Monday, 17 December 2012

types of costs

Types of costs
Classification of costs:

    • Materials – costs of raw materials, components and other goods used.

    • Labor – cost of employees wages and salaries.

    • Expenses – costs which cannot be included in materials and labor.

Variable costs – these costs varies directly with changes in the level of quantity, over a defined period of time.

Fixed costs – are not affected by the changes in the level of activity, over a defined period of time.

Semi variable costs – for example, office salaries where there is a core of long term secretarial staff plus employment of temporary staff when activity levels rise.

Direct and indirect costs

Costs of a business activity can also be classified as direct and indirect costs.

    • Direct cost – can be identified directly with each unit of output.

    • Prime cost – total of all direct costs

    • Indirect cost or overheads – are costs other than those identified as direct costs. They cannot be identified directly with specific units.

Remote costs – are costs which cannot be associated closely with any particular revenue generating function within the business, but which are incurred on behalf of the whole organization.

Product and Period costs – are those costs which are treated as expenses in the period in which they are incurred.

Classification by Function

  1. Premises costs

These are the costs that are related to the area in which a business runs its work.

    • Rent – some businesses might not own the work area, therefore the company must pay the owner for the rent.

    • Rates – these are forms of taxes to be paid to the local authority that contributes to the services provided by that authority.

    • Heating and lighting-gas and electricity bills must be paid to the company supplying the service.

    • Insurance – the buildings must be insured against physical damages like fire and explosions.

  2. Administrative costs
  1. Direct Costs
    • Direct costs represent any cost related to the production of goods or services. Raw materials, labor and manufacturing overhead are primary direct costs. Raw material costs include the physical materials a company uses to produce consumer goods. Labor represents employees directly involved in the company's manufacturing process. These individuals run the equipment or convert raw materials into finished goods. Manufacturing overhead is the cost of facilities or equipment companies use to produce goods and services.
Indirect Costs
    • Indirect costs include expenses outside of a company's production process. Office supplies, sales personnel, accounting and customer service operations represent a few common indirect costs. The amount of indirect costs should represent a much smaller proportion of the company's overall business expenditures. High indirect costs indicate companies spend more money on potentially non-essential business functions.
Fixed Costs
    • Direct and indirect costs are either fixed or variable. Fixed costs represent items that do not change based on the amount of goods or services a company produces. Depreciation, rent , insurance and management salaries represent fixed costs. Businesses must pay fixed costs each month regardless of how many items a company produces or sells.
Operating leverage is a term that represents the amount of fixed costs a company generates in its operations. A high degree of operating leverage indicates a company with high fixed costs must offset these costs with higher sales.
    • Variable costs represent items that change based on a company's production output. Hourly employee wages, utilities, raw materials and shipping charges are a few common variable costs. Business owners can typically avoid high variable costs if they produce fewer goods or services. However, sales will also fall since companies have lower production outputs and fewer opportunities to generate consumer sales.
The overall objectives of a firm’s financial accounting statements are: (Stickney et al, 1991):
1) To provide information useful for making rational investment and credit decisions.
2) To allow investors and creditors to assess the amount, timing, and uncertainty of cash flows.
3) To provide information about the economic resources of a firm and the claims on those
4) To provide information about a firm’s operating performance during a period.
5) To provide information on how a firm obtains and uses money and other financial resources.
6) To provide information on how management has discharged its stewardship responsibility to
owners and the Management or Cost Accounting Systems and Capital Budgeting
Management or cost accounting systems are part of an enterprise’s information system and refer
to the internal cost tracking and allocation systems to track costs and expenditures. These are
internal rather than external accounting systems. There are no fixed rules governing how an entity
should keep track of cash flows internally, although there are many formal methods available for
users. Capital budgeting is basically a form of predictive cost accounting over a set time frame
which is used to analyze the costs of alternative projects or expenditures over the specified
1.     period of time.public.

