Description
Cost Structure and its classification and it contains topics like basic definations, functional qualifications, classification according to variablity, elements of cost
CLASSIFICATION
OF COSTS
Some basic definitions:
Cost Centre: A cost centre is a location, person or item of equipment, in respect of which costs may be ascertained and related to cost units for control purposes. e. g. production department, service department, foreman, Customer, vehicles, a group of machines, etc. Cost Unit: A cost unit is a unit of production, service or time in relation to which costs may be ascertained or expressed. e.g. Kilowatt-hour, Tonne-kilometre, etc. Cost allocation: It is the allotment of whole items of costs to cost centres or cost units. Cost apportionment: It is the allotment of proportions of items of costs to cost centres or cost units.
COST CLASSIFICATION:
Costs can be classified in a number of ways. The more important classifications are as under:
Direct and Indirect costs:
A cost that can be economically and conveniently traced to a cost centre, i.e. that can be allocated to a cost centre is a direct cost of that cost centre, e. g. cost of wood in manufacture of windows.
The cost which is apportioned to different cost centres on some suitable basis is an indirect cost for each of those cost centres. e.g. cost of electricity consumed for manufacture of windows.
Functional classification
Classification according to the purpose for which they are incurred: e.g. Production cost Administration cost Selling cost Distribution cost
Research and Development cost
Classification according to variability: Fixed costs and Variable costs:
Fixed costs are costs which tend to be unaffected by variations in volume of output. These are generally costs related to creation of capacity e.g. depreciation, or contractual costs e. g. rent, salary of managers, insurance of factory buildings, etc.
Variable costs are costs which tend to vary directly with volume of output. e.g. direct materials, direct wages, direct expenses and variable overheads
Degree of association with the product
On this basis, costs are classified into „product costs? and „period costs?.
Product costs: These are the costs which are to be included in the valuation of inventories. These would typically include all direct costs and appropriate manufacturing and administrative overheads necessarily incurred for bringing the inventory into its present state and condition. Parts of administrative overheads not related to manufacturing activity and selling and distribution overheads are treated not as product costs, but as period costs. e.g. depreciation on manufacturing machinery, other manufacturing overheads, etc. Period costs: These are indirect costs which are charged off as expenses in the period in which they are incurred. They are not associated with the products manufactured during the relevant period. e.g. interest on loans, audit fees, selling and distribution overheads, etc.
Controllability of costs:
Controllable costs: These can be influenced by the action of a given member, e.g. direct materials, wages or expenses are generally controllable by the shop level management.
Uncontrollable costs: These can not be influenced by the action of a given member of the hierarchy. e.g. share of tool-room expenses apportioned to a machine shop is not controllable at the level of the machine shop foreman. Costs not controllable by an individual, may be controllable at a higher level in the hierarchy. Costs, which are uncontrollable in the short term, generally become controllable in the long term.
Normality of costs:
Normal costs: A cost which is normally incurred at a given level of output in the conditions in which that level of output is normally attained. Abnormal costs: A cost which is not normally incurred at a given level of output under normal conditions.
Relevant and Irrelevant costs:
Relevant costs are those costs which are relevant for decision-making, e.g. marginal costs, opportunity costs, differential costs etc. (explained later)
Irrelevant costs are those costs which have no bearing on the decision to be made, e.g. sunk costs, committed costs, etc.
Classification according to elements of cost:
Overview: Direct materials Direct wages Direct expenses Indirect materials Production overhead
Prime cost
Indirect wages Indirect expenses
Administration overhead
Selling & Distribution Overhead
Elements of cost:
Direct materials cost: This is the cost of materials which can be economically or conveniently identified with and allocated to cost centres or cost units, e.g. main raw materials, primary packing materials, etc.
Direct wages cost: These are wages which can be easily allocated to cost centres, e.g. wages of workers who are directly involved in the manufacturing operations.
Direct expenses: These are expenses which can be directly Identified with the job, order or process, e.g. cost of special designs or drawings, cost of hiring special tools for a job.
Elements of cost: (Contd.)
