Management Accounting 2 Cost Definition and Classification

Cost Concept Cost is a source of sacrifice to achieve specific objective. Generally cost may be explained as the amount of expenditure, actual or estimated, relating to a specific thing or activity such as product, job, service, process etc.

Cost Concept Cost can be identified as; Acquisition Costs Manufacturing costs (Production costs) Period costs Selling and Marketing Costs Material Costs, Labor Costs, Overheads, Variable and Fixed Costs Actual cost, budgeted cost, historical cost.

Cost Concept Acquisition (Purchasing) Cost Acquisition costs consist of; acquisition price, transportation, insurance assembly cost tax and other expense related with acquisition.

Classification of Costs According to Nature and Function Nature Material Labor Other Expenses (Wages, Salaries, Depreciation, Utility, etc.) Function Production Costs Selling Costs Administrative Costs Research and Development Costs According to the Identifiable (Cost Center and Production) Direct Costs Indirect Costs According to Behavior (Variability) Fixed Costs Variable Costs

Cost Concept Manufacturing Cost Production or Manufacturing costs are all production cost incurred to manufacture the products and to bring them to a saleable condition, including direct materials, direct labor and indirect manufacturing (or factory overhead) costs.

Cost Concept Manufacturing Cost Manufacturing Costs Direct Material Direct Labor Factory Overhead (Indirect Material, Indirect Labor, factory and Depreciation, Rent, etc.)

Cost Concept Manufacturing Cost Manufacturing costs are often classified as follows: Direct Material Direct Labor Manufacturing Overhead Prime Cost Conversion Cost

Manufacturing Costs Versus Period Costs Manufacturing (Production) costs include direct materials, direct labor, and manufacturing overhead. Period costs are not included in product costs. They are expensed on the income statement. Inventory Cost of Goods Sold Balance Sheet Income Statement Sale Costs can also be classified as product or period costs. Product costs include all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. The discussion in the chapter follows the usual interpretation of GAAP, whereby all manufacturing costs are treated as product costs. Period costs include all marketing or selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees. Expense Income Statement

Cost Concept Period Costs Administrative Cost is the cost of formulating the policy, directing and controlling the business activities which is not related directly to a production, selling & distribution, research or development activity or function. Selling Costs are the costs of marketing function. Distribution costs include expenditure incurred in packing, unpacking, and transporting activities. Research and Development Costs are the cost of research and development activity.

Cost Concept Period Costs Selling Costs Costs necessary to get the order and deliver the product. Administrative Costs All executive, organizational, and clerical costs.

Product Costs Versus Period Costs Balance Sheet Product Costs (manufacturing costs) Current assets and inventory Income Statement Revenue COGS Gross profit Expenses Net income. When goods are sold. as incurred Period Costs (operating expenses and income taxes.) as incurred

Comparing Merchandising and Manufacturing Activities Merchandisers . . . Buy finished goods. Sell finished goods. Manufacturers . . . Buy raw materials. Produce and sell finished goods. MegaLoMart

Cost Concept Reporting Merchandising Activity BALANCE SHEET Assets Liability and Equity Inventory Costs Inventory Raw Material and Other Supplies Merchandise Tangible Assets (Property, Plant and Equipment) Investment Costs Intangible Assets

Cost Concept Reporting Manufacturing Activity BALANCE SHEET Assets Liability and Equity Inventory Costs Inventory Raw Material and Other Supplies Work-in Progress Finished Goods Tangible Assets (Property, Plant and Equipment) Investment Costs Intangible Assets

The Flow Of Manufacturing Costs Direct materials purchased Materials Inventory $$$ Direct materials used Work in Process Inventory $$$ Direct Material, Direct labor & Manufacturing overhead Cost of goods manufactured Cost of Goods Sold $$$ Finished Goods Inventory $$$

Cost Concept Reporting Manufacturing Activity BALANCE SHEET Assets Liability and Equity Inventory Raw Material and Other Supplies Work-in Progress Finished Goods Materials waiting to be processed. Partially complete products – some material, labor, or overhead has been added. Part I Raw materials are the materials used to make the product. Part II Work in process consists of units of product that are partially complete, but will require further work to be saleable to customers. Part III Finished goods consists of units of product that have been completed, but not yet sold to customers. Completed products awaiting sale.

Cost Concept Expenditure An expenditure is a payment in cash or barter credits, or the incurrence of a liability by an entity, in exchange for goods or services.

Cost Concept Expenditure There is a close association between incurring expenditure and generating assets but the two do not necessarily same.

Cost Concept Expenditure An asset is recognized in the balance sheet when expenditure has been incurred for which it is considered probable that economic benefits will flow to the entity.

Cost Concept Reporting Cost of Assets BALANCE SHEET Assets Liability and Equity Inventory Costs Inventory Raw Material and Other Supplies Merchandise Tangible Assets (Property, Plant and Equipment) Investment Costs Intangible Assets

Loss is lost cost. Cost Concept Loss In financial accounting, it is used to describe a circumstance where expenses exceed revenues for an accounting period, that is, the reverse of net income (earnings) for the accounting period.

Cost Concept Loss Loss also defined as unfavorable event which does not arise from a normal business activity but from non-operating transactions or events.

