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    Chapter - 02 - MA

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    Maithri Vidana Kariyakaranage
    Here are the key points in my response: - A direct cost can be both direct and indirect depending on the cost object. For example, the salary of a production supervisor is a direct cost to the production department but an indirect cost to individual products being manufactured. - Direct costs are costs that can be traced to a specific cost object like a product, service, or department. Indirect costs cannot be directly traced to cost objects. - When the cost object is an individual product, the supervisor's salary is an indirect cost. But when the cost object is the production department, the supervisor's salary is a direct cost to that department. - So the same cost can be either direct or indirect depending on the perspective

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    Chapter - 02 - MA

    Uploaded by

    Maithri Vidana Kariyakaranage
    36 views23 pages
    Here are the key points in my response: - A direct cost can be both direct and indirect depending on the cost object. For example, the salary of a production supervisor is a direct cost to the production department but an indirect cost to individual products being manufactured. - Direct costs are costs that can be traced to a specific cost object like a product, service, or department. Indirect costs cannot be directly traced to cost objects. - When the cost object is an individual product, the supervisor's salary is an indirect cost. But when the cost object is the production department, the supervisor's salary is a direct cost to that department. - So the same cost can be either direct or indirect depending on the perspective

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    Here are the key points in my response: - A direct cost can be both direct and indirect depending on the cost object. For example, the salary of a production supervisor is a direct cost to the production department but an indirect cost to individual products being manufactured. - Direct costs are costs that can be traced to a specific cost object like a product, service, or department. Indirect costs cannot be directly traced to cost objects. - When the cost object is an individual product, the supervisor's salary is an indirect cost. But when the cost object is the production department, the supervisor's salary is a direct cost to that department. - So the same cost can be either direct or indirect depending on the perspective

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    36 views23 pages

    Chapter - 02 - MA

    Uploaded by

    Maithri Vidana Kariyakaranage
    Here are the key points in my response: - A direct cost can be both direct and indirect depending on the cost object. For example, the salary of a production supervisor is a direct cost to the production department but an indirect cost to individual products being manufactured. - Direct costs are costs that can be traced to a specific cost object like a product, service, or department. Indirect costs cannot be directly traced to cost objects. - When the cost object is an individual product, the supervisor's salary is an indirect cost. But when the cost object is the production department, the supervisor's salary is a direct cost to that department. - So the same cost can be either direct or indirect depending on the perspective

    Copyright:

    © All Rights Reserved
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    Download as pptx, pdf, or txt
    of 23

    Chapter

    2
    COST TERMS,
    CONCEPTS &
    CLASSIFICATION
    WHY WE NEED COST INFORMATION?
    1. To make informed management decisions
    2. To plan, control and performance measurement
    3. For inventory valuation and profit reporting
    Cost
     A monetary measure of the resources that
    must be sacrificed to attain a particular
    objective.
    Cost Object
     A Cost Object is any activity for which a separate
    measurement of costs is desired.
    Examples:
    • Cost of a product
    • Cost of rendering a service
    • Cost of operating a particular department
    Question
    In Pizza Hut, if customer is treated as the cost object, what are the
    costs that can be attributed to the cost object?
    CLASSIFICATION OF COSTS
     Direct and indirect costs
     Manufacturing and Non – Manufacturing Costs
     Period and product costs
     Relevant and irrelevant cost
     Avoidable and unavoidable cost
     Sunk cost
     Opportunity cost
     Incremental and marginal cost
    DIRECT AND INDIRECT COSTS
     Direct Costs
    Costs that can be specifically identified with a particular cost object

     Indirect Cost
    Costs that cannot be specifically identified with a particular cost object

