CLASSIFICATION OF COSTS: managerial aspect Alina V. RABOSHUK, Ph. D Zhytomyr State Technological University
Cost of the item = a physical quantity measurement x a price measurement Alina Raboshuk Cost classification: a managerial aspect 2
Traditional types of cost classification • Variable costs and fixed costs • Direct costs and indirect costs • Product costs and period costs Alina Raboshuk Cost classification: a managerial aspect 3
Activity and output • Acitivity – a • Output – a general product or description to service provided cover any physical by the enterprise operation that or by one of its takes place in an internal sections enterprise Alina Raboshuk Cost classification: a managerial aspect 4
A variable cost is one which varies directly with changes in the level of activity, over a defined period of time Examples of variable cost are: - material used to manufacture a unit of output or to provide a type of service; - labor costs of manufacturing a unit of output or providing a type of service; - commission paid to a salesperson. Alina Raboshuk Cost classification: a managerial aspect 5
A fixed cost is one which is not affected by changes in the level of activity, over a defined period of time Examples of fixed cost are: - rent of buildings; - salary paid to a supervisor; - advertising in the trade journal; - business rates paid to the local authority; - depreciation of machinery calculated on the straightline basis. Alina Raboshuk Cost classification: a managerial aspect 6
Cost Classifications Alina Raboshuk Cost classification: a managerial aspect 7
A semi-variable cost is one which is partly varies with changes in the level of activity, over a defined period of time Examples of semi-variable costs: • office salaries where there is a core of long-term secretarial staff plus employment of temporary staff when activity levels rise. Alina Raboshuk Cost classification: a managerial aspect 8
Step costs A fixed cost that increases in steps is called a step cost. Examples: • the cost of renting storage space; • The cost of paying a supervisor of a team of employees. Alina Raboshuk Cost classification: a managerial aspect 9
Step-Variable Costs Cost Total cost remains constant within a narrow range of activity. Activity Alina Raboshuk Cost classification: a managerial aspect 10
Rent Cost, thousands of dollars Step-Fixed Costs 9 Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. 6 3 0 1, 000 2, 000 3, 000 Rented Area (m 2) Alina Raboshuk Cost classification: a managerial aspect 11
The definition of direct and indirect costs depends on the purpose for which the cost will be used. • Direct costs are directly traceable to an identifiable unit, such as product or service or department of the business, for which costs are to be determined. • Indirect costs are spread over a number of identifiable units of the business, such as products or services or departments, for which costs are to be determined. Indirect costs are also called overhead costs. • Overhead costs are the costs which cannot be identified directly with products or services. Alina Raboshuk Cost classification: a managerial aspect 12
Direct and Indirect Costs Direct costs Indirect costs • Costs that can be easily and conveniently traced to a product or department. • Costs that must be allocated in order to be assigned to a product or department. • Example: cost of paint in the paint department of an automobile assembly plant. Alina Raboshuk • Example: cost of national advertising for an airline is indirect to a particular flight. Cost classification: a managerial aspect 13
Product costs are those costs associated with goods or services purchased, or produced, for sale to customers. Period costs are those costs which are treated as expenses in the period in which they are incurred. Alina Raboshuk Cost classification: a managerial aspect 14
Prime cost of production is the total of direct materials, direct labor and other direct costs. Production overhead costs comprises indirect materials, indirect labor and other indirect costs of production. Alina Raboshuk Cost classification: a managerial aspect 15
Exhibit 1 Statement of product cost £ £ Direct materials Direct labor Other direct costs XXX XXX Prime cost Indirect materials Indirect labor Other indirect costs Production overhead XXX XXX XXX Total product cost Alina Raboshuk XXX Cost classification: a managerial aspect 16
Marginal Costs & Average Costs The extra cost incurred to produce one additional unit. The total cost to produce a quantity divided by the quantity produced. Marginal and average costs are largely a function of cost behavior variable and fixed costs. Alina Raboshuk Cost classification: a managerial aspect 17
Planning involves looking forward and asking questions of the type “what if … ? ” Alina Raboshuk Cost classification: a managerial aspect 18
Exhibit 2 Cost classification for planning purposes Planning questions Cost classification 1. What is the cost impact of a change in levels of production over a period of time? Fixed and variable costs. 2. What is the cost effect of Direct and indirect costs, in planning to expand operations by relation to the location. opening a new outlet in a separate location? 3. What is the cost impact of Fixed and variable costs. remaining open for longer hours to improve on existing client services? Alina Raboshuk Cost classification: a managerial aspect 19
Manufacturing Costs Direct Labor Direct Material Manufacturing Overhead The Product Alina Raboshuk Cost classification: a managerial aspect 20
Decision making involves asking questions of the type “Should we do … ? ” Alina Raboshuk Cost classification: a managerial aspect 21
Exhibit 3 Cost classification for decision-making purposes Decision-making questions Cost classification 1. Should the company produce components in the country or produce them overseas? Fixed and variable costs. 2. Should the company continue to provide a service when demand is falling? Fixed and variable costs. The price paid by customers must at least cover the variable costs. Alina Raboshuk Cost classification: a managerial aspect 22
Process of Management Planning Control Managers need cost information to perform each of these functions. Decision Making Alina Raboshuk Directing Cost classification: a managerial aspect 23
Control involves looking back and asking question of the “how and why … ? ” type. Alina Raboshuk Cost classification: a managerial aspect 24
Exhibit 4 Cost classification for control purposes Control questions Cost classification 1. How closely do the costs of each product match the targets set? Direct and indirect costs in relation to the product. 2. How closely do the costs of a service department match the budget set for the department? 3. Is the value of the stock of unsold goods stated correctly Direct and indirect costs related to the department. Alina Raboshuk Product costs and period costs. Cost classification: a managerial aspect 25
Cost code A cost code is a system of letters and/or numbers designed to give a series of unique labels which help in classification ad analysis of cost information. Alina Raboshuk Cost classification: a managerial aspect 26
Cost selection and reporting A cost centre is the unit of the organization in respect of which a manager is responsible for costs under his or her control. A cost centre should be a location (e. g. a department) or a function (e. g. the manufacture of a product), or it could even be a production machine or group of similar machines. Alina Raboshuk Cost classification: a managerial aspect 27
Profit centre A profit centre is a unit of organization in respect of which a manager is responsible for revenue as well as costs. Alina Raboshuk Cost classification: a managerial aspect 28
Investment centre An investment centre is a unit of organization in respect of which a manager is responsible for capital investment decisions as well as revenue and costs. These decisions could be related to such matters as purchases and disposal of equipment. Alina Raboshuk Cost classification: a managerial aspect 29
Controllable cost A controllable cost is one which is capable of being managed by the person responsible for the cost centre, profit centre or investment centre to which the cost is reported. Alina Raboshuk Cost classification: a managerial aspect 30
Responsibility Centers Cost Center Segment has control over the incurrence of costs. The Paint Department in an automobile plant. Alina Raboshuk Revenue Center Segment is responsible for the revenue of a unit. The Reservations Department of an airline. Cost classification: a managerial aspect 31
Responsibility Centers Profit Center Segment has control over both costs and revenues. Company-owned restaurant in a fast-food chain. Alina Raboshuk Investment Center Segment has control over profits and invested capital. A division of a large corporation. Cost classification: a managerial aspect 32
Costs and Benefits of Information Benefits Costs More information does not mean more benefits if information overload results. Alina Raboshuk Cost classification: a managerial aspect 33
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