(b).Direct Labour Cost
The labour cost incurred on the employees who are engaged directly in making the product , their work can be identified clearly in the process of converting the raw material into finished product is called ‘direct labour cost ‘. For example, wages paid to the workers engaged in machining, fabrication department, assembling department etc.
The direct expenses refers to expenses that are specifically incurred and charged for specific or particular job , process, service, cost unit or cost centre. These expenses are called ‘chargeable expenses.’ Some of the examples of direct expenses include the following:
- Cost of drawings , designs and layout
- Royalty’s payable on use of patents, copyrights etc.
- Hire charges of special tool and equipment for a particular job or work.
- Architects , surveyors and other consultation fees of particular job or work
Sometimes, if the direct expenses are negligible or small amount, it will be treated as overhead.
Indirect costs cannot be allocated but which can be apportioned to cost centres or cost units. These costs are also called as ‘common costs’. The indirect costs are not traceable to any plant, department, and operation or to any individual final product. All overhead costs are indirect costs. Costs of indirect material, indirect labour and indirect expenses in aggregate constitute the overhead costs and are the indirect component of the total cost. Indirect costs cannot be directly allocated to cost units or cost centres and have to be absorbed or recovered into cost units are termed as indirect costs.
the costs incurred on materials used to further the manufacturing process which cannot be traced into the end product and the material required in the production process but not necessarily built into the product are called ‘indirect material’. For example cutting oil used in cutting surface, threads and buttons used in stitching clothes , lubricants used in maintenance of plant and machinery , cotton , waste used in cleaning the machinery etc. are considered as indirect materials. Sometimes indirect materials like coal, fuel used in kilns etc. are considered as part of the prime cost and some materials which are binding the books even though forming part of direct material cost, but is considered not worth contained in small quantities in the end product like gums and threads used in analyzing to cost unit and may be categorized as indirect material cost.
The cost of indirect labour consist of all salaries and wages paid to the staff for the purpose of carrying out tasks incidental to goods or services provided which will not from part of salaries and wages paid in working directly upon the product. For example, salaries and wages paid to store keepers, watch and ward, supervisor, time-keepers , quality control , manager, clericals staff, salesmen etc. these indirect labour costs cannot be identified with any particular job, process , cost unit or cost centre.
Indirect expenses are those which are incurred by the organisation in carrying out their total business activities and cannot be conveniently allocated to job, process, cost unit or cost centre. Rent, rates, taxes, insurance, lighting, telephone, postage and telegrams, depreciation etc. are the examples of indirect expenses.
The concepts of direct and indirect costs are meaningless without identification of the relevant cost unit or cost centre. Segregation of costs into direct and indirect costs is essential for proper accounting and control of costs and also for managerial decision making purpose. Advanced manufacturing technologies such as robotics, computer aided design and manufacture, flexible manufacturing systems, optimized production technology, just in time etc .., are revolutionising the manufacturing process at shop-floor, quality and creating areas for improved opportunities. They have dramatically changed the manufacturing cost behaviour patterns. The direct cost component of product cost is decreasing while depreciation m engineering and information processing costs are increasing. These changes have resulted in higher overhead rates and a shrinking base of direct costs over which to allocate those costs.
Bba Study Material to Concepts for Decision Making short Note of Classification by Function / Activities
Classification by Function / Activities
Based on function, the costs can be classified as follows:
Production cost –
The production cost is inclusive of all direct material, direct labour, direct expenses and manufacturing expenses. The manufacturing expenses is inclusive of all indirect materials, indirect labour and indirect expenses concerned with manufacturing activity which starts with supply of materials and ends with primary packing of the product. Production cost is also called ‘manufacturing cost, works cost, factory cost’. The manufacturing expenses which can be classified as production costs include the following:
- Factory rent, rates, lighting and heating.
- Insurance of plant and machinery, factor buildings, furniture and equipment.
- Repairs and maintenance of plant and machinery, factory premises.
- Salaries, wages and incentives to indirect workers and staff like factory watch and ward , office boys, time-keepers, store- keepers, factory clerical staff, maintenance staff, tool room operators etc.
