Cost Concepts and Application-09-10-2022

Session-1:
Understanding Cost for Decision Making

1
 Cost Concepts, purpose and application, overview

of Management Accounting.
Prof.Seshadev Sahoo, IIM Lucknow

Financial Accounting (FA)
2
1. FA does not provide detailed cost information for different

departments, process, products, jobs in the production
divisions.
2. Difficult to know the behavior of different costs in FA

Analyst Point
3
 Managers must understand cost in order to interpret

and act on accounting information.

Case: GM Collapses under the Weight of its
Fixed Costs
4
 After nearly 80 years as the world’s largest automaker,

General Motors (GM) was forced to be filed for bankruptcy
protection in 2009. Declining sales and the rise of Japanese
competitors, such as Toyota and Honda, affected GM’s
viability given its high fixed cost-cost that did not decrease as
the number of cars that GM made and sold declined. A
decade of belt-tightening brought GM’s variable cost-cost such
as material cost that vary with the number of cars that GM
makes-in line with those of the Japanese.
 Unfortunately for GM, a large percentage of its operating
costs were fixed because union contracts made it difficult for
the company to close its factories or reduce pensions and
health benefits owed to retire workers.
Difference between FA and CA
5
Accounting
Financial Management
Interested parties or
External reporting Internal reporting Interested parties
Users
Planning Management
Income statement Shareholders
Decision making -Top
Balance sheet Investors
Performance -Middle
Cash flow statement Creditors
Evaluation -Lower
Management Accounting
6
 Cost Accounting (CA)- Cost accumulation for Inventory

valuation and income determination.
 Management accounting (MA) – Emphasis on the use of cost
data for planning, control and decision making purposes.
1. It helps the management in planning and controlling costs
relating to both production and distribution activities.
2. Both cost and management accounting are interlinked with
each other.

Comparison of Financial and
Managerial Accounting
7
Financial Accounting Managerial Accounting

1. Users External persons who Managers who plan for
make financial decisions and control an organization
2. Time focus Historical perspective Future emphasis
3. Verifiability Emphasis on Emphasis on relevance
versus relevance verifiability for planning and control
4. Precision versus Emphasis on Emphasis on
timeliness precision timeliness
5. Subject Primary focus is on Focuses on segments
the whole organization of an organization
6. GAAP Must follow GAAP Need not follow GAAP
and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory

Analyst’s Point
8
 When Times are good companies often focus on selling as

much as they can, with costs taking a back seat. But when
times get tough, the emphasis usually shifts to costs and cutting
them.
General Motors 2001-2009
Suzlon Energy 2008-2014
 To effectively communicate information, accountants must
clearly understand the differences among the various types of
costs, their computations, and their usage.
Refer the note: GM Collapses under the weight of its fixed costs

Cost Concepts
9
1. Cost is the amount of expenditure actual (incurred) or notional

(attributable) relating to cost object.
2. When cost is incurred, it can be in the form of deferred cost (asset)
or expired cost (expense).
3. Deferred costs are capitalized costs and known as assets.
Example- plant, equipment, building, inventory, prepaid rent and
insurance.
4. When these deferred cost are used up or give up their usefulness,
they are written off or expensed and to that extent they become
expense.

Accountants View
10
 Accountants define cost as a resource sacrificed or foregone

to achieve a specified objective. An actual cost is the cost
incurred (historical or past) as distinguished from a budgeted
cost, which is predicted or forecasted cost (future cost).

1. Cost object
11
 When you think of cost, you invariably think of it in the context of

finding the cost of a particular thing- Cost object
 Cost object is anything for which a separate measurement of cost
is desired. Cost object might be:
1. A product
2. A process
3. A Service
4. A department
5. A project
6. An Activity
 Analyst’s viewpoint: cost object chosen should be appropriate to
the purpose for which costs will be collected and analyzed.
Decision Point-1
12
 Suppose you were a manager at MSL’s Gurgaon

Plant. MSL makes several different types of cars
and Baleno at this plant.
What cost objects can you think of ?.

