Cost Concepts

MANAGEMENT ACCOUNTING & CONTROL

SESSION 3-5

1
Objective
At the end of this session you should be able to understand
Types of cost – historical costs, future costs, standard costs,
period costs, prime costs, direct and indirect costs, opportunity
costs, imputed costs, programmed costs, joint cost, sunk cost,
discretionary cost, out of pocket cost, differential cost, capacity
cost, conversion cost, committed cost
Cost unit, cost center
Cost Sheet

2
Cost
Cost is the amount of expenditure, actual (incurred) or notional
(attributable), relating to a specific thing or activity
Cost is the amount of resources given up in exchange for
some goods or services
Expenses are expired costs, incurred and totally used up in
generation of revenue
Loss is lost cost

3
Classification of Cost
Objectives
◦ Determining product costs for stock valuation and profit
measurement
◦ Planning
◦ Decision Making
◦ Control

4
Natural Classification
Direct Material: Cost of materials which are conveniently and
economically traceable to specific units of cost
Direct Labour: Labour of those workers who are engaged in
the production process
Direct Expenses: Any expenditure other than direct material
and direct labour directly incurred on a specific product or job
As per CIMA, Prime Cost is the total cost of direct material and
direct labour

5
Natural Classification
Conversion Costs: Conversion costs are the combination of
direct labor costs plus manufacturing overhead costs.
Committed Cost: A committed cost is an investment that a
business entity has already made and cannot recover by any
means, as well as obligations already made that the business
cannot get out of.

6
Natural Classification
Factory Overhead: Cost of indirect materials, indirect labour
and indirect expenses
The total of (i) Prime Cost and, (ii) Factory Overheads is
known as ‘Factory Cost’.
Selling, Distribution and Administrative Overheads: Covers the
cost of making sales and delivering/dispatching products
The Sum of (i) Prime Cost, (ii) Factory Overhead and (iii)
Selling and Distribution and Administrative Overhead is the
Total Cost, that is, the cost “to make and sell”.

7
Cost Behaviour (in Relation to Changes
in Output or Activity or Volume)
Fixed Cost: which does not change in total for a given time
period despite wide fluctuations in output or volume of activity
Committed Costs
Managed Costs
Discretionary Costs
Step Costs

8
Cost Behaviour (in Relation to Changes
in Output or Activity or Volume)
Variable Cost: Those costs that vary directly and
proportionately with the output
Mixed Cost: Made up of fixed and variable elements. They are
a combination of semi-variable and semi-fixed costs

9
Degree of Traceability to the Product
Direct Cost: Costs which are easily traceable or identifiable
with a product are called direct costs
Indirect Cost: Costs which cannot be identified with, or traced
to a single product because they are incurred for several
products

10
Association with the Product
Product Cost: Those costs which are identified with the
product and included in inventory values.
In a manufacturing concern, they are composed of: (i) direct
materials, (ii) direct labour, (iii) direct expenses, and (iv)
manufacturing overhead
Period Cost: Costs which are not identified with product or job
and are deducted as expenses during the period in which they
are incurred

11
Functional Classification of Costs
Refers to how the cost was used (manufacturing,
administration or selling)
It provides an opportunity to the management to evaluate the
efficiency of departments performing different functions in the
organisation

12
Relationship with Accounting Period
Capital Expenditure: provides benefit to future periods and is
classified as an asset
Revenue Expenditure: assumed to benefit the current period
and is classified as an expense

13
Costs for Decision Making and
Planning
Opportunity Cost: Cost of opportunity lost. Cost of selecting
one course of action in terms of the opportunities which are
given up to carry out that course of action
Sunk Cost: Cost that has already been incurred. Unavoidable
cost. Costs which cannot be changed or avoided by any
decision that is made in the future
Relevant Cost: Which are affected and changed by a decision.
They are only (i) future costs and (ii) incremental or avoidable
costs

14
Costs for Decision Making and
Planning
Historical Cost: These are past costs which are ascertained
after these have been incurred. Nothing but actual costs.
Future Cost: No decision can change what has already
happened. Only costs which are relevant for decision making
are future costs
Discretionary Cost: A discretionary cost is a cost or capital
expenditure that can be curtailed or even eliminated in the
short term without having an immediate impact on the short-
term profitability of a business.

