c
Discuss the various costs used in decision making and explain their characteristics?

:-
It is the amount of resources given up in exchange for some goods or services. Cost is
defined as "the amount of expenditure incurred on or attributable to a given thing or to ascertain
the cost of given thing."


 

Cost classification is the process of grouping costs according to their common characteristics.
Classifying costs sets a basis for financial analysis. A suitable classification of costs is of vital
importance in order to identify the cost with cost centers or cost units. Costs may be classified
on the basis of their functions, their nature or their behavior and a number of other
characteristics.

 
  
 


  






 




 
 


 
 
 
 

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According to this classification, the costs are divided into three categories i.e. materials ,labor,
expenses. There can be further classification of each element for example material into raw
material components, spare parts etc. This classification is important as it helps to find out total
cost , how much total cost constituted and valuation of work-in-progress.




 
 


On the basis of functions costs are classified into Prime Cost, Factory Cost, Cost of Production,
Cost of Sales or Total Cost.
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Y Prime Cost
Direct material and direct labor are often referred to as prime cost. It is the
total of material costs, direct labor costs, and direct expenses.

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Y Factory Cost
Total Cost of making a product at the production location.Factory Cost is

also known as Works Cost.

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Y Cost of Production
Cost of production or Production Cost is the combined cost of Raw
Material and Labor incurred in producing goods. 

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Y Cost of Sales / Total Cost
 Cost of goods sold (COGS) includes the direct costs
attributable to the production of the goods sold by a company. This amount includes the
materials cost used in creating the goods along with the direct labor costs used to produce
the good.
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Y Factory Overheads
total of all costs of manufacturing except direct materials and direct
labor, also called manufacturing overhead, indirect manufacturing expenses, factory
expenses, and factory burden. In addition to indirect material and indirect labor , it
includes such items as depreciation, setup costs, quality costs, cleanup costs, fringe
benefits, payroll taxes, and insurance. It is an inventory cost charged by allocation to
work-in-process (WIP) .


ë Indirect Materials such as coal, grease, lubricating oil etc. required in the
manufacture of a product are known as Factory Overheads.
ë Indirect Labor such as remuneration of factory watchman, supervisor, cleaner,
sweeper etc.
ë Factory rent, rates, taxes, power and other factory expenses.
ë Excise Duty
ë Depreciation on plant and machinery, equipments and other factory assets etc.

Y Administrative Overheads
Costs of record keeping, mailings, maintaining a customer

service line, etc. These are all necessary costs, though they vary in size from fund to
fund.
ë Office rents, rates and taxes, insurance, electricity, repairs, general expenses,
printing and stationery.
ë Depreciation on computer, furniture office air conditioner etc.

Y Selling and Distribution Overheads:

ë Advertisement, Commission, packing and sales expenses.

ë Carriage Outward, delivery charges, depreciation on delivery van etc.

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   :-

According to this classification, total cost is divided into direct costs or indirect costs.

|  :-
Direct Costs are those which are incurred for and may be conveniently identified with
a particular cost centre or cost unit.
 Example:- Material used and labor employed in manufacturing an article or in a particular
process of production are common example of direct cost.

!  :-
Indirect costs are those costs which are incurred for the benefit of a number of cost
centre or cost unit.

Example:- Indirect Cost include rent of building , management salaries, machinery

depreciation etc.

     


Based on nature costs are classified into three categories;





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*  !  
 Costs whose total amount remains the same at different levels of
production i.e. the total amount will not increase or decrease even if production is
increased or decreased such costs are known as Fixed Costs. Fixed costs are business
expenses that are not dependent on the activities of the business. They tend to be time-
related, such as salaries or rents being paid per month. Fixed costs are defined as
"expenses that do not change in proportion to the activity of a business, within the
relevant period". Administrative Overheads are Fixed Costs by nature.
 A good example is a lease payment. If you are leasing a building at Rs. 2,000 per
month, then you will pay that amount each month, no matter how well or how
poorly the business is doing.

*   
Variable costs are expenses that change in proportion to the activity
of a business. Variable cost is the sum of marginal costs. It can also be considered
normal costs. Variable costs are sometimes called unit-level costs as they vary with
the number of units produced.

A cost of labor, material or overhead that changes according to the change in the volume of
production units. Combined with fixed costs, variable costs make up the total cost of
production. Variable costs are corporate expenses that vary in direct proportion to the
quantity of output

*      
 Semi variable cost is an expense which contains both a fixed cost
component and a variable cost component. The fixed cost element shall be a part of the cost
that needs to be paid irrespective of the level of activity achieved by the entity. On the other
hand the variable component of the cost is payable proportionate to the level of activity.

Costs are fixed for a set level of production or consumption, becoming variable after the level
is exceeded. This cost is also known as a "semi-fixed cost.´

This type of cost is variable in the sense that greater levels of production increase total cost. If
no production occurs, then a fixed cost is still incurred.

Labor costs in a factory are semi-variable. The fixed portion is the wage paid to workers for
their regular hours. The variable portion is the overtime pay they receive when they exceed
their regular hours

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When student numbers on this particular course are between 1 and 299, they can be
accommodated in a single examination hall under the supervision of one team of invigilators at a
cost of Rs. 2,000. However, if three hundred students are enrolled, they can no longer be
accommodated at a single examination venue. Semi-variable costs will thus increase to Rs.
4,000, because it will be necessary to hire a second hall and employ additional invigilators.
These step-like increases occur every time student numbers increase by three hundred.

  :-

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Controllable Costs are those which can be influenced by the action of
specified member of an undertaking i.e. which are at least partly under the control of
management.
Example:- All direct costs including direct material , direct labor and some of the overhead
expenses are controllable by lower level of management.
#$%  :- Uncontrollable cost are those which cannot be influenced by the
action of a specified member of an undertaking i.e. which are not under the control management.
Example:- Rent of building is not controllable so is managerial salaries.