    Direct Costs Indirect costs


    - Wood - Salaries of factory
    supervisors
    - Wages of operatives - Rent of the factory
    CATEGORIES OF MANUFACTURING COST
     All costs incurred by the firm must be accounted for in its
    financial statements
    MANUFACTURING COSTS
    Direct Labor (DL)
    Direct Materials (DM) Prime Cost
    Direct Expenses (DE) Total
    Overhead (OH) Manufacturing
    Indirect Materials Cost
    Indirect Labor Manufacturing
    Other Overhead
    NON-MANUFACTURING COSTS
    Marketing or Selling Costs
    Administrative Costs
    MANUFACTURING COSTS
    Direct Costs
    Direct Materials (DM)
    • Materials that are consumed in the manufacturing process and physically
    incorporated in the finished product
    Direct Labor (DL)
    • Labor cost that is physically traceable to the products being manufactured
    Direct Expenses (DE)
    • Other direct expenses directly traceable to the product
     The three direct costs are summed to derive the prime cost or total direct cost
    of a product
    MANUFACTURING COSTS
    Indirect costs
    Indirect materials
    • production materials that do not actually become part of the finished
    product. e.g. Lubricating oils and cleaning materials
    Indirect labour
    • production labour cost which cannot be directly associated with the
    production of any particular product. e.g. Salaries of supervisory labour
    Indirect expenses
    • all the other production overheads associated with running the factory,
    including factory rent and rates, heating and lighting, etc. These indirect
    costs must be shared out over all of the batches produced in a period
    e.g. Factory rent and power
    QUESTION
    Would below costs be a direct cost or an indirect cost of the
    quality control activity which is undertaken in a company’s
    factory?
    ● The salary of the quality control supervisor.
    ● The rent of the factory.
    ● The depreciation of the quality testing machine.
    ● The cost of the samples destroyed during testing.
    ● The insurance of the factory.
    NON MANUFACTURING COSTS
    Selling and distribution overhead
    • Includes the sales force salaries and commission, the cost of
    operating delivery vehicles and renting a storage warehouse, etc.
    These are indirect costs which are not specifically attributable to a
    particular cost unit.
    Administration overhead
    • Includes the rent on the administrative office building, the
    depreciation of office equipment, postage and stationery costs, etc.
    These are also indirect costs which are not specifically attributable
    to a particular cost unit
    PERIOD AND PRODUCT COST
    Product Costs
     Costs that are identified with goods purchased or produced for
    resale
     Product costs include direct materials, direct labor, and
    manufacturing overhead
     Unsold part of product cost is Included in the inventory valuation.
    Period Costs
     Period costs are non manufacturing costs such as selling and
    administrative costs are expense
     Product costs are not included in the inventory valuation
    • S & S Company came into a rent agreement with a building owner
    on 30th June 2011. As per the agreement, Rs. 20 000 monthly rent
    should be paid for a minimum of one year. It further says that the
    agreement cannot be cancellable. By end of 2011, company thinks
    whether to construct its own building or to continue the rent.
    What is the sunk cost of this decision?
    • A company has received a special order from a customer to
    produce 750 units of a customized product. This special order
    requires additional variable cost of Rs. 20,000. To produce one
    unit of this product two machine hours are required. Currently
    machines are working are at their full capacity. If the special order
    is accepted, current output of product A (the standard product)
    will have to be reduced. To produce one unit of product A 1.5
    machine hours are required. The contribution per unit of product
    A is Rs. 30.

    • Find the opportunity cost of fulfilling the customer’s order


    • What is the minimum price that should be charged to the order?
    • ABC Company purchased Rs. 20,000 worth of raw materials a few
    years ago. Currently there is no possibility of selling these
    materials or using them in future production. Recently a customer
    saw these materials at the company premises and requested the
    company to sell those materials to him. However, this customer is
    not prepared to pay more than Rs. 12,000. The additional cost of
    Rs. 5,000 would be required to change these materials according
    to the customer requirement.
    •
    • What are the relevant costs and revenues in this case?
    •
    • Should company sell these materials to the customer?
    COST BEHAVIOUR
    • Refers to the way in which costs are affected by fluctuations
    in the level of activity
    • Understanding cost behavior is essential for decision making.
    • The level of activity can be measured in many different ways.
    Example:
    number of units produced, miles travelled, hours worked, meals
    served, percentage of capacity utilized, students enrolled
    Fixed Costs
    • Costs that remain constant over a specific range of
    activity for a specified time period
    Ex: rent, insurance and executive salaries
    Total Fixed
    Cost,
    Rs

    Level of activity
    Stepped Fixed Costs
    • Costs that are constant for a given level of activity,
    but increase or decrease once a threshold is reached
    Ex: rent cost
    Total Cost,
    Rs

    Level of activity
    Fixed Cost per Unit
    • Fixed cost per unit decrease proportionally with the
    level of activity

    Fixed Cost,
    per unit
    Rs

    Level of activity
    Variable cost
    • Costs that varies in relation to changes in the volume
    of activity

    Total variable
    cost
    Rs

    Level of activity
    Variable cost per unit
    • Variable cost per unit is constant

    Per unit
    variable
    Cost,
    Rs

    Level of activity
    QUESTION
    Are all direct costs variable and all indirect costs fixed?

    All direct costs are not variable!


    There could be direct fixed costs as well. e.g Labour in some instances
    Also
    Not all indirect costs are fixed!
    There could be indirect variable costs. e.g power cost in a tile factory
    Practice Questions
    Which of the following best describes a fixed cost?
    a) Increases proportionately with output
    b) Remains constant irrespective of the level of activity
    c) Varies with the level of output
    d) Has a direct relationship with output

    Which of the following statements is TRUE?


    a) Unit variable costs are constant as volume increases.
    b) Unit fixed costs are constant as volume increases.
    c) Unit variable costs decrease as volume decreases.
    d) Unit fixed costs increase as volume increases

    Prime cost is
    a) all costs incurred in manufacturing a product
    b) the total of direct manufacturing costs
    c) the material cost of a product.
    d) the cost of operating a department
    PRACTICE QUESTIONS
    1. Explain the following commonly used cost terms in management accounting:
    cost object
    • direct and indirect costs
    • variable and fixed costs
    • product and period costs.
    Illustrate your answer with examples

    2. Describe how a direct cost can be both a direct cost and indirect tcost

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