Professional Documents
Culture Documents
What is a Cost?
A cost can be defined as the value attributed to a resource.
There are three elements of a cost - material, labour and services (expenses) for a manufacturing organization.
Cost data are internal for an organization and are normally not disclosed to outsiders unlike Balance Sheet and Profit and Loss Statements though these statements themselves may be based on cost data.
These developments are interesting and exciting, but they are also challenging cost accounting systems to provide reliable useful information and that can be used to keep a company efficient and, most of all, competitive in the global market.
Historic costs are used for comparison with budgeted performance in order to highlight areas where control action may be necessary.
Revenue Costs
Incurred when running the business and charged to the P&L account.
Capital Costs
Incurred in acquiring long-term assets, which are not purchased for resale purposes. This expenditure is shown in the balance sheet.
Controllable Costs
Variable costs such as raw materials, labour, and other overheads deemed controllable by management. Some fixed costs (discretionary costs), such as advertising, accounting, legal and R&D can be controlled in the short run.
Uncontrollable Costs
Cannot be controlled by a specified member / department of an undertaking. Most of the fixed cost are uncontrollable cost. For example, factory manager's salary, Depreciation etc. Committed costs like rent etc.
Product Costs
Those costs identified as part of stock are called product costs, and only become expenses in the form of cost of goods sold when the stock is sold.
Period Costs
Those costs that are not identified with stock are called period costs and are deducted as expenses during the period in which they are incurred. They are not carried forward in the closing stock to the next period.
Direct Costs
All costs which are identifiable with the end-product: Raw material used in manufacturing the product - direct material; machine operators who make the product - direct labor; royalties paid or special plant hired direct expenses.
Indirect Costs
All costs which are not identifiable with the end-product: Lubricants and scrap metal indirect material; supervisors indirect labour, rent, rate and depreciation - indirect expenses. Indirect costs are often called overheads.
Administration Overheads
Office Rent Power Salaries Office Utilities
Fixed Cost
Unaffected by changes in the level of activity: Salary Depreciation Rent
Variable Cost
Sensitive to changes in the level of activity: Direct Material Direct Labour Direct Expenses
Mixed Cost
Comprises both fixed and variable elements: Telephone bill having a fixed rental cost & variable costs varying with calls made.
It is important to identify the purpose for which the cost is required in order to classify it correctly.
Cost Object
A cost object is any unit or activity for which management wants to accumulate and measure a cost. The unit or activity may be a product or service unit; a batch of like units; or a contract, project, process, function, goal, department, business segment, or other subdivision of a company. The idea of a cost object is central to cost accounting. A cost object is always present when accumulation, measurement allocation, or reporting of costs occurs.
Cost accounting often involves the calculation of the cost of something - that something is a cost object.
Product Costs
In a manufacturing environment, product costs are those costs that incurred to manufacture inventory.
Thus, until the related goods are sold, product costs represent inventory and they are reported on the balance sheet as an asset. When the goods are ultimately sold, product costs are transferred from the balance sheet to the income statement, where they are deducted from revenue as the cost of goods sold.
Period Costs
Operating expenses that are associated with time periods, rather than with the production of inventory, are referred to as period costs. Period costs are charged directly to expense accounts on the assumption that their benefit is recognized entirely in the period when the cost is incurred. Period costs include all selling expenses, general and administrative expenses, interest expense and income tax expense. In short, period costs are classified on the income statement separately from cost of goods sold, as deductions from a companys gross profit.
Absorption Costing
Each unit of output is charged with both variable and fixed production costs. The fixed production costs are treated as part of actual production. Closing stock is therefore valued on a full production cost basis, and when sold in the next period these costs are released and matched with revenue of that period.
Marginal Costing
Each unit of output is charged with only variable production costs. The fixed production costs are not treated as part of actual production. Most fixed costs, such as rent, depreciation and salaries relate to time and therefore are charged to the period in which they are incurred. Closing stock is therefore valued on a variable production cost basis.
(17000)
(34000) (12000) 4000
(0)
(46000)
(0)
(34000) (12000) 4000 4000
Sales
Cost of Production:
62500 7500
15000 3000 12000 37500 25500 (0) (37500) (0)
62500 7500
15000 3000
Direct Materials
Direct Laour Variable O/H Fixed O/H Less: Closing Stock (NIL) Less: Cost of Opening Stock (5000 units) Less: Fixed O/H Net Profit
(21000) 4000
The difference is one of timing; the actual amount of expenses do not differ, only the periods in which they are charged against profits.
Over the complete life of a product, both methods will show the same total profits, as in the long run, production equals sales.
In practice, some firms incorporate both costing techniques in their accounting systems.
Allows more competitive pricing as fixed overheads are not included in production costs. The contribution approach aids profit planning.
Fixed costs may not be controlled at the departmental level, so should not be included in product costs at cost center level.
The allocation of fixed costs make managers more aware of these costs and of services they provide.
THANK YOU