MSL’s Product Portfolio
13
Baleno

MSL’s Gurgaon Plant
14
Cost Object Explanation

1. Product Baleno
2. Service Telephone hotline providing information and assistance to MSL dealers
3. Project R& D project on enhancing the DVD system in MSL cars
4. Customer Herb Chamber motors , the MSL dealer that purchases a broad range of
MSL vehicles
5. Activity Setting up machines for production or maintaining production equipment
6. Department Environmental, Health and safety department.

Analyst’s point
15
A. At MSL managers want to know the cost of various cost

objects.
B. Manager wants to know the budgeted and actual cost.
C. How does a cost system determine the costs of various cost
object- Typically in two basic stages:
(a) Cost accumulation, followed by (b) Assignment
a. Collection of cost data in some organized way by means of
an accounting system. Example: collection of costs for
materials, labor and supervision
b. Management accountants then assign these accumulated
costs to designated cost objects. i.e. different models of cars.
Cost accumulation and Cost assignment
16
A. Cost accumulation – a collection of cost data in an organized

manner
B. Cost assignment – a general term that includes gathering
accumulated costs to a cost object. This includes:
1. Tracing accumulated costs with a direct relationship
to the cost object and
2. Allocating accumulated costs with an indirect
relationship to a cost object

Analyst’s point
17
 Why it is useful to assign costs?

Think that some costs, such as cost of materials are
easier to assign to a cost object than others, i.e.
supervision cost, rent, administration cost.

1
Define Cost: Monetary measure of resources given up to attain an objective (such as

acquiring a good or delivering a service)
2. Direct costs
19
A. Direct costs of a cost object: related to the particular

cost object and can be traced to it in an economically
feasible (cost-effective) way.
 Example: cost of steel or tires is a direct cost of
Baleno.
 Note: The term cost tracing is used to describe the
assignment of direct costs to a particular cost object.

 Baleno line request for steel and tires from
warehouse – material requisition document identifies
these costs directly.
Indirect costs
20
B. Indirect cost of a cost object: Related to a particular cost object,

but cannot be traced to it in an economically feasible (cost-effective)
way.
Example: salaries of plant administrators.
Note:
1. Plant administrators also oversee the production of other products.
2. Unlike the cost of steel and tires there is no requisition of plant
administration services.
3. The term cost allocation is used to describe the assignment of
indirect costs to cost object.
4. Cost assignment is a general term that include both tracing direct
cost to cost object and allocating indirect cost to cost object.
Challenges in cost allocation
21
 Consider the cost of the lease of the MSL’s Gurgaon

plant.

Implication
22
A. This cost is an indirect cost of the Baleno

B. There is no separate lease agreement for the space used to make
the Baleno.
C. But MSL allocates to Baleno a part of the lease cost of the
building.
Analyst’s point:
Managers want to assign cost accurately to cost objects. Inaccurate
product costs will mislead managers about the profitability of different
products.
 How to allocate plant administration cost to Baleno?

Allocation of plant administration costs
23
1. Number of workers working on each car model

2. Number of cars produced of each model

Implication
24
 Indirect costs are often referred as Overheads

 Costs may also indirect with respect to particular
company segments or divisions.
“The salary of the plant manager of plant
A is a direct cost of plant A. But if the multiple
products are produced in plant A, the managers
salary is indirect to specific products.”
Note: What is a direct cost for one purpose may be

an indirect cost for another purpose.
Factors affecting direct
and indirect cost classification
25
 Several factors affect the classification of a cost as direct or

indirect:
1. Materiality of the cost in question.-
2. Available information gathering technology: improvements in
information gathering technology make it possible to consider
more and more costs as direct costs.
3. Design of operations: Classifying a cost as direct is easier if a
company’s facility (or some part of it) is used exclusively for a
specific cost object such as specific product or a particular
customer.
Example: cost of general chemical facility that is dedicated to
manufacturing soda ash is a direct cost of soda ash.
Baleno: Assigning Costs to a Cost Object
26
Baleno
Baleno
MSIL Baleno

