1.1 identify the elements of costs 1.2 understand various classification of costs 1.3 identify the cost unit 1.4 identify the cost center 1.5 exercise regarding costs concepts

1. CHAPTER 02
FUNDEMENTAL CONCEPT OF
COSTING
CONDUCTED BY:
P. Ayanthi Madumali

2. Intended Learning Outcomes
• At the end of the chapter, you will able to
• 1.1 identify the elements of costs
• 1.2 understand various classification of costs
• 1.3 identify the cost unit
• 1.4 identify the cost center
• 1.5 exercise regarding costs concepts

3. Cost
• The CIMA London cost define as, the amount of expenditure
incurred( actual ) or attributable ( notional) to a specified thing
or activity.
• Expenses: are the consumption of asset for the purpose of
generating revenue

4. Elements of cost
In order to interpret the term cost correctly & to ascertain
the cost with respect to the cost centers, the attached with
the manufacturing process may be subdivided knows as ,
Elements of costs,
1. Material
2. Labour
3. Expenses

5. Material Cost
• Material is the substance, from which a product is made. It may
be in a raw or a manufactured state. It can be direct or indirect.
• Direct Material
Direct materials are raw materials that become an integral part of
the finished product and can be conveniently traced to the units.
Example: Steel used to manufacture the
automobile

6. • Indirect Material
Indirect Material Cost is used to support the production process
and cannot be conveniently identified with the individual cost
center. Example: Consumable stores, oil and grease, printing and
stationery material etc.

7. Labour Cost
• This is the cost, incurred in the form of remuneration paid to the
employees or labour of the organization. The workforce
required to convert material into finished product is called
labour. It can be direct or indirect.
• Direct Labour
Direct labor consists of that portion of labor cost that can be
easily traced to a product. Sometimes referred to as “touch
labor,”.
Example: Wages paid to automobile assembly workers

8. • Indirect Labour
Indirect Labour Cost is the cost incurred on those employees who
do not directly take part in the manufacturing process and cannot
identified with the finial product.
Example: Maintenance workers
Janitors
Security guard

9. Other Expenses
• Expenses are the costs of services provided to the organization.
It can be direct or indirect.
• Direct Expenses
Direct Expenses are the expenses which can be directly identified
with the cost unit. Example: hire charges of machinery, cost of
defective work for a particular job or contract etc.

10. • Indirect Expenses
Indirect Expenses are the expenses which cannot be directly,
conveniently and wholly allocated to cost center & cost unit..
Example: rent, lighting, telephone expenses, tax and insurance
etc.

11. Elements
of Cost
Material
Direct Indirect
Labour
Direct Indirect
Other
expenses
Direct Indirect

12. Classification of Costs
The different bases of cost classification are:
1. By time ( Historical , Pre determined)
2. By nature or element (Material ,labour and overhead)
3. By degree of traceability to the product ( Direct , indirect)
4. Associated with the product (( Product , Period)
5. By change in activity or volume ( Fixed , variable ,semi variable)
6. By function (Manufacturing, Administrative , R&D , Pre production)
7. Relationship with accounting period ( Capital , Revenue)
8. Controllability ( Controllable , Non controllable)
9. Cost for analytical & decision making purpose (Opportunity, sunk,
differential, joint, common, imputed, out of pocket, marginal, uniform,
replacement)
10. Others ( conversion , Traceable, normal, avoidable , unavoidable ,total)

13. 01.Classification on the Basis of Time
a) Historical costs: costs are ascertained after they are incurred.
Such cost are available only when the particular thing has
already been done.
b) Pre-determine costs: These costs are calculated before they
are incurred on the basis of a specification of all factors
affecting cost. Such costs may be:
i. Estimated costs: Costs are estimated before goods are
produced: these are naturally less accurate than standard.
ii Standard costs: setting up predetermined standards for
each element of cost and each product.

