ost oncepts Dr. Suchismita Sengupta IES MCRC “Nothing in life is certain except death and taxes.” --Benjamin Franklin

LEARNING OBJECTIVES  Define and illustrate a cost object  Distinguish between direct costs and indirect costs  Explain variable costs and fixed costs  Interpret unit costs cautiously  Distinguish among manufacturing companies, merchandising companies, and service-sector companies  Describe the three categories of inventories commonly found in manufacturing companies  Distinguish inventoriable costs from period costs  Explain why product costs are computed in different ways for different purposes  Describe a framework for cost accounting and cost management 2

 Cost – sacrificed resource to achieve a specific objective  Actual cost – a cost that has occurred  Budgeted cost – a predicted cost  Cost object – anything of interest for which a cost is desired 3 Basic Cost Terminology

4 Introduction  Different cost concepts and terms are often used in accounting reports.  Managers who understand these concepts and terms are able to... – best use the information provided, and – avoid misuse of that information.

5 Cost Object Examples at BMW

Cost Object Illustration Product BMW X 5 sports activity vehicle Service Dealer-support telephone hotline Project R&D project on DVD system enhancement Customer Herb Chambers Motors, a dealer that purchases a broad range of BMW vehicles Activity Setting up production machines Department Environmental, Health & Safety

7 Cost  Cost is a resource sacrificed or forgone to achieve a specific objective.  It is usually measured as the monetary amount that must be paid to acquire goods and services.  An actual cost is the cost incurred (a historical cost) as distinguished from budgeted costs.

8 Cost Object  A cost object is anything for which a separate measurement of costs is desired. – Product – Service – Project – Brand – Activity – Department

9 Cost Accumulation - Assignment  There are two basic stages of accounting for costs: 1 Cost accumulation 2 Cost assignment to various cost objects

10 Cost Accumulation - Assignment Cost accumulation – a collection of cost data in an organized manner Cost assignment – a general term that includes gathering accumulated costs to a cost object. This includes: Tracing accumulated costs with a direct relationship to the cost object and Allocating accumulated costs with an indirect relationship to a cost object

11 Cost Accumulation - Assignment  Cost accumulation is the collection of cost data in some organized way by means of an accounting system.  Cost assignment is a general term that encompasses... – tracing accumulated costs to a cost object, – allocating accumulated costs to a cost object.

12 BMW: Assigning Costs to a Cost Object

Cost Examples 13  Direct Costs – Parts – Assembly line wages  Indirect Costs – Electricity – Rent – Property taxes

14 Classification of Cost Concepts

15 Descriptive Terms Tracebility Criterion Direct Costs  Direct costs of a cost object are those that are related to a given cost object (product, department, etc.) and that can be traced to it in an economically feasible way.  Cost-Tracing describes the assignment of direct costs to the particular cost object.

16 Descriptive Terms Tracebility Criterion Indirect Costs IDC are related to the particular cost object but cannot be traced to it in an economically feasible way.

17 Direct & Indirect Costs  Several factors affect the classification of a cost as direct or indirect: – The materiality of the cost in question – Available information-gathering technology – Design of operations – Contractual arrangements  The direct/indirect classification depends on the choice of the cost object.

18 Descriptive Terms Separability Criterion  Separate Cost – which can be traced to each particular unit of batch of production  Common Cost – which are common for 2 or more products / product lines which can be produced separately

19  Joint Cost – which are incurred in producing products which must necessarily be produced together  By-Product Cost – is variation of Joint Cost – BP & JP cost depends upon significance and importance Descriptive Terms Separability Criterion

20 Descriptive Terms Computation Criterion  Historical Cost – is on past figures  Replacement Cost – is present replacement value  Standard Cost or Budgeted – is based on standards

21 Descriptive Terms Function Criterion  Manufacturing Cost – is total of consumption of raw materials, direct labour and manufacturing overheads  Selling & Distribution Cost – is cost incurred to sell & distribute  Administrative Cost – is incurred in office administration

22 Statistical Terms Average Criterion  Total Cost – sum total of all costs  Unit Cost – is Total Cost divided by number of units produced – Hours worked – Packages delivered – No. of units assembled

23 Statistical Terms Grouping Criterion  Prime Cost – total of Cost of RM consumed & Direct Labour – Here Cost of RM consumed = Op. Stock RM + Purchases RM – Closing Stock RM  Conversion Cost – total of Direct Labour and Manufacturing OH RMDLMOH PCCC

24 Behavioural Terms Variability Criterion  Fixed Cost – which do not vary with cost object/no. of units produced  Variable Cost – which varies with no. of units produced  Semi-Fixed  Semi-Variable

25 Conceptual Terms  Marginal Cost – is cost of producing one more unit  Sunk Cost – is cost which cannot be recovered even if the course of action is not made  Period Cost – is for a particular period

26 Cost Drivers  A cost driver is a factor, such as the level of activity or volume, that causally affects costs (over a given time span).  The cost driver of variable costs is the level of activity or volume whose change causes the (variable) costs to change proportionately.

27 Relationships of Types of Costs Direct Indirect VariableFixed

28 Manufacturing  Manufacturing-sector companies purchase materials and components and convert them into finished goods.  A manufacturing company must also develop, design, market, and distribute its products.

29 Trading  Trading-sector companies purchase and then sell tangible products without changing their basic form.

30 Service Companies – provide services or intangible products to their customers.  Labour is the most significant cost category.

31 COST OF GOODS MANUFACTURED COST OF RM CONSUMED +DIRECT MANUFACTURING LABOR COSTS PRIME COST => +INDIRECT MANUFACTURING COSTS FACTORY COST => +OP. STOCK WIP - CL. STOCK WIP COST OF GOODS MANUFACTURED =>

32 COST OF GOODS SOLD (COGS) OP. STOCK FG +COGM -CL. STOCK FG COST OF GOOD SOLD =>

33 INCOME STATEMENT REVENUES (SALES) -COGS GROSS PROFIT/MARGIN -Sales & Dist. Cost OPERATING INCOME

34 IMPACTS  BALANCE SHEET  PROFIT & LOSS ACCOUNT

35 Thank You ‘Cost means sacrifice’