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Cost Classification and Statements
Cost Classification and Statements
Cost
Cost
Object
Indirect
Cost Driver
Indirect Costs
Insurance
Administration
Accounting
Advertising
Adapted from Peter Clarke (2002), Accounting Information for Managers
The clients for the wedding function have chosen a steak meal for the main
course. The ingredients, quantities required, quantities purchased and costs
are given below:
The $295 represents the total direct labor cost for the function. As the
wedding function will cater for 50 guests, the direct labor cost per meal is
$5.90 ($295 ÷ 50 meals).
In catering for the meal at the wedding function, it is anticipated that direct
expenses including fresh table arrangements, serviettes, place cards and
sundry items will amount to $150 for a wedding party of 50.
The total direct expenses of $150 divided by 50 meals will amount to $3.00
per meal
The prime cost can be established as follows:
Manufacturing
Overhead
Costs
Selling Costs
Non-
Manufacturing
Administrative
Costs
Manufacturing costs are often combined as follows:
Costs
Manufacturing
Direct Material Direct Labor
Overhead
Manufacturing
Direct Materials Direct Labor
Overhead
Period Cost
Calculate:
Amount ($)
Product Costs
Period Costs
Prime Costs
Conversion Costs
Cost classification by behaviour is primarily used for
management planning decisions. It is a crucial
classification in that it allows an insight into how
costs react to different circumstances. In trying to
predict and plan for the future, it is essential to
understand costs and what drives and creates costs. In
particular, this classification looks at the relationship
between costs and sales volume / production output.
When planning to increase output (sales volume), it is
important to understand and appreciate how costs
will react to this.
Cost
Fixed Variable
Mixed
Variable costs are costs that
increase as sales or production
volume increases.
Examples would include direct
materials (cost of food or beverages
for a restaurant or toys in a
toyshop)
Variable costs in total change in
response to changes in activity
levels.
Variable cost per unit will remain
constant in relation to changes in
sales activity.
The graph illustrates the variable cost of producing a meal in a restaurant is €2 and, as sales
volume increases, the variable costs increase. The variable cost graph shows that the
variable cost of producing 2,000 meals is €4,000 and the variable cost of producing 4,000
meals is €8,000.
The proportion of variable costs differs across organizations. For
example . . .
A merchandising company
A service company
usually will have a high
will normally have a high
proportion of variable costs
proportion of variable costs
like cost of sales.
Merchandising companies – cost of goods sold
Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced short-term by current
in the short term managerial decisions
Examples Examples
Depreciation on Advertising and
Equipment and Real Research and
Estate Taxes Development
Total Curvilinear Total
Dollars Cost Curve
Output
Start-up Normal Exceeding
Range Operations Capacity
In some situations increases in activity (volume)
can affect the cost structure.
Range
Accountant’s Straight-Line
Approximation (constant unit
variable cost)
Activity
Behavior of cost within the relevant range:
Fixed Monthly
Phone Charge
Fixed Monthly
Phone Charge
X
Activity (minutes)
The total mixed cost line can be expressed
as an equation: Y = a + bX
Y
Where: Y = the total mixed cost
a = the total fixed cost (the
vertical intercept of the line)
Total Mobile Phone Cost
Variable cost
per minute
Fixed Monthly
X Phone Charge
Activity (minutes)
Accounts analysis method
Scatter-graph method
High-low method
Linear regression
Under this method each cost is examined and, using
judgement and experience, classified into fixed,
variable and semi-variable categories. The semi-
variable category is further apportioned individually
into its fixed and variable components, normally on a
percentage basis. This method is based mainly on
experience and personal judgement and thus can be
quite subjective. Management can however, reduce this
level of subjectivity as follows.
Asking a person associated with the cost item who knows its
behavioural pattern and can give a best estimate of the variable
and fixed components to the cost.
* * * ** *
**
Cost
10 * *
0 X
0 1 2 3 4
Activity Level
Draw a line through the data points with about an
equal numbers of points above and below the line.
Y
20
* * * ** *
**
Cost
10 * *
0 X
0 1 2 3 4
Activity Level
Use one data point to estimate the total level of
activity and the total cost.
* * * ** *
**
Cost
10 * *
Intercept = Fixed cost: $10
0 X
0 1 2 3 4
Activity Level
Activity 0.8 units
Make a quick estimate of variable cost per unit and determine the cost equation
$1
Variable cost per unit = = $ 1.25/ unit of output
0.8
Y = $10 + $1.25X
Establish the cost function for repairs and maintenance using high-low method.
Activity Cost ($)
Step 1 High 900 6,000
Low 300 4,200
Step 2 Difference 600 1,800
Step 3 Variable cost per unit 1,800 ÷ 600 = $3.00
Step 4 Total Cost Fixed Cost + VC per Unit × No. of Units
Y =a +b ×X
6,000 =a + $3.00 × 900
6,000 =a + $ 2,700
a = 6,000 – 2,700 = 3,300
Thus, the cost function for repair and maintenance in this hotel is
summarized as:
Y = $3,300 + $3X
Differential / Incremental Costs
Differential or incremental cost is that additional cost which will incur if one
alternative is chosen in place of other.
Only relevant costs are taken into consideration (No fixed costs are taken)
This analysis is only for the purpose of taking managerial decisions and has no
relevance in book keeping and accounting
Differential
Cost to
Option C
Costs for Costs for
Option A Option B
Costs for
Option C
Opportunity Costs
Opportunity cost is the potential benefit that is given
up when one alternative is selected over another.
Fallacy:
People find it hard to abandon their past
investment and continue investing
although the past investment does not
influence on the future outcome
IS
COGS
COGM Sales
TMC Less
Look for spread in inventory (difference between beginning and ending) to judge
performance
Evaluate performance:
COGM: Factory
COGS: Marketing
Operating Expense: Administration and Marketing
Understand the impact of expenses on Gross Profit and Net Profit via COGM,
COGS and Operating Expenses
Impact of change in cost per unit due to nature of costs in period of rising prices
and changing volume of production
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