FM 6 Elements of Cost 8 M

8/19/2019 FM 6 Elements of Cost 8 M

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Elements of Cost

Prime/Basic Cost Overheads


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Elements of Cost(by elements material! labour and e"#enses )

$irect %aterial All materials &hich become aninegral #art of the finished #roduct and &hich canbe conveniently assigned to s#ecific #hysical unitsis termed as direct material. 'or e"am#le

a. %aterials or com#onents s#ecifically#urchased #roduced or reuisitioned for thes#ecific #roduct.

b. Primary #acaging materials lie cartons!&ra##ings! cardboard! bo"es etc.

c. Purchased com#onents in finished or semifinished stage s#ecifically meant for the final#roduct.


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*ndirect %aterial All materials &hich are usedfor #ur#oses ancilliary to the business and &hichcan not be conveniently assigned to s#ecific#hysical units! are termed as indirect materials.'or e"am#le

a. Consumable stores.

b. Oils/lubricants! coolents and &astes etc.

c. Printing and stationery materials etc.


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+u#ervisor

,orman- ,orman ,orman

Conce#t of $irect 0 *ndirect 1abour


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$irect 1abour 1abour &hich taes an activeand direct #art in #roduction of a #articularcommodity is called direct labour. $irect labourcost are! therefore! s#ecifically and convenientlytraceable to a s#ecific #roduct.

*ndirect 1abour 1abour em#loyed for the#ur#ose of carrying out tass incidental to#roduction of goods or services is termed asindeirect labour. +uch labour is not directly

em#loyed in #roduction and its cost can not be#ractically traced to s#ecific unit of out#ut. ,agesof storeee#ers! timeee#ers! gateee#erforemen! directors2 fee! salaries to salesmen etcare all e"am#les of inderect labour costs.


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$irect E"#enses 3hese are all the e"#enses &hich canbe directly! conveniently and &holly allocated to s#ecificcost centres or cost units. 4iring charges #aid for s#ecialmachinery reuired for a a #rticular contract and cost ofrectification incurred on in connection &ith a #articular 5ob

or contract are some of the e"am#les of direct e"#enses.

*ndirect E"#enses 3hese are the e"#enses &hich cannot be directly! conveniently and &holly allocated to costcentres or cost units. Payment to&ards rent! lighting! and

insurance charges etc are the e"am#les of indirecte"#enses.


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Overheads in Case of a %anufacturing

Organisation

3he term overhead includes indirect materials! indirectlabour and indirect e"#enses. A manufacturingorganisation can be broadly #ut into three divisions

-. 'actory or ,ors &here the #roduction is done. Office and Administration &here routine as &ell as#olicy matters are decided

. +elling and $istribution &here the #roduct are sold and

finally des#atched to the customer E"#enditure incurred on indirect material! indirect labouror indirect e"#enses in the factory or in office or in selling0 distribution division &ill be #art of overheads


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Com#onents of 3otal Cost

Direct Material + DirectLabour + DirectExpenses

Direct Cost or Prime Costor Basic Cost

Direct Cost +Factory/WorksOverea!s

Works/Facptory/Pro!uction/ Manu"acturin# Cost

Manu"acturin# Cost +O$ce % &!ministartive

Overea!s

'otal Cost o" Pro!uction

'otal Pro!uction Cost +(ellin# % DistributionOverea!s

'otal Cost


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Classification of Costs (by Behaviour)

'i"ed Costs 'i"ed costs are the costs &hichremain constant irres#ective of the uantum of

out#ut &ithin and u# to the ca#acity that has

been built u# such as rent! insurance charges

and management salary etc. 3he fi"ed costs arealso sometimes referred to as #eriod costs. 'i"ed costs are of t&o ty#es.

Committed 'i"ed Costs $iscretionary 'i"ed Costs


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Classification of Costs(by Behaviour)

Committed 'i"ed Costs 3his largelyconsists of those fi"ed costs that arise from#ossession of #lant! eui#ment! and creatingbasic organisational structure. 'or e"am#le!

once a building is constructed and #lant isinstalled! nothing much could be done to reducethe cost to&ards de#reciation! #ro#erty ta"es!insurance charges and salaries to the #ersonnel

etc. &ithout im#aring the organisation2scom#etence to meet its long term goals


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Classification of Costs(by $ecision %aing)

$iscretionary 'i"ed Costs 3hese are set atfi"ed amount for s#ecific time #eriod by themanagement in budgeting #rocess. 3hese costdirectly reflect to# management2s #olicies and

have #articular relationshi# &ith volume ofout#ut. 3hese costs can! therefore! be reducedor totally eliminated if the circumstances soreuire. 60$ costs! advertising 0 sales#ro#motion costs! donations! management

consulting fees etc. are some of the e"am#les ofdiscretionary fi"ed costs. 3hese costs are alsotermed as managed or #rogrammed costs


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+emi7ariable Costs 3hese are costs &hich

do vary but not in direct #ro#ortion to out#ut.3hey are made u# of both fi"ed and variablecost elements such as de#reciation! re#airs!light heat! tele#hones charges etc. *dentificationof fi"ed and variable elements of semivariable

costs is im#ortant for the management for#lanning controls.

