ELEMENTS COST MATERIALS

COST

OF

LABOUR

OTHER EXPENSES

DIRECT

INDIRECTDIRECT

INDIRECT

DIRECT

INDIRECT

OVERHEADS DOH

FOH

AOH

SOH

Direct Cost Indirect Cost

Trace Allocate

Cost Object

Cost is the amount of actual or notional expenditure relating to a product, job, service, process or activity.ost is a resource sacrificed or foregone to achieve a specific objective Direct Cost a cost which is related to a particular cost objective and can be traced to it in an economically feasible way Indirect Cost a cost which is related a particular cost objective but cannot be traced to it in an economically feasible way indirect costs are allocated to cost objectives

Elements of Cost
MATERIAL: The substance from which the finished product is made is known as material. It may be direct and indirect. Direct Material :- Identify in the product easily measure & directly charge to the producte.g. Timber in furniture making Categories raw material Specifically purchased for specific job or process Parts or components purchased. e.g. tyres for cycles Primary Packing material to protect finished product for easy handling inside the factory. Indirect Material is that material which cannot be easily and conveniently identified and related with a particular product, job, process, and activity. At factory level lubricants, oil, consumables, etc. At office level Printing & stationery, Brooms, Dusters, etc. At selling & dist. level Packing materials, printing & stationery, etc. LABOUR is the main factor of production. For conversion of raw material into finished goods, human resource is needed, and such human resource is termed as labor. Labor cost is the main element of cost in a product or service. Labor can be classified into two categories: Direct Labour Indirect Labour Direct Labour engaged in converting raw material into finished goods, Altering the construction, Actual Production, Composition of Product i.e labour cost which can be attributed to a particular job, product or process Exception :- Where the cost is not significant like wages of trainees- their labour though directly spent on product is not treated as direct Labour Test: Easily Identify Feasible to Identify Indirect labour is that labour which can not be easily identified and related with specific product, job, process, and activity. It includes all labour not directly engaged in converting raw material into finished product. It may or may not vary

directly with the volume of output. Labour employed for the purpose of carrying out tasks incidental to goods or services provided is indirect labour. At factory level foremens salary, works managers salary, gate keepers salary,etc At office level Accountants salary, GMs salary, Managers salary, etc. At selling and dist.level salesmen salaries, Logistics manager salary, etc. Expenses The cost of services provided to an undertaking and the notional cost of the use of owned assets. Direct Expenses These are the expenses that can be directly, conveniently and wholly allocated to specific cost centers or cost units. Examples of such expenses are as follows: Hire of some special machinery required for a particular contract Cost of defective work incurred in connection with a particular job or contract etc. Direct expenses are sometimes also described as chargeable expenses. Indirect Expenses These are the expenses that cannot be directly, conveniently and wholly allocated to cost centers or cost units. At factory level factory rent, factory insurance, lighting, etc. At office level office rent, office insurance, office lighting, etc. At sales & dist.level advertising, show room expenses like rent, insurance, etc. Overheads :- It may be defined as the aggregate of the cost of indirect materials, indirect labour and such other expenses including services as cant conveniently be charged direct to specific cost unit. Categories: Manufacturing Overheads Administration of machines Selling & distribution of machines

No. Cost Co
Production /stores and spares manufacturing Expenses : Consumable works overhead/ Depreciation of plant and machinery, factory building, etc., Lease rent of production assets Repair and maintenance of plant and machinery, factory building, etc., Indirect employees cost connected with production activities Drawing and Designing department cost. Insurance of plant and machinery, factory building, stock of raw materials & WIP, etc. Amortized cost of jigs, fixtures, tooling, etc. Service department cost e.g. Tool Room, Engineering & Maintenance, Pollution Control. Salaries for staff for production planning, technical supervision, factory administration etc., Normal idle time cost & all normal losses. Abnormal losses are transfer to P& l a/c Expenses for stores management Security expenses in the factory Labour welfare expenses Dispensary and canteen expenses

1. 2.

P rim e C W o rk s C ost

Administrative overheads in relation to activities other than manufacturing activities e.g. marketing, projects management, corporate office expenses, etc.,

shall be excluded from the cost of production. Nothing mentioned in the problem , consider it as a part of Marketing overhead the example of Administrative Expenses are Salaries of administrative and accounts staff General office expenses e.g. rent, lighting rates and taxes, telephone, stationery, etc., Bank charges Audit fees Legal expense Depreciation & repair and maintenance of office building etc. Selling overheads are indirect costs related to selling of products or services and include all indirect cost in sales management for the organization. Salaries commission and traveling expenses for sales personnel Advertisement cost Legal expenses for debt realization Market research cost Royalty on sale After sales service cost Rent of the show room Traveling expenses Warranty claim Brokerage & commission Advertisement relating to sales and sales promotion Sales incentive Bad debt (deductible from actual sales), etc., Distribution overheads are the cost incurred in handling a product from the time it is completed in the works until it reaches the ultimate consumer. Transportation cost Cost of warehousing salable products cost of delivering the products to customers Secondary Packaging Freight & Forwarding Insurance of Warehousing & Storage Additional Notes : 1. Primary packing costs is included in production cost whereas secondary packing cost is distribution cost. Primary packing is the minimum required

packing at the time completion o production. So it should be added with the complete product although it is a direct expense. 2. In exceptional cases, for example in case of heavy industries equipment supply, installation cost at delivery site for heavy equipments which involves assembling of parts, testing etc., is included in production cost but not distribution cost. For example, installation cost of a gas turbine at plant site is included in the cost of production of gas turbine. 3. Items not included in cost accounting because of the financial nature Purely financial Expenses: Loss on investment Capital loss Penalties and fines Interest on debenture, mortgage and bank loan Discount on debenture and bonds Damage payable Purely financial incomes: Dividend Received Rent received Interest on bank deposits Capital profits Transfer fees received Items of appropriation of profit Transfer to general reserve Transfer to specific reserve (DRR, DEF) Taxes on income Divided paid Donations and charities Amount written of Goodwill, Pre expenses, underwriting comm. Discount on issue of share and debenture Item of abnormal losses and expenses Cost of abnormal wastage of material Loss by fire

Loss by theft

CLASSIFICATION OF COST

Classification

By Nature or Elem

Direct Material Co

Indirect Material C

Classification By Function
Production Cost

Classification Adm inistrative Cost

By Variability /
Selling Cost

Fixed Cost

Classification By Inventory

Product Cost Period Cost Expired Cost Deferred Cost

C s ific tio M laDecisionn aking s a By

Relevant Costs Irrelevant Costs Sunk Costs

Production Cost The cost of sequence of operations which begins with supplying materials, labor and services and ends with the primary packing of the product. Thus, it includes the cost of direct material, direct labor, direct expenses and factory overheads. Administration Cost The cost of formulating the policy, directing the organization and controlling the operations of an undertaking which is not related directly to a production, selling, distribution, research or development activity or function. Selling Cost It is the cost of selling to create and stimulate demand (sometimes termed as marketing) and of securing orders. Distribution Cost It is the cost of sequence of operations beginning with making the packed product available for dispatch and ending with making the reconditioned returned empty package, if any, available for reuse.

Behavior- Wise Costs : Fixed ,Variable & Semi-

Variable cost: which directly varies with activity level or unit of activity is known as variable cost Example Varies with Cost elements Activity level Material, Labour Production, Volume Electric, power Kwh, Mwh Transport Distance Rent, salary Time period All these costs are fixed per activity Variable cost/unit also may change as the production volume changes. For e.g. material cost in general Rs. 10/kg. If the consumption is more then 500 kg. The ratio will decrease to 9.7. This decrease in rate is applicable for whole quantity. But if the problem mentioned it for additional Qty. only then we have to calculate the total cost a below. For 600 kg. Rate for additional Qty. = Total cost = 500*10+100*97 = 5,970 Nothing sold TC = 600*9.7 = Rs. 5,820

Fixed cost: which does not varies with production volume Fixed cost are of
two types: 1. Committed Fixed cost This cost are to be paid even when the production volume is zero.This cost can we saved only when the factory is totally closed

down. That is why it is known as SHUT DOWN COST. For e.g. depreciation of the machine, rent of the factory premises, salary of the top management etc. 2. Discretionary Fixed cost -where the cost is to be incurred at the discretion of the top management & it has no direct relationship with the present product volume. For e.g.- advertisement, labour amenities, special machine or dice required for an additional offer etc. Fixed cost are some times Step Fixed cost & Slab Fixed costs. e.g. up 50% of capacity 2,00,000 p.a. for every 25% or part three 80,000 p.a. off of additional capacity Semi-variable:- Costs that have both a variable and fixed component. Eg -Commercial leases.They often have a fixed rent per month plus an additional rent based on the amount of production or sales. For example, rent is Rs 6,000 plus Rs0.50 for each product that is made. The base rent of Rs 6,000 is a fixed cost and the Rs 0.50 per product is a variable cost. Step variable or step fixed:-Costs that are constant over a range of production. If one employee can make 5000 units, then the employees wage is constant over a production range of one to 5000 units. If you produce 5001 units, you will need another employee. So your cost doubles. If you make 14,000 units your cost triples because you need three employees. It can be defined as Fixed costs that increases to a new level in steps with significant change in activity or usage. Semi-variable expenses are further segregated into fixed and variable expenses by any of the following methods 1. Comparison by period. 2. Comparison by level of activity-percentage of activity, Direct labour hours or machine hours etc. 3. High and Low points method. 4. Survey method. 5. Simultaneous Equation Method. 6. Scatter diagram. 7. Method of Least Squares. . Controllable costs:

