Cost Concepts

MANUFACTURING COSTS
Direct Labor (DL)
Direct Materials (DM)
Overhead (OH)
Indirect Materials
Indirect Labor
Other
NON-MANUFACTURING COSTS
Marketing or Selling Costs
Administrative Costs


Elements
A. MATERIAL
B. LABOUR
C. EXPENSES
 MATERIAL

A. Direct: traceable to one particular process, job or

product – identified with each unit of product
B. Example: manufacturing an apparel
C. Cloth, collar, buttons, cufflinks, thread
D. Primary packing material (e.g., carton, wrapping,
cardboard, boxes, etc.)

F. Fuel, lubricating oil etc for operating &

maintenance of machine
G. Small tools
H. Materials used for repairs & maintenance
 LABOUR

A. Inspectors
B. Supervisors
C. Internal transport staff
D. Storekeeper, maintenance staff
 EXPENSES

A. Expenses leading to a job or contract

B. Traveling expenses for negotiation
C. Special pattern, design
D. Special tools for executing the contract
E. Rent
F. Insurance
G. Canteen, hospital, power , lighting,
maintenance
Behaviour
Fixed
in short run & long run

Variable
Varies with volume and constant per unit

Semi-variable
A cost could be variable for one level of activity whereas it could
be fixed for another.

Not inherently fixed or variable

Many costs are semi-variable in nature
CLASSIFICATION EXERCISE
Classify the following cost items
○ Depreciation on factory building
○ Depreciation on office equipment
○ Property tax on finished goods warehouse
○ Wages paid to forklift operator in finished
goods warehouse
○ Wages paid to forklift operator in factory
○ Wages paid to welders when welding
equipment is not working
○ Paper used in textbook production
○ Paper used in central office computer
○ Wages paid to assembly line workers
○ Maintenance cost for machines
Functions
A. Production Cost
B. Administration Cost
C. Selling Cost
D. Distribution Cost
Normality
A. Normal
B. Abnormal
Control
Controllable
&
Uncontrollable
Planning & Control
A. Budgeted Cost: estimate of expenditure
for different business operations
B. Standard Cost: for prescribed set of
operating conditions, labour, material and
overheads are predetermined; budget
translated into actual operation through
standard costs
Relevance
A. Relevant
B. Irrelevant
Cont…..

A. Irrelevant cost: not relevant for decision

making
B. Example: Sunk costs: Sunk cost is the cost of
abandoned plant less salvage value. Not
relevant for decision making.
C. Imputed (Notional cost): Actually not
incurred (interest on own capital, rent on
owned building, etc.) Taken into account in
capital budgeting decisions.
D. Replacement cost: Cost of replacing at
current market price.
Cont…..

Avoidable and unavoidable cost: Cost

that can be avoided by eliminating a
product or department is avoidable and
that which cannot be, is unavoidable.
Ex. – Rent of factory is unavoidable if a
product is discontinued.
 PRODUCT COSTS AND PERIOD COSTS
A. Inventoriable cost/ product cost is that cost which
is regarded as asset when incurred, but becomes
a part of cost of goods sold when the product is
sold. For manufacturing units, all manufacturing
cost is inventoriable cost. (Raw material to WIP to
Finished goods) For a service sector unit, absence
of inventory means all are period costs.
B. Period costs (non-product cost): all costs in P&L
account except cost of goods sold. So, in a mfg.
sector unit, all non-manufacturing costs are
period costs. (Ex. Distribution cost, design cost,
R&D costs, Marketing costs, customer-service
costs, etc.)
PRODUCT COSTS VERSUS PERIOD
COSTS
Product costs include Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of 

Inventory Goods Sold
Expense

Sale

Balance
 Income
 Income


Sheet Statement Statement
COSTS RELATED TO DECISION
MAKING
Opportunity Costs - costs when taking one action
requires giving up the opportunity to earn profits from a
different action

○ Nike Inc. has limited production capacity. What would

be Nike’s opportunity cost of accepting a special order
from the military for combat boots? 


If Nike accepts the special order, they may not be able to

produce enough product for other sales. So, Nike would
lose the profit from the other sale.
COSTS RELATED TO DECISION
MAKING
Incremental Costs or Differential Costs –
additional costs incurred when choosing a certain
course of action over another (Note that
incremental costs can include opportunity costs)

○ What would be Macy’s incremental costs of

expanding its fragrance department and
shrinking its accessories department?

The costs of stocking and staffing the new

fragrance area, opportunity costs of lost profit
from the decrease in sales of accessories
COSTS RELATED TO DECISION
MAKING
Incremental Benefits or Differential Benefits – additional
benefits reaped when choosing a certain course of action over
another
○ What would be Macy’s incremental benefits of expanding its
fragrance department and shrinking its accessories department?
Profits Macy’s expects to earn on the new fragrances it displays/
stocks


Sunk Costs – Costs that have been incurred and that are not
affected by any current/future action
○ What would be considered sunk cost if Macy’s decides to expand
its fragrance department and shrink its accessories department?
Depreciation on the building, cost of the building