1

3. Cost Behavior Patterns:
Variable Costs and Fixed Costs
28
 Recording the costs of resources acquired and used allows

managers to see how costs behave.
 Cost Behavior in relation to changes in output, and activity:
Reaction to Changes in Activity.
a. Variable cost
b. Fixed cost
c. Mixed cost (Semi variable and semi fixed cost)
d. Step cost- increases at certain activity levels
Relevant Range—normal operating range

a. Variable Cost
29
 A variable cost changes in total in proportions to

changes in the related level of total activity or
volume.
 Example: Steering wheel cost for the cost object
Baleno.
 Cost per unit of a variable cost is constant.
 When considering how variable costs behave,
always focus on total costs (rather than cost per unit)

Analyst’s point
30
 Costs are defined as variable or fixed with respect

to a specific activity and for a given time period.

Cost Reaction to Changes in Activity
 Variable cost  Fixed Cost

$ $
Total Total
# of Units # of Units
Unit $ Unit $
# of Units # of Units
Within the relevant range
b. Fixed cost
32
 A fixed cost remains unchanged in total for a given time period,

despite wide changes in the related level of total activity or volume.
 Example: MSL incurs a total cost of Rs.200 lakh per year for
supervisors who work exclusively on the Baleno line.
 Just as in the case of variable cost, when studying the behavior of
fixed costs- always focus on total fixed costs.
 Also known as period cost, standby cost, capacity cost, - arise
primarily because of provision of facilities (both physical and
human) to carry on business operation.
 By nature total fixed cost is constant and are expressed in terms of
time i.e. per day, per month, per year and not per unit.
Analyst’s Point
33
 Why are some costs are variable and others

are fixed costs ?

Analyst’s point
34
1. MSL buys steering wheels only when they are needed.

2. Level of supervision is acquired and put in place well before MSL
uses it to produce Baleno.
3. Fixed cost of resources (i.e. line supervision) cannot be quickly and
easily changed to match the resources needed or used.
4. Do not assume that individual cost items are inherently variable or
fixed. Example: Labor cost can be treated as fixed in some cases,
while variable in some others.
5. A particular cost item could be variable with respect to one level
of activity and fixed with respect to another.
6. Example: annual registration and license cost (RLC) for a fleet of planes owned by an
airline company- Variable with respect to number of planes owned. But RLC of a
particular plane are fixed with respect to the miles flown by that plane during a year.
Analyst’s point
35
6. Management policy decides the nature of the

cost as fixed or variable.
7. Example: if depreciation on machinery is charged
with reference to total number of hours for which
the machine is expected to function.

Cost Behavior Summarized
36
Behavior of Cost (within the relevant range)

Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
More output = More cost of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes. More output = lower cost per unit

4. Cost Drivers
37
 A cost driver is a variable, such as the level of activity or

volume, that causally affects costs over a given time span.
 Activity that has a direct cause-effect relationship on
cost.
 Directly causes the cost to change
Example:
1. Miles driven is often a cost driver of distribution costs.
2. Number of vehicles assembled at Baleno line is the cost driver
of the total cost of steering wheels (which is a variable cost).
3. If set-up workers are paid an hourly wage, the number of set-
up hours is the cost driver of total set-up cost.
Cost Drivers
38
 What about cost driver for fixed costs ?

Implication
39
 Costs that are fixed in the short run have no cost

driver in the short run but may have a cost driver
in the long run.
 Example: Costs of testing the color printers at
Hewlet-Packard. These costs include equipment and
staff costs of “testing department”.
 Note: Costing systems that identify the cost of each
activity such as: testing, design or set-up are called
activity-based costing system.