- Idle time wages
- Fire protection service
- Carriage inwards
- Canteen and staff welfare
- Depreciation of plant and machinery, factory buildings and other assets
- Cost of estimation department, drawing office, quality control department etc.
- Remuneration paid to directors and other higher officials concerned with production and factory management
- Factory administration cost like printing and stationery, postage and telegrams, telephone, computer department cost.
The administration cost is incurred for carrying the administrative function of the organization i.e., cost of policy formulation and its implementation to attain the objectives of the organisation. The administration costs may include the following:
- Office rent, rates and taxes
- Office lighting, heating and cleaning
- Depreciation, insurance, repairs , and maintenance of office buildings, furniture , equipment and fittings
- Salaries of administrative staff
- Printing and stationery, postage and telegrams, telephones etc.
- Accounting and secretariat cost
- Audit and legal fees
- Bank charges
- Salaries to office staff
- Directors remuneration and sitting fees
The selling cost refers to the cost of selling function i.e. the cost of activities relating to create and stimulate demand for company’s products and to secure orders. The selling costs include the following:
- Salaries, commissions and travelling expenses to sales staff
- Remuneration of sales director
- Administration and upkeep of sales office and showrooms
- Advertising and publicity expenses
- Cost of catalogues, price lists and samples
- Depreciation, insurance , repairs, maintenance of sales office and showrooms
- Bad debts and costs incurred for collection of bad debts
- Discount and rebates.
The distribution cost will be incurred on goods made available to the customers. These costs include the cost of maintaining and creating demand for the product, making the goods available in the hands of customer. The distribution costs include the following:
- Carriage and freight outwards
- Packing and delivery charges
- Depreciation insurance and maintenance of distribution outlets
- Administration cost of distribution outlets
- Wages of packers , drivers and delivery boys
- Running expenses of delivery vehicles.
Research and Development Expenditure-
The research expenditure is the cost of searching for new products, new manufacturing process, and improvement of existing products, processes or equipment. The development expenditure is the cost of putting research result on commercial basis. Some of the costs relating to research and development overhead is given below.
- Cost of raw materials used in research
- Salaries and wages of R&D staff
- Subscriptions to books and journals
- Subscriptions to research associations
- Cost of tests conducted and trail runs
- Depreciation, insurance, repairs and maintenance of buildings and research equipment, plant etc.
- Patent fees
- Up-keep and maintenance of R & D office
- Travelling cost for surveys etc.
Bba Study Material to Cost Accounting Cost Concepts for Decision Making short notes of Classification of Cost by Time
Classification of Cost by Time
The historical cost is the actual cost, determine after the event. Historical cost valuation states costs of plant and material, for example, at the price original paid for them. Costs reported by conventional financial accounts are based on historical valuations. But during periods of changing price levels, historical costs may not be correct basis for projecting future costs. Naturally historical costs must be adjusted to reflect current or future price levels.
These costs relating to the product are computed in advance of production, on the basis of a specification of all the factors affecting cost and cost data. Pre-determined costs may be either standard or estimated.
It is a predetermined calculation of how much costs should be under specified working conditions. It is built up from an assessment of the value of cost elements and correlates technical specifications and the quantification of materials, labour and other costs to the prices and /or usages rates expected to apply during the period in to provide basis for control through variance accounting for the valuation of stock and work in progress and in some cases, for fixing selling prices . A standard cost is a planned cost for a unit of product or service rendered.
It is a predetermined cost based on past performance adjusted to the anticipated changes. No minute appraisal of each individual component cost. It can be used in any business situation or decision making which does not require accurate cost . It is used in budgetary control system and historical costing system. Its emphasis is on the level of costs not to be exceeded. It is used in decision making and selection of alternative with maximum profitability. It is also used in price fixation and tendering. It is determined generally for the period.
Bba Study Material to Cost Accounting Cost Concepts for Decision Making short notes of Classification of Cost for Management Decision Making
Classification of Cost for Management Decision Making
For the managerial decision making the cost data can be analysed keeped in view the following cost concepts:
The term marginal cost is defined as the amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit. It is a variable cot of one unit of a product or a service i.e., a cost which would be avoided if that unit was not produced or provided.
