Part Two

The Basic Principle of Cost Accounting

Argument and discussion

• How do the resources flow in a typical firm?

• What is the differences among expenditure, expense, cost, and asset?

Cost Classification

A Simple Categorization of Costs

Direct Indirect

Variable

Fixed

Cost Definitions

• Direct Cost :a cost that can be traced fully to the cost objects (a product, service or department).

• Indirect Cost (overhead) :a cost incurred in the course of making a product, providing a service or running a department, but which can’t be traced directly and fully to the cost objects.

• Material, labor, and expenses can be either direct costs or indirect costs.

Cost Definitions

• Fixed costs: incurred for a particular period of time and within certain activity levels, unaffected by changes in the activity levels. Depreciation

• Variable costs: tends to vary with activity levels, such as direct material costs.

• Mixed costs (semi-fixed or semi-variable costs): items of expenditure are part-fixed and part-variable, such as telephone call charges.

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Analysis of Total Cost

Total cost=materials+ labor+ expenses

=direct cost (or prime cost) +overhead

• Prime cost= direct material+ direct labor+ direct expenses

• Overhead=indirect material+ indirect labor+ indirect expenses=production overhead +administration overhead +selling overhead +distribution overhead

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Direct material: all material becoming part of the product (unless used in negligible amounts and/or having negligible cost).

Direct labour: all wages paid for labour (either as basic hours or as overtime) expended on work on the product itself.

Direct expenses: any expense which are incurred on a specific product other than direct material cost and direct wages.

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Production overhead: includes all indirect material costs, indirect wages and indirect expenses incurred in the factory from receipt of the order until its completion.

Administration overhead: all indirect material costs, wages and expenses incurred in the direction control and administration of an undertaking.

Selling overhead: all indirect material costs, wages and expenses incurred in promoting sales and retaining customers.

Distribution overhead: all indirect material costs, wages and expenses incurred in making the packed product ready for despatch and delivering it to the customer.

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Product costs and period costs

For the preparation of financial statements, costs are often classified as product costs and period costs

• Product costs are those identified with goods produced or purchased for resale, such as the cost of finished products.

• Period costs are those deducted as expenses during the current period, such as administration overhead, selling overhead, distribution overhead, and financing costs.

This distinction is the basis of valuing inventory and calculating profit

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Classification by function involves ：

production/manufacturing costs administration costs marketing/selling, distribution costs, R&D costs financing cost

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Other cost classifications

• Avoidable and unavoidable costs.

• Controllable costs and uncontrollable costs.

• Discretionary costs.

• Sunk cost and opportunity cost.

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Cost units, cost objects and responsibility centers

Responsibility centers: a department or organizational function whose performance is the direct responsibility of a specific manager cost centers revenue centersprofit centersinvestment center

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Cost centers ； are collecting places for costs before they are further analyzed, such as a department, a machine, a project, overhead.

Revenue centers: are similar to cost centers but are accountable for revenues only.

Profit centers: are similar to cost centers but are accountable for costs and revenues. Performance indicator such as profit margin, or contribution.

Investment centers: is a profit center with additional responsibilities for capital investment and possibly for financing, and whose performance is measured by its return on investment.

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Cost units, cost objects and responsibility centers

• Cost objects is any activity for which a separate measurement of costs is desired. Such as a product, a service.

• Cost units is a unit of product or service to which costs can be related and which can be used to establish a cost per cost units. It is the basic control unit for costing purposes. Such as kilogram, barrel.

Thanks for Your Attention