Two basic stages in Costing System

I.

Cost Accumulation

Collection of cost data in organised way through an accounting system

- accumulates costs by classification such as materials, labour, fuel, advertising
or shipping
II.

Cost Assignment

Assigning costs to costs objects

i.
ii.
iii.

Tracing accumulated costs to a cost object direct costs

Allocating accumulated costs to a cost object indirect costs
Costs incurred (historical costs) as distinguished from budgeted/forecasted
costs actual costs

Direct Costs costs related to the particular cost object and that can be traced to
it in an economically feasible (cost-effective) way
Indirect Costs costs that are related to the particular cost object but cannot be
traced to it in an economically feasible (cost-effective) way

Cost Reduction and Cost Management

I.
II.

Focusing on value-added activities that is those activities that customers

perceive as adding value to the products/services they purchase
Efficiently managing the use of the cost drivers in those value-added
activities

Cost-Drivers (aka cost generator, cost determinant)

- factor that affects total costs
- change in level of cost driver will cause of a change in the level of the total cost
of a related cost object
e.g. R&D no. of research projects, labour hours on a project
Variable Costs- costs that changes in total in proportion to changes in related
level of total activity or volume (cost-drivers)
- vary in direct proportion to the level of production
-decreases when less units are produced
- variable in total costs, per-unit costs are constant
Fixed Costs costs that does not change in total despite changes in the related
level of total activity or volume (cost-drivers)
- will incur even if no units are produced
- becomes progressively smaller on a per-unit basis as the cost driver increases
- total costs remain same, per-unit cost changes with level of cost-driver
- the more production, the lesser per-unit fixed cost

Cost Terminology
Two categories of costs (applies to all sectors of economy service, merchandising,
manufacturing)

Capitalised Costs
first recorded as an asset when incurred
- presumed to provide future benefits to the company
- costs to acquire motor vehicles, computer equipment
- written off to those periods assumed to benefit from their incurrence

Revenue Costs
- expenses of the accounting period when they are incurred
- salaries paid to marketing personnel, monthly rent paid for offices

Service Sector
- do not have tangible product at the end of accounting period
- operating cost line items include costs from all areas of value chain (production of services,
marketing etc)

Operating costs: costs associated with generating revenues

Merchandising Sector
- provide tangible products previously purchased in the same basic form from suppliers
- merchandise not sold at the ending of accounting period is held as stock
Manufacturing Sector
- provide tangible products that have been converted to a different form from that of the
products purchased from suppliers
- at the ending of accounting period, manufacturer has stock that can include direct materials,
work in progress or finished goods

Merchandising and manufacturing companies have holding of stock, hence they have
stock-related costs (unlike service sectors)
Stock-related costs (inventorial costs):
- costs associated with purchase of goods for resale for merchandising
- costs associated with acquisition and conversion of materials and other
manufacturing inputs into goods for sale for manufacturing
Operating costs
- other than costs of goods sold, the costs associated with generating revenues

Manufacturing Sector

Direct materials costs

- acquisition costs of all materials that eventually become part of the cost object
(either work-in-progress stock/finished goods stock)
- easily identifiable with a specific job, contract, work order
- varies directly with the volume of output
- includes goods-in (inward delivery) charges, sales taxes and custom duties
Direct manufacturing labour costs
- include compensation of all manufacturing labour that is specifically identified
with the cost object
- may/may not vary directly with the volume of output
- wages and fringe benefits paid to machine operators and assembly line workers
Indirect manufacturing costs (manufacturing overhead costs)
- manufacturing costs considered to be part of the cost object but cannot be traced
in an economically feasible way
- power, supplies, indirect materials, indirect labour, plant rent, plant insurance,
property taxes, plant depreciation, salaries of managers

Prime Costs All direct manufacturing/production costs

- direct materials, direct labours, commission, piece-rate pay
- to determine to the contribution margin of a product/service
- to calculate the minimum price at which a product should be sold
- does not include overheads costs, hence not advisable for long-term profitability
Conversion Costs- All manufacturing costs other than direct material costs
- costs to transform materials into finished goods
Administration Costs consists of all costs incurred in formulating the policy, directing the
organization and controlling the operations
- not related directly to manufacturing, selling and distribution, research and development,
activity
- includes accounts and personnel offices expenses, legal expenses, directors remuneration,
audit fees etc
Expenses all costs other than materials and labour cost
Direct expenses = Direct costs Direct Materials Costs Direct Labour Costs
excise duty (goods taxes), job process charges, royalty fees, hiring charges for machines,
tools, equipment
Indirect expenses = Indirect costs Indirect Material costs Indirect Labour Costs
rent and taxes of building, telephone expenses, repairs, insurance, depreciation of building,
plant, machinery and furniture, cleaning expenses