AFU: 07409 COST

ACCOUNTING

Classify costs for

various purpose
Sub Enabling outcome
1.2.1: Classifying costs into different
categories

Classifycosts for various purpose

Cost behaviour and ascertain cost

2
 Cost Classification
Cost classification is the arrangement
of costs according to the purpose to
be fulfilled or degree of similarity

The main purpose of cost classification

is to ensure that right and relevant cost
information is available to right user
3
 Classify costs for various purpose
Types of cost
Nature of Material, Labour and other overhead cost
Basis of classification
expense
Relation to Direct, Indirect
cost object
Function Production, administration, selling, distribution, R&D,
quality
Behaviour Fixed, variable, semi variable and step cost

Purpose of Opportunity cost, imputed cost, Relevant and irrelevant

decision costs, Avoidable and unavoidable costs, Sunk costs,
making Incremental costs, marginal cost
Production Batch cost, process cost, operation cost, joint cost, prime
process cost
Stock Period and product costs, Job and process costs,
valuation, Elements of manufacturing costs (direct material, labour,
expenses and factory overheads)
Time period Historical, Predetermined, estimated, standards cost

4
 Costs for Stock valuation
Based on stock valuation; Costs can be
classified as:

Period and product

 Job and process costs
Elements of manufacturing

5
 Costs for Stock valuation

Product Costs Versus Period Costs

Product costs include Period costs include all
direct materials, direct selling costs and
labor, direct expenses, administrative costs.
and manufacturing
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
6
 Costs for Stock valuation

Job Costs Vs. Process Costs

Job A Mixing
Department

Finishing
Job B Department
Process costing is
Job costing is used when used when costs are
Costs are accumulated by accumulated by
jobs on job cost sheet departments on cost
Production reports
7
 Costs for Stock valuation

Classification of Manufacturing Costs

Direct
Direct Direct
Direct M
Maannu
Direct
Direct uffaacct
Labor
Labor Expenses
Expenses Ovveer tuurriinngg
O
Materials
Materials rhheeaad
d

The Product 8
 Costs for Stock valuation
Direct costs
Direct Materials: Consist of all
those materials that can be physically
identified with a specific product. E.g.
Wood used to manufacture a table

Direct Labour: Consists with labor costs that can

be specifically traced to or identified with a
particular product. e.g. Wages paid to workers
who assemble parts into the finished products

Direct expenses: Is an expense incurred specifically for the

production of the product e.g. the cost of hiring a machine for
producing specific product.

9
 Costs for Stock valuation
Manufacturing Overhead
Consists of all manufacturing costs other than direct materials, direct labor and direct expenses.

Indirect materials costs

Indirect labor costs
Other indirect costs

10
 Costs for Stock valuation
Manufacturing Overhead
Indirect material: Materials used to
repair a machine which was used to
manufacture a table

Indirect labour: Wages paid to workers in the

store is indirect labor cost

Other Indirect expenses such as factory

rent, machine depreciation

11
Summary
Direct + Indirect = Material Cost
Materials Material
cost
+
Direct + Indirect = Labour cost
Labour Labour cost
cost
+
Direct + Indirect = Other Expenses
Expenses Expenses in total
Prime + Overhead = Total Cost
12
Cost cost
 Manufacturing costs are often
classified as follows:

Direct Direct Direct Manufacturing

Material Labor Expenses Overhead

Conversion
Cost

Prime Overhead
Cost Cost 13
 Costs for Decision making
Possible methods of cost classifications for
decision making include:
Relevant and irrelevant costs
Avoidable and unavoidable costs
Sunk costs
Opportunity costs
Incremental costs

14
Costs for Decision making
.
Relevant costs Are those future costs that will be changed by a
decision
In the short term not all costs are relevant for
decision making.

Irrelevant costs Irrelevant costs are those costs which will not be
affected by the decision. e.g. past costs

Avoidable costs- Are those costs that may be saved by not adopting a
given alternative. They are relevant costs

Unavoidable costs These are costs which cannot be saved.They are

irrelevant for decision making.

