Analysis of cost & Overhead

Dr Rabindra Kumar Swain

P.G. Department of Commerce
Utkal University, Vani Vihar
Bhubaneswar
 Concept of cost
• A cost should be studied in relation to its
purpose and condition.
• Different costs are ascertained for different
purposes under different conditions.
 Classification of costs
• Process of grouping costs on the basis of their
common characteristics.
• Such characteristics are-
 Element –wise
 Function- wise
 Behaviour/ Nature-wise
 Controllability
 Normality
 Time
 In relation to managerial decision
 Element – wise classification

 Material Costs Direct

Indirect

 Direct
Labour costs Direct
Indirect

Other costs Direct

Indirect
 Direct Material cost
• Direct material cost is the cost which can be
conveniently identified with and allocated to cost
units.
• It is generally a part of finished product.
 Examples-clay in bricks making
 Steel in machines
 Timber in furniture
 Alumina and bauxite in aluminum
 Titanium , steel, aluminum in aircraft making
 Indirect materials
• Materials which cannot be conveniently with cost
units are indirect materials but they are part of
the finished product.
Examples-
 Lubricating oil
 Nuts and bolts
 Coal
 Small tools
 Office stationery
 Direct labour
• wages/remuneration paid to workers directly engaged in
converting raw materials into finished product.
• These wages can easily be identified with a particular
product or job or process.
Examples –
 Machine operator
 Shoe maker
 Carpenter
 Weaver
 Tailor
 Indirect labour
• It can not be conveniently identified with the product
but it is a part of product cost.
• Indirect labour assists in the production operation.
Examples-
 Supervisor
 Inspector
 Cleaner
 Clerk
 Peon
 watchman
 Direct other costs
• Those expenses other than direct materials and direct
labour which can be identified and allocated to cost
centre or cost units are direct expenses.
Examples-
 Hire of special plant for a particular job
 Travelling expense for a particular contract
 Experimental costs
 Cost of special design and layout
 Carriage for materials purchased
 Royalty paid in mining
 Indirect other costs
• All indirect costs other than indirect materials and
indirect labour costs are termed as indirect expense.
Examples-
 Rent and rates
 Depreciation
 Lighting and power
 Advertising
 Insurance
 Administrative expenses
 Selling and Distribution Expenses
• Prime cost = Direct material + Direct Labour +
Direct other costs

• Material cost= 38,000 Direct + Indirect

• Labour cost 10,000 Direct + Indirect
• Other cost= 2000 Direct + Indirect
• Overheads= Indirect Mat + Indirect Lab + Indirect
other cost
• Total cost= prime cost + Overheads
• To produce a product
• Direct costs(M, L and Other)-10,000 Prime cost
• Indirect Costs (Overheads) 3,000
• Total cost = prime cost + Overheads
• = 10,000+ 3,000= 13,000
• Profit = 10%
• Profit = 10% of 13,000= 1,300
• Selling price = TC + profit = 14,300
• DM + DL + DOC= Prime cost 60 to 70%
• IMC + ILC + IOC= Overheads
• TC = Prime cost + Overheads
• SP= TC +/- Profit
 Function-wise classification
Manufacturing Expenses

Administrative Expenses

Selling & Distribution Expenses

Research & Development

Expenses
 Manufacturing Expenses/ overheads
• It includes all operations and process starting
from the receipt of raw materials and ending
with storage of finished goods.
• All expenses incurred in these operations and
process, other than Direct materials, Direct
Labour and Direct expenses are classified as
manufacturing expenses/work expenses
 examples
• Depreciation on PPE
• Insurance charges and repairs of PPE
• Power consumption
• Coal and other fuel charges
• Wages to foreman, repair gangs, watch and ward
staff or indirect workers
• Work manager’s salary
• Canteen and welfare activities
• Cost of indirect materials
• Factory rent and factory lighting
Office and Administrative Expenses
• All expenses relating to general administration
not related to production and sales are
included in office and administrative expenses.
Examples are:
 Salary to manages and employees working in
the office
 Office rent and lighting
 Depreciation on office furniture and premises
 Examples
 Insurance of office premises and equipments
 Fees of directors other than those connected
with production and sales.
 Telephone, telegram, postage , printing and
stationery etc
 Legal expenses
 Audit fees
 Bank charges
 Selling and Distribution Expenses
• Selling expenses are those which are incurred
to create and stimulate demand to secure
orders for sales
• Distribution expenses are those which are
incurred in moving the goods from the
company’s godowns to the customers’
premises
 Examples
• Salary of sales manager and his staff
• Commission or remuneration or travelling
expenses to salesmen
• Advertising and showroom expenses
• Rent of godowns
• Bad debts and legal charges for recovery of debts
• Fees to sales director
• Delivery van charges and depreciation thereon
 Research and Development Expenses
• It is a capital expenditure and shown as assets
in the balance sheet.
• Only amortized part of it is treated as
expenses.
Behaviour-wise classification

