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Classification of cost

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Classification of cost

  1. 1. Classification of Cost
  2. 2. Classification of CostCost may be classified into different categories depending upon the purpose of classification. Some of the important categories in which the costs are classified are as follows:1. Classification of cost methods on the basis of nature of production or manufacturing process i. Job Costing and ii. Process Costing2. Classification of Costs on the basis of their variability in relation to output:- i. Fixed Cost ii. Variable Cost iii. Semi-Variable and Semi-Fixed Cost3. Costs for Managerial Decision Making :- i. Marginal Costing ii. Incremental ( or Differential ) Cost iii. Uniform Costing iv. Opportunity Cost v. Replacement Cost vi. Sunk Cost vii. Relevant Cost Arunraj Arumugam
  3. 3. 4. Costs According to Functions (Manufacturing & Non-Manufacturing Cost):- i. Manufacturing or Production Cost ii. Administrative Cost iii. Selling and Distribution Cost iv. Research & Development Cost v. Pre-Production Cost 5. Classification of cost methods on the basis of Time:- 1. Historical Cost 2. Pre-Determined Costs6. Classification of Costs based on establishment of relationship between input and output:- i. Engineering Cost ii. Managed Cost, discretionary or programmed Cost 7. Controllable and Uncontrollable costs8. Other Types of CostsCosts which arises in a particular contests and which are used for particular purposes are :- Conversion Cost Common Cost Traceable Cost or Directly Attributable Cost Joint Cost Avoidable Cost Unavoidable Cost Total Cost Arunraj Arumugam
  4. 4. Fixed, Variable and Semi-Variable Costs The cost which varies directly in proportion with every increase or decrease in the volume of output or production is known as variable cost. Some of its examples are as follows: • Wages of laborers • Cost of direct material • Power Semi-variable costs are costs that have both a variable and fixed component. Commercial leases often have a fixed rent per month plus an additional rent based on the amount of production or sales. For example, rent is $5,000 plus five cents for each pencil that is made. The base rent of $5,000 is a fixed cost and the five cents per pencil is a variable cost. Step-variable costs are costs that are constant over a range of production. If one employee can make 10,000 pencils, then the employee’s wage is constant over a production range of one to 10,000 pencils. If you produce 11,000 pencils, you will need another employee. So your cost doubles. If you make 25,000 pencils your cost triples because you need three employees. Arunraj Arumugam
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  6. 6. Product Costs and Period CostsProduct costs• The costs which are a part of the cost of a product rather than an expense of the period in which they are incurred are called as “product costs”. e.g., cost of raw materials and direct wages, depreciation on plant and equipment etc.Period costs.• The costs which are not associated with production are called period costs.• They are treated as an expense of the period in which they are incurred. They may also be fixed as well as variable.• Such costs include general administration costs, salaries salesmen and commission, depreciation on office facilities etc. Arunraj Arumugam
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  8. 8. Direct and Indirect Costs• The expenses incurred on material and labor which are economically and easily traceable for a product, service or job are considered as direct costs. In the process of manufacturing of production of articles, materials are purchased, laborers are employed and the wages are paid to them.• The expenses incurred on those items which are not directly chargeable to production are known as indirect costs.For example, salaries of timekeepers, storekeepers and foremen. Also certain expenses incurred for running the administration are the indirect costs. Arunraj Arumugam
  9. 9. Decision-Making Costs and Accounting Costs• Decision-making costs are future costs. They represent what is expected to happen under an assumed set of conditions.• Accounting costs are compiled primarily from financial statements. They have to be altered before they can be used for decision-making Arunraj Arumugam
  10. 10. Relevant and Irrelevant Costs• Relevant costs are those which change by managerial decision.• Irrelevant costs are those which do not get affected by the decision.For example,if a manufacturer is planning to close down an unprofitable retail sales shop, This will affect the wages payable to the workers of a shop. This is relevant in this connection since they will disappear on closing down of a shop. But prepaid rent of a shop or unrecovered costs of any equipment which will have to be scrapped are irrelevant costs which should be ignored. Arunraj Arumugam
  11. 11. Shutdown and Sunk Costs• Sunk costs are historical or past costs. These are the costs which have been created by a decision that was made in the past and cannot be changed by any decision that will be made in the future. – Investments in plant and machinery, buildings etc. • A manufacturer or an organization may have to suspend its operations for a period on account of some temporary difficulties, e.g., shortage of raw material, non-availability of requisite labor etc. During this period, though no work is done yet certain fixed costs, such as rent and insurance of buildings, depreciation, maintenance etc., for the entire plant will have to be incurred. Such costs of the idle plant are known as shutdown costs. Arunraj Arumugam
