DIFFERENCE BETWEEN COST & PRICE

IMT 2412INDUSTRIAL MANAGEMENT

INTRODUCTION TO BUSINESS FINANCE

MR REKAJON BIN NGADIMUN

ABDUL HALIM BIN KALYUBIABDUL AZIZ BIN JAAFARMUHAMMAD IZZAT BIN ZAINAL

INTRODUCTION TO BUSINESS FINANCE

Financial AccountingManagement AccountingProject Accounting Cash-Flow StatementFINANCIAL ACCOUNTINGKeeps a record of all the financial transactions,payments in and payments out.Information gives the financial status of a company using the generally accepted accounting principles.Three main reports are: a)the balance sheet. b)the income statement. c)the cash-flow statement. MANAGEMENT ACCOUNTINGAlso called cost accounting,uses the above financial information.This analysis will assist management decision-making with respect to estimating,planning,budgeting,implementation and control.PROJECT ACCOUNTINGUses a combination of booth financial accounting and management accounting.Some special project management tools(WBS,CPM and earned value)to integrate the project account.CASH-FLOW STATEMENTDocument which models the flow of money in and out of the project.The time frame is usually monthly,to coincide with the normal business accounting cycle.Based on the same information used in a typical bank statement,except that here the income(cash inflow)and expenditure(cash outflow).The contractors income would come from the monthly progress payments,and the expenses would be wages,materials,overheads,interest and bought in services.

DIFFERENCE BETWEEN COST & PRICECost : is the expense that a business incurs in bringing a product or service to market.Price : is the amount a customer pays for that product or service.

CLASSIFICATION OF COSTS

INTRODUCTION TO COST ACCOUNTING:Cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets financial and non-financial information for 3 major purposes, they are, 1.Ascertainment of cost of a product or service 2.Operational planning and control3.Decision making

Classification of costs: Cost classification is the process of grouping costs according to their common features or characteristics. Classification of costs is necessary for detailed recording and accurate cost ascertainment. Cost can be classified according to, 1.Elements 2.Functions 3.Behaviour

Classification on the basis of element of cost:On the basis of element of cost can be classified into following types, 1.Direct materials- Direct materials are those materials which enter into part of the product, the cost of which from part of the prime cost. Direct materials are also called process materials or prime cost materials . It includes all materials specially purchased for a particular process, job or production order. Ex-The clay in bricks, the wood in furniture, the leather in shoes etc.

2.Indirect materials - Indirect materials are those which can not be traced as a part of the product. But they are necessary for the production process. Indirect materials are also known as on cost materials or expense materials. Ex- Fuel, lubricating oil etc required for operating and maintaining plant and machinery Small tools for general use

3.Direct wages -Direct wages are the cost of remuneration, such as wages, salaries, commissions, bonus etc Direct wages refers to the cost of wages paid to operatives who help in altering the construction, composition, conformation or condition of the product manufactured by a concern. Ex- wages paid to drivers It is also called as direct labor or productive labor or process labor.

4.Indirect wages - Indirect wages represent the cost of labor employed in the works or factory which is ancillary to production. In short, wages which can not be directly identified with a job, process or operation are generally treated as indirect wages. Ex-a. General indirect labour such as inspectors, supervisors etc b.Micsellaneous allowances to labour.

5.Direct Expenses -Direct expenses are those which are neither direct material cost nor direct wages but directly identifiable with a job process or operation. Direct expenses are also known as chargeable expenses, prime cost expenses, productive expenses etc Ex-a. Hire charge of a special concrete mixer required for civil engineering job. b. Cost of special pattern, drawing or layout.

6. Indirect expenses -Indirect expenses which can not be charged to a product directly and which are neither indirect material cost nor indirect wages are regarded as indirect expenses. Ex-a. Rent, rates and taxes b. Insurance c. Canteen expenses

On the basis of functions of manufacturing concerns the costs can be classified to the following types

1.Product cost -This is the cost of sequence of operations which begins with supplying materials, labour and services and ends with primary packing of the product. Therefore production represents prime cost + absorbed production over head

Classification on the basis of Functions:

1.Variable cost- It is the cost which tends to follow (in the short term) the level of activity , this cost will tend to vary directly with output. Variable costs are also known as direct costs. Ex- a. Direct materials b. Direct labor c. Direct expenses

2.Administration cost-It refers to the cost of management and of secretarial accounting and administrative service, which can not be directly related to production, marketing, research or development functions of the enterprise. In short administration expenses are in the nature of indirect expenses and include the following, Ex-a. Salaries of office staff, accountants directors etc b. Maintainance of factory estate etc