Relationships of Types of costs
40
C Assignment of costs to cost object

o Indirect costs
s
Direct costs
t
Cost object: MSL’s Cost object: Baleno
B Example: Power cost at
Baleno Gurgaon plant. Power usage is
b Variable costs Example: Tires used in
e metered only to the plant, where
assembly of automobile multiple products are
h
a (Baleno) assembled.
v
I
o
r Cost object: Baleno Cost object: Baleno
Fixed costs Salary of supervisor on Annual lease cost at Gurgaon
P Baleno assembly line plant. Lease is for whole plant,
a where multiple products are
t produced.
t
e
r
n
5. Total Cost and Unit Cost
41
Unit Cost:
Generally the decision maker should think in terms of total costs rather
than unit costs, however, in many decision contexts, calculating a unit
cost is essential.
 Cost unit as a unit of quantity of product, service or time (or a
combination of those) in relation to which costs may be ascertained

or expressed.
 Note: unless the total cost is unitized (i.e. averaged w.r.t. level of
activity or volume), its interpretation is difficult.

 Choice of cost unit depends on the nature of the product
manufactured, methods of production and trade practices.

Sl.No. Industry /product Cost Unit
1 Automobile Numbers
2 Steel Ton
3 Sugar Ton
4 Cement Kg, Bag
5 Chemical Litre, Kg, Ton
6 Brick works 1000 Bricks
7 Cosmetics Grams, jars or tubes
8 Mineral water Cases or 24 bottles
9 Shoes Pairs
10 Timber Cubic ft, tons
42 Prof.Seshadev Sahoo, IIM Lucknow
Analyst’s point
43
1. Unit costs should be interpreted cautiously.

2. Since unit costs change with a different level of output or
volume, it may be more prudent to base decisions on a total
dollar basis.
Unit costs that include fixed costs should always reference a given
level of output or activity. Unit Costs are also called Average
Costs
Example: The unit cost of Rs.800 applies only when

5,00,000 units are produced. Refer Excel Unit Cost
1

6. General Cost Classification
45
6.1 Manufacturing cost and Non-manufacturing cost

6.2 Product cost versus period cost
6.3 Prime cost and conversion cost

6.1 Manufacturing Costs
46
 Three terms commonly used while describing

manufacturing costs: Direct material cost, Direct
manufacturing labor cost, and indirect
manufacturing costs.

Direct material
47
 Raw materials that become an integral part of the

product and that can be conveniently traced directly
to it.
Example: A radio installed in an automobile, Crude
oil to produce petrol or diesel, raw cotton in textile,
Steel in automobile making.

Direct material
48
 Materials specifically purchased for a particular

job, order, process or product.
 Materials passing from one process to another
process
 Primary packing materials, wrapping, and
cardboard boxes.
Note; Import duties, dock charges, transport cost of
materials, storing of material cost, and cost of
purchasing and receiving materials are added to
their invoiced price .
Indirect Material
49
 Materials which are used for maintenance and

repair of machinery, running of service department,
spare and components, packing materials.
 They don’t normally form a part of the finished
product.

Direct manufacturing labor
50
 Labour of those workers who are engaged in the

production process. Can be easily (i.e. physically
and conveniently) traced to individual units of
product.
 Some times called as touch labour.
Example: labor cost of assembly line workers.
Note: Direct labors are expended directly upon the

materials comprised finished product.
Indirect Labor
51
 Wages which can not be allocated to different jobs

or products . Indirect wages are part of factory
expenses.
 Example: wages paid to watch and ward staff,
repair gangs, supervisor, general helpers, cleaners,
employees engaged in maintenance work.

Other direct expenses or charges
52
 Expenses which can be allocated conveniently to a

unit of cost other than direct material and direct
labor.
 Carriage on materials, royalty paid on the basis of
quantity of goods produced.
 Special necessary expenses can be identified with
cost units and are charged directly to the product
as part of the prime cost. Also called as chargeable
expenses.

Some examples of direct expenses
53
1. Cost of hiring special machinery or plant.

2. Cost of special moulds, designs and patterns
3. Experimental costs and expenditure on model and
pilot schemes
4. Fees paid to architects, surveyors and other
consultants
5. License fees
6. Cost of patents and royalties

Indirect Expenses
54
1. Rent, insurance-fire and liability

2. Taxes
3. Depreciation
4. Maintenance and repair
5. Power, light, steam and heat

Manufacturing or factory overhead
55
Manufacturing costs that cannot be traced

directly to specific units produced.
Examples: Indirect materials and indirect labor
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.
Nonmanufacturing Costs
56
Selling Administrative
Costs Costs
Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.

