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Topic 1-Intro & Cost Classification
Topic 1-Intro & Cost Classification
Topic 1-Intro & Cost Classification
Introduction to Costing
Semester 2 2008/ 2009
Topic Outline:
1. Learning Objectives
2. Differences between Financial, Management & Cost Accounting
3. Role of Costing
4. Key Concepts in Costing
5. Classification of Costs
5.1. Costs for stock valuation
5.2. Costs for decision-making
5.3. Costs for control
1. Learning Objectives
After studying this topic, students should be able to:
Differentiate between management accounting, cost accounting and financial accounting
Describe and explain briefly the key concepts in cost accounting
Identify the roles of costing within an organisation
Describe the cost objectives and the classification of costs therein
Cost Accounting
~ is concerned with the cost accumulation for stock valuation to meet the requirements of external
reporting (Drury)
~ "The establishment of budgets, standard costs and actual costs of operations, processes,
activities or products; and the analysis of variances, profitability, or the social use of funds" (Lucey)
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3. Role of Costing
Foundation of the internal financial information system
Management needs a variety of information to plan, to control, and to make decisions.
Cost units
Costs are always related to some object or function or service
A unit of product or service in relation to which costs are ascertained
May be units of production (e.g. tonnes of cement, typewriters) or units of service (e.g.
consultation hours, number of invoices processed, kilowatt-hours)
E.g. cost of making one unit of table (cost/unit), cost of producing ten tonnes of iron ore
(cost/tonne)
Direct costs
Costs which can be directly identified with a job, batch, product or service
Consists of direct materials, direct labour and direct expenses
Do not have to be spread between various categories – the whole cost can be attributed
directly to a production unit or saleable service
Total of direct costs is known as prime cost.
Indirect costs
All material, labour and expense costs that cannot be identified as direct costs are termed
indirect costs.
The three elements of indirect costs: indirect materials, indirect labour and indirect expenses
are collectively known as overheads.
In practice, overheads are usually separated in categories such as Production Overheads,
Administrative Overheads and Selling Overheads
Cost Centre
A production or service location, function, activity or item of equipment for which costs are
accumulated
Responsibility centre where managers are accountable for the expenses that are under their
control
Normally consists of departments, but in some instances they consist of smaller segments
such as groups of machines within a department
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Cost allocation
To assign a whole item of cost, or of revenue, to a single cost unit, centre, account or time
period
Applies to direct costs as well as indirect costs
Cost apportionment
To spread revenues or costs over two or more cost units, centres, accounts or time periods.
This may also be referred to as ‘indirect allocation’.
The choice of an appropriate basis is a matter of judgement to suit the particular
circumstances of the organisation and wherever possible there should be a cost-cause
relationship
The process of apportionment is an essential part of the build-up of overheads, because
many indirect costs apply to numerous cost centres rather than just to one
5. Classification of Costs
Costs Objectives
Any activity for which a separate measurement of costs is desired
In other words, if the users of accounting information want to know the cost of something, this
something is called a cost objective.
E.g. Cost of a product, the cost of rendering a service to a bank or hospital patient
E.g.
Cost of operating an existing machine is a cost objective that may be required for a
comparison with the costs of operating a replacement machine. – costs for decision making
Cost of operating a department is a cost objective that may be required for a comparison with
the budgeted costs – costs for control
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5.1. Classification of Costs for Stock Valuation and Profit Measurement
Prime cost – direct costs of the product – direct materials + direct labour + direct expenses
Direct materials – all those materials that can be physically identified with a specific
product. E.g. Wood – direct materials in producing a desk.
Direct labour – those labour costs that can be specifically traced to or identified with a
particular product. E.g. – wages of operatives who assemble parts into the finished
products (desk)
Direct expense – expenses incurred specifically for a particular product. E.g. royalties
paid per unit for a copyright design
Manufacturing overhead – all manufacturing costs other than direct labour, direct
materials and direct expenses
Indirect materials – Those materials that cannot be directly traced to a particular unit
of product. E.g. varnish
Indirect labour – Those labour costs that cannot be physically identified with a
particular product. E.g. salaries of factory supervisors
Indirect expense – expenses that cannot be traced to the item being manufactured.
E.g. rent and rates of the factory
Period costs – costs that are not included in the stock valuation. Treated as expense in the
period in which they are incurred (Non-manufacturing costs)
Financial expenses: bank charges, interest on loan, discounts allowed
Selling and distribution: salesmen’s salaries, commission
Administrative: salaries of office staff
Process costing
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Helps to determine the cost per unit of product produced in an environment where identical
products are produced for all customers.
E.g.
Electronic assembly line where all products produced are identical
Biscuit manufacturing where although there may be more than one product line, each
line is a separate, continuos process producing identical products
Cost accounting is concerned with the calculation of actual product costs for stock valuation and
profit measurement, whereas management accounting is concerned with the provision of
information to help people within the organisation make good decisions.
a) Cost behaviour
1. Fixed costs
Remain constant over wide ranges of activity for a specified time period
E.g. depreciation of the factory machine, supervisors’ salaries, rent
Graph:
Activity level
Activity level
2. Variable costs
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Vary in direct proportion to the volume of activity – doubling the level of activity will double the
total variable cost
Total variable costs are linear and unit variable cost is constant
5,000
4,000
3,000
2,000 10
1,000
100 200 300 400 500 100 200 300 400 500
Activity level Activity level
(units of output) (units of output)
E.g. sales commissions, raw materials, petrol
Level of activity
4. Semi-variable costs
Include both a fixed and a variable component
These are costs that change with production, but not in direct proportion to the volume.
E.g. telephone charges which has a fixed charge for line rental of say RM68 per month and a
variable charge per minute for call charges of say RM0.30 per minute.
104
68
120 Minutes
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b) Relevant and Irrelevant Costs and Revenues
--- past vs future
--- differ between alternatives
For decision-making, costs and revenues can be classified according to whether they are
relevant to a particular decision
Relevant costs and revenues are those future costs and revenues that will be changed by a
decision, whereas irrelevant costs and revenues are those that will not be affected by the
decision
E.g. Petrol costs is relevant in deciding whether to have a journey by own car or public
transport. But the neither car insurance nor car tax costs are relevant.
Sometimes, the terms avoidable and unavoidable costs might be replacing the terms relevant
and irrelevant costs.
c) Sunk costs
The cost of resources already acquired where the total will be unaffected by the choice
between various alternatives
They are the costs that have been created by the decision made in the past and that cannot
be changed by any decision that will be made in the future.
E.g. Let say you want to conduct a project. You have two alternatives whether using the old
machine or replacing it with a new machine. The cost of purchasing the old machine is
therefore sunk cost. Whether you want to use it or you want to buy a new one, the cost has
already incurred
Sunk costs are irrelevant for decision making.
Distinguished from irrelevant costs because not all irrelevant costs are sunk costs
d) Opportunity costs
Cost that measures the opportunity that is lost or sacrificed when the choice of one course of
action requires that an alternative course of action be given up.
E.g. if an asset such as capital is used for one purpose, the opportunity cost is the value of the
next best purpose the asset could have been used for. Acquiring or renting? Let say, you
choose to acquire a building. A saving of RM150 per month of renting might be your
opportunity cost.