2. Types of Cost

Question 1

What is a cost object?

Answer 1

A product, service, centre, activity, customer or distribution channel in relation to which costs are ascertained

Question 2

What is a cost centre?

Answer 2

Any unit such as a division, department or group of employees, to which costs are assigned or allocated

Question 3

What is a profit centre?

Answer 3

A business division responsible for operating costs and revenues

Question 4

What is a revenue centre?

Answer 4

A business division responsible to generate revenues only

Question 5

What is an investment centre?

Answer 5

A business division responsible for operating costs and revenues plus capital investment spending

Question 6

What is a cost unit?

Answer 6

A unit of product or services in relation to which costs are ascertained

Question 7

What is historic cost?

Answer 7

The costs that have actually been incurred and recorded

Question 8

What is economic cost?

Answer 8

The value represented by the next best course of action that could have been taken with the resources available (includes opportunity cost)

Question 9

What is economic value?

Answer 9

The amount that someone is willing to pay for an item

Question 10

What is cost classification?

Answer 10

The arrangement of elements of cost into logical groups with respect to their nature, function or use in the business entity

Question 11

What are direct costs?

Answer 11

Expenditure that can be attributed to a specific cost unit, e.g. materials and labour

Question 12

What is the total of all direct costs referred to as?

Answer 12

Prime cost

Question 13

What are indirect costs?

Answer 13

Expenditure on labour, materials or services that cannot be economically identified with a specific saleable cost unit (also known as overheads)

Question 14

How are overtime or bonuses usually classified?

Answer 14

As an indirect cost, unless:

• The customer has required overtime specifically to be worked in order to get the job done
• Overtime is regularly worked

Question 15

What is full production cost?

Answer 15

Materials + Labour + Production Overheads

Question 16

What is full cost?

Answer 16

The total of all production and non production costs (full production cost + non production overheads)

Question 17

What is marginal cost?

Answer 17

The amount by which the total cost increases if one more unit of a product is made

Question 18

What are the three requirements of a Relevant Cost?

Answer 18

• Future (only future costs considered, those in the past are sunk)
• Incremental (only costs affected by the decision)
• Cash Flow (must affect physical cash transactions)

Question 19

What is the relevant cost of using a material that is not currently in inventory?

Answer 19

Current purchase price (need to buy in order to use)

Question 20

What is the relevant cost of using a material that is currently in inventory, but not for use elsewhere in the business?

Answer 20

Its scrap or resale value (that we could get if we sold it on)

Question 21

What is the relevant cost of using a material that is currently in inventory, is used elsewhere in the business but can be replaced?

Answer 21

Current purchase price (need to buy more in order to use)

Question 22

What is the relevant cost of using a material that is currently in inventory, is used elsewhere in the business and cannot be replaced (is scarce)?

Answer 22

The contribution it could have helped us earn if it was used elsewhere in the business

Question 23

What is the relevant cost of labour, if our labour force is not at full capacity?

Answer 23

Zero

Question 24

What is the relevant cost of labour, if our labour force is at full capacity but we cannot hire more or work overtime?

Answer 24

The contribution (before labour cost) we would lose out on by moving the labour to this job instead: VC of labour + lost contribution

Question 25

What is the relevant cost of labour, if our labour force is at full capacity and we can hire more or work overtime?

Answer 25

The cost of hiring more staff, or the overtime cost

Question 26

What is the option flow for pricing a non current asset?

Answer 26

First: what is the higher of the scrap value or economic value to the business? i.e. would we keep or dispose
Second: what is the lower of the replacement cost or the above? i.e. what is the current value of the machine

Question 27

What is the opportunity cost?

Answer 27

The benefit foregone by choosing one course of action instead of the next best alternative (so, the value of the second best option)

Question 28

What is shareholder value?

Answer 28

The total return to the shareholders in terms of both dividends and share price growth, calculated as the present value of future free cash flows, discounting at the weighted average cost of capital, less the market value of its debt

Question 29

What are the main issues faced in managing environmental costs?

Answer 29

Identification and measurement

Question 30

What things are included in environmental costs to a business?

Answer 30

Conventional costs, clean up costs and compliance costs