  12. 12. Learning Objective 1Identify and give examples of each of the three basic manufacturing cost categories. Arunraj Arumugam
  13. 13. Manufacturing Costs Direct Direct Direct Direct Manufacturing ManufacturingMaterialsMaterials Labor Labor Overhead Overhead The Product Arunraj Arumugam
  14. 14. Direct MaterialsRaw materials that become an integral partof the product and that can be conveniently traced directly to it. Example: A radio installed in an automobile Example: A radio installed in an automobile Arunraj Arumugam
  15. 15. Direct LaborThose labor costs that can be easily traced to individual units of product.Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers Arunraj Arumugam
  16. 16. Manufacturing OverheadManufacturing costs cannot be traced directly to specific units produced. Examples: Indirect materials and indirect labor Examples: Indirect materials and indirect laborMaterials used to support Wages paid to employeesthe production process. who are not directly involved in production Examples: Lubricants and work.cleaning supplies used in the Examples: Maintenance automobile assembly plant. workers, janitors and security guards. Arunraj Arumugam
  17. 17. Classifications of Nonmanufacturing Costs Arunraj Arumugam
  18. 18. Learning Objective 2 Distinguish betweenproduct costs and periodcosts and give examples of each. Arunraj Arumugam
  19. 19. Product Costs Versus Period CostsProduct costs include Period costs are notdirect materials, direct included in product labor, and costs. They are manufacturing expensed on the overhead. income statement. Cost ofInventory Goods Sold Expense SaleBalance Income Income Sheet Statement Statement Arunraj Arumugam
  20. 20. Quick Check Which of the following costs would beconsidered a period rather than a product costin 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. Arunraj Arumugam
  21. 21. Quick Check Which of the following costs would beconsidered a period rather than a product costin 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. Arunraj Arumugam
  22. 22. Prime Cost and Conversion Cost Manufacturing costs are often classified as follows: Direct Direct Direct Direct Manufacturing ManufacturingMaterialMaterial Labor Labor Overhead Overhead Prime Conversion Cost Cost Arunraj Arumugam
  23. 23. Comparing Merchandising and Manufacturing ActivitiesMerchandisers . . . Manufacturers . . . – Buy finished goods. – Buy raw materials. – Sell finished goods. – Produce and sell finished goods. MegaLoMart Arunraj Arumugam
  24. 24. Balance Sheet Merchandiser ManufacturerCurrent Assets Current Assets  Cash Cash  Receivables Receivables  Prepaid Expenses Prepaid Expenses  Merchandise Inventories: Inventory 1. Raw Materials 2. Work in Process 3. Finished Goods Arunraj Arumugam
  25. 25. Balance Sheet Merchandiser ManufacturerCurrent Assets Current Assets  Cash Cash  Receivables Receivables Materials waiting to  Prepaid Expenses Prepaid Expenses be processed.  Merchandise Partially complete Inventories: Inventory – some products 1. Raw Materials material, labor, or 2. Work in Process overhead has been 3. Finished Goods added. Completed products Arunraj Arumugam awaiting sale.
  26. 26. Learning Objective 3 Prepare an income statement includingcalculation of the cost of goods sold. Arunraj Arumugam
  27. 27. The Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.Merchandising CompanyCost of goods sold: Beg. merchandise inventory $ 14,200 + Purchases 234,150 Goods available for sale $ 248,350 - Ending merchandise inventory (12,100) = Cost of goods sold $ 236,250 Arunraj Arumugam
  28. 28. Inventory Flows Withdrawals WithdrawalsBeginningBeginning Additions Additions Ending Ending balance balance + to inventory to inventory = balance balance + from from inventory inventory Arunraj Arumugam
  29. 29. Quick Check If your inventory balance at the beginning ofthe month was $1,000, you bought $100during the month, and sold $300 during themonth, what would be the balance at the endof the month?A. $1,000.B. $ 800.C. $1,200.D. $ 200. Arunraj Arumugam
  30. 30. Quick Check If your inventory balance at the beginning ofthe month was $1,000, you bought $100during the month, and sold $300 during themonth, what would be the balance at the endof the month?A. $1,000. $1,000 + $100 = $1,100B. $ 800. $1,100 - $300 = $800C. $1,200.D. $ 200. Arunraj Arumugam
  31. 31. Learning Objective 4Prepare a schedule of cost of goods manufactured. Arunraj Arumugam
  32. 32. Schedule of Cost of Goods Manufactured Calculates the cost of raw material, direct labor andmanufacturing overhead used in production.Calculates the manufacturingcosts associated with goodsthat were finished during the period. Arunraj Arumugam
  33. 33. Schedule of Cost of Goods Manufactured Manufacturing Work As items are removed from As items are removed from Raw Materials Costs In Process raw materials inventory and raw materials inventory and Beginning raw materials inventory placed into the production placed into the production+ Raw materials process, they are called direct process, they are called direct purchased= Raw materials materials. materials. available for use in production– Ending raw materials inventory= Raw materials used in production Arunraj Arumugam
