OPERATINGCOSTING.1INDEXSr. No.Particulars PageNo.1. COST ACCOUNTING 92. ELEMENTS OF COST. 113. CLASSIFICATION OF COST 124. TYPES OF COST 175. OPERATING COSTING 196. HOW OPERATING COST WORKS 207. WHICH PRODUCTS ARE SUITALE! 20". HOW TO DETERMINE THE ATCHES! 219. FEATURES OF OPERATING COSTING 2110. COST IN DIFFERENT UNDERTAKINGS. 2511. ILLUSTRATION #O$ER$IEW 27COST ACCOUNTING2Cost accounting is a process of collecting, analyzing, summarizing and evaluating various alternative courses of action. Its goal is to advise the management on the most appropriate course of action based on the cost efficiency and capability. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future.Since managers are making decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, information must be relevant for a particular environment. Cost accounting information is commonly used in financial accounting information, but first we are concentrating on its use by managers to make decisions.Unlike the accounting systems that help in the preparation of financial reports periodically, the cost accounting systems and reports are not subjectto rules and standards like the enerally !ccepted !ccounting "rinciples. !s a result, there is wide variety in the cost accounting systems of the different companies and sometimes even in different parts of the same company or organization.#rigins!ll types of businesses, whether service, manufacturing or trading, re$uire cost accounting to track their activities. Cost accounting has long been used to help managers understand the costsof running a business. %odern cost accounting originated during the industrial revolution, when the comple&ities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions.In the early industrial age, most of the costs incurred by a business were what modern accountants call 'variable costs' because they varied directly with the amount of production. %oney was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. %anagers could simply total the variable costs for a product and use this as a rough guide for decision(making processes.Some costs tend to remain the same even during busy periods, unlike variable costs, which rise and fall with volume of work. #ver time, these 3'fi&ed costs' have become more important to managers. )&amples of fi&edcosts include the depreciation of plant and e$uipment, and the cost of departments such as maintenance, tooling, production control, purchasing, $uality control, storage and handling, plant supervision and engineering. Inthe early nineteenth century, these costs were of little importance to most businesses. *owever, with the growth of railroads, steel and large scale manufacturing, by the late nineteenth century these costs were often more important than the variable cost of a product, and allocating them to a broad range of products lead to bad decision making. %anagers must understand fi&ed costs in order to make decisions about products and pricing.+or e&ample, ! company produced railway coaches and had only one product. -o make each coach, the company needed to purchase ./0 of raw materials and components, and pay / laborers .10 each. -herefore, total variable cost for each coach was .200. 3nowing that making a coach re$uired spending .200, managers knew they couldn4t sell below that price without losing money on each coach. !ny price above .200 became a contribution to the fi&ed costs of the company. If the fi&ed costs were, say, .5000 per month for rent, insurance and owner4s salary, the company couldtherefore sell 6 coaches per month for a total of .2000 7priced at ./00 each8, or 50 coaches for a total of .1600 7priced at .160 each8, and make a profit of .600 in both cases.Cost !ccounting vs +inancial !ccounting. +inancial accounting aims at finding out results of accounting year inthe form of "rofit and 9oss !ccount and :alance Sheet. Cost !ccounting aims at computing cost of production;service in a scientific manner and facilitate cost control and cost reduction. +inancial accounting reports the results and position of business to government, creditors, investors, and e&ternal parties. Cost !ccounting is an internal reporting system for an organization2?-ypes of cost accounting-he +ollowing are different Cost !ccounting !pproaches, standardized or standard cost accounting lean accounting activity(based costing resource consumption accounting throughput accounting 9ife cycle costing environmental accounting -arget costing)lements of cost:asic cost elements are,5. @aw materialsA. 9abor52. Indirect e&penses;overhead %aterial 7%aterial is a very important part of business8 Birect material;Indirect material 9abor Birect labor;Indirect labor #verhead 7Cariable;+i&ed8 "roduction or works overheads !dministration overheads Selling overheads Bistribution overheads %aintenance D @epair Supplies Utilities #ther Cariable )&penses Salaries #ccupancy 7@ent8 Bepreciation6 #ther +i&ed )&penses%I& '()* +(),-&.*'/ )-+0.