15
Costs for Decision Making and
Planning
Differential Cost: differential in total costs between any two
alternatives. Also known as incremental costs. They
encompass both cost increases and cost decreases between
alternatives
Imputed Cost: Not actually incurred in any transaction but
which are relevant to the decision as they pertain to a
particular situation
The revenue foregone represents an opportunity cost, and
thus imputed costs are opportunity costs

16
Costs for Decision Making and
Planning
Out-of-Pocket Cost: Signify the cash cost incurred on an
activity. Significant for the management to decide whether the
project will return the cash expenditures associated with the
project
Shut Down Cost: Costs which have to be incurred under all
situations in the case of stopping manufacture of a product or
closing down a department or a division. Always fixed costs.

17
Costs for Control
Controllable Cost: A cost which cannot be influenced by the
action of a specified member of an undertaking. Two factors: (i)
the time period factor, and (ii) the decision-making authority,
can make a cost controllable or uncontrollable.
Standard Cost: Costs which are planned or predetermined cost
estimates for a unit of output in order to provide a basis for
comparison with actual costs. Used to prepare budgets.

18
Costs for Control
Programmed Cost: The programmed costs is a costs that is
subject to both management discretion and management
control but which has little immediate relevant to current
operation although it is generally incurred to ensure long term
survival.
Capacity Cost: A fixed expense incurred by a company or
organization in order to provide for or increase its ability to
conduct business operations.

19
Other Costs
Joint Cost: arise where the processing of a single raw material
or production resources results in two or more different
products simultaneously. It’s the cost of two or more products
that are not identifiable as individual types of products until a
certain stage of production known as the split-off point is
reached.
Common Cost: Those which are incurred for more than one
product, job, territory or any other specific costing object

20
Cost Control
Management actions to keep the costs within standards and/or
budget.
Comparative analysis of actual costs with appropriate
standards or budgets to facilitate performance evaluation and
formulation of corrective measures
Does not necessarily mean reducing the cost but its aim is to
have the maximum utility of the cost incurred

21
Cost Reduction
A planned, positive approach to bring costs down
Implies real and permanent reduction in the unit cost of goods
manufactured or services rendered without impairing their
quality or suitability for the use intended that is, without
reducing their value in terms of utility or satisfaction to the
customers.
Achieved by (i) reducing cost per unit, (ii) increasing
productivity

22
Cost Management
It considers both cost control and cost reduction in its
perspective
The objective is to increase productivity of resources and
factors of production and to relate them to enhance profitability
It identifies, collects, measures, classifies and report
information that is useful to managers and other internal users
in cost ascertainment, planning, controlling and decision
making

23
Cost Unit
A unit of quantity of product, service or time (or a combination
of these), in relation to which cost may be ascertained or
expressed
In job costing method, cost unit a single specific order; in batch
costing it consists of a group of similar articles; and in contract
costing, it consists of a single product

24
Cost Centre
A location, person, or item of equipment for which costs may
be ascertained and used for purposes of cost control.
Impersonal CC: Consists of a location or item of equipment
Personal CC: which consists of a person or group of persons
Operation CC: which consists of the machines and/or persons
carrying out similar operations
Process CC: which consists of a specific process or a
continuous sequence of operations

25
Cost Sheet
A cost sheet is a
statement of cost
which is prepared to
ascertain the cost of
products. It shows
element wise cost of
products.

26
Conclusion
In this session we learnt about
Types of cost – historical costs, future costs, standard costs,
period costs, prime costs, direct and indirect costs, opportunity
costs, imputed costs, programmed costs, joint cost, sunk cost,
discretionary cost, out of pocket cost, differential cost, capacity
cost, conversion cost, committed cost
Cost unit, cost center,
Cost Sheet

27