Concept of Cost

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COST CLASSIFICATION

CONCEPT OF COST:
DEFINITION:

A SACRIFICE OR GIVING UP OF RESOURCES FOR A PARTICULAR PURPOSE FREQUENTLY MEASURED BY THE MONETARY UNITS (RUPEES, DOLLARS) THAT MUST BE PAID FOR GOODS AND SERVICES .

➢ EMPHASIS ON COST INFORMATION:
MANAGEMENT ACCOUNTANTS PAY A LOT OF ATTENTION TO COSTS BECAUSE COST HAVE A VITAL ROLE TO PLAY IN PLANNING , EVALUATING AND DECISION MAKING. FOR EXAMPLE IN PLANNING THE ROUTE AND FLIGHT SCHEDULES THE MANAGER OF AN AIR LINE MUST CONSIDER AIR CRAFT FUEL COST, SALARIES OF FLIGHT CREWS, AND COST OF LANDING ETC.

➢ CLASSIFICATION OF COST:

BEFORE MANAGEMENT ACCOUNTANTS CAN CLASSIFY COST THEY NEED TO CONSIDER HOW MANAGERS WILL USE THE INFORMATION. DIFFERENT COST CONCEPTS AND CLASSIFICATIONS ARE USED FOR DIFFERENT PURPOSE, SOME ARE USED FOR PLANNING AND CONTROL AND OTHER ARE RELEVANT FOR COSTING PRODUCTS AND REPORTING RESULTS. THE SAME COST CAN BE CLASSIFIED IN NUMBER OF WAYS DEPENDS ON INTENDED USE OF THE COST INFORMATION.

➢ COMMON COST CLASSIFICATIONS IN MANAGERIAL ACCOUNTING

THE FOLLOWING ARE SOME BASIS ON WHICH COST CAN BE CLASSIFIED INTO VARIOUS TYPES

1. MANUFACTURING (PRODUCT COST)
2. NON MANUFACTURING(PERIOD COST)
3. TRACEABILITY
4. BEHAVIOR
5. CONTROLLABILITY

1. MANUFACTURING COST: THE COST INCURRED WITHIN THE MANUFACTURING AREA

CLASSIFICATION:
a. DIRECT MATERIAL
b. DIRECT LABOR
c. FACTORY OVERHEADS (INDIRECT MANUFACTURING COST)

USED TO:
i. ESTIMATE COST OF PRODUCT
ii. COGS ( PROFIT AND LOSS ACCOUNT)
iii. INVENTORY FOR BALANCE SHEET

RECALL THE LECTURE “CONCEPT OF COST” OF COST ACCOUNTING.

2. NON MANUFACTURING COST (PERIOD COST): REFERRED TO ALL COST INCURRED OUTSIDE THE MANUFACTURING AREA.

CLASSIFICATION:
a. SELLING, DISTRIBUTION AND ADMINISTRATIVE EXPENSES (OPERATING EXPENSES)

USED TO:
i. PREPARE PROFIT AND LOSS ACCOUNT
ii. BALANCE SHEET

3. TRACEABILITY: REFERRED TO MANUFACTURING COST THAT CAN BE TRACED TO PRODUCT IN ECONOMIC OR NON ECONOMIC MANNER.

CLASSIFICATION
a) DIRECT PRODUCT COST (D/M , D/L)
b) INDIRECT PRODUCT COST (MANUFACTURING OVERHEADS, INCLUDES SUPPORT OR SERVICE DEPARTMENT COST AS WELL. USED TO:

i. COST OF PRODUCT
ii. CONTROL COSTS
iii. TO ALLOCATE COST OF SERVICE DEPARTMENT
iv. COST OF DEPARTMENT

4. BEHAVIOR: REFERRED TO THE RELATIONSHIP BETWEEN A COST AND THE LEVEL OF ACTIVITY.

CLASSIFICATION:
a VARIABLE COST
b FIXED COST
c SEMI VARIABLE COST
d STEP FIXED COST.

FIXED COST: A FIXED COST IS A COST WHICH IS INCURRED FOR A PARTICULAR PERIOD OF TIME AND WHICH WITHIN CERTAIN ACTIVITY LEVELS IS UNAFFECTED(IN TOTAL) BY CHANGES IN THE LEVEL OF ACTIVITY

EXAMPLE: SALARY OF MANAGING DIRECTOR, RENT OF A SINGLE FACTORY BUILDING, STRAIGHT LINE DEPRECIATION OF A SINGLE MACHINE

VARIABLE COST: A COST WHICH TENDS TO VARY WITH THE LEVEL OF ACTIVITY( PER UNIT FIXED)

EXAMPLE: COST OF RAW MATERIAL (PROVIDED NO DISCOUNT ON BULK PURCHASE), DIRECT LABOR COST (THOUGH BASIC WAGES ARE FIXED) CLASSIFIED AS VARIABLE COST, SALES COMMISSION ETC

SEMI VARIABLE COST: ARE COST WHICH ARE PARTLY FIXED AND PARTLY VARIABLE WITH THE CHANGE IN THE LEVEL OF ACTIVITY

EXAMPLE: SALE REPRESENTATIVE SALARY WHICH IS PARTLY FIXED AND PARTLY COMMISSION SAY 10% OF SALES.

STEP COST: A COST WHICH IS FIXED IN NATURE UP TO CERTAIN LEVEL OF ACTIVITY

EXAMPLE: RENT IS A STEP COST IN SITUATION WHERE ACCOMMODATION REQUIREMENT INCREASE AS OUTPUT LEVEL GET HIGHER, BUS FARE

USED TO:
i. FORECAST BUDGET
ii. CONTROL COST
iii. MAKE DECISIONS

5. CONTROLLABILITY: THE CONTROL OF COSTS CAN BE ENHANCED BY CLASSIFYING RESPONSIBILITY CENTRE COST AS EITHER...
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