Classification of Cost

CLASSIFICATION OF COST

Comparing Merchandising and Manufacturing Activities

Merchandisers . . . Buy finished

goods. Sell finished goods.

Manufacturers . . . Buy raw materials. Produce and sell

finished goods.

Shoppers Stop

Classification Of Cost

1. According To Nature2. According to function3. According To Identifiably4. According To Behavior5. According Association With Products6. According to Controllability7. According To Normality8. According To Time9. According To Relevance and 10.Other Costs

Classification Of Cost

1. According To Nature Or Elements

Materials Cost

LabourCost

Expenses

Cost Elements

Materials Labour Expenses

Classification Of Cost

2 According to functions

ProductionCost

AdministrationCost RD Cost

Selling &Distribution

Cost

Classification Of Cost

3 According To Identifiably

Direct Indirect

Direct Costs and Indirect Costs

Direct costs

Costs that can beeasily and conveniently traced to a unit of product or other cost objective.

Examples: direct material and direct labor

Indirect costs

Costs cannot be easily and conveniently traced to a unit of product or other cost object.

Example: manufacturing overhead

The ProductThe Product

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

Manufacturing Costs

Direct Materials

Those materials that become an integral part of the product and that can be conveniently

traced directly to it.

Example: A radio installed in an automobileExample: A radio installed in an automobile

Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers

Direct Expenses

Those Expenses that can be easily Charged to individual units of product.

Example: Design Cost Of a carExample: Design Cost Of a car

Classification Of Cost

4 According To Behavior

Fixed VariableSemi-Fixed

Variable

Cost Classifications for Predicting Cost Behavior

How a cost will react to changes in the level of

business activity. Total variable costs

change when activity changes.

Total fixed costs remain unchanged when activity changes.

How a cost will react to changes in the level of

business activity. Total variable costs

change when activity changes.

Total fixed costs remain unchanged when activity changes.

Total Variable Cost

Total Cost of materials depends upon How much materials you use

Materials used

Tot

al m

ater

ials

bill

Variable Cost Per Unit

Materials Cost

Per

Uni

t Cos

t

Per unit materials cost will remain constant

Total Fixed Cost

Your fixed cost probably does not change when you makeproduction.

Total production

Mon

thly

Bas

ic T

Bill

Fixed Cost Per Unit

production

Mon

thly

Bas

ic B

ill p

er u

nit

The average fixed cost per unit decreases as more production is made.

Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Fixed cost per unit goesthe same even when the down as activity level goes up. activity level changes.

Quick Check

Which of the following costs would be variable with respect to the number of cones sold at a Walls Ice Cream shop? (There may be more than one correct answer.)

A. The cost of Rent of the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers.

Quick Check

Which of the following costs would be variable with respect to the number of cones sold at a Walls Ice Cream Shop? (There may be more than one correct answer.)

A. The cost of rent of the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers.

Quick Check

Which of the following costs would be variable with respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.)

A. The cost of hiring the film.

B. Royalties on ticket sales.

C. Wage and salary costs of theater employees.

D. The cost of cleaning up after the show.

Quick Check

Which of the following costs would be variable with respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.)

A. The cost of hiring the film.

B. Royalties on ticket sales.

C. Wage and salary costs of theater employees.

D. The cost of cleaning up after the show.

The royalties on ticket sales is directly related to the number of tickets sold.

The cost of cleaning up MAY also be variable if the theater pays cleaning crews by the hour. The more tickets sold would

increase the time it would take to clean up the theater.

Classification Of Cost

5 According to Association With Products

ProductCosts

PeriodCosts

Quick Check

Which of the following costs would be considered a period rather than a product cost in a manufacturing company?

A. Manufacturing equipment depreciation.

B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the production facility.

Quick Check

Which of the following costs would be considered a period rather than a product cost in a manufacturing company?

A. Manufacturing equipment depreciation.

B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the production facility.

Classification Of Cost

6 According to Controllability

ControllableCosts

Uncontrollable Costs

Classification Of Cost

7 According To Normality

NormalCosts

AbnormalCosts

Classification Of Cost

8 According To Time

HistoricalCosts

Pre-determined Costs

Classification Of Cost

9 According To Relevance

Opportunity CostRelevant CostSunk CostShut Down CostDifferential CostImputed CostOut-Of-Pocket CostMarginal CostReplacement Cost

Opportunity Costs

The potential benefit that is given up when one alternative is selected over another.

Example: If you werenot attending college,you could be earningRs.15,000 per year. Your opportunity costof attending college for one year is Rs.15,000.

Sunk Costs

Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when

making decisions.

Example: You bought an automobile that cost Rs.3.5 lacs two years ago. The Rs.3.5 lacs cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the Rs 3.5 Lacs cost.

Quick Check

Suppose that your car could be sold now for Rs2.5 Lacs. Is this a sunk cost?

A. Yes, it is a sunk cost.

B. No, it is not a sunk cost.

Quick Check

Suppose that your car could be sold now for Rs. 2.5Lacs. Is this a sunk cost?

A. Yes, it is a sunk cost.

B. No, it is not a sunk cost.

Differential Costs and Revenues

Costs and revenues that differ among alternatives.

Example: You have a job paying Rs.1,500 per month in your hometown. You have a job offer in a neighboring city that pays Rs.2,000 per month. The commuting cost to the city is Rs.300 per month.

Example: You have a job paying Rs.1,500 per month in your hometown. You have a job offer in a neighboring city that pays Rs.2,000 per month. The commuting cost to the city is Rs.300 per month.

Differential revenue is: Rs.2,000 – Rs.1,500 = Rs.500

Differential cost is: Rs.300

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the pizza you ate last night relevant in this decision? In other words, should the cost of the pizza affect the decision of whether you drive or take the train to Mumbai?

A. Yes, the cost of the pizza is relevant.

B. No, the cost of the pizza is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the pizza you ate last night relevant in this decision? In other words, should the cost of the pizza affect the decision of whether you drive or take the train to Mumbai?

A. Yes, the cost of the pizza is relevant.

B. No, the cost of the pizza is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Mumbai?

A. Yes, the cost of the train ticket is relevant.

B. No, the cost of the train ticket is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Mumbai?

A. Yes, the cost of the train ticket is relevant.

B. No, the cost of the train ticket is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the depreciation on your car relevant in this decision?

A. Yes, the depreciation is relevant.

B. No, the depreciation is not relevant.

Quick Check

Suppose you are trying to decide whether to drive or take the train to Mumbai to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the depreciation on your car relevant in this decision?

A. Yes, the depreciation is relevant.

B. No, the depreciation is not relevant.

Depreciation thatis a function of miles driven

would be relevant.

Depreciation that is a function of the passage of

time would not be relevant.

Classification Of Cost

10 Other Costs

Conversion Costs

AvoidableCosts

Unavoidable Costs

TIME FOR QUESTIONS