Chapter 2

Download as ppt, pdf, or txt
Download as ppt, pdf, or txt
You are on page 1of 47

ACCT130

Session 1

Cost Terms, Concepts and


Classifications
Omair Haroon
omair.haroon@lums.edu.pk
Mission

Planning

Create
Strategic Directing and
Motivating
Plan

Implement
Plan Control

Measure
And
Evaluate
What is the difference between financial
and management accounting?

Financial Accounting Data Management Accounting

-External
-Internal
-Past
-Future
-Objectivity and
-Relevance
verifiability
-Timeliness
-IFRS
-No IFRS
-Mandatory
-Optional
-Summary of entire
-Detailed (segmented)
organization
Financial
Financialaccounting
accountingprepares
prepares Managerial
Managerialaccounting
accountingprepares
prepares
reports
reportsmost
mostfrequently
frequentlyused
usedbyby reports
reportsmost
mostfrequently
frequentlyused
usedbyby
decision
decisionmakers
makersexternal
externaltotothe
the decision
decisionmakers
makersinternal
internalto
tothe
the
organization.
organization. organization.
organization.

Cost
Costaccounting
accountingisisaa“method
“methodforformeasuring
measuringthe
thecost
costofofaaproject,
project,process,
process,or
or
thing”*.
thing”*.ItItincludes
includesboth
bothfinancial
financialand
andnonfinancial
nonfinancialinformation
informationand
andisisused
usedfor
for
both
bothfinancial
financialand
andmanagerial
managerialaccounting.
accounting.
Comparing Merchandising and
Manufacturing Activities
Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

Hyperstar
COST OBJECT
 What are we trying to find cost of?
Period vs. Products Costs
 Period costs: Costs are shown on the
income statement (i.e. they become
expenses) in the period in which they are
incurred.

 Product costs: Costs are stored on the


balance sheet in the form of inventory until
the goods are sold. When they are sold, then
they appear on the income statement as a
cost of goods sold.
Manufacturing/Product Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product
Direct Materials
Those materials that become an integral part of the
product and that can be conveniently traced
directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
Direct Labor
Those labor costs that can be easily traced to
individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
Manufacturing Overhead
Manufacturing costs that cannot be traced directly to
specific units produced.
Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials

Wages paid to employees Materials used to support


who are not directly the production process.
involved in production
work. Examples: lubricants and
Examples: maintenance cleaning supplies used in the
workers, janitors and automobile assembly plant.
security guards.
Classifications of Costs
Manufacturing costs are often
classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
Nonmanufacturing/Period Costs

Marketing and Administrative


Selling Cost Cost

Costs necessary to get the All executive,


order and deliver the organizational, and
product. clerical costs.
Funky Tunes is a Karachi based
company that manufactures audio
systems. You are required to classify
their costs:

1. The cost of the transmitters


and capacitors used in an
audio set…
DM

Product Cost DL

MOH

Period Cost Selling

Admin
2. Factory air conditioning
costs…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
3. Factory equipment
maintenance costs…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
4. Training costs for new
administrative employees…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
5. The cost of the solder that is
used in assembling the audio
systems…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
6. The travel costs of the
company’s salespersons…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
7. Wages and salaries of
factory security personnel…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
8. The cost of air-conditioning
executive offices…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
9. Wages and salaries in the
department that handles
billing customers…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
10. Depreciation on the
equipment in the fitness room
used by factory workers…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
11. Telephone expenses
incurred by factory
management…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
12. The costs of shipping
completed audio systems to
customers…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
13. The wages of the workers
who assemble the audio
systems…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
14. The CEO’s salary…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
15. Health insurance premiums
for factory personnel…

DM

Product Cost DL

MOH

Period Cost Selling

Admin
Direct and Indirect Costs
Direct costs Indirect costs
 Costs that can be  Costs that must be
easily and conveniently allocated in order to be
traced to a product or
assigned to a product or
department.
department.
 Example: cost of wheels
in an automobile  Example: salary of
assembly plant. design engineer in an
aircraft manufacturing firm
Fixed vs. Variable Costs

 Fixed costs do not change in total as the


volume of product produced changes.

 Variable costs do change in total as the


volume of product produced changes
Total Fixed Cost
Your monthly telephone line rent does not
change when you make more local calls.
Monthly Telephone
Line Rent

Number of Local Calls


Fixed Cost Per Unit
The average cost of line rent per local call
decreases as more local calls are made.

Monthly Telephone Line


Rent Local Call
Number of Local Calls
Total Variable Cost

Your total telephone bill is based on how many


minutes you talk (after free minutes expire).
Telephone Bill
Total

Minutes Talked
Variable Cost Per Unit

The cost per long distance minute talked is


constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
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 remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Which of the following costs would be variable with
respect to the number of cones sold at an ice cream
shop?

A. The cost of lighting the store.


B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
Which of the following costs would be variable with
respect to the number of people who buy a ticket for a
show at a cinema?

A. The cost of renting the film.


B. Royalties on ticket sales.
C. Wage and salary costs of cinema employees.
D. The cost of cleaning up after the show.
Decision making
 Opportunity cost: The potential benefit that is
given up when one alternative is selected
over another.
 Sunk cost: A cost that has already been
incurred and cannot be changed by any
decision made in the future.
 Differential cost: A cost that changes between
alternatives.
 Incremental cost: The increased cost of
choosing one alternative over another.
Opportunity Costs
The potential benefit that is
given up when one alternative
is selected over another.

Example: If you were


not attending LUMS,
you could be earning
Rs.35,000 per month.
Your opportunity cost
of attending LUMS for one
month is Rs.35,000.
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.500,000


two years ago. The Rs.500,000 cost is sunk because
whether you drive it, park it, trade it, or sell it, you cannot
change the Rs.500,000 cost.
Suppose that your car could be sold now for Rs100,000.
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 Rs150,000 per month
in your hometown. You have a job offer in a
neighboring city that pays Rs.200,000 per month. The
commuting cost to the city is Rs.30,000 per month.

Differential revenue is:


200,000 – 150,000 = Rs50,000

Differential cost is:


Rs.30,000
Relevant Cost

 Every decision involves a choice between at


least two alternatives.
 Only those costs and benefits that differ
between alternatives (i.e., Differential costs
and benefits) are relevant in a decision. All
other costs and benefits can and should be
ignored.
Suppose you are trying to decide whether to drive or
take the train to Islamabad 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 Motor
Vehicle Tax of your car relevant in this decision?

A. Yes, the licensing cost is relevant.


B. No, the licensing cost is not relevant.
Suppose you are trying to decide whether to drive or
take the train to Islamabad 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.
Suppose you are trying to decide whether to drive or
take the train to Islamabad 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?

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


B. No, the cost of the train ticket is not relevant.
PURPOSE OF COST CLASSIFICATIONS

Preparation of financial statements  Product costs


 Period costs

Predicting cost behavior in response to  Variable costs


changes in activity  Fixed costs

Assigning costs to cost objects such  Direct costs


as departments or products  Indirect costs

Making decisions  Differential costs


 Sunk costs
 Opportunity costs

You might also like