Cost classification
Chapter 4
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COST OBJECTIVES
FOR INVENTORY FOR DECISION-
FOR CONTROL
VALUATION MAKING
• Budget vs Actual
• Cost behaviour
• Asset/Expense • Fixed/variable/semi-
• Period/product variable
• Functional RESPONSIBILITY
• Cost per unit CENTRE
classification • Avoidable/unavoidable
• Direct/indirect • High-low analysis • Cost/Revenue/Profit
/Investments centres
2
Terminology
Cost – is a resource forgone to achieve a
specific objective
Cost object – the thing to which cost data
is attributed (e.g. a division, a contract,
a job, a product)
Cost unit – a unit of product/service for
which costs are ascertained (Cost per
unit)
Cost centre – a location, function or item
of equipment for which costs may be
ascertained and related to cost units for
control purposes 3
Terminology
4
Terminology
A particular unit is required to be selected. It
helps to identify the cost accurately and
allocate the various expenses.
Cost unit
hotel industry room
steel industry a ton
car industry a car
cigarette manufacturer carton of 20 packets
Simple unit represents a single standard
measurement like per kilogram, per piece, per
meter, etc. a complex unit uses a
combination of two simple units like per
kilowatt-hour, per tonne-kilometre, etc. 5
Illustration
Activity / company Cost Cost
object unit
Paint production Paint kg/tonnes
Beverage production drink Litres of coca
Coca-cola cola/ bottle
Power plant Electricity Kilowatt hours
Soap Factory Soap per dozen, per
kilogram, or
per tablet
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A Cost Centre is a physical place
(e.g. sales department, production
department etc.) or person within a
business that can be held responsible
for certain expenses incurred in the
runnnig of that business.
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Cost Classification
Function – production/non-production
Nature – materials/ labour/ expenses
Relation to cost object– direct/indirect
Behavior – variable, fixed, stepped fixed
cost, semi-variable cost
Relevance – avoidable/ unavoidable
For external reporting– period/ product
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Costs for inventory
valuation
9
2.1 Assets/Expense
Asset (unexpired cost) >>> Statement of financial position
Expense (expired cost) >>> Statement of profit or loss
$
Opening inventory x
Production costs x
Less: Closing inventory (x) >>> Statement of financial position
Cost of goods sold X >>> Statement of profit or loss
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2.2 Period/product cost
2.3 Functional classification
Total costs
Non-
Production
production
Distribution Finance
Administrative
Selling
Production costs
- directly connected to generating
revenue Research and
- all the costs involved in the manufacture of development
goods (costs incurred inside the
factory during production
process) 12
2.3 Direct/indirect
Direct costs >>> relate to a cost object and can be
traced to it
Indirect (production overheads) >>> relate to a cost
object and can not be traced to it
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2.3 Direct/indirect
Production
Indirect
Direct (production
overheads)
1. Direct materials
Raw materials: [Link]
Carbon fibre, titanium alloys Costs of electricity
or ceramics, nylon, polyamide Depreciation
[Link] labour
Wages per hour
racket
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Check your knowledge
TASK from google disk
See link (email)
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Costs for decision-making
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Cost Behaviour
Fixed Costs that does not changes in total
despite to changes in the related
level of activity
Variable Costs that changes in total in
proportion to changes in the related
level of activity
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19
Cost Behaviour
Fixed
CPU – decrease proportionally
Variable
CPU – constant
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Cost Behaviour
Semi-variable/ Stepped
Mixed
Variable with Variable with
prospective retrospective
discounts discount
21
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High-Low Analysis
Variable cost per unit:
(Cost at high level of activity – Cost at low level of activity)
(High level of activity – Low level of activity)
Advantages The high-low method is
used to calculate the
✓ Simple to calculate and use
variable and fixed cost of
✓ Can be used for forecasting a product or entity with
mixed costs.
Disadvantages
▪ Considers only two pairs of data
▪ Data collected at extremes may be untypical of normal operating condition
▪ Relationship may not be linear
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑉𝐶 + 𝐹𝐶
𝑉𝐶 = 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 ∗ 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡 23
High-low method
(251750-246500)/(18500-17000)=3,5 $
per unit
VC=3,5
FC = 246500 -17000*3,5=187 000
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17
17 000 ∗ 𝑉𝐶 + 𝐹𝐶 = 246 500
ቊ
18 500 ∗ 𝑉𝐶 + 𝐹𝐶 = 251 750
FC= 246500-17000VC
18500VC-17000VC+246500=251750
1500VC=5250
VC=3,5
FC=246500-17000*3,5=187000
OR High-low method
(251750-246500)/(18500-17000)=3,5 $ per unit
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Costs for control
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Terminology
Control ensures that activities conform to plans and
that objectives are achieved
Responsibility center is a part of an organization whose
performance is the direct responsibility of a specific
manager
1. Cost centre – manager accountable for costs only
2. Revenue centre - manager accountable for revenue only
3. Profit centre - manager accountable for revenues and
costs
4. Investment center - manager accountable for
investments, revenues and costs
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Illustration
Department Revenue Cost Investment Profit
centre centre centre centre
The
maintenance
department
The sales
department
The hotel
manager
The regional
manager
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