Direct Costing
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Direct Costing
Direct Costing
• A direct cost is a cost that is directly associated with changes in production volume.
• This restricts the definition of direct costs to direct materials and direct labor.
Example
• The materials used to create a product are a direct cost, whereas the machine used to convert the materials into a finished product is not a direct cost, because it is still going to be sitting on the factory floor, irrespective of any changes in production volume.
Facets of Direct Costing
Direct Costing
Internal Use
Profit Planning
Product Pricing
Decision Making
Cost Control
External Use
Costing of Inventory
Income Determination
Financial Reporting
Internal Uses
• Profit Planning
Profit plan often called a budget or a plan of operations. Includes both short and long range operations. Useful in planning, pricing and in making decisions. Direct costing as a tool of planning and evaluating profit.
Internal Use
• Product Pricing
Prices will be regulated through supply and demand. In multi product pricing management need to know In making pricing decisions the useful part of unit cost is the
direct cost segment since it consists of those cost element that are comparable among firms in the same industry.
Internal Use
• Decision Making
The direct costing method isolate the fixed and variable cost. The classification of costs as either fixed or variable, with semi
variable expenses properly subdivided into their fixed and variable components, which provide a frame work for accumulation and analysis of costs.
Internal Use
• Decision Making (Contd.) This provide a basis for the study of contemplated change in
production level or proposed action concerning new market, plant expansion or contraction, or special promotional activities.
Internal Use
• Control Tool The direct costing is said to be the product of
incomprehensible income statement prepared for management.
The reports based on direct costing are far more effective for management control than those based on absorption costing. The reports are more directly related to the profit objective or budget for the period. Deviations from standards are more readily apparent and can be corrected more quickly.
Internal Use
• Control Tool(Contd.)• The marketing manger should receive a
statement placing sales and production costs in direct relationship to one another & difference between intended sales and actual sales caused by changes in sales price.
Two Costing Method
• Absorption Costing Used for external financial reporting Includes direct materials, direct labor, variable factory
overhead, and fix factory overhead as part of total product cost.
• Direct Costing Used for internal planning and decision making Does not include factory overhead(Fix.) as a product cost
Absorption Costing Compared to Direct Costing
Direct Costing
Absorption Costing
Cost of Goods Manufactured
Cost of Goods Manufactured
DirectMaterials
DirectLabor
VariableFactory OH
FixedFactory OH
Period Expense
Direct Costing Income Statement
Sales (15,000 x $50) $750,000Variable cost of goods sold:
Variable cost of goods mfg.(15,000 x $25) $375,000
Less ending inventory 0Variable cost of goods sold 375,000
Variable Gross profit $375,000Variable selling and administrative
expenses (15,000 x $5) 75,000Contribution margin $300,000Fixed costs:
Fixed manufacturing costs $150,000Fixed selling and administrative
expenses 50,000 200,000Income from operations $100,000
Units Manufactured Equal Units Sold
Sales (15,000 x $50) $750,000Cost of goods sold: Cost of goods manufactured
(15,000 x $35) $525,000Less ending inventory 0Cost of goods sold 525,000
Gross profit $225,000Selling and administrative expenses
($75,000 + $50,000) 125,000Income from operations $100,000
Sales (15,000 x $50) $750,000Cost of goods sold: Cost of goods manufactured
(15,000 x $35) $525,000Less ending inventory 0Cost of goods sold 525,000
Gross profit $225,000Selling and administrative expenses
($75,000 + $50,000) 125,000Income from operations $100,000 Income from operations $100,000
Absorption Costing Income Statement
Units Manufactured Equal Units Sold
When the number of units manufactured equals the number of units sold, income from operations will be
the same under both methods.
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