Costing: Cost Objects and Classifications

• Costing refers to determining the monetary value of resources for production/services.
• It identifies, measures, and assigns costs to specific products, projects, or activities.
• Costing is essential for decision-making, performance evaluation, and cost control.
• Accurate costing aids pricing, profitability analysis, and resource allocation.

Cost Objects

• A cost object is any item needing separate cost measurement.
• Examples: products, services, projects, departments, or customer segments.
• Cost objects facilitate tracing and allocating costs to specific business areas.

Cost Classification

• Direct costs are traceable to a cost object (e.g., raw materials, direct labor).
• Indirect costs aren't easily traced to a cost object (e.g., factory overhead, admin expenses).
• Fixed costs remain constant regardless of production volume within a relevant range (e.g., rent, salaries).
• Variable costs change proportionally with production volume (e.g., direct materials, direct labor).
• Product costs are linked to production and included in inventory (e.g., direct materials, direct labor, manufacturing overhead).
• Period costs aren't directly related to production and are expensed when incurred (e.g., selling, general, and administrative expenses).

Costing Methods

• Job costing is for unique/custom products; costs are tracked per job.
• Process costing is for large quantities of similar products; costs are averaged over total units.
• Activity-based costing (ABC) assigns costs to activities and then to products/services based on activity consumption.
• ABC provides more accurate cost allocation than traditional methods.

Cost-Volume-Profit (CVP) Analysis

• CVP analysis examines the relationship between costs, volume, and profit.
• It helps determine break-even point, target profit, and the impact of cost/volume changes on profitability.
• The break-even point is where total revenues equal total costs.
• Contribution margin is the difference between sales revenue and variable costs.
• It represents the amount available to cover fixed costs and generate profit.
• CVP analysis assumes constant sales prices, linear cost behavior, and a constant sales mix.

Budgeting Techniques

• Budgeting creates a financial plan, estimating revenues, expenses, and cash flows.
• Budgeting aids planning, coordination, control, and performance evaluation.
• A budget is a quantitative expression of a plan for a specific period.

Types of Budgets

• The master budget covers all aspects of an organization's operations.
• It includes the operating and financial budgets.
• The operating budget focuses on income-generating activities.
• It includes the sales, production, and selling/administrative expense budgets.
• The financial budget focuses on financial resources.
• It includes the cash, capital expenditure, and budgeted balance sheet.
• The sales budget estimates expected sales volume and revenue; it's the foundation for all other budgets.
• The production budget determines the units to produce based on sales demand and inventory needs.
• The cash budget forecasts cash inflows/outflows to manage balances and prevent shortages.

Budgeting Approaches

• Traditional budgeting sets budgets based on historical data/incremental changes and is often seen as inflexible.
• Zero-based budgeting (ZBB) requires justifying all budget items each period, promoting efficiency.
• Activity-based budgeting (ABB) focuses on budgeting for cost-driving activities, aligning budgets with strategy.
• A rolling budget is continuously updated, adding a new period and dropping the oldest, for a flexible budget.

Budgetary Control

• Budgetary control compares actual results with budgeted figures.
• Variances are analyzed to identify concerns and correct them.
• Variance analysis helps evaluate performance and improve future budgets.
• A favorable variance means results are better than budgeted.
• An unfavorable variance means results are worse than budgeted.

Benefits of Budgeting

• Improved planning and coordination: Budgeting forces proactive thinking and cross-department coordination.
• Enhanced communication: Budgets communicate goals and expectations.
• Performance evaluation: Budgets offer a performance benchmark.
• Resource allocation: Budgets allocate resources to the most profitable areas.
• Cost control: Budgeting increases cost awareness and helps control expenses.