Terms
Cost is the sacrifice made, usually measured by the resources given up, to
achieve a particular purpose. A sacrifice made in order to obtain some goods
or services
Costs are not always Expenses.
Some costs are Assets, other costs are Expenses
Expenses are Expired (Used up) Costs
Eventually, costs will become expenses.
Product cost
It is cost assigned to goods either purchased or manufactured for resale. Costs
that are incurred for producing or buying a product. Product costs are initially
identified as part of the inventory on hand. (Raw materials, Work-in-process,
Finished goods
Inventoriable cost
It is another name for product cost, and it is stored as the cost of inventory
until the goods are sold. Become expenses (Cost of goods sold) when the
product is sold.
Period cost
Period costs are expensed during the time period in which they are incurred.
Costs that are treated as expenses of the period in which the costs are
incurred.
Manufacturing cost/ Elements of Cost
Product costs consisting of:
Direct material (DM)
Direct labor (DL)
Manufacturing overhead (MOH, OH)
Manufacturing cost formula:
Manufacturing costs = DM + DL + MOH
Direct material (DM)
It is raw material that is physically incorporated into the finished product.
Direct labor cost
It is the cost of salaries, wages, and fringe benefits for personnel who work
directly on the manufactured products.
Manufacturing overhead
Manufacturing costs other than direct material and direct labor costs.
Indirect material
These are required for the production process but do not become an
integral part of the finished product.
Indirect labor
It is the cost of personnel who do not work directly on the product. but
whose services are necessary for the manufacturing process.
Conversion cost
Conversion Costs are direct labor costs plus manufacturing-overhead costs.
Prime costs
These are the costs of direct material and direct labor.
1. Prime cost = Direct Material + Direct Labor
2. Conversion cost = Direct labor + Factory Overhead
3. Factory Cost = Direct Materials + Direct Labor + Factory overhead
Non-manufacturing cost
Period costs (expenses) incurred in and Administrative activities.
Cost Behavior
Fixed Costs (FC) The costs which don’t vary with changing output.
Variable Costs (VC) Costs which depend on the output produced.
Semi-Variable Cost. Labor might be a semi-variable cost. If you produce
more cars, you need to employ more workers; this is a variable cost. However,
even if you didn’t produce any cars, you may still need some workers to look
after an empty factory.
Marginal Costs – Marginal cost is the cost of producing an extra unit. If the
total cost of 3 units is 1550, and the total cost of 4 units is 1900. The marginal
cost of the 4th unit is 350.
Opportunity Cost – Opportunity cost is the next best alternative foregone. If
you invest £1million in developing a cure for pancreatic cancer, the
opportunity cost is that you can’t use that money to invest in developing a
cure for skin cancer
Operating Costs
Operating Cost are expenses associated with day-to-day business
activities but are not traced back to one product. Operating costs can be
variable or fixed. Examples of operating costs, which are more commonly
called Operating Cost. include rent and utilities for a manufacturing
plant. Operating costs are day-to-day expenses, but are classified separately
from indirect costs – i.e., costs tied to actual production. Investors
can calculate a company's operating expense ratio, which shows how efficient
a company is in using its costs to generate sales.
Sunk Cost These are costs that have been incurred and cannot be recouped. If
you left the industry, you could not reclaim sunk costs. For example, if you
spend money on advertising to enter an industry, you can never claim these
costs back. If you buy a machine, you might be able to sell if you leave the
industry.
Avoidable Costs. Costs that can be avoided. If you stop producing cars, you
don’t have to pay for extra raw materials and electricity. Sometimes known as
an escapable cost
Explicit costs – these are costs that a firm directly pays for and can be seen on
the accounting sheet. Explicit costs can be variable or fixed, just a clear
amount.
Implicit costs – these are opportunity costs, which do not necessarily appear
on its balance sheet but affect the firm. For example, if a firm used its assets,
like a printing press to print leaflets for a charity, it means that it loses out on
revenue from producing commercial leaflets.
Absorption Costing
Absorption costing (also known as full absorption costing) indicates that all of
the manufacturing costs have been assigned to (absorbed by) the units of goods produced.
In other words, the cost of a finished product includes the following costs:
direct materials
direct labor
variable manufacturing overhead
fixed manufacturing overhead
Absorption Costing Formula:
In absorption costing,
Unit Costs of Product = Direct Cost + Production Overhead Cost
Direct Cost = Direct Material + Direct Labor
Production Overhead Cost = Variable Manufacturing Overhead + Fixed
Manufacturing Overhead
Budget costing
A budget is a financial plan that includes both financial and non-financial information. Its
most obvious features are a projection of revenue (how much you anticipate selling) and
expenses (how much you anticipate spending). ... And a budget looks into the future.
Product lifecycle costing
Product lifecycle costing is the accumulation of a product's costs over its whole life, from inception to
abandonment. The typical stages of a product's whole life are:
Introduction
Growth
Maturity
Decline.
“The total cost throughout its life including planning, design, acquisition and support
costs and any other costs directly attributable to owning or using the asset”.
Target costing
Target costing is a system under which a company plans for the price points ,
product costs, and margins that it wants to achieve for a new product. If it cannot
manufacture a product at these planned levels, then it cancels the design project
entirely.
