THE FUNDAMEBTALS OF
COSTING
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LEARNING OBJECTIVES:
1. Identify and give examples of the three basic manufacturing cost .
2 Distinguish between product costs and period costs.
3. Understand variable costs, fixed costs, and mixed costs.
4. Analyze a mixed cost.
5. Prepare income statements .
6. Understand the differences between direct and indirect costs.
7. Understand cost classifications used in making decisions: differential
costs, opportunity costs, and sunk costs.
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2.1. General Cost Classifications
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2.1.1. Manufacturing Costs:
Most manufacturing companies separate manufacturing
costs into three categories:
- Direct materials
- Direct labor
- Manufacturing overhead.
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Direct Materials:
Those materials that become an part of the finished product
and whose costs can be conveniently traced to the
finished product
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Direct Labor:
Consists of labor costs that can be easily traced to
individual units of product
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Manufacturing Overhead:
The third element of manufacturing cost, includes all manuf
acturing costs
Except direct materials and direct labor.
Manufacturing overhead includes items such as indirect ma
terials; indirect labor; maintenance and repairs on produc
tion equipment; and heat and light, property taxes, depre
ciation, and insurance on manufacturing facilities.
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2.1.2. Nonmanufacturing Costs
Nonmanufacturing costs are often divided into two
categories:
(1) selling costs and
(2) administrative costs
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Selling costs:
Include all costs that are incurred to secure
customer orders and get the finished
product to the customer
Administrative costs
Include all costs associated with the general
management of an organization
2.2. Product Costs versus Period Costs
2.2.1. Product Costs
For financial accounting purposes, product costs include all
costs involved in acquiring or making a product.
In the case of manufactured goods, these costs consist of
direct materials, direct labor, and manufacturing
overhead.
2.2.2. Period Costs
Period costs are all the costs that are not product costs.
All selling and administrative expenses are treated as
period costs.
For example, sales commissions, advertising...
2.2.3. Prime Cost and Conversion Cost
Two more cost categories are often used in
discussions of manufacturing costs - prime
cost and conversion cost
Prime cost
Is the sum of direct materials cost and
direct labor cost
Conversion cost:
Is the sum of direct labor cost and
manufacturing overhead cost
2.3. Cost Classifications for Predicting Cost
Behavior
2.3.1.Variable cost
Costs which tends to vary with the level of activity.
The variable cost per unit is the same amount for each unit is
produced.
The level of activity can be:
- Number of products are produced
- The number of consumer products
- Revenue
- Number of hours the machine
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Variable costs
A constant variable cost per unit implies that the price per unit of like, m
aterial purchased is constant, and that the rate of material usage is
also constant.
a. The most important variable cost is the cost of raw materials
b. Direct labour costs: classed as a variable cost even though basic wa
ges are usually fixed.
c. Sales commission is variable in relation to the volume or value of sal
es.
d. Bonus payments for productivity to employees might be variable onc
e a certain level of output is achieved
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Formula variable costs
y = ax
y: Total variable costs
a: Variable cost per unit
x: Activity level
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2.3.2. Fixed cost
The total cost that does not increase or decrease depending on the
level of activity
Fixed costs are a period charge, in that they relate to a span of time; as
the time span increases, so too will the fixed costs (which are
sometimes referred to as period costs for this reason).
It is important to understand that fixed costs always have a variable
element, since an increase or decrease in production may also bring
about an increase or decrease in fixed costs.
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Examples
• The salary of the managing director (per month or per
annum)
• The rent of a single factory building (per month or per
annum)
• Straight line depreciation of a single machine (per month
or per annum)
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Formula fixed costs
y=b
Example:
Rental cost: fixed because it is a constant amount,
within a stated time period
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2.3.3. Mixed costs
Costs including fixed costs and variable costs
EX: telephone call charges: semi-fixed or semi variable overhead cost,
Charges increase if the volume of business expands, but there is a
fixed element of line rental
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Examples
a. Electricity and gas bills
(i) Fixed cost = standing charge
(ii) Variable cost = charge per unit of electricity used
b.Salesman's salary
(i) Fixed cost = basic salary
(ii) Variable cost = commission on sales made
c. Costs of running a car
(i) Fixed cost = road tax, insurance
(ii) Variable costs = petrol, oil, repairs (which vary with miles tra
velled)
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Example: cost behaviour and activity level
Hans Bratch has a fleet of company cars for sales representatives. Run
ning costs have been estimated as follows.
