1. Cost & Mangerial
Decisions

2. What is the Cost?
 Several years ago you purchased a bottle of
wine for $25. Today it is worth $75. If you
give the bottle to a friend as a gift, what is the
cost of your gift?
 $0
 $25
 $25+
 $75
 ($50)

3. Cost Objects
 Anything whose cost we want to determine
 Product, process, location, person, region, etc.
 Whether a cost is direct or indirect depends
on the cost object
 As cost object becomes more detailed, fewer
costs are directly related

4. ELEMENTS OF COST
 For proper control and managerial decisions, management is
to be provided with necessary data to analyze and classify
costs. For this purpose ,the total cost is analysed by elements
of cost i.e., MATERIALS, LABOUR and other expenses.
 ELEMENTS OF COST ARE
 Materials
Direct and indirect.
 LABOUR
Direct and indirect.
 OVERHEADS
Direct and indirect.

5. DIRECT MATERIALS
 These are those materials which can be identified in
the product and can be conveniently measured and
directly charged to the product. For eg:
 all raw materials like jute in the manufacture of
gunny bags.
 Materials specifically purchased for a specific job.
 Parts or components purchased or produced.
 Primary packing materials like cartons.

6. DIRECT LABOUR
 It is all labour expended in altering the construction ,
composition ,confirmation or condition of the
product.
 It is the labour which can be conveniently identified
or attributed wholly to a particular job ,product or
process or expended in converting raw materials
into finished goods. Wages of such labour are known
as direct wages.

7. DIRECT EXPENSES
 All expenses which can be identified to a particular cost
centre and hence directly charged to the centre are known
as direct expenses.
 All expenses (other than direct material and direct labour)
incurred specifically for a particular product ,job ,department
etc. are called direct expenses.
 These are directly charged to the product.
 Examples of such expenses are royalty ,excise duty etc.

8. OVERHEADS
 It may be defined as the aggregate of the cost of
indirect materials ,indirect labour and such other
expenses including services as conveniently be
charged direct to specific cost units.
 So , these are all expenses other than direct
expenses. These comprise all expenses incurred for or
in connection with the general organization of the
whole or part of the undertaking i.e. the cost of
operating supplies and services used by the
undertaking and including the maintenance of
capital assets.

9. GROUPS OF OVERHEADS
1) MANUFACTURING/FACTORY/PRODUCTION/
WORKS OVERHEADS
 It is the indirect expense of operating the manufacturing divisions of a concern and
covers all indirect expenditure incurred by the undertaking from the receipt of the
order until its completion ready for dispatch either to the customer or to the
finished goods store.
 For example depreciation and insurance charges on fixed assets like plant and
machinery, works building, and electric equipments and floating assets like stores
finished goods etc.
2)ADMINISRATION/OFFICE OVERHEADS
 It is the indirect expenditure incurred in formulating the policy, directing the
organization, controlling and managing the operations of an undertaking which is
not related directly to a research, development, production or selling activity or
function.
 For example expenses in running the general office eg. Office rent, light, heat,
salaries and wages.

10. 3)SELLING OVERHEAD
 It is the cost of seeking to create and stimulate demand and of
securing orders and comprises the cost of soliciting and recurring
orders for the articles or commodities dealt in and of efforts to find and
retain customers.
 It refers to those indirect cost which are associated with marketing and
selling activities.
 For example sales office expenses, showroom expenses, samples ands
free gifts.
4)DISTRIBUTION OVERHEAD
 It is the expenditure incurred in the process which begins with making
the packed product available for dispatch and ends with making the
reconditioned return empty package, if any available for reuse.
 For example warehouse rent, warehouse staff salaries, insurance etc.

11. 5)RESEARCH AND DEVELOPMENT EXPENSES
 Research cost is the cost of searching for new and
improved products, new applications of
materials or products, and new applications and
improved methods .
 Development cost is the cost of the process which
begins with implementations of the decision too
produce a new or improved method and ends
with the commencement of formal production of
that product or by that method.

12. CLASSIFICATION OF
OVERHEAD
 Indirect materials : those materials which do not
normally form a part of the finished product. These are
the materials which can not be allocated but which can
be apportioned to or absorbed by cost centres or cost
units.
 Indirect labour : the wages of that labour which can not
be allocated but which can be apportioned to or
absorbed by cost centres or cost units is known as
indirect labour.
 Indirect expenses : such expenses which can not be
allocated but can be apportioned to or absorbed by
cost centres or cost units ,as rent, rates, insurance,
municipal taxes, etc are known as indirect expenses.