Production or factory overhead:
Indirect material: Material that can not be easily traced in the finished product, e.g. consumable stores such as lubricants, cotton waste, grease, oil, etc.
Indirect wages: Wages that are not charged directly, e. g. maintenance labour, internal transport, watch and ward, etc.
Indirect expenses: Indirect costs other than material or labour, e.g. factory rent, rates, insurance, depreciation of machinery, etc.
Elements of cost: (Contd.)
Administrative overheads: Includes all indirect costs incurred in the direction, control and administration of an undertaking, e.g. printing and stationery, office salaries, rent, lighting, cleaning of general office, legal charges, audit fees, etc.
Selling and distribution overhead: Includes all indirect costs incurred in promoting sales, retaining custom, and dispatching, e.g. mailing literature, catalogues, remuneration of sales staff, indirect packing material, wages of packers, carriage outward, etc.
Some costs which are relevant for decision-making
Marginal cost: This is the total variable cost. It varies directly with production.
Differential cost:: It is the change in costs due to change in the level of activity or pattern or method of production. In case of increase, they are incremental costs, and in case of decrease they are called decremental costs.
Opportunity costs: It is the benefit or contribution foregone due to not availing the other alternative. This cost is relevant where alternatives are available.
Out-of-pocket costs: These entail current or near future outlays for the decision at hand.
Some costs which are relevant for decisionmaking (contd.)
Replacement costs: It is the cost of replacement at current market price of an asset or material that is being replaced or revalued.
Imputed costs: These are notional costs which are relevant e.g. where alternative capital investments are being evaluated, it is necessary to consider the imputed interest on capital.
Some costs which are irrelevant for decisionmaking:
Sunk cost: It is cost which is already incurred or “sunk” in the past, e.g. book value of assets which are to be scrapped.
Committed cost: A cost which has been already committed by the management is not relevant for decision making.
Absorbed fixed cost: Fixed costs which are already absorbed in the cost of production at the normal rate are not relevant for decision-making
doc_270493815.ppt
Cost Structure and its classification and it contains topics like basic definations, functional qualifications, classification according to variablity, elements of cost
CLASSIFICATION
OF COSTS
Some basic definitions:
Cost Centre: A cost centre is a location, person or item of equipment, in respect of which costs may be ascertained and related to cost units for control purposes. e. g. production department, service department, foreman, Customer, vehicles, a group of machines, etc. Cost Unit: A cost unit is a unit of production, service or time in relation to which costs may be ascertained or expressed. e.g. Kilowatt-hour, Tonne-kilometre, etc. Cost allocation: It is the allotment of whole items of costs to cost centres or cost units. Cost apportionment: It is the allotment of proportions of items of costs to cost centres or cost units.
COST CLASSIFICATION:
Costs can be classified in a number of ways. The more important classifications are as under:
Direct and Indirect costs:
A cost that can be economically and conveniently traced to a cost centre, i.e. that can be allocated to a cost centre is a direct cost of that cost centre, e. g. cost of wood in manufacture of windows.
The cost which is apportioned to different cost centres on some suitable basis is an indirect cost for each of those cost centres. e.g. cost of electricity consumed for manufacture of windows.
Functional classification
Classification according to the purpose for which they are incurred: e.g. Production cost Administration cost Selling cost Distribution cost
Research and Development cost
Classification according to variability: Fixed costs and Variable costs:
Fixed costs are costs which tend to be unaffected by variations in volume of output. These are generally costs related to creation of capacity e.g. depreciation, or contractual costs e. g. rent, salary of managers, insurance of factory buildings, etc.
Variable costs are costs which tend to vary directly with volume of output. e.g. direct materials, direct wages, direct expenses and variable overheads
Degree of association with the product
On this basis, costs are classified into „product costs? and „period costs?.