Allocation source
The allocation source establishes which costs are allocated. Allocations are defined in allocation source and allocation target tables. Each allocation consists of an allocation source and one or more allocation targets. For example, all costs for the heating cost type, which is an allocation source, can be allocated to the workshop, production, and sales cost centers, which are three allocation targets.
Allocation target
The allocation targets determine where the costs are allocated. Allocations are defined in allocation source and allocation target tables. Each allocation consists of an allocation source and one or more allocation targets. For example, all costs for the heating cost type, which is an allocation source, can be allocated to the workshop, production, and sales cost centers, which are three allocation targets.
Cost accounting
In cost accounting, actual costs of operations, processes, departments, or products are recorded. These costs are allocated to cost centers and cost objects by using different cost allocation methods. Managers use statistics and reports, such as cost distribution sheet and profit and loss analysis to make decisions and reduce costs. Cost accounting retrieves data from the general ledger, but works independently. Therefore transactions posted in cost accounting do not affect the data in the general ledger.
Cost type
The chart of cost types has the same function as the chart of accounts in the general ledger. They are often structured similarly. Therefore it is possible to transfer the general ledger chart of accounts to the chart of cost types and then modify it. The chart of cost types can also be created from scratch.
Cost center
Cost centers are most often departments and profit centers that are largely responsible for company’s costs and income. Cost centers can be synchronized with dimensions in the general ledger. It is also possible to add new cost centers and define their own sorting with subtotals.
Cost object
Cost objects are products, product groups or services of a company, the finished goods of a company, that in the end carry the costs. Cost objects can be synchronized with dimensions in the general ledger. It is also possible to add new cost objects and define their own sorting with subtotals.
Cost allocation
Cost allocation is a process of allocating costs to cost centers or cost objects. For example, the wage of the truck driver of the sales department is allocated to the sales department cost center. It is not necessary to allocate the wage cost to other cost centers. Another example is that the cost of an expensive computer system is allocated to the products of the company that use the system.
Dynamic allocation
Dynamic allocations are dependent on changeable allocation bases, for example, the number of department employees, or the sales revenue of the project within a certain period of time. There are nine predefined dynamic allocation bases that users can define by using five filters.
Direct cost
Direct costs are the costs that can be directly allocated to a cost object, for example, material purchase for a specific product.
Fixed cost
Fixed costs are the costs that are not dependent on the level of goods or services produced by the company. They tend to be time-related, such as salary or rent being paid per month. They are in contrast to variable costs, which are volume-related, and are paid per quantity produced.
Indirect cost
Indirect costs are not directly accountable to a cost object, such as a particular function or product. Indirect costs may be either fixed or variable. Indirect costs can be tax, administration, personnel, and security costs and are also known as overhead costs.
Level is used to define allocation order. Level is defined as a number between 1 and 99. The allocation posting follows the order of the levels. For example, level ensures that first administration is allocated to workshop before workshop is allocated to vehicle and production.
Static allocation
Static allocations are based on a fixed set of values, for example, the square meters used, or an established allocation ratio, such as 5:2:4.
Operational cost
Operational costs are the recurring expenses which are related to the operation of a business, a device, and a component.
Overhead cost
Overhead costs refer to ongoing expenses of operating a business. They are all costs on the income statement except for direct labor, direct materials, and direct expenses. Overhead costs include accounting fees, advertising, depreciation, insurance, interest, legal fees, rent, repairs, supplies, taxes, telephone bills, travel, and utilities costs.
Step variable cost
Step variable costs are costs that change dramatically at certain points because they involve large purchases that cannot be spread out over time. For example, one employee can produce 100 tables in a month. The employee’s wage is constant over a production range of 1 to 100 tables. If the company wants to produce 110 tables, the company needs two employees. So the cost will double.
The portion or part that is allocated among cost centers or cost objects.
Static weighting
Costs are allocated according to allocation keys, which can be modified by using a multiplier. For example, two departments, with 20 and 10 employees respectively, share canteen costs. The costs are distributed between the departments by using an allocation key that represents the number of employees that eat in the canteen. In the first department, only 5 employees eat in the canteen, so this department has a multiplier of 0.25. The basis for allocation is 20 x 0.25 = 5. The total number of employees that eat in the canteen is 15. One third of the costs are allocated to the first department and two thirds of the costs are allocated to the second department.
Variable cost
Variable costs are expenses that change in proportion to the activity of a business. Variable costs are the sum of marginal costs over all units produced. Fixed costs and variable costs make up the two components of total costs.
