Classification of Cost CostingClassification of Cost Cost may be classified into different categories depending upon the purpose of classification. Some of the important categories in which the costs are classified are as follows: Classification of cost methods on the basis of nature of production or manufacturing process |. Job Costing and ii. Process Costing 2. Classification of Costs on the basis of their variability in relation to output:- ‘SomiVarlable and Semi-Fixed Cost Jn Making :~ Marginal Costing Incremental (or Differential) Cost Uniform Costing |. Opportunity Cost Replacement Cost ‘Sunk Gost Relevant Cost ‘Arunraj Arumugam ‘ppt.com4. Costs According to Functions (Manufacturing & Non-Manufacturing Cost):- i. Manufacturing or Production Cost Administrative Cost Selling and Distribution Cost Research & Development Cost ¥. Pre-Production Cost 5. Classification of cost methods on the basis of Time: 1. Historical Cost 2. Pre.Determined Costs 6. Classification of Costs based on establishment of relationship between input and output:- Enginsering Cost Managed Cost, discretionary or programmed Cost 7. Controllable and Uncontrollable costs ther Types of Costs \ ich arises in a particular contests and which are used for particular purposes are: Conversion Cost ‘Common Cost ‘Traceable Cost or Directly Attributable Cost TotalCost — Arunraj Arumugam. {fppt.comar Total Costs Units Lt The cost which varies directly in proportion with every increase or decrease in the volume of output or production is known as variable cost. Some of its examples are as follows: + Wages of laborers * Cost of direct material + Power Semi-variable costs aro costs that have both a variable and fixed component. Commercial leases often have a fixed rent per month nal rent based on the amount of production or For example, rent is $5,000 plus five cents for each pencil that is made. The base rent of $5,000 is a fixed cost and the five cents per pencil is a variable cost. Step-variable costs are costs that are constant over a range of production. If one employee can make 10,000 pencils, then the employee's wage is constant over a production range of one to 10,000 pencils. If you produce 11,000 pencils, you will need another employee. So your cost doubles. If you make 25,000 pencils your cost triples because you need three employees. ‘Arunraj Arumugam fopt.comple 1 Using the pencil maker example above, the variable and fixed costs are show below, \ariable cost per pencil Erasers $20 Rent 05 Labor 10 Total 8.35 Fixed cost Rent $5,000 Labor 10,000 Total $15,000 Total cost can be computed using this formula ‘Total Cost = (Variable Cost X Units Produced) + Fixed Costs 11 10,000 pencils are made, total costis $18,500 Total Cost = ($.35 x 10,000) + $1,000 Total Cost = $3,500 + $15,000 Total Cost = 18,500 11 100,000 pencits are made, total cost is ‘$50,000 Total Cost = ($.35 X 100,000) + $15,000 Total Cost = $35,000 + $15,000 Total Cost $50,000 ‘Aruhraj Arumugam fppt.comers (Also called Product Costs or Inventoriable Costs) — — Direct Materials Direct Labor Manufacturing Overhead Materials that can be Labor core that can be physically All costs of manulieturing a ‘hyticaly and converienty and conveniently traced to a Product other than direct traced to aproduct (xuch product (uch as astembly.line ‘material and direct bor (such 35 wood ina able) ‘workers in a plant): sometimes at indirect materia, indirect called touch labor labor, factory wives, and depreciation o factory buildings Centar CUO ee kenetern Td orem) ‘Selling Costs ‘Administrative Costs ‘All costs necessary to secure ‘Al costs assogated with the gen- customer orders and get the ‘eral management of he company fished product or service into a8 a whole (such a3 executive the hande of the customer compensation, executive trivel (such as sales commissions. ‘cost, seeretaral salaries, and advertising, and depreciation, ugam | deprecition of office buldings er Attra] Arumugam| ; fished goods warehouses) sptcomDirect and Indirect Costs The expenses incurred on material and labor which are economically and easily traceable for a product, service or job are considered as direct costs. In the process of manufacturing of production of articles, materials are purchased, laborers are employed and the wages are paid to them. The expenses incurred on those items which are not directly chargeable to production are known as indirect costs. For example, salaries of timekeepers, storekeepers and foremen. Also certain expenses incurred for running the administration are the