Cost Behavior

COST BEHAVIOR When we talk about cost behavior, we aren't referring to "good" or "bad" behavior. Cost behavior is nothing more than the sensitivity of costs to changes in production or sales volume. The range of output or sales over which cost behavior patterns remain unchanged is called the relevant range.

COST BEHAVIOR
FIXED COSTS: Fixed costs are constant in total over the relevant range. Fixed costs per unit often shows the inverse relationship between fixed costs and increases in production. As production increases, total fixed costs stay the same within the relevant range, but since we are dividing a constant numerator [total fixed costs] by a progressively larger denominator [total production or sales], the resulting costs per unit become smaller and smaller. Fixed costs include things like rent, insurance premiums, management salary, depreciation and property taxes.

E.g., Straight-line depreciation is an example of a fixed cost. It does not matter whether the machine is used to produce 1,000 units or 1,00,000 units in a month, the depreciation expense is the same because it is based on the number of years the machine will be in service.

VARIABLE COSTS: Variable costs vary in total with volume, but are constant per unit within the relevant range. Total variable costs for a given situation are equal to the number of units multiplied by the variable cost per unit. Variable costs include things like labor and materials. Some overhead [indirect costs] such as indirect labor, supplies and some utilities are also variable.

E.g., If it takes one yard of fabric at a cost of $5 per yard to make one chair, the total materials cost for one chair is $5. The total cost for 10 chairs is $50 (10 chairs $5 per chair) and the total cost for 100 chairs is $500 (100 chairs $5 per chair).

RELATIONSHIP BETWEEN FIXED COST PER UNIT AND VARIABLE COST PER UNIT

The graphs for the fixed cost per unit and variable cost per unit look exactly opposite the total fixed costs and total variable costs graphs. Although total fixed costs are constant, the fixed cost per unit changes with the number of units. The variable cost per unit is constant.

MIXED COSTS: Some costs, called mixed costs, have characteristics of both fixed and variable costs. For example, a company pays a fee of $1,000 for the first 800 local phone calls in a month and $0.10 per local call made above 800. During March, a company made 2,000 local calls. Its phone bill will be $1,120 ($1,000 +(1,200 $0.10)).

Meaning of costing
Costing is a technique and process of ascertaining costs. This technique consists of principle and rules which govern the procedure of ascertaining the cost of product/ service. The process of costing includes routines of ascertaining cost by historical costing, standard costing or marginal costing.
DIFFERENCE BETWEEN COSTING AND COST ACCOUNTING Basis of Costing Cost Accounting distinction Nature Scope It is technique and process of ascertaining cost. The costing techniques include principles and rules which govern the procedure of ascertaining the cost of product/ services The process of costing includes routines of ascertaining cost by historical costing, standard costing or marginal costing. It is regarded as a specialized branch of Accounting It involves accumulation, classification, assignment and control of cost

Process

It involves establishment of budgets, standard costs or actual cost of operation, classification, recording and appropriate allocation of cost.

DIFFERENCE BETWEEN COSTING AND PRICING

The word costing refers to the cost incurred to manufacture the product and pricing is cost of selling the same product in the market . example : if we manufacture a toy which costs 200/- and the same toy we are going to sell in the market is 500/-.this is called pricing. Pricing is based on the data produced in the costing process, the value customer place on the product and the competition in the market. Costing is exclusive of profit margin. Whereas pricing is inclusive of profit margin.

METHODS OF COSTING Various methods of ascertaining costs are available to suit the business needs. But the basic principles are the same in every method. The choice of a particular method of costing depends on the nature of business of the concern. There are two basic methods of costing (a) SPECIFIC ORDER COSTING-: Specific order costing is the category of basic costing method applicable where the work consists of separate job, batches or contract each of which is authorized by specific order or contract. Job costing, batch costing, contract costing are included in this category.

METHODS OF COSTING (b) CONTINUOUS OPERATION OR PROCESS COSTING-:This category of basic costing methods applicable where standardized goods and services results from a sequence of repetitive and continuous operations or process to which cost is charged before being averaged over unit produced during the period. Thus here the cost object is masses of identical or similar units of product or service. Example: Citibank provides the same services to all its customers when processing customer deposits, Intel provides the same product (Say a P-5 chip) to all its customers.