  34. 34. Schedule of Cost of Goods Manufactured Manufacturing Work Conversion Conversion Raw Materials Costs In Process costs are costs costs are costs Beginning raw Direct materials incurred to incurred to materials inventory + Direct labor convert the+ Raw materials + Mfg. overhead convert the purchased = Total manufacturing direct material direct material= Raw materials costs into a finished into a finished available for use product. product. in production– Ending raw materials inventory= Raw materials used As items are removed from raw As items are removed from raw in production materials inventory and placed into materials inventory and placed into the production process, they are the production process, they are called direct materials. called direct materials. Arunraj Arumugam
  35. 35. Schedule of Cost of Goods Manufactured Manufacturing Work Raw Materials Costs In Process Beginning raw Direct materials Beginning work in materials inventory + Direct labor process inventory+ Raw materials + Mfg. overhead + Total manufacturing purchased = Total manufacturing costs= Raw materials costs = Total work in available for use process for the in production period– Ending raw materials – Ending work in inventory All manufacturing costs incurred All manufacturing costs incurred process inventory= Raw materials used during the period are added to the during the period = Cost of goods the are added to in production beginning balance of work in manufactured. beginning balance of work in process. process. Arunraj Arumugam
  36. 36. Schedule of Cost of Goods Manufactured Manufacturing Work Raw Materials Costs In Process Beginning raw Direct materials Beginning work in materials inventory + Direct labor process inventory+ Raw materials + Mfg. overhead + Total manufacturing purchased = Total manufacturing costs= Raw materials costs = Total work in available for use process for the in production period– Ending raw materials – Ending work in inventory process inventoryCosts associated with the goods that Costs associated with the goods that= Raw materials used = Cost of goods areincompletedduring the period are arecompleted during the period are production manufactured. transferred to finished goods transferred to finished goods inventory. inventory. Arunraj Arumugam
  37. 37. Cost of Goods Sold Arunraj Arumugam
  38. 38. Manufacturing Cost Flows Balance Sheet Income Costs Inventories StatementMaterial Purchases Raw Materials Expenses Direct Labor Work in Process Manufacturing Overhead Finished Cost of Goods Goods Sold Selling and Period Costs Selling and Administrative Administrative Arunraj Arumugam
  39. 39. Quick Check Beginning raw materials inventory was$32,000. During the month, $276,000 of rawmaterial was purchased. A count at the end ofthe month revealed that $28,000 of rawmaterial was still present. What is the cost ofdirect material used? A. $276,000 B. $272,000 C. $280,000 D. $ 2,000 Arunraj Arumugam
  40. 40. Quick Check Beginning raw materials inventory was$32,000. During the month, $276,000 of rawmaterial was purchased. A count at the end ofthe month revealed that $28,000 of rawmaterial was still present. What is the cost ofdirect material used? A. $276,000 B. $272,000 C. $280,000 D. $ 2,000 Arunraj Arumugam
  41. 41. Quick Check Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What weretotal manufacturing costs incurred for themonth? A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined. Arunraj Arumugam
  42. 42. Quick Check Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What weretotal manufacturing costs incurred for themonth? A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined. Arunraj Arumugam
  43. 43. Quick Check Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 ofpartially finished goods remaining in work inprocess inventory at the end of the month.What was the cost of goods manufacturedduring the month? A. $1,160,000 B. $ 910,000 C. $ 760,000 D. Cannot be determined. Arunraj Arumugam
  44. 44. Quick Check Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 ofpartially finished goods remaining in work inprocess inventory at the end of the month.What was the cost of goods manufacturedduring the month? A. $1,160,000 B. $ 910,000 C. $ 760,000 D. Cannot be determined. Arunraj Arumugam
  45. 45. Quick Check Beginning finished goods inventory was$130,000. The cost of goods manufactured forthe month was $760,000. The ending finishedgoods inventory was $150,000. What was thecost of goods sold for the month? A. $ 20,000. B. $740,000. C. $780,000. D. $760,000. Arunraj Arumugam
  46. 46. Quick Check Beginning finished goods inventory was$130,000. The cost of goods manufactured forthe month was $760,000. The ending finishedgoods inventory was $150,000. What was thecost of goods sold for the month? A. $ 20,000. B. $740,000. $130,000 + $760,000 = $890,000 $890,000 - $150,000 = $740,000 C. $780,000. D. $760,000. Arunraj Arumugam
  47. 47. Learning Objective 5 Define and giveexamples of variablecosts and fixed costs. Arunraj Arumugam