indirect costs. Arunraj Arumugam, fppt.comDecision-Making Costs and Accounting Costs * Decision-making costs are future costs. They represent what is expected to happen under an assumed set of conditions. * Accounting costs are compiled primarily from financial statements. They have to be altered before they can be used for decision-making Arunraj Arumugam ) fppt.comRelevant and Irrelevant Costs + Relevant costs are those which change by managerial decision. + Irrelevant costs are those which do not get affected by the decision. For example, if a manufacturer is planning to close down an unprofitable retail sales shop, This will affect the wages payable to the workers of a shop. This is relevant in this connection since they will disappear on closing down of a shop. But prepaid rent of a shop or unrecovered costs of any pment which will have to be scrapped are irrelevant costs | which should be ignored. Arunraj Arumugam fppt.comShutdown and Sunk Costs * Sunk costs are historical or past costs. These are the costs which have been created by a decision that was made in the past and cannot be changed by any decision that will be made in the future. = Investments in plant and machinery, buildings ete. + Amanufacturer or an organization may have to suspend its operations for a period on account of some temporary difficulties, e.g., shortage of raw material, non-availability of requisite labor etc. During this period, though no work is done yet certain fixed costs, such as rent and insurance of buildings, depreciation, maintenance etc., for the entire plant will have to be incurred. Such costs of the idle plant are known as shutdown costs. Arunraj Arumugam fppt.comfppt.com Learning Objective 1 Identify and give examples of each of the three basic manufacturing cost categories.Manufacturing Costs Direct Direct Materials Labor Manufacturing Overhead The Product fppt.comDirect Materials Raw materials that become an integral part of the product and that can be conveniently traced directly to it. CS A e Vy, radio installed in an automobile Tppt.comDirect Labor Those labor costs that can be easily traced to individual units of product. Tppt.comManufacturing Overhead Manufacturing costs cannot be traced directly to specific units produced. Melee toi Murrow em elie e lees Materials used to support Wages paid to employees the production process. who are not directly involved in production Examples: Lubricants and work. cleaning supplies used in the Examples: Maintenance automobile assembly plant. workers, janitors and security guards. fppt.comClassifications of Nonmanufacturing Costs Administrative Selling Costs Coste Costs necessary to get All executive, the order and deliver organizational, and the product. clerical costs. fpptcomLearning Objective 2 Distinguish between product costs and period costs and give examples fppt.comProduct Costs Versus Period Costs Product costs include direct materials, direct labor, and manufacturing overhead. Cost of Invento! Goods Sold ——> Sale 4 1 Balance Income Sheet Tppt.com Statement Period costs are not included in product costs. They are expensed on the income statement. Expense 4 Income StatementQuick Check ¥ Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions. fppt.comQuick Check “” Which of the following costs would be considered a period rather than a product cost in a manufacturing company? (© Property taxes on corporate headquarters. (© ales commissions. fppt.comPrime Cost and Conversion Cost Manufacturing costs are often classified as follows: Direct Direct Manufacturing Material Labor Overhead Conversion Cost Tppt.comComparing Merchandising and Manufacturing Activities Merchandisers ... Manufacturers ... — Buy finished goods. — Buy raw materials. — Sell finished goods. — Produce and sell finished goods. MegaLoMart Arunraj Aruimjugam tppt.com —=Balance Sheet Merchandiser Manufacturer Current Assets Current Assets * Cash 0 Cash * Receivables 0 Receivables * Prepaid Expenses 0 Prepaid Expenses * Merchandise 0 Inventories: Inventory 1. Raw Materials 2. Work in Process 3. Finished Goods fppt.com aeBalance Sheet Merchandiser Manufacturer Current Assets Current Assets * Cash 0 Cash * Receivables Prepaid Expenses Partially complete U Inventories: products - some 1. Raw Materials material, labor, or 2. Work in Process overhead has been 3. Finished Goods added. “Completed products La F™ awaiting sale. Materials waiting to. \ be processed. Tppt.comLearning Objective 3 Prepare an income statement including calculation of the cost of goods sold. fppt.comThe Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers. Merchandising Company Manufacturing Company Cost of goods sold: Cost of goods sold: Beg. merchandise Beg. finished inventory $ 14,200 goods inv. $ 14,200 + Purchases 234,150 + Cost of goods Goods available manufactured 234,150 for sale $248,350 Goods available - Ending for sale $248,350 merchandise - Ending inventory (12,100) finished goods = Cost of goods inventory (12,100) aoe ==>-E- = Cost of goods ints) m sold 250Inventory Flows Beginning |, Additions |_| Ending Bees balance toinventory} | balance on oe inventory fppt.comQuick Check ¥ If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month? A. $1,000. B.