COST CONTROL: CONCEPT, THEORY, AND ITS PRACTICE

Dr. Wiwiek M. Daryanto SE.Ak., MM, CMA

Educational background

Accountant (1981), cum-laude, UGM Registered Indonesian Accountant:D.2794 Master of Management (1988), College of Economics and Management, University of the Philippines Doctor of Philosophy (2004), IPB Certified Management Accountant (2000), Australia
HP: 0811-89-42-73 Email:wdaryanto@cbn.net.id

OUTLINE

COST CONCEPT THE CLASSIFICATION OF COSTS DIFFERENT COST FOR DIFFERENT PURPOSES THE BEHAVIOR OF COSTS BREAK EVEN POINT ANALYSIS

COST CONCEPTS

Four terms: cost, expenditure, expense, and disbursement Cost is a monetary measurement of the amount of resources used for some purpose. An expenditure is a decrease in an asset (usually cash) or an increase in a liability (often accounts payables) associated with the incurrence of a cost.

COST CONCEPT

The expenditures in an accounting period equal the cost of all the goods and services acquired in that period. An expense is an item of cost applicable to the current accounting period. An expense represents resources consumed by the entitys earnings activities during the current period.

COST CONCEPTS

When an expenditure is made, the related cost is either an asset or an expense. If the cost benefits future periods, it is an increase in an asset. If not, it is an expense a reduction in retained earnings of the current period.

COST CONCEPTS

A disbursement is the payment of cash. A cash expenditure is a disbursement; but so is any cash payment, such as paying an account payable, repaying a loan, or paying a cash dividend to shareholders.

Matching Concept
Cost
Capital /Investment Expenditures CAPEX
Amortization : 1) Depreciation Tangible FA 2)Depletion

Expenditures
Operating / Revenue Expenditures OPEX = Expenses

Natural resources 3) Amortization Intangible FA

Cash

Payable

Disbursement= Cash Payment

CLASSIFICATION OF COST

Concept of Different Cost for Different Purposes Classification of Cost, based on: Nature Main Functions (Production; Marketing; General and Administration) Cost Object (Direct and Indirect Costs) Behavior of Costs (Fixed & Variable Costs)

CLASSIFICATION OF COST BASED ON MAIN FUNCTIONS

Raw Material Exp. Prodn Exp. Direct Labor Exp. Factory Overhead Exp. Marketing Exp. Gen & Adm Exp.

Primary Exp.

Conv. Exp.

EXPENSES

Commercial Expenses

Cost Classification The Overlap of Cost Classification Approaches

The Financial Accounting-Management Accounting Cost Classification Link Materials Labour Factory workers wages, Factory supervisors salary Overhead

Production

Raw Materials (e.g. steel), Purchased components (e.g. valves).

Power, Depreciation of machines, Rent of factory space

Selling

Samples, Brochures and Catalogues, Display signs Stationery, Costs of tea and coffee

Counter staff wages, Salesmens salaries and commissions Payroll Clerks salary, Secretarys salary, Computer operators salary

Transport costs, Advertising costs, Depreciation of vehicles Depreciation of office equipment. Rent of office space.

Administration

Cost Object:

Is the technical name for the product, project, organizational unit, or other activity or purpose for which costs are measured. Some people prefer cost

objective

Full Cost

Full cost means all the resources used for a cost object.

The full cost of a cost object is the sum of its direct costs plus a fair share of applicable indirect costs.

Direct and Indirect Costs

The direct costs of a cost object are items of costs that are specifically traced to, or caused by, that cost object. Indirect costs are element of costs that are associated with, or caused by, two or more cost objects jointly but that are not directly traced to each of them individually. The nature of an indirect cost is such that it is not possible, or at least not feasible, to measure directly how much of the cost is attributable to a single cost object.

The Overlap Of Cost Classification Methods VARIABLE FIXED

D I R E C T I N D I R E C T

Raw material purchase costs; Finished product purchase cost; Wages of production workers.

Depreciation of a machine used only for the production of a single product type; Salary of a factory supervisor who oversees production of a single product type.

Wages of workers shared amongst different product types; Raw materials or purchased components shared (e.g. fuel, nuts and bolts); Overhead expenses such as discounts, commissions etc.

