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Product Mix sk2

The document discusses various types of costs involved in manufacturing: direct material costs, direct labor costs, and manufacturing overhead costs. It also discusses classifications of costs like prime costs, conversion costs, fixed costs, and variable costs. Key concepts discussed include differential/incremental costs, opportunity costs, sunk costs, and marginal costs. The application of these cost concepts to decision making is emphasized.

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100 views22 pages

Product Mix sk2

The document discusses various types of costs involved in manufacturing: direct material costs, direct labor costs, and manufacturing overhead costs. It also discusses classifications of costs like prime costs, conversion costs, fixed costs, and variable costs. Key concepts discussed include differential/incremental costs, opportunity costs, sunk costs, and marginal costs. The application of these cost concepts to decision making is emphasized.

Uploaded by

gr8shanky
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Classification of Costs

Direct Material

Direct Labor

Manufacturing Overhead

COSTS

Selling Expenses

General & Administrative


Expenses
Manufacturing Costs
1. Direct Material Costs

Include the acquisition costs of all


materials that are physically
identified as a part of the
manufactured goods and that may be
traced to the manufactured goods in
an economically feasible way.
Manufacturing Costs
2. Direct Labor Cost -

Include the wages of all labor


that can be traced specifically
and exclusively to the
manufactured goods in an
economically feasible way.
Manufacturing Costs
3. Manufacturing Overhead
 Or “Indirect manufacturing cost” or
“factory overhead”
 Include all costs associated with the
manufacturing process that cannot
be traced to the manufactured goods
in an economically feasible way.
 Can be further classified as:
Production Cost
Material

Labor Production Cost

Manufacturing
Overhead
Prime Costs and Conversion Costs

 All indirect costs are commonly combined into a single cost pool
call factory overhead

 Prime cost refers to direct materials and direct labor that are
sometimes considered together

 Conversion cost refers to direct labor and factory overhead


combined into a single amount
Direct
Direct Direct
Direct Factory
Factory
Materials
 Manufacturing costs
Materials are oftenLabor
combined
Labor as follows:
Overhead
Overhead
Fixed Costs or capacity cost
 Definition: The costs of providing a
company’s basic operating capacity
 Cost behavior: Remain constant over the
time though volume may change.
 Some examples; Annual insurance premium,
property tax, and license fee, building rents,
depreciation of buildings, salaries of
administrative and production personnel.
Variable Costs
 Definition: Costs that vary depending on the
level of production or sales

 Cost behavior: Increase or decrease


according to the level of volume change.

 Example: Ice cream cone company, wages,


payroll taxes, sales tax, and supplies. Fuel
consumption is directly related to miles driven.
Cost Concepts relevant to the decision
making.

 Costs are an important feature of many


business decisions. In order to make such
decisions following cost needed to be well
understood…
 Differential
costs
 Opportunity costs
 Sunk costs
 Marginal costs
Differential (Incremental) Costs Revenues

 Decision involve selection among alternatives.


 Each alternative have certain costs / benefits that
are needed to be compared to the costs / benefits
of the other alternatives

Increase or decrease in total cost resulting from an


alternative course of action
Differential (Incremental) Costs and
Revenues

 Definition: Difference in
costs between any two
alternatives known as
Differential cost.
 Difference in revenues
between any two
alternatives is known as
differential revenue.
Example 3.3: Differential Cost Associated with Adopting a New
Production Method

Current Dies Better Dies Differential Cost

Variable costs:
Materials $150,000 $170,000 $20,000
Machining labor 85,000 64,000 -21,000
Electricity 73,000 66,000 -7,000
Fixed costs:
Supervision 25,000 25,000 0
Taxes 16,000 16,000 0
Depreciation 40,000 43,000 3,000
Total $392,000 $387,000 -$5,000
Opportunity Costs
 Definition: The potential
benefit that is given up as
you seek an alternative
course of action
 Example: When you
decide to pursue a college
degree, your opportunity
cost would include the 4-
year’s potential earnings
foregone.
Sunk Costs
 Definition:Cost that has
already been incurred by
past actions
 Economic Implications: Not
relevant to future decisions
 Example: Rs. 500 spent to
replace tires last year—not
relevant in making selling
decision in the future
Marginal Costs

 Definition: Added
costs that result from
increasing rates of
outputs, usually by
single unit
Unit Marginal Contribution (MC)
 Definition: Difference between the
unit sales price and the unit
variable cost, also known as
marginal income or producer’s
marginal contribution (MC). This
means each unit sold contributes
toward absorbing the company’s
fixed cost.
MC = Sales price – Variable cost
 Application: Break-even volume
analysis:

Fixed costs
Break - even volume =
MC
Income Statement For External
Reporting
Sales Revenue $400,000

Less Cost of Goods Sold 210,000

Gross Margin $190,000

Less Mktg. & Admin Exp. 80,000

Net Income Before Taxes $110,000


Contribution Margin Format Income
Statement
Sales Revenue $400,000
Less Variable Costs:
Variable Cost of Sales $160,000
Variable Mktg & Admin 8,000168,000
Contribution Margin $232,000
Less Fixed Costs:
Fixed Cost of Sales $50,000
Fixed Mktg & Admin 72,000122,000
Net Income Before Taxes $110,000
Marginal Costing-short term
decision making
 Selling price decision
 Exploring new markets
 Make or buy decisions
 Sales mix decision
 Selecting a suitable method of production
 Plant shut down decision
EXAMPLES OF OPERATING DECISIONS

 PRICE OF SALES
 IN HOUSE PRODUCTION (MAKE) OR
OUTSOURCING (BUY)
 END OF PRODUCTION LINES
 RESOURCES REPLACEMENT
 SPECIAL ORDERS
 PRODUCTS MIX
 ETC.
IF ALL THE PRODUCTS ARE
INDEPENDENT, WE DON’T HAVE TO
CHOOSE ONE TO PUSH MORE
(we’ll try to maximize the sales of all products)
ANSWERING THE QUESTION USING

“CONTRIBUTION MARGIN”

PROPORTIONED TO
THE SCARCE RESOURCE
(ratio)

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