&* +('1 .' '*23*2-1*4 53() (6*30*-4 -&4 3*,(31*4 -' - '*,-3-1* *7*)*&18Classification of costsClassification of cost means, the grouping of costs according to their common characteristics. -he important ways of classification of costs are,5. :y )lement, -here are three elements of costing i.e. material, labor and e&penses.A. :y Eature or -raceability,Birect Costs and Indirect Costs. Birect Costs are Birectly attributable;traceable to Cost #bject. Birect costs are assigned to Cost #bject. Indirect Costs are not directly attributable;traceable to Cost #bject. Indirect costs are allocated or apportioned to cost objects.2. :y +unctions, production,administration, selling and distribution, @DB.1. :y :ehavior, fi&ed, variable, semi(variable. Costs are classified according to their behavior in relation to change in relation to production volume within given period of time. +i&ed Costs remain fi&ed irrespective of changes in the production volume in given period of time. Cariable costs change according to volume of production. Semi(variable Costs costs are partly fi&ed and partly variable.6. :y control ability, controllable, uncontrollable costs. Controllable costs are those which can be controlled or influenced by a conscious management action. Uncontrollable costs cannot be controlled or influenced by a conscious management action./. :y normality, normal costs and abnormal costs. Eormal costs arise during routine day(to(day business operations. !bnormal costs arise because of any abnormal activity or event not part of routine business operations. ).g. costs arising of floods, riots, accidents etc.7F. :y -ime, *istorical Costs and "redetermined costs. *istorical costs re costs incurred in the past. "redetermined costs are computed in advance on basis of factors affecting cost elements. )&ample, Standard Costs.G. :y Becision making Costs, -hese costs are used for managerial decision making. %arginal Costs, %arginal cost is the change in the aggregate costs due to change in the volume of output by one unit. Bifferential Costs, -his cost is the difference in total cost that will arise from the selection of one alternative to the other. #pportunity Costs, It is the value of benefit sacrificed in favor of an alternative course of action. @elevant Cost, -he relevant cost is a cost which is relevant in variousdecisions of management. @eplacement Cost, -his cost is the cost at which e&isting items of material or fi&ed assets can be replaced. -hus this is the cost of replacing e&isting assets at present or at a future date. Shutdown Cost,-hese costs are the costs which are incurred if the operations are shut down and they will disappear if the operations are continued. Capacity Cost, -hese costs are normally fi&ed costs. -he cost incurred by a company for providing production, administration and selling and distribution capabilities in order to perform various functions. #ther CostsStandard cost accountingIn modern cost account of recording historical costs was taken further, by allocating the company4s fi&ed costs over a given period of time to the 8items produced during that period, and recording the result as the total costof production. -his allowed the 5977 +('1 of products that were not sold in the period they were produced to be recorded in inventory using a variety of comple& accounting methods, which was consistent with the principles of !!" 7enerally !ccepted !ccounting "rinciples8. It also essentially enabled managers to ignore the fi&ed costs, and look at the results of each period in relation to the 'standard cost' for any given product.+or e&ample, if the railway coach company normally produced 10 coaches per month, and the fi&ed costs were still .5000;month, then each coach could be said to incur an #perating Cost;overhead of .A6 H7.5000 ; 108. !dding this to the variable costs of .200 per coach produced a full cost of .2A6 per coach.-his method tended to slightly distort the resulting unit cost, but in mass(production industries that made one product line, and where the fi&ed costswere relatively low, the distortion was very minor.+or e&ample, if the railway coach company made 500 coaches one month, then the unit cost would become .250 per coach 7.200 I 7.5000 ; 50088. If the ne&t month the company made 60 coaches, thenthe unit cost H .2A0 per coach 7.200 I 7.5000 ; 6088, a relatively minor difference.!n important part of standard cost accounting is a variance analysis, which breaks down the variation between actual cost and standard costs into various components 7volume variation, material cost variation, labor cost variation, etc.8 so managers can understand :0; +('1' :*3* 4.55*3*&1 53() :0-1 :-' ,7-&&*4 and take appropriate action to correct the situation.%arginal costing -he cost(volume(profit analysis is the systematic e&amination of the relationship between selling prices, sales, production volumes, costs, e&penses and profits. -his analysis provides very useful information for decision(making in the management of a company. +or e&ample, the 9analysis can be used in establishing sales prices, in the product mi& selection to sell, in the decision to choose marketing strategies, and in the analysis of the impact on profits by changes in costs. In the current environment of business, a business administration must act and take decisions in a fast and accurate manner. !s a result, the importance of cost(volume(profit is still increasing as time passes.CONTRIUTION MARGIN! relationship between the cost, volume and profit is the contribution margin. -he contribution margin is the revenue e&cess from sales over variable costs. -he concept of contribution margin is particularly useful in the planning of business because it gives an insight into the potential profits that can generate a business. -he following chart shows the income statement of a company