  48. 48. Cost Classifications for Predicting Cost Behavior How a cost will react to How a cost will react to changes in the level of changes in the level of business activity. business activity.  Total variable costs  Total variable costs change when activity change when activity changes. changes.  Total fixed costs remain  Total fixed costs remain unchanged when activity unchanged when activity changes. changes. Arunraj Arumugam
  49. 49. Total Variable CostYour total long distance telephone bill is based on how many minutes you talk. Minutes Talked Telephone Bill Total Long Distance Arunraj Arumugam
  50. 50. Variable Cost Per UnitThe cost per long distance minute talked isconstant. For example, 10 cents per minute. Minutes Talked Telephone Charge Per Minute Arunraj Arumugam
  51. 51. Total Fixed Cost Your monthly basic telephone billprobably does not change when you make more local calls. Number of Local Calls Telephone Bill Monthly Basic Arunraj Arumugam
  52. 52. Fixed Cost Per UnitThe average fixed cost per local calldecreases as more local calls are made. Monthly Basic Telephone Bill per Local Call Number of Local Calls Arunraj Arumugam
  53. 53. Cost Classifications for Predicting Cost Behavior Behavior of Cost (within the relevant range) Cost In Total Per UnitVariable 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. Arunraj Arumugam
  54. 54. Quick Check Which of the following costs would be variablewith respect to the number of cones sold at aBaskins & Robbins shop? (There may bemore than one correct answer.)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. Arunraj Arumugam
  55. 55. Quick Check Which of the following costs would be variablewith respect to the number of cones sold at aBaskins & Robbins shop? (There may bemore than one correct answer.)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. Arunraj Arumugam
  56. 56. Learning Objective 6 Define and giveexamples of direct and indirect costs. Arunraj Arumugam
  57. 57. Assigning Costs to Cost ObjectsDirect costs Indirect costs• Costs that can be • Costs that cannot be easily and conveniently easily and conveniently traced to a unit of traced to a unit of product or other cost product or other cost object. object.• Examples: Direct • Example: Manufacturing material and direct labor overhead Arunraj Arumugam
  58. 58. Learning Objective 7Define and give examples of cost classifications used inmaking decisions: differentialcosts, opportunity costs, and sunk costs. Arunraj Arumugam
  59. 59. 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 to the decision. All othercosts and benefits canand should be ignored. Arunraj Arumugam
  60. 60. Differential Costs and Revenues Costs and revenues that differ among alternatives.Example: You have a job paying $1,500 per month inyour hometown. You have a job offer in aneighboring city that pays $2,000 per month. Thecommuting cost to the city is $300 per month. Differential revenue is: Differential cost is: $2,000 – $1,500 = $500 $300 Net Differential Benefit is: $200 Arunraj Arumugam
  61. 61. Opportunity CostsThe potential benefit that is given up when one alternative is selected over another. 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. Arumugam Arunraj
  62. 62. Sunk CostsSunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions. 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. Arunraj Arumugam
  63. 63. Quick Check Suppose you are trying to decide whether todrive or take the train to Agra to attend aconcert. You have ample cash to do either, butyou don’t want to waste money needlessly. Isthe cost of the train ticket relevant in thisdecision? In other words, should the cost of thetrain ticket affect the decision of whether youdrive or take the train to Agra? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant. Arunraj Arumugam
  64. 64. Quick Check  Suppose you are trying to decide whether todrive or take the train to Agra to attend aconcert. You have ample cash to do either, butyou don’t want to waste money needlessly. Isthe cost of the train ticket relevant in thisdecision? In other words, should the cost of thetrain ticket affect the decision of whether youdrive or take the train to Agra? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant. Arunraj Arumugam
  65. 65. Quick Check Suppose you are trying to decide whether todrive or take the train to Agra to attend aconcert. You have ample cash to do either,but you don’t want to waste moneyneedlessly. Is the annual cost of licensing yourcar relevant in this decision?A. Yes, the licensing cost is relevant.B. No, the licensing cost is not relevant. Arunraj Arumugam
  66. 66. Quick Check Suppose you are trying to decide whether todrive or take the train to Agra to attend aconcert. You have ample cash to do either,but you don’t want to waste moneyneedlessly. Is the annual cost of licensing yourcar relevant in this decision?A. Yes, the licensing cost is relevant.B. No, the licensing cost is not relevant. Arunraj Arumugam
  67. 67. Quick Check Suppose that your car could be sold now for$5,000. Is this a sunk cost?A. Yes, it is a sunk cost.B. No, it is not a sunk cost. Arunraj Arumugam
  68. 68. Quick Check Suppose that your car could be sold now for$5,000. Is this a sunk cost?A. Yes, it is a sunk cost.B. No, it is not a sunk cost. Arunraj Arumugam
  69. 69. Summary of the Types of Cost Classifications Predicting Financial Cost Reporting Behavior Assigning Decision Costs to Making Cost Objects Arumugam Arunraj

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