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Cost Classification
Total product/ service
The total cost of making a product or providing a service consists of the following.
▪ Cost of materials
▪ Cost of the wages and salaries (labour costs)
▪ Cost of other expenses
(i) Rent and rates
(ii) Electricity and gas bills
(iii) Depreciation

Direct cost and indirect cost

▪ A direct cost is a cost that can be traced in full to the product, service or department that is being costed.
▪ An indirect cost (or overhead) is a cost that is incurred in the course of making a product, providing a
service or running a department, but which cannot be traced directly and in full to the product, service or
department.

Functional
Classification by function involves classifying costs as production/manufacturing costs, administration costs or
marketing/selling and distribution costs.

Production overhead
• Wages of non-productive personnel in the production department, eg foremen
• Rent, rates and insurance of a factory
• Depreciation, fuel, power, maintenance of plant, machinery and buildings

Administration overhead
• Depreciation of office buildings and equipment
• Office salaries, including salaries of directors, secretaries and accountants
• Rent, rates, insurance, lighting, cleaning, telephone charges and so on

Selling overhead
• Printing and stationery, such as catalogues and price lists
• Salaries and commission of salespeople, representatives and sales department staff
• Advertising and sales promotion, market research
• Rent, rates and insurance of sales offices and showrooms, bad debts and so on

Distribution overhead
• Cost of packing cases
• Wages of packers, drivers and despatch clerks
• Insurance charges, rent, rates, depreciation of warehouses and so on

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Question – 1
George plc makes stationery. How would he classify the following costs?
Cost Production Administration Distribution
Purchases of plastic to make pens
Managing director’s bonus
Depreciation of factory machinery
Salaries of factory workers
Insurance of sales team cars

Question – 2
A company manufactures and sells toys and incurs the following three costs:
Production Distribution Selling
Rental of the finished goods warehouse
Rent and insurance of sales offices and showrooms
Rental of the raw materials warehouse
Depreciation of its own fleet of delivery vehicles
Insurance charges, rent, rates, depreciation of finished goods
warehouses
Commission paid to sales staff
Depreciation of office buildings and equipment
Depreciation of factory buildings and equipment
Salaries of security guard in raw material warehouse

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Cost Behavior
Cost behavior pattern
▪ A Fixed cost is a cost which is incurred for a particular period of time and which, within certain activity
levels, is unaffected by changes in the level of activity.
▪ A variable cost is a cost which tends to vary with the level of activity.
▪ A step cost is a cost which is fixed in nature but only within certain levels of activity.
▪ A semi-variable/semi-fixed/mixed cost is a cost which contains both fixed and variable components and
so is partly affected by changes in the level of activity.

Examples of fixed and variable costs

(a) Direct material costs (costs of materials consumed in the manufacturing process) are variable costs because
they rise as more units of a product are manufactured.
(b) Sale commission is often a fixed percentage of sales turnover, and so is a variable cost that varies with the
level of sales.
(c) Telephone call charges are likely to increase if the volume of business expands, but there is also a fixed
element of line rental, and so they are a semi- variable overhead cost.
(d) The rental cost of business premises is a constant amount, at least within a stated time period and so it is a
fixed cost.
(e) The salary paid to a factory supervisor might be considered a step- fixed cost. For example the factory may
be able to produce up to 20,000 products units with one supervisor, but needs a second supervisor once this
level of activity is exceeded.
Question-1
Are the following likely to be fixed, variable or mixed costs?
Fixed Variable Mixed Step-
Costs Fixed

One supervisor is needed for every ten employees added to the staff
Annual salary of the chief accountant
Cost of materials used to pack 20 units of product X into a box
A production worker is paid a salary of $650 per month, plus an extra 5
cents for each unit produced during the month.
Wages of warehousemen

Question-2
The costs of operating the canteen at 'Eat a lot Company' for the past three months is as follows
Month Cost Employees
$
1 72,500 1,250
2 75,000 1,300
3 68,750 1,175
Calculate
(a) Variable cost (per employee per month)
(b) Fixed cost per month

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Question-3
A company has recorded the following data in the two most recent periods.
Total costs Volume of
of production Production
$ Units
13,500 700
18,300 1,100
(a) What is the best estimate of the company's fixed costs per period?
(b) Calculate the total cost of production if volume of production unit is 1,500 units.

