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A WRITE UP ON COSTS
Analysis of Costs. 1. 2. 3. There are three methods adopted for cost analysis.

Direct and Indirect Costs method Variable, Fixed and Semi Variable Costs method rod!ction, "dmin, Sales # Finance Costs method

Direct Cost is the cost $hich is directly related to a partic!lar acti%ity. In con%erse $ay it is the expendit!re $hich can be a%oided if the partic!lar acti%ity is not !nderta&en. '(. The ra$ material !sed for man!fact!rin( an item. If a partic!lar item is not man!fact!red, the ra$ material and conse)!ential cost of ra$ material is sa%ed*not spent. Indirect Cost is that cost $hich is not directly related to acti%ity. In other $ords it is the cost $hich may still ha%e to be inc!rred irrespecti%e of acti%ity pro(ressin( or not. S!ch costs normally co%er m!ch $ider ran(e of acti%ities li&e "dministrati%e costs. Variable Costs are the costs $hich chan(e in direct proportion $ith the )!ant!m of acti%ity or $ith sales. In s!ch cases there is direct fixed relation bet$een )!ant!m of acti%ity and the cost inc!rred. '.(. F!el expendit!re of yo!r car $hich is directly proportional to the !sa(e of the car. "nother example co!ld be, ima(ine that a boo&shop b!ys in boo&s for an a%era(e price of +s. 1,, each. It then resells the boo&s for a hi(her price. For the boo&shops the %ariable cost is +s. 1,, per !nit. Total costs are fo!nd by addin( to(ether fixed and %ariable costs.

Fi ed Costs are the cost $hich remain constant -s!b.ect to a pre/specified maxim!m limit of acti%ity, or $ith sales after $hich it $ill chan(e0 irrespecti%e of the )!ant!m of acti%ity. '(. Depreciation cost of 1achinery, Ins!rance and finance cost of yo!r %ehicle $hich remain constant irrespecti%e $hether the %ehicle is r!n or not. "nother example is, one of the fixed costs of a hi(h street shop is the rent paid for the property. The rent is still the same $hether the shop sells one item or tho!sands.

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Se!i Variable Costs are the costs $hich do chan(e as the acti%ity le%el chan(es b!t the %ariation is not in direct proportion to the acti%ity le%el %ariation chan(e $ith %ol!me, b!t in increments.. This is basically s!m of a fixed cost element and a %ariable cost element. 'xample2 hirin( of a car $hich has a fixed daily hirin( char(es and in addition, per &ilometre r!nnin( char(es applicable. 3r for a hotel b!siness, if ho!se&eepin( staff can clean no more than 1, rooms each, a co!nt of 41 (!ests $o!ld re)!ire six staff. If nine more (!ests arri%e to brin( the total co!nt to 5,, the n!mber of ho!se&eepin( staff needed is still only six. The next (!est after that $ill re)!ire (oin( to the next 6step7, or se%en staff. Total Costs TC = F + VCq where F => Fixed cost , VC => Variable Cost, q=> Quantity Produced

Econo!ies of Scale

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In partic!lar, econo!ies of scale describe sit!ation $hen the total costs rise less than proportionally to prod!ction increases, as yo! see in the follo$in( dia(ram

Dis"econo!ies of scale represent the opposite sit!ation

Constant ret#rn to scale is the intermediate sit!ation in $hich the (ro$th in prod!ction is exactly matched by the same percenta(e increase in total costs, i.e. elasticity of costs to prod!ction le%els is 2

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In t$is case% &rod#cti'ity is constant Con'ertin( Variable to Fi ed Costs 8hen a b!siness is (ro$in(, it is often better to con%ert %ariable to fixed cost. " smaller hotel may pay for la!ndry at a rate per po!nd to an o!tside %endor. "s it (ro$s, it may be $orth ma&in( a one/ time p!rchase of $ashin( machines. If %ol!me is declinin(, it is best to con%ert fixed cost into %ariable.

