Classifying Costs a l By Element v Material
Classifying Costs (a) l By Element v Material v Labour v Expense l By Traceability v Direct v Indirect
Classification by element Material Labour The Product Expense
Classification of Costs by Traceability Direct Costs Indirect Costs l Costs that can l Costs cannot be easily and conveniently traced to a unit of product or other cost object. l Examples: v Direct material v Direct labor be easily and conveniently traced to a unit of product or other cost object. l Example: v Manufacturing overhead
Direct and Indirect Costs Direct costs Indirect costs l Costs that can be l Costs that must be easily and conveniently traced to a product or department. l Example: cost of paint in the paint department of an automobile assembly plant. allocated in order to be assigned to a product or department. l Example: cost of national advertising for an airline is indirect to a particular flight.
Classification by element or traceability Materials Labour Current Direct Indirect Expenses Direct Indirect Product costs = Materials+Labour+Expenses Direct Indirect Or Direct costs + Indirect costs
Classifications of Costs in Manufacturing Companies Manufacturing costs are often combined as follows: Direct Material Direct Labour & Direct Expenses Prime Cost Manufacturing Overhead Conversion Cost
Classifying Costs (b) l By Function v. Product v. Period
Manufacturing Cost Flows Costs Balance Sheet Inventories Material Purchases Raw Material Direct Labor Work in Process Manufacturing Overhead Selling and Administrative Finished Goods Period Expenses Income Statement Expenses Cost of Goods Sold Selling and Administrative
Cost Classification by Function Product costs Include expenditures that are necessary and integral to finished products. Capitalized on the balance sheet until sold. Inventory Cost of Good Sold Period costs Include expenditures identified more with a time period than with finished products. Expensed on the income statement. Expense Sale Balance Sheet Income Statement
Classification of Costs by Function Product Costs Period Costs l Direct materials l Selling l Direct labor l General and l Overhead administrative expenses
Classifying Costs (c) l By Behaviour v Fixed v Variable v Semi-fixed v Semi-variable
Cost Classifications by Behaviour Cost Behaviour How a cost will react to changes in the level of business activity. Ø Total variable costs change when the level of activity changes. Ø Total fixed costs remain unchanged when the level of activity changes.
Total Variable Cost Total Long Distance Telephone Bill A variable cost is one that changes in total in proportion to changes in the volume of activity. Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked
Variable Cost Per Unit On a per unit basis, a variable cost remains constant over a wide range of activity. Per Minute Telephone Charge The cost per long distance minute talked is constant. For example, 10 cents per minute. Minutes Talked
Cost Behaviour Merchandisers Service Organizations Cost of Goods Sold Supplies and travel Examples of variable costs Manufacturers Direct Material, Direct Labor, and Variable Manufacturing Overhead Merchandisers and Manufacturers Sales commissions and shipping costs
Total Fixed Cost A fixed cost is one that remains constant in total even when the volume of activity changes. Monthly Basic Telephone Bill Your monthly basic telephone bill probably does not change when you make more local calls. Number of Local Calls
Fixed Cost Per Unit On a per unit basis, a fixed cost changes as the volume of activity changes. Monthly Basic Telephone Bill per Local Call The average cost per local call decreases as more local calls are made. Number of Local Calls
Cost Behaviour Examples of fixed costs Merchandisers, manufacturers, and service organizations Real estate taxes Insurance Sales salaries Depreciation Advertising
Cost Classifications for Predicting Cost Behavior
Fixed Costs and Relevant Range Rent Cost in Thousands of Dollars The company’s normal operating range 90 60 30 00 Relevant Range Total cost doesn’t change for a wide range of activity. It then jumps to a new higher cost for the next higher range of activity. 1, 000 2, 000 3, 000 Rented Area (Square Feet)
Fixed Costs and Semi-fixed (or Step -Wise or Step-Variable) Costs How does this type of fixed cost differ from a step-variable (or stepwise) cost? Step-variable (or step-wise) costs can be adjusted more quickly and. . . The width of the activity steps is much wider for the fixed cost.
Semi-fixed Costs (or Step-Variable or Step-Wise) Cost Total cost increases to a new higher cost for the next higher range of activity. Total cost remains constant within a narrow range of activity. Activity
Semivariable Cost Total Utility Cost Slope is variable cost per unit of activity. r a v i l a t o le b ia t s co m se T Variable Utility Charge Fixed Monthly Utility Charge Activity (Kilowatt Hours)
Curvilinear Cost Total Cost Curvilinear Cost Function Relevant Range Activity A straight-Line (constant unit variable cost) closely approximates a curvilinear line within the relevant range.
Relevant Information is relevant to a decision problem when. . . ÊIt has a bearing on the future, ËIt differs among competing alternatives.
Identifying Relevant Costs and Benefits Sunk costs Costs that have already been incurred. They do not affect any future cost and cannot be changed by any current or future action. Sunk costs are irrelevant to decisions.
Relevant Costs Ø Relevant costs are those costs and/or benefits that differ between alternatives. Ø Costs that can be eliminated (in whole or in part) by choosing one alternative over another are avoidable costs. Ø Avoidable costs are relevant costs. Ø Unavoidable costs include: üSunk costs. üFuture costs that do not differ between the alternatives. Ø Unavoidable costs are never relevant.
Add or Drop a Product Incremental Costs
Summary DECISION RULE Swick should drop the digital watch segment only if its fixed cost savings exceed lost contribution margin.
Marginal Costs and Average Costs The extra cost incurred to produce one additional unit. The total cost to produce a quantity divided by the quantity produced. Marginal and average costs are largely a function of cost behavior -- variable and fixed costs.
Costs and Benefits of Information Costs Benefits More information does not mean more benefits if information overload results.
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