Question-4
DG Co has recorded the following total costs during the last five years.
Year Output volume Total cost
Units $
2010 65,000 145,000
2011 80,000 162,000
2012 90,000 170,000
2013 60,000 140,000
2014 75,000 160,000

Required
Calculate the total cost that should be expected in 2015 if output is 85,000 units.

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Marginal costing
Marginal cost is the variable cost of one unit of product or service.
The marginal production cost per unit of an item usually consists of the following.
▪ Direct material
▪ Direct labour
▪ Variable production overheads

Question-1
A company is about to introduce a new product to the market. The cost data is as follows:
$000
Selling price per unit 120
Direct material cost per unit 28
Direct wages cost per unit 30
Variable overhead cost per unit 26
Associated total fixed costs 385,000
Required:
(a) Variable cost per unit
(b) Profit
Question-2
Hypertech Ltd produces and markets one type of product. The accountant has produced the following cost
analysis of this produce based on the past results:
$
Variable cost per unit 10
Fixed cost per unit 12
Selling price per unit 30
Profit per unit 8

The fixed cost per unit represents all fixed costs incurred in running the business and has been calculated on the
basis that the company will produce and sell 100,000 units of the product.
Required
Calculate the profit of the company if the following occur:
(a) 80,000 unit are made and sold
(b) 100,000 units are made and sold
(c) 120,000 units are made and sold

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Question -3
A company is about to introduce a new product. The following budgeted data has been prepared:
£
Direct material cost per unit 60
Direct labour cost per unit 40
Variable overhead cost per unit 80

Proposed selling price per unit 220

Fixed costs allocated to the product 460,000

The first draft production and sales budget is 25,000 units.

The maximum possible output is 32,000 units.
Required
Calculate the first draft budgeted profit.

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Cost Volume Profit Analysis
Cost-volume-profit (CVP) analysis is the study of the interrelationships between costs, volume and profit at
various levels of activity.

Break Even Point

(a) The breakeven point which is the activity level at which there is neither profit nor loss.
(b) The amount by which actual sales can fall below anticipated sales, without a loss being incurred.

Question – 1
Expected sales 10,000 units at $8 = $80,000
Variable cost $5 per unit
Fixed costs $21,000
Required:
Compute the breakeven point.

Question – 2
Riding Breeches Co makes and sells a single product, for which variable costs are as follows.
$
Direct materials 10
Direct labour 8
Variable production overhead 6
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The sales price is $30 per unit, and fixed costs per annum are $68,000. The company wishes to make
a profit of $16,000 per annum.
Required
Determine the sales required to achieve this profit.

Question – 3
Budgeted Profit statement for a period $
Sale ($5 x 20,000 units) 100,000
Less: Total variable cost ($3 x 20,000 units) 60,000
Contribution per period 40,000
Less: Total fixed cost (20,000)
Profit 20,000
Required:
(a) Contribution per unit (CPU)
(b) Break-even point in -Sale unit
(c) To get Target Profit $40,000-Sale unit

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Questions - 4
Information concerning K Limited's single product is as follows.
$ per unit
Selling price 6.00
Variable production cost 1.20
Variable selling cost 0.40
Fixed production cost 4.00
Fixed selling cost 0.80
Budgeted production and sales for the year are 10,000 units.
(a) What is the company's breakeven point, to the nearest whole unit?
(b) How many units must be sold if K Limited wants to achieve a profit of $11,000 for the year?

Questions - 5
Phobos started to produce D44 at the start of February 2018. The production and costs relating to February and
March 2018 were as follows:
February March
Units produced 42,000 55,000
Total production costs ($) 558,070 602,270
The selling price of D44 was $9.95 per unit.
Phobos estimates that by June 2018 sales of D44 will be 80,000 units per month.
Costs and revenues per unit are not expected to change from February to June 2018.
(a) Calculate, for D44, the:
(i) variable costs per unit
(ii) fixed costs per month
(b) Calculate the break-even point in units
(c) Calculate the sales unit required for the business to make a profit of $131,000 per month