13. SHEET
Total cost Cost per unit
Direct materials
Direct labour
Direct or
chargeable
expenses
prime
cost
****** ******
aDD : aDministration
overheaDs
cost oF proDuction
****** ******
aDD : selling anD
Distribution
overheaDs
total cost or cost
oF sales
****** ******

14. COST COCEPTS
 Some of the which are used in the cost accounts are as follows
:
a) Cost
b) Expenses and losses
c) Cost centre
d) Profit centre
e) Cost object and cost driver
f) Conversion cost
g) Contribution margin
h) Carrying cost
i) Out –of-stock cost
j) Ordering cost
k) Development cost
l) Policy cost

15. Continued cost concepts
m)Discretionary cost
n)Idle facilities cost
o)Expired cost
p)Incremental revenue
q)Added value
r)Urgent cost
s)Postponable cost
t)Pre –production cost
u)Research cost
v)Training cost

16. COST CLASSIFICATIONS
 Cost classifications is the process of grouping costs
according to their common characteristics. It is
the placement of like items together according
to their common characteristics.
 Cost may be classified according to their nature
as follows:

17. Important ways of classifying
cost are as follows :
1) By nature of elements
2) By functions
3) By degree of traceability
4) By changes in activity or volume
5) By controllability
6) By normality

18. Continued cost classifications
7)By relationship with accounting period
8)By time
9)By association with the product
10)According to planning and control
11)For managerial decisions

19. CONCLUSION
 Cost accounting is a branch of accounting and has
been developed due to limitations of financial
accounting.
 Cost accounting involves the classifying, recording
and appropriate allocation of expenditure for the
determination of the costs of products or services,
and for the presentation of suitably arranged data
for purposes of control and guidance of
management.
 Thus cost accounting indicates the costs of single units
and overcome financial accounting.

20. Fundamentals of Product
and Service Costing

21. Direct vs. Indirect Costs
 Direct cost
 Easily and conveniently traceable to the cost
object
 Indirect
 Not easily or conveniently traceable
 Cost is shared among cost objects
 No apparent “link” between the cost and the object
 Not cost effective to trace

22. Product vs. Period Costs
 Product costs
 Reasonable and necessary costs to prepare the
product for sale to the customer
 Direct materials
 Direct labor
 Overhead
 Part of inventory until product is sold
 Period costs
 Non-manufacturing costs
 Expensed when incurred

23. Product vs. Period CostsProductcosts
Direct material
Direct labor
Overhead
Prime costs
Conversion costs

24. Product vs. Period Costs
 Distinction between product and period costs
is blurred for internal reporting
 Marketing cost may be considered part of the total
cost of a product
 Labor may be considered overhead
 Only incremental costs may be considered
 Etc.

25. Manufacturing Cost Flows
Raw Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
Cost of
Goods Sold
Factory Labor
Overhead
(2) (3)(1)
(1) Materials are placed into production (Raw
materials used in production)
(This plus direct labor and overhead
equals total manufacturing costs, i.e.
inputs)
(1) Goods are completed (Cost of goods
manufactured, i.e. outputs)
(2) Goods are sold

26. Manufacturing Cost Flows
Beginning raw materials inventory 5,000$
Add: Purchases of raw materials 187,000
Raw materials available 192,000$
Less: Ending raw materials inventory (7,000)
Raw materials used in production 185,000$ (1)
Direct labor 71,000
Overhead 134,000
Total manufacturing cost 390,000$ Input
Add: Beginning work in process inventory 6,000
396,000$
Less: Ending work in process inventory (8,000)
Cost of goods manufactured 388,000$ Output (2)
Add: Beginning finished goods inventory 3,000
Goods available for sale 391,000$
Less: Ending finished goods inventory (2,000)
Cost of goods sold 389,000$ Expense (3)
Example Company
Statement of Cost of Goods Manufactured and Sold

27. Cost Drivers
 The cause of a particular cost
 Capacity driver
 Decision to acquire capacity
 Transaction driver
 Each occurrence causes the cost
 Duration driver
 Amount of cost depends on the duration of the event

28. Cost Hierarchy
 Unit level
 Each additional unit (of something) creates more
cost
 Batch level
 Each new batch, or the crossing of some
threshold creates more cost
 Product level
 Change to product, or additional product, creates
more cost