A variant is used as an optional user-defined label for allocations. The purpose of the label is to filter groups of allocation.
See Also Cost is “the amount, measured in money, of cash expended or other property transferred, capital stock issued, services performed, or a liability incurred, in consideration of goods or services received or to be received.”
Expense is “all expired costs which are deductible from revenues.” In a narrower sense "the term 'expense' refers to operating, selling, or administrative expenses, interest, and taxes." Items included in cost of manufacturing, such as materials, labor, and overhead, should be described as costs, not expenses.
Loss is “(1) the excess of all expenses, in the broad sense of that word, over revenues for a period, or (2) the excess of all or the appropriate portion of the cost of assets over related proceeds, if any, when the items are sold, abandoned, or either wholly or partially destroyed by casualty or otherwise written off. When losses such as those described' in (2) are deducted from revenues, they are expenses in the broad sense of that term.”
Activities of the Cost Department
The principal activities or tasks of cost accounting include:
1. Providing data to aid management in making a choice among two or more alternatives.
2. Preparing data to aid in the reduction or improvement of costs.
3. Aiding in the creation and execution of budgets.
4. Computing costs and profit for an accounting period.
S. Developing inventory costs for inventory control and pricing.
Classification of Costs
Classification of costs is necessary in order to determine the most suitable method of accumulating and allocating cost data. The principal methods of accumulating costs are described below.
Manufacturing: Costs applied to producing a product.
Marketing: Costs incurred in selling a product or service. Administrative: Costs incurred in policy-making activities.
Financial: Costs related to financial activities.
Direct material: Material which is an integral part of the finished product.
Direct labor: Labor applied directly to components of the finished product.
Factory overhead: Indirect materials, indirect labor, and the manufacturing expenses that cannot logically be charged directly to specific units, jobs, or products.
Direct: Costs which are charged to the product and require no further allocation.
Indirect: Costs which are allocated.
Production: A unit in which operations are performed on the part or    product and whose costs are not further allocated.
Service: A unit not directly engaged in production and whose costs are ultimately allocated to a production unit.
When Charged to Income
Product: Costs included when product costs, as defined above, are computed. Product costs are included in inventory and in cost of sales when the product is sold.
Period: Costs associated with the passage of time rather than with the product. These are closed out to the income summary each period since no future benefits are expected.
Relation to Volume
Variable: Costs which change in total in direct proportion to changes in related activity.
The unit cost remains the same regardless of volume. Fixed. Costs which do not change in total over wide ranges of volume. The unit costs decrease as volume increases.
Period Covered
Capital. Costs which are expected to benefit future periods and are classed as assets.
Revenue. Costs which benefit only the current period and are thus expenses.
Degree of Averaging
Total. The cumulative cost for the established category.
Unit. The total cost divided by the number of units of activity or volume.
Cost Systems
The cost classifications do not provide all required cost data. Most cost planning and control data can only be provided by an adequate cost system, designed so that individual supervisors, department heads, and executives can be held accountable for all costs which are their responsibility. The concepts of authority and responsibility are closely related to accountability and are carefully considered in evaluating personal performance.
The cost system must be closely tailored to the organizational structure of the company, the manufacturing process, and the type of information desired and required by executives. There are numerous kinds of cost systems, each with its own advantages and disadvantages. The principal types of cost systems, classified according to their particular attribute, are described below.
Nature of Manufacturing
Job order: The cost unit is the job and costs are accumulated by job. It is most suitable where each job or order is different than others, such as in a printing shop.
Process. The cost unit is the average cost for the units produced in a specified period of time, such as a week. The method is most suitable where high-volume similar products are produced, such as those of flour mills, steel mills, paper mills, etc.
Time When Computed
Actual Costs are collected as they occur, but determination of unit costs must wait for completion of manufacturing operations for the period.
Standard. Costs are. predetermined some time ahead of production. Standards may be used for both quantity and dollar value. Differences between actual and standard costs are shown in variance accounts which are then analyzed to determine the cause of the difference. Application of Overhead
Direct costing. This method, sometimes called variable costing, assigns only direct product costs to inventory. The fixed overhead costs are charged against revenue in the period incurred.
Full absorption. All costs, including fixed overhead costs, are applied to the product and are included in inventory.
Unit Costs
The total cost figure is usually unsatisfactory from a control standpoint since the quantity of production varies greatly from period to period. Therefore, . some common denominator, such as unit costs, must be available for

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