a. Cars cost $12,000 when new, and have a guaranteed trade-in value
of $6,000 at the end of two years. Depreciation is charged on a strai
ght-line basis.
b. Petrol and oil cost 15 cents per mile.
c. Tyres cost $300 per set to replace; replacement occurs after 30,000
miles.
d. Routine maintenance costs $200 per car (on average) in the first yea
r and $450 in the second year.
e. Repairs average $400 per car over two years and are thought to var
y with mileage. The average car travels 25,000 miles per annum.
f. Tax, insurance, membership of motoring organisations and so on cos
t $400 per annum per car.
Required:
Calculate the average cost per annum of cars which travel 15,000 mile
s per annum and 30,000 miles per annum
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Solution
Costs may be analysed into fixed, variable and stepped cost items, a
stepped cost being a cost which is fixed in nature but only within certain
levels of activity
a Fixed costs $ per annum
Depreciation $(12,000 - 6,000) ÷ 2 3,000
Routine maintenance $(200 + 450) ÷ 2 325
Tax, insurance etc 400
Total 3,725
b Variable costs $ per mile
Petrol and oil 15.0
Repairs (400/50,000 miles)* 0.8
Total 15.8
* If the average car travels 25,000 miles per annum, it will be expected to travel
50,000 miles over two years (this will correspond with the repair bill of $400
over two years).
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Solution (cont...)
Step costs are tyre replacement costs, which are $300 at the end of
c
every 30,000 miles.
If the car travels less than or exactly 30,000 miles in two years, the tyres
i
will not be changed. Average cost of tyres per annum = $0.
If a car travels more than 30,000 miles and up to 60,000 miles in two yea
ii rs, there will be one change of tyres in the period. Average cost of tyres
per annum = $150 ($300 ÷ 2). (
If a car exceeds 60,000 miles in two years (up to 90,000 miles) there will
iii
be two tyre changes. Average cost of tyres per annum = $300 ($600 ÷ 2)
costs per annum of cars travelling 15,000 miles per annum and 30,000 miles per annum
15,000 miles per annum ($) 30,000 miles per annum ($)
Fixed cosds 3,725 3,725
Variable costs
(15.8c per mile) 2,370 4,740
Tyres 0 150
Cost per annum 6,095 8,615
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The following table relates to different levels of production of the (X).
The variable cost of producing a (X) is $5. Fixed costs are $5,000
1X ($) 10X ($) 100X ($)
Total variable cost
Variable cost per unit
Total fixed cost
Fixed cost per unit
Total cost (fixed and variable)
Total cost per unit
What happens when activity levels rise ?
1. The variable cost per unit ...........................................
2. The fixed cost per unit ................................................
3. The total cost per unit ................................................
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Are the following likely to be fixed, variable or mixed costs?
Refr Costs Fixed Variable Mixed
1 Telephone bill
2 Annual salary of the chief accountant
Cost of materials used to pack 20 units of p
3
roduct X into a box
4 Wages of warehousemen
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2.4. The Analysis of Mixed Costs
The fixed and variable elements of Mixed costs can be
determined by the high-low method
There are several methods for identifying the fixed and
variable elements of mixed costs. Each method is only
an estimate, and each will produce different results. One
of the principal methods is the high-low method
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Analyze mixed costs into variable costs and fixed costs
•There are three methods:
1. Hight-low method (cực đại-cực tiểu)
2. Scater graph method (đồ thị phân tán)
3. Least squares method (bình phương bé nhất)
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High-low method
The steps below to estimate the fixed and variable elements of semi-variable costs.
• Step 1: Review records of costs in previous periods
- Select the period with the highest activity level.
- Select the period with the lowest activity level.