Depreciation of Assets shared amongst different product types; Salary of factory supervisors, payroll clerks, salesmen etc. shared; Overhead expenses such as rent of premises, audit fees, hire purchase payments etc.

Cost Driver
1. Payroll Related. The employers share of social security taxes, health insurance, and other fringe benefits may be allocated on the basis of the total labor costs. Alternatively, as mentioned above, fringe benefit costs for direct workers may enter into the calculation of direct labor costs; if so, they will not appear as overhead costs at all.

2. Headcount Related. Human resource department costs and other costs associated with the number of employees rather than with the amount that they are paid may be allocated on the basis of number of employees (headcount)
3. Material Related. This category of costs typically includes the costs of purchasing and receiving materials, including counting, weighing, or inspecting them. These costs may be allocated on the basis of either the quantity or the costs of direct material used in production cost centers. Alternatively, they may be excluded from the cost center overhead costs and instead assigned to product as part of their material cost. For example, if the material-related cost rate is 10 percent of direct material cost, then a product with $5 direct material cost will have this cost grossed up to %5.50 so as to include the material-related costs.

Cost Driver
4. Space related. Some items of cost are associated with the space that the cost center occupies, and they are allocated to cost centers on the 5.
basis of the relative floor area or cubic or space or the cost centers. These are also called facility Related costs. Transaction Related. Some costs are caused by the number of time some activity is performed rather than by the value of the goods or services associated with the activity. For example, the cost of preparing a purchase order is unaffected by the dollar amount of the items on the order, and the cost of scheduling a job is the same whether it is large job or a small one. Such drivers are also called Activity Related. If the activity is performed once for each batch of product that is processedsuch as preparing a set of production document for a job, scheduling the job, setting up a piece of equipment, or inspecting one items from each batch produced the drivers is called a Batch Level Driver. Product Related. Some cost are caused by the existence of the product it self. Examples include engineering change order cost for a product, the cost of tools and dies that are used only for a single product, and the cost maintaining product-related document such as drawings, bills of material, and production routings.

6.

Cost Driver
7. Overall drivers. As mentioned above, if the pool of cost to be allocated include a mixture of activities, then a clear-cut causally related driver is difficult to identify. In these instances, abroad, overall measure such as DLH, DL $, machine hours, material cost, prime cost (direct material plus direct labor), or number of units is used. Because the choice of such a driver often is made only after the failure to find a driver that more clearly reflects a clear-cut causal relationship, some people refer to these as default drivers. Note that these drivers all have something in common; any of them will assign twice a much cost to two of product as to one unit. This is because two units have twice as much direct-labor content, machine time, direct material, of prime costs as does one unit. Drivers with this characteristic are therefore called Unit-level drivers. Plantwide Overhead Rate. Many companies, although having a number of production departments, use the same overhead rate for all of them. This Plantwide overhead rate is calculated by dividing total plant overhead costs by an overall activity measure, usually DLH or DL $. This is the simplest possible way to allocate overhead to products; it involves none of the complications illustrated in the Marker Pen example because there is only one cots center in the product costing system the entire plant.

ELEMENTS OF PRODUCT COST

Direct Labor Conversion Cost Full Production Cost (or Inventory Cost) Full Cost

= +
Overhead

=
Direct Material Cost

=
Selling Cost

Cost

+
General And Administrative Cost

ELEMENTS of PRODUCT COST

The most common cost object of interest in a business is a product. This can be either a tangible good, such as a batch of jeans, or a service, such as a repair job on an automobile. The system that accumulates and reports the costs of product cost objects is called a product costing system. Elements of product cost are either material, labor, or services. In a product costing system these elements are customarily recorded in certain categories.

Direct Material Cost: The quantities of material that can be specifically identified with a cost object in an economically feasible manner, priced at the unit price of direct material are the direct material cost of a cost object. These materials, often called raw materials or just materials, are to be distinguished from supplies, or indirect materials, which are materials used in the production process but not directly traced to individual products. Examples of supplies include lubricating oil for factory machinery and spices in a restaurants kitchen.

Direct Labor Cost. The labor quantities that can be specifically identified with a cost object in an economically feasible manner, priced at a unit price of direct labor are the direct labor of a cost object. Other Direct Costs. Conceptually, any cost traced to a single product is a direct cost of that product. Example: energy costs. However, most companies classify only direct material and direct labor costs as direct production costs.