J, which has been prepared to show its contribution margin,Sales .5,000,0007(8 Cariable Costs ./00,000Contribution %argin .100,0007(8 +i&ed Costs .200,000Income from #perations .500,000CONTRIUTION MARGIN RATIO-he margin contribution can also be e&pressed as a percentage. -he contribution margin ratio, which is sometimes called the profit(volume ratio, indicates the percentage of each sales dollar available to cover fi&ed 10costs and to provide operating revenue. +or the company +usion, Inc. the contribution margin ratio is 10K, which is computed as follows,-he contribution margin ratio measures the effect on operating income of an increase or a decrease in sales volume. +or e&ample, assume that the management of +usion, Inc. is studying the effect of adding .G0,000 in sales orders. %ultiplying the contribution margin ratio 710K8 by the change in sales volume 7.G0,0008 indicates that operating income will increase .2A,000 if additional orders are obtained. -o validate this analysis the table below shows the income statement of the company including additional orders,Sales .5,0G0,0007(8 Cariable Costs ./1G,000 75,0G0,000 & /0K8Contribution %argin .12A,000 75,0G0,000 & 10K87(8 +i&ed Costs .200,000Income from #perations .52A,000Cariable costs as a percentage of sales are e$ual to 500K minus the contribution margin ratio. -hus, in the above income statement, the variable costs are /0K 7500K ( 10K8 of sales, or ./1G,000 7.540G0,000 J /0K8. -he total contribution margin .12A,000, can also be computed directly by multiplying the sales by the contribution margin ratio 7.540G0,000 J 10K8.-L") #+ C#S-,11Up-front costs comprise the initial investments and e&penses necessary to implement %SM services. -hese include public education and outreach, land ac$uisition, permitting, and building construction or modification.Operating costs are the e&penses of managing %SM on a daily basis, including operations and maintenance, capital costs, debt service, and any une&pected costs.Back-end costs include e&penditures to properly wrap up operations and take proper care of landfills and other %SM facilities at the end of their useful lives. Costs include site closure, building;e$uipment decommissioning, postclosure care, and retirement;health benefits for current employees.Remediation costs at inactive sites include investigation, containment, andcleanup of known releases and closure and postclosure care at inactive sites. %any local governments have inactive %SM landfills that re$uire 'corrective action' for known contamination of ground water, soil, or surface water. -hese remediation costs can be relatively well estimated, though with somewhat more uncertainty than other types of engineering projects such as road building.Including these costs in +C! is a matter of choice. -he decision to include remediation costs depends on the intended use of the +C! information. +ore&ample, if you are using +C! to document the revenue needs of an %SM program, you might want to include costs entailed by inactive sites. *owever, if you intend to use +C! to reveal the current economics 7e.g., cost per ton8 of current %SM management or compare your performance to other communities or state benchmarks, you might want to e&clude inactive sites from such calculations.Contingent costs are costs that might or might not be incurred at some point in the future. )&amples include the costs of remediating unknown or future releases of pollutants, such as leaks from currently operating municipal landfills. Contingent costs also include the liability costs of compensating for undiscovered or future damage to property or persons 12adversely affected by %SM services. :oth of these types of contingent costs can be projected, but not very precisely. 7In contrast, where there is a known need to remediate, costs can be projected much more precisely.8Environmenta costs are the costs of environmental degradation that cannot be easily measured or remedied, are difficult to value, and are not subject to legal liability. -o truly capture all of the important life(cycle costelements, some people advocate assessing the upstream and downstream environmental costs of resource use, pollution, and waste generated by providing goods and services.Socia costs are adverse impacts on human beings, their property and welfare that cannot be compensated through the legal system. Social costs 7also termed 'social e&ternalities'8 might include the impacts of %SM transport on neighborhoods along the routes taken, as well as the impacts of %SM facilities themselves. !dverse effects on property values, community image, and aesthetics, as well as the increase of noise, odor, and traffic all contribute to social costs.Operating cost#perating costs are costs that are incurred on a da!-to-da! "asis related tothe business operations. It can also be related to the operation of a device,component, andpieceofe$uipment orfacility.#peratingcostsarealsoknown as operating e#penses. +or e&ample sales and administration costsare operating costs. #perating costs are referred to as cost per unit of aproductor service,or theannual costincurredonacontinuousprocess.-heoperatingcostsarethosethat donot include capita outa!s orthecosts incurred in design and impementation phases of a new process.