• Step 2: Determine the following
- Total cost at high activity level
- Total cost at low activity level
- Total units at high activity level
- Total units at low activity level
• Step 3: Calculate the following
Total cost at high activity level - total cost at low activity level
Variable cost
per unit (v) =
Total units at high activity level - total units at low activity level
• Step 4: The fixed costs can be determined as follows
F = Total cost at high activity level – total units at high activity level × variable cost per unit
M = vX + F; Y = ax +b
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y = x+80,000
Y(85,000) = 85,000 + 80,000 = 165,000
Example: The high-low method with stepped fixed costs
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Example: The high-low method with a change in the variable cost per unit
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Exercise
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Example:
The following information for advertising and sales has been establishe
d over the past six months:
Required:
1. Using the high-low method what are the variable cost for per unit and
total fixed costs
2. Using the high-low method which of the following is the correct
equation for linking advertising and sales
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Table:
Month Sales revenue $,000 Advertising expenditure,000
1 155 3
2 125 2.5
3 200 6
4 175 5.5
5 150 4.5
6 225 6.5
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Solution:
Variable cost per unit (a) = ...........................................
Total fixed cost (b) = .....................................................
y = ax + b = ...................................................................
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Manufacturing costs incurred in the six months
Month Machine operating hours Manufacturing cost ($)
1 1,000 42,000
2 1,200 48,000
3 1,400 54,000
4 1,600 60,000
5 2,000 72,000
6 1,800 66,000
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•Manufacturing costs in January include:
- Management salaries: $10,000
- Indirect materials:(used according to the number of hours the
machine): $20,000
- Electricity: (office and production):$12,000
Required:
1. Compute the cost of electricity in May
2. Using the high-low method to analysis of the cost of electricity, and
set up equation of electricial costs.
3. Set up equation of manufacturing cost and estimate manufacturing
cost for 2,100 hours machine in July
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Solution:
Manufacturing costs in May = Management salaries + Indirect
materials + Electricial cost
•Management salaries in January = Management salaries in May =
$10,000 (Fixed cost)
•Indirect materials in May = (20,000/1,000) x 2,000 = $40,000 (Variable
per unit constant)
=> Electricity cost in May = 72,000 - 10,000 - 40,000 = 22,000
2.5. Traditional and Contribution Format
Income Statements
The Traditional Format Income Statement
Traditional income statements are prepared
primarily for external reporting purposes
The cost of goods sold for a merchandising
company
Can be computed directly by multiplying the
number of units sold by their unit cost or indirectly
using the equation below:
Cost of goods sold =Beginning merchandise
inventory + Purchases – Ending merchandise
inventory
The Contribution Format Income Statement
The crucial distinction between fixed and variable costs is
at the heart of the contribution approach to constructing
income statements
2.6. Cost Classifications for Assigning Costs
to Cost Objects
A cost object is anything for which cost data
are desired—including products, customers,
jobs, and organizational subunits
Direct and indirect costs
Direct cost indirect cost (overhead)
incurred in the course of (qúa trình)
Can be traced in full to the product, making a product, provinding a service or
service or department that is costed running a department, but not be traced
direct and in full
Materials, labour and other expense can be classified as either direct costs or indirect
costs
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2.7. Cost Classifications for Decision Making
Costs are an important feature of many business
decisions. In making decisions, it is essential to
have a firm grasp of the concepts differential
cost, opportunity cost, and sunk cost
Differential Cost and Revenue
In business decisions, each alternative will have
costs and benefits that must be compared to the
costs and benefits of the other available
alternatives. A difference in costs between any
two alternatives is known as a differential cost.
Opportunity Cost
Is the potential benefit that is given up
when one alternative is selected over
another
Example 1 Vicki has a part-time job that pays $200 per
week while attending college. She would like to spend a
week at the beach during spring break, and her employer
has agreed to give her the time off, but without pay. The
$200 in lost wages would be an opportunity cost of taking
the week off to be at the beach.
Sunk Cost
A sunk cost is a cost that has already been
incurred and that cannot be changed by
any decision made now or in the future.
Vinasoy Company pay the salaries and wages for
salesman under the month and under product with
$6,000 per month, plus 10% of sales. In February,
company sold 38,000 units and in May sold 82,000 units.
The selling price 20$ per unit
Required:
1. Compute total salaries and wages expenses incurred
in February and May?
2. If have 100,000 unit products were sold in August.
Base on the result of (1) above and using high-low
method in order to compute total salaries and wages in
August
