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Chapter 3
Cost Classification Ibrahim Sameer (MBA - Specialized in Finance,
B.Com – Specialized in Accounting & Marketing)
www.ibrahimsameer.wordpress.com
Total Cost / Service Costs
• A direct cost is a cost that can be traced in full to
the product, service, or department that is being
costed.
• An indirect cost (or overhead) is a cost that is
incurred in the course of making a product,
providing a service or running a department, but
which cannot be traced directly and in full to
the product, service or department.
Direct Cost & Indirect Cost
• Primary data are data collected especially for a
specific purpose. Raw data are primary data
which have not been processed at all, and which
are still just a list of numbers.
• For Eg: Telephone survey conduct by Dhiraagu to
monitor the effectiveness of the customer service.
Direct Cost & Indirect Cost
• Direct Materials
• Direct materials is all material becoming part of
the product.
• For eg: component part, part finished product,
primary packing materials.
Direct Cost & Indirect Cost
• Direct Labour
• Direct wages are all wages paid for labour
expended on work on the product itself.
Direct Cost & Indirect Cost
• Direct Expenses
• Direct expenses are any expenses which are
incurred on a specific product other than direct
material cost and direct wages. It is also referred
as chargeable expenses.
• For eg: the hire of tool or equipment for particular
job, maintenance costs of tool.
Direct Cost & Indirect Cost
• Production overhead
• Production OH include all indirect material costs,
indirect wages and indirect expenses incurred
in the factory from receipt of the order until its
completion.
Functional Costs
• Classification by Function
• Classification by function involves classifying
costs as production / manufacturing costs,
administration costs or marketing / selling and
distribution cost.
Functional Costs
• Functional cost Includes:
• Production cost
• Administration cost
• Selling cost
• Distribution costs
Fixed Costs & Variable Costs
• A fixed cost is a cost which is incurred for a
particular period of time and which, within certain
activity levels, is unaffected by changes in the
level of activity.
• Eg: Rent
Fixed Costs & Variable Costs
• A variable cost is a cost which tends to vary with
level of activity.
• Eg: Direct materials, sales commission
Fixed Costs & Variable Costs
• Many items of expenditure are part fixed and part
variable and hence are termed as semi fixed or
semi variable costs.
• Eg: telephone call charges
Production & Non Production
Cost
• For the preparation of financial statements, costs
are often classified as production costs and non
production costs.
Production & Non Production
Cost
• Production costs are all the costs involved in
the manufacture of goods. In the case of
manufactured goods, these costs consist of direct
material, direct labour and manufacturing
overheads.
Production & Non Production
Cost
• Non - Production costs are taken directly to the
income statement as expenses in the period in
which they are incurred; such cost consist of
selling and administrative expenses.
Controllable cost & Period cot
• Controllable cost
• Controllable costs are items of expenditure which
can be directly influenced by a given manager
within a given time span. OR
• A cost which can be influenced by its budget
holder.
Controllable cost & Period cot
• Period cost
• Period costs is charged against the sales for the
period. It is not carried forward in inventory to a
future period. OR
• A cost that relates to a time period which is
deducted as expenses for the period and is not
included in the inventory valuation.
Cost Codes
• Once costs have been classified, a coding system
can be applied to make it easier to manage the
cost data, both in manual systems and in
computerized systems.
Cost Codes
• Feature of a good coding system
• The code must be easy to use and
communicate.
• Each item should have unique code.
• The coding system must allow for expansion.
• The coding system should be brief.
• The likelihood of error going undetected should be
minimized.
Types of Codes
• Sequential (or progressive) codes
• Numbers are given to items in ordinary numeral
sequence, so there is no obvious connection
between an item and its code. For example
• 000042 42cm nail
• 000043 office stapler
• 000044 hand wash
Types of Codes
• Block (or group classification) codes
• These are an improvement on simple sequence
codes, in that digit (often the first one) indicates the
classification of an item. For example
• 4NNNNN Nails
• 5NNNNN Screws
• 6NNNNN Bolts
Types of Codes
• Faceted codes
• These are a refinement of block codes, in that
each digit of the code gives information about an
item. For example
Types of Codes
• The 1st digit: 1 Nails
• 2 Screws
• 3 Bolts
• The 2nd digit: 1 Steel
• 2 Brass
• 3 Copper
Types of Codes
• The 3rd digit: 1 50mm
• 2 60mm
• 3 75mm
• A 60mm steel screw would have a code of 212
Types of Codes
• Mnemonic codes
• Under this type of coding the code means
something, it may be an abbreviation of the object
being coded. Most of the time airport use this type
of coding. For example
• SIN – Singapore
• LAX – Los Angeles
Types of Codes
• Hierarchical codes
• This is a type of faceted code where each digit
represents a classification, and each digit further to
the right represents a smaller subset than those to
the left. For example
• 3 = Screws
• 31 = flat headed screws
Advantages of Coding
• A code usually briefer than a description, thereby
saving clerical time in a manual system & storage
space in a computerized system.
• A code is more precise than a description and
therefore reduce ambiguity.
• Coding facilitates data processing.
Cost unit, Cost object &
Responsibility centres
• Cost centres
• Cost centres are collecting places for costs
before they are further analysed. Cost are further
analysed into cost units once they have been
traced to cost centres.
• Cost centres may include a department, a
machine, a project.
Cost unit, Cost object &
Responsibility centres
• Cost units
• A cost unit is a unit of product or service to
which cost can be related. The cost unit is the
basic control unit for costing purpose.
• Eg: room (in hotel), Barrel (in the brewing industry)
Cost unit, Cost object &
Responsibility centres
• Cost objects
• If the user of management information wish to
know the cost of something, this something is
called a cost object.
• Eg: the cost of product, the cost of service, the
cost of operating a department.
Cost unit, Cost object &
Responsibility centres
• Profit centres
• A profit centre is any section of an organization to
which both revenues and costs are assigned, so
that the profitability of the section may be
measured.
• Remember that there can be several cost centres
within a profit centre.
Cost unit, Cost object &
Responsibility centres
• Some examples of profit centre:
• A sales division selling products to customers.
• A service division providing after sales service.
• Individual shop in a retail chain.
• Local branches in a regional or nationwide
distribution business.
• A geographical region. Eg: a country
Cost unit, Cost object &
Responsibility centres
• Revenue centre
• Revenue centres are similar to cost centres and
profit centres but are accountable for revenue
only.
• Revenue centre managers should normally have
control over how revenues are raised.
Cost unit, Cost object &
Responsibility centres
• Investment centre
• An investment centre is a profit centre whose
performance is measured by its return on
capital employed.
Cost unit, Cost object &
Responsibility centres
• Responsibility centre
• A responsibility centre is a function or department
of an organization that is headed by a manager
who has direct responsibility for its
performance. (OR)
• It is an organization unit for which a manager is
made responsible.