Administrative overheads
57
a. Office salaries, rent, executive salaries

b. Depreciation of equipment, Telephone,
c. Travel
d. Property taxes
e. Auditing expenses
f. Stationery, and printing, postage and other
administrative expenses.

Selling and distribution overheads
58
a. Advertising, sales promotion, samples

b. Salesmen salaries, travel
c. Depreciation of sales equipment
d. Rent of sales branches/stores
e. Telephone, telegraph, supplies at sales
department
f. Stationery, printing, freight and carriage out
g. Sales accounting.

1

6.2: Timing of charges against sales revenue
60
a. Product cost or inventoriable cost

b. Period cost

a. Product cost or inventoriable cost
61
 Product costs are all costs of a product that are considered as

assets in the balance sheet when they are incurred and that
become cost of goods sold only when the product is sold.
 Identified as part of inventory on hand.
 For manufacturing sector companies- All manufacturing costs are
product costs (DM + DL + Manufacturing overhead).

 In a manufacturing firm these include:
1. Direct material
2. Direct labor
3. Direct expenses
4. Manufacturing overhead
Note: Product cost is a full factory cost.
An example:
62
A. A manufacturer of cellular phones:- Example

B. For merchandising sector companies – Bharti Wal-
Mart.
C. Explaining the flow of inventoriable costs and
period costs.
Refer Excel-Inventoriable

Implication
63
 Product costs are initially assigned to an inventory

account on the balance sheet. When the goods are sold,
the costs are released from inventory as expenses
(typically called as cost of goods sold) and matched
against sales revenue. Thus becoming part of the period
costs at the time revenue is realized.
 Note: Product costs are not necessarily treated as
expenses in the period of occurrence rather, they are
treated as expenses in the period in which the related
products are sold.
b. Period cost
64
 Period costs are all costs in the income statement

other than cost of goods sold.
 Period costs are those which are not included in
stock valuation and treated as expenses during the
period in which they are incurred. Hence, non-
inventoriable costs.
 In a manufacturing firm these cost include:
Selling, distribution and administrative costs. They
are treated as expenses in the same period in
which the costs are incurred.
Implication
65
 Product costs influence the value of inventory as

such costs by nature should be included in the cost
of product.
 The nature of the firm, to a great extent,
determines which costs should be included in the
product costs:
1. Manufacturing firm:
2. Service firm:
3. Merchandising firms:

Implication
66
FIRMS
1. Manufacturing firm Sales-cost of goods sold= gross margin- selling and
administrative = net income for the period.
2. Service firm No such thing is called as product costs. All expenses are
classified as operating expenses which expire during
current accounting period, and are deducted from revenues
to determine the net income.
3. Merchandising firm Example: Departmental stores, grocery, drug stores etc.
The cost incurred i.e. purchase price paid by a
merchandising firm in buying the merchandise is the
product cost. This product cost (purchase price) appears on
the balance sheet as an asset (unexpired cost) till a sale is
made.
Note: Because there is no inventoriable costs for service sector companies, all
costs in the income statement are period costs.
Quick Check 
67
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.

Quick Check 
68
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.

Classifications of Costs
69
Manufacturing costs are often

classified as follows:
Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost

a. Capital cost
70
 A capital expenditure provides benefit for future

periods and is classified as an asset.
 A revenue expenditure is assumed to benefit the
current period and is classified as an expense and
hence matched with revenue for the current period.
 A capital expenditure will flow into the cost stream
as an expense when the asset is used up or written
off.

