Cost Accounting

Classification of Cost

Cost (basis of variability)

Fixed Cost Variable CostSemi variable

Cost

Fixed Cost Associated with those inputs which do not

vary with changes in volume of output or activity with in a specified range of activity or output(relevant range) for a given budget period.

Remains constant whether activity increases or decreases with in a relevant range.

Example : Rent of factory, senior executive’s salaries remain same whether there is increase or decrease in volume of activity.

Fixed cost is subject to change over a period of time. Example: Rent of factory may increase after

cercertain time. Remains unaffected by volume changes

Total Fixed Cost Production(in units)

Average Fixed Cost

10000 1000 10

10000 2000 5

10000 5000 2

10000 10000 1

1000 2000 5000 100000

2000

4000

6000

8000

10000

12000

Total Fixed Cost

Total Fixed Cost

Units of Products

1000 2000 5000 100000

2

4

6

8

10

12

Average Fixed Cost

Average Fixed Cost

Increase in volume means fixed cost per unit gets progressively smaller.

Variation in unit fixed cost creates problems in product costing.

Cost being depended on number of units produced. This aspect has been referred to as trouble some fixed costs.

Organization often view fixed cost as either Committed or Discretionary fixed cost.

Commited Fixed Cost Fixed costs caused by the purchase of

capacity producing assets such as plant and equipment are called as commited cost.

It can not be easily changed on short run without having significant impact on organisation.

Depreciation, rent, property taxes are some of its examples.

Discretionary Fixed Cost

Also known as programmed costs or managed cost.

These are cost caused by management policy decision to undertake activities such as research & development, training for employees, advertising and sale promotion and so on are Discretionary Fixed Cost.

It can be reduced substantially for a given year in difficult times.

Management can cut Discretionary Fixed cost when profit declines. Example : Stop advertising in news paper

It’s amount is decided by top management at beginning of budget.

It can be changed in short run.

Variable Costs Tends to vary in direct proportion. Changes with production and sales activity.

Production

Material Cost

Labour Cost

Total Variable Cost

1 5 2 7

10 50 20 70

100 500 200 700

1000 5000 2000 7000

1 10 100 10000

1000

2000

3000

4000

5000

6000

7000

8000

Total Variable Cost

Total Variable Cost

Total Variable Cost

Productions

TVC

Cost

Semi Variable Costs Also known as Mixed Cost All costs which are neither perfectly variable

nor absolutely fixed in relation to volume changes

It consists of Fixed Cost and Variable Cost Example : Telephone Bill

0 1 2 30

5

10

15

20

25

30

Series 1

Series 1

Fixed Rental Charges

Minutes of Call

Price

0

Total Mixed Cost= Total Fixed Cost+(Unit variable cost X number of units)

Break-Even Analysis Also Known as CVP (Cost Volume Profit

Analysis) It is a technique to formulate profit planning. It’s an analytical technique for studying the

relationship between production costs and revenue.

It answers “What’s the amount need to be sold to cover all the costs”

Break Even Point Break-Even Point is the point where you

neither make nor lose money. Break-Even Point is the point where total cost

is equal to revenue. The breakeven point has three simple

elements: Includes fixed costs and variable costs. Includes revenue Assumes profit of zero.

Sales=variable cost+ fixed cost+ profit At breakeven there is no profit

Breakeven sales=variable cost+ fixed cost

Limitation Of Break Even Analysis Costs are either fixed or variable Fixed and variable costs are clearly

discernable over the whole range of output Short term analysis Difficult to use by multiple product producing

firm Assumes that the quantity of goods produced

is equal to the quantity of goods sold

Contribution Margin It is a cost accounting concept that allows a

company to determine the profitability of individual products.

It indicates why operating income changes as the number of units sold changes.

Contribution Margin = Total revenue – Variable cost

Contribution Margin per unit = Selling price/unit-Variable cost/unit

Contribution Margin Ratio = Total Contribution Margin/Total Revenue

Profit/Loss = Total contribution Margin-Total fixed Asset PL=TR-TC TC=TFC+TVC Let C=Unit contribution Margin

P=Unit RevenueV=Unit Variable Cost

C=P-VPL=TR-TC = P x X-(TFC+V x X) (since, TR=P x X, TVC=V

x X) = (C+V) x X-(TFC +V x X) = C x X+ V x X –TFC –V x X =C x X - TFC =TCM – TFC

(where X is the number of units)

Example

5 packages sold 40 packages sold

Revenue 10000(2000X5) 80000(2000X40)

Variable

Purchase cost = 6000 (1200*5) Purchase cost = 48000 (1200X40)

Fixed cost = 20000 Fixed Cost = 20000

Operating Income = 16000 Operating Income=12000

Contribution Margin = 4000(10000-6000)

Contribution Margin = 32000(80000-48000)