Description
This is a presentation explaining cost terms and concepts.
Chapter 3
Cost Terms and Concepts
From the viewpoint of managerial needs, cost concepts fall into four broad categories.
(1) Income Measurement (2) Profit Planning
(3) Cost Control
(4) Special Situations
7-2
Manufacturing Costs
Direct Materials Direct Labor Manufacturing Overhead
The Product
7-3
Direct Materials
Raw materials that become an integral part of the product and that can be conveniently traced directly to it.
Example: A radio installed in an automobile
7-4
Direct Labor
Those labor costs that can be easily traced to individual units of product. Also called as Touch Labor
Example: Wages paid to automobile assembly workers
7-5
Manufacturing Overhead
Manufacturing costs that cannot be traced directly to specific units produced. Also known as factory overhead, factory burden Examples: Indirect labor and indirect materials Wages paid to employees who are not directly involved in production work.
Examples: maintenance workers, janitors and security guards.
Materials used to support the production process.
Examples: lubricants and cleaning supplies used in the automobile assembly plant.
7-6
Non-manufacturing Costs
Marketing or Selling Cost Administrative Cost
Costs necessary to get the order and deliver the product.
All executive, organizational, and clerical costs.
7-7
Classifications of Costs
Manufacturing costs are often classified as follows
:
Manufacturing Overhead
Direct Material
Direct Labor
Prime Cost
Conversion Cost
7-8
n
Marketing & Selling Overheads
n
Sales commissions, traveling, advertising, warehousing costs, sales office costs
n
Administrative Overheads
n
Accounting, legal, CEO and other support staff salaries
7-9
Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing Cost of Good Inventory overhead. Sold
Sale
Period costs include all marketing or selling costs and administrative costs.
Expense
Balance Sheet
Income Statement
Income Statement
7-10
Manufacturing Cost Flows
Costs
Material Purchases Direct Labor Manufacturing Overhead
Balance Sheet Inventories
Raw Materials Work in Process
Income Statement Expenses
Finished Goods
Cost of Goods Sold
Selling and Administrative
7-11
Selling and Administrative
Period Costs
COST CONCEPTS RELATING TO PROFIT PLANNING
(i) Fixed, Variable and Semivariable/Mixed Costs
(ii) Future Costs and Budgeted Costs
7-12
Fixed Costs Fixed (non-variable) costs do not change with changes in volume of output or activity within a specified range of activity/output (relevant range) for a given budget period.
Committed Fixed Costs Committed fixed costs are costs caused by the acquisition of capacity-producing assets.
Discretionary Fixed Costs Discretionary fixed costs are costs caused by management policy decisions.
7-13
Table 1: Production Volume and Fixed Costs Total fixed cost Rs 10,000 10,000 10,000 10,000
Y Average Fixed Cost (in rupees) 10,000 Total Fixed Cost (in rupees)
10
Production (in units) 1,000 2,000 5,000 10,000
Y
Average fixed cost per unit Rs 10 5 2 1
8
6
4
2
X
0
X
0
2,000 4,000 6,000 8,000 10,000
2,000
4,000
6,000
8,000
10,000
X
Volume of Activity (in Units)
Volume of Activity (in Units)
Figure 2: Volume and Total Fixed Costs
Figure 3: Volume and Fixed Costs Per Unit 7-14
Figure 2 portrays the relationship between volume and total fixed costs. The relationship between volume and fixed costs per unit is exhibited by Figure 3. While fixed cost remain constant at Rs 10,000 in total, cost per unit starts decreasing as the volume increases. Thus, there is an inverse relationship between production volume and fixed cost per unit (Figure 3). As stated earlier, fixed costs will not change over a wide range of volume (the relevant range). They will fluctuate before and beyond that range.
Y For example, prolonged strike or lockout may cause fixed costs to be reduced if executives or employees are laid off. Likewise, an expansion of activity beyond the present capacity will require purchase of new plant and equipment, engaging additional foremen and supervisors and, hence, additional fixed costs will result from these new inputs. 0 Such costs behaviour is shown Volume of Activity (in Units) Figure 4: Behaviour of Fixed Costs in Figure 4. Total Fixed Cost (in rupees)
Fixed Cost
X
7-15
Variable costs
Costs that tend to vary in total in direct proportion within a relevant range and for a given period or in one-to-one relationship to changes in production/sales/some other measure of volume are variable costs.
7-16
Table 2: Production Volume and Variable Costs Production (unit) 1 10 100 1,000 Material costs Rs 5 50 500 5,000 Labour costs Rs 2 20 200 2,000 Total variable cost Rs 7 70 700 7,000
Y Total Variable Costs (in rupees) Variable Costs per unit (in rupees)
Y
TVC Line
TVC Line
X Production in Units Production in Units
X
Figure 5: Total Variable Cost
Figure 6: Variable Cost Per Unit
7-17
Semi-Variable (mixed) Costs
All costs which are neither perfectly variable nor absolutely fixed in relation to volume changes are called semi-variable (mixed) costs. They consist of both fixed costs and variable costs.
Y
Semi-Variable Costs (in rupees)
X
Figure 7: Semi-Variable Cost
7-18
Opportunity Costs
The potential benefit that is given up when one alternative is selected over another. Example: If you were
not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000.
Sunk Costs
Sunk costs have already been incurred and cannot be changed 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 sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.
doc_797782446.ppt
This is a presentation explaining cost terms and concepts.
