The document discusses cost classification and behavior. It defines different types of costs such as direct costs, indirect costs, variable costs, fixed costs, and semi-variable costs. It also discusses responsibility centers such as cost centers, profit centers, revenue centers, and investment centers. Sample problems are provided to illustrate calculation of variable and fixed costs using the high-low method.
The document discusses cost classification and behavior. It defines different types of costs such as direct costs, indirect costs, variable costs, fixed costs, and semi-variable costs. It also discusses responsibility centers such as cost centers, profit centers, revenue centers, and investment centers. Sample problems are provided to illustrate calculation of variable and fixed costs using the high-low method.
The document discusses cost classification and behavior. It defines different types of costs such as direct costs, indirect costs, variable costs, fixed costs, and semi-variable costs. It also discusses responsibility centers such as cost centers, profit centers, revenue centers, and investment centers. Sample problems are provided to illustrate calculation of variable and fixed costs using the high-low method.
The document discusses cost classification and behavior. It defines different types of costs such as direct costs, indirect costs, variable costs, fixed costs, and semi-variable costs. It also discusses responsibility centers such as cost centers, profit centers, revenue centers, and investment centers. Sample problems are provided to illustrate calculation of variable and fixed costs using the high-low method.
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Chapter 4
COST CLASSIFICATION AND BEHAVIOUR
1. Cost classification Cost classification is the arrangement of cost items into logical groups. For example: by their nature (materials, wages etc.); or function (administration, production etc.). The eventual aim of costing is to determine the cost of producing a product/service; for profitability analysis, selling price determination and stock valuation purposes.
Cost unit - A cost unit is a unit of product or service in relation to which costs may be ascertained. The cost unit should be appropriate to the type of business.
For example: Suggest appropriate cost units for the following businesses Solution Business Appropriate cost unit Car manufacturer one car Cigarette manufacturer carton of 20 packets Builder (builder of houses) one house Audit Company one hour of work
Only the production costs will be relevant in costing.
Direct costs - Direct costs are those costs which can be identified/measure with and allocated to a particular cost unit. Ex: we can measure 5 by 5 square the wood of the desk.
Per unit 2 Direct costs examples: materials [2m * $5] = 10 Direct labor [3 hours *$10] = 30
Prime cost= 40
TOTAL DIRECT COSTS = PRIME COST
Indirect production costs (overheads)
Indirect production costs (known as production overheads) are those costs which are incurred in the course of making a product/service but which cannot be identified with a particular cost unit. Ex of production overheads: Rent of factory Wages of maintenance men Depreciation of machines
TOTAL PRODUCTION COST = PRIME COST + PRODUCTION OVERHEADS
Non-production costs Other costs required to run the business.
Ex of non-production costs: Wages of accounts department
Rent of offices Cost of delivery to customers
TOTAL COSTS = PRODUCTION COSTS + NON-PRODUCTION COSTS
2. Cost behavior It is expected that costs will increase as production increases (i.e. as output increases) but the exact way in which costs behave with output may differ.
Types of behaviour : (a) Variable cost total cost varies with level of production $ E.g. materials $5 per unit $ Total cost
Cost per unit ($5)
Production Production (b) Fixed cost it does not vary with the level of production E.g. rent of a factory $ Total cost
Production (c) Stepped fixed cost A stepped fixed cost is one that, in the short term, remains the same over a given range of activity but beyond that increases and then remains constant at a higher level of activity.
E.g. Rent of factory
20,000
10,000 2 factories
1 factory
100,000 200,000 Production
(d) Semi variable/fixed cost
It is a combination of both E.g. electricity for factory used to power machines- variable (the more we use/produce the machines the more the cost will be) Used to light factory-fixed
Linear assumption - For this examination we will assume that total variable costs vary linearly with the level of production (or that the variable cost per unit remains constant) With the linear assumption all costs can be categorised as either fixed or variable.
Direct costs- By their nature direct costs will be variable costs.
Indirect costs/overheads- Overheads can be fixed or variable
Non-manufacturing costs - can be fixed or variable
Semi-variable costs - It is necessary to determine the fixed and variable elements of semi-variable costs. A method known as High-Low can be used to establish the fixed and variable elements. This technique is best illustrated by the use of an example.
The total costs of a business for differing levels of output are as follows:
Output Total Costs
(units) ($000)
200 30
1,000 110
(a) What are the fixed and variable elements of the total cost using the High-Low method? (fixed and variable cost per unit)
(b) Describe the relationship between the output and costs in the form of a linear
equation.
(A)
High 1000 110 000
Low 200 30 000
Difference 800 80 000
Variable cost = $80 000
$80
= $100 variable cost per unit
Taking high
Total cost 110,000
Total variable (1000 * $ 100) 100,000
Fixed cost $10,000
To check if your answer is good then check for low
Fixed variable
10,000 + (200 * $100) = $30,000
(B)
Total cost = fixed cost($10,000) + variable cost($100x) where x is the number of units
3. Responsibility centres Cost centres: Cost centres are areas where costs are collected e.g. individual departments or individual machines
Profit centres: Profit centres are where both costs and revenues are collected. Many companies will have separate divisions and make the divisional manager responsible for the profit of that division.
Revenue centres: Here, the manager is only responsible for the revenues of his division or department not for the costs.
Investment centres: This is like a profit centre except that the manager also has the responsibility for new capital investment (i.e. the purchase of new machines etc.
Qu.1
Which of the following should be classified as indirect labor?
Machinists in a factory producing clothes.
Bricklayers in a house building company Assembly workers on a car production line Truck drivers in the stores of an engineering company
Ans D because they are not actually involved in production.
Qu.2
An organization has the following costs at two activity levels:
Activity level (units) 16,000 22,000
Total costs ($) 135,000 170,000
The variable cost per unit is constant within this range of activity but there is a step up/increase of $5,000 in the total fixed costs when the activity exceeds 17,500 units.
What is the total cost of an activity of 20,000 units?
$163,000 $158,000 $155,000 $160,000
Difference in costs= $170,000 $135,000
= $35,000
Total costs= fixed cost + variable cost
$35,000= $5000 + variable cost
Variable cost= $35,000 - $5000
=$30,000
The difference in costs is $35,000. $5000 this is due to the increase in fixed costs, and so the increase in variable costs is $30,000
So the variable cost per unit = 30,000 / (22,000 16,000)
=$5 per unit
Activity of 20,000 units is 2,000 less than 22,000 units.
Therefore the total cost will be $170,000 (2,000 * $5) =$160,000
Qu.3
An organization has the following costs at two activity levels:
Activity level (units) 20,000 25,000
Total costs ($) 110,000 135,000
What is the total cost at an activity of 22,000 units?
$130,000 $120,000 $125,000 $115,000
High = 25,000
Low= 20,000
Difference in units= 5,000
High= 135,000
Low= 110,000
Difference in total costs ($) = 25,000
Variable cost per unit = 25,000 / 5,000
= $5 variable cost per unit
Activity of 22,000 units is 3,000 less than 25,000 units.
