Costing Overview and Concepts

Costing Overview

• Costing is a method of determining the costs of products or services, involving classifying, recording, and allocating expenditure. It's essential for management control and guidance.

Costing Objectives

• Determine the cost of each operation to control wages
• Establish product selling prices and company pricing policies
• Provide information for purchasing decisions
• Assist management in making decisions, minimizing waste, and reducing manufacturing costs

Cost Concepts

• Cost is the resources exchanged for goods or services.
• Cost is the expenditure associated with a specific object or activity.
• Cost is the initial monetary value to achieve a particular objective.

Cost Nature

• Cost analysis depends on the business type. Manufacturing concerns focus on per-unit product costs, while service businesses like utilities and transportation focus on costs per service rendered.
• Cost analysis varies by purpose. For pricing, all production, administrative, and selling costs are considered. Inventory valuation only includes production costs.
• Different conditions affect costs. Work-in-progress is valued at factory cost, while finished goods are valued at their production cost.
• Cost is a broad term that includes various expenditure types (fixed, variable, sunk). The cost type chosen depends on its context.

Cost Classification

• Categorization of costs by managerial function:

  • Manufacturing costs involve converting raw materials into finished products (raw materials, direct labor, factory overhead).
  • Non-manufacturing costs are not directly related to transforming materials into finished goods (selling expenses, administrative expenses).

• Classification by traceability:

  • Direct costs are traceable to specific cost objects (materials, direct labor, some operating expenses).
  • Indirect costs are not directly traceable to cost objects (factory overhead, operating expenses for multiple products).

• Classification by timing of charges to revenue:

  • Product costs are part of inventory and are charged against revenue (direct materials, direct labor, factory overhead).
  • Period costs are immediately charged against revenue (selling and administrative expenses).

• Classification by accounting period:

  • Capital expenditure pertains to acquiring or improving assets for increased revenue-generating capacity (land, building, machinery).
  • Revenue expenditure maintains assets in working order and benefits the current accounting period (maintaining equipment, supplies).

• Classification by relevance to decision-making:

  • Overhead costs encompass ongoing business expenses not related to direct materials or labor (rent, utilities, insurance).
  • Standard costs are pre-determined costs based on experience/budgets/industry standards.
  • Opportunity costs represent the forgone benefits from choosing an alternative course of action (lost rent from a building used for production).
  • Sunk costs are historical costs not relevant to current decisions (previous purchase of equipment).
  • Committed costs are fixed, structural costs (property taxes, management salaries, facility rent).
  • Discretionary costs are expenditures based on management decisions (research and development, charitable donations, advertising).
  • Controllable costs are those that supervisors/managers can influence (office supplies, overtime).

Cost Behavior

• Fixed costs remain constant regardless of output volume (rent, insurance, salaries).

• Variable costs change proportionally with output volume (materials, direct labor, variable manufacturing costs).

• Mixed costs contain both fixed and variable components (utilities).

• Step costs remain constant within certain output ranges, increasing by a fixed amount when the range changes (supervisor salaries).

Separating Mixed Costs

• High-low method is used to identify variable and fixed components of mixed costs, useful in budgeting.

Inventory Accounting

• Raw Materials Inventory tracks available raw materials.
• Work-in-Process Inventory represents costs of partially completed goods.
• Finished Goods Inventory stores the costs of completed, ready-for-sale products.
• Perpetual Inventory System maintains detailed records of inventory movements (stock cards)
• Periodic Inventory System counts inventory physically to determine quantities on hand.

Costing Methods

• Actual Costing System charges all production costs (direct materials, direct labor, manufacturing overhead) to the specific jobs or products. It uses actual figures for all costs.
• Normal Costing System applies predetermined overhead rates to estimate manufacturing overhead costs. It uses actual amounts for direct materials and direct labor, and a predetermined rate for manufacturing overhead.