Cost – What it is

7/29/2019 Cost What it is

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Cost What it is

Cost is the amount of resources given upin exchange for some goods services interms of money.

The cost incurred is deferred, unexpiredcost or capitalised cost. They providefuture benefits & shown in balance sheet.

when these assets are used up theybecome expenses and expenses areexpired costs.


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Cost

Price the amount sacrificed for the value

of a commodity or service one derives

from it

Value The amount of satisfaction one

receives by consuming or utilising a

service

Loss- loss cost i.e. if no benefits is

received from the cost incurred.


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COST Accounting

In your career you may be a Director HR, maybe a marketing Manager or CEO of your own co.In all these positions you will have to planoperations, evaluate your subordinates andmake variety of decisions using accountinginformation.

It is the process of identifying, measuring,analysing, interpreting and communicatinginformation in pursuit of organisational goals.

It stresses accounting concepts and proceduresthat are relevant for preparing internal reports.


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Goals Of Managerial Accounting

Planning: it communicates organisations goals

to employees aiding coordination to various

functions. financial plan is budget. (the

accounting people are expected to do things thatare much more strategic and much more

forward looking)

Control: ensuring that the organisation operates

in the intended manner to achieve goals. It is toevaluate performance of managers and

operations.


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Goals

Directing operational activities: How much

financial and physical resources.

Decision making: Choosing the best

among available alternatives.


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Basic Approaches

Cost-benefit approach buy and make

decisions

Behavioural and technical considerations

motivating the employee is the

behavioral aspect whereas making wise

economic decisions is technical

consideration.

Different costs for different purposes.


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Cost Management system

To measure the cost of resources

To identify and eliminate non-value-added

costs

To determine efficiency and effectiveness

of major activities

To identify and evaluate new activities


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Strategic cost management & value

chain

Steps in value chain;

a) securing raw material and other resources

b) Research & Development

C) product design d) production

e) Marketing

f) Distribution & sales Strategic cost management is to to makeeach activity cost effective.


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Cost concepts

Cost is defined as the sacrifice made(resources given up) to achieve aparticular purpose.

An expense is defined as the costincurred when asset is used up or soldfor the purpose of generating revenue.


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Classification of cost

Direct and indirect cost: traceability orassignment.

If you have an employee performing

assembly operations this is id direct labourcost. When you put a Robot to do that jobthen you may have to engage an engineer tomake sure that the Robot is programmedright. This will be indirect cost.

The difference between direct and indirectdepends on the object of cost.


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Cost classification

Variable cost: changes in direct proportion to a

change in the level of activity or the cost driver.

Fixed cost: the cost which remains fixed for aparticular level of activity. (categories- committed

cost, managed cost, discretionary cost and step

cost )

Semi-variable cost: the part of the cost remains

fixed irrespective of use and remaining depends

on the use.


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Controllable: if the cost can be influencedby the managerial decisions, it iscontrollable.

Uncontrollable: it can not be influenced orcontrolled.

Opportunity cost: the benefit which is

sacrificed when the choice of one actionprecludes taking an alternative betteraction.


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Sunk Cost: cost incurred in the past and can notbe changed by any current or future action.These costs are irrelevant to all future decisions.

Product cost or inventoriable cost: it is used tovalue the inventory of manufactured goods untilthe goods is sold.

Time period cost: the costs are identified with

the period of time in which they are incurred. It isrecognised as expenses during the time they areincurred


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Incremental Analysis

It involves calculation of the difference in

revenue and difference in cost between

decision alternatives.

the difference in the revenue is the

incremental revenue of one alternative

over another.

Difference in cost is incremental cost of

one alternative over the other


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Marginal Cost

A change in total cost on account of

change in the cost of an additional unit.

Marginal cost= dTC / dQ.

Average cost


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Differential cost

The amount by which the cost differs

under two alternative actions


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Cost classification

Shutdown cost- Fixed cost associated with theplant even if the plan does not function. The unitmay remain close for any reason but these costscan not be avoided.

Standard cost predetermined for the unit ofoutput

Joint cost total costs incurred up to a point of

separation (crude oil) Common cost- which are incurred for more than

one product, job, territory. They are apportioned


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Manufacturing cost

The cost incurred in manufacturing

process. It consists of;

- direct material

- direct labour

- manufacturing overheads


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Out of pocket cost

The cost which requires payment of cash

or other assets as a result of their

ocurrance.


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Cost classification

The following are the cost items of a departmentof a Bank.

Salary to the loan department Manager

Cost of office supplies used by the department

Cost of departments PC bought last year

Cost of general advertising by the bank which isallocated loan dept.