Product costs: These are the costs which are to be included in the valuation of inventories. These would typically include all direct costs and appropriate manufacturing and administrative overheads necessarily incurred for bringing the inventory into its present state and condition. Parts of administrative overheads not related to manufacturing activity and selling and distribution overheads are treated not as product costs, but as period costs. e.g. depreciation on manufacturing machinery, other manufacturing overheads, etc. Period costs: These are indirect costs which are charged off as expenses in the period in which they are incurred. They are not associated with the products manufactured during the relevant period. e.g. interest on loans, audit fees, selling and distribution overheads, etc.
Controllability of costs:
Controllable costs: These can be influenced by the action of a given member, e.g. direct materials, wages or expenses are generally controllable by the shop level management.
Uncontrollable costs: These can not be influenced by the action of a given member of the hierarchy. e.g. share of tool-room expenses apportioned to a machine shop is not controllable at the level of the machine shop foreman. Costs not controllable by an individual, may be controllable at a higher level in the hierarchy. Costs, which are uncontrollable in the short term, generally become controllable in the long term.
Normality of costs:
Normal costs: A cost which is normally incurred at a given level of output in the conditions in which that level of output is normally attained. Abnormal costs: A cost which is not normally incurred at a given level of output under normal conditions.
Relevant and Irrelevant costs:
Relevant costs are those costs which are relevant for decision-making, e.g. marginal costs, opportunity costs, differential costs etc. (explained later)
Irrelevant costs are those costs which have no bearing on the decision to be made, e.g. sunk costs, committed costs, etc.
Classification according to elements of cost:
Overview: Direct materials Direct wages Direct expenses Indirect materials Production overhead
Prime cost
Indirect wages Indirect expenses
Administration overhead
Selling & Distribution Overhead
Elements of cost:
Direct materials cost: This is the cost of materials which can be economically or conveniently identified with and allocated to cost centres or cost units, e.g. main raw materials, primary packing materials, etc.
Direct wages cost: These are wages which can be easily allocated to cost centres, e.g. wages of workers who are directly involved in the manufacturing operations.
Direct expenses: These are expenses which can be directly Identified with the job, order or process, e.g. cost of special designs or drawings, cost of hiring special tools for a job.
Elements of cost: (Contd.)
Production or factory overhead:
Indirect material: Material that can not be easily traced in the finished product, e.g. consumable stores such as lubricants, cotton waste, grease, oil, etc.
Indirect wages: Wages that are not charged directly, e. g. maintenance labour, internal transport, watch and ward, etc.
Indirect expenses: Indirect costs other than material or labour, e.g. factory rent, rates, insurance, depreciation of machinery, etc.
Elements of cost: (Contd.)
Administrative overheads: Includes all indirect costs incurred in the direction, control and administration of an undertaking, e.g. printing and stationery, office salaries, rent, lighting, cleaning of general office, legal charges, audit fees, etc.
Selling and distribution overhead: Includes all indirect costs incurred in promoting sales, retaining custom, and dispatching, e.g. mailing literature, catalogues, remuneration of sales staff, indirect packing material, wages of packers, carriage outward, etc.
Some costs which are relevant for decision-making
Marginal cost: This is the total variable cost. It varies directly with production.
Differential cost:: It is the change in costs due to change in the level of activity or pattern or method of production. In case of increase, they are incremental costs, and in case of decrease they are called decremental costs.
Opportunity costs: It is the benefit or contribution foregone due to not availing the other alternative. This cost is relevant where alternatives are available.
Out-of-pocket costs: These entail current or near future outlays for the decision at hand.
Some costs which are relevant for decisionmaking (contd.)
Replacement costs: It is the cost of replacement at current market price of an asset or material that is being replaced or revalued.
Imputed costs: These are notional costs which are relevant e.g. where alternative capital investments are being evaluated, it is necessary to consider the imputed interest on capital.
Some costs which are irrelevant for decisionmaking:
Sunk cost: It is cost which is already incurred or “sunk” in the past, e.g. book value of assets which are to be scrapped.
Committed cost: A cost which has been already committed by the management is not relevant for decision making.
Absorbed fixed cost: Fixed costs which are already absorbed in the cost of production at the normal rate are not relevant for decision-making
doc_270493815.ppt