Cost classification

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Cost classification

  1. 1. Cost Classifications Chapter 2
  2. 2. Classification of cost <ul><li>According to: </li></ul><ul><li>Nature/ Elements </li></ul><ul><li>Function </li></ul><ul><li>Degree of traceability to product </li></ul><ul><li>Change in volume </li></ul><ul><li>Controllability </li></ul><ul><li>Normality </li></ul>
  3. 3. Classification of cost contd…. <ul><li>Time </li></ul><ul><li>Planning & control </li></ul><ul><li>In relationship with accounting period </li></ul><ul><li>Association with product </li></ul><ul><li>Managerial decisions </li></ul>
  4. 4. Elements of Costs The Product Materials Labour Expense
  5. 5. Direct Materials <ul><li>Those materials that become an integral part of the product and that can be conveniently traced directly to it. </li></ul>Example: A radio installed in an automobile
  6. 6. Indirect Material <ul><li>Those materials that do not become an integral part of the product but which helps in production. </li></ul>Example: indirect materials Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.
  7. 7. Direct Labor <ul><li>Those labor costs that can be easily traced to individual units of product. </li></ul>Example: Wages paid to automobile assembly workers
  8. 8. Indirect Labour <ul><li>Those labor costs that cannot be easily traced to individual units of product. </li></ul>Examples: Indirect labor Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards.
  9. 9. Expense <ul><li>The cost of services provided to an undertaking and the notional cost of the use of owned asset. </li></ul><ul><li>Expenses are of two types: </li></ul><ul><li>Direct expense </li></ul><ul><li>Indirect expense </li></ul>
  10. 10. Expense <ul><li>Direct expense is an expense which is incurred with manufacture of a product. </li></ul><ul><li>Eg: Purchase of raw materials, factory labour, factory wages, electricity </li></ul><ul><li>Indirect expense also called as overhead are additional expenses which are incurred on bringing a product to final customer. </li></ul><ul><li>Eg: Sales and Distribution, Office Salary, office electricity, office water, printing and stationery, outsourcing expenses, advertising expenses etc. </li></ul>
  11. 11. By Function Marketing and Selling Cost Costs necessary to get the order and deliver the product. Administrative Cost All executive, organizational, and clerical costs.
  12. 12. Direct Costs and Indirect Costs <ul><li>Direct costs </li></ul><ul><li>Costs that can be easily and conveniently traced to a unit of product or other cost objective. </li></ul><ul><li>Examples: direct material and direct labor </li></ul><ul><li>Indirect costs </li></ul><ul><li>Costs cannot be easily and conveniently traced to a unit of product or other cost object. </li></ul><ul><li>Example: manufacturing overhead </li></ul>
  13. 13. Cost Classifications for Predicting Cost Behavior <ul><li>How a cost will react to changes in the level of business activity. </li></ul><ul><ul><li>Total variable costs change when activity changes. </li></ul></ul><ul><ul><li>Total fixed costs remain unchanged when activity changes. </li></ul></ul>
  14. 14. A Cell Phone Bill…. <ul><li>Family Plan for cell phone usage, unlimited nights and weekends, $60.00 </li></ul><ul><li>Includes 250 text messages </li></ul><ul><li>Any text messages above 250 are $0.10 per text sent AND $0.10 text received. </li></ul><ul><li>You do NOT have a DATA PLAN and pay $0.01 per KB </li></ul>
  15. 15. Variable Cost Per Unit <ul><li>The cost per KB of DATA is constant. For example, $.01 cents per KB. </li></ul>DATA COST Per KB Used Per KBs used Per Minute Telephone Charge
  16. 16. Total Variable Cost <ul><li>Your total DATA cost is based on how many KB you use.. </li></ul>DATA used Total DATA COST on your Cell phone Bill
  17. 17. Total Fixed Cost <ul><li>Your monthly basic cellphone bill does not change when you make more calls. </li></ul>NTT DoCoMo's wristwatch-style cellphone Number of Local Calls Monthly Basic Telephone Bill
  18. 18. Fixed Cost Per Unit <ul><li>The average cost per call decreases as more local calls are made. </li></ul>Number of Local Calls Monthly Basic Telephone Bill per Local Call
  19. 19. Cost Classifications for Predicting Cost Behavior
  20. 20. Quick Check  Variable/Fixed Costs <ul><li>Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) </li></ul><ul><ul><li>A. The cost of lighting the store. </li></ul></ul><ul><ul><li>B. The wages of the store manager. </li></ul></ul><ul><ul><li>C. The cost of ice cream. </li></ul></ul><ul><ul><li>D. The cost of napkins for customers. </li></ul></ul>
  21. 21. Quick Check  Variable/Fixed Costs <ul><li>Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) </li></ul><ul><ul><li>A. The cost of lighting the store. </li></ul></ul><ul><ul><li>B. The wages of the store manager. </li></ul></ul><ul><ul><li>C. The cost of ice cream. </li></ul></ul><ul><ul><li>D. The cost of napkins for customers. </li></ul></ul>
  22. 22. Quick Check  Variable/Fixed Costs <ul><li>Which of the following costs would be variable with respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.) </li></ul><ul><ul><li>A. The cost of renting the film. </li></ul></ul><ul><ul><li>B. Royalties on ticket sales. </li></ul></ul><ul><ul><li>C. Wage and salary costs of theater employees. </li></ul></ul><ul><ul><li>D. The cost of cleaning up after the show. </li></ul></ul>