29. Cost Hierarchy
 Customer level
 Each new customer creates more cost
 Facility level
 Change to facility creates more cost

30. Cost Behavior
 How a cost changes in relation to changes in
volume of activity
 Behavior depends on the definition of activity
and relevant range
 Unit of product or batch?
 Fixed per batch, but vary inversely per unit
 Narrow or wide range?
 Fixed over a narrow range but step over a wider range

31. Fixed Cost
 Total cost remains constant
 Cost per unit varies inversely with activity
Fixed Cost
0
20
40
60
80
100
120
1 2 3 4 5 6 7 8 9 10
Units of activity
Cost
Total Cost
Cost per Unit

32. Step Fixed Cost
 Fixed through some range, but increases
when some increment is crossed
Step Fixed Cost
0
20
40
60
80
100
120
140
1 2 3 4 5 6 7 8 9 10
Units of activity
Cost
Total cost
Cost per unit

33. Variable Cost
 Cost per unit remains constant
 Total cost varies directly with activity
Variable Cost
0
20
40
60
80
100
120
1 2 3 4 5 6 7 8 9 10
Units of Activity
Cost
Total Cost
Cost per Unit

34. Mixed Cost
 Contains a fixed and a variable component
 Cost per unit is not constant
Mixed Cost
0
20
40
60
80
100
120
140
1 2 3 4 5 6 7 8 9 10
Units of activity
Cost
Total cost
Cost per unit

35. Absorption vs. Variable
Costing
 Absorption costing
 Product costs include material, labor, variable and
fixed overhead
 All of the reasonable and necessary costs to produce
the product
 Income statement arranged by type of cost
 Product or period
 Revenue – cost of goods sold = gross profit
 Gross profit – S&A expenses = net income

36. Absorption vs. Variable
Costing
 Variable costing
 Product costs only include material, labor and
variable overhead
 Fixed overhead is treated as a period cost
 Income statement arranged by cost behavior
 Variable then fixed
 Revenue – variable costs = contribution margin
 Contribution margin – fixed costs = net income

37. Absorption vs. Variable
Costing
Selling price 100$ per unit
Material 30$ per unit
Labor 15$ per unit
Variable overhead 5$ per unit
Fixed overhead 50,000$
Variable selling expenses 10$ per unit
Fixed selling expenses 10,000$
Year 1 Year 2 Year 3
Units produced 2,000 4,000 2,000
Units sold 2,000 2,000 4,000

38. Absorption vs. Variable
Costing
Year 1 Year 2 Year 3
Sales 200,000$ 200,000$ 400,000$
Cost of goods sold 150,000 125,000 275,000
Gross profit 50,000$ 75,000$ 125,000$
Selling expenses 30,000 30,000 50,000
Net income 20,000$ 45,000$ 75,000$
Sales 200,000$ 200,000$ 400,000$
Var. cost of goods sold 100,000 100,000 200,000
Var. selling expenses 20,000 20,000 40,000
Contribution margin 80,000$ 80,000$ 160,000$
Fixed overhead 50,000 50,000 50,000
Fixed selling expenses 10,000 10,000 10,000
Net income 20,000$ 20,000$ 100,000$
Difference -$ 25,000$ (25,000)$
Absorption costing income statements
Variable costing income statements

39. Absorption vs. Variable
Costing
 Fixed overhead
 Is it necessary to produce the product?
 Is it related to production volume?
 Is it a product or period cost?
 Which is more useful?
 Financial reporting
 Absorption required
 Decision making
 Variable does not distort cost as volume changes

40. Throughput Costing
 Product costs only include unit level spending
for direct costs (i.e. incremental costs)
 Materials, commissions, etc.
 All other indirect, past or committed costs are
treated as period costs
 Labor (unless piece-rate), overhead, etc.

41. Resources Supplied vs. Resources
Used
 Cost of resource supplied
 Capacity (hours, etc.) available * cost per unit of capacity
 Cost of resource used
 Capacity used * cost per unit of capacity
 Cost of unused capacity
 Cost of resource supplied – cost of resource used
A worker is paid for an 8-hour day. The worker can produce 10 units per hour and is
paid $10 per hour ($1 per unit). The worker only produced 50 units on Monday.
Cost of capacity available: $80 Cost of capacity used: 50 units * $1 per unit = $50
Cost of unused capacity: $80 - $50 = $30