C o s

t

8nits of Production

7ariable Element of Cost

'i"ed Element of Cost


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+te# Costs 'i"ed cost in general remains

fi"ed over a range of activities and then 5um#sto a ne& level as the activity changes. 'ore"am#le! a foreman can su#ervise a givennumber of &orers. Beyond this number! it isnecessary to hire second foreman. +uch costs

5um# in ste#s as sho&n belo&

C o s

t

8nits of Production

'i"ed cost rising in ste#s


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+ome Other Conce#ts of Costs

+hut $o&n Costs

3he fi"ed costs &hich have got to be incurred even ifthe #lant is under shut do&n and there is no

#roduction are termed as shut do&n costs.6ent!

*nsurance!

$e#reciation 0

%aintenance etc.are the e"am#les of shut do&n costs.


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+un Costs! 4istorical Costs or Past Costs(by timings)

Costs &hich have been incurred as a result of decision

taen in the #ast to set u# the infrastructure facilities.+uch costs can not be reversed or revised bysubseuent decisions. *nvestment made in

Plant and machinery 0

Building etc.

are #rominent e"am#les of such costs.


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Controllable 0 8ncontrollable Costs

3hese are the costs &hich can be influenced by the action ofa s#ecified memeber of an organisation. 3he foreman of

#roduction sho# can control the utilisation of #o&er or ra&materials in his sho#. 3hese are therefore! controllable costsas far as he is concerned. 4o&ever! the same foreman hasno control on the &astage of #o&er that might be taing

#lace in the #o&er house itself resulting in higher cost #erunit of #o&er to him.

+imilarly! he can not control increase in cost of materialsconsumed in his de#artment if the #urchase de#artmentbuys the materials at higher #rice due to their o&n

inefficiency.


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*m#uted or 4y#othetical Costs(by timings)

3hese are the costs &hich do not involve cashoutlay. 3hey are not included in cost accounting

but they are im#ortant for maing managementdecisions. *nterest on ca#ital is an e"am#le ofim#uted cost &hich is ignored in cost accountingbut considered in financial accounting. *f t&o#ro5ects reuire uneual outlay of cash! the

management must tae into consideration theinterest on ca#ital to 5udge the relative#rofitability of the #ro5ects.


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$ifferential! *ncreamental or $ecreamental Costs

3he difference in total costs bet&een t&oalternatives is termed as differential cost. *n

case the choice of an alternative results inincrease in the total cost! such increased costsare no&n as increamental costs. *f the choiceresults in decrease in total costs! the resulting

decrease is no&n as decreamental cost.,hile assessing the #rofitability of the#ro#osed change the increamental costs arematched &ith increamental revenues.


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.OutofPocet Costs

3his means the #resent or future cash e"#enditureregarding certain decisions &hich may vary

de#ending u#on the nature of the decision made. 'or

e"am#le if a management has decided to hire

trans#ort for trans#ortation of goods in stead of usingits o&n! it may tae into account the #resent

e"#enditure on fuel! hiring charges and maintenance

etc. &hich have to be incurred in cash under the

changed circumstances even though the

management might not have been consideringde#reciation as cost earlier. +uch costs for arriving at

a decision are termed as outof #ocet costs.


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O##ortunity Costs

3he o##ortunity cost refers to the advantage inmeasurable terms &hich might have been

foregone on account of not using the faciliities inthe manner originally #lanned. 'or e"am#le! ifan o&ned building is #ro#osed to be utilised forhousing a ne& #ro5ect #lant! liely revenue&hich the building could fetch if rented out! is the

o##rtunity cost &hich should be taen intoaccount &hile evaluating the #rofitability of the#ro5ect.


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3raceable 0 8ntraceable Costs (by nature of traceability)

3he costs &hich can be easily identified or traced tos#ecific #roducts! services or units such as ra& materials

and labours etc are termed as traceable costs other&isethey are called untraceable costs. 8ntraceable costs arealso called common costs as they are incurredcollectively for number of #roducts. All ty#es ofoverheads incurred for the factory as a &hole are the

e"am#les of untraceable costs. 3he untraceable costsare a##ortioned on different #roducts using somesuitable criterion


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9oint Costs (by nature of traceability)

,henever t&o or more #roducts are #roduced out

of one and the same ra& material or #rocess! thecost of materials #urchased and the cost of#rocesing are called 5oint costs. Oil refinery &hererange of #roducts lie bitumen! #etrol! diesel anderosene are derived in the #rocess of refining

crude oil is a ty#ical e"am#le of 5oint costcom#rising of crude and cost incurred in thecourse of refining. 3hese 5oint costs are to bea##ortioned to various #roducts on some basis.


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Conversion Costs

3he cost of transforming direct materials intofinished #roducts e"clusive of direct material

cost is no&n as conversion cost. *t is usuallytaen as the aggregate of cost of direct labour!direct e"#enses and factory overheads.

3he above classification conce#ts of costs hel#

the management in decision maing #rocess&ith regard to fi"ing the accountability andcontrolling the costs.


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:ormal Costs 0 Abnormal Costs (by normality)

:ormal costs arise during routine daytoday

business o#erations. Abnormal costs arisebecause of any abnormal activity or event not

#art of routine business o#erations. Costs

arising because of floods! riots! accidents etc.


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Documents

FM 6 Elements of Cost 8 M