section 2-basic cost concepts and classifications

7/24/2019 Section 2-Basic Cost Concepts and Classifications

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1

Le Hoang Oanh

BASIC COST CONCEPTSAND CLASSIFICATIONS

Section 2

2

LEARNING OBJECTIVES

Understanding the cost classification in different ways

for different purpose

Identify the types of costs in each classification

Understand the analysis of mixed cost


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3

CONTENTS

Basic Cost concepts

Cost classifications

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BASIC COST CONCEPTS


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COST TERMS

Define

Cost is defined as a resource sacrificed or forgone to achieve a

specific objective in production and business activities of

enterprises.

Cost is classified differently according to the immediate needs

of management

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Financial accounting:

Actual cost

Managerial accounting:

Actual cost, budgeted cost, opportunity cost,

COST IN ACCOUNTING SYSTEM OF ENTERPRISE


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COST

CLASSIFICATION

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COST CLASSIFICATION

6 ways of Costclassification

By functionsBy traceability by associationwith the product

By element By behaviorfor decision

making


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COST CLASSIFICATION BY ELEMENT

Types of cost

Material ExpensesLabour

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Types of costs

Indirect costsDirect costs

COST CLASSIFICATION BY TRACEABILITY


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Direct

materials

Direct costs

Direct labour Direct expenses

- Directly involve to a cost unit.

Easily and conveniently

traced to the particular cost unit

which form partof the endproduct

which involveddirectlyin making the

product

it is rare for expto be directlytraceable to theproduct

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Indirect costs

Indirect

materials

Indirect labour Indirect expenses

as lubricants formachinery

as supervisorsand

maintenanceworkers

as heating andlighting for thefactory

Non-mfg overhead

Manufacturing overhead

still part of the costof making product

Not included inproduction Cost of

goods or for Inventoryvaluation purpose

not easily &

conveniently

traced to the

particular cost

unit



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Cannie Ltd makes dog leads. It buys in leather,

thread and metal clips to make them, employs

people to operate stitching machines and assemble

the finished leads and has various running costs

(overhead) for the rented factory space it uses

Which of the following activities would be

classified as indirect labour

A. Dog lead clip

B. Factory rent

C. Wages for machine operator

D. Wages for factory manager


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COST CLASSIFICATION BY FUNCTION

Productioncosts

Types of costs

Distribution& Selling costs

Administrationcosts

Financing

costs

Costs incurred to

make things & get

them ready to sale

- Direct Materials

- Direct Labour

- Mfg Overhead

Costs incurred to get

the finished items to the

point where people can

buy and persuade

people to buy them.

Costs incurred in co-

ordinating activities

of the production

function and the

distribution and

selling function.

Costs incurred when a

business has to borrow to

purchase non-current

assets or to operate on a

day to day basis


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COST CLASSIFICATION BY ASSOCIATION WITH THEPRODUCT

Types of costs

Period costsProduct costs

Costs of making or buying the

stock item.

No direct relations to the

production of goods or

purchase of goods Identified with the product &

included in inventory values Not identified with product or

job Prior sales: deferred as

inventories; shown on the

balance sheet as assets At the time revenue is realized:

become part of the period costs

(inventory account COGS

account)

charged in the profit and

loss account for the period

in which they are incurred

Not carried forward as a part

of value of inventory to the

next accounting period

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Quick Check

Which of the following costs would beconsidered a period rather than a productcost in 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.


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COST CLASSIFICATION BY BEHAVIOR

Cost behavior is the way that costs change

as the level of activity changes

refers to the amount ofwork done, or the volume

of production

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COST CLASSIFICATION BY BEHAVIOR

Types of costs

Variable costs Fixed costs

Mixed costs

(semi-variable/semi-fixed costs

Stepped fixed

costs


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VARIABLE COSTS

A cost that changes in total in

direct proportion to changes in

the volume of output.

The variable costper unit is the

same for each

unit produced

Variable costs - Cost of raw materials- Direct labour costs

- Purchase price per unit of

materials purchased- Cost per labour hour worked

- Rate of material usage

- Labour productivity

Impliedconstant

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VARIABLE COSTS

Total cost ($)

Level of activity


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Minutes Talked

TotalLongDistance

TelephoneBill

VARIABLE COSTS

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VARIABLE COST PER UNIT

Costper unit

($)

Level of activity


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Minutes Talked

PerMinute

TelephoneCharge

VARIABLE COST PER UNIT

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FIXED COSTS

A cost that remains constant in

total even when the volume of

output changes

Fixed cost per unit will decrease

as more units are produced.

Fixed costs- Salary of managingdirector


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FIXED COSTS

Total cost ($)

Fixed cost

Level of activity

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Number of Local Calls

MonthlyBasic

TelephoneBill

FIXED COSTS


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FIXED COST PER UNIT

Cost perunit ($)

Level of activity

28Number of Local Calls

MonthlyBa

sicTelephoneBill

per

LocalCall

FIXED COST PER UNIT


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Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activitydecreases.

c. Total costs that increase as activityincreases.

d. Total costs that remain constant.

Quick Check

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Variable costs are usually characterized by:

a. Unit costs that decrease as activity

increases.

b. Total costs that increase as activitydecreases.

c. Total costs that increase as activityincreases.

d. Total costs that remain constant.