  23. 23. Quick Check  Variable/Fixed Costs <ul><li>Which of the following costs would be variable with respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.) </li></ul><ul><ul><li>A. The cost of renting the film. </li></ul></ul><ul><ul><li>B. Royalties on ticket sales. </li></ul></ul><ul><ul><li>C. Wage and salary costs of theater employees. </li></ul></ul><ul><ul><li>D. The cost of cleaning up after the show. </li></ul></ul>The royalties on ticket sales is directly related to the number of tickets sold. The cost of cleaning up MAY also be variable if the theater pays cleaning crews by the hour. The more tickets sold would increase the time it would take to clean up the theater.
  24. 24. Classification of cost contd…. Controllability Controllable cost Uncontrollable cost
  25. 25. Classification of cost contd…. Normality Normal cost Abnormal cost
  26. 26. Classification of cost contd…. Time Historical cost Predetermined cost
  27. 27. Classification of cost contd…. Planning & Control Standard cost Budgeted Cost
  28. 28. Product Costs Versus Period Costs <ul><li>Product costs include direct materials, direct labor, and manufacturing overhead. </li></ul><ul><li>Period costs are not included in product costs. They are expensed on the income statement. </li></ul>
  29. 29. Quick Check  Period vs. Product Costs <ul><li>Which of the following costs would be considered a period rather than a product cost in a manufacturing company? </li></ul><ul><ul><li>A. Manufacturing equipment depreciation. </li></ul></ul><ul><ul><li>B. Property taxes on corporate headquarters. </li></ul></ul><ul><ul><li>C. Direct materials costs. </li></ul></ul><ul><ul><li>D. Electrical costs to light the production facility. </li></ul></ul>
  30. 30. Quick Check  Period vs. Product Costs <ul><li>Which of the following costs would be considered a period rather than a product cost in a manufacturing company? </li></ul><ul><ul><li>A. Manufacturing equipment depreciation. </li></ul></ul><ul><ul><li>B. Property taxes on corporate headquarters. </li></ul></ul><ul><ul><li>C. Direct materials costs. </li></ul></ul><ul><ul><li>D. Electrical costs to light the production facility. </li></ul></ul>
  31. 31. Differential Costs and Revenues <ul><li>Costs and revenues that differ among alternatives. </li></ul>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 Differential cost is: $300
  32. 32. Quick Check  - Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the pizza you ate last night relevant in this decision? In other words, should the cost of the pizza affect the decision of whether you drive or take the train to Portland? </li></ul><ul><ul><li>A. Yes, the cost of the pizza is relevant. </li></ul></ul><ul><ul><li>B. No, the cost of the pizza is not relevant. </li></ul></ul>
  33. 33. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the pizza you ate last night relevant in this decision? In other words, should the cost of the pizza affect the decision of whether you drive or take the train to Portland? </li></ul><ul><ul><li>A. Yes, the cost of the pizza is relevant. </li></ul></ul><ul><ul><li>B. No, the cost of the pizza is not relevant. </li></ul></ul>
  34. 34. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? </li></ul><ul><ul><li>A. Yes, the cost of the train ticket is relevant. </li></ul></ul><ul><ul><li>B. No, the cost of the train ticket is not relevant. </li></ul></ul>
  35. 35. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? </li></ul><ul><ul><li>A. Yes, the cost of the train ticket is relevant. </li></ul></ul><ul><ul><li>B. No, the cost of the train ticket is not relevant. </li></ul></ul>
  36. 36. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? </li></ul><ul><ul><li>A. Yes, the licensing cost is relevant. </li></ul></ul><ul><ul><li>B. No, the licensing cost is not relevant. </li></ul></ul>
  37. 37. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? </li></ul><ul><ul><li>A. Yes, the licensing cost is relevant. </li></ul></ul><ul><ul><li>B. No, the licensing cost is not relevant. </li></ul></ul>
  38. 38. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the depreciation on your car relevant in this decision? </li></ul><ul><ul><li>A. Yes, the depreciation is relevant. </li></ul></ul><ul><ul><li>B. No, the depreciation is not relevant. </li></ul></ul>
  39. 39. Quick Check  Relevant Costs <ul><li>Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the depreciation on your car relevant in this decision? </li></ul><ul><ul><li>A. Yes, the depreciation is relevant. </li></ul></ul><ul><ul><li>B. No, the depreciation is not relevant. </li></ul></ul>Depreciation that is a function of miles driven would be relevant. Depreciation that is a function of the passage of time would not be relevant.
  40. 40. Opportunity Costs <ul><li>The potential benefit that is given up when one alternative is selected over another. </li></ul>Example: If you were not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000.
  41. 41. Sunk Costs <ul><li>Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions. </li></ul>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.
  42. 42. Quick Check  Sunk Costs <ul><li>Suppose that your car could be sold now for $5,000. Is this a sunk cost? </li></ul><ul><ul><li>A. Yes, it is a sunk cost. </li></ul></ul><ul><ul><li>B. No, it is not a sunk cost. </li></ul></ul>
  43. 43. Quick Check  Sunk Costs <ul><li>Suppose that your car could be sold now for $5,000. Is this a sunk cost? </li></ul><ul><ul><li>A. Yes, it is a sunk cost. </li></ul></ul><ul><ul><li>B. No, it is not a sunk cost. </li></ul></ul>

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