Cost

Lecture 12Shahid Iqbal

Cost is a resource sacrificed or forgone to achieve a specific objective.

Anything incurred during the production of the good or service to get the output into the hands of the customer.

The customer could be the public (the final consumer) or another business.

Controlling costs is essential to business success.

Not always easy to pin down where costs are arising!

Direct cost

Cost that can be identified specifically with or traced to a given cost object. The direct costs consist of the following three elements:

Direct materialsDirect labourDirect expenses

Direct materials

The cost of materials used entering into and becoming the elements of a product or service. e.g. fabrics in garments

Direct labour

The cost of remuneration for working time e.g. assembly workers’ wages in toy assembly

Direct expenses

Other costs which are incurred for a specific product or service. e.g. royalty

Indirect cost (overhead)

Cost that cannot be identified specifically with or traced to a given cost object. They are identified with cost centers as overheads:Indirect materialsIndirect labourIndirect expenses

Indirect materialsSuch as stationery, consumable supplies, spare parts for machine that assist to the production of final products.

Indirect labour

Such as salaries of factory supervision and office staff that do not directly involve in production of the final product.

Indirect expenses

Such as rent, rates, depreciation, maintenance expenses that do not have instant relationships with the manufacturing processes.

Direct and Indirect Costs

Direct CostsExample: Oak wood used to Mfg. of chairs.

Indirect CostsExample: salary of thePlant night watchperson.

COST OBJECT

Example: 50 Oak Chairs produced inMay.

Prime Costs

DirectMaterials

DirectLabor

PrimeCosts+ =

CostingCosting means the process of ascertainment of costs. e.g. Calculate the different resources needed to achieve your implementation plans.

• Note that some of the resources will be shared across several programmes, rather than specific to your issue.

Cost AccountingThe application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.

Cost ControlCost control means the control of costs by management. Following are the aspects or stages of cost control.

1- JOB COSTING

It helps in finding out the cost of production of every order and thus helps in ascertaining profit or loss made out on its execution. The management can judge the profitability of each job and decide its future courses of action.

2. Batch Costing

Batch costing production is done in batches and each batch consists of a number of units, the determination of optimum quantity to constitute an economical batch is all the more important.

Why Examine Costs?Why Examine Costs?

For routine budgeting:

1st reason We need to estimate the costs required in order to secure funds and hence the resources needed for our plans to be implemented.

2nd reason

For costing is to develop plans and strategies for scaling up or expanding specific intervention activities. Or if the govt is committed to expanding coverage to people in need of services, we need to be able to cost what will be required to reach these groups.

3rd reason

DecidingDeciding on how best to allocate resources, by looking at costs and results of different activities or interventions.

• The issue is efficiency in terms of whether we are doing the right things.

4th reasonTo look into the efficiency of services. It can be useful to compare for example, what it costs to run services in different districts (e.g. costs of drugs per case).

• If there are differences it will be a starting point to find out why

Finally

• Finally, we need to know what resources are available and what more is available for current and future activities.

• We need to understand if costs are changing over time and why.

• Keeping track of costs is good management.

Terminologies in CostingTerminologies in CostingFinancial cost

In budgeting the costs calculated are the financial cost required to acquire the resources.

Opportunity CostOpportunity for using these resources in some other way, this is what economists call the ‘opportunity cost’.

For example if resources are used for one health care programme, the opportunity to use those resources in another programme is forgone or is sacrificed.

Types of Costs to be considered28

DirectAll the expenses incurred in delivering the health service, including shared costs –drugs, supplies, lab. Tests, shared costs

Indirect costsThose additional costs, usually from the perspective of the patient, in accessing treatment, eg. Transport, loss of productivity, etc

Intangible costsThose difficult to identify and measure eg. The drawbacks due to illness, depression, loss of quality of life.

Risks

Financial Risks Examples:

Interest ratesCommodity pricesForeign exchange

What is Risk Management?

Risk Management is the name given to a logical and systematic method of identifying, analyzing, treating and monitoring the risks involved in any activity or process.

Risk Management is a methodology that helps managers make best use of their available resources

What is Risk Management ?What is Risk Management ?

• Good management practices

• Process steps that enable improvement in decision making

• A logical and systematic approach

• Identifying opportunities

• Avoiding or minimizing losses

Who uses Risk Management ?

Risk Management practices are widely used in public and the private sectors, covering a wide range of activities or operations. These include:

• Finance and Investment• Insurance• Health Care• Public Institutions• Governments

Who uses Risk Management?Who uses Risk Management?

• Effective Risk Management is a recognized and valued skill.

• Educational institutions have formal study courses and award degrees in Risk Management.

• The Risk Management process is well established. (International RM process standards)

Who uses Risk Management?

Risk Management is now an integral part of business planning.

How is Risk Management used?How is Risk Management used?

The Risk Management process steps are a generic guide for any organization, regardless of the type of business, activity or function.

How is Risk Management used?

The basic process steps are:

• Establish the context• Identify the risks• Analyze the risks• Evaluate the risks• Treat the risks

The Risk Management process:

Establish the context

• The strategic and organizational context in which risk management will take place.

• For example, the nature of your business, the risks inherent in your business and your priorities.

The Risk Management process:

Identify the risks• Defining types of risk, for instance, ‘Strategic’ risks

to the goals and objectives of the organisation.• Identifying the stakeholders, (i.e.,who is involved or

affected). • Past events, future developments.

The Risk Management process:

Analyze the risks• How likely is the risk event to happen? (Probability

and frequency?)• What would be the impact, cost or consequences of

that event occurring? (Economic, political, social?)

The Risk Management process:

Evaluate the risks• Rank the risks according to management priorities,

by risk category and rated by likelihood and possible cost or consequence.

• Determine inherent levels of risk.

The Risk Management process:

• Monitor and review• Risk Managers must monitor activities and

processes to determine the accuracy of planning assumptions and the effectiveness of the measures taken to treat the risk.

• Methods can include data evaluation, audit, compliance measurement.

The Risk Management process:• Treat the risks• Develop and implement a plan with specific counter-measures

to address the identified risks.Consider:• Priorities (Strategic and operational)• Resources (human, financial and technical)• Risk acceptance, (i.e., low risks)• Document your risk management plan and describe the

reasons behind selecting the risk and for the treatment chosen.• Record allocated responsibilities, monitoring or evaluation

processes, and assumptions on residual risk.

‘Risk’ is dynamic and subject to constant change, so the process includes continuing:

Monitoring and review &

Communication & consultation