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Elements of Cost
Prime/Basic Cost Overheads
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Elements of Cost(by elements material! labour and e"#enses )
$irect %aterial All materials &hich become aninegral #art of the finished #roduct and &hich canbe conveniently assigned to s#ecific #hysical unitsis termed as direct material. 'or e"am#le
a. %aterials or com#onents s#ecifically#urchased #roduced or reuisitioned for thes#ecific #roduct.
b. Primary #acaging materials lie cartons!&ra##ings! cardboard! bo"es etc.
c. Purchased com#onents in finished or semifinished stage s#ecifically meant for the final#roduct.
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Elements of Cost(by elements material! labour and e"#enses )
*ndirect %aterial All materials &hich are usedfor #ur#oses ancilliary to the business and &hichcan not be conveniently assigned to s#ecific#hysical units! are termed as indirect materials.'or e"am#le
a. Consumable stores.
b. Oils/lubricants! coolents and &astes etc.
c. Printing and stationery materials etc.
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+u#ervisor
,orman- ,orman ,orman
Conce#t of $irect 0 *ndirect 1abour
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Elements of Cost(by elements material! labour and e"#enses )
$irect 1abour 1abour &hich taes an activeand direct #art in #roduction of a #articularcommodity is called direct labour. $irect labourcost are! therefore! s#ecifically and convenientlytraceable to a s#ecific #roduct.
*ndirect 1abour 1abour em#loyed for the#ur#ose of carrying out tass incidental to#roduction of goods or services is termed asindeirect labour. +uch labour is not directly
em#loyed in #roduction and its cost can not be#ractically traced to s#ecific unit of out#ut. ,agesof storeee#ers! timeee#ers! gateee#erforemen! directors2 fee! salaries to salesmen etcare all e"am#les of inderect labour costs.
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Elements of Cost(by elements material! labour and e"#enses )
$irect E"#enses 3hese are all the e"#enses &hich canbe directly! conveniently and &holly allocated to s#ecificcost centres or cost units. 4iring charges #aid for s#ecialmachinery reuired for a a #rticular contract and cost ofrectification incurred on in connection &ith a #articular 5ob
or contract are some of the e"am#les of direct e"#enses.
*ndirect E"#enses 3hese are the e"#enses &hich cannot be directly! conveniently and &holly allocated to costcentres or cost units. Payment to&ards rent! lighting! and
insurance charges etc are the e"am#les of indirecte"#enses.
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Overheads in Case of a %anufacturing
Organisation
3he term overhead includes indirect materials! indirectlabour and indirect e"#enses. A manufacturingorganisation can be broadly #ut into three divisions
-. 'actory or ,ors &here the #roduction is done. Office and Administration &here routine as &ell as#olicy matters are decided
. +elling and $istribution &here the #roduct are sold and
finally des#atched to the customer E"#enditure incurred on indirect material! indirect labouror indirect e"#enses in the factory or in office or in selling0 distribution division &ill be #art of overheads
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Com#onents of 3otal Cost
Direct Material + DirectLabour + DirectExpenses
Direct Cost or Prime Costor Basic Cost
Direct Cost +Factory/WorksOverea!s
Works/Facptory/Pro!uction/ Manu"acturin# Cost
Manu"acturin# Cost +O$ce % &!ministartive
Overea!s
'otal Cost o" Pro!uction
'otal Pro!uction Cost +(ellin# % DistributionOverea!s
'otal Cost
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Classification of Costs (by Behaviour)
'i"ed Costs 'i"ed costs are the costs &hichremain constant irres#ective of the uantum of
out#ut &ithin and u# to the ca#acity that has
been built u# such as rent! insurance charges
and management salary etc. 3he fi"ed costs arealso sometimes referred to as #eriod costs. 'i"ed costs are of t&o ty#es.
Committed 'i"ed Costs $iscretionary 'i"ed Costs
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Classification of Costs(by Behaviour)
Committed 'i"ed Costs 3his largelyconsists of those fi"ed costs that arise from#ossession of #lant! eui#ment! and creatingbasic organisational structure. 'or e"am#le!
once a building is constructed and #lant isinstalled! nothing much could be done to reducethe cost to&ards de#reciation! #ro#erty ta"es!insurance charges and salaries to the #ersonnel
etc. &ithout im#aring the organisation2scom#etence to meet its long term goals
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Classification of Costs(by $ecision %aing)
$iscretionary 'i"ed Costs 3hese are set atfi"ed amount for s#ecific time #eriod by themanagement in budgeting #rocess. 3hese costdirectly reflect to# management2s #olicies and
have #articular relationshi# &ith volume ofout#ut. 3hese costs can! therefore! be reducedor totally eliminated if the circumstances soreuire. 60$ costs! advertising 0 sales#ro#motion costs! donations! management
consulting fees etc. are some of the e"am#les ofdiscretionary fi"ed costs. 3hese costs are alsotermed as managed or #rogrammed costs
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Classification of Costs(by Behaviour)
+emi7ariable Costs 3hese are costs &hich
do vary but not in direct #ro#ortion to out#ut.3hey are made u# of both fi"ed and variablecost elements such as de#reciation! re#airs!light heat! tele#hones charges etc. *dentificationof fi"ed and variable elements of semivariable
costs is im#ortant for the management for#lanning controls.