 Prime cost
Variable cost  Overheads-power,
consumables

Overheads
 Salary
Fixed cost  rent

Overheads
 Depreciation
Semi-variable/ semi-fixed cost  Telephone charge
Repair & maintenance
 Variable costs
• These costs vary in direct proportion to the
volume of output.
• When volume of output increases, cost also
increases and vice versa.
• But variable cost per unit remains fixed.
Examples:
 Direct Material costs
 Direct Labour costs
 Direct other costs
• Power
• Royalties
• Normal spoilage
• Commission of salesmen
• Small tools
• Lubricants
• Oil and fuel
 Fixed expenses/costs
• These costs remain fixed or constant in total
amount regardless of volume of output
produced.
• Fixed cost per unit decrease with increase in
volume of output but total fixed cost remains
constant up to a particular installed capacity
and vice versa
• Fixed cost= 10,000
• Output=1000
• Fc per unit= 10,000/1000=10
• Output=2000
• Fc per unit = 10,000/2000=5
• Output= 5000
• Fc per unit= 10,000/5000=2
 Examples
• Rent and lease
• Managerial salaries
• Building insurance
• Salary and wages of permanent staff
• Municipal taxes
 Variable Cost per
Produced Total Variable Cost Total Fixed Cost
Steering Wheel

1 $250 $250 $550,000

500 $250 $125,000 $550,000

1000 $250 $250,000 $550,000

1500 $250 $375,000 $550,000

 Fixed Costs Variable Costs
Meaning In accounting, fixed costs Variable costs are expenses
are expenses that remain that change directly and
constant for a period of proportionally to the
time irrespective of the changes in business activity
level of outputs. level or volume.

Incurred when Even if the output is nil, The cost

fixed costs are incurred. increases/decreases based
on the output

Also known as Fixed costs are also known Variable costs are also
as overhead costs, period referred to as prime costs
costs or supplementary or direct costs as it directly
costs. affects the output levels.
Nature Fixed costs are time- Variable costs are volume-
related i.e. they remain related and change with
constant for a period of the changes in output
time. level.
Examples Depreciation, interest paid Commission on sales,
 Semi – Fixed or Semi- Variable costs
• These costs include both a fixed and a variable
component
• These are partly fixed and partly variable
Examples are:
 Supervision
 Maintenance and repairs
 Compensation for accidents
 Telephone expenses
 Light and power
 Depreciation
Segregation of Semi-Variable Costs
(Comparison Method)
(Equation Method)
 Comparison
• Level of output= 1000 units
• Cost= 9,000/- jan
• 1000 x 5= 5,000
• Fc = 9000-5000=4000
• feb
• Level of output = 2000 units
• Cost= 14,000
• 2000 x 5= 10,000
• Fc= 14,000-10,000= 4000
• Variable cost= 5000/1000= 5/- per unit
• Fixed cost=
 Equation
• Y= mx +c
• Y = Tc
• M= VC per unit
• C = fixed cost
• X = output
• Level-1
• 9000= 1000m + c---------1
• 14000= 2000m + c -------2
• 2-1 - 1000m=5000
• M= 5000/1000= 5/- per unit
• 9000= 5000 + c
• C= 9000-5000=4000
• FC= 4000
Example
 Equation Method
• y = mx + c
• Where, y = Total semi-variable cost/TC
• x = Output (in units)
• m = Variable Cost per unit
• c = Fixed Cost Element
1st year output=1000units, TC=10,000
10,000= 1000m + c -----------1
2nd year , output=1200, TC=10,800
10,800= 1200m + c ----------2
2-1= 800= 200m
M= 800/200= 4/- per unit
Putting the value of m in eq1= C= 10,000-4000= 6000 FC
Classification as per controllability

Controllable cost Variable costs

Uncontrollable cost Fixed costs

 Controllable costs
• These costs may be regulated at a given level
of management authority.
• Variable costs are controllable by department
heads
Examples: cost of raw materials may be
controlled by purchasing in larger quantities
 Uncontrollable Costs
• Those costs can not be controlled or
influenced by the action of a particular entity.
• Fixed costs are generally uncontrollable costs

• However in the long run all costs are

controllable at some appropriate
management level.
Classification as per normality

Normal cost

Examples of abnormal costs

 Breakdown of machine
Abnormal cost  Inefficient management
 Natural calamities
 Cost based on Time
1. Actual Costs/Historical costs