Overhead Cost. All indirect production costs all production costs other than direct costs are included in overhead cost. One element of overhead is indirect labor: the earnings of employees who do not work directly on a single product but whose efforts are related to the overall process of production. Examples include supervisors, janitors, materials handlers, stockroom personnel, inspectors, and crane and forklift operators.

Another element of overhead is indirect material costs, described above.

Overhead also includes such items as heat, light, power, maintenance, depreciation, taxes, and insurance related to assets used in the production process.

Conversion Cost. The sum of direct labor cost and overhead cost is conversion cost. It includes all production costs needed to convert direct materials into finished goods. As factories become automated, direct material costs tend to become a much more significant cost element than direct labor; at the same time the distinction between direct labor and indirect labor becomes blurred. As a result, some companies no longer distinguish between direct labor and overhead cost; instead, the single category of conversion cost is used.

Full production Cost. The sum of direct material cost and conversion cost is full production cost. In a manufacturing firm full production cost often is called inventory cost because this is the cost at which completed goods are carried as inventory and the amount that is reported as cost of sales when the goods are sold. The cost at which goods are carried in inventory includes neither distribution nor selling costs, nor those general and administrative costs that are unrelated to production operations. in a manufacturing firm full production cost includes only the costs that are incurred within the four factory walls

In a financial accounting these full production cost that flow through inventory accounts are called product costs to distinguish them from period cost, which do not flow through inventory accounts but rather are charged are expenses of the period in which they are incurred. The term inventory cost is more descriptive of full production costs than product cost because the full cost a product cost object also includes nonmanufacturing costs such as the cost of selling the product. Nevertheless, referring to inventory cost as product costs is well established in practice.

Non-production cost. Nonproduction cost (also called period costs) are all costs incurred in an organization other than inventory costs. These include selling costs, research and development costs, general and administrative cost, and interest cost. In a companys income statement, many of these cost are reported as a lump sum under the single caption, selling general and administrative expense (informally called SG&A by many businesspersons).

In a manufacturing firm selling costs include both marketing (order-getting) costs and logistics (order-filling) costs. The distinction between the two types of selling cost is that marketing costs are incurred before a sales order is received whereas logistics costs are incurred after the goods have been produced. Marketing costs include market research, advertising, point-of-sale promotions, and sales persons compensation and travel costs. Logistics cost include warehousing and delivery costs as well as the recordkeeping cost associated with processing an order.

General administrative costs include the costs of service and staff units (such as the human resource management and public relations departments) and general corporate costs, including the compensation of top management and donations to charitable organizations. Interest costs are the costs of using borrowed funds. In most companies no attempt is made to associate interest cost with specific products. Research and development (R&D) costs are the costs associated with efforts to find new or improved products or production processes.

Full cost. The full cost of product is simply the sum of all the cost elements described above. Thus full product costs includes both inventory (full Production) cost and non production cost. However, in practice, many accountants use the term full cost to mean only full production cost. This is another example of the lack of precision in practitioners use of costrelated terms and another reason why one must look beyond the label to be certain what the user of really term means.

The Behavior of Costs

Understanding cost-volumerelationships, how cost behave as the level of activity changes. The concepts of fixed and variable costs Variable costs are items of cost that vary, in total, directly and proportionately with volume. Fixed costs are items of cost that, in total, do not vary at all with volume.

The Classification of Costs

Semi-variable costs are those costs that include a combination of variable costs and fixed cost item. Semi-variable costs are also called semifixed, partly variable, or mixed costs.