Chapter 3
Cost Terms and Concepts
From the viewpoint of managerial needs, cost concepts fall into four broad categories.
(1) Income Measurement (2) Profit Planning
(3) Cost Control
(4) Special Situations
7-2
Manufacturing Costs
Direct Materials Direct Labor Manufacturing Overhead
The Product
7-3
Direct Materials
Raw materials that become an integral part of the product and that can be conveniently traced directly to it.
Example: A radio installed in an automobile
7-4
Direct Labor
Those labor costs that can be easily traced to individual units of product. Also called as Touch Labor
Example: Wages paid to automobile assembly workers
7-5
Manufacturing Overhead
Manufacturing costs that cannot be traced directly to specific units produced. Also known as factory overhead, factory burden Examples: Indirect labor and indirect materials Wages paid to employees who are not directly involved in production work.
Examples: maintenance workers, janitors and security guards.
Materials used to support the production process.
Examples: lubricants and cleaning supplies used in the automobile assembly plant.
7-6
Non-manufacturing Costs
Marketing or Selling Cost Administrative Cost
Costs necessary to get the order and deliver the product.
All executive, organizational, and clerical costs.
7-7
Classifications of Costs
Manufacturing costs are often classified as follows
:
Manufacturing Overhead
Direct Material
Direct Labor
Prime Cost
Conversion Cost
7-8
n
Marketing & Selling Overheads
n
Sales commissions, traveling, advertising, warehousing costs, sales office costs
n
Administrative Overheads
n
Accounting, legal, CEO and other support staff salaries
7-9
Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing Cost of Good Inventory overhead. Sold
Sale
Period costs include all marketing or selling costs and administrative costs.
Expense
Balance Sheet
Income Statement
Income Statement
7-10
Manufacturing Cost Flows
Costs
Material Purchases Direct Labor Manufacturing Overhead
Balance Sheet Inventories
Raw Materials Work in Process
Income Statement Expenses
Finished Goods
Cost of Goods Sold
Selling and Administrative
7-11
Selling and Administrative
Period Costs
COST CONCEPTS RELATING TO PROFIT PLANNING
(i) Fixed, Variable and Semivariable/Mixed Costs
(ii) Future Costs and Budgeted Costs
7-12
Fixed Costs Fixed (non-variable) costs do not change with changes in volume of output or activity within a specified range of activity/output (relevant range) for a given budget period.
Committed Fixed Costs Committed fixed costs are costs caused by the acquisition of capacity-producing assets.
Discretionary Fixed Costs Discretionary fixed costs are costs caused by management policy decisions.
7-13
Table 1: Production Volume and Fixed Costs Total fixed cost Rs 10,000 10,000 10,000 10,000
Y Average Fixed Cost (in rupees) 10,000 Total Fixed Cost (in rupees)
10
Production (in units) 1,000 2,000 5,000 10,000
Y
Average fixed cost per unit Rs 10 5 2 1
8
6
4
2
X
0
X
0
2,000 4,000 6,000 8,000 10,000
2,000
4,000
6,000
8,000
10,000
X
Volume of Activity (in Units)
Volume of Activity (in Units)
Figure 2: Volume and Total Fixed Costs
Figure 3: Volume and Fixed Costs Per Unit 7-14
Figure 2 portrays the relationship between volume and total fixed costs. The relationship between volume and fixed costs per unit is exhibited by Figure 3. While fixed cost remain constant at Rs 10,000 in total, cost per unit starts decreasing as the volume increases. Thus, there is an inverse relationship between production volume and fixed cost per unit (Figure 3). As stated earlier, fixed costs will not change over a wide range of volume (the relevant range). They will fluctuate before and beyond that range.
Y For example, prolonged strike or lockout may cause fixed costs to be reduced if executives or employees are laid off. Likewise, an expansion of activity beyond the present capacity will require purchase of new plant and equipment, engaging additional foremen and supervisors and, hence, additional fixed costs will result from these new inputs. 0 Such costs behaviour is shown Volume of Activity (in Units) Figure 4: Behaviour of Fixed Costs in Figure 4. Total Fixed Cost (in rupees)
Fixed Cost
X
7-15
Variable costs
Costs that tend to vary in total in direct proportion within a relevant range and for a given period or in one-to-one relationship to changes in production/sales/some other measure of volume are variable costs.
7-16
Table 2: Production Volume and Variable Costs Production (unit) 1 10 100 1,000 Material costs Rs 5 50 500 5,000 Labour costs Rs 2 20 200 2,000 Total variable cost Rs 7 70 700 7,000
Y Total Variable Costs (in rupees) Variable Costs per unit (in rupees)
Y
TVC Line
TVC Line
X Production in Units Production in Units
X
Figure 5: Total Variable Cost
Figure 6: Variable Cost Per Unit
7-17
Semi-Variable (mixed) Costs
All costs which are neither perfectly variable nor absolutely fixed in relation to volume changes are called semi-variable (mixed) costs. They consist of both fixed costs and variable costs.
Y
Semi-Variable Costs (in rupees)
X
Figure 7: Semi-Variable Cost
7-18
Opportunity Costs
The potential benefit that is given up when one alternative is selected over another. Example: If you were
not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000.
Sunk Costs
Sunk costs have already been incurred and cannot be changed 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 sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.
doc_797782446.ppt