7: Decision making and planning
71
a. Opportunity cost
b. Differential cost and revenue
c. Sunk cost
d. Relevant cost
e. Imputed cost
f. Shutdown cost

a. Opportunity cost
72
 The potential benefit that is given up or sacrificed when one

alternative is selected over another.
 It is the income foregone by selecting another alternative.
 It is the cost of opportunity lost.
 Example: It is assumed that the manufacturer can sell a semi-

finished product to a customer for Rs. 50,000. He decides
however, to keep it and finish it. The opportunity cost is Rs.
50,000.
 The general rule is that the opportunity cost should not
exceed the value of the option selected.
b. Differential cost
73
 Every decision involves a choice between at least two

alternatives.
 Only those costs and benefits that differ between

alternatives are relevant in a decision. All other costs
and benefits can and should be ignored.

Differential cost
74
 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 in a
neighboring city that pays $2,000 per month. The
commuting cost to the city is $300 per month.
Differential revenue is:
$2,000 – $1,500 = $500
Differential cost is:
$300
c. Sunk cost
75
 Sunk costs have already been incurred and cannot

be changed now or in the future. They should be
ignored while making decisions.
 It is a past or committed cost, cost gone forever.
 Any historical cost is a sunk cost
 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.

Implication
76
1. If a plant was purchased five years ago for Rs.

500, 000. with the expected life of 10 years and
scrap value is nil. Then the WDV is Rs.2,50,000
(straight line method) will have to be written off no
matter what alternative future action is chosen.
2. Note: sunk cost are not relevant for decision making.
A past cost has no meaning in decisions to hold, use
or sell. Only current and future values have
meaning.

d. Relevant cost
77
1. Relevant costs are those future costs which differ

between alternatives.
2. Costs which are affected and changed by a decision.
(Irrelevant costs are those costs which remain the same
and not affected by the decision , whatever alternative
is chosen. Hence irrelevant but not forgotten).
3. Relevant costs are future costs i.e. those costs which are
expected to be incurred in future.
4. Relevant costs are only incremental (additional) or
avoidable costs. Incremental costs refer to an increase
in cost between two alternatives.

Case:
78
 A business firm purchased a plant for Rs.1,00,000

and has now a book value of Rs. 10,000. The plant
has become obsolete and cannot be sold in its
present condition. However, the plant can be sold
for Rs.15,000 if some modification is done on it
which will cost Rs. 6000.

Implication
79
 Rs. 6000 (modification cost) and Rs. 15000 (sales

value) both are relevant. Generates incremental
cost, reflect future, and future revenues. Incremental
benefit, Rs.15000-6000=Rs. 9000.
 Rs. 100,000 has already been incurred and being
a sunk cost is not relevant for decision i.e. whether
modification should be done or not. Similarly the
book value of Rs. 10,000 has to be written off
whatever future action is chosen is also not relevant.

Quick Check 
80
Suppose you are trying to decide whether to drive or

take the train to New Delhi 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 New Delhi?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

Quick Check 
81

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 New Delhi?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

Quick Check 
82

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.

Quick Check 
83

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.

Quick Check 
84
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 
85
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.

e. Imputed cost
86
 Imputed costs are cost not actually incurred in some

transaction but which are relevant to the decision as
they pertain to a particular situation.
 These costs do not enter into traditional accounting
systems, but they have economic utility, help in
making economic decisions.
 Imputed costs are opportunity cost.( If internal funds
are invested in projects, interest would have been
earned).

Example:
87
These are some examples of imputed costs

1. Interest on internally generated funds
2. Rental value of a company owned property.
3. Salaries of owner in a sole trading and
partnership firm.
Note: Costs paid or incurred are not imputed costs.
For example Rs.50, 000 paid for machinery
purchase is an outlay cost but not imputed cost.

f. Shutdown cost
88
1. Shutdown costs are those costs which have to be

incurred under all situations in case off stopping
manufacture of a product or closing down a
department or division.
2. Shut down costs are always fixed costs. Why?
3. Shut down costs thus refer to minimum fixed cots
which are incurred in the event of closure of a
department, division etc.

Implication
89
1. Shut down costs are always fixed costs,

because, if the manufacturing of a
product is stopped variable costs will not be incurred.
Example:
a. rent, watchman’s salary, property taxes. Such fixed
costs are unavoidable.
b. Some fixed costs can be avoidable: Supervisor’s
salary, Factory manager salary, Lighting.