15
 Costs for Decision making
Sunk cost
These are costs of resources already
acquired.
They are costs that have been created
by a decision made in the past.
All sunk costs are irrelevant for
decision making

16
 Costs for Decision making
Opportunity costs
Is the cost that measures the opportunity that is lost or
sacrificed when the choice of one course of action
requires that an alternative course of action be given
up.
Example: If labour is diverted from one product to
another, the relevant cost is not the amount paid to
the worker but the Contribution lost if the original
product cannot be made
Opportunity cost for Product B is the contribution
lost for not producing product A
17
 Costs for Decision making

Incremental costs
Is the additional cost resulted from a group
of additional units of output.

Marginal cost
Is the additional cost resulted from one
additional unit of output

18
 Cost for Control
Costs for control objective can be classified by
the following methods:
Controllable Cost is controllable when at a particular
costs level of management, a manager can
exercise significant influence over the cost.
A cost is controllable if a manager at a
particular level of management can
authorize the cost.

Uncontrollable These are costs incurred at a certain

costs management level in which manager cannot
exercise significant influence over the cost.

19
 Cost behaviour

According to the cost behavior costs can be

classified as:
Variable costs
Fixed costs
Semi variable costs
Step cost

20
 Variable Costs
These are costs which vary in direct
proportion to the volume of activity. i.e. in
doubling the output will double total
variable costs. Eg. Manufacturing variable
cost is direct materials

Non manufacturing variable cost is

petrol, sales commissions

21
 Variable Costs

Direct materials
Sales commission

Units of Output Cost

(Tables) (Wood)
10,000 50,000,000
20,000 100,000,000
30,000 150,000,000
22
 Variable Costs

Your total texting cost is based

on how many texts you send.
Total Texting
cost

Number of Texts Sent

23
 Variable Cost per Unit

The cost per text sent is constant at

60 Tzs. per text message.

Cost Per Text Sent

Number of Texts
Sent
24
 Fixed Costs

Remain constant over a wide ranges of

activity for a specified period of time. e.g.
depreciation of the factory building.

Total fixed costs are constant for all levels of

Activity where as unit fixed costs decrease
proportionally with the level of activity.

25
 Fixed Costs

Rent of a factory

Units of Output Cost

10,000 50,000,000
20,000 50,000,000
30,000 50,000,000
26
 Fixed Cost
Your monthly rent does not change based
on the number of outputs produced
Monthly rent

Outputs
27
 Fixed Cost per Unit
Within the monthly contract, the average fixed
cost per Square Feet rented decreases as
number of output increases

Monthly rent

Number of outputs
28
 Relevant Range
A range of business activity within
which the assumptions made about cost
behavior are valid.
Variable costs on a per unit basis
remain the same within the relevant
range, and in total vary directly with the
level of activity
Fixed costs in total remain fixed within
the relevant range, but will change on a
per unit basis as the level of activity
changes
29
 Fixed Costs and Relevant Range

90
Tanzanian shillings

Total
Total cost
cost doesn’t
doesn’t
Thousands of
Rent Cost in

Relevant change
change for
for aa wide
wide
60 range
range of
of activity,
activity,
Range and
and then
then jumps
jumps to to aa
new
new higher
higher cost
cost for
for
Relevant
30 the
the next
next higher
higher
Range range
range of
of activity.
activity.
0
0 1,000 2,000 3,000

Outputs 30
 Semi variable/Mixed Costs
Semi variable costs include both a fixed
and a variable component.

e.g. Electricity charges consists of standing

charge (fixed) and an amount which is
dependent on the units consumed.
l Cost
Tota

Variable
Component
Fixed
Component
Total costs starts from here 31
 Mixed Costs

Y b X
Total Utility Cost

a +
Y =
o st
d c
i xe
l m
t a
To Variable
Cost per KW b
X
a
Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
32
 Mixed Cost-An example

IfIf your
your fixed
fixed monthly
monthly utility
utility charge
charge isis Tzs.
Tzs. 20,000,
20,000,
your
your variable
variable cost
cost is
is Tzs.
Tzs. 15 15 per
per kilowatt
kilowatt hour,
hour, and
and
your
your monthly
monthly activity
activity level
level is
is 2,000
2,000 kilowatt
kilowatt hours,
hours,
what
what is
is the
the amount
amount of of your
your utility
utility bill?
bill?