Quick Check


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Quick Check

Which of the following costs would bevariable with respect to the number of conessold at a Baskins & Robbins shop? (Theremay be more 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.

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STEPPED-FIXED COSTS

Costs that are fixed in nature

within certain level of activity

Stepped-Fixed costs


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Activity

Cost

Total cost remains

constant within anarrow range of

activity.

STEPPED-FIXED COSTS

Activity

Cos

t

Total cost increases to anew higher cost for the next higher

range of activity.

STEPPED-FIXED COSTS


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Total cost ($)

Level of activity

STEPPED-FIXED COSTS

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MIXED COSTS

Part fixed and part variable

Partly affected by changes in the

level of activity.

Mixed costs

Electricity bills =Standing basic charge+ A variable charge per

unit of consumption


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FC y = a

X

Y

MIXED COSTS

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Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

TotalUtilityCost

bX

aX

Y

MIXED COSTS


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MIXED COST

FC = road tax, insurance, VC = petrol, oil, repairs

(vary with miles travelled)

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Are each of the following likely to be variable or fixed

costs

(a) Charges for telephone calls made

(b) Charges for rental of telephone

(c) Annual salary of the chief accountant

(d) Cost of materials used to pack 20 units of

product X into a box

Quick Check


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A production worker is paid a salary of $650 per

month, plus an extra 5 pence for each unit

produced during the month. The month cost is best

described as:

A. A variable cost

B. A fixed cost

C. A step cost

D. A semi-variable cost

Quick Check

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A particular cost is classified as being semi-

variable

If activity increased by 10% what will happen to the

cost per unit?

A. Increase

B. Reduce but not in proportion to the change in

activityC. Reduce in proportion to the change in activity

D. Remain constant

Quick Check


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2 approaches

Estimate b -> ax = y b -> a.

Estimate a -> ax -> b = y ax.

MIXED COST

3 methods

The high-low method

The scattergraph Method: not in this course

The least-squares Regression method: not in this course

To better control mixed costs analyze mixed cost into

fixed component and variable component

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Estimate a:

Determining data points: A1 (x1, y1), , An (xn, yn)

y1 = ax1 +b

yn= axn +b.

Identifying 2 periods with 2 levels of activity within the

relevant range

Lowest level of activity Ai (xi, yi)

yi = axi + b. Highest level of activity Aj (xj, yj)

yj = axj + b.

Solving equations a = yj yi/ xj xi

Estimate b: b = y ax.

THE HIGH-LOW METHOD


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THE HIGH-LOW METHOD

Plot the data points on a graph, connecting the lowest andhighest data point to have the straight lineof mixed cost

x x x

x

x

x

Simple to apply

incorrect

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Month Direct LaborHours

Total maintenancecost ($)

1 1.100 2.650

2 1.000 2.500

3 1.300 3.150

4 1.150 2.700

5 1.400 3.350

6 1.250 2.900

7 1.100 2.650

8 1.200 2.900

9 1.350 3.250

10 1.450 3.400

11 1.150 2.700

12 1.500 3.500

Example:

Determine variable

cost per hour of

maintenance, total

fixed cost of

maintenance,

Cost equation for

maintenance at

Company M

in 2008

THE HIGH-LOW METHOD


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variablecost perhour

=

Totalfixed cost

=

or =

Cost equation for maintenance:

y =

THE HIGH-LOW METHOD

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THE HIGH-LOW METHOD

Relevant range

Total cost($)

Lowactivity level

High activity level

Directlabour hours

3.500

2.500

500

1000 1500


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COST CLASSIFICATION FOR DECISIONMAKING

Every decision involves a choice between at least twoalternatives.

Only those costs and benefits that differ betweenalternatives are relevant in a decision. All other costsand benefits can and should be ignored.

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DIFFERENTIAL COST AND REVENUE

Costs and revenues that differamong alternatives.

Example: You have a job paying $1,500 permonth in your hometown. You have a job offer ina neighboring city that pays $2,000 per month.The commuting cost to the city is $300 per month.

Differential revenue is:

Differential cost is:


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OPPORTUNITY COST

The potential benefit that isgiven up when one

alternative is selected overanother.

Example: If you werenot attending college,you could be earning$15,000 per year.Your opportunity cost

of attending college for oneyear is $15,000.

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Sunk Costs

Sunk costs have already been incurred and cannot bechanged now or in the future. They should be

ignored when making decisions.

Example: You bought an automobile that cost$10,000 two years ago. The $10,000 cost is sunkbecause whether you drive it, park it, trade it, or

sell it, you cannot change the $10,000 cost.


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Quick Check

Suppose you are trying to decide whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want towaste money needlessly. Is the cost of the trainticket relevant in this decision? In other words,should the cost of the train ticket affect the decisionof whether you drive or take the train to Portland?

A. Yes, the cost of the train ticket is relevant.

B. No, the cost of the train ticket is not relevant.

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Quick Check

Suppose you are trying to decide whether todrive or take the train to Portland to attend aconcert. You have ample cash to do either, butyou dont want to waste money needlessly. Isthe annual cost of licensing your car relevant inthis decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.


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Quick Check

Suppose that your car could be sold nowfor $5,000. Is this a sunk cost?A. Yes, it is a sunk cost.

B. No, it is not a sunk cost.

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End of Section 2

section 2-basic cost concepts and classifications

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