1. THE HIGHEST-LOWEST METHOD

ACTIVITIES THE HIGHEST (AUG,85) VOLUME (UNITS) TOTAL COST (Rp 000) 8,000 600,THE LOWEST (FEB,84) 6,000 500,THE DIFF. () 2,000 100,-

*UVC = Rp 100,000,- : 2000 = Rp 50,-

TFC CALCULATION :
THE HIGHEST ACTIVITY TOTAL COST TOTAL VAR. COST: 8,000 x Rp. 50,6,000 x Rp. 50,TFC / MONTH Rp. 600.000,400.000,Rp. 200.000,THE LOWEST ACTIVITY Rp. 500.000,300.000,Rp. 200.000,-

2. THE LEAST SQUARE METHOD / LINEAR REGRESSION

TOTAL COST : Y = a + b x

n xy - x y
b= nx2(x)2 a=

y-bx
n

Break-even Volume

At the break-even volume, total costs equal total revenue. Total Revenue (TR) = Total Costs (TC) TR = Price/u * Volume (X) TC = TFC + (VC/u * X), so P/u * X = TFC + (VC/u * X) Break-even Volume=X = TFC / P/u VC/u

Case:JACKSON THOMAS (Q 1)
-

Variable Costs per unit: Purchased parts $2.68 Labor ($11.75*1.2/15) .94 Shipping Costs.. .16 Total VC/unit. $3.78

JACKSON THOMAS (Q1)

FIXED COST/MONTH: Rent........... GMs Salary. Off Mgrs Salary Other. Total FC/month

$1,900 6,300 2,200 1,500 $ 11,900 or

$ 142,800 per year

JACKSON THOMAS (Q1&2)

Total Costs = 142,800 + 3.78X If X = 400,000 TC=1,654,800 AC=$4.14 If X = 450,000 TC=1,843,800 AC=$4.10 If X = 525,000 TC=2,127,300 AC=$4.05

JACKSON THOMAS (Q3)

If volume up to 450,000 units per year: Total Costs = (142,800 +15 persons (2,000*11.75*1.2) + (2.68 + .16)X

Jackson Thomas (Q3)

And for volume between 450,000 and 525,000 units per year: TC= 565,800+2.84(450,000)+(X450,000)(2.84+(21.15/15) = 1,843,800 + (X-450,000)(4.25) = -68,700 + 4.25X

Jackson Thomas (Q3)

Total and average unit costs at the three volumes are as follows:

X 400,000 450,000 525,000

TC $ 1,701,800 $1,843,800 $ 2,162,550

Cost/U $4.25 $4.10 $4.12

Jackson Thomas (Q4)

Number of assemblers required to produce 525,000 units: (525,000 units/year) / (2,000 hrs/yr) / (15 units/worker/hr)=17.5 workers, or 18 units: Fixtures: 18@$1,575= $28,350 Other: 18@$945= $17,010 Total $45,360

Jackson Thomas (Q4)

Monthly depreciation = $45,360/6*12=$630 Annual depreciation= $ 7,560 Thus, Monthly FC = $11,900+$630=$12,530 Annual FC = $142,800 + $7,560=$150,360 Variable costs remain unchanged, so we have:

Jackson Thomas (Q 4)
X 400,000 450,000 525,000 Total Cost $1,662,360 $1,851,360 $2,134,860 Cost/Unit $4.16 $4.11 $4.07

Jackson Thomas (Q5)

X
400,000 450,000 525,000

T Revenue
$1,780,000 $2,002,500 $2,336,250

T Costs
$1,654,800 $1,843,800 $2,127,300

Profit
$125,200 $158,700 $208,950

Pak Amat
Dalam suatu pasar malam, Pak Amat akan membuka tempat penitipan sepeda. Dia menyewa tempat yang dapat menampung 500 sepeda. Sewa tempat tersebut per malam Rp 1500,-. Untuk menjaga sepeda dia akan memperkerjakan dua orang, dengan upah Rp1000,- semalam per orang, ditambah upah insentip sebesar Rp2,50 per orang untuk setiap sepeda yang masuk titipan. Tarif titipan yang dibebankan adalah Rp 25,- per sepeda semalam. Berapa jumlah sepeda minimum yang harus masuk setiap malam agar supaya usaha titipan tersebut tidak rugi?

Flexible Budget Pak Amat (untuk 500 unit)

Jumlah Hasil Penjualan= 500*Rp25,-=Rp 12.500,Biaya Variabel: Upah: 500*2org*rp2,50= (2.500,-) Contribution Margin (10.000,-) Biaya Tetap: Sewa tempat Rp1.500,Upah 2 org 2.000,(3.500,-) Laba Bersih Rp 6.500,% 100

20 80

28 52

SCHEMATIC OF CONTRIBUTION

Revenues

Contribution

Fixed Costs

Profit