33
 Semi variable/Mixed Cost

Methods used to break down mixed

costs:

High- low method

Scatter graph method
Least square method

34
 High-Low Method
Highest activity level (Tzs.) minus
Variable cost per unit = lowest activity level (Tzs.)
Highest level of activity (n) minus
lowest level of activity (n)l of
activity (n)

Fixed cost=Mixed cost - Variable cost per unit

* level of activity
a =Y- bx

Y = a + bx
35
 High-Low Method
Actual costs incurred
ElectricityTotal
(Units) Cost
Tzs. What month has
June 1,000 45,550
July 1,500 52,000 the highest level
August 2,100 61,500 of activity?
September 1,800 57,500
October 750 41,250

Highest activity level (Tzs.) minus

Variable cost per unit = lowest activity level (Tzs.)
Highest
2,100 –level of level
lowest activity (n) minus
of activity (n)
lowest level of activity (n)lowest
36
 High-Low Method
Actual costs incurred
Electricity Total
(Units) Cost
Tzs. For the highest
June 1,000 45,550 level of activity,
July 1,500 52,000
August 2,100 61,500
what is the cost
September 1,800 57,500 of electricity?
October 750 41,250

Highest activity level (Tzs.) minus

Tzs.61,500
lowestminus lowest
activity level cost (Tzs.)
(Tzs.)
Variable cost per unit =
Highest level
2,100 of activity
minus (n) minus
lowest level of
lowest level of activity
activity (n) (n)
37
 High-Low Method
Actual costs incurred
Electricity Total
(Units) Cost
Tzs.
What month has
June 1,000 45,550 the lowest level of
July 1,500 52,000 activity? What is
August 2,100 61,500
September 1,800 57,500 the cost?
October 750 41,250

Tzs.61,500 minus lowest activity

Tzs.61,500
level –(Tzs.)
Tzs.41,250
Variable cost per unit =
2,100 minus lowest level of
2,100 – 750
activity (n)
38
 High-Low Method
Actual costs incurred
Electricity Total
(Units) Cost
Tzs. What is the
June 1,000 45,550
July 1,500 52,000
variable cost per
August 2,100 61,500 unit?
September 1,800 57,500
October 750 41,250

TZS.
$57,500 20,250
– $41,250
Variable cost per unit = Tzs.15
1,350
2,100 – 750
39
 High-Low Method
Actual costs incurred
Electricity Total Variable cost per unit = Tzs.15
(Units) Cost
Tzs. What is the total
June 1,000 45,550
July 1,500 52,000 fixed cost (using the
August 2,100 61,500 highest level)?
September 1,800 57,500
October 750 41,250

Total cost = (Variable cost per unit x Units of electricity)

+ Fixed cost
Tzs.61,500 = (Tzs.15 x 2,100) + Fixed cost
Tzs. 61,500 = (Tzs.15 x 2,100) + Tzs.30,000
40
 High-Low Method
Actual costs incurred
Variable cost per unit = Tzs.
Electricity Total
(Units) Cost 15
Tzs. The fixed cost is
June 1,000 45,550
July 1,500 52,000 the same at the
August 2,100 61,500 lowest level.
September 1,800 57,500
October 750 41,250
Total cost = (Variable cost per unit x Units of electricity)
+ Fixed cost
Tzs.41,250 = (Tzs.15 x 750) + Fixed cost
Tzs. 41,250 = (Tzs. 15 x 750) + Tzs.30,000
41
 Least Square Method

This method based on the assumption that

there is a linear relationship between
costs and level of activity
y = a + bx
Where y = mixed cost
a = fixed cost component
b = variable cost per unit
x = level of activity

42
 Least Square Method

bnxy-xy
nx ² -x²

aybx
n

43
 Least Square Method
Actual costs incurred
Electricity Total bnxy-xy
(Units) Cost nx2-x²
Tzs. x2
x y xy
June 1,000 45,550 45,550,000 1,000,000
July 1,500 52,000 78,000,000 2,250,000
August 2,100 61,500 129,150,000 4,410,000
September 1,800 57,500 103,500,000 3,240,000
October 750 41,250 30,937,500 562,500
387,137,500 11,462,500
7,150 257,800

n= xy = 387,137,500 x = 7,150 y = 257,800

5
x ² =11,462,500 x² = (7150) ² = 51,122,500 44
 Least Square Method

bnxy–xy =5(387,137,500)- 1,843,270,000

nx2-x² 5 (11,462,500) - 51,122,500

b=15

45
 Least Square Method
a ybx
n
257,800-15(7,150)
5
a 30,110
You can now identify the variable
component and fixed component at any
level of activity using the equation:
Fixed component
Variable component
Equation: y= 30,110 + 15 x 46
 Scatter Graph Method
 A scatter graph plot (also called the quick-and-dirty method) is a
quick and easy way to isolate the fixed and variable components of
a mixed cost.

