Chapter 2 Cost Classification & Cost Behaviour Ibrahim Sameer (MBA - Specialized in Finance, B.Com Specialized in Accounting & Marketing)
Total Cost / Service Costs The total cost of making a product or providing a service consists of the following: Cost of materials Cost of the wages and salaries (labour costs) Cost of other expenses (rent and rates, electricity bill, depreciation)
Direct Cost & Indirect Cost A direct cost is a cost that can be traced in full to the product, service, or department that is being costed. An indirect cost (or overhead) is a cost that is incurred in the course of making a product, providing a service or running a department, but which cannot be traced directly and in full to the product, service or department.
Examples of Direct Cost & Indirect Cost
Direct Cost & Indirect Cost
Direct Cost & Indirect Cost Direct Materials Direct materials is all material becoming part of the product. For eg: component part, part finished product, primary packing materials.
Direct Cost & Indirect Cost Direct Labour Direct wages are all wages paid for labour expended on work on the product itself.
Direct Cost & Indirect Cost Direct Expenses Direct expenses are any expenses which are incurred on a specific product other than direct material cost and direct wages. It is also referred as chargeable expenses. For eg: the hire of tool or equipment for particular job, maintenance costs of tool.
Direct Cost & Indirect Cost Prime cost: is total of direct materials, direct labour & direct expenses.
Direct Cost & Indirect Cost Production overhead Production OH include all indirect material costs, indirect wages and indirect expenses incurred in the factory from receipt of the order until its completion.
Functional Costs Classification by Function Classification by function involves classifying costs as production / manufacturing costs, administration costs or marketing / selling and distribution cost.
Functional Costs Functional cost Includes: Production cost Administration cost Selling cost Distribution costs
Fixed Costs & Variable Costs A fixed cost is a cost which is incurred for a particular period of time and which, within certain activity levels, is unaffected by changes in the level of activity. Eg: Rent
Fixed Costs & Variable Costs A variable cost is a cost which tends to vary with level of activity. Eg: Direct materials, sales commission
Fixed Costs & Variable Costs Many items of expenditure are part fixed and part variable and hence are termed as semi fixed or semi variable costs. Eg: telephone call charges
Production & Non Production Cost For the preparation of financial statements, costs are often classified as production costs and non production costs.
Production & Non Production Cost Production costs are all the costs involved in the manufacture of goods. In the case of manufactured goods, these costs consist of direct material, direct labour and manufacturing overheads.
Production & Non Production Cost Non - Production costs are taken directly to the income statement as expenses in the period in which they are incurred; such cost consist of selling and administrative expenses.
Controllable cost & Period cost Controllable cost Controllable costs are items of expenditure which can be directly influenced by a given manager within a given time span. OR A cost which can be influenced by its budget holder.
Controllable cost & Period cost Period cost Period costs is charged against the sales for the period. It is not carried forward in inventory to a future period. OR A cost that relates to a time period which is deducted as expenses for the period and is not included in the inventory valuation.
Introduction to Cost Behaviour Cost behaviour is the way in which costs are affected by changes in the volume of output. The basic principle of cost behaviour is that as the level of activity rises, costs will usually rise. It will cost more to produce 2,000 unit of output than it will cost to produce 1,000 units.
Cost Behaviour Pattern Fixed cost A fixed cost is a cost which tends to be unaffected by increases or decreases in the volume of output.
Cost Behaviour Pattern Examples of fixed cost include: The salary of the MD (per month or per annum) The rent of a single factory building (per month or per annum) Straight line depreciation of a single machine (per month or per annum)
Cost Behaviour Pattern Step cost A step cost is a cost which is fixed in nature but only within certain level of activity.
Cost Behaviour Pattern Examples of step cost include: Basic pay of employees is nowadays usually fixed, but as output rises, more employees are required. Royalties
Cost Behaviour Pattern Variable cost A variable cost is a cost which tends to vary directly with the volume of output. The variable cost per unit is the same amount for each unit produced.
Cost Behaviour Pattern Semi Variable cost A semi-variable/semi-fixed/mixed cost is a cost which contains both fixed and variable components and so is partly affected by changes in the level of activity.
Cost Behaviour Pattern Examples of these costs include the following: Electricity and gas bill FC = standing charges VC = charge per unit of electricity used Cost of running car FC = road tax, insurance VC = petrol, oil, repair
Cost Behaviour Pattern Cost behaviour and cost per unit The following tables relates to different level of production of the zed. The variable cost of producing a zed is $5. Fixed costs are $5,000.
Cost Behaviour Pattern What happen when activity level rise can be summarised as follows:
Cost Behaviour Pattern The variable cost per unit remain constant. The fixed cost per unit falls The total cost per unit falls
Determining the fixed & variable elements of semi-variable cost The fixed & variable elements of semi variable cost can be determined by the high low method. Steps in high low method are as follows:
Determining the fixed & variable elements of semi-variable cost
Linear Equation A linear equation is a straight line and has the general form where y = a + bx y = is the dependent variable x = is the independent variable a = is a constant, that is fixed amount b = is also constant, being coefficient of x
Questions & Answers
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