1. Classifying Costs (a) By Element  Material  Labour  Expense By Traceability  Direct  Indirect

2. Classification by element The Product Material Labour Expense

3. Classification of Costs by Traceability Direct Costs Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples:  Direct material  Direct labor Indirect Costs Costs cannot be easily and conveniently traced to a unit of product or other cost object. Example:  Manufacturing overhead

4. Direct and Indirect Costs Direct costs Costs that can be easily and conveniently traced to a product or department. Example: cost of paint in the paint department of an automobile assembly plant. Indirect costs Costs that must be allocated in order to be assigned to a product or department. Example: cost of national advertising for an airline is indirect to a particular flight.

5. Classification by element or traceability Materials DirectIndirect Labour DirectIndirect Expenses DirectIndirect Current Product costs = Materials+Labour+Expenses Or Direct costs + Indirect costs

6. Classifications of Costs in Manufacturing Companies Prime Cost Conversion Cost Manufacturing costs are often combined as follows: Direct Material Direct Labour & Direct Expenses Manufacturing Overhead

7. Classifying Costs (b) By Function  Product  Period

8. Manufacturing Cost Flows Manufacturing Overhead Material Purchases Direct Labor Balance Sheet Costs Inventories Finished Goods Cost of Goods Sold Income Statement Expenses Selling and Administrative Period Expenses Work in Process Raw Material

9. Cost Classification by Function Product costs Include expenditures that are necessary and integral to finished products. Capitalized on the balance sheet until sold. Period costs I nclude expenditures identified more with a time period than with finished products. Expensed on the income statement. Inventory Cost of Good Sold Balance Sheet Income Statement Sale Expense Income Statement

10. Classification of Costs by Function Product Costs Direct materials Direct labor Overhead Period Costs Selling General and administrative expenses

11. Classifying Costs (c) By Behaviour  Fixed  Variable  Semi-fixed  Semi-variable

12. Cost Classifications by Behaviour Cost Behaviour How a cost will react to changes in the level of business activity. Cost Behaviour How a cost will react to changes in the level of business activity.  Total variable costs change when the level of activity changes.  Total fixed costs remain unchanged when the level of activity changes.  Total variable costs change when the level of activity changes.  Total fixed costs remain unchanged when the level of activity changes.

13. Total Variable Cost Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked Total Long Distance Telephone Bill A variable cost is one that changes in total in proportion to changes in the volume of activity.

14. Variable Cost Per Unit Minutes Talked Per Minute Telephone Charge The cost per long distance minute talked is constant. For example, 10 cents per minute. On a per unit basis, a variable cost remains constant over a wide range of activity.

15. Cost Behaviour Merchandisers Cost of Goods Sold Manufacturers Direct Material, Direct Labor, and Variable Manufacturing Overhead Merchandisers and Manufacturers Sales commissions and shipping costs Service Organizations Supplies and travel Examples of variable costs

16. Total Fixed Cost Your monthly basic telephone bill probably does not change when you make more local calls. Number of Local Calls Monthly Basic Telephone Bill A fixed cost is one that remains constant in total even when the volume of activity changes.

17. Fixed Cost Per Unit Number of Local Calls Monthly Basic Telephone Bill per Local Call The average cost per local call decreases as more local calls are made. On a per unit basis, a fixed cost changes as the volume of activity changes.

18. Examples of fixed costs Merchandisers, manufacturers, and service organizations Real estate taxes Insurance Sales salaries Depreciation Advertising Cost Behaviour

19. Cost Classifications for Predicting Cost Behavior

20. Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet) 0 30 60 Fixed Costs and Relevant Range 90 Relevant Range Total cost doesn’t change for a wide range of activity. It then jumps to a new higher cost for the next higher range of activity. The company’s normal operating range

21. How does this type of fixed cost differ from a step-variable (or step- wise) cost? Step-variable (or step-wise) costs can be adjusted more quickly and... The width of the activity steps is much wider for the fixed cost. Fixed Costs and Semi-fixed (or Step-Wise or Step-Variable) Costs

22. Semi-fixed Costs (or Step-Variable or Step-Wise) Activity Cost Total cost remains constant within a narrow range of activity. Total cost increases to a new higher cost for the next higher range of activity.

23. Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Total semivariable cost Semivariable Cost Slope is variable cost per unit of activity.

24. Curvilinear Cost Curvilinear Cost Function Relevant Range Activity Total Cost Curvilinear Cost Function A straight-Line (constant unit variable cost) closely approximates a curvilinear line within the relevant range.

25. Relevant Information Information is relevant to a decision problem when... Ê It has a bearing on the future, Ë It differs among competing alternatives. Information is relevant to a decision problem when... Ê It has a bearing on the future, Ë It differs among competing alternatives.

26. Identifying Relevant Costs and Benefits Sunk costs Costs that have already been incurred. They do not affect any future cost and cannot be changed by any current or future action. Sunk costs are irrelevant to decisions.

27. Relevant Costs  Relevant costs are those costs and/or benefits that differ between alternatives.  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 include: Sunk costs. Future costs that do not differ between the alternatives.  Unavoidable costs are never relevant.

28. Add or Drop a Product Incremental Costs

29. Summary DECISION RULE Swick should drop the digital watch segment only if its fixed cost savings exceed lost contribution margin.

30. Marginal Costs and Average Costs The extra cost incurred to produce one additional unit. The total cost to produce a quantity divided by the quantity produced. Marginal and average costs are largely a function of cost behavior -- variable and fixed costs.

31. Costs and Benefits of Information Costs Benefits More information does not mean more benefits if information overload results.