Presentation on theme: "1 1 Accounting The Make up of Costs Dr Clive Vlieland-Boddy."— Presentation transcript:
1 1 Accounting The Make up of Costs Dr Clive Vlieland-Boddy
2 StrategyEvaluation Feedback Forecasting The Functions of Management
3 Behavior – how costs react to changes in underlying cost driver –Variable or Fixed Function – related to production or sales –Product or Period –Product costs – Direct Material Direct Labor Factory Overhead Traceability (cost of tracing cost to a cost driver directly should be lower than the benefits. Summary of Objectives
4 Costs Anything incurred during the production of the good or service to get the output into the hands of the customer The customer could be the public (the final consumer) or another business Controlling costs is essential to business success Not always easy to pin down where costs are arising!
5 Cost A cost may be defined as a sacrifice or giving up of resources for a particular purpose. Costs are frequently measured by the monetary units that must be paid for goods and services. Costs are different from expense
6 Direct Vs Indirect Costs Direct / Indirect costs Direct costs Direct labor Direct materials Whether the cost can be directly allocated to a given product Indirect costs (overheads) Managing directors salary Rent rates Administration expenditure
7 Cost Concepts for Decision Making A relevant cost is a cost that differs between alternatives. 1 2
8 Relevant Costs Relevant Irrelevant
9 Identifying Relevant Costs Costs that can be eliminated (in whole or in part) by choosing one alternative over another are avoidable costs. Avoidable costs are relevant costs. They are costs that will be incurred and can be traced to the product or process.
10 Product Cost Product cost is the traceable costs that are attributable to a product or process. Calculations under any costing system will include be the Actual Cost.
11 Non-manufacturing Costs Marketing or Selling Costs Costs necessary to get the order and deliver the product. Administrative Costs All executive, organizational, and clerical costs.
12 Product Costs Vs Period Costs Product costs include direct materials, direct labor, and manufacturing overhead. Period costs include all marketing or selling costs and administrative costs. Inventory Cost of Good Sold Balance Sheet Income Statement Sale Expense Income Statement
13 Manufacturing Cost Flows Finished Goods Cost of Goods Sold Selling and Administrative Period Costs Selling and Administrative Manufacturing Overhead Work in Process Direct Labor Balance Sheet Costs Inventories Income Statement Expenses Material PurchasesRaw Materials
14 Product Cost Flows
15 General Cost Terms Manufacturing Costs Direct materials Direct labor Mfg. Overhead Non-manufacturing Costs Overhead Marketing Administrative
16 Classifying Costs for Financial Statements Matching Concept: The costs incurred to generate particular revenue should be recognized as expenses in the same period that the revenue is recognized. Period costs: Those costs that are matched against revenues on a time period basis Product costs: Those costs that are matched against revenues on a product basis.
17 Cost Classification for Predicting Cost Behavior Volume index Cost Behaviors Fixed costs Variable costs Mixed costs Stepped costs Average unit costs
18 Cost Classifications for Predicting Cost Behavior By reaction to changes in the level of activity within the relevant range. –Total variable costs change when activity changes. –Total fixed costs remain unchanged when activity changes.
19 Types of cost behaviour
20 Fixed Costs Fixed costs remain the same even if output changes. ( They are costs that must be paid on a regular basis.) There is a minimum charge for the telephone and utilities that must be paid every month whether they are used or not.
21 Fixed Costs Definition: The costs of providing a companys basic operating capacity Cost behavior: Remain constant over the relevant range
22 Fixed Costs - Example Damon Company leases its productive facilities for $10,000 per month Total fixed costs of the facilities remain constant at all levels of activity - $10,000 per month On a per unit basis, the cost of rent decreases as activity increases and vice versa At 2,000 radios, the unit cost is $5 ($10,000 ÷ 2,000 units) At 10,000 radios, the unit cost is $1 ($10,000 ÷ 10,000 units)
23 Fixed Costs Graphs
24 Variable Costs Variable costs are costs that change with production or sales. The costs of raw materials increase as more of a product is produced (made). Labour costs (wages) also increase with production as more workers are needed. Utility (electricity, water, telephone) costs may increase also.
25 Variable Costs Definition: Costs that vary depending on the level of production or sales Cost behavior: Increase or decrease proportionally according to the level of volume
26 Variable Costs Costs that vary in total directly and proportionately with changes in the activity level Example: If the activity level increases 10%, total variable costs increase 10% Example: If the activity level decreases by 25%, total variable costs decrease by 25% Variable costs remain constant per unit at every level of activity.
