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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
2-5
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Purpose ofCost Classification
2-6
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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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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
Days Computers, Inc.
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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
Days Computers, Inc.
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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
Days Computers, Inc.
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Cost Behavior of Fixed & variable Costs
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Cost Behavior of Fixed & variable Costs
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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Cost Behavior of Fixed & variable Costs
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
Days Computers, Inc.
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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Cost Classification by Degree of Traceability
C = P * Qwhere
C = cost ofinput resource
P =price perunit ofresourceQ = quantity (numberofunits) ofresource
Direct costsDirect costs Equation
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Cost Classification by Degree of Traceability
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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Cost Classification by Degree of Traceability
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Direct
Indirect
Variable Fixed
Cost Classification by Degree of Traceability
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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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Cost Classification by Degree of Traceability
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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
Cost Classification by Function
Variable Cost
Generally
Variable Cost
Mixture of Fixed& Variable Cost
Mixture of Fixed& Variable Cost
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All Costs
Cost Classification by Function
Variable Cost
Generally
Variable Cost
Mixture of Fixed& Variable Cost
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All Costs
Cost Classification by Function
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
Selling andAdministrative
CostsCosts
Total CostFlow & Classification
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Work inProcessInventory
Balance Sheet
MaterialsInventory
Product Costs
MaterialsPurchases
Period Costs
Income Statement
Direct
Labor
FactoryOverhead
Selling andAdministrative
CostsCosts
Total CostFlow & Classification
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FinishedGoods
Inventory
Work inProcessInventory
Balance Sheet
MaterialsInventory
Product Costs
MaterialsPurchases
Period Costs
Income Statement
Direct
Labor
FactoryOverhead
Selling andAdministrative
CostsCosts
Cost ofGoodsManufactured
Total CostFlow & Classification
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Cost ofGoods Sold
FinishedGoods
Inventory
Work inProcessInventory
Balance Sheet
MaterialsInventory
Product Costs
MaterialsPurchases
Period Costs
Income Statement
Direct
Labor
FactoryOverhead
Selling andAdministrative
CostsCosts
Product costsflowthrough the
balance sheet tothe income
statement
Total CostFlow & Classification
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Selling andAdministrative
Cost ofGoods Sold
FinishedGoods
Inventory
Work inProcessInventory
Balance Sheet
MaterialsInventory
Product Costs
MaterialsPurchases
Period Costs
Income Statement
Direct
Labor
FactoryOverhead
Selling andAdministrative
CostsCosts
Period costsflowdirectly to the income
statement
Total CostFlow & Classification
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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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Cost Classification by Relevance
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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Cost Classification by Relevance
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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