COST CONCEPTS
Manager needs costs information to make a decision such as:
• Product managers evaluated market demand and product cost data for their own and their
competitors
• Comparing manufacturing costs of various facilities
Period costs  costs created as expenses in the period in which they incured because they
can not be associated with manufacture of products
Product costs  costs associated with the manufacture of products
Traditional Cost Classification:
a.
Manufacturing raw materials, labour, and overhead
Direct costs costs that can be traced directly to a product
Indirect costs costs that cannot be traced easily to a product
b. Nonmanufacturing  distribution costs, selling costs, marketing costs, R & D costs, and
general and administrative costs
Cost Structure Today
In 1900, direct labour represented > 50%
In industrial environment, labour costs only 5 % - 15 % and direct materiaals 40% - 60%
1
Activity Based Analysis of Costs
MANUFACTURING Overhead Costs Indirect cost of transforming raw materials into finished
product
Type of Production Activities;
a.
Unit related activities  those whose volume or level is associated with number of units
produced
DLH, manchine hours, and quality inspector related to number of unit produced
b.
Bacth related activities  related to number of batch produced
 Machine set up, costs of materials handling, and first time quality inspection
c,. Product sustaining activities  performed to support the production and sale of individual
products
 Administrative efforts for drawing and routing of parts, product engineering efforts for
maintaining specifications for individual products
Product sustaining activities for Ice cream company: design new ice cream flavor, developing,
maintaining and improving recipes, designing packaging and marketing materials for individual
products
d.
Facility sustaining activities  performed to provide the managerial infrastructure and to
support maintaining the plants
 Plant rental and depreciation, plant maintenance, insurances and taxes, housekeeping,
landscaping, lighting, and security
2
Activity cost driver unit of measurement for the level of quantity of the activity
performed
Catagories of Activities and their Activity Cost Driver
Catagories
Representative Activities
Activity Cost Drivers
Facility Sustaining Activities

Plant management
 Accounting and personnel
 Housekeeping
 Rent and depreciation

Square feet of space
 Number of workers
Product Sustaining Activities

Product design
 Parts administration
 Engineering
 Expediting production
orders

Batch related Activities

Manchine set up
 First time inspection
 Purchase ordering
 Materials handling
 Production scheduling

Unit related Activities

Every item inspection
 Supervision of direct labor
 Consumption of power and
oils to run machines

Number of products
 Number of parts
Setup hours
 Inspection hours
 Number of orders
 Number of materials move
 Number of production run
number of units
 DLH
 Machine hours
3
Cost Distortion with One Driver
Production process with 5 activities (X1, X2, X3, X4, and X5)
Overhead rate for each activitiy:
R1 = C1/X1, R2 = C2/X2, R3 = C3/X3, R4 = C4/X4, R5 = C5/X5
Total Overhead Costs = C1 +C2+C3+C4+C5
C1 +C2+C3+C4+C5
Single cost driver  R = C / X1 = ----------------------X1
X1 = Direct labour hours, X2 = Setup hours
C = 70 X1 + 500 X2, X1 = 1,000 DLH, X2 = 60 setup hours
C = $ 100,000
With one driver (X1), R = $ 100,000 / 1,000 = $ 100 per DLH
Prediction X1 = 90 DLH and X2 = 7 setup hours
a.
Estimated cost of overhead = 90 DLH x $ 100 = $ 900 (single driver)
b.
Estimated cost of overhead = 70 x 90 + 500 x 7 = $ 9,800
4
Standard Cost Accounting System
Standard Costs Efficient and attainable benchmarks established in advance for the costs of
activity resources that should be consumed by each product
It involves measuring standard costs and actual costs and comparing them.
Three principal uses of standard cost system:
a.
Estimated cost of product Standards are developed for the consumption of DM, DL, and
overhead activity resources per unit of each product
b.
Budget for Costs and Expenditure TC representing the consumption of each activity
estimated based on the standard amount consumption of an activity to produce each product
and planned production levels for those products
c.
Control costs relative to standards comparing actual and standard costs for finding
favourable or unfavourable variances
5
Cost Behavior
Fixed Costs Costs that are independent of the level of production
Costs
FC
Q
6
Variabel costsCosts that change proportionally with the level of production
Costs
TVC
VC/Unit
Q
Mixed CostsCosts that comprising both fixed and variable costs
Costs
VC
FC
7
Q
Exp. Riverside General Hospital has information on 18 account names and expenses
for the fiscal year 1994
ACCOUNT NUMBER
ACCOUNT NAME
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
Nursing services
Nursing administration
Pharmacy
Laboratory
Medical supplies
Linen and laundry
Dietary
Employee cafeteria
Housekeeping
Medical records & library
Social services
Patient scheduling & administration
Billing & collection
Plant operation
Plant maintenance
Medical equipment operations
Property insurance
Depreciation
Total operating costs
COST
$ 2,973,154
1,269,762
496,629
312,347
482,165
358,736
813,148
167,239
706,308
250,345
199,026
60,238
112,280
301,238
386,622
496,275
38,350
960,573
$ 10,384,435
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Activity Overhead rates for the fiscal year 1994
Account
Number
Account Name
Cost Driver
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
Nursing services
Nursing administration
Pharmacy
Laboratory
Medical supplies
Linen and laundry
Dietary
Employee cafeteria
Housekeeping
Medical records & library
Social services
Patient scheduling &
administration
Billing & collection
Plant operation
Plant maintenance
Medical equipment operations
Property insurance
Depreciation
Nursing hours
Nursing hours
Direct
Number of test
Number of patient days
Pounds of laundry
Number of meals
Number of nurse-days
Square feet of space
Number of patients
Number of patients
Number of patients
Number of patients
Square feet of space
Square feet of space
Number of procedures
Value of property
Value of property
Total operating costs
$ 10,384,435
Activity Level
Overhead rate
280,621
280,621
80,224
45,606
840,749
88,673
35,078
23,798
8,367
8,367
8,367
8,367
23,798
23,798
62,179
$ 21,567,322
$ 21,567,322
10.59490915
4.524828862
3.89343588
10.57240275
0.426686205
9.170187092
4.767632134
29.67930078
29.92052109
23.78702044
7.199474125
13.41938568
12.65812253
16.24598706
7.981392432
0.001778153
0.044538353
$ 10,384,435
$ 10,384,435
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Activity Classification:
A. Unit Related Activities
ACCOUNT NAME
ACCOUNT NUMBER
101
102
103
104
105
106
107
108
116
COST
Nursing services
Nursing administration
Pharmacy
Laboratory
Medical supplies
Linen and laundry
Dietary
Employee cafeteria
Medical equipment operations
$ 2,973,154
1,269,762
496,629
312,347
482,165
358,736
813,148
167,239
496,275
Total unit related costs
Number of patient days
Cost per patient day
$ 7,369,455
45,606
$ 161.59
B. Batch Related Activities
ACCOUNT NUMBER
ACCOUNT NAME
COST
110
111
112
113
Medical records & library
Social services
Patient scheduling & administration
Billing & collection
250,345
199,026
60,238
112,280
Batch Related costs
Number of patients
Cost per patient
$ 621,889
$
8,367
74.33
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C. Facilities Sustaining Activities
ACCOUNT
NUMBER
109
114
115
117
118
ACCOUNT NAME
Housekeeping
Plant operation
Plant maintenance
Property insurance
Depreciation
Facilities sustaining costs
COST
706,308
301,238
386,622
38,350
960,573
$ 2,393,091
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