Differential cost also known as incremental cost is the difference in total cost that will arise from the selection of one alternative to the other. It is an added cost of a change in the level of activity. This concept is similar to the economists concept of marginal cost which is defined as the additional cost incurred by producing one more unit of product/existing product , changing distribution channels, add or drop business segments , adding new machinery, sell or process further , accept or reject special order etc.
it is the value of a benefit sacrificed in favour of an alternative course of action. It is the maximum amount that could be obtained at any given point of time if a resource was sold or put to the most valuable alternative use that would be practicable. Opportunity cost of goods or service is measured in terms of revenue which could have been earned by employing that goods or service in some other alternative uses. Opportunity cost can be defined as the revenue forgone by not making the best alternative use. Opportunity costs represent income foregone by rejecting alternatives. They are , therefore not incorporated into formal accounting systems because they do not incorporate cash receipts or outflows.
The replacement cost is a cost at which material identical to that is to be replaced could be purchased at the date of valuation (as distinct from actual cost price at the date of purchase). The replacement cost is a cost of replacing an asset at any given point of time either at present or in the future (excluding any element attributable to improvement)
The relevant cost is a cost appropriate in aiding to make specific management decisions. Business decisions involve planning for future and consideration of several alternative courses of action. In this process the costs which are affected by the decisions are future costs. Such costs are called relevant costs because they are pertinent to the decisions in hand. The cost is said to be relevant if it helps the managers in taking a right decision in furtherance of the company’s objectives. a relevant cost is a future cost which is affected by the decision at hand . The relevant cost must be a future cost, i.e., one which has already been incurred.
The imputed cost is a cost which doesn’t involve actual cash outlay, which are used only for the purpose of decision making and performance evaluation. Imputed cost is a hypothetical cost from the point of view of financial accounting j. interest on capital is common type of imputed cost. No actual payment of interest is made but the basic concept is that, had the funds been invested elsewhere they would have earned interest. Thus, imputed costs are a type of opportunity costs.
The sunk cost is one for which the expenditure has taken place in the past. This cost is not affected by a particular decision under consideration. Sunk costs are always results of decision in future. The sunk costs are those costs that have been invested in a project and which will not be recovered if the project is terminated. The sunk cost is one for which the expenditure has taken place in the past. This cost is not affected by a particular decision under consideration. Sunk costs are always results of decisions taken in the past. This cost cannot be changed by any decision in future. Investment in plant and machinery as soon as it is installed, its cost is sunk cost and is not relevant for decisions. Amortization of past expenses e.g., depreciation is a sunk cost. Sunk costs will remain the same irrespective of the alternative selected. Thus, it need not be considered by the management in evaluating the alternatives as it is common to all of them.
The normal cost is normally incurred at a given level of output in the conditions in which that level of output is achieved. Normal cost includes those items if cost which occur in the normal situation of production process or in the normal environment of the business. The normal idle time is to be included in the ascertainment of normal cost.
It is an unusual or a typical cost whose occurrence id usually irregular and unexpected and due to some abnormal situation of the production. Abnormal cost arises due to idle time for some heavy break down or abnormal process loss. They are not considered in the cost of production for decision making and charged to profit and loss account.
Avoidable Costs –
The avoidable costs are those costs which under given conditions of performance efficiency should not have been incurred. Avoidable costs are logically associated with some activity or situation and are ascertained by the difference of actual cost with the happening of the situation and the normal cost. When spoilage occurs in manufacture in excess of normal limit, the resulting cost of spoilage is avoidable cost. Cost variances which are controllable may be termed as avoidable cost. This costs are also called as ‘escapable costs’. The avoidable cost will not be incurred if an activity is not undertaken or discontinued. Avoidable cost will often correspond with variable costs. Avoidable cost can be identified with an activity or sector of a business and which would be avoided if that activity or sector did not exist. It refer to costs which can be reduced due to a contraction in the activates of a business enterprise. it is the net effect on cost that is important , not just the costs directly avoidable by the contraction. Examples:
- Closing apparently unprofitable branch house- storage costs of other branches and transportation charges would increase.