)at$e!atical )odel of Fi ed and Variable Costs Sl -a0 -b0 -c0 Ite! Depreciation +a$ 1aterial 9+s24*/per !nit "d%ertisement Fixed Component Variable Component 9+s2*/per !nit *+++ Units +s 1,,,,*/ +s 4,,,,*/ +s 2,,,,*/ +s 15,,,*/ +s ;,,,*/ ,+++ Units +s 1,,,,*/ +s 124,,,*/ +s 25,,,*/ +s 15,,,*/ +s 1,,,,*/ -+++ #nits +s 1,,,,*/ +s :4,,,*/ +s 22,,,*/ +s 15,,,*/ +s 5,,,*/ Re!ar.s Fixed Cost Variable Cost Semi Variable cost

In case of Fi ed costs% a!o#nt is constant. In case of Variable costs% #nit rate is constant. E a!&le. " factory can prod!ce 14,,, !nits per month. The follo$in( is their data for "pril # 1ay2 / Sl -a0 -b0 -c0 -d0 Ite! Total rod!ction Direct 1aterial Cost Direct >abo!r Cost Depreciation A&r /Units0 <,,, +s 1,=,,,*/ +s =1,,,*/ +s 2,,,,*/ )ay /Units0 12,,, +s 1;;,,,*/ +s 1,=,,,*/ +s 2,,,,*/

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-e0 -f0 -(0

rod!ction 3%erheads "dmin 3%erhead Sales 3%erhead

+s 34,,,*/ +s 14,,,*/ +S 3,,,,*/

+s ;;,,,*/ +s 154,,*/ +s 35,,,*/

The factory is expectin( to prod!ce and sell 1,,,, !nits in ?!n at a sellin( price to earn a profit of 2,@ on the cost. repare a cost statement and sellin( price for ?!n. Cost Analysis State!ent Sl -a0 -b0 -c0 -d0 -e0 -f0 -(0 Ite! Total rod!ction Direct 1aterial Cost Direct >abo!r Cost Depreciation rod!ction 3%erheads Fixed cost Variable Cost 9 1*/ "dmin 3%erhead Fixed Cost Variable Cost 9,.4, Sales 3%erhead Fixed Cost Variable Cost 92*/ A&r <,,,-Anits0 +s 1,=,,,*/ +s =1,,,*/ +s 2,,,,*/ +s 34,,,*/ +s =,,,*/ +s 2:,,,*/ +s 14,,,*/ +s 1,4,,*/ +s ;4,,*/ +S 3,,,,*/ +s 12,,,*/ +s 1=,,,*/ )ay 12,,,-Anits0 +s 1;;,,,*/ +s 1,=,,,*/ +s 2,,,,*/ +s ;;,,,*/ +s =,,,*/ +s 35,,,*/ +s 154,,*/ +s 1,4,,*/ +s 5,,,*/ +s 35,,,*/ +s 12,,,*/ +s 2;,,,*/ 1#n 1,,,,-Anits0 +s 12,,,,*/ +s <,,,,*/ +s 2,,,,*/ +s 3=,,,*/ +s =,,,*/ +s 3,,,,*/ +s 144,,*/ +s 1,4,,*/ +s 144,,*/ +s 32,,,*/ +s 12,,,*/ +s 2,,,,*/

Cost State!ent for 1#ne Sl -a0 -b0 -c0 -d0 -e0 -f0 -(0 -h0 -.0 -&0 Ite! Total rod!ction Direct 1aterial Cost Direct >abo!r Cost Depreciation rod!ction 3%erheads "dmin 3%erhead Sales 3%erhead Total rod!ction Cost rofit 2,@ Sellin( Price 1#n 1,,,,-Anits0 +s 12,,,,*/ +s <,,,,*/ +s 2,,,,*/ +s 3=,,,*/ +s 144,,*/ +s 32,,,*/ +s 3144,,*/ +s531,,*/ Unit Cost +s 12*/ +s <.,, +s 2.,, +s 3.=, +s 1.44 +s 3.2 +s31.44 +s 5.31 Rs -2.34

5.,0 Cost ty&es6 Costs $a'e reso#rce and acti'ity co!&onents only. +eso!rce costs are the costs that $o!ld be inc!rred if, hypothetically, no acti%ities $ere performed. Salaries tied to time, for instance, are reso!rce costs, as are rent payments and the !tilities that m!st be paid to s!pport the reso!rces. These costs represent the reso!rces of the company. "cti%ity costs are those that increase as a res!lt of performin( an acti%ity. Frei(ht, prod!ction, and lon(/distance phone calls are examples of acti%ity costs. 4

