costs to be incurredto replace or revalue any fixed asset or items at the current market value .H istorical costs: Costs that happen

already i .e . past cost or sunk costs .

Marginal costs: Total of variable costs .

Marginal costs = DM+ D L + Variable FOH


21/29

Imputed, implicit or notional costs: Costswhich involve no cash outlay . Despitehaving no cash outlay, they are importantin managerial decision .

Example:Rent charged on the house owned by the

owner, interest on capital invested by theowner . In both the cases, no cash outlay isinvolved .


22/29

Controllable costs: Costs which can becontrolled by the management .

Example: A cquisition or use of plant

N on-controllable costs: Costs that are notwithin management control .

Example:Cost of increased price of material or

conveyance due to strike, layout etc .


23/29

Committed costs: A rises out of basicorganizational structure or previously committedfacilities .

Example:Plant, salaried personnel, essential property etc .

Discretionary fixed costs: These costs are at thediscretion of the management and hence subject

to control i .e . can be reduced or increased atany point of time without affecting the efficientoperation of the business .


24/29

Example:Executive training, research, advertising and other costsresulting from policy decisions .Relevant costs: Costs which are relevant (important) in

managerial decision-making .Relevant costs are costs that are

for future differ in between alternative course of actions subject to eliminate if decision is changed .Example:Cost of a plant acquired tk . 10,000


25/29

Irrelevant costs: Costs that have noimpact on decision making . They have thefollowing traits:

Do not differ in between alternatives Past or sunk costs Cannot be eliminated Example:Cost of a plant to be acquired in future


26/29

Differential costs: The difference betweenthe alternative course of actions . If thecost of one alternative is increasing fromanother, its known as differential or incremental costsDecremental costs: if the cost of one

alternative is declining to another, itsDecremental cost .


27/29

O pportunity costs: The opportunity lost is theopportunity cost . B enefits lost from rejecting thenext best alternative are the opportunity cost for the chosen alternative .

Example:Cost needed to buy a certain material

= tk . 10 per unitCost needed to make the same material

= tk . 11 per unit .N ow if the company decides to buy, tk . 10 is the

opportunity cost for the buy decision


28/29

S hutdown costs: Costs those will be evenincurred if there is no production .

Example:S alary to staffs, insurance costs, storagecosts etc .

This costs frequently faced by seasonalbusiness in their off season .


29/29

N ormal costs: Costs that normally happenor are expected to happen in case of agiven production level .

Example:L eakage, evaporation etc .

A bnormal costs: Costs which are not

expected in a given level of output .Example:

F ire, strike, natural disaster, theft etc .

Documents

Cost Slide 03