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1661_2CostConceptsandClassifications_Module4.pdf

B.Com(H),SemIV,PaperBCH4.1

COSTACCOUNTINGMODULE4

CostConceptsand

Classifications

CostIngeneral,Costmeansamountofresources

foregoneorsacrificedtoachieveaspecifiedpurpose

Itcanbedefinedas"theamountofexpenditure

(actualornotional),incurredorpotentiallytobe incurred,toachieveaspecificpurposeor attributabletoaspecifiedthingoractivity"

ICWAI,India

definescostas"measurementin monetaryterms,oftheamountofresourcesusedfor thepurposeofproductionofgoodsorrendering services"

Cost:Expense,LossandAsset

ThetermCOSTisnotthesamethingas

Expense,LossandAsset.Thethreeterms

havedifferentmeaningsandcanbesaidtobe thesubsetsofCost

ExpenseExpense:FinancialAccountingConcept

Expenseisthatportionofthecostwhichhasbeen

consumedduringthecurrentaccountingperiodand whichhascontributedtotherevenuegeneration

Inotherwords,whentheeconomicbenefitofan

outflowofresourcesisreceivedandmatched againstarevenue,itbecomes anexpenseofthat year

AlsocalledasEXPIREDCOST

Example:depreciationonmachine

LossLossisthatportionofthecostwhichhasbeen

incurredbutwhichdidnotcontributetotherevenue generation

Inotherwords,lossisincurredwhentheresources

havebeenforegonebuttheeconomicbenefitof theoutflowofresourceshasneitherbeenreceived norwillitbereceived infuture

Example:lossofanuninsuredassetlikestockof

materialoramachineryduetofire

AssetItisthatportionofthecostwhichhasnotbeen

consumedduringthecurrentaccountingperiodand isexpectedtogeneratebenefitinthefutureperiod

Inotherwords,whentheeconomicbenefitofan

outflowofresourcesisexpectedtobereceivedina futureperiod,itis termedasanasset

AlsocalledasUNEXPIREDCOST

ShownontheassetsideofBalanceSheet

Example:closingstockofmaterial,workͲinͲprogress andfinishedstock,depreciatedvalueofamachine etc.

ClassificationofCost

GroupingofCostsaccordingtotheircommon

characteristics

CostClassification

Elements

Material

Labour

Expense

Functions

Manufacturing

Administrative

Selling

Distribution

Traceability

toCost

Object

Direct

Indirect

Variability/

Behaviour

Fixed

Variable

SemiͲVariable

Controllability

Controllable

Uncontrollable

Normality

Normal

Abnormal

Decision

Making

Costs

CostClassification:ByElementsof

Cost •Everycostismadeupofthreeelements:Material,LabourandExpense •N

•*Note:itreferstoexpenseasacomponentoftotalcostandnottheexpenseasafinancialaccountingconceptdiscussedearlier

MaterialCost•Referstocostincurredonthe

commodities/substance,which maybecomeormaynotbecome theintegralpartoftheproduct •Examples: •Timberforfurniture •Paperinbooks •Consumablestores •Stationaryusedinaccounts officeorsalesdepartmentetc.

LabourCost•Referstocostofhumaneffort

involvedintheprocessof production,administrationand sales •Examples: •WagesofCarpenter •Supervisorsalaries •Manager'sRemuneration •SalesmanCommissionetc.

Expense*•Referstoeverysuchcostwhich

isneithermaterialcostnor labourcost •Examples: •Royaltypayable •Hiringchargesonequipment •Rent,ratesandtaxes •Depreciationonequipment •Costofpowerandelectricity etc. CostClassification:ByFunctionsCostcanalsobeclassifiedbythefunctionitrelatestoas:

ManufacturingCost

Itisthecostofsequenceofoperationswhichbeginswithsupplyingmaterials,labourandservicesandendswiththeprimarypackingoftheproduct

Takinganexampleofafurnituremanufacturer,manufacturingcostwillincludecostofwood,wagesofcarpenter,costofconsumablestores,printing,postageandstationery

usedintheworkshop(productiondepartment),salariesofsupervisorandforeman,repairs,insuranceanddepreciationofassetsusedinproductiondepartment,excisedutyonproductionetc.

AdministrativeCost

Itrepresentsthecostofformulatingthepolicy,directingtheorganisationandcontrollingtheoperationsoftheundertaking,notrelatedtoproduction,salesandresearch&development.

CostClassification:ByFunctions

(contd..)

SellingCost

Itisthecostincurredforthepurposeofpromotingsales

(stimulatingthedemand)andretainingcustomers

Itincludescostincurredonadvertisements,costoffree

samplesdistributed,exhibitionsconducted,printingofsales catalogues,aftersaleservicesetc.

DistributionCost

Itrepresentsthecostincurredonmakingthepacked

productavailabletothecustomer.Itconsistsofthepacking cost(meantforfacilitatingstorageandtransportationof product),carriageoutward,warehousingcosts,showroom rentetc.