Basic Cost Concepts Expenditure- Cost- Expense Expenditure and Expired Costs Favorable and Normal Yes Expense No Unfavorable and Abnormal Loss

Basic Cost Concepts Expenditure-Cost- Expense Expenditure and Expired Costs Used up in Generating Revenue Yes Favorable and Normal Expense No Loss Generating Assets Cost

Cost Concept Reporting Expired Cost Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

Manufacturing Cost Flows Balance Sheet Costs Inventories Income Statement Expenses Material Purchases Raw Materials Manufacturing Overhead Work in Process Direct Labor Finished Goods Cost of Goods Sold Selling and Administrative Selling and Administrative Period Costs

Reporting in Financial Statements Cost, Expense and Loss BALANCE SHEET Assets Liability and Equity INCOME STATEMENT Inventory Costs Inventory Expired Cost Sales Cost of Goods Sold Tangible Assets (Property, Plant and Equipment) Gross Sales Profit Investment Costs Intangible Assets Depreciation Operating Expense Operating Profit Other Income and Profit Other Expense and Loss Expense Finance Cost

Fixed Cost Variable Cost Semi Variable Cost Semi Fixed Cost Classification of Cost According to Behavior Fixed Cost Variable Cost Semi Variable Cost Semi Fixed Cost

Cost Classifications for Predicting Cost Behavior How a cost will react to changes in the level of business activity. Total variable costs change when activity changes. Total fixed costs remain unchanged when activity changes.

Cost Classifications for Predicting Cost Behavior Managers often need to be able to predict how costs will change in response to changes in activity. The activity might be the output of goods or services or it might be some measure of activity, internal to the company, such as the number of purchase orders processed during a period. In this chapter, nearly all of the illustrations assume that the activity is the output of goods or services. Later, other measures of activity will be introduced.

Classification of Cost According to Behavior In this classification, costs are classified by their behavior to changes in the level of activity. This is the analysis of how cost or profits change as volume changes. In this context volume might be an activity such as the number of machine hours, the number of units produced, the number of pounds processed, the number of units sold, or the TL of goods sold.

Cost Classifications for Predicting Cost Behavior Total Variable Cost The costs tend to vary with the volume of output called variable costs . Any increase in the volume of production results in an increase in the variable cost. Example: cost of material, cost of labor etc. For example total direct material cost will vary on the base of change in level of production. Product Unit=x Direct Material Cost=y

a=Variable cost per unit Total Variable Cost = ax x=production unit Cost Classifications for Predicting Cost Behavior Total Variable Cost Per Unit Although variable costs change in total as the activity level rises and falls, variable cost per unit is constant. For example, direct material per unit is constant. a=Variable cost per unit Total Variable Cost = ax x=production unit Variable cost per unit remains constant. Production Unit=x Direct Material Per Unit=a

Cost Classifications for Predicting Cost Behavior Total Fixed Cost The cost which does not vary but remains constant within a given period of time or range of activity is called fixed costs. Example: Rent, insurance of factory buildings, depreciation etc. remain the same for different levels of production. For example depreciation cost will remain constant change in level of production (activity). Product Unit Depreciation Cost

Unit Depreciation Cost Cost Classifications for Predicting Cost Behavior Total Fixed Cost Per Unit When expressed on a per unit basis, The total fixed cost per unit will decreases on the base of level of activity. For example, the average depreciation cost per production unit decreases as more the production are made. b=Total Fixed Cost Unit Fixed Cost= b x x=production unit Fixed cost per unit decreases when activity rises and increases when activity falls. Production Unit Unit Depreciation Cost

Total Cost=Variable Cost + Fixed Cost TC= ax + b Cost Classifications for Predicting Cost Behavior Variable-Fixed Total Cost=Variable Cost + Fixed Cost TC= ax + b

Cost Classifications For Decision Making It is important to realize that every decision involves a choice between at least two alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. Costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits are irrelevant and can and should be ignored. Every decision involves a choice between at least two alternatives.

Costing Methods In Decision Making Illustration Example: The costs of ABC company occurred in September are as follows: Costs’ Nature Fixed Costs Variable Costs Material Costs Direct Material Indirect Material - 50.000 40.000 10.000 Labor Costs Direct Labor Indirect Labor 20.000 Utility Costs 25.000 35.000 Depreciation Costs 55.000 Other Costs 9.000 6.000 Total 129.000 111.000 While the monthly normal production capacity is 25.000 unit in September, company has decided to manufacture 20.000 unit. On 20th of September company received an additional order involving 4.000 unit production with 4TL unit price. Selling price of each product is 8 TL. Company sold 15.000 unit finished goods in September. Required: Ascertain the total and unit cost of current production and evaluate whether the additional order to accept or reject.

Costing Methods in Decision Making Costing Methods On The Base Of Behavior These methods deals with the behavior of costs to the changes in level of activity. Prime Costing Absorption Costing Variable Costing and Normal Costing

Costing Methods In Decision Making Absorption Costing Method (Tam Maliyet) This method also termed as Full Costing. It is the technique that takes into account charging of all costs both variable and fixed costs to operation processed or products or services. Under absorption costing full costs, i.e. fixed and variable costs are absorbed to the production Variable (Marginal) Costing (Değişken Maliyet) In Marginal Costing, it allocates only variable costs to the production. It does not take into account the fixed cost of production. This type of costing emphasizes the distinction between fixed and variable costs.

Differential (Ek Maliyet) Costs And Revenues Costs and revenues that differ among alternatives. Differential costs (or incremental costs) is a difference in cost between any two alternatives. A difference in revenue between two alternatives is called differential revenue. Differential costs can be either fixed or variable.

Differential Costs And Revenues For example, assume you have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month. In this example, the differential revenue is $500 and the differential cost is $300. Differential revenue is: $2,000 – $1,500 = $500 Differential cost is: $300

Opportunity Costs (Fırsat Maliyeti) An opportunity cost is the potential benefit that is given up when one alternative is selected over another. These costs are not usually entered into the accounting records of an organization, but must be explicitly considered in all decisions.

Opportunity Costs (Fırsat Maliyeti)

Sunk Costs (Batık Maliyet) A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed, they cannot be differential costs; therefore, sunk costs should be ignored in decision making.

Sunk Costs (Batık Maliyet) 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.