27 Variable Costs - Example Damon Company manufactures radios that contain a $10 clock Activity index is the number of radios produced For each radio produced, the total cost of the clocks increases by $10: If 2,000 radios are made, the total cost of the clocks is $20,000 (2,000 X $10) If 10,000 radios are made, the total cost of the clocks is $100,000 (10,000 X $10)
28 Variable Costs – Graphs
29 Costs that have both a variable cost element and a fixed cost element Sometimes called semi-variable cost Change in total but not proportionately with changes in activity level Mixed Costs
30 Activity (minutes) Mixed Costs Fixed Monthly Phone Charge Total Mobile Phone Cost X Y Total mixed cost
31 Fixed Monthly Phone Charge Variable Cost per minute Activity (minutes) Total Mobile Phone Cost X Y Mixed Costs Total mixed cost
32 Mixed costs must be classified into their fixed and variable elements One approach to separate the costs is called the high-low method Uses the total costs incurred at both the high and the low levels of activity to classify mixed costs The difference in costs between the high and low levels represents variable costs, since only variable costs change as activity levels change Mixed Costs: High–Low Method
33 Mixed costs consist of what? a. Variable cost element and a fixed cost element. b. Fixed cost element and a controllable cost element. c. Relevant cost element and a controllable cost element. d. Variable cost element and a relevant cost element. Lets Review - Test
34 Stepped Costs Volume of activity Stepped costs Definition: A stepped cost is one that will vary with levels of activity but not directly. Example: A company may rent a warehouse that is able to store say 100 tons of material. When they reach 101 tons then an additional warehouse is required.
35 What is a Variable Costing System? A cost accounting system which treats fixed manufacturing overheads as a period cost and values stock on hand at the variable cost of production. Technique/Method of reporting –Internal Reporting –Contribution Concept Product Variable Costs Fixed Costs I/S B/S
36 What is an Absorption Costing System? A financial accounting system which values stock on hand at the variable and fixed cost of production. Technique/Method of reporting –External and Internal Reporting –GAAP, AC108 Product Variable Costs Fixed Costs I/S B/S
37 What is the difference between Variable and Absorption Costing? Variable costing just takes the variable costs. Fixed Costs are written off as incurred. Absorption Costing is Variable and traceable Fixed Costs.
38 Relevant Costs Relevant Irrelevant
39 Identifying Relevant Costs Costs that can be eliminated (in whole or in part) by choosing one alternative over another are avoidable costs. Avoidable costs are relevant costs. Unavoidable costs are never relevant and include: Sunk costs. Future costs that do not differ between the alternatives.
40 Irrelevant Costs Irrelevant cost: not relevant for decision making Example: Sunk costs: Sunk cost is the cost of abandoned plant less salvage value. Not relevant for decision making. Imputed (Notional cost): Actually not incurred (interest on own capital, rent on owned building, etc.) Taken into account in capital budgeting decisions. Replacement cost: Cost of replacing at current market price.
41 Cont….. Avoidable and unavoidable cost: Cost that can be avoided by eliminating a product or department is avoidable and that which cannot be, is unavoidable. Ex. – Rent of factory is unavoidable if a product is discontinued.
42 Other costs: Future costs: cost to be incurred in future Programmed cost: Cost incurred as per policy of top management. Ex.- Donation to charity. Joint cost: cost of joint or by-products incurred before separation, which cannot be traced to particular products. Conversion cost: cost of converting raw material to finished goods = Production cost- direct material. Discretionary cost: not essential for decision on hand. Ex.- Training expenses of workers, R&D cost. Committed cost: Costs incurred due to past decisions and are not within control in the short run at present. Ex.- Depreciation on Plant, Rent, etc.
44 Fixed and Variable Costs Fixed / Variable costs Volume of activity Cost or revenue Sales revenue Variable cost Fixed cost Total cost Break-even point
45 Stepped and Variable Costs Stepped / Variable costs Volume of activity Stepped cost Volume of activity Variable cost
46 Assigning Costs to Cost Objects Direct costs Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples: direct material and direct labor Indirect costs Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead
47 Cost Classifications for Decision Making 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.
48 Opportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending this program, you could save 10,000 per year. Your opportunity cost?
49 Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions. 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.
50 Idle Time The labor costs incurred during idle time are ordinarily treated as manufacturing overhead. Machine Breakdowns Material Shortages Power Failures
51 Overtime The overtime premiums for all factory workers are usually considered to be part of manufacturing overhead.
52 Problems in Identifying and Measuring Costs What is the cost of a dissatisfied customer? How do I measure the cost of setting my price too high? How do I measure the cost of poor quality? What is the cost of postponing this years training program?