Cost Terms and concepts Flashcards
Cost unit (definition)
a measurement of output, e.g., a ton of steel, a litre of paint, a kg of sugar.
Cost object (definition)
any activity for which a separate measurement of cost is required (e.g. cost of making a product or providing a service)
Cost centre (definition)
a part of the business for which a measurement of cost is required.
A cost collection system normally accounts for costs in two broad stages:
- Accumulates costs by classifying them into certain categories (e.g. labour, materials and
overheads); - Assigns costs to cost objects.
What is the difference between direct costs and indirect costs?
Direct costs
- can be specifically and exclusively identified with a given cost object.
Indirect costs
- cannot be specifically and exclusively identified with a given cost object.
- are assigned to cost objects on the basis of cost allocations.
Costs incurred in a manufacturing business diagram
Cost allocation (definition)
- the process of assigning costs to cost objects that involve the use of surrogate, rather than direct measures.
The distinction between direct and indirect costs depends on …?
The distinction between direct and indirect costs depends on what is identified as the cost object.
Product costs (definition)
those that are identified with products and included in the stock (inventory) valuation
Prime cost (definition)
the direct cost of a commodity in terms of the materials and labour involved in its production, excluding fixed costs
Eg. Direct materials + Direct labour = Prime cost
Period costs (definition)
- not specifically related to the product and are not included in the inventory valuation.
- They are treated as expenses in the period in which they are incurred
Figure 2.2 - Treatment of period and product costs
- Manufacturing cost is a product cost
- Non-manufacturing costs are period costs
When a product cost is unsold it is recorded as an asset in the balance sheet but becomes an expense when the product is sold in the profit and loss account
A period cost is recorded as an expense in the profit and loss account in the current accounting period
Why is cost behaviour important?
- to predict costs and revenues at different activity levels for many decisions.
Examples of production overheads and non-production overheads?
Production overheads:
- Rent and rates
- Factory power
- Factory heat and light
- Factory expenses
- Depreciation of plant
Non-production overheads:
- Selling and distribution
- Advertising
- Admin expenses (salaries of office staff and office expenses)
Variable costs (definition)
Costs that vary in direct proportion with activity.
Fixed costs (definition)
Costs that remain constant over wide range of activity
Semi-fixed costs (definition)
Costs that are fixed within specified activity levels, but they eventually increase or decrease by some constant amount at critical activity levels
Semi-variable costs (definition)
Costs that include both a fixed and a variable component (e.g. telephone charges)
Variables Costs diagrams
Fixed Costs diagrams
Step-fixed costs diagram
Sunk costs (definition)
Opportunity costs (definition)
Incremental cost (definition)
Marginal costs (definition)
Sunk costs
- costs that have been incurred and cannot be changed by any decision in the future
Opportunity costs
- Costs that measure the opportunity that is sacrificed when the choice of one course of action requires that an alternative course of action is given up
Incremental cost
- the difference between costs of alternative courses of action
Marginal costs
- the cost of one extra unit of output
What is the difference between relevant/avoidable costs & revenues and irrelevant/unavoidable costs & revenues
Relevant/ Avoidable costs and revenues:
- are changed by a future decision
Irrelevant/ unavoidable costs and revenues:
- are not changed by a future decision
A cost and management accounting system should generate information for meeting the following
requirements: (4)
- Inventory valuation for internal and external profit measurement.
- Provide relevant information to help managers make better decisions.
- Provide information for planning, control, and performance measurement.
A database should be maintained, with costs appropriately coded and classified so that relevant information can be extracted to meet each of the above requirements.
There are three main costs that businesses incur:
- Materials
- Labour
- Expenses
Correctly identifying these, working out the right amount of cost and treating them correctly is critical for all
businesses
There are two reasons why knowing the cost of inventory is vital:
- Value of goods ‘issued’
- Value of goods held
Features of manufacturing, merchandising and service organisations
What type of materials are held by businesses will depend on the type of business
Manufacturing:
- Raw materials
- Work in progress
- Finished goods
Merchandising/retail:
- Tangible products for resale i.e. finished goods inventory
Service organisations:
- Provide a service that cannot be stored, but may have work in progress
Material costs – valuation
- Actual cost
- The First In First out method FIFO (what is it?)
- The Last in First out method LIFO (what is it?)
- The Weighted Average Cost method WAS (what is it?)
FIFO:
- assumes that the oldest items are used first, so that inventory is VALUED at the most recent prices
LIFO:
- assumes that the latest items are used first, so that inventory is valued at the oldest prices
- (this method is not allowed by IAS Inventories 2)
WAS:
- assumes no pattern of the order in which items are used, so all are VALUED at the same value, which is the average one.
Labour costs
This can be one of the most expensive elements within the cost of unit, especially for service industries.
Labour costs can be worked out per hour or per unit – read the question carefully.
For example, a question could state that each unit has a labour cost of £20. Or, the question could state that each unit takes 2 hours to make and labour costs are £10 per hour
What factors can affect labour costs? (5)
- Wages rates paid by other businesses
- National / living wages imposed by Government
- Government incentives
- Local employment conditions – availability of unskilled and / or skilled workforce
- Employer costs above gross salaries (about 20%)