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50 Reso#rce costs 'xamples of reso!rce costs are salaries, b!ildin(s, machinery, and comp!ter systems. These costs $ill chan(e only $ith a chan(e in reso!rce le%els by the cost of these reso!rces. For example, a company can increase its h!man reso!rce capacity by hirin( more people. These costs, ho$e%er, exist re(ardless of the prod!ction %ol!me. *0 Acti'ity costs "cti%ity costs are inc!rred by performin( a partic!lar acti%ity. These costs may or may not be independent of the n!mber of !nits prod!ced. 1achine set/!p operations, $here additional scrap mi(ht be prod!ced in order to allo$ for steady/ state operation prior to processin( the sched!led parts, is independent of prod!ction %ol!me This cost is a f!nction of the acti%ity, not of the n!mber of !nits prod!ced. The more set!ps, the hi(her the scrap cost, $hether no prod!cts are processed d!rin( the prod!ction phase or an infinite n!mber are processed. -0 Factor costs rod!ction costs that increase directly $ith increased prod!ction are called factor costs. Factor costs are (enerally B b!t not al$ays B material costs. >abor paid by piece$or& is a factor costC labor paid by the ho!r, $ee&, month, or year is not. 70 )i ed costs Some costs exhibit beha%ior that is similar to both factor and reso!rce costs. "n example is electricity. The cost to t!rn on the li(hts in the office is independent of the n!mber of !nits prod!ced and so co!ld be considered a reso!rce cost. Do$e%er, if a machine re)!ires po$er to stamp the n+1st fender, $hich $o!ld not ha%e been !sed had prod!ction stopped $ith the nth !nit. Therefore, electricity can also beha%e as a factor costC the difference is in the application. This %al!e sho!ld be incl!ded in the !nit factor cost. 8hereas traditional cost acco!ntin( $o!ld consider !tilities mixed costs or semi %ariable costs, they can, in fact, be bro&en do$n into factor and reso!rce components. Cost S$eet of a Prod#ct 1. rod!ction Cost -a0 Direct Cost -"lso called Pri!e Cost0 /b0 Indirect Cost -"lso called Prod#ction O890 incl!des indirect material, indirect labo!r, po$er and f!el depreciation on machinery etc.

2. 3.

"dmin Cost is also called "dmin 3*D. Sellin( and Distrib!tion Cost called Sellin( and Distrib!tion 3*D.

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;. Financial Costs called Financial 3*D. -Eot incl!ded in cost sheet as this cost %aries bet$een pro.ect to pro.ect and it is diffic!lt to arri%e at a proper fi(!re. F!t this cost is f!lly ad.!sted $hile calc!latin( sellin( price to an article or ser%ice0. P#r&ose of Pre&arin( a Cost S$eet. 1. 2. 3. ;. To find profitability of a prod!ct To fix sellin( price to plan cost of a ne$ prod!ct To control cost of an existin( prod!ct

Cost s$eet is a &rofit and loss acco#nt of a &rod#ct. Princi&les of a Profit and :oss Acco#nt 1. 2. 3. +elate to a period -an acco!nt is applicable for a specified period only0. +elate to a prod!ct -for e%ery indi%id!al and specific prod!ct0 +elate to a le%el of acti%ity - rod!ction rate0.

W$ile &re&arin( Cost S$eet of a &rod#ct it is necessary to $a'e o&enin( stoc. of6 " -a0 -b0 -c0 +a$ 1aterial 8or& in pro(ress -i.e. Stoc& of semi finished prod!cts0 Finished prod!cts

Cost S$eet )odel of a Prod#ct ; Period6 <<<<<<<<<<<<< Prod#ction = 5++++ #nits Sl -a0 Sale = >,++ #nits Ite! Total Per Unit

Direct 1aterial Cost -i0 3penin( +a$ 1aterial stoc& Gx -ii0 !rchased d!rin( period Gx -iii0 +emainin( or Closin( stoc& Gx -b0 rod!ction Cost -c0 Direct 8a(es 1. rime Cost -a0H-b0H-c0 "dd rod!ction 3%erhead 2. Factory Cost I rime Cost H rod!ction 3%erhead "dd H 3penin( 8I Stoc& >ess / Closin( 8I Stoc& 3. 8or&s Cost - rod!ction cost of finished prod!ct0 "dd "dmin 3*D I Cost of prod!ction of 1,,,, !nitsJ "dd H 3penin( finished (oods stoc& /4,, >ess / Closin( finished (oods stoc& K 1,,, ;. Cost of Loods Sold K <4,, !nits "dd Sellin( 3*D K <4,, !nits

GGGG GGGG GGGG GGGG GGGG GGGG GGGG GGGG GGGG GGGG GGGG GGGG GGGG

G G G G G G G G G G G G G :

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GGGG GGGG GGGG G G G

4. "dd 5.