3.Marketing cost- The cost incurred in researching the potential markets and promoting products in suitable attractive forms and at acceptable prices. It includes the selling cost, publicity cost, distribution cost etc

Classification on the basis of Behviourwise:With the increase or decrease in production , some costs will increase or decrease directly, some costs will remain unaffected while others will change but not in direct proportion to the change in volume , thus costs can be grouped according to their behaviour as,

2.Fixed cost -It is defined as the cost which accures in relation to the passage of time and which within certain output and turnover limits, tends to be unaffected by fluctuations in the levels of activity ( output or turnover). Other terms used include period cost and policy cost. Ex-a. Rent and rates of the factory building b. Depreciation of building c. Insurance

3.Mixed cost- These contains both fixed and variable characteristics over various relevant ranges of operation. These are 2 types, 1.Semi-variable cost-The fixed part of a semi-variable cost usually represents a minimum fee for making a particular item/service available. The variable portion is the cost charges for actually using the service. Ex-Truck rentals, equipment rentals and utilities

Step cost -The fixed part of step costs changes abruptly at various levels of activity because these costs are acquired in indivisible portions. A step cost is similar to a fixed cost within a very small relevant range. Ex-a. salary to supervisor b. Inspection cost

BREAK EVEN CALCULATERFixed Cost:The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed.

Variable Unit Cost:Costs that vary directly with the production of one additional unit. Expected Unit Sales:Number of units of the product projected to be sold over a specific period of time.

Unit Price:The amount of money charged to the customer for each unit of a product or service.

Total Variable Cost:The product of expected unit sales and variable unit cost. (Expected Unit Sales * Variable Unit Cost )

Total Cost:The sum of the fixed cost and total variable cost for any given level of production. (Fixed Cost + Total Variable Cost )

Total Revenue:The product of expected unit sales and unit price. (Expected Unit Sales * Unit Price )

Profit (or Loss):The monetary gain (or loss) resulting from revenues after subtracting all associated costs. (Total Revenue - Total Costs)

BREAK EVEN POINT:Number of units that must be sold in order to produce a profit of zero (but will recover all associated costs).

Break Even Point (IN UNIT)= Fixed Cost /S. Price- Variable Unit Cost

Break Even Point (in Rs)=Fixed Cost/ S. Price-Variable unit Cost*Units

For example, suppose that your fixed costs for producing 100,000 product were 30,000 RM a year.Your variable costs are RM2.20 materials, RM4.00 labour, and RM0.80 overhead, for a total of RM7.00 per unit.If you choose a selling price of RM12.00 for each product, then:30,000 divided by (12.00 - 7.00) equals 6000 units.This is the number of products that have to be sold at a selling price of RM12.00 before your business will start to make a profit.

Break-Even AnalysisCosts/RevenueOutput/SalesInitially a firm will incur fixed costs, these do not depend on output or sales.FCAs output is generated, the firm will incur variable costs these vary directly with the amount producedVCThe total costs therefore (assuming accurate forecasts!) is the sum of FC+VCTCTotal revenue is determined by the price charged and the quantity sold again this will be determined by expected forecast sales initially.TRThe lower the price, the less steep the total revenue curve.TRQ1The Break-even point occurs where total revenue equals total costs the firm, in this example would have to sell Q1 to generate sufficient revenue to cover its costs.Break-Even AnalysisCosts/RevenueOutput/SalesFCVCTCTR (p = 2)Q1If the firm chose to set price higher than 2 (say 3) the TR curve would be steeper they would not have to sell as many units to break evenTR (p = 3)Q2Break-Even AnalysisCosts/RevenueOutput/SalesFCVCTCTR (p = 2)Q1If the firm chose to set prices lower (say 1) it would need to sell more units before covering its costsTR (p = 1)Q3Break-Even AnalysisCosts/RevenueOutput/SalesFCVCTCTR (p = 2)Q1Q2Assume current sales at Q2Margin of SafetyMargin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be madeTR (p = 3)Q3A higher price would lower the break even point and the margin of safety would widenUSES OF BREAK EVEVN POINTHelpful in deciding the minimum quantity of salesHelpful in the determination of tender priceHelpful in examining effects upon organizations profitabilityHelpful in deciding about the substitution of new plantsHelpful in sales price and quantityHelpful in determining marginal cost

LIMITATIONS Break-even analysis is only a supply side (costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. It assumes that fixed costs (FC) are constant It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period. In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant.