ANALYSIS OF COST

Dr. Ashok Panigrahi

 Costs
Anything incurred during the production of the
good or service to get the output into the hands of
the customer
The customer could be the public (the final
consumer) or another business
Controlling costs is essential to business success
Not always easy to pin down where costs are
arising!
 Cost
A cost may be defined as a sacrifice or giving up of
resources for a particular purpose.
Costs are frequently measured by the monetary
units that must be paid for goods and services.
Costs are different from expense
 Direct Vs Indirect Costs
Direct / Indirect costs

Direct labor

Direct costs

Direct materials
Whether the cost
can be directly
allocated to a Managing
given product directors salary

Indirect costs Administration

(overheads) expenditure

Rent rates
Assigning Costs to Cost Objects
Direct costs
Costs that can be
easily and conveniently
traced to a unit of product
or other cost object.
Examples: direct material
and direct labor
Indirect costs
Costs that cannot be easily
and conveniently traced to a
unit of product or other
cost object.
Example: manufacturing
overhead
Cost Concepts for Decision Making

A relevant cost is a cost that differs

between alternatives.
 Cost Classifications for Decision Making

Every decision involves a choice between at

least two alternatives.

Only those costs and benefits that differ

between alternatives are relevant in a decision.
All other costs and benefits can and should be
ignored.
 Identifying Relevant Costs
Costs that can be eliminated (in whole or in part)
by choosing one alternative over another are
avoidable costs. Avoidable costs are relevant costs.
They are costs that will be incurred and can be
traced to the product or process.
 Product Cost & Period Cost
Product cost is the traceable costs that are
attributable to a product or process.
Product costs include direct materials, direct
labor, and manufacturing overhead.
Period costs include all marketing or
selling costs and administrative costs.
Cost Classification for Predicting Cost
Behavior

Fixed costs
Variable costs
Mixed costs
Stepped costs
 Cost Classifications for
Predicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Types of cost behaviour
 Cost Concepts (Short-run)
1. Total Fixed Cost (TFC)
2. Total Variable Cost (TVC)
3. Total Cost (TC=TVC+TFC)
4. Average Fixed Cost (AFC=TFC/Q)
5. Average Variable Cost (AVC=TVC/Q)
6. Average Total Cost (AC=AFC+AVC)
7. Marginal Cost (MC= AVC/Q
 Total Fixed Cost

Total fixed cost (TFC) is more commonly

referred to as "sunk cost.
Examples: include the payment or rent for land,
buildings and machinery.
The fixed cost is independent of the level of
output produced.
Graphically, depicted as a horizontal line
 Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the short-
significantly reduced term by current managerial
decisions
in the short term.

Examples Examples
Depreciation on Advertising and
Equipment and Research and
Real Estate Taxes Development
 Fixed Costs
Definition: The costs
of providing a
companys basic
operating capacity
Cost behavior: Remain
constant over the
relevant range
 Fixed Costs - Example
Suppose Philips Company produces radios for which it
pays $10,000 per month as rent.
The total fixed costs i.e. rent of the building remain
constant at all levels of activity - $10,000 per month
On a per unit basis, the cost of rent decreases as
activity increases and vice versa
At 2,000 radios, the unit cost is $5
($10,000 2,000 units)
At 10,000 radios, the unit cost is $1
($10,000 10,000 units)
Fixed Costs Graphs
 Total Variable Cost
Total variable cost (TVC) refers to the cost
that changes as the quantity of output produced
is changed.
Examples - purchases of raw materials, payments to
workers, fuel and power costs.
Total variable cost increases as the amount of output
increases.
If no output is produced, then total variable cost is zero;
the larger the output, the greater the total variable cost.
 Variable Costs
Definition: Costs that
vary depending on the
level of production or
sales
Cost behavior: Increase
or decrease
proportionally
according to the level
of volume
 Variable Costs - Example
Suppose Philips Company decided to manufacture radios
that contain a digital clock costing $10 per clock.

For each radio produced, the total cost of the clocks

increases by $10.

If 2,000 radios are made, the total cost of the clocks is

$20,000 (2,000 X $10)

If 10,000 radios are made, the total cost of the clocks is

$100,000 (10,000 X $10)
Variable Costs Graphs
 Mixed Costs
Costs that have
both a variable cost
element
and a fixed
cost element
Sometimes called
semi-variable cost
Change in total but
not proportionately
with changes in
activity level
 Stepped Costs
Definition: A stepped
cost is one that will vary
Stepped costs with levels of activity but
not directly.
Example: A company
may rent a warehouse
that is able to store say
100 tons of material.
When they reach 101
Volume of activity tons then an additional
warehouse is required.
 TOTAL COST
Total cost (TC) is the sum of total fixed cost
and total variable cost

TC=TFC+TVC

As the level of output increases, total cost of the

firm also increases.
 Marginal & Average Cost
Marginal cost = the extra or additional cost of
producing 1 extra unit of output

Average cost (unit costs) concept that

enables a firm to find out whether or not it is
making a profit (compared with price or average
revenue)
AC can be broken down into two components
AFC and AVC

Average Fixed Cost

Total Fixed Cost divided by output
FC
AFC
Q

Average Variable Cost

VC divided by output
VC
AVC
Q
 Total Costs of Production
Total Total Average
Units of Total Fixed Variable Total Marginal Labour
Labor Product Cost Cost Cost Cost Cost
L TPL TFC TVC TC MC AC
0 0 100 0 100 - -
1 6 100 30 130 30 130
2 10 100 50 150 20 75
3 12 100 60 160 10 53.3
4 13 100 65 165 5 41.25
5 15 100 75 175 10 35
6 19 100 95 195 20 32.5
7 25 100 125 225 30 32.14
8 33 100 165 265 40 33.12
9 43 100 215 315 50 35
10 55 100 275 375 60 37.5