- Reducing credit sales-costs estimated may be less than the benefits otherwise available/
The unavoidable costs are inescapable costs which are essentially to be incurred, within the limits or norms provided for. It is cost that must be incurred under a programme of business restriction. It is fixed in nature and inescapable.
The product cost is aggregate of costs that are associated with a unit of product. Such costs may or may not include an element of overheads depending upon the type of costing system in force absorption or direct. Product costs are related to good produced pr purchased for re-sale and initially as part of inventory. These product or inventory costs become expenses in the form of cost of goods sold only when the inventory is sold. Product cost is associated with unit of output. The costs of inputs in forming the product viz. the direct material, direct labour, factory overhead constitute the product costs.
The period cost is that tends to be unaffected by changes in level of activity during a given period of time. Period cost is associated with a time period rather than manufacturing activity and these costs are deducted as expenses during the current period without previously classified as product costs. Selling and distribution costs are period costs and are deducted from the revenue without their being regarded as part of the inventory cost.
The traceable costs are those which can be identified easily and indisputably with a unit of operation or costing unit or cost centre. Costs of direct material, direct labour and direct expenses can be directly allocated or identified with particular cost centres or cost units and can be directly charged to such cost centres or cost units.
The common costs cannot be allocated but which can be apportioned to cost centres or cost units. The indirect costs are not traceable to any plant,; department, operation or to any individual final product. All overhead costs are indirect costs . cost of indirect material, indirect labour and indirect expenses in aggregate constitute the overhead costs and are the indirect component of the total cost. The concepts of direct and indirect costs are meaningless without identification of the relevant cost unit or cost centre. Segregation of costs into direct and indirect costs is essential for proper accounting and control of costs and also for managerial decision making purpose.
The controllable cost is a cost chargeable to a budget or cost centre, which can be influenced by the action of the person in whom control of the centre is vested. It id always not possible to predetermine responsibility, because the reason for deviation from expected performance may only become evident later. For example excessive scrap may arise from inadequate supervision or from latent defect in purchased material. The controllable cost is a cost that can be influenced and regulated during a given time span by the actions of a particular individual within an organisation. The controllability of cost depends upon the level of responsibility under consideration direct costs are generally controllable by the shop level management. The uncontrollable cost is a cost that is beyond the control (i.e., uninfluenced by action) of a given individual during a given period of time.
Short- run Cost-
The short-run costs are costs that vary with output when all input factors including plant and equipment vary and become relevant when the firm has to decide whether to set-up a new plant or to expand the existing one.
The long-run costs are those which vary with output when all input factors including plant and equipment vary and become relevant when the firm has to decide whether to set-up a new plant or to expand the existing one.
The past costs are actual costs incurred in the past and are generally contained in the financial account. These costs report past events and the time lag between event and its reporting makes the information out of date and irrelevant for decision making. These costs will just act as a guide for future course of action.
The future costs are costs expected to be incurred at a later date and are the only costs that matter for managerial decisions because they are subject to management control. Future costs are relevant for managerial decision making in cost control, profit projections, appraisal of capital expenditure, introduction of new products, expansion programmes and pricing etc.
Out of Pocket Cost-
The out of pocket cost is a cost that will necessitate a corresponding outflow of cash. These costs involve cash outlay or payments to other parties are termed as out of pocket costs. Out of pocket costs are relevant in some decision making problems such as fluctuation of prices during recession make or buy decisions etc.
The book costs are those which do not require current cash payments. Depreciation is a notional coat in which no cash transaction is involved. Book costs can be converted into out of pocket costs by selling the assets and having them on hire. Rent would the replace depreciation and interest.
The shutdown costs are the costs incurred in relation to the temporary closing of a department /division enterprise. Such costs include those of closing, as well as, those of reopening. The shutdown costs are defined as those costs which would be incurred in the event of suspension of the plant operation and which would be saved if the operations are continued. Examples of such costs are costs of sheltering the plant and equipment and construction of sheds for storing exposed property. Further, additional expenses may have to be incurred when operations are restored e.g., re-employment of workers may involve cost of recruitment and training.