COST

• In performing managerial functions of

planning and control, the manager
should know costs of each alternative.
• Costs data are also needed to make
decisions such as pricing, volume,
make or buy, replacements, asset
acquisition, product mix etc.
• Further the performance of executives
and their sub ordinates can be
evaluated and controlled only when a
comparison of actual cost incurred and
the costs that should have been
incurred is made.
COST AND COST
CURVES
DEWETT 206/217
MANUFACTURING COSTS
• Manufacturing is a process of
converting raw materials into
finished goods through the use
of labor service and other
facilities in factories
2. DIRECT MATERIAL COST
3. DIRECT LABOR COST
4. FACTORY OVERHEAD COST
• In a manufacturing company,
manufacturing costs will include
material, labor and factory
overheads, while non-
manufacturing costs will include
distribution and administration
expenses.
 DIRECT MATERIALS COST.

• Materials are physical commodities that enter

into the making of a product.
• These are stores or raw materials.
• Direct materials are those which can be
directly and conveniently identified with the
physical units of finished product. These
materials really enter into, and become part
of a finished product. For eg, leather used to
manufacture shoes or wood used to make
chair or steel to make steel almirah are direct
materials since they can be directly traced to
finished products.
• Indirect materials are used to in the
manufacturing operations, but do not become
part of the finished products and cannot be
identified separately .eg are cotton waste,
lubricants, grease. Oil etc.
 DIRECT LABOR COST

• Like materials, labor is also classified as

direct and indirect
• Direct labor is one which is directly involved
in converting raw materials into finished
goods. These labor costs vary very closely
with units of finished goods. The wages paid
to workers who operate the machine is an
example for Direct labor.
• Indirect labor is required to perform
manufacturing activities generally, but is not
directly involved in the conversion of raw
materials into finished goods. Eg, wages paid
to Foreman, clerks, time keepers, purchase
and store items, maintenance employees.
Indirect labor is included in factory overfead
 FACTORY OVERHEADS
• Comprises all indirect manufacturing costs
which cannot be identified with specific units
of finished products. All manufacturing costs
except direct materials except direct
materials and direct labor are included in
factory overheads.
• Two important elements of factory overhead
are indirect materials cost and indirect labor
costs.
• Other indirect costs included in the factory
overheads are factory rent, depreciation,
repairs, maintenance, power, light, taxes etc.
 FACTORY OVERHEAD
• Again divided into
Variable factory overhead &
Fixed factory overhead
Variable factory overheads is one
which varies in direct proportion
to units of output – example is
supplies.
fixed factory overhead is non
variable with production-
depreciation, insurance, rent,
supervisor’s salary
 Combining Elements of
Manufacturing cost
• Direct mat cost + Direct Labor cost =
Prime cost

• Prime cost + Factory Over Head =

Factory cost

• Factory Cost + Sales Over Head = Total

Cost
 COST OF PRODUCTION
• Supply of a commodity by the cost
of its production. In order to
produce a commodity, the
producer must have the factors of
production. He should pay wages
to the laborers, interest to capital,
rent on land, payment for raw
materials, transportation cost etc.
 CONCEPT OF COST OF
PRODUCTION
COSTS ARE SOMETIMES
CLASSIFIED AS
• NOMINAL OR MONEY COST
• REAL COST
NOMINAL/MONEY COST AND
REAL COST
• Nominal cost is the money cost of
production. It is also called the
expenses of production- payment to
factors of production, raw materials
etc. Make sure that the price he gets
for the product covers, in the long run,
nominal profit also.
• Real cost . Alfred Marshall regarded
pain and sacrifices of labor as real cost
of production. It is the actual expenses
incurred for organizing a product or
services. These are costs generally
recorded in the accounts ie wages
paid, interest paid, cost of materials
purchased etc
 EXPLICIT COSTS AND
IMPLICIT COSTS.
• Cost of production can be classified as EXPLICIT
COSTS and IMPLICIT COSTS.
• EXPLICIT COSTS are also called paid- out costs to
those from whom he has obtained factors of
production or services. For instance, he has to pay
wages to the labors employed, interest on capital, rent
for land and building. These are EXPLICIT COSTS.
• IMPLICIT COSTS are costs which have not paid out to
others but the costs which the entrepreneur pays to
himself. Perhaps he himself is the owner of the
business, invested his own capital or borrowed capital,
may be the Managing Director for which he may not
draw salary. If he had lent out these factors to outside,
he would have received remuneration from them.
• Hence, they must be taken into account while
calculating profit. But since they are not actually paid
out to anybody, they are called IMPLICIT COSTS
 OPPO RT UNI TY
COS TS
• OPP ORT UNIT Y C OS T is the cost expr ess ed in
ter ms of opportun ity sac rificed. It is the income
fr om the next best al ternat iv e sacr ificed.
• Resourc es ar e s carce and they have alter nate
uses. Wh en a resource is put t o one use, its
alt ernate uses are sacr ificed. T he cost of
alt ernative sacrif ice d i s called oppor tunity
cost.
• For ex ample,
• A per son inv est s R s 1 lakh in business and earn
12% ret urn in investment. S uppose the ne xt
best alt ernat iv e is t o de pos it the amount in a
bank for 10% i nterest .
• If the money is t o be inv est ed in busi ne ss, t he
int erest income has to be sacrifi ced.
• Thus we can say t hat that the oppor tunity cost
of investment of Rs I lakh in busines s is t he
int erest income fr om bank deposit ie 10%
 PRODUCTION COST
• PRODUCTION COST refer to the total
amount of money spent in the
production of goods. They include the
cost of raw materials and freight, the
wages of workers engaged and salaries
of the manager and other office staff.
They include other overheads like rent,
interest on capital, taxes, insurance
and other incidental expenses.
 SELLING COSTS
• Selling costs are the costs of marketing,
advertisement and salesmanship.
• Essential in the competitive economy
• These costs are incurred to attract
customers.
• Selling costs are a peculiarity of an imperfect
market and have no place in a fully
competitive market where dealers are
supposed to be fully aware of the quality of
the goods and the conditions of the market.
 Costs- classification for
planning and control
purpose
1. Fixed and variable costs
2. Budgeted and standard cost
3. Controllable and non controllable
expenses
4. Differential and managerial costs
 FIXED AND VARIABLE
COSTS.
• PRIME OR VARIABLE COST
• They include the money cost of raw material
used in making the commodity, the wages of
the labor and wear and tear of the machine
etc. for eg, if you ask a carpenter what he
would charge for the chair, he would first
think of the wood and cane that he used and
the number of days worked to make it. This is
prime/variable cost.
• Prime cost varies with quantity produced. If
more chairs are made, more money will be
spent . If production is stopped, the prime
costs disappear.
• Prime costs, therefore, are also called the
Variable costs
 FIXED COSTS or
SUPPLEMENTARY COSTS.
• Will the carpenter charge only wood and his
wages for the chair?
• Of course N0!!
• He will think of charging portion of rent,
interest on capital employed, municipal taxes
etc. A big company will have to include a
portion of Manager’s salary, the clerks, the
peons, the cost of advertisement and
salesmanship etc. These costs must also be
covered.
• They are called supplementary costs, on-
costs or over-head charges or fixed costs.
• The fixed costs do not vary with volume of
production. Even if the factory is closed,
these costs will continue.
 FIXED COSTS AND
VARIABLE COSTS
• Can be explained with the help of a
table. The fixed costs are unavoidable
which occur even at the ZERO level of
output.
Unit of output 0 1 2 3 4 5 6 7 8
Fixed cost 40 40 40 40 40 40 40 40 40
 FIXED COSTS AND
VARIABLE COSTS
• Variable costs are one which vary as
the level of output varies