METHODS OF COSTING (b) CONTINUOUS OPERATION OR PROCESS COSTING-: Customers of Nirma Detergents Co., all receive the same product . In each period, process costing systems divide the total costs of producing an identical or similar product or service by the total number of units produced , in order to obtain per unit cost. This per unit cost is the average unit cost that applies to each of the identical or similar units produced.

JOB COSTING: Under this method, cost is accumulated and collected for each job, work order or project separately. The system of costing is used where production is not highly repetitive and in addition consists of distinct jobs so that the material and labor costs can be identified by order number. This method is followed by these concerns when work is carried on by the customers request A job card is prepared for each job for cost accumulation. This method is applicable to printers, machine tool manufactures, foundries and general engineering workshops.

METHODS OF COSTING Job Costing Examples: 1. A Specialized machine made by Hitachi 2. Construction project managed by GMR 3. A repair job done at the Maruti Service center 4. An advertising campaign done by O&M 5. Cost incurred by the Raytheon Corporation for manufacturing multiple units of the Patriot Missile for U.S. Dept of Defence 6. Garments costing as per style variations/Hooded jacket, Track Pant, t-Shirts are different jobs even if the material used here is the same.

CONTRACT COSTING: Contract costing does not in principle differ from job costing. A contract is a big job whereas a job is a small contract. The term is usually applied where large-scale contracts are carried out. In case of builders, civil engineering contractors, constructional and mechanical engineering firm,this system of costing is used. A separate account is kept for each contract. BATCH COSTING: This is the extension of job costing. A batch is a group of identical products. Under batch costing a batch of similar products is treated as a separate unit for the purpose of ascertaining cost. The total costs of a batch is divided by the total number of units in a batch to arrive at the costs per unit. This method is used in biscuit manufacture, garments manufacturer and spare parts and component manufacture.

PROCESS COSTING: This method is suitable where production is continuous, manufacturing is carried on by distinct and well defined process, the finished product of one process becomes raw material of subsequent process, different product with or without by-product are produced simultaneously at the same process and product produced during a process are exactly identical. As finished product obtained at end of each process, it will be necessary to ascertain not only the cost of each process, but also cost per unit at each process. A separate account is opened for each process to which all expenditure incurred are charged. This is also known as Average processing or continuous processing. This method is used in textile industries , chemical industries, tanneries, paper manufacture, soap manufacturing etc

ONE OPERATION ( UNIT OR OUTPUT ) COSTING: This method is suitable for industries where manufacture is continuous and unit are identical. This method is applicable in industries like mines, quarries, oil drilling, breweries, cement work, brick work etc. In all theses industries there is standard unit of cost say, a barrel of beer in breweries, a tonne of coal in collieries, a thousand of brick in brick work etc.

SERVICE COSTING: This is suitable for industries which render services as distinct from those which manufacture goods. This is applied in transport, power supply companies, municipal service, hospitals , hotel etc. This method is used to ascertain cost per service rendered. There is usually a compound unit in such undertaking tonne-kilometer(transport), kilowatthour(power supply), patient day(hospital).

FARM COSTING: It help in calculation of total cost and per unit cost of various activities covered under farming. Farming activities include agriculture, animal husbandry, horticulture, poultry farming, pisciculture, dairy, sericulture, nurseries etc.
OPERATION COSTING:Operation costing is a further refinement of process costing. The system is employed in the industries of the following types: The industry in which mass or repetitive production is carried out The industry in which articles or components have to be stocked in semi-finished stage to facilitate the execution of special orders, or for the convenience of issue for later operations

The procedure of costing is broadly the same as process costing except that in this case, cost unit is an operation instead of a process. For example, the manufacturing of handles for bicycles involves a number of operations such as those of cutting steel sheets into proper strips, moulding , machining and finally polishing. The cost to complete these operations may be found out separately.

MULTIPLE COSTING: It represents the application of more than one method of costing in respect of the same product. This is suitable to industries where a number of components parts are separately produced and then assembled into final product. In such industries each component defer to another as to price, material used and process of manufacture undergone. So it is necessary to ascertain cost of each component. For this purpose process costing will be applied. To ascertain cost of final product batch costing may be applied. This method is applicable in cycle, automobile, engines, radio, typewriter, aeroplanes.
DEPARTMENTAL COSTING :The ascertainment of the cost of output of each department separately is the objective of departmental costing. In case where a factory is divided into a number of departments, this method is adopted.

