01. Different types of costs
(a) Direct Cost.
Direct costs are those which have direct relationship with a unit of operation like manufacturing a product, organizing a process or an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs is related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is also called as “Traceable Costs”.
(b) Indirect Cost.
Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department. Like the direct costs indirect costs, do not vary i.e., they may or may not be variable in nature. However, the nature of indirect costs depends upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.
(c) Opportunity Cost.
Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return from the second best use of the firms’ resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input.
(d) Incremental Cost.
Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be avoided by not bringing any variation in the activity the activity, they are also called as “Avoidable Costs” or “Escapable Costs”. More ever incremental costs resulting from a contemplated change is the Future, they are also called as “Differential Costs”
Example: Change in distribution channels adding or deleting a product in the product line.
e) Relevant cost.
Relevant cost is a managerial accounting term that describes past or sunk costs that are not used to make current business decisions. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision making process. As an example relevant cost is used to determine whether to sell or keep business unit.
Different types of costs relating to the Munchee Biscuits (PVT) Ltd.
Generally this company is introduced new biscuit to the market in every year or less. Therefore I would like take Munchee Sun Cracker which was introduced recently for identify different type of costs relating to that product.
|Direct cost||Direct Material||Wheat flour , Sugar|
|Direct other||Packing cost|
|Indirect cost||Indirect Material||Oil , Baking powder|
|Indirect Labour||Supervisors’, Cleaners’ wages|
|Indirect other||Electricity ,Telephone bills|
|Incremental cost||Technology improvements|
|Opportunity cost||The land can be used for providing car park facilities|
Different types of Costing Methods
Methods of costing for ascertainment of actual cost may be identified in many names according to the variation of procedure adopted to determine cost for different types of product. Broadly there are two group of costing method specific order, costing. Specific order or job costing is applicable for specific jobs, batches or contracts each of which is undertaken by specific order or contract job costing. Batch costing and Contract costing are included in this group.
Job costing is concerned with the finding of the cost of each job or work order. This method is followed by these concerns when work is carried on by the client request, such as printer general engineering work shop etc. under this system a job cost sheet is required to be prepared find out profit or losses for each job or work order. Costing technique used to ascertain cost of a job or work-order is called job costing.
One of example for job costing is a customer gives order to a carpenter for making a bed on his personal requirements so this job is separated from other jobs of carpenter
Some products are to pass through different stages of production before their completion. The different stages of production are called ‘process’ and each process is distinct and well defends. Output of one process is used as raw material for the next process. It may be in a saleable state. It is necessary to ascertain total cost of each of such processes and cost per unit at each process. So a separate account for each process is maintained and that method of maintaining record and ascertaining cost of production is known as process costing. Sometimes, it is also referred as ‘average’ costing. It is used in case of textile, chemical, paints, food product, paper, sugar, etc.
Batch costing is a form of specific order costing. Job costing refers to costing of jobs that are executed against specific orders whereas in batch costing items are manufactured for stock. A finished product may require different components for assembly and may be manufactured in economical batch lots. When orders are received from customers there are common products among orders; then production orders may be issued for batches, consisting of a predermined quantity of each type of product. Batch costing method in such cases to calculate the cost of each such batch.
The examples for Batch costing: This method is mainly applied in biscuits manufacture, garments manufacture, spare parts and component manufacture, pharmaceutical enterprises etc.
01._Absorption costing method
Sales (14000*25) 350
Variable (15000*15) 225
(+)Opening stock –
(-)Closing stock (W1) (16)
Production cost of sales 221
Under/over absorbed overhead (3)
Total cost 218
Gross profit 132
Variable (30+15) 45
Fixed (6+18) 24 69
Net profit 63
_Marginal Costing method
Sales (14000*25) 350
Cost of sales
Variable cost (15000*15) 225
(+) opening stock __
(-) closing stock (W1) (15)
(-) variable selling & so on (45) 165
(-) Fixed cost: Production 12
Selling & so on 24 36
Net profit 149
- Closing Stock
Production units 15000
Sold units 14000
Absorption cost valuation 1000*16 = 16000
Marginal cost valuation 1000*15 = 15000
- under/over absorption
Actual production 15000
Budgeted production 12000
Over production 3000
Fixed production over-
Head per unit 1/=
02. The difference in profits reported under the two costing methods is due to the different inventory valuation methods used.
a) If inventory levels increase between the beginning and end of a period, absorption costing will report the higher profit because some of the fixed production overhead incurred during the period will be carried forward in closing inventory (which reduce s cost of sales) to be set against sales revenue in the following period instead off in full against profit in the period concerned.
b) If inventory levels decrease ,absorption costing will report the lower profit because as well as the fixed overhead incurred, fixed production overhead which had been carried forward in opening inventory is released and also included in cost of sales.