$ 800. C. $1,200. D.$ 200 fppt.comQuick Check ¥ If your inventory balance at the beginning of the month was $1,000, you bought $100 during the month, and sold $300 during the month, what would be the balance at the end of the month? 800- Tppt.comLearning Objective 4 Prepare a schedule of cost of goods manufactured.Schedule of Cost of Goods Manufactured Calculates the cost of raw material, direct labor and manufacturing overhead used in production. Calculates the manufacturing costs associated with goods that were finished during the period. fpptcomSchedule of Cost of Goods Raw Materials Beginning raw materials inventory + Raw materials purchased ='Raw materials available for use in production — Ending raw materials inventory ='Raw materials used in production Manufactured As items are removed from raw materials inventory and placed into the production process, they are called direct materials. Arunraj Arumugam. | )Schedule of Cost of Goods Raw Materials Beginning raw materials inventory + Raw materials purchased ='Raw materials available for use in production — Ending raw materials inventory = "Raw materials used in produ Manufactured Manufacturing Conversion Coss costs are costs ct materials incurred to convert the Total manufacturing direct material costs into a finished product. As items are removed from raw materials inventory and placed into the production process, they are called direct materials.Schedule of Cost of Goods Manufactured Manufacturing Work Raw Materials Costs In Process Beginning raw Direct materials Beginning work in materials inventory + Direct labor process inventory + Raw materials + Mfg. overhead + Total manufacturing purchased =Total manufacturing 7 costs ='Raw materials costs =Total workin available for use process for the in production period — Ending raw materials inventory = Raw materials used in production fppt.comSchedule of Cost of Goods Manufactured Manufacturing Work Raw Materials Costs In Process Beginning raw Direct materials Beginning work in materials inventory + Direct labor process inventory + Raw materials + Mfg. overhead + Total manufacturing purchased = Total manufacturing costs ='Raw materials costs =Total workin available for use process for the in production period — Ending raw materials — Ending workin process inventory = Cost of goods manufactured. Tppt.comCost of Goods Sold Work In Process Finished Goods Beginning work in Beginning finished process inventory goods inventory + Manufacturing costs + Cost of goods for the period = Total work In process for the period - Ending workin recess inventoi ‘Ost of goods. manufactured manufactured = Tost oF goods available for sale - Ending finished joods invento: Cost of goods sold fppt.comManufacturing Cost Flows Balance Sheet Income Costs Inventories Statement Material Purchases Expenses Direct Labor Manufacturing Overhead Period Costs Acuna) ArumugamQuick Check ¥ Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used? A. $276,000 B. $272,000 C. $280,000 D. $ 2,000 fppt.comQuick Check ¥ Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still pre Beg. raw materials $ 32,000 direct material used? + Raw materials purchased 276,000 A. $276,000 ~-Rawimatertals avaliable B. $272,000 foruse in production $ 308,000 — Ending raw materials $280,000 inventory ° 28,000 $ 2.000 =Rawmateralsused in production $ 280,000 fppt.comQuick Check Vv Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month? A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined. Tppt.com aEQuick Check ¥ Direct materials used in production totaled | $280,000. Directh® © "777 777 . Direct Materials $280,000 factory ovetnead 4 + Direct Labor 375,000 month? = "Mpg. Costs Incurred $550,000) — a A. $835,000 . $655,000 D. Cannot be determined.Quick Check “” Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month? A. $1,160,000 B. $ 910,000 C. $ 760,000 