It is to be noted that basically there are only two methods of costing viz. job costing and process costing. Job costing is employed in cases where expenses are traceable to specific jobs or orders, e.g., house building, ship building etc. In case where it is impossible to trace the prime cost of the items for a particular order because of the reason that their identity gets lost while manufacturing operations, process costing is used. For example, in a refinery where several tons of oil is being produced at the same time, the prime cost of a specific order of 10 tons cannot be traced. The cost can be found out only by finding out the cost per ton of total oil produced and then multiplying it by ten. It may, therefore, be concluded that the methods of batch contract and contract costing are only the variants of job costing whereas the methods of unit, operation and Service costing are the variants of process costing.

SPECIFIC ORDER COSTING

Job Costing Batch Costing Contract Costing

CONTINOUS OPERATION OR PROCESS COSTING

Process costing Operation costing Multiple costing Service costing Farm costing

Absorption costing

Uniform costing

Marginal costing

TECHNIQUE OF COSTING

Differential Costing

Standard costing

CLASSIFICATION OF COST
Cost classification is the process of grouping costs according to their common characteristics. A suitable cost classification is of vital importance in order to identify the cost with cost centre or cost units.

The Important ways of classification are

By Nature or Element. By Function By degree of Traceability to the product By changes in the Activity or Volume By controllability By Normality By relationship with Accounting Period By Time According to Planning and Control By Association with product. For Managerial Decisions.

BY NATURE OR ELEMENT:
According to this classification, the costs are divided into three categories Materials Cost Labor Cost Expense Cost

BY FUNCTION
According to this classification cost are divided in the light of different aspect of basic managerial activities involved in the operation of business. (a) PRODUCTION OR MANUFACTURING COST: Manufacturing costs are those costs which are incurred in the course of manufacture. It includes cost of raw material, cost of labour, other direct cost and factory indirect cost. Example of production or manufacturing costs may be power, lighting, heating, rent, depreciation etc. (b) OFFICE AND ADMINISTRATION COST: These costs are incurred for the general administration of the enterprise. It includes office costs as well as administration cost. For example, salary of office staff, rent of office building, electricity charges, audit fee, printing and stationeries etc. (c) SELLING AND DISTRIBUTION COST: It includes both selling cost as well as distribution cost. Selling costs are those costs which are incurred in connection with the selling of goods and services Distribution costs are those costs which are incurred on despatch of finished goods to the consumers. Example of selling and distribution costs are: sales men salary, packing charges, carriage, out ward, advertisement, ware house charges etc.

BY DEGREE OF TRACEABILITY:
According to this , total cost is divided into DIRECT COST: Direct cost are those cost which are incurred for and may be conveniently identified with a particular cost centre or cost unit. Material used and labor employed are example of direct costs. INDIRECT COST: Indirect cost are those which are incurred for the benefit of a number of cost centre or cost unit and cannot be conveniently identified with a particular cost centre or cost unit. Example of indirect cost are rent, management salaries etc.

BY CHANGE IN ACTIVITY OR VOLUME:

According to this classification, costs are classified according to their behavior in relation to change in the level of activity or volume of production. FIXED COST:Fixed costs are those costs which remain fixed irrespective of the change in volume of out put. As production increases cost per unit of the fixed cost decreases and as production decreases fixed costs are, rent of the factory building depreciation, salary of the office manager etc VARIABLE COST: Variable costs are those costs which vary in direct proportion to the volume of out put. As production increases total cost increases but also per unit remains constant. As production decreases total cost decreases and cost per unit also decreases. Example of variable costs are, cost of raw materials labor etc.

SEMI VARIABLE COST:These costs are partly fixed and partly variable. Examples of variable costs are telephone rent. It includes partly fixed charge up to a certain level and then varies according to the calls.

BY CONTROLLABILITY: Under this, cost are classified according to whether or

not they are influenced by the action of a given member of the undertaking. CONTROLLABLE COST: Controllable cost are those which can be influenced by the action of a specified member of an undertaking that is which are at least partly within the control of management. Example , all direct materials, direct labor are controllable by lower level management. UNCONTROLLABLE COST: Uncontrollable cost are those which cannot be influenced by the action of a specified member of an undertaking, that is which are not under the control of management. Example, rent of building, managerial salaries etc.

BY NORMALITY: under this , cost are classified as

NORMAL COST: It is the cost which is normally incurred at a given level of out put. These costs are part of cost production. ABNORMAL COST: It is the cost which is not normally incurred at a given level of out put. These costs are not charged to the cost of production. It is transferred to the costing profit and loss account.