Cost of Sales rofit or >oss Sales -1oney realised thro!(h Sales0 Cost Analysis and Pre&aration of Cost State!ent

-a0 Cost. Cost is all e &endit#re inc#rred to brin( t$e (oods or ser'ices in t$e &resent condition or location. / / / Implies that all expendit!re is not cost Cost to be calc!lated $ith some reference point There is a chan(e in location or condition or chan(e in both.

-i0 +a$ 1aterial Stoc& Cost -to be %al!ed at cost0 / / / / / / / S!pplierMs price >oadin( Char(es Transportation Transit ins!rance Import d!ty or octroi etc Anloadin( char(es Lodo$n char(es G -a0 Lodo$n char(es are sometimes not considered as cost as there is no chan(e in location or condition -b0 Lodo$n char(es are considered only after the item is shifted from (odo$n. In case of !sin( (odo$n d!rin( the transit, the char(es are to be incl!ded. -ii0 Finished Loods Stoc& / / / -a0 -b0 -c0 -d0 -e0 / +a$ material cost 8a(es Factory expenses 8ater 'lectricity Shed rent Depreciation on asset for prod!ction Factory taxes ac&in( =

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/ / / -iii0

'xcise d!ty Sales tax G "d%ertisin( G

Semi finished (oods / / / +a$ material 8a(es Factory expenses 3n proportionate basis

Cost S$eet and Absor&tion costin( Proble!s

?5. 8hen the sellin( price of a prod!ct N Mfor the year 2,,3 $as +s 1,*/, the total sales $ere +s 1,,,,,*/. For the year 2,,;, the sellin( price has been increased by 1,@. The total sales are expected to increase by 21@. For the year 2,,3, the materials cost $as ;,@, labo!r cost $as 3,@ and total o%erheads $ere 2,@ of sales. For the year 2,,;, the material rates ha%e increased by 1,, labo!r rates by 4@ and total o%erheads by +s 31,,*/ repare the cost sheet for the year 2,,3 and 2,,; and find o!t the profitability. ?*. " >td company man!fact!res and sells electrical o%ens. The sellin( price of the same for the year 2,,3, $as +s 24,,. For the year 2,,3, the material $as ;,@, labo!r 3,@ and total o%erheads $ere 3,@ of the cost of sales. For the year 2,,;, the material rates ha%e increased by 4 @, labo!r rates by 1,@ b!t no chan(e in o%erheads. If the mana(ement fixes the same sellin( price of +s 24,, for the year 2,,;, there shall be a red!ction in the profit of 2,,; by 2,@ of s!ch profits. The mana(ement $ants yo! to s!((est s!ch as price for 2,,; so that same percenta(e of profit shall be maintained. ?-. G >td has a capacity to man!fact!re 24,,, !nits per ann!m. For the l year 2,,3, they prod!ced and sold 2,,, !nits in domestic mar&et and the data for same is as !nder2 / 1aterial >abo!r rod!ction 3%erheads -4,@ fixed0 "dmn 3%erheads -4,@ %ariable0 Sales 3%erhead -:4@ %ariable0 Cost of sales rofit +s 5,,,,, +s 35,,,, +s 2,,,,, +s 4,,,, +s 1,,,,, +s 131,,,, +s 1<,,,, <

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Sales

+s 14,,,,,

For 2,,;, the domestic demand shall red!ce by 1,@ b!t the company is expected to !tilise 1,,@ of capacity by exportin( the !nits of balance capacity. The rates of all the %ariable costs shall increase by 12,@ b!t the fixed costs are not expected to chan(e. The %ariable sales o%erheads rate for the export is expected to be 4,@ of the similar rate for domestic sale. The company is expected to maintain same le%el of profit also for 2,,;. repare the cost sheet for 2,,; and find o!t $hat sellin( price shall be char(ed for exports if domestic sellin( price is not expected to chan(e for 2,,;.

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