1. COST TERMS, CONCEPTS AND
CLASSIFICATIONS
Fixed vs Direct vs
Variable Indirect
Functional vs Behavioral
2. Meaning of cost
Cost means the amount of
expenditure (actual or notional)
incurred on, or attributable to, a
given product.
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3. COST ACCOUNTING
Cost accounting is concerned with
- recording,
- classifying
- and summarizing costs
for determination of costs of products or services.
Further, it is concerned with
- planning,
- controlling and
- reducing such costs
and finally furnishing of information to management for
decision making.
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4. OBJECTIVES OF COST ACCOUNTING
Ascertainment of costs
Estimation of costs
Cost control
Cost reduction
Determining selling price
Facilitating preparation of financial and other
statement
Providing basis for operating policy
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8. DIRECT MATERIAL is one which can be
directly or easily identified in the product
e.g., Fibre in yarn, Fabric in dress, etc.
INDIRECT MATERIAL is one which
cannot be easily identified in the product.
9. EXAMPLES OF INDIRECT MATERIAL
Factory level
–lubricants, oil, consumables etc.
Office level
–Printing & stationery, Brooms,
Dusters etc.
Selling & distribution level
–Packing materials, printing,
stationery etc.
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10. Labour
The human effort required to
convert the materials into finished
product is called labour.
11. DIRECT LABOUR: is one which can be
conveniently identified or attributed wholly to a
particular job, product or process.
e.g., wages paid to machine operator, fees paid to
tailor, etc.
INDIRECT LABOUR: is one which cannot be
conveniently identified or attributed wholly to a
particular job, product or process.
LABOUR
12. EXAMPLES OF INDIRECT LABOUR
Factory level
– foremen’s salary, works manager’s
salary, gate keeper’s salary etc.
Office level
– Accountant’s salary, GM’s salary,
Manager’s salary etc.
Selling and distribution level
– Salesmen salaries, logistics manager
salary etc.
13. OTHER EXPENSES: are those expenses
other than materials and labour.
DIRECT EXPENSES: are those expenses
which can be directly allocated to
particular job, process or product
e.g. Excise duty, royalty, special hiring
charges etc.
INDIRECT EXPENSES: are those expenses
which cannot be directly allocated
to particular job, process or product.
14. Examples of other expenses
Factory level
- factory rent, factory insurance, lighting, etc.
Office level
- office rent, office insurance, office lighting etc.
Sales & distribution level
- advertising, show room expenses like rent,
insurance etc.
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16. COST CLASSIFICATIONS
Functional – Product Detail
Product
Marketing
R&D
Admin
Materials
Labour
Mfg.
Overhead
Prime costs = Direct Materials + Direct Labour
Conversion costs = Direct Labour + Total Mfg.
Overhead
18. Behaviour
Fixed Cost
Fixed costs do not respond to changes in unit level cost
Variable Cost
Varies with volume and constant per unit
Semi-variable Cost
A cost could be variable for one level of activity whereas it could
be fixed for another.
Not inherently fixed or variable
- Many costs are semi-variable in nature
23. Planning & Control
Budgeted Cost: estimate of expenditure for
different business operations
Standard Cost: for prescribed set of operating
conditions, labour, material and overheads are
predetermined; budget translated into actual
operation through standard costs
24. Cost classifications for decision making
Every decision involves a choice between at
least two alternatives.
Only those costs and benefits that differ
between alternatives are relevant in a
decision. All other costs and benefits can and
should be ignored.
25. Decision Making
Marginal vs. Absorption Costing
(with fixed cost and without Fixed cost)
Sunk - irrelevant
Committed – pre committed
Opportunity
Incremental / Differential
Avoidable & Unavoidable
Controllable / Uncontrollable
26. Differential Cost and Revenue
Costs and revenues that differ
among alternatives.
Example: You have a job paying Rs. 45,000 per month
in your hometown. You have a job offer in a
neighboring city that pays 60,000 per month. The
commuting cost to the city is Rs. 10000 per month.
Differential revenue is:
Rs. 60,000 – Rs. 45,000 = Rs. 15000
Differential cost is:
Rs. 10000
27. Opportunity Cost
The potential benefit that is given
up when one alternative is
selected over another.
Example: If you were not attending college,
you could be earning Rs45,000 per year.
Your opportunity cost of attending college for one
year is Rs45,000.
28. Sunk Costs
Sunk costs have already been incurred and cannot
be changed now or in the future. They should be
ignored when making decisions.
Example: You bought an automobile that cost Rs
500,000 two years ago. The Rs 500,000 cost is
sunk because whether you drive it, park it, trade it, or
sell it, you cannot change the Rs 5 00,000 cost.
29. Quick Check
Suppose that your car could be sold now for Rs
250,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
31. Quick Check
Suppose you are trying to decide whether to drive
or take the Metro to Nehru Place 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 Metro ticket relevant in this
decision?