Unit of output 0 1 2 3 4 5 6 7 8
Fixed cost 0 20 30 32 34 36 38 40 46
 DIAGRAMATIC
REPRESENTATION
• Total cost = FC Y
+VC
600

C TC
500
O
S 400
VARIABLE COST
T
300

200

FIXED COST
100

0 1 2 3 4 5 X
QTY
FC, VC, TC
 BUDGET AND STANDARD
COST
• A standard cost is predetermined
cost under given operating
conditions
 COST SHEET
• When we want to find out the cost of a
product, we should know the total cost of
that product manufactured. To know the total
cost, preparation of cost sheet is essential.
Cost sheet is prepared when the production is
uniform, cost units are identical. After
preparing the cost sheet (we get total cost)
the total cost will be divided by number of
units produced to get the cost per unit. Cost
sheet may be prepared weekly, monthly or
according to their requirement.
• Cost sheet gives the details regarding
the various elements of cost, which
may be used by the management for
detailed analysis and for comparison
with previous year’s cost figures.
• Direct cost(+) direct labor(+) direct
expenses = PRIME COST
• Indirect materials(+) indirect labor(+)
indirect cost = OVERHEADS
• PR IME COST + OVE RH EA DS =
TO TA L C OST
 OVERHEADS
• Overheads included
2. Production or factory or works
overheads
3. Administrative overheads
4. Selling and distribution
overheads
 PERFORMA OF A SIMPLE
COST SHEET
particulars Total cost Cost/unit
• Cost sheet for the Direct materials Xxxxx
period – for the Direct wages Xxxxx

production Direct expenses xxxxx

Prime cost xxxxx
of – units XXXXX
fact/works O.H
Works cost xxxxx
Office/admn OH xxxx
Cost of prodn xxxx
Selling&distribn xxxxx
expenses
Total cost or cost xxxxx
of sales
Profit or loss Xxxxx

sales xxxxxxx
 ILLUSTRATION – COST
SHEET
• From the following prepare a cost sheet
showing the total cost / unit when the
production is 100 units during MAY 08.
• Direct materials consumed Rs 10,000
• Direct labor(wages) Rs 8,000
• Direct expenses Rs 6,000
• Factory OH Rs 3,000
• Office & Admn overheads Rs 2,500
• Selling/distribution expenses Rs 3,500
• Sales during the period Rs 40,000
 Solution- cost sheet for May
08 for an output of 1000
Particulars
units Total cost in Rs Total cost/unit -Rs

Direct materials 10000 10

Direct labor 8000 8
Direct wages 6000 6
PRIME COST 24000 24
Factory or works overheads 3000 3
WORKS COST 27000 27

Office and Admn overheads 2500 2.5

COST OF PRODN 29500 29.5

Selling/distrn expenses 3500 3.5

TOTAL COST 33000 33

PROFIT 7000 7
SALES 40000 40