COST FOR PRODUCTION INCLUDING BREAKING ANALYSIS

CONTENTS

• CONCEPTS OF COST• VARIOUS TYPES OF COST• BREAK EVEN ANALYSIS• BREAK EVEN POINT

CONCEPT OF COSTFor every business

organization, it is essential to install a set up as per the nature and need of the product. Number of employees are employed in the business organization for transforming the raw material into finished products using machines. So, business organization incurs various types of costs.

So, profit = Total Revenue –Total Costs

VARIOUS TYPES OF COSTTOTAL COST

TOTAL COST

FIXED COST VARIABLE COST

TOTAL COSTTotal cost is summation of fixed cost and variable

cost.Total cost = Fixed cost + Variable cost

VARIABLE COSTVariable cost is the cost which varies with

number of unit produced. It increases with increase in number of units produced and vice versa.

Example - Raw material consumption, Electricity bill, Extra labour hours etc.

FIXED COSTFixed cost is the cost which do not vary with

number of units produced. It incurs even if the organization does not produce a single unit of product.

Example - Rent, Advertising, Insurance, Cost of machine installation, Salaries of employees, Minimum electricity bill etc.

DIRECT COSTDirect cost can be completely attributed to the

production of specific goods or service. Direct costs refer to materials, labor and expenses related to the production of a product. Direct cost varies with number of unit produced.

Example – Electricity bill, installation of machinary etc.

INDIRECT COSTExpenses which are not specific to any

product or good, but these type of cost are incurred in combined for the business are termed as indirect cost.

Example – Rent, Advertising, Maintenance, Security etc.

AVERAGE COSTAverage cost is equal to total cost divided by the

number of units of goods produced.Average cost is also known as unit cost.

MARGINAL COSTMarginal Cost is defined as the ratio of change of total

cost to the change in quantity produced.

INCREMENTAL COSTIncremental cost is the cost associated with increasing

production by one unit. The incremental cost total is always made up of purely variable costs.

RECURRING COSTFor each item produced or each service performed is

termed as recurring cost.Example – Insurance premium, Electricity bill etc.

NON – RECURRING COSTA one-time Charge incurred as a result of rare event or

activity, such as purchase of machine, building construction, design, development and investment cost is termed as non-recurring cost.

SUNK COSTSunk cost is a retrospective (past) cost that has

already been incurred and cannot be recovered. Sunk costs are independent of any event that may occur in the future.

IMPLICIT COSTAn implicit cost, also called an imputed cost, implied

cost, or notional cost, is the opportunity cost equal to what a firm must given up in order to use factors which it neither purchases nor hires.

OPPORTUNITY COSTWhen any of the option is selected out of available

options, other options are not selected. Hence, selector sacrifices all other options. So, the value which is forgone for selecting the mutually exclusive alternatives is termed as opportunity cost.

CASH COSTCash costs are costs are costs that businesses

pay for when using cash, or a check, but not credit. On a cash accounting basis, the cost paid for by using credit would not be recorded in the general ledger until the actual cash has been paid.

SHORT RUN COSTWe consider that any company is installing a plant

for manufacturing a product. For certain period of time, company cannot adjust the number or size of plants. By hiring more workers only number of products manufactured can be increased. So, fixed cost incurred in installing the plant cannot be varied during certain period of time, is termed as short run cost.

LONG RUN COSTAfter several years, company can either expand the

existing plant or increase the number of plants. So, in long run cost of plants can be varied and hence it is termed as long run cost.

BREAK EVEN ANALYSIS - BEP The point at which the company starts to

earn profit is termed as Break Even Point (BEP) and its analysis is termed as Break Even analysis (BEA).

Sales revenue = All variable fixed cost

Methods to find out BEPBEP in Physical Quantity ProducedBEP in terms of Sales Volume

BEP in Physical Quantity ProducedBEP is defined as the ratio of total fixed cost to the

contribution per unit. Here, contribution is defined as the difference between revenue generated and variable cost incurred.

Where, Contribution (C) = Revenue – Variable Cost

BEP in terms of Sales VolumeBEP is defined as the ratio of fixed cost to the

contribution ratio. Contribution ratio is the ratio of total contribution to the total sales. This indicates the profit per unit volume sold. So, contribution ratio also known as P/V ratio.

REFRENCES• Engineering Economics & Management (Akshay A. Pujara)