Cost Classification Behaviour and Estimation
What is Costing
Total Cost incurred by a company can be categorised into two broad categories
Manufacturing Costs
⭐Product Costs
Direct Materials
Prime Cost
Direct Labour
Manufacturing Overheads
Non-Manufacturing Costs
⭐Period Costs
Marketing and selling costs
Administrative Costs
Statement of financial position
Inventory
Raw materials
Work-in Progress
Finished goods
Opening Balance
+Purchases
= Available for use
-Closing Balance
=Raw materials used in production ⭐
Opening Balance
+Raw materials used in production ⭐
+Direct labour
+Manufacturing overheads
=Total manufacturing cost
-Closing balance
=Cost of goods manufactured ❤
+Cost of goods manufactured ❤
-Closing balance
Opening balance
Cost of goods sold
Cost Classification for assigning cost to cost objects
how cost will react to changes in the level of business activity
Variable Costs
Semi-Fixed Costs
Mixed Costs/Semi-Variable
Contains both variable and constant cost elements
Cost Classification
Direct costs
Indirect costs
can easily and conveniently be trace back to the cost object
Cost can't easily and conveniently be traced back to the cost object
Cost Classification for Decision Making
Sunk Cost
Opportunity Cost
A cost that has already incurred and cannot be changed by any decision made now or in the future
Another Important Formula
Work in Progress ending balance
— Direct Material Cost
— Direct labour Cost
=Overhead
Conversion Cost
Is a system for assigning costs to any element of a business that includes:
Prime Cost and Conversion Cost
Financial Statements Treatment for Costing
Product Costs:
Period Costs:
Treated as Inventory Costs
Only expensed when the finished product is sold
Initially recorded on the balance sheet as an asset in the form of ⭐Inventory
Expensed to ⭐cost of goods sold when the inventory is sold in The Statement of Profit or Loss
Expensed as they are incurred
Since they not related to the production of goods
Recorded directly on the income statement in the period they are incurred
They are subtracted from revenue to determine the company's net income or loss
Accounted for on the income statement as Cost of Goods sold, which is subtracted from revenue to determine ⭐Gross Profit
Important in determining the breakeven point of a busines, which is the level of sales at which the busines covers all of its costs
Can be used to calculate ⭐contribution margin, which is the amount of revenue left over after variable costs are subtracted, and is used to cover fixed costs and generate profit
Expenses that vary in proportion to the level of output or activity of a business
Increase or decrease as production or sales levels change
Direct Labour
Sales Commission
Direct Materials
Examples
Cost Estimation
Includes both the fixed cost element that does not vary with changes in production or sales volume and a variable cost element that increases or decreases as production or sales volume changes
Telephone bill
Vehicle expense
Cost Estimation Techniques
1. The Linear Equation
A "straight line equation" that would represent our total cost
Can be represented using the equation Y = a + bX
Can be separated into their fixed and variable components using statistical methods such as regression analysis or the high-low method
Behaviour of Cost
Variable
Fixed
In Total
Per Unit
In Total
Per Unit
Total Variable Cost Changes as activity level changes
Variable cost per unit remains the same over wide ranges of activity
Total fixed costs remain the same even when the activity level changes
Fixed Cost per unit goes down as activity level goes up
The potential benefit that is given up when one alternative is selected over the other
Every decision involves choosing between at least two alternatives
Only costs and benefits that differ between alternatives are relevant in making the selection
Differential cost and revenue are the cost and revenue items that differ between alternatives
A Differential Cost is a cost that is different between two decisions
Cost Objective
- A cost object is a term used in cost accounting to describe something that costs are assigned to. Cost objects can include activities, projects, organizations, intangible assets, and other resources.
Summary of Cost Classification
X represents the level of production or sales volume
We need to identify the different types of cost (variable, fixed or mixed) of the cost object before we can apply the "Cost Estimation" techniques
b represents the variable cost per unit
a represents the fixed cost (Per period)
where Y represents the Total Cost
TC = FC + VC
We get "Mixed Cost", if there's a value for Fixed and Variable Cost
2. The scatter diagram
3. High-Low Method
y= mx+c
y = is the total cost
m = gradient
x = cost driver level
c = Fixed cost
m =(High Cost - Low Cost)/(High Activity - Low Activity)
c =y-mx
4. Least squares regression
To solve for the intercept:
To solve for the gradient or slope:
m = [n(x.y) - (x)(y)]/[n(x)^2 - x^2]
c = [y - m(x)]/ n
Cost Estimation summary