2. Predetermined costs/ Future costs( it can be

either standard cost or estimated costs)
This cost is used for planning and control
purposes
 Cost based on Managerial Decision

1. Marginal Cost
2. Differential Cost
3. Opportunity cost
4. Sunk cost
5. Explicit cost
6. Imputed cost (Implicit cost)
 Marginal costs
• Additional cost of producing one more unit of
production.
• Marginal cost is the sum of all variable costs
Suppose cost of producing 10 units is Rs. 100
And cost of producing 11 units is Rs 112
Then cost of producing additional one more
unit= 112-100= Rs. 12
So, marginal cost of one unit = Rs. 12
• 10units = 100/-
• 11 units= 108/-
• For additional one unit additional cost= 8/-
• Marginal/variable cost= 8/-
• 10 x 8= 80
• TC=100
• FC= 100-80= 20/-
• 2nd case
• VC=11 x 8= 88
• TC=108/-
• FC= TC-VC= 108-88= 20/_
• Product X= marginal cost = 15/VC
• Fixed cost = 4
• Total cost = 19/-

• Extra unit= 15/-

• Or

• In the market the same product available = 14/-

• Decide whether to make or buy
• Sp per unit = 10/-
• Vc = variable cost per unit= 6/-
• Fixed cost =100/- (total )
20 units are produced
Sp = 20 x10= 200
Less VC 6 x 20=120
Contribution= SP-VC= 120
Profit = 120-100= 20/-
Customer from USA wanted to buy your product at
5/-
• Domestic market = 20/-
• Foreign market = sp- vc= 7-6= 1/- contribution
• Total profit =20 + 1=21
 Contd.
• It is also called the product cost
• But fixed costs are charged to profit and loss
being period cost under this technique.
• Marginal costing is one of the important
techniques of taking managerial decisions like
make or buy or expansion or diversification
or modernization or replacement decisions
 Differential costs
• This is the difference in total cost resulting from
the change of production
• Increase or decrease in total cost that results
from alternate course of action
• It is ascertained by subtracting the cost of one
alternative from the cost of another alternative
• Alternative choice may arise due to change in
method of production, sale volume, make or
buy decision, take or refuse decisions etc
 Examples
• Cost of producing the product by Machine A=
Rs.110 cr
• Cost of producing the same product by
machine B= Rs. 109.80 cr
• Differential cost = 110-109.80= 0.20 cr
decremental -profitable
 Opportunity cost
• Potential benefit lost or sacrificed when one course
of action is taken up in place of alternative course of
action
• For example
A company has deposited Rs. 1 Lakh in bank @10%
interest p.a. now it is considering a proposal to
invest this amount in debentures where the yield is
12% p.a.. If the company decides to invest in
debenture, it will have to forego bank interest of Rs.
10,000 p.a. which is the opportunity cost
• Bank 10% interest invested

• Share 20%
 Contd.
• Opportunity cost is a decision making cost
• It does not require cash outlay and not
entered in accounting books.
 Sunk cost
• The cost that has already been incurred is sunk cost
and that cannot be changed by any decision made
now or future.
• Sunk costs are also called historical costs or past
costs
• They are irrelevant for decision making about the
future but it can be analyzed before decision about
future courses of action are made.
• Example- amount of Rs. 105cr spent for acquiring a
Plant and Machine
 Imputed cost/ implicit cost
• Implicit costs occur when the company uses the resources
belonging to the owner such as capital, inventory, land,
building etc
• It is also referred as imputed cost or opportunity costs
• These costs are not recorded for cost calculation or profit
determination
• It is used for decision making purposes
• It is also economic cost
• It does not involve outflow of cash
• Examples- interest on owner’s capital, rent to self on own
land and building etc
Own Business Reliance co 100 cr
Bikash babu 100 CR Return 18 cr

Rate of Interest 5%
profit = 20 Cr

Imputed cost 5% of 100 = 5Cr

Profit= 20
Less int 5
NET profit + 15
 Explicit cost
• Costs resulting in an immediate outflow of cash
from the business are termed as explicit costs.
• These are incurred during the production process
or regular course of action of the business
• They are recorded in the books of accounts to
calculate cost of production and profit or loss of
the business
• It is also called out of pocket cost
• Examples- materials, wages, salary, rent etc
• A co is acquired by B co
• Goodwill purchased =2000cr
• In balance sheet as asset goodwill= 2000cr
• Amortized Exp 2000/10= 200 cr to p/l statement exp= non
cash item
• Depreciation
• Depreciation and appreciation
• Patent = 100cr
• Patent value is appreciated by 10cr
• In balance sheet = 100 + 10= 110 cr
• Profit on valuation = 10cr as Reserve and surplus Liability