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8/9/2019 Cost Class if Cation
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Amity School of Business
Cost Concepts/ Cost Classification
On the basis of Business Function: Direct and Indirect costs.
Manufact uring and Non manufact uring costs.
Prod uct and Period Costs.
On the basis of normality:
Normal cost and abnormal cost.
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Amity School of Business
On the basis of planning and Control:
Fixed and variable costs.
Controllable and Non-controllable.
On the basis of Decision Making:
Sunk Costs.
Relevant and Irrelevant costs.
Incremental Costs.
Differential costs.
O ut of pocket.
Replacement costs.
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Amity School of Business
On the basis of Business Function
Direct costs Costs that can be easily and conveniently traced to a unit of
prod uct or other cost objective.
Examples: Direct material, Direct labor and Direct expenses.
Direct Material: The cost of material entering into and becoming
constit uent element of prod uct or saleable service.
Direct labor: The cost of remu
neration for employees efforts and skills applied directly to a prod uct or saleable service.
Direct expense: The cost other than material and labor which are
incurred for a specific prod uct or saleable service.4
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Amity School of Business
Indirect costs
Costs cannot be easily and conveniently traced to a unit of prod uct or other cost object.
Example: Manufact uring O verhead.
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Amity School of Business
Manu
fact u
ring overheads (Indirect Costs) Included all overhea ds other than direct material, direct labor,
direct expenses.
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Examples: Indirect labor and indirect materials
Wages paid to employees whoare not directly involved in
production work.Examples: maintenance workers
and security g uards.
Materials used to support theproduction process.
Examples: lubricants and cleaning supplies used in the a utomobile
assembly plant.
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Amity School of Business
Classifications of Costs
Direct
Material
Direct
La bor
Manufact uring
O verhea d
Prime
Cost
Conversion
Cost
Manufact uring costs are often classified as follows:
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Amity School of Business
Product Costs Versus Period Costs
Pro
duct costs incl
ude
direct materials, direct la bor, and
manufact uring overhea d.
Perio
dcosts are not incl
ude
din
product costs. They are expensed on
the income statement.
Period costs are recorded as
expenses of the accounting period
in which they are incurred.
Inventory Cost of Good Sold
Balance
Sheet
Income
Statement
Sale
Expense
Income
Statement
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Amity School of Business
Flow of Manufact uring Costs
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Direct Materials
Direct La bor
Factory O verhea d
Work in Process
(Assets)
Finished Goods
(Assets)
Cost of Goods Sold
(Expenses)
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Amity School of Business
Element Wise classification
According to the nature of and source of expenditure, the overheads areclassified into:
Indirect Material:
Materials other than direct material cost.
It cannot be allocated but can be apportioned to cost centres and costunits.
Example: Oil, grease etc.
Indirect labour:
Wage cost other than direct wage cost.
It cannot be allocated but can be apportioned to cost centres and cost
units.
Example: Staff of personnel department, Idle time wages.
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Amity School of Business
Fixed costs:
That does not change with
the change in the level of
activity. Examples: Depreciation,
Rent, Supervisors salary.
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Whichcannot be
easily orquickly eliminated.
Eg: Depreciation, Property Taxes, lease
rentals.
Fixed Costs
Which canbediscontinued
at management discretion.
Eg: a d vertisement programmes,
A dministrativ
e salary
Discretionary Fixed Costs
Thumb Rule
Think of fixed costs as a total. Total fixed costs remain unchanged
regardless of changes in cost-driver activity
On the Basis of Planning and Control
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Amity School of Business
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Amity School of Business
On the Basis of Planning and Control
Varia ble Costs
Where total varies directly
and proportionally with the
volu
me of activity. There is a fixed ratio between
the change in cost and change
in activity.
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T humb R ule
T hink of variable costs on per unit basis. T he per-unit variable cost remains
unchanged regardless of changes in the cost-driver activity.
Variable Costs
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Amity School of Business
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Amity School of Business
On the Basis of Planning and Control
Semi Varia b
le Cost Contains both fixed and variable elements.
Partly effected by the fluctuation in the level of activity.
For example: telephone expenses include a fixed portion of annual charge
plus variable charge according to calls.Types of Semi variable costs
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Semi variable costs
Variable elementoperates at all thelevels of activity.
Semi variable costs
Variable elementcomes intooperation aftercertain level of activity.
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Amity School of Business
On the Basis of Planning and Control
Controlla ble Costs
Manager has a direct and complete decision a uthority.
Two basic characteristics:
Level of Organization.
Point of time.
Non Controlla ble Costs
Beyond the influence of manager beca use he cannot a uthorize it.
Example: Depreciation of wareho
use will not
be controlla
ble
b y the production manager or sales manager.
To determine whether the cost is controlla ble or non- controlla ble,
both the characteristics m
ust
be consi
dere
dconc
urrent 17
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Amity School of Business
On the basis of Decision Making
Relevant Costs
Vary depending upon the alternative selected in a particular
decision.
Irrelevant Costs
Not effected b y the decision taken or b y the option selected.
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Amity School of Business
On the basis of Decision Making
Su
nk Costs Those costs have alrea d y been incurred and spent.
Sunk costs cannot be changed b y any decision. They are not
differential costs and should be ignored when making decisions.
These costs are create
d b y a
decision in the past an
dno present or f ut ure decision can change such costs.
Example: The written down value of the fixed asset.
Differential Costs Costs that differs between decision alternatives.
The differential cost may be incremental or decremental.
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Amity School of Business
On the basis of Decision Making
Opport unity costs The costs that measures the next best alternative that is lost or
sacrificed.
The choice of one course of action is given b y rejecting the other.
Does not involve any flow of cash or payment.
Not found in the accounting system.
Every decision maker must incorporate the expected
benefits that have been sacrificed.
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Amity School of Business
On the basis of Decision Making
Out of pocket costs Signifies the cash outlay required for undertaking project.
Management is interested in knowing whether the income from
the particular project will at least cover the expendit ure on that
project.
Replacement cost
The cost of replacing an assets at current market value.
Example : cost of replacing a machinery is considered, it meansthe cost of purchasing a machinery at the current market price
and not the price at which it was purchased.
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Amity School of Business
On the basis of Decision Making
Avoida ble cost Cost that can be eliminated in case of product or department is
discontinued.
Unavoida ble cost Indirect cost that cannot be eliminated with the discontinuation
of a product or department.
Example: Rent of factory, salary of production manager.
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Amity School of Business
On the basis of Normality
Normal cost Cost which is normally incurred at a given level of output in the
condition in which that level of output is normally attained.
Example: Idle time for factory workers.
A bnormal cost
Cost which is not normally incurred at a given level of output in
the conditions in which that level of output is normally attained.
Example: Strikes, lockouts in a factory.
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