In other words, should the cost of the Metro ticket
affect the decision of whether you drive or take the
Metro to Nehru Place?
A. Yes, the cost of the Metro ticket is relevant.
B. No, the cost of the Metro is not relevant.
32. Quick Check
Suppose you are trying to decide whether to drive
or take the Metro to Nehru Place 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 Metro ticket relevant in this
decision?
In other words, should the cost of the Metro ticket
affect the decision of whether you drive or take the
Metro to Nehru Place?
A. Yes, the cost of the Metro ticket is relevant.
B. No, the cost of the Metro ticket is not relevant.
33. Quick Check
Suppose you are trying to decide whether to
drive or take the Metro to Nehru Place 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?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
34. Quick Check
Suppose you are trying to decide whether to
drive or take the Metro to Nehru Place 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?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
35. Cont…..
Irrelevant cost: not relevant for decision making
Example: Sunk costs: Sunk cost is the cost of
abandoned plant less salvage value. Not
relevant for decision making.
Imputed (Notional cost): Actually not incurred
(interest on own capital, rent on owned building,
etc.) Taken into account in capital budgeting
decisions.
Replacement cost: Cost of replacing at current
market price.
36. Cont…..
Avoidable and unavoidable cost:
Cost that can be avoided by
eliminating a product or
department is avoidable and that
which cannot be, is unavoidable.
e.g. – Rent of factory is unavoidable
if a product is discontinued.
37. Other costs:
Future costs: cost to be incurred in future
Programmed cost: Cost incurred as per policy of top
management. e.g.- Donation to charity.
Joint cost: cost of joint or by-products incurred before
separation, which cannot be traced to particular
products.
Conversion cost: cost of converting raw material to
finished goods = Production cost- direct material.
Discretionary cost: not essential for decision on hand.
e.g- Training expenses of workers, R&D cost.
Committed cost: Costs incurred due to past decisions
and are not within control in the short run at present.
e.g.- Depreciation on Plant, Rent etc.
38. INVENTORIABLE COSTS AND PERIOD
COSTS
Inventoriable cost is that cost which is regarded as asset
when incurred, but becomes a part of cost of goods sold
when the product is
sold.
- All manufacturing cost is inventoriable cost.
(Raw material to WIP to Finished goods)
- For a service sector unit, absence of inventory means all are
period costs.
Period costs (non-product cost): all costs in P&L account
except cost of goods sold.
So, in a manufacturing sector, all non-manufacturing costs
are period costs. (e.g. Distribution cost, design cost, R&D costs,
Marketing costs, customer-service costs etc.)
39. Income Statement
Manufacturing Company
Beg. WIP
+ Direct Mat’l
Used
+ Direct Labor
+ Mfg. Overhead
- End. WIP
=
Cost of Goods Mfg.
Beg. Fin. Goods
+
Rs 24,00,000
Cost of Goods Mfg.
-
End. Finished Goods
=
Rs 26,00,000
Cost of Goods Sold
Rs 40,00,000
Sales
-
Rs 26,00,000
Cost of Goods Sold
=
Rs 14,00,000
Gross Margin
-
• Selling expenses
• Admin. expenses
• Income taxes
Rs 9,00,000
Other Oper.Expenses
=
Rs 5,00,000
Net Income
40. • Selling Expenses
• Administrative Expenses
• Income taxes
• Direct Materials/ Supplies
• Direct Labor
• Indirect Costs or Overhead
INCOME STATEMENT
- Service Organization
Rs 26,00,000
Cost of Services
Rs 9,00,000
Operating Expenses
Rs 40,00,000
Sales
Rs 5,00,000
Net Income
Rs 14,00,000
Gross Margin
-
=
-
=
41. Cost Classifications for Predicting Cost
Behaviour
How a cost will react to changes in the level of
activity within the relevant range.
Total variable costs change when activity
changes.
Total fixed costs remain unchanged when activity
changes.
42. Total fixed costs do not respond to changes
in unit level cost drivers within a period.
Total
fixed
costs (Y)
Total activity (X)
0
0
Basic Cost Behavior Patterns
43. Fixed Cost
Your monthly basic telephone bill probably does not
change when you make more local calls.
Number of Local Calls
Monthly
Basic
Telephone
Bill
44. Fixed Cost Per Unit
The average fixed cost per local call decreases as more
local calls are made.
Number of Local Calls
Monthly
Basic
Telephone
Bill
per
Local
Call
45. Committed fixed costs are
required to maintain the
current service or production
capacity to fill previous legal
commitments.
Fixed Costs
46. Discretionary fixed costs are set at a fixed
amount each year at the discretion of
management.
Fixed Costs
47. Total variable costs increase in proportion
to increases in unit level cost drivers.
Total
variable
costs (Y)
Total activity (X)
0
0
Basic Cost Behavior Patterns
48. Variable Cost
Your total long distance telephone bill is based on how
many minutes you talk.