Expenses excluded from cost
90
 The total cost of a product should include only those

items of expenses which form part of cost of production
and which are charged against profit. Items of
expenses which are appropriation or apportionment of
profit should not form a part of costs.
Example:
 Corporate tax (Income tax)
 Dividend to shareholders
 Commission to partners and managing agents
 Appropriations

Some facts:
91
 Costs are expired or unexpired.

 Loss is lost cost i.e. cost which expires without giving
any revenue benefit.
 Cost incurrence and cost recognition are different
from each other. Cost incurrence refers to the
receipt of goods or services at a bargained price in
an exchange. Cost recognition is the identification
of the cost as expired and showing it as an
expenses or loss in a given years income statement.
 Cost incurrence logically precedes cost recognition.

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Session-1:

Understanding Cost for Decision Making

 Cost Concepts, purpose and application, overview

Prof.Seshadev Sahoo, IIM Lucknow

1. FA does not provide detailed cost information for different

Prof.Seshadev Sahoo, IIM Lucknow

 Managers must understand cost in order to interpret

Prof.Seshadev Sahoo, IIM Lucknow

 After nearly 80 years as the world’s largest automaker,

 Cost Accounting (CA)- Cost accumulation for Inventory

Prof.Seshadev Sahoo, IIM Lucknow

Financial Accounting Managerial Accounting

Prof.Seshadev Sahoo, IIM Lucknow

 When Times are good companies often focus on selling as

Prof.Seshadev Sahoo, IIM Lucknow

1. Cost is the amount of expenditure actual (incurred) or notional

Prof.Seshadev Sahoo, IIM Lucknow

 Accountants define cost as a resource sacrificed or foregone

Prof.Seshadev Sahoo, IIM Lucknow

 When you think of cost, you invariably think of it in the context of

 Suppose you were a manager at MSL’s Gurgaon

What cost objects can you think of ?.

Prof.Seshadev Sahoo, IIM Lucknow

Cost Object Explanation

2. Service Telephone hotline providing information and assistance to MSL dealers

3. Project R& D project on enhancing the DVD system in MSL cars

5. Activity Setting up machines for production or maintaining production equipment

6. Department Environmental, Health and safety department.

Prof.Seshadev Sahoo, IIM Lucknow

A. At MSL managers want to know the cost of various cost

A. Cost accumulation – a collection of cost data in an organized

Prof.Seshadev Sahoo, IIM Lucknow

 Why it is useful to assign costs?

Prof.Seshadev Sahoo, IIM Lucknow

Define Cost: Monetary measure of resources given up to attain an objective (such as

A. Direct costs of a cost object: related to the particular

assignment of direct costs to a particular cost object.

B. Indirect cost of a cost object: Related to a particular cost object,

 Consider the cost of the lease of the MSL’s Gurgaon

Prof.Seshadev Sahoo, IIM Lucknow

A. This cost is an indirect cost of the Baleno

 How to allocate plant administration cost to Baleno?

Prof.Seshadev Sahoo, IIM Lucknow

1. Number of workers working on each car model

Prof.Seshadev Sahoo, IIM Lucknow

 Indirect costs are often referred as Overheads

Note: What is a direct cost for one purpose may be

 Several factors affect the classification of a cost as direct or

Prof.Seshadev Sahoo, IIM Lucknow

Define Cost: Monetary measure of resources given up to attain an objective (such as

 Recording the costs of resources acquired and used allows

Relevant Range—normal operating range

 A variable cost changes in total in proportions to

Prof.Seshadev Sahoo, IIM Lucknow

 Costs are defined as variable or fixed with respect

Prof.Seshadev Sahoo, IIM Lucknow

 Variable cost  Fixed Cost

 A fixed cost remains unchanged in total for a given time period,

 Why are some costs are variable and others

Prof.Seshadev Sahoo, IIM Lucknow

1. MSL buys steering wheels only when they are needed.

6. Management policy decides the nature of the