03. Break even analysis or cost-volume-profit analysis is the study of the interrelationship between cost, volume and profit at various levels of activity.
The break-even point occurs when there is neither a profit nor a loss and fixed costs equal contribution.
Hence the BEP for above organization is calculated bellow.
BEP = Fixed Cost
Contribution for unit
In revenue, BEP = 5142*25
- Contribution = 25 – 18 = 7
- Fixed cost = 36000
Sales above Rs.128550 will result in profit of Rs.7/= per unit of additional sales below Rs.128550 will mean a loss of Rs.7/= per unit for each unit by which sales fall short 5142 units. In other words profit will improve or worsen by the amount of contribution per unit.
Purposes and Objectives of Budgeting process
- Ensure the achievement of the organization’s objectives.
- Compel planning
- Communicate ideas and plans
- Coordinate activities
- Provide a framework for responsibility accounting
- Establish a system of control
- Motivate employees to improve their performance
- Evaluate of managerial performance
The principle behind the zero based budgeting is that the budget for each cost Centre should be made from “scratch” or zero. Every item of expenditure must be justified in its entirety in order to be included in next year’s budget.
There is a three step approached to ZBB.
- Define decision units
- Evaluate and rank packages.
- Allocate resources
ZBB rejects the assumption inherent in incremental budgeting that this year’s activities will continue at the same level or volume next year, and that next year’s budget can be based on this year’s costs plus an extra amount perhaps for expansion and inflation.
Zero based budgeting involves preparing a budget for each cost center from a zero base. Every item of expenditure has then to be justified in its entirety in order to be included in the next year’s budget.
Preparation of budgets.
|Product||Sales unit||Unit selling price||Total sales|
|Product||Sales unit||+Closing stock||=||(-)Opening stock||Product to be produce|
Material Usage Budget
Material Purchase budget
|Total material purchase||169800||161700||235800||119300||53500||740100|
|Cost per unit||0.50/=||0.35/=||0.60/=||0.55/=||1/=||2.45/=|
Direct Labour Cost
|D/L per unit||2||4||3|
|Rate per hour||2/=||2/=||2/=|
|Total labour cost||82400||156000||92400|
|Quarter 01||Quarter 02||Quarter 03||Quarter 04||Total|
Direct materials cost variance
|Actual Purchase * Actual Price|
90000 * 8 = 720000
Price Variance = 270000 (Adverse)
|Actual Purchase * Standard Price|
90000 * 5 = 450000
Usage Variance = 50000 (Favorable)
|Standard Usage * Standard Price 10000 * 5 = 500000|
Direct labor cost variance
|Actual working hours * Actual rate|
Wage ate variance = 2600 (Favorable)
|Actual working hours * Standard rate|
19400 * 50 = 970000
Efficiency variance = 14400 (Adverse)
|Standard hours * standard ate|
10000 * 8 = 80000
Variance overhead cost variance
|Actual overhead expenditure = 25000|
V / O / H /E / variance = 8600 (Adverse)
|Actual working hours * Absorption rate|
8200 * 2.5 = 16400
V / O / H /E / efficiency variance = 3600 (Favorable)
|Standard hours * Absorption rate|
10000 * 2 = 20000
F / O / H Variance
|Actual F/O/H = 9800|
F / O / H expenditure variance = 1600 (Adverse)
|Actual working hours * Absorption rate|
8200 * 1 = 8200
F / O / H volume variance = 1800 (Favorable)
|Budgeted hours * Budgeted rate|
10000 * 12 = 100000
Sales value variance
|Sales margin price = Actual sales (Standard margin – Actual margin)|
= 1000 ( 290 – 365 )
= 75000 (Favorable)
|Sales volume price = Standard margin (Actual sales –Budgeted sales)\|
= 290 (1000 – 1020)
= 5800 (Adverse)
Reconciliation of budgeted & actual profit
|Budgeted net profit|
V / O / H
F / O / V
(Prime Minister’s Strategy Unit. 2004)
Return-on-investment calculator, developed by the NHS Institute of Innovation and
_improvement tools/Return_on_Investment_ (ROI) _calculator.html
Coates, J.B., Richwood, C. and Stacey, R.J. (1996) Management Accounting for Strategic and Operational Control, Oxford, Butterworth-Heinemann.
Davenport T.H. and Prusak, L (1997) Working Knowledge, Boston, MA, Harvard Business School Press.
Professional Accountants in Business Committee (2009). Evaluating and Improving Costing in Organizations (International Good Practice Guidance). International Federation of Accountants. p. 7. ISBN 9781608150373.
“Cost Management”. Thomson Reuters.( 2011). Retrieved November 12, 2011