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Cost Terms, Concepts, and Classifications
Chapter
2
Prepared By:Subika Kaleem (BB-25063)Arsalan Javed (BB-25079)Anora Zfar (BB-25801)
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-2
General Cost Classification
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-3
Product Cost Versus Period Cost
Product cost It includes all the
costs that are involved in acquiring or making a product i.e direct materials,
direct labor, and manufacturing
overhead costs.
Period cost
It includes all the costs that are not
involved in the product cost. They
are expenses recorded in the
income statement period in which
they are incurred.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-4
Cost Classifications for Predicting Cost Behavior
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.
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.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-5
Total Variable CostA cost that varies in total in direct proportion to changes
in the level of activity.
example: Your total long distance telephone bill is based on how many minutes you talk.
Minutes Talked
Tot
al L
ong
Dis
tanc
eT
elep
hone
Bill
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-6
Total Fixed Cost
Minutes Talked
Per
Min
ute
Tel
epho
ne C
harg
e
A cost that remains constant in total regardless of changes in the level of activity.
example: The cost per long distance minute talked is constant, i.e 10 cents per minute.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-7
Direct Costs and Indirect Costs
Direct costsCosts that can be
easily and conveniently traced to a unit of product or other cost objective.
Examples: direct material and direct labor
Indirect costsCosts cannot be easily
and conveniently traced to a unit of product or other cost object.
Example: manufacturing overhead
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-8
Differential Costs and Revenues
Costs and revenues that differ among alternatives.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
Differential revenue is: $2,000 – $1,500 = $500
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-9
Differential Costs and Revenues
Costs and revenues that differ among alternatives.
Differential revenue is: $2,000 – $1,500 = $500
Differential cost is:$300
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-10
Opportunity Costs
The potential benefit that is given up when one alternative is selected over another.Example: If you werenot attending college,you could be earning$15,000 per year. Your opportunity costof attending college for one year is $15,000.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-11
Sunk Costs
Sunk costs cannot be changed by any decision. They are not differential costs and should be
ignored when making decisions.
Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
2-12
Thank You !!!