CostClassification:ByFunctions

(contd..)

ResearchCost

Itconsistsofthecostofsearchingforneworimproved

products,newapplicationofmaterials,ornewor improvedmethodsofproductionetc.

DevelopmentCost

Itreferstothecostofprocesswhichbeginswiththe

implementationofthedecisiontoproduceanewor improvedproductortoemployaneworimproved methodsofproductionandendswithcommencement offormalproductionofthatproductorbythemethod

CostClassification:ByTraceabilityto

CostObject

CostsmaybecategorisedasDirectCostorIndirectCostwith respecttoitstraceabilitytothecostobject(aunit,amachineora department,oranythingforwhichaseparatemeasurementofcost isdesired)

DirectCost

Costwhichcabbetraced

convenientlyandlogicallytoa costobject

Example-clothusedinagarment,

woodinfurniture,flourusedina cakeetc.

IndirectCost

Costwhicharecommonto

multiplecostobjectsandcannot betracedtoasinglecostobject

Example-Salaryofasupervisor

lookingafter3machines,Factory renthavingmultipleproduction departmentsetc.

CostClassification:By

Variability/Behaviour

Costsarealsoclassifiedas:

FixedCosts

Variablecosts

SemiͲVariable/SemiͲfixedcosts

onthebasisoftheirvariability,i.e.behaviourwiththe changeinthelevelofactivity(likechangeinthevolumeof production)

FixedCosts

(costclassificationbyvariability)

Thesearethecostswhichdonotvarywiththechangein

thelevelofactivity,i.e.theyremainconstantatdifferent levelsofactivitybutuptoagivenrangeofoutput

Iftherangeofoutputiscrossed,thesecostsjumpuptoa

newlevelandremainsconstant atthatlevelfornext rangeofoutput

Example:rentofabuilding,insurancepremiumonplant

andmachinery,manager'ssalaryetc. TypesofFixedCosts•Fixedcostscanalsobeoftwotypes:

Committedfixedcosts

Costslikerentofabuilding,insurancepremiumon

plantandmachinery,manager'ssalaryetc.which cannotbeavoidedandaffectedinshortrunifan organisationhastofunction.

DiscretionaryFixedCosts

CostssuchasResearchanddevelopmentexpenditure,

advertisingbudget,trainingbudgetetc.,whichareset atafixedamountandperiodicallyrevisedbythe managementinthebudgetingprocess.Thesearethe costsresultingfrommanagementdiscretionandpolicy

VariableCosts

(costclassificationby variability)

Thesearethecostswhichchangesproportionally

withthechangeinthevolumeofoutput.

Example:costofrawmaterialusedforproduct,

wagesoflabourconvertingmaterialintoproductetc.

Itisthetotalvariablecostwhichchangeswiththe

changeinlevelofoutput,butthevariable costper unitremainsconstant

SemiͲVariableCosts/SemiͲFixedCosts

(costclassificationbyvariability)

Certaincostsaremixedinnature,i.e.theyneitherremainconstantnorchangesproportionallywiththechangeinlevelofoutput

Suchcostscomprisesonecomponentasfixedandanothervariable.Forexample,ifthetelephonerentalispaidasRs.200fixedmonthlyand30paiseperminuteofcall,thenRs.200isaminimumunavoidablefixedamountwhichispayableirrespectiveoftheusageand30pperminuteisthevariableamountwhichwillchangeproportionallywith

usage

OtherexamplesofsemiͲvariableorsemiͲfixedcostscouldbeDepreciation(lossofvalueduetolapseoftimeisboundtotakeplaceirrespectiveofuseofassetandlevelofusagewillalsoaffectlossofvalue),repairsandmaintenance,electricitybilletc.

CostClassification:By

Controllability

Costscanalsobecategorisedascontrollablecostsor

uncontrollablecostswithreferencetoaspecifiedlevelof authority.

Ifacostcanbesignificantlyinfluencedbytheactionofa

memberofaspecifiedlevelofauthority,itissaidtobea controllablecostatthatlevel, whileifacostcannotbe influencedbytheactionatthatlevelofauthority,itissaidto beuncontrollablecost Forexample,costduetoefficiencyintheusageofmaterial, labouretc.arecontrollablebyafactorysupervisor(shoplevel management)whilefactoryrentormanagerialsalaries are notcontrollableathislevel.

CostClassification:ByNormality

OnthebasisofNormality,costcanbeclassifiedas:

NormalCost

Itisthecostwhichisnormallyincurredatagivenlevelofoutput intheconditionsinwhichthatlevelofoutputisnormally attained

Itistreatedaspartofcostofproduction

Example:costofmaterialandlabourrequiredasperstandard

AbnormalCost

Itisthecostwhichisnotnormallyincurredatagivenlevelof outputintheconditionsinwhichthatlevelofoutputisnormally attained

Itisnottreatedaspartofcostofproduction

ItischargedtoCostingP&Laccount

Example:wagespaidforstrike

period,costofmaterialdestroyed duetofireetc.