BY RELATIONSHIP WITH ACCOUNTING PERIOD

CAPITAL EXPENDITURE: The cost which is incurred in purchasing an asset either to earn income or increase the earning capacity of the business is called capital expenditure. Such cost is incurred one point of time but benefit are spread over number of accounting years. Example, Cost of rolling machine in steel plant. REVENUE EXPENDITURE: If any expenditure is incurred to maintain earning capacity of the concern such as cost of maintaining an asset or running a business is called revenue expenditure. Example, Cost of material, labour cost, salaries, depreciation, selling and distribution charges. BY TIME: Cost can be classified as HISTORICAL COST: The cost which are ascertained after being incurred is called Historical cost. Such cost are available only when the production of a particular thing has already done. Such cost are only of historical value and not helpful for cost control purpose. PREDETERMINED COSTS: Such cost are estimated cost i.e, computed in advance of production taking into consideration the previous periods, cost and factors affecting such costs. Perdetermined cost determined on scientific basis become standard cost. Such a cost when compared with actual will give reason of variance and help the management to take remedial action.

ACCORDING TO PLANNING AND CONTROL: Planning and control are two important function of management. Cost accounting provide information to management which is helpful in discharge of two function. Based on this , cost is classified as BUDGETED COST: Budgeted cost represent an estimate of expenditure for different phases of business operation such as manufacturing, administration, sales, research and development etc. coordinated in well conceived framework for a period of time in future which subsequently become the written expression of managerial targets to be achieved. Various budget are prepared for various phases such as raw material budget, sales budget, production budget, cash budget, overhead budget etc STANDARD COST: Budget cost are translated into actual performance through instrument of standard cost. Standard cost is the predetermined cost based on technical estimate of material, labor, and overhead for a selected period of time and for a prescribed set of working condition. BY ASSOCIATION WITH THE PRODUCT: PRODUCT COST: Product cost are cost which are traceable to product and are included in inventory control. Product cost are inventoriable cost and they become basis for product pricing and cost plus contracts. They comprises direct material, direct labor and production overhead in manufacturing concern. PERIOD COST: Period cost are incurred on the basis of time such as rent, salaries etc. these may relate to administration and selling cost essential to keep business running. Though these are not associated with production and are necessary to generate revenue.

FOR MANAGERIAL DECISIONS: On this basis, costs may be classified into following costs MARGINAL COST: Marginal cost is the total of variable costs i.e, prime cost plus variable overheads. It is based on the distinction between fixed and variable costs. Fixed cost are ignored and only variable costs are taken into consideration for determining the cost of product and value of work-in-progress and finished goods. OUT-OF-POCKET COST: This is that portion of the costs which involves payment to outsiders i.e., give rise to cash expenditure as apposed to such cost as depreciation, which do not involves any cash expenditure. DIFFERENTIAL COST: The change in cost due to change in level of activity or patterns or method of production is called differential cost. If the change increases the cost, it will be called incremental cost. If there is decrease in costs resulting from decrease in output, the difference is known as decremental cost. SUNK COST: Sunk costs are historical or past costs. These are the costs which have been created by a decision that was made in the past and cannot be changed by any decision that will be made in the future. Investments in plant and machinery, buildings etc. are prime examples of such costs. Since sunk costs cannot be altered by decisions made at the later stage, they are irrelevant for decision-making.

SHUTDOWN COST: A manufacturer or an organization may have to suspend its operations for a period on account of some temporary difficulties, e.g., shortage of raw material, non-availability of requisite labor etc. During this period, though no work is done yet certain fixed costs, such as rent and insurance of buildings, depreciation, maintenance etc., for the entire plant will have to be incurred. Such costs of the idle plant are known as shutdown costs. NOTIONAL COST OR IMPUTED COST: Imputed cost and notional cost have same meaning. These cost are notional in nature and do not cause any cash outlay. It is defined as the value of benefit where no actual cost is incurred. Even though such cost do not involve cash outlay, but they are taken into consideration while making managerial decision. E.g, Rent charged on business premises owned by proprietor, interest on capital for which no interest is paid. OPPORTUNITY COST: It is the maximum possible alternative earning that might be earned if the productive capacity or service had been put to alternative use. For example, if owned building is proposed to be put for a project, the likely rent of the building is the opportunity cost which should be taken into consideration while evaluating profitability of project.