Module 9 Cost Characteristics and Behavior 9 1 Introduction With knowledge of costs manager can Every organization needs to know the cost of particular goods or services over a period of time This module describes the cost collection process and also the cost allocation process control actual performance against planned and take corrective action if necessary plan next year s cost carefully allowing for what happened last year determine a desirable selling price track the consumption of the organization s resources choose among alternative courses of action decisions are not just based on cost though 9 2 Cost A Deceptively simple word Costs behave many different ways depending on context We need to define these contexts and specify what we are costing e g a cost item like a tin of paint 9 3 Variable and Fixed Costs Overhead comprises of cost incurred by the business in support of the cost items made but not easily identifiable in the product as materials and labor Manufacturing Overhead includes depreciation on production machinery energy costs for machinery salaries of foreman general management Non Manufacturing Overhead includes depreciation on office equipment rent salaries of office and Variable Costs are those that vary with the volume produced e g materials labor in the long haul companies can recruit and dispose of labor as they see fit Variable Cost 10 per unit Volume of Output The only overhead cost that varies with production is energy costs for production machinery the rest are fixed costs Fixed Costs do not vary with production output e g depreciation is a fixed cost because its loss in value is more to do with the passage of time then usage patterns Fixed Cost Volume of Output Semi Variable costs are one which have the features of both fixed and variable costs a telephone bill has a fixed monthly cost plus variable per call costs Semi Variable Cost Volume of Output Total Cost Variable Cost Fixed Cost Volume of Output Manager can read off the chart the total costs involved at any production level Th chart below shows fixed and variable costs together 9 4 Beware Unitizing Fixed Costs Case Study A dept of a company makes four types of casing for a electric meter The following are the costs for the different casings and your competitor s prices Product Costs per Unit Materials Labor Manufacturing Overhead Total Competitors Price Product Costs per Unit Materials Labor Manufacturing Overhead Total Competitors Price W 7 4 11 12 W 7 5 71 12 71 12 X 11 3 14 12 X 0 0 0 12 Y 12 2 14 16 Y 12 2 86 14 86 16 Z 6 1 7 9 Z 6 1 43 7 43 9 To reduce costs you decide to buy in casing X from the competitor This is the result Note The previous manufacturing overhead costs totaled 10 which was allocated to each of the four products using the ratios of 4 10 3 10 2 10 and 1 10 Now take away product X each of the remaining three products need be allocated the 10 He uses the ratios 4 7 2 7 and 1 7 so for example 4 7 x 10 5 71 Now W is cheaper if you buy from competitor should you Ans No the mistake was already made to drop X The fixed costs of 3 to produce a unit of X now has to be borne by the other products in the assembly line The decision to buy in X actually cost the company 1 per unit that s the difference of the competitors price and the variable cost This is Economies of Scale in action 9 5 Direct and Indirect Costs Direct Costs are those that are incurred simply because the item is manufactured e g materials and labor and selling Indirect Costs are those that are incurred in the support of the fundamental activities of manufacturing Indirect costs support every product and range or products of the business where direct costs are specific to an individual product Direct costs are very similar to Variable costs but there can be differences for example a new machine is bought for a specific product this means that its is a direct cost its attributable to a specific product but it is also a fixed cost Indirect costs are similar to Fixed but they are not exactly the same 9 6 Traceable and Common Costs Traceable costs direct costs Common costs indirect costs A business producing one product has no common costs 9 7 Product Costs and Period Costs materials direct labor depreciation Product costs are costs which can be attached to the cost items without too much difficulty e g raw Period costs are costs which although incurred ultimately in support of the product are best controlled in time periods eg selling administrative costs Product and period costs include a blend of direct traceable indirect common fixed and variable Their significance is in valuing inventory for financial accounting purposes not used in management costs accounting 9 10 Controllable and Non Controllable Costs Controllable refers to a person someone who is accountable for the costs being measured For example overtime is a controllable cost for a shift supervisor whereas factory insurance is not Control is influenced by the time scale involved a production manager is not responsible for a sudden machine breakdown but is responsible for the 12 month maintenance budget A standard cost is the budgeted cost for one cost item Actual costs are measured and compared against standard costs from period to period 9 11 Standard and Actual Costs Management want to receive explanations of any variances between the two A standard costs comprises both variable and a share of fixed costs 9 12 Engineering and Discretionary Costs avoided for example wood in a cabinet Engineering costs are those costs that are engineered into the product and therefore can not be Discretionary costs are those which need not be incurred every accounting period at the levels that they have been incurred in the past examples are maintenance and R D 500K 300K 150K 9 13 The Break Even Chart Sales Revenue Loss Total Cost Breakeven point Breakeven point Profit Fixed Cost Volume of Output Where the sales revenue line crosses the total cost line is the break even point The break even point is the point at which if all units made were sold the total costs fixed and variable would be met by revenue from sales The break even point can be read off in terms of units or money The wedges on either side of the break even point show the areas where the company makes and profit or loss The greatest loss is where the sales revenue is zero and total costs fixed costs The difference between the break even point and the actual level of output achieved if greater than break even