DecisionͲMakingCosts

•TherearecertainspecialcostsusedforManagerialDecisionͲ

Making

•ThesearetheSpecialPurposecostswhichareascertainedto suitspecificdecisionandareusefulforspecialpurposeonly •Theymaynotconformtoestablishedaccountingpractices •Theyarefuturisticincharacter •Differentdecisionmakingcostsare calculatedtosuitdifferent decisionareas •Example:Shutdowncosts,Sunkcosts,Opportunitycosts, Imputedcosts,RelevantandIrrelevantcosts,OutͲofͲpocket cost,Differentialcostetc.

RelevantandIrrelevantCost

(Decisionmakingcost)

RelevantCosts

Allthosecostswhichinfluenceachoiceofalternativesina particularsituation(decisiontobetaken)andarealso affectedbythatdecisionaresaidtoberelevantcostsof thatdecision

IrrelevantCosts

Allthosecostswhichremainthesameandarenot

affectedbythedecisionwhateveralternativeischosen aresaidtobeirrelevantcostsforthatdecision

ExampleofRelevantandIrrelevantCost•Anorganisationhastotakeadecisionregardingproductionofanewproduct,tobeproducedinsamefactorypremiseswhereproductionisalreadytakingplaceandthereissufficientcapacity(space)foradditionalproduction.CompanyispayingannualrentofRs.1,00,000forthefactory.Forthisdecision,raw

materialcostofnewproductisarelevantcostasitwillbeincurredifdecisiontoproducewillbetakenandwillnotbeincurredifproductisnotproduced.Howevertherentpaidforthefactoryisanirrelevantcostofthisdecisionasrentwillbepaidirrespective

ofproductionornonproductionofnewproduct. Note:

anycostisrelevantorirrelevantincontextofdecisioninhand.Oneitemofcostrelevantinonesituationmaybeirrelevantfordecisionmakinginanothersituation

OtherDecisionͲmakingCostsSunkCosts

Sunkcostsarethehistoricalcoststhatariseduetodecisionsmadeinthepastandcannotbechangedbyanydecisionmadeinfuture

Example:investmentsinPlant&Machineryisaprimeexampleofsunkcost;indecisionsrelatingtoreplacementofoldmachine,thewrittendownvalue

ofoldmachineadjustedforitsrecoverablevalueisasunkcostasithasbeenincurredinpastandcannotbechangedbyfuturedecision

Sincesunkcostscannotbealteredinfuture,theyarealwaysirrelevantcostsinfuturedecisionmaking

ShutͲdownCosts

Thesearetheunavoidablefixedcostswhichcontinuetobeincurredevenwhenaplantistemporarilyshutdown Example:rent,insuranceanddepreciationofbuilding,salariesofpermanentstaffetc. ManagersmusttakeintoaccountshutͲdowncostswhileconsideringshutͲdownorcontinuedecisions

OtherDecisionͲmakingCosts

(contd...)

Imputed/Hypothetical/NotionalCosts

Thesearethecostsforwhichneitheranytransactionhastakenplacenoranycashoutlayistherebutitrepresentsasacrificeorresourceusecapableofbeingmeasuredinmonetaryterms

Example:aproducerisdoingproductioninhisownpremisesforwhichnorentispaidbut

whichhasamarketvalueofRs.15,000permonth,hecanrecordRs.15,000permonthasnotionalfactoryrentwhiledeterminingthecostofproductionofoutput

Similarly,interestwhichonewouldhaveearnedonhiscapital,ifitwasinvestedoutsideisanotionalorimputedrent cost

NotionalcostsdonotappearinFinancialaccounts

ItissameasconceptofopportunitycostinEconomics

OtherDecisionͲmakingCosts

(contd...)

DifferentialCosts

Thedifferenceintotalcostresultingfromaproposed

change(likechangeinactivitylevel,technology,process ormethodofproductionetc.)iscalledDifferentialcosts

Itistheincreaseordecreaseintotalcostduetoan

alternativecourseofaction

Ifchoiceofalternativeresultsinincreased

cost,such increasedcostsaretermedasIncrementalCost.While assessingtheprofitabilityofaproposedchange,the incrementalcostsarematchedwithincrementalrevenues.

Choiceofalternativeresultingindecreasedcost,such

decreaseincostiscalledasDecrementalCost

OtherDecisionͲmakingCosts

(contd...)

OutofPocketCost/ExplicitCosts

Thesearethosecoststhatrequirecashoutlayduetoa

particularmanagerialdecision

Itrepresentsbothpresentandfutureoutflowofcashdue

toadecision

Example:Indecisionregardingreplacementofowntruck

byaprivatecareer,presentexpenditureonfuel,salaryto drivers,roadtaxetc. willbeconsideredasoutͲofͲpocket costs,whiledepreciationdoesnotrequireanycashoutlay andthusnotconsidered

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