14. 02. By Nature of Elements..
 Material Costs
Direct Material
Indirect Material
 Labour Costs
Direct Labour
Indirect Labour
 Expenses
Direct Expenses
Indirect Expenses

15. 03.By Degree of Traceability to the
Product
• Direct Costs
• Costs that can be easily and conveniently traced to a unit of product
or department or some specific activity. It is also called traceable cost.
Examples: Cost of wood for making furniture
• Indirect Costs
• Costs that cannot be easily and conveniently traced to a unit of
product or department. It is uneconomic to do so. They are common
to several products .It is also called common costs.
Example: Salary of a factory manager
Cost may be direct or indirect with respect to a particular division
or department

16. 04.Association with the Product
• Product Costs:
• Period costs are traceable to the product & included in inventory
values.
• It comprises the cost of direct materials, direct labour and
manufacturing overheads. Product costs are used for valuing
inventories which are shown in the balance sheet as asset till
they are sold. The product cost of goods sold is transferred to
the cost of goods sold account.
Inventory Cost of Good Sold
Balance
Sheet
Income
Statement
Sale

17. • Period costs
Period costs are incurred on the basis of time such as rent
,salaries etc.. Include selling & administrative costs. They are
charged to the period in which they are incurred and treated as
expenses. Period costs include all
selling costs and
administrative costs.
Expense
Income
Statement

18. Quick Check 
Which of the following costs would be considered a period
rather than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

19. Which of the following costs would be considered a period
rather than a product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.

20. 05. By change in Activity or volume
• Fixed Costs
• The cost which is incurred for a period and within certain output
tends to be unaffected by fluctuations in the level of activity (output
or turnover)
• Fixed costs remain fixed only in the short run.
• Ex: rent , property , insurance , supervisor's salaries
0
20,000
40,000
60,000
80,000
100,000
120,000
0 20 40 60
TotalCost
Rs.1,00,000
Volume (In Thousands)
FIXED COST

21. E.g Your monthly contract fee for your cell phone is fixed for
the number of monthly minutes in your contract. The monthly
contract fee does not change based on the number of calls you
make.
Number of Minutes Used
Within Monthly Plan
MonthlyCellPhone
ContractFee

22. • Fixed cost can be classified into following categories for
purpose of analysis:
1. Committed costs: These costs are incurred to maintain certain
facilities and cannot be quickly eliminated.
e.g: rent , insurance etc.
2. Policy & managed costs: These costs are incurred for
implementing particular management policies such as executive
development , staff services
3. Discretionary costs: These are not related to operations and
can be controlled by the management. These cost results from
new researches, new system development, marketing programme

23. • 4.Step costs: Costs are constant for a given level of output &
then increase by a fixed amount at a higher level of output.
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
0 20 40 60 80 100
FixedCost(Rs.)
Relevant Range or volume
Production Units (In Thousands)
Between 20,000 & 80,000 units of production, fixed cost is Rs. 50,000
In excess of 80,000 units, fixed cost becomes Rs. 60,000. This assumes that increase in
production after a certain level requires increase in fixed expenses such as additional
supervision, increase in quality control costs.

24. Fixed Cost Per Unit
Within the monthly contract allotment, the average fixed cost
per cell phone call made decreases as more calls are made.
Number of Minutes Used
Within Monthly Plan
MonthlyCellPhone
ContractFee
Fixed cost per unit goes down as activity level goes up.
Fixed cost = TFC
per unit No of Unit

25. • Variable Cost
 Costs which vary directly or proportionately with the output.
Direct materials cost & direct labour cost are the costs which
are generally variable
 Total variable costs change as more units are produced. If a
factory is shut down, variable costs are eliminated
0
50,000
100,000
150,000
200,000
250,000
300,000
0 1000 2000 3000 4000 5000 6000
TotalDirect
MaterialCost(Rs.)
Production Units

26. E.g :For example, if you don’t have a texting plan on your cell
phone, text messaging costs 5 cents per text. Your total texting bill
increases with the number of texts you send. Your total texting bill
is based on how many texts you send.
Number of Texts Sent
TotalTextingBill

27. Cost Classifications for Predicting Cost
Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost Increase Variable cost per unit
and decrease in proportion remains constant.
to changes in the activity level.
Fixed Total fixed cost is not affected Fixed cost per unit decreases
by changes in the activity as the activity level rises and
level within the relevant range. increases as the activity level falls.

28. Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
TotalUtilityCost
X
Y
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
Semi Fixed ( Semi variable)

29. The graph depicts the mixed costs of a normal utility bill. As illustrated in the
graph, a utility bill contains a fixed and a variable cost component.
The fixed portion of the utility bill is constant regardless of kilowatt hours
consumed. This cost represents the minimum cost that is incurred to have the
service ready and available for use.
The variable portion of the utility bill varies in direct proportion to the
consumption of kilowatt hours.
The total mixed cost line can be expressed
as an equation: Y = a + bX
Where: Y = The total mixed cost.
a = The total fixed cost (the
vertical intercept of the line).
b = The variable cost per unit of
activity (the slope of the line).
X = The level of activity.