D. Cannot be determined. fppt.comQuick Check ¥ Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods ramainina in wark in process inventory at th PANS ventory $128,000 What was the cost of g + mg. costs incurred dUring}the ment (ill Serer during the period $960,000 — Ending work in ——Process inventory __200,000 __ ©) $ 760,000 ~="casergooa — manufactured $760,000 fppt.comQuick Check ¥ Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month? A. $ 20,000. B. $740,000. C. $780,000. D. $760,000. Tppt.comQuick Check ¥” Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. The ending finished goods inventory was $150,000. What was the cost of goods sold for the month? fppt.comLearning Objective 5 Define and give examples of variable costs and fixed costs.Cost Classifications for Predicting Cost Behavior How a cost will react to changes in the level of business activity. ~ Total variable costs change when activity changes. ~ Total fixed costs remain unchanged when activity __ changes. fppt.comTotal Variable Cost Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked Ine euoydajaL fppl.comTppt.com Variable Cost Per Unit The cost per long distance minute talked is constant. For example, 10 cents per minute. Minutes Talked abieyo euoydelal aqNUIW 18dTotal Fixed Cost Your monthly basic telephone bill probably does not change when you make more Jocal calls. Number of Local Call: Ig euoydeje fppt.comFixed Cost Per Unit The average fixed cost per local call decreases as more local calls are made. Monthly Basic Telephone Bill per Local Call sled e907] Jo seqUINN Tppt.comCost Classifications for Predicting Cost Behavior Behavior of Cost (within the relevant range) ble cost changes | Variable cost per unit remains level changes. the same over ranges ofa Total fixed cost rem: Average fixed cost per unit goes the same even when the down as activity level goes up. level changes. fppt.comQuick Check “” Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers. fppt.comQuick Check ¥ Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) (C.)The cost of ice cream. (D.)The cost of napkins for customers. fppt.comLearning Objective 6 Define and give examples of direct and indirect costs.Assigning Costs to Cost Objects Direct costs Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples: Direct material and direct lal en Indirect costs * Costs that cannot be easily and conveniently traced to a unit of product or other cost object. + Example: Manufacturing overhead ed we t ae Arunraj Arumugam —Learning Objective 7 Define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs. fppt.comCost Classifications for Decision Making Every decision involves a choice between at least two alternatives. Only those costs and benefits that differ between alternatives are relevant to the decision. All other costs and benefits can and should be ignored. fppt.comDifferential Costs and Revenues Costs and revenues that differ among alternatives. Example: You have a job paying $1,500 per month in your hometown. You have a job offer ina neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month. Differential cost is: Differential revenue is: $2,000 — $1,500 = $500 $300 Net Differential Benefit is: | Arunraj “¢900" fppt.comOpportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000. fppt.comSunk Costs Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.Quick Check ¥ Tpptcom Suppose you are trying to decide whether to drive or take the train to Agra to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Agra? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant.Quick Check ¥ Suppose you are trying to decide whether to drive or take the train to Agra to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Agra? (a) es, the cost of the train ticket is relevant. fppt.comQuick Check “¥ Suppose you are trying to decide whether to drive or take the train to Agra to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant. B. No, the licensing cost is not relevant. fppt.comQuick Check ¥” Suppose you are trying to decide whether to drive or take the train to Agra to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? (Bo, the licensing cost is not relevant. fppt.comfppt.com Quick Check ¥ Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost. B. No, it is not a sunk cost.Quick Check ¥ Suppose that your car could be sold now for $5,000. Is this a sunk cost? (@o, it is not a sunk cost.Summary of the Types of Cost Classifications Predicting Cost Behavior Financial Reporting Assigning Costs to Cost Objects Decision Making fppt.com