#perating costs are divided into two categories. -hey are fi#edcosts and varia"e costs. +i&ed costs are those which are fi&ed and do notvary with the changes in the level of output. -hey do not change whether13the business is inactive or operating at fu capacit!. Cariable costs arethose costs which vary with the changes in the level of output. +le&iblee&penditures are also known as the variable operating costs. -hee&penses fuctuate on the basis of a variety of factors.#perating e&penses differ in every country. -he actua e#penses vary ineverylocation. -hecalculationofoperatingcostsisessential for sound"usiness panning. -hese costs should be properly budgetedN otherwise itwill adverselyaffect thebusiness. -helackof planninginabusinessincreases theriskthat abusiness will not maintainade$uatefunds tooperate properly. Mhen the operating costs are fi&ed, the likely "usinessinterruptions or economicdecines shouldbetakenintoconsideration.-he business generally cannot be deferred until a business finds itconvenient to pay them. +i&ed operating costs are set ona paymentschedule and need to be paid accordingly for the company tomaintain good credit$#peration costing is an accounting method used to allocate costs of similarproducts that are manufactured in batches. It combines two other popular costing methods to get a more accurate picture of how a particular company4s manufacturing process works. It simplifies the accounting process by only differentiating activities that cause a variation in cost between products. Similar items are allocated in batches that reflect the actual cost involved in creating that group. *ere is a basic guide to the operation costing accounting method.Operation costing% &o' it 'orks#peration costing is a combination of process costing and job(order costing. "rocess costing is an accounting method used for the creation of identical products. -he costs are allocated to all products in a batch e$uallybecause they are all identical. Oob(order costing is better suited for products that are different from each other. -he products are separated into batches. -he costs of each batch tracked separately and allocated only to the products contained in that batch.Operation costing% ()at products are suita"e14#peration costing works for products that have some similarities, but can still be separated out into batches. Some common products that use operation costing are electronic e$uipment or cosmetics. -he manufacturing process is similar for all of the individual products, but there may be different costs involved. Using computer monitors as an e&ample, each size of monitor may use the same manufacturing process, but will incur different levels of materials cost. -he labor costs could then be allocated using a process costing system while the materials costs are allocated with a job(order costing system to account for the different sizes.Operation costing% *rocedures var! "! compan!)ach company has its own specific operation costing procedures, but most of them will resemble both process costing and job(order costing. Birect materials costs are usually booked into work(in(process accounts in batches the way they would be under a job(order system. %ost operation costing systems re$uire the use of several work(in(process accounts to keep the batches separate. Conversion and labor costs are tracked in a lumpsum that is later spread to all units produced during the accounting period.Operation costing% &o' to determine t)e "atc)es-he variation between products can be large or small, as long as it can be differentiated from another group of products. Mhen deciding how to group products for operation costing, the difference in cost is the most important consideration. #ne product may have more features than another, but that only matters if it costs significantly more to produce that item. )ach company must tailor its operating costing system to their specific products.+)!-U@)S #+ #")@!-IE C#S-IE-he main features of operating costing are as following,15+,- -heundertakingwhichadoptsservicecostingdoesnot produceanytangible goods. -hese undertakings render uni$ue services to theircustomers.+.- -he e&penses are divided into fi&ed and variable cost . Such aclassification is necessary toascertain the cost of service and the unit costof service.+/- -he cost unit may be simple or composite. -he e&amples of simple costunits are cost perunit in electricity supply , cost per litre in water supply,cost permealincanteenetc. Similarlycostperpassengerkilometersintransport cost per patient(day in hospital, costper room(dayin hotel etc.are the e&amples of composite cost unit.+0- -otal cost are averaged over the total amount of service rendered.+1- Costs are usually computed period(wise. *owever,in the case ofutilizationofvehicles, use ofroad(rollersetc., thecostsarecomputedorderwise.+2- Service costing can be used for service performed internally ore&ternally.+3- documents like the daily log sheet, cost sheet etc. are used forthe collection of cost data.Operating +cost-c)aracteristicsIn some cases, the supplier and customer may wish to come to an agreement about how the risks of incorrect decisions might be shared between them by e&amining the respective levels of risk P in the first case, in percent risk terms, but also in economic terms.Operating c)aracteristic +po'er- curves16#perating characteristicClassical statistical hypothesis testing >%ontgomery 5QQ/? uses percent risk tools such as the so(called =operating characteristic< or =power curve