CAPE UNIT 2 ACCOUNTING: TYPES OF COST

1. COST is the monetary measure of resources given up to attain a product or

service.

2. COST is based on the objective or information desired;

(*) time of incurrence,
(*) reaction to change,
(*) classification, and
(*) impact on decision-making

3. COST is classified according to the degree of similarity of the purpose;

(*) inventory valuation,
(*) income determination,
(*) decision-making, and
(*) planning and control

COST BEHAVIOUR:
Costs react to changes in activity; or purpose in decision making; therefore there
are categorized as either DIRECT or INDIRECT

4. DIRECT COSTS (or VARIABLE Cost)

are those which change (in total) in direct proportion to the change in activity.

5. INDIRECT COSTS (or FIXED Cost )

are those remain constant within the relevant (normal) range of the activity
CATEGORIES OF COST BEHAVIOURS

 STEP VARIABLE COSTS

(the assigned costs attributed are varied to match different levels in the
specific activity)

 MIXED COSTS
which does not change in direct proportion to the activity; nor does it
remain constant with a change in the activity.

 STEP FIXED COSTS (constant costs attributed to match different levels in the activity)

 RELEVANT COSTS (or Avoidable cost)

These affect the decision making process; costs which are chosen
according to some future action , once that path is chosen they cannot be
avoided.

 IRRELEVANT COSTS (or Unavoidable cost)

These have no recognizable effect on the decision making process; cost
which resulted from a past activity (sunk or expired by past action); and so
have no bearing on the present activity.

 PLANNED COSTS

those costs which had been budgeted or estimated specifically for the
activity

 ACTUAL COSTS
the real costs (measured at the end) incurred in conducting the activity

 CONTROLLABLE COSTS
those costs which can be changed (incurred or avoided) by management’s
actions

 UNCONTROLLABLE COSTS
those costs which cannot be changed by the actions of the entity.

 OPPORTUNITY COST
The potential benefit given up by selecting one course of action over
another.
6. PRODUCT COSTS (also known as manufacturing costs OR inventoriable costs)
These costs include:
o DIRECT MATERIALS - Material costs that can be traced to the product
o DIRECT LABOUR - Labour costs that can be traced to the product
o FACTORY OVERHEAD - All manufacturing costs other that those that
are direct

7. PRIME COST - Sum of direct materials, (direct expenses), and direct labour

8. CONVERSION COST - Sum of direct labour and factory overheads

9. Manufacturing cost = prime cost + factory overheads

10. PERIOD COSTS

(also known as non-manufacturing costs OR non-inventoriable costs)

These costs include:

o MARKETING (SELLING) COSTS

All costs necessary to secure orders; and to get the
finished product/service into the customer’s hands

o ADMINISTRATIVE COSTS
All costs of general administration (management) of the
company as a whole.
[The manufacturing enterprise]
MANUACTURED (FINISHED) GOODS
The manufacturing account is used to disclose the cost of producing a finished
product.
The cost are separated into PRIME COST and OVERHEAD COST.

PRIME COST
The sum of all those costs that can be traced directly to the creation of the
product; whose contribution was so great that the product would not exist
without them.

DIRECT MATERIALS The cost of acquiring actual materials from which the product is made

DIRECT LABOUR The cost (wages) of the workers who actually make the product

DIRECT EXPENSES The cost (expense) of acquiring the rights to make the product

PRIME COST = DIRECT MATERIALS + DIRECT LABOUR + DIRECT EXPENSES

MANUFACTURING (FACTORY) OVERHEAD COST

The sum of all those costs (other than prime cost) that were used in the factory;
but their contribution was too marginal to be traced directly to the product.

INDIRECT EXPENSES The cost exclusively incurred in operating the factory on a whole

INDIRECT MATERIALS The cost purchased for the factory but not to make the product

INDIRECT LABOUR
The cost (wages) of the workers in the factory who do not actually make the
product.

OVERHEAD COST = INDIRECT EXPENSES + INDIRECT LABOUR + INDIRECT MATERIALS

PRIME COSTS + FACTORY OVERHEAD COSTS = MANUFACTURING COSTS

INCOMPLETE WORK
Due to timing differences the END of the FINANCIAL YEAR and the END of a
PRODUCTION CYCLE do not always coincide. As a result work which is in the process of
being made at the CUT-OFF DATE can only be measured to the stage (percentage) of its
completion.

WORK-IN-PROGRESS at start
Goods which were in the process of being made at the end of the previous year, but
which forms part of the input for the current year’s production of FINISHED GOODS.

WORK-IN-PROGRESS at close
Goods which were in the process of being made at the end of the current year, and so
must be removed from the current year’s production of FINISHED GOODS.

PRIME COSTS + FACTORY OVERHEAD COSTS + NET WORK IN PROGRESS = COST OF FINISHED GOODS
MANUFACTURED

[COST OF FINISHED GOODS MANUFACTURED is also referred to as the COST OF PRODUCTION]

TRADING OF THE FINISHED GOODS by the factory requires the calculation of the COST OF GOODS SOLD

FINISHED GOODS at start + COST OF FINISHED GOODS TRANSFERRED FROM PRODUCTION – FINISHED
GOODS at close = COST OF GOODS SOLD

[Stocks of finished goods are valued at cost (as with any other type of stock)]

Finished goods transferred from production may incur additional cost (carriage) or mark-up
(profit percentage)

Mark-up profits are ONLY realized when the goods are sold!

NON-MANUFACTURING OVERHEADS

These are expenses incurred at a management and administrative level as part of the
function of the entire business. These expenses must now be removed to reveal if the
company is operating profitably.
t should be noted that there are TWO ACCOUNTING methods {we will examine these later} for
treating overheads.

THE ABSORPTION METHOD

Direct materials used SALES (net of returns)

+ Direct labour cost of goods

manufactured
= Prime cost
COST OF GOODS SOLD
Variable (factory) overheads

= GROSS PROFIT
Fixed (factory) overheads

Variable (non-
= manufacturing cost manufacturing) overheads

+ net work in progress Fixed (non-manufacturing)

overheads
= COST OF GOODS
MANUFACTURED = NET PROFIT