MBA Accounting

A Cost Unit

Is the quantitative unit of product or service in relation to which costs can be ascertained.

Examples:

Jobs, contracts, kilowatt hours, cost per patient day

Cost Centre

Is “a location, person or item of equipment ( or group of these) in respect of which costs may be ascertained and related to cost units’

In a business, it is divided into sections called cost centre where costs are accumulated.

Example of Classification of Cost centre:

Production cost centre:

- where production takes place like machining and assembling department.

Service Cost Centre:

- which provides services to other cost centre like stores, production planning, store and maintenance.

Process Cost Centre:

- where a specific process or a continuous sequence of operations take place like refining process.

(1) By Nature

Based on nature of major costs like material, labour and other expenses.

Material can be sub-classified into:

Raw material, semi-finished materials, components, consumables, maintenance materials

Labour can be sub-classified into:

Maintenance, supervision, clerical and others

Other expenses can be sub-classified into:

Rent, water, electricity and depreciation

(2) By Function:

Costs are classified by function to which they relate.

They are:

Production Costs:

All costs involved in the acquiring of raw materials to the delivery of finished goods to the warehouse.

For example, production overheads, direct materials, direct labour and direct costs.

Administration Costs

All costs involved in the general administration including managing the operations of the organization

For example:

Depreciation, Electricity and Audit fee

Marketing Costs

Costs incurred in securing orders, selling, advertising, promoting, distributing of the finished products

For example:

Salesmen salaries, commission and incentives

Samples, cost of advertisement, trade fairs, warehouse rent, transport costs and others

Finance Costs

Relate to the financing the activities of the business.

For example:

Overdraft interest, fixed term loan interest and commitment fees

Research Costs

Costs incurred in seeking new or improved ideas, designs, process/methods and new products

For example:

Cost of salaries of researches personnel, laboratory maintenance and cost of feasibility

Development Costs

Costs incurred in developing new or improved ideas, methods/process or new products so that production can take place.

For example:

Cost of tests/trail runs

4) Based on Time

Categorized into two types:

Historical or Sunk Costs:

- costs that have already been incurred. For example like cost of fixed assets

Future Costs:

- costs that needs to be predetermined like standard cost.

(5) By Cost Units

A cost unit consist of material, labor and other expenses. In turn they are analysed into direct and indirect costs. Direct costs are charged directly to a cost unit whilst indirect costs relate to more than one cost unit. Unlike direct cost, indirect cost cannot be charged to a cost unit.

Example of direct costs: direct material, direct labour and direct expenses

Example of indirect costs: indirect materials, indirect labour and indirect expenses/overheads.

(6) By Controllability

Categorized into two types:

Controllable or Managed Costs:

- costs that are influenced by the decisions or actions of a manager like shut down costs -retrenchment wages

Uncontrollable Costs:

- costs that are not influenced by the decisions or actions of a manager like increased price increase of raw materials.

(7) By Normality

Costs can be categorized into:

Normal costs are those costs that management expects to incur and is within a normal range for example: loss due to evaporation

while

Abnormal costs are those that are not expected to recur or one that is smaller or larger than expected for example lost production due to plant breakdown.

(8) Product Or Period Costs

Product costs are costs incurred in the manufacturing of the goods.

These costs comprise all cost of production whether it is direct or indirect which can be assigned to the goods produced.

Period costs related to costs that cannot be assigned to the goods produced and are incurred during the period and are charged as that year’s expense in the profit and loss account.

9) Relevant and Non-Relevant Costs

Refer to earlier article on relevant and non-relevant costs

Product costs:

Those costs that are identified with goods purchased or produced for resale. In manufacturing firm, these costs are attached to the product and included in stock valuation for finished goods or work-in-progress, until they are sold.

Period costs:

Those costs that are identified with a SPECIFIC TIME INTERVAL and not inventoried. They are charged to the period as another form of matching expenses with revenue.

Salient Point:

In a manufacturing concern, all manufacturing costs are regarded as product costs and non-manufacturing costs as period costs.

VARIABLE COSTS:

Those cost that change in total in direct proportion to CHANGES IN LEVEL OF ACTIVITY. An increase/(decrease) in activity brings proportional increase/(decrease) in total variable costs.

Examples like direct material costs and direct labour costs which increase in proportionate to the increase in the number of units manufactured.

Salient point :

In total absolute costs, TOTAL variable costs changes in proportionate to the changes in the level of activity BUT PER UNIT variable costs remain CONSTANT across a REASONABLE range of activity.

FIXED COSTS:

Those cost that DOES NOT change regardless of changes in activity level.

Examples like depreciation and rental remain fixed irrespective of the level of activity.

Salient point:

Those cost that DOES NOT change regardless of changes in activity level namely costs are constant hence the FIXED COST PER UNIT will VARY at different level of activity.

Example:

The more units the business produce the fixed cost per unit will decrease. Vice versa, if fewer units are produced, fixed cost per unit will increase.

Hence, cost per unit depends on the number of outputs or the level of activity.

FIXED COSTS CAN BE DISCRETIONARY OR COMMITTED:

Those fixed costs, where management have control and can change are known as DISCRETIONARY Fixed Costs And

Those fixed costs, management cannot control and must be incurred are known as COMMITTED Fixed Costs.

MIXED COSTS: