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Basic Cost Concepts

Objectives
1. State the meaning of cost;
2. Understand direct and indirect cost;
3. Explain the elements of cost;
4. State the meaning of overheads;
5. Explain the classification of cost
COST
 The amount of expenses incurred on or attributable
to specified thing or activity
 Measurement in monetary terms of the amount of
resources used for the purpose of production of
goods or rendering services.
 Can be expressed in terms of money
Cost in
Manufacturing/Production

Sum total of the values of resources used like raw


material and labor and other expenses
incurred in producing or manufacturing of
given quantity
Classification of Cost
 Direct
◦ costs which can be accurately traced to a cost object with
little effort.
◦ Example: cost of sugar, flour and wages incurred on
production of cake
 Indirect
◦ Costs which cannot be accurately attributed to specific
cost objects
◦ Example: Cost of work tables and other equipment used
during cake production
Determine if the following cost are direct or
indirect in the production of ice cream
 Cost of milk  Direct cost
 Cost of rent  Indirect cost

 Cost of security  Indirect cost


 Cost of labor  Direct/Indirect cost
 Cost of packaging  Direct/Indirect cost
 Cost of manager salary  indirect cost
 Cost of water  Direct/Indirect cost
Elements of cost

Material Labor Expenses


Material
 Materials that are required for production
 Direct material
 Easily identified and related with specific
product, job or process.
 Furniture –wood
 Garments – cloth
 Grape wine – grapes
 Cake - flour
Material
 Indirect material
 Material which cannot be easily or conveniently
identified and related with a particular product,
job or process
 Cake – paper were the design was sketched
 Milk – reagents used for physicochemical
analysis
Labor
 Human resource needed to convert raw material
into finished goods.
 Direct labor
 Takes active part in the production of the product
 It is also known as process labor, productive labor,
operating labor, direct wages
 Wages of baker – cake production
 wages of carpenters – furniture production
Labor
 Indirect labor
 Labor not directly engaged in converting raw
materials into finished product
 Office worker
 Cleaning staff
 Production supervisor
Expenses
 Other expenses not considered as material cost and
labor cost
Indirect Indirect Indirect
Overhead = Material + labor + expenses

OVERHEADS
Includes cost of indirect material, indirect
labor, indirect expenses
Overheads
 Factory/works
 Indirect material
 Indirect wages
 Indirect expenses
 Office and administrative
 Expenses related to management and administration
 Selling and distribution overhead
 Expenses related to sales of product
Cost behavior: FIXED
 Fixed cost
 A cost that remains constant with a given period
of time and range of activity
 Fixed cost per unit decreases as product
increases
 Examples: rent and salary of employees
Fixed cost per
Output (units) Total fixed cost
unit
0 10, 000 10,000

100 10, 000 100

1,000 10, 000 10

2,000 10, 000 5

5,000 10, 000 2

10,000 10, 000 1


Cost behavior: VARIABLE
 Variable cost
 Cost that vary directly in proportion to changes
in volume of production
 Cost which increases or decreases in the same
proportion with the units produced
 Example: direct material, direct labor, direct
expenses
Total variable Variable cost per
Output (units)
cost unit
0 0 0

100 1,000 10

1,000 10,000 10

2,000 20,000 10

5,000 50,000 10

10,000 100,000 10
 Imagine you are setting up a
small business, a fried chicken
How do you stand. You will not be
determine employing anyone you will be
working in a small rented unit.
the selling
1. Name some variable cost you
price of your
are likely to have
product? 2. Name some of the fixed cost
you are likely to have
COSTING
Computing cost of production
Cost = Material cost + Labor cost + Expenses
Break even point
Cost of production is equivalent to income
Income covers cost of production
You made 5 layers of lasagna. Cost are as follow:
Total cost of materials is $22
Total cost of labor $0
Total cost of expenses $2
(estimated cost of electricity
water and LPG)
1. Determine the break even point
2. How much should your selling price be?
A pineapple juice processing plant produces 2000
cans of juice every day. The processing plant has 15
employees working 8 hours a day at a wage rate of
$15/hour. Material cost is $4000 and total expenses is
$3000.
1. If the selling price of the pineapple juice is $4/can
will the product be profitable?
2. How much will the company gain/loss?
3. What is the break even point?
4. If the company wants to have a 50% profit what
should be the price of the product?

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