 The first step when using this method to analyze a mixed cost is to
plot the data on the scatter graph. The cost, which is known as the
dependent variable, is plotted on the Y (vertical) axis. The activity,
which is known as the independent variable, is plotted on the X
(horizontal) axis.

 The second step is to examine the dots on the scatter graph to see
if they are linear, such that a straight line can be drawn that
approximates the relation between cost and activity. If the dots are
not linear, do not analyze the data any further. Instead, search for
another independent variable that bears a stronger linear
relationship with the dependent variable.

 If there does appear to be a linear relationship between the level of

activity and cost, we will continue our analysis.
47
 Scatter graph Method

ElectricityTotal
(Units) Cost
Tzs.
June 1,000 45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October 750 41,250

48
 Scatter Graph Method
Plot
Plot the
the data
data points
points on
on aa graph
graph
(Total
(Total Cost
Cost YY vs.
vs. Activity
Activity X).
X).
Y
Total Electricity Cost

Electricity Units X
49
 Scatter Graph Method
Draw
Draw aa line
line through
through the
the data
data points
points with
with about
about anan
equal
equal numbers
numbers of of points
points above
above and
and below
below the
the line.
line.
Y
Total Electricity Cost

Intercept
Interceptis
isthe
theestimated
estimated
fixed
fixedcost
cost==Tzs.30,000
Tzs.30,000

Electricity Units X
50
 Scatter Graph Method
The
The slope
slope is
is the
the estimated
estimated variable
variable cost
cost per
per unit.
unit.
Slope
Slope == Change
Change inin cost
cost ÷÷ Change
Change in
in units
units
Y
Total Electricity Cost

Vertical
Verticaldistance
distanceisis
Horizontal the
thechange
changeinincost.
Horizontaldistance
distanceis isthe
the cost.
change
changeininactivity.
activity.

Electricity Units X51

 Scatter Graph Method
The
The slope
slope is
is the
the estimated
estimated variable
variable cost
cost per
per unit.
unit.
Slope
Slope == Change
Change inin cost
cost ÷÷ Change
Change in
in units
units

a = 30,000

b = 61,500 – 41,250
2,100 – 750

= 20,250
1,350
= 15
52
Comparison of Methods

53
 o n
t i
a
t fic s
o s i
C as riou
s
l
c r va se s
fo rpo
p u

54
Classification for various
purposes
There are different costs for different
purposes.
A sound system of cost accounting
provides cost information that could be
used for variety of purposes
The following are the classifications of
costs for various purposes

55
Classification of costs for various purposes

 Historical costs and replacement costs

 Past costs and future costs
 Incremental costs and sunk costs
 Shut down costs and Abandonment costs

56
Historical and replacement costs
 Historical cost
Is the actual cost of an asset at the time of its
acquisition.

 Replacement cost
Is the cost to be incurred on an asset if it is
purchased now. In case the price of the asset
remain the same with the passage of time,
historical costs coincide with replacement costs.
57
Past and future costs
Past costs
Are actual costs incurred in the past and
recorded in the books of account.

Future costs
 Are those costs that are likely to be
incurred in a future period.
 Are not recorded in the books of
accounts.
 Should be estimated.
58
Future costs
Future costs are used for decision
making
They can be controlled and reduced
They can be met or avoided
They are relevant for decision making

59
Incremental and Sunk costs

Incremental (differential) costs

Is the increase in total cost resulting
from a change in the volume of
business.
Is the difference in costs between two
policies.

60
Incremental and Sunk costs contd.

Sunk costs
Are not altered as a result of
managerial decision.
Are not relevant for managerial
decision

61
Shut down and Abandonment costs
Shut down costs
Should be incurred in the event of
temporary cessation of activities.
Can be saved if activities are
allowed to continue

62
Shut down and Abandonment costs contd.

Abandonment costs
Are those costs that result from a
permanent cessation of business
activities e.g. costs connected with
disposal of Non current assets

63
 Next Lecture:

Topic 3…
Accounting for Materials

64