42. Miscellaneous Cost Terms
 Committed cost
 Decision has been made to incur the cost in the future
 Discretionary cost
 Cost which can be increased or decreased at will
 Sunk cost
 Cost incurred previously
 Opportunity cost
 Benefit given up when one alternative is chosen over
another

43. Cost Management Systems
L.O. 1 Explain the fundamental themes underlying
the design of cost systems.
• The objective of the cost management system
is to provide information about costs relevant
for decision making.
• The cost system accumulates and reports costs
about processes, products, and services.
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44. Reasons to Calculate Product
or Service Costs
• For decision making
• For deciding what to sell
• For setting prices
• For knowing the cost of goods sold
• For knowing the cost of inventory
LO1
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45. Cost Allocation and Product
Costing
L.O. 2 Explain how cost allocation is used
in a cost management system.
Basic Cost Flow Diagram
Direct
materials
Direct
labor
Manufacturing
overhead
Alpha Beta
Cost
pools
Cost
objects
Cost
allocation
rule
Indirect
(allocated
by direct
labor cost)Direct
6 - 45

46. Basic Cost Flow Model
L.O. 3 Explain how a basic product costing system works.
• How costs and units move through inventories:
• This is true for the following accounts:
– Raw Materials (RM)
– Work-in-Process (WIP)
– Finished Goods (FG)
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47. Costing with No Work-in-
Process Inventories
• Baxter Paint begins production on April 1.
• It starts and completes production of 100,000
gallons of paint in April and has no ending
work-in-process inventory.
Materials $ 400,000
Labor 100,000
Manufacturing overhead 500,000
Total $1,000,000
Cost of resources used in April:
LO3
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48. Costing with No Work-in-
Process Inventories
• What are the costs at the end of the period?
• $1,000,000 was added to work-in-process
and then transferred out to finished goods.
• Since Baxter produced 100,000 gallons of
paint, then the cost per gallon of paint is $10.
LO3
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49. Costing with Work-in-Process
Inventories
Beginning inventory -0-
Started in May 110,000
Total 110,000
Ending WIP (50% complete) 20,000
Transferred out 90,000
Production for Baxter Paint for May follows (gallons):
LO3
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50. Costing with Work-in-Process
Inventories
FG
LO3
6 - 50

51. Costing with Work-in-Process
Inventories
• How do we cost Baxter’s 20,000 gallons of paint that
are only half finished?
• 20,000 gallons half finished is equivalent to 10,000
gallons finished.
• 90,000 gallons transferred out plus 10,000 equivalent gallons
of finished paint equals 100,000 equivalent gallons of paint.
Gallons of paint transferred out 90,000
Equivalent gallons of finished paint 10,000
Total equivalent gallons of paint 100,000
LO3
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52. Costing with Work-in-Process
Inventories
Direct material + Direct labor + Overhead
($990,000)
Finished goods
inventory
$891,000
Work-in-process
inventory
$99,000
Equivalent gallons
90,000
gallons
(90%)
10,000
gallons
(10%)
LO3
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53. Predetermined Overhead
Rates
L.O. 4 Understand how overhead cost is allocated to products.
• Indirect costs are allocated using a predetermined
overhead rate (POHR).
• POHR is the cost per unit of the allocation base used
to charge overhead to products.
POHR = $ ÷ Base
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54. Multiple Allocation Bases
and Two-Stage Systems
L.O. 5 Explain the operation of a two-stage allocation
system for product costing.
• We can use two or more allocation bases to allocate
manufacturing overhead to products.
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55. Multiple Allocation Bases
and Two-Stage Systems
Manufacturing overhead
Machine-related
costs
Direct labor-related
costs
C-27s C-20s
Cost
pool
Cost
objects
Cost
allocation
rules
Indirect costs Indirect costs
(allocated in proportion
to machine hours)
(allocated in proportion
to direct labor costs)
Second
stage
First stage
LO5
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56. Multiple Allocation Bases
and Two-Stage Systems
Cost
pool
Cost allocation
rule
Intermediate
cost pools
Overhead
$180,000
Labor-related
$108,000
Machine-related
$72,000
Direct labor
costs
Machine
hours
LO5
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57. Product Costing Systems
L.O. 6 Describe the three basic types of product costing
systems: job order, process, and operations.
• Job costing:
– An accounting system that traces costs to individual units
or to specific jobs, contracts, or batches of goods.
(custom homes, movies, services)
• Process costing:
– An accounting system used when identical units are
produced through a series of uniform production steps.
(cornflakes, facial tissues, paint)
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