Revenue the loan dept would have generated ifanother branch would have been opened.

Difference in the cost incurred b the bank onprocessing additional loan application.


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The cost items may be classified in the

following categories;

a) controllable by the loan department b)

uncontrollable c) direct cost to loan

department d) indirect cost e) Differential

cost f) Marginal cost g) opportunity cost h)

sunk cost i) out of pocket cost.


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solution

1. b , c ,i

2. a, c, i

3. a, c, h 4. b, d, I

5. g

6. e and f


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CVP ANALYSISAn analysis of how cost and profit changes when volume

changes is known asCost Volume Profit analysis.

The Relationship

-Profit depends on selling price, cost ofmanufacturing and volume of sale

-Selling price depends on cost of manufacturing

-Volume of sales depends on volume of production

The volume of production depends on cost

Profit = Selling price - Variable cost - Total fixed cost


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OBJECTIVES OF CVP

To forecast profit fairly accurately

Forecast sales volume to achieve a particular level ofprofit

To prepare flexible budgets where variable cost alonechanges

If sales volume increases what would be the profit

Effect on profit if fixed cost or variable cost changes

Required sales volume to cover additional fixed charges

And so many other business operation related decisions


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BREAK EVEN ANALYSIS

The break even point is the sales volume at which there isneither profit nor loss, costs being equal to revenue.

Fixed Cost

Break Even (volume) = ---------------------Contribution margin (Selling price Variable cost per unit)

It measures the amount each unit sold contributes to coverfixed cost and increase profits.

Fixed Cost

BEP (Amount) = -----------------

PV Ratio


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PROFIT VOLUME RATIO (PV Ratio)

PV Ratio also known as contribution margin ratio, marginal income ratio orvariable profit ratio is useful;

a) For determining the desired volume of output for specified amount

of profit

b) To know changes in profit due to changes in volume

A HIGHER PV RATIO INDICATES THAT A SIGNIFICANT INCREASE INVOLUME WITHOUT ANY INCREASE IN THE FIXED COST WOULD

RESULT IN HIGHER PROFITSContribution margin per unit

PV ratio = ----------------------------------

Selling price per unit

This indicates the contribution of every additional rupee of sales to cover

fixed cost and generating a profit If my fixed cost is Rs. 20,000 and PV ratio is 40 % the break even would be

Fixed cost 20,000

--------------- = ----------- = Rs.50,000

PV Ratio 40%


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VV RATIO

Variable cost to volume ratio indicates

relationship between variable cost and

sales volume.

VV RATIO = 1 - PV ratio


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MARGIN OF SAFETY It is better to have a level of sales greater than break even sales.

Margin of safety is the difference between the expected or actuallevel of sales and break even sales.

Actual sales Break Even sales volume

Margin of safety % = ------------------------------------------------ X 100

Actual sales

A HIGHER MARGIN OF SAFETY SHOWS THAT BREAK EVEN

POINT IS MUCH BELOW THE ACTUAL SALES. EVEN IF THEREIS A FALL IN SALES , THERE WILL STILL BE PROFIT.

If Actual sales is Rs. 6,000 and Break Even Rs. 3,600 the MS ratiowould be 40%. This means actual sales may be reduced up to 40 %to reach a break even level.

Margin of safety can also be used to measure the amount of profit

Profit = margin of safety amount X PV ratio

If Margin of safety is Rs.2.400 and PV ratio is 33.335 THE PROFIT

WOULD BE Rs.800

SALES VOLUME REQUIRED TO DESIRED


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SALES VOLUME REQUIRED TO DESIREDOPERATING PROFIT

Fixed cost + Desired operating profit

Required sales volume = --------------------------------------------PV Ratio

Ex. Calculate desired level of operation from the followingfigures assuming a tax rate of 40% and the net profit

expectation of 20% on capital of Rs. 2 Crore after tax)( Rupees )

Selling price per unit 400

Variable cost 250

Fixed cost

Staff salaries for the year 12,00,000

General office exp 13,00,000

Depreciation on assets 10,00,000

Other fixed expenses 2,50,000


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Desire Income before tax i.e. operating income

Expected profit 20% after tax on Rs. 2 crore = 40,00,000

Tax rate = 40%

Profit before tax = 40,00,000 X 100 = 66,66,667

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PV Ratio = Contribution margin per unit / selling price

= 400-250/ 400 = 0.375

Fixed cost Rs. 37,50,000

37,50,000 + 66,66,667

Required sales revenue = 0.375

= Rs.2,77,77,776

Desired level of output=2.77 crore/400=69444.44 units

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Cost – What it is