Chapter 3Costs, Concepts, Uses, and Classification

The Concept Cost

Cost must be based on relevant facts

Cost accounting is means to an end not an end itself.

Cost accounting measures cost in accordance with the plans and needs of management.

The Concept CostWhen the term cost is used specifically , it should be modified with reference to object costed, using such descriptions as direct, prime, conversion, indirect, fixed, variable, controllable, product, period, joint , estimated, standard, future , replacement , opportunity, sunk, imputed , differential and out of pocket.

Uses of Cost DataPlanning profit by means of budget

Controlling costs via responsibility accounting.

Measuring annual and periodic profit, including inventory costing.

Assisting in establishing selling price and a pricing policy.

Furnishing relevant cost data for analytical processes for decision making.

Planning Profit by Means of Budget

Budgeting is the forecast of the effects on profits of varying volumes of activity.Materials costs Quantities Labor costs Predetermined quantities of costs Quantities of time required to manufacture each product Factory overhead & non-manufacturing costs

Controlling Costs via Responsibility Accounting

To control costs, these fundamentals should be observedFixing responsibility for control.

Reporting the performance of the individual.

Measuring Annual Or Periodic Profit, Including Inventory CostingInvolves the matching principle concept.

This process requires distinguishing between short-run & long-run costs.

A companys financial statements reflect the results of separating the costs applicable to the units sold from the costs applicable to the units in inventories.

Variable manufacturing costs are assigned first to the units manufactured & then matched with the units sold; variable non-manufacturing costs typically are matched initially with the units sold.

Assisting In Establishing Selling Prices & A Pricing PolicyCombined knowledge of costs & their volume is required.

Supply & demand are the cornerstones for pricing.

Furnishing Relevant Cost Data For Analytical Processes For Decision MakingChanges in production methods,

making or buying a component part,

replacing equipment,

substituting materials,

accepting or rejecting a price or an order

Classifications Of CostsCosts are classified:

By the nature of the item.With respect to the accounting period to which they apply.By their tendency to vary with volume or activity.By their relation to the product.By their relation to manufacturing departments.According to their nature as common and/or joint costs.For analytical processes.

Natural Classification Of Costs

Total operating cost is divided into

Manufacturing costCommercial expenses

Manufacturing cost is the sum of three cost elements

Direct materialsDirect laborFactory overhead.

ContdCommercial expenses fall into two large classifications

Marketing expensesAdministrative expenses

Analysis of Total Operating Cost

Costs With Respect To The Accounting Period To Which They Apply

Expenditures can be divided into two broad classes:

Capital expendituresRevenue expenditures

Fixed vs. Variable Cost

FIXEDVARIABLEFixed amount within a relevant output range.Variability of total amount in direct proportion to volumeDecrease of fixed cost per unit withincrease output.Comparatively constant cost per unit inface of changing volume within arelevant rangeAssignment to departments often made by arbitrary managerial decisionsor cost allocation methodsEasy and reasonable accurate assignments to operating departmentsControl of incurrence resetting in mostcases with executive management rather than operating supervisors.Control of their incurrence and consumption by the responsible department head

Variable factory OverheadSuppliesFuelPowerSmall toolsSpoilage, salvage and reclamation expensesReceiving costsCommunication costRoyaltiesOvertime premium

Fixed Factory overheadSalaries of production executiveDepreciationProperty taxPatent amortizationRentMaintenance and repair of buildings and groundsInsurance Wages of security guards, janitors and fire fighters.

Semivariable Factory OverheadA Semivariable expense is often characterized by a fixed dollar element below which it will not fall at all relevant levels of output. e.g. electricity cost

Following items generally contain both fixed and variable elements:SupervisorsInspectionPayroll department serviceFactory office servicesMaterial and inventory servicesCost department servicesMaintenance and repairs of machinery and equipmentCompensation insuranceHealth and accident insurance Payroll taxesIndustrial relation and employee welfare expensesHeat , light and power

Cost in Their Relation to the ProductElements of manufacturing costs:

Direct labor, Direct material Factory overhead

TMC= DM+DL+FOH

Prime cost = DM + DL

Conversion cost = DL + FOH

Indirect material

Indirect Labor

Cost in their Relation to Manufacturing DepartmentsA factory is generally organized along departmental lines for production purposes.

Cost Budgeting with responsibility accounting and controlA greater degree of reliable costing

The departments of factory fall into two category:

Producing DepartmentService Department

Common or Joint CostsCommon costs

Joint Cost

Cost for Planning and ControlBudgets

When all phases of business have been coordinated into a well- thought out budget program , the budget becomes the written expression of managements plan for the future

Standard Costs

Closely allied with budgets are standard costs , which are predetermined cost for direct labor, direct material and factory overhead.

Cost For Analytical ProcessesCosts as the basis for analysis are estimated costs which may be incurred if any one of several alternative courses of action is adopted.

DifferentialOpportunity costsSunk costs