C o s
t
8nits of Production
7ariable Element of Cost
'i"ed Element of Cost
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Classification of Costs(by Behaviour)
+te# Costs 'i"ed cost in general remains
fi"ed over a range of activities and then 5um#sto a ne& level as the activity changes. 'ore"am#le! a foreman can su#ervise a givennumber of &orers. Beyond this number! it isnecessary to hire second foreman. +uch costs
5um# in ste#s as sho&n belo&
C o s
t
8nits of Production
'i"ed cost rising in ste#s
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+ome Other Conce#ts of Costs
+hut $o&n Costs
3he fi"ed costs &hich have got to be incurred even ifthe #lant is under shut do&n and there is no
#roduction are termed as shut do&n costs.6ent!
*nsurance!
$e#reciation 0
%aintenance etc.are the e"am#les of shut do&n costs.
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+ome Other Conce#ts of Costs
+un Costs! 4istorical Costs or Past Costs(by timings)
Costs &hich have been incurred as a result of decision
taen in the #ast to set u# the infrastructure facilities.+uch costs can not be reversed or revised bysubseuent decisions. *nvestment made in
Plant and machinery 0
Building etc.
are #rominent e"am#les of such costs.
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+ome Other Conce#ts of Costs
Controllable 0 8ncontrollable Costs
3hese are the costs &hich can be influenced by the action ofa s#ecified memeber of an organisation. 3he foreman of
#roduction sho# can control the utilisation of #o&er or ra&materials in his sho#. 3hese are therefore! controllable costsas far as he is concerned. 4o&ever! the same foreman hasno control on the &astage of #o&er that might be taing
#lace in the #o&er house itself resulting in higher cost #erunit of #o&er to him.
+imilarly! he can not control increase in cost of materialsconsumed in his de#artment if the #urchase de#artmentbuys the materials at higher #rice due to their o&n
inefficiency.
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+ome Other Conce#ts of Costs
*m#uted or 4y#othetical Costs(by timings)
3hese are the costs &hich do not involve cashoutlay. 3hey are not included in cost accounting
but they are im#ortant for maing managementdecisions. *nterest on ca#ital is an e"am#le ofim#uted cost &hich is ignored in cost accountingbut considered in financial accounting. *f t&o#ro5ects reuire uneual outlay of cash! the
management must tae into consideration theinterest on ca#ital to 5udge the relative#rofitability of the #ro5ects.
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+ome Other Conce#ts of Costs
$ifferential! *ncreamental or $ecreamental Costs
3he difference in total costs bet&een t&oalternatives is termed as differential cost. *n
case the choice of an alternative results inincrease in the total cost! such increased costsare no&n as increamental costs. *f the choiceresults in decrease in total costs! the resulting
decrease is no&n as decreamental cost.,hile assessing the #rofitability of the#ro#osed change the increamental costs arematched &ith increamental revenues.
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+ome Other Conce#ts of Costs
.OutofPocet Costs
3his means the #resent or future cash e"#enditureregarding certain decisions &hich may vary
de#ending u#on the nature of the decision made. 'or
e"am#le if a management has decided to hire
trans#ort for trans#ortation of goods in stead of usingits o&n! it may tae into account the #resent
e"#enditure on fuel! hiring charges and maintenance
etc. &hich have to be incurred in cash under the
changed circumstances even though the
management might not have been consideringde#reciation as cost earlier. +uch costs for arriving at
a decision are termed as outof #ocet costs.
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+ome Other Conce#ts of Costs
O##ortunity Costs
3he o##ortunity cost refers to the advantage inmeasurable terms &hich might have been
foregone on account of not using the faciliities inthe manner originally #lanned. 'or e"am#le! ifan o&ned building is #ro#osed to be utilised forhousing a ne& #ro5ect #lant! liely revenue&hich the building could fetch if rented out! is the
o##rtunity cost &hich should be taen intoaccount &hile evaluating the #rofitability of the#ro5ect.
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+ome Other Conce#ts of Costs
3raceable 0 8ntraceable Costs (by nature of traceability)
3he costs &hich can be easily identified or traced tos#ecific #roducts! services or units such as ra& materials
and labours etc are termed as traceable costs other&isethey are called untraceable costs. 8ntraceable costs arealso called common costs as they are incurredcollectively for number of #roducts. All ty#es ofoverheads incurred for the factory as a &hole are the
e"am#les of untraceable costs. 3he untraceable costsare a##ortioned on different #roducts using somesuitable criterion
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+ome Other Conce#ts of Costs
9oint Costs (by nature of traceability)
,henever t&o or more #roducts are #roduced out
of one and the same ra& material or #rocess! thecost of materials #urchased and the cost of#rocesing are called 5oint costs. Oil refinery &hererange of #roducts lie bitumen! #etrol! diesel anderosene are derived in the #rocess of refining
crude oil is a ty#ical e"am#le of 5oint costcom#rising of crude and cost incurred in thecourse of refining. 3hese 5oint costs are to bea##ortioned to various #roducts on some basis.
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+ome Other Conce#ts of Costs
Conversion Costs
3he cost of transforming direct materials intofinished #roducts e"clusive of direct material
cost is no&n as conversion cost. *t is usuallytaen as the aggregate of cost of direct labour!direct e"#enses and factory overheads.
3he above classification conce#ts of costs hel#
the management in decision maing #rocess&ith regard to fi"ing the accountability andcontrolling the costs.
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+ome Other Conce#ts of Costs
:ormal Costs 0 Abnormal Costs (by normality)
:ormal costs arise during routine daytoday
business o#erations. Abnormal costs arisebecause of any abnormal activity or event not
#art of routine business o#erations. Costs
arising because of floods! riots! accidents etc.
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3han ;ou
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