These are the costs which can be influenced by the action of a specified member of an undertaking. A business organization is usually divided into a number of responsibility centers & each such centre is headed by an executive. Controllable costs incurred in a particular responsibility centre can be influenced by the action of the executive heading that responsibility centre. 21. Uncontrollable costs: Costs which cannot be influenced by the action of a specified member of an undertaking are known as uncontrollable costs. For example, expenditure incurred by, say, the Tool Room is controllable by the foreman in charge of that section but the share of the tool room expenditure which is apportioned to a machine shop is not to be controlled by the machine shop foreman. Normal cost Abnormal cost . Shut down costs: Those costs which continue to be incurred even when a plant is temporarily shut down, e.g. rent, rates, depreciation, etc. These costs can be eliminated with permanent the closure of the plant. In other words, all fixed costs which cannot be avoided during the temporary closure of a plant will be known as shut down costs. 15. Sunk costs: Historical costs incurred in the past are known as sunk costs. They play no role in decision making in the current period. For example, in the case of a decision relating to the replacement of a machine, the written down value of the existing machine is a sunk cost & therefore, not considered. . Opportunity cost: This cost refers to the value of sacrifice made or benefit of opportunity foregone in accepting an alternative course of action. For example, a firm financing its expansion plan by withdrawing money from its bank deposits. In such a case the loss of interest on the bank deposit is the opportunity cost for carrying out the expansion plan. Imputed costs: These costs are notional costs which do not involve any cash outlay. Interest on capital, the payment for which is not actually made, is an example of imputed cost. These costs are similar to opportunity costs. . Out of pocket cost:

It is that portion of total cost which involves cash outflow. This cost concept is a short run concept & is used in decisions relating to fixation of selling price in recession, make or buy, etc. Outof pocket costs can be avoided or saved if a particular proposal under consideration is not accepted.

Marginal cost . Differential cost: (Incremental and detrimental costs). It represents the change (increase or decrease) in total cost (variable as well as fixed) due to change in activity level, technology, process or method of production, etc. For example if any change is proposed in the existing level or in the existing method of production, the increase or decrease in total cost or in specific elements of cost as a result of this decision will be known as incremental cost or excremental cost. Standard cost Relevant costs are those which change by managerial decision. Irrelevant costs are those which do not get affected by the decision. For example, if a manufacturer is planning to close down an unprofitable retail sales shop, this will affect the wages payable to the workers of a shop. This is relevant in this connection since they will disappear on closing down of a shop. But prepaid rent of a shop or unrecovered costs of any equipment which will have to be scrapped are irrelevant costs which should be ignored. Period costs: These are the costs which are not assigned to the products but are charged as expenses against the revenue of the period in which they are incurred. All non manufacturing costs such as general & administrative expense, selling & distribution expenses are recognized as period costs. Research Cost It is the cost of searching for new or improved products, new application of materials, or new or improved methods. Development Cost

The cost of process which begins with the implementation of the decision to produce a new or improved product or employ a new or improved method and ends with the commencement of formal production of that product or by the method. Pre-Production Cost The part of development cost incurred in making a trial production as preliminary to formal production is called pre-production cost. Conversion Cost Conversion Cost : Costs of converting material input into semi-finished or finished products, i.e. additional direct materials, direct wages, direct expenses and absorbed production overhead . Discretionary costs: it is a fixed cost in relation to a decision. Discretionary cost can be explained with the help of following two important features. i. They arise from periodic (usually yearly) decisions regarding the maximum outlay to be incurred. ii. They are not tied to a clear cause and effect relationship between inputs and outputs. Examples of discretionary costs includes: advertising, public relations, executive-training, teaching, research, health care and management consulting services. 18. Explicit costs: These costs are also known as out of pocket costs refer to costs involving immediate payment of cash. Salaries, wages postage and telegram, printing and stationery, interest on loan etc. are some examples of explicit costs involving immediate cash payment. 19. Implicit costs: These costs do not involve any immediate cash payment. They are not recorded in the books of account. They are also known as economic costs. 10. Inventoriable costs: (or product costs). These are the costs which are assigned to the product. For example under marginal costing, variable manufacturing costs and under

absorption costing, total manufacturing cost (variable and fixed) constitute Inventoriable or product costs. 16. Absolute cost: These costs refer to the cost of any product, process or unit in its totality. When costs are presented in a statement form, various cost components may be shown in absolute amount or as a percentage of total cost or as p.u. cost or all together. Here the costs depicted in absolute amt. may be called absolute costs & are costs on which further analysis and decisions are based.