1. Types of Cost and Classification

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Chapter 1

Cost Accounting, CostClassification and Cost

Behaviour


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WHAT IS COST ACCOUNTING?

Who can provide the answers to the

following questions?

What was the cost of goods produced orservices provided last quarter?

What was the cost of operating a

department last month?

What revenues were earned last quarter?


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WHAT IS COST ACCOUNTING?

Cost accounting is concerned with providing

information to assist the following.

Establishing stock valuations, profits and balancesheet items

Planning

Control Decision making


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THE ORGANISATION

An organisation, whether it is amanufacturing company, a provider of

services (such as a bank or a hotel) or apublic sector organisation (such as ahospital), may be divided into a number ofdifferent functions within which there are a

number of departments.


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THE ORGANISATION, COST

CENTRES AND COST UNITS


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Cost centres

In general, for cost accounting purposes,

departments are termed cost centres

The product produced by an organisationis termed the cost unit.


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Cost centres (Examples)

A department

A machine, or group of machines;

A project (eg the installation of a new

computer system);

A new product (to enable the costs of

development and production to be

identified).


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Cost unit

A cost unit is a unit of product or service to

which costs can be related The cost unit is

the basic control unit for costing purposes


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Different organisations use different

cost units


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COST CLASSIFICATION

Classification involves arranging costs into

groupings of similar items in order to make

stock valuation, profit measurement,planning, decision making and control

easier.


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COST CLASSIFICATION FOR STOCK

VALUATION AND PROFIT MEASUREMENT

The total cost of a cost unit is made up of

the following:

Materials

Labour

Other expenses (such as rent and

rates, interest charges and so on)


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Direct and Indirect cost

A direct cost is a cost that can be traced in full tothe product, service, or department that is beingcosted.

An indirect cost or overhead is a cost that isincurred in the course of making a product,providing a service or running a department, butwhich cannot be traced directly and in full to the

product, service or department. Examples mightbe the cost of supervisors wages, cleaningmaterials and buildings insurance.


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Prime Cost

Total direct cost is often referred to as prime cost.


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Direct materials

Direct materials costs are the costs of materialsthat are known to have been used in making andselling a product (or providing a service).

Examples:

Component parts or other materials specially purchased for aparticular job, order or process.

Part-finished work which is transferred from department 1 to

department 2 becomes finished work of department 1 and a directmaterial cost in department 2.

Primary packing materials like cartons and boxes.


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Direct labour

Direct labour costs are the specific costs of the workforce used tomake a product or provide a service. Direct labour costs areestablished by measuring the time taken for a job, or the time takenin direct production work.

Direct wages are all wages paid for labour (either as basic hours oras overtime) expended on work on the product itself.

Examples:

(a) Workers engaged in altering the condition, conformation or composition of theproduct.

(b) Inspectors, analysts and testers specifically required for such production.


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Direct expenses

Direct expenses are any expenses whichare incurred on a specific product other

than direct material cost and direct wages.

Example:

The cost of special designs, drawings or layouts

The hire of tools or equipment for a particular job Maintenance costs of tools, jigs, fixtures and so on


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Overheads

Overheads include all indirect material

cost, indirect wages and indirect expenses

incurred by a business.


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Production Overheads (Examples)

Indirect materialswhich cannot be traced in thefinished product. Consumable stores, eg material used in negligible amounts

Indirect wages,meaning all wages not charged directlyto a product. Salaries and wages of non-productive personnel in the

production department, eg foremen

Indirect expenses(other than material and labour) notcharged directly to production. Rent, rates and insurance of a factory

Depreciation, fuel, power, repairs and maintenance of plant,machinery and factory buildings


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Admin Overheads (examples)

Depreciation of office equipment.

Office salaries, including salaries of

secretaries and accountants. Rent, rates,insurance, lighting, cleaning and heating of

general offices, telephone and postal

charges, bank charges, legal charges,audit fees.


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S & D Overheads (examples)

Printing and stationery, such as catalogues and pricelists.

Cost of packing cases.

Salaries and commission of sales representatives andsales department staff and wages of packers, driversand despatch clerks. Advertising and sales promotion,market research.

Rent, rates and insurance of sales offices and

showrooms, bad debts and collection charges, cashdiscounts allowed, after sales service. Freight andinsurance charges, rent, rates, insurance anddepreciation of warehouses, depreciation and runningexpenses of delivery vehicles.


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Product costs

Product costs are costs identified with a

finished product. Such costs are initially

identified as part of the value of stock.They become expenses (in the form of

cost of goods sold) only when the stock is

sold.


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Period costs

Period costs are costs that are deducted

as expenses during the current period

without ever being included in the value ofstock held.

Selling and administrative expenses


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COST CLASSIFICATION FOR

DECISION MAKINGAfixed costis a cost which is incurred for

a particular period of time and which,

within certain activity levels, is unaffectedby changes in the level of activity.

A variable costis a cost which tends tovary with the level of activity.


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DECISION MAKING- Examples Direct Material Cost

Sales Commission

Telephone Bills

Rental cost of Business Premises


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CONTROLA Controllable cost is a cost which can be

influenced by management decisions and

actions.An Uncontrollable cost is any cost that

cannot be affected by management within

a given time span.


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COST BEHAVIOUR

AND LEVELS OFACTIVITY


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Fixed Cost


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Variable Cost


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Semi-Variable Cost


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Cost Behavior

Fixed Cost Variable Cost


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High-low method

a) Records of costs in previous periods are reviewed and the costsof the following two periods are selected.

The period with the highest volume of activity

The period with the lowest volume of activity

(b) The difference between the total cost of these two periods will bethe variable cost of the difference in activity levels (since the samefixed cost is included in each total cost).

(c) The variable cost per unit may be calculated from this (differencein total costs difference in activity levels), and the fixed cost maythen be determined by substitution.


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Scattergraph method

1. Types of Cost and Classification

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