Minutes Talked
Total
Long
Distance
Telephone
Bill
49. Variable Cost Per Unit
The cost per long distance minute talked is constant. For
example, Rs 5/- per minute.
Minutes Talked
Per
Minute
Telephone
Charge
50. Cost Classifications for Predicting Cost
Behaviour
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
51. Quick Check
Which of the following costs would be variable
with respect to the number of cones sold at a B
& R shop?
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
52. Quick Check
Which of the following costs would be variable
with respect to the number of cones sold at a B
& R shop?
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
53. Total mixed costs contain fixed and variable
cost elements. They increase, but not in direct
proportion to increases in unit level cost drivers.
Total
mixed
costs (Y)
Total activity (X)
0
0
Sometimes
called
semivariable
costs
Basic Cost Behavior Patterns
54. Total step costs are constant over a range of
activity for a unit level cost driver but moves to
a different amount at different ranges.
Total
step
costs (Y)
Total activity (X)
0
0
Basic Cost Behavior Patterns
55. Variable costs--The cost of the ingredients used to make the
pizzas
Fixed costs--Depreciation, property taxes, and property
insurance
Mixed costs--Cost of electricity
Step costs--Employee wages
Basic Cost Behavior Patterns
Pizza Hut
56. Total
costs
(Y)
Value of independent variable (X)
0
0
Fixed costs (a)
Variable costs (b)
Total costs
Y = a + bX
Variable costs are
layered on top of
fixed costs.
Slope,
b =
Y
X
Total Cost Behavior With A Single
Unit Level Cost Driver
57. Y = a + bX
total costs
vertical axis intercept
(an approximation of
fixed costs)
slope (an
approximation of
variable costs per unit
of X)
value of
independent
variable
Equation for Total Costs
58. High activity period
Low activity period
Number of Packaging
Shipments Costs
January 6,000 Rs 17,000
February 9,000 26,000
March 12,000 32,000
April l0,000 20,000
Variable cost
per unit (b) =
Difference in total costs
Difference in activity
b = Rs 32,000 - Rs17,000
12,000 - 6,000
High-Low Cost Estimation
59. Variable cost
per unit (b) = Rs 2.50
January
a = Total costs - Variable costs
Rs 17,000 = a + (Rs 2.50 x 6,000 shipments)
a = Rs 2,000
March
Rs 32,000 = a + (Rs 2.50 x 12,000 shipments)
a = Rs 2,000
Same answer!
High-Low Cost Estimation
60. Y = Rs 2,000 x Rs 2.50X
Total packing
department costs
Number of
shipments
High-Low Cost Estimation
61. Direct materials, the cost
of primary raw materials
converted into finished
goods. The word “direct”
indicates costs that are
easily or directly traced to a
finished product or service.
Direct labor, the wages earned by
production employees for the time
they spend converting raw
materials into finished products.
Manufacturing overhead
includes all manufacturing costs
other than direct materials and
direct labor.
Composition of
Manufacturing Costs
63. Composition of
Manufacturing Costs
Prime costs = Direct materials + Direct labor
Conversion costs = Direct labor +
Manufacturing overhead (fixed & variable)
64. Percent of Total
Manufacturing
Costs
0
100
1980 2000 2019
Year
Total
manufacturing
costs
Direct materials has increased
Direct labor has decreased
Manufacturing overhead has
increased
Changing Composition of
Total Manufacturing Costs
65. The Basic Concept of
Overhead Application
Applied overhead is the basis for computing per-unit
overhead cost
Applied overhead is rarely equal to a period's actual
overhead costs.
Applied overhead = Overhead rate x Actual activity
Key considerations
66. CONVENTIONAL PRODUCT COSTING
Overhead Application
Predetermined Total budgeted overhead
Overhead Rate = Expected level of activity *
• Conventional costing typically used volume (or a
surrogate for volume such as DLH)
• Problems
- Budgeted overhead contains both fixed and
variable costs
- Selection of expected level of activity
67. Select An Appropriate Activity Base
Criterion:
Cause and Effect
Relationship
Possible Measures of
Production Activity
1. Units produced
2. Direct labor
hours
3. Direct labor rupees
4. Machine hours
5. Direct materials
Choice of Activity
Base to be Used
for Computing the
Predetermined
Overhead Rate
68. Comparison of Traditional and
Contemporary Cost Management
Systems
Cost
Information
System
Traditional Contemporary
1. Unit-based drivers
2. Allocation intensive
3. Narrow view of
product costs
4. Focus on cost mgt.
5. Little activity information
6. Maximizes unit
production
7. Uses financial measures
of performance
1. Uses of nonunit drivers
2. Tracing intensive
3. Expanded product costing
4. Managing activities
5. Detailed activity
information
6. System-wide performance
appraisals
7. Use of nonfinancial
measures of performance