 :-
Under this , costs are classified according to whether these are costs which are normally incurred
at a given level of output in the conditions in which that level of activity is normally attained.
Depending upon the cost which normally incurred or abnormally incurred ,they are classified
into normal or abnormal cost respectively.

  :-
Costs can be classified as:-

($&  
 The costs which are ascertained after being incurred are called historical
cost .
($'     
 Such costs are estimated costs i.e. computed in advance of
production taking into consideration the previous periods costs .

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According to planning and control, costs are classified as budgeted and standard costs.

    :- Budgeted costs represent an estimate of expenditure for different phases of

business operation such as manufacturing , administration, sales , research, and development etc.
coordinated in a well conceived framework for a period of time in future which subsequently
becomes the written expression of managerial targets to be achieved .

   
 The Chartered Institute of Management Accountants, London defines

standard cost as " the predetermined cost based on a technical estimate for materials, labor and
overhead for a selected period of time and for a prescribed set of working conditions. "

Budgeted costs deal with aggregates whereas standard costs deal with individual parts which
make the aggregate.

Example:- Budgeted costs are calculated for different functions of the business i.e. production
,sales etc. whereas standard costs are compiled for various elements of costs i.e. materials,labor.







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The measure types of costs in Managerial Decision are explained below:-

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Where a decision to pursue one alternative is made, the benefits of other
options are forgone. Benefits lost from rejecting the next best alternative are the opportunity
costs of the chosen action. Since opportunity costs are not actually incurred, they are not
recorded in the accounting records. They are, however, relevant costs for decision-making
purposes and must be considered in evaluating a proposed alternative.

The cost of passing up the next best choice when making a decision is referred to as opportunity
cost. For example, if an asset such as capital is used for one purpose, the opportunity cost is the
value of the next best purpose the asset could have been used for. Opportunity cost analysis is an
important part of a company's decision-making processes, but is not treated as an actual cost in
any financial statement.

  
 Marginal Cost is the total of variable costs i.e. prime cost plus variable
overheads.

   
 The change in costs due to change in the level of activity or pattern or
method of production is known as differential cost.

(
A sunk cost is an irrecoverable cost and is caused by complete abandonment of a

plant.
c)
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Raw Materials consumed (Direct Materials)  1,00,000
Direct Labor  30,000
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Wages of foreman 2,500 
Oil and Water 500 
Electric Power 200 
Lighting 1,500 
Storekeeper Wages 1,000 
Rent 5,000 
Repairs & Renewals (Plant) 3,500 
Depreciation (Plant) 500 
Consumable Stores 2,500 -*),,
Works Cost *.-*),,



      
Lighting 500 
Rent 2,500 
Repairs 500 
Depreciation Office Premises 1,250 
Manager's Salary 5,000 
Director's fee 1,250 
Office Stationery 500 
Telephone charges 125 
Postage & Telegram 250 11,875

'    */0*,-/

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Salesman Salary 1,250
Travelling 500 
Advertising 1,250 
Warehousing Charges 500 
Carriage Outward 375 3,875

  *2)*0/,

Profit 26,550
  *30*/,,




c+
Discuss the practical implications of the above.

The various elements of costs and the classification of costs into different categories have
number of implications.

  
The implication for management in its planning and controlling of variable costs
is with all other factors held constant, such as selling price per unit and total fixed cost, each
desired per-unit expansion of productive activity triggers an incremental change in total variable
costs equal to a constant amount per unit. As long as the selling price per unit exceeds the
variable cost per unit, productive activity should be expanded.

 ! 
Theseare those in which total fixed cost remains constant over a relevant range of
output, while the fixed cost per unit varies with output.   "  
    
"   

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With all other factors held constant, such
as selling price per unit and variable cost per unit, productive activity should be expanded as far
as possible, which will reduce the fixed cost per unit to its lowest amount. This is the very
essence of the important concept of fully utilizing productive capacity.

"" 
To illustrate some of the powerful implications of the concept of opportunity
cost, consider the case of rural boys and girls not attending school on account of having to
contribute on the farm and the kitchen respectively. Is it not fair that the governments
compensate the parents' loss of real income when children are taken off farms and kitchens to
attend school? The issue is taken care of by way of incentives in the form of free uniforms,
books, transport, mid-day meals and so on. On the top of the income in kind, if the school and
teachers are attractive to the pupils, within a short while, we will see rural India bubbling with
schools full of healthy and happy school children.

  
A distinction is made between direct materials and indirect materials when the product
is the relevant cost objective. Direct materials are those which can be logically and readily
identified with the product. Lumber required for manufacturing furniture, steel for manufacturing
automobiles, and crude-oil for petroleum products are examples of direct materials. When we
talk of material cost of a product, we refer to the cost of direct materials only.

!    
Indirect materials are those which are not readily identified with the
product. Examples of indirect materialsare: glues, nails, and tacks. These are included under
manufacturing overhead

5
As in the case of materials, a distinction is made between direct labor and indirect labor.
Direct labor represents labor which works directly on the product (the cost objective for our
present purposes). Examples of direct labor are: lathe operators, welders, assembly workers. The
cost element labor includes the cost of direct labor only. Indirect labor represents labor which
does not work directly on the product. Examples: foremen, janitors, watchmen. Indirect labor is
included under manufacturing overhead.


   
This refers to manufacturing costs other than direct material and
direct labor costs. The major items included under manufacturing overhead are indirect
materials, indirect labor, factory supplies, utilities depreciation, repairs and maintenance, and
rent and insurance.