30. Mixed Costs – An Example
If your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100

31. Variable cost per unit
• Variable cost per unit remains the same over wide range of activity.
E.g: The petrol cost per km constant.
0 20 40 60
Cost
Petrol
Km
Variable Cost per unit

32. 06.Functional Classification of Costs
• Manufacturing/production Costs
• It is the cost of operating the manufacturing division. It include DM,
DL , DE , packing..etc....
• Administration Costs
• They are indirect & covers all expenditure incurred in formulating the
policy, directing the organization & controlling the operation . E.g:
managers salaries, rent ,training ,welfare
• Selling & distribution costs
• Cost of seeking to create & motivate demand. E.g. advertise, market
research , cartage..etc..

33. • Research & Development Costs
• Cost of discovering new ideas, process, products by experiments.
• Pre production Cost
• When a new factory started or new product is introduced those costs
are incurred. There are trial run.

34. 07.Relationships with accounting period
• Capital Expenses
• Provide benefits to future period & is called as “asset”
• Revenue Expenditure
• Benefits only current period & is treated as “expenses.”

35. 08. Controllability
• Controllable Cost
• Cost which can be influenced by its budget holder.
• Uncontrollable cost.
• Costs that a manager cannot influence significantly .
Cost item Manager Classification
Cost of food used in a
restaurant
Restaurant
manager
Controllable
Cost of national advertising
by restaurant chain
Restaurant
manager
Uncontrollable

36. 09. Costs for Analytical & Decision making
purpose
• Opportunity Costs
• Opportunity cost is the Cost of selecting one courses of action and the
losing of other opportunities to carry out that course of action.
• The potential benefit that is given up when one alternative is selected over
another.
• Eg: Capital invested in plant & ,machinery .it cannot be now invested in
shares. The loss of interest and dividend that would be earned is the
opportunity cost.
• Opportunity costs are not recorded in the books.it is important in decision
making & comparing alternatives

37. • Sunk Costs
• All costs incurred in the past that cannot be changed by any decision made
now or in the future are “sunk cost”. Sunk costs should not be considered in
decision.
• It has also been defined as the different between the purchase price of an
asset and its salvage value.
• E.g: you bought an automobile that cost $ 12,000 two years ago. The $
12,000 cost is sunk because whether you drive it, park it, trade it, or sell it
you cannot change the $ 12,000 cost

38. • Differential Costs
The difference between in total cost among alternatives. Differential cost is the
decrease or increase in total costs resulting out of:
 Producing few more or few less of products
 A change in method of production
 An additional or deletion products
E.g; you can earn $ 1500 per month in your hometown or $ 2000 per month in
a nearby city. your commuting costs are $ 50 per month in your home town
and $ 300 per month to the city.
Differential cost = ( 300-50) = $ 250.

39. • Marginal costs : The extra cost incurred to produce one additional unit.
• Joint costs
• Common costs
• Imputed costs
• Uniform costs
• Replacement costs
• Out of pocket cost

40. Cost Unit
• The CIMA define a cost unit as “ a unit of product or service in relation to
which costs are ascertained”.
• Costs units are usually the units of physical measurement like number,
weight, area, length, value, time etc…
Industry/ Product Cost unit
Automobile Number
Cement Tonne
Transport Km, Passenger
Chemicals Litre , gallon
Steel Tonne
Sugar Tonne

41. Cost Centre
• Cost Centre is a location , a person, a function or an item of
equipment ( or group of these) for which costs are accumulated.
Cost Centre may be classified as follows:
Impersonal Cost Centre: which consists of a location or item of equipment
( or group of these). E.g.: School: library , staff room, sport room, lab.
Personal Cost Centre: which consists of a person or group of persons. E.g.:
Librarian , principal, coach , lab assistant

42. .Operation Cost Centre: which consists of the machine and/or persons
carrying out similar operations. E.g.: Advertising , production , welfare
Process Cost Centre: which consists of a specific process or a continuance
of operation. E.g.: During the oil refinery process we can ascertain or control
cost of petrol, diesel, tar

43. Thank You..