Topic+2(Cost+Terms,+Concepts+and+Classifications).Ppt

Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Costs Terms, Concepts and Classifications

Topic Two (2)


Variable and Fixed Cost

• Variable cost is a cost that varies in total in direct proportion to changes in activity.

• Fixed cost is a cost that remains constant in total within the relevant range of activity


Cost Classifications for Predicting Cost Behavior

How a cost will react to changes in the level of

activity within the relevant range.

Total variable costs change when activity changes.

Total fixed costs remain unchanged when activity changes.

How a cost will react to changes in the level of

activity within the relevant range.

Total variable costs change when activity changes.

Total fixed costs remain unchanged when activity changes.


Total Variable Cost

Your total long distance telephone bill is based on how many minutes you talk.

Minutes Talked

Tot

al L

ong

Dis

tanc

eT

elep

hone

Bill


Variable Cost Per Unit

Minutes Talked

Per

Min

ute

Tel

epho

ne C

harg

e

The cost per long distance minute talked is constant. For example, 10 cents per minute.


Total Fixed Cost

Your monthly basic telephone bill probably does not change when you make more local

calls.

Number of Local Calls

Mon

thly

Bas

ic

Tel

epho

ne B

ill


Fixed Cost Per Unit

Number of Local Calls

Mon

thly

Bas

ic T

elep

hone

B

ill p

er L

ocal

Cal

l

The average fixed cost per local call decreases as more local calls are made.


Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Average fixed cost per unit goesthe same even when the down as activity level goes up.

activity level changes.


Cost Estimation Techniques

• The High-Low Method

• Scatterplot Method

• The Method of Least Squares


Cost Objects

• A cost object is any activity for which a separate measurement of cost is required (e.g. cost of making a product or providing a service).


Direct and Indirect Costs

Direct costs

• Costs that can beeasily and conveniently traced to a unit of product or other cost object.

• Examples: direct material and direct labor

• E.g. Wood to make furniture, hours worked on project, flour to make cake.

Indirect costs• Costs that cannot be easily

and conveniently traced to a unit of product or other cost object.

• Example: manufacturing overhead

• E.g. rent of a factory that make cars/furniture, manager’s salary.


Cost Drivers

• A cost driver is an activity or occurrence that has a direct cause-effect relationship with a cost.

• E.g. Production volume (units) has a direct effect on the total cost of raw materials used.

• A change in production volume causes a similar change in the cost of raw materials


Control and Uncontrollable costs

• Controllable costs are those costs that can be saved by not adopting a given alternative.

• Uncontrollable costs are those costs that cannot be saved.

• Example: send a salesman to Penang for business trip. Alternatives available: drive or fly.

Controllable costs: petrol/air ticket

Uncontrollable costs: salary, insurance


The ProductThe Product

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead


Manufacturing Costs


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 automobileExample: A radio installed in an automobile


Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers


Manufacturing costs that cannot be traced directly to specific units produced.

Manufacturing Overhead

Examples: Indirect labor and indirect materialsExamples: 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.


Classifications of Costs

DirectMaterialDirect

MaterialDirectLaborDirectLabor



PrimeCost

ConversionCost

Manufacturing costs are oftenclassified as follows:


Categories of Manufacturing Costs

• Conventional cost systems accumulate product cost as:

Direct materials xxx

+ Direct Labour xxx+ other direct expenses xxx= prime cost xxx+ manufacturing overhead xxx = total manufacturing costs xxx+ Non-manufacturing overhead xxx= Total cost xxx

Manufacturing overhead = indirect material + indirect labour + indirect expenses


Non-manufacturing Costs

Marketing or Selling Cost

Costs necessary to get the order and deliver

the product.

Administrative Cost

All executive, organizational, and

clerical costs.


Product Costs Versus Period Costs

Product costs include direct materials, direct

labor, and manufacturing overhead.

Period costs include all marketing or selling

costs and administrative costs.

Inventory Cost of Good Sold

BalanceSheet

IncomeStatement

Sale

Expense

IncomeStatement


Comparing Merchandising and Manufacturing Activities

Merchandisers . . . Buy finished goods. Sell finished goods.

Manufacturers . . . Buy raw materials. Produce and sell

finished goods.

MegaLoMart


Balance Sheet

Merchandiser Current assets

CashReceivablesPrepaid ExpensesMerchandise

Inventory

Manufacturer Current Assets

Cash Receivables Prepaid Expenses Inventories

Raw Materials

Work in Process

Finished Goods

Topic+2(Cost+Terms,+Concepts+and+Classifications).Ppt

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