Classification of costs
1. Classification of costs according to traceability to product or service
1.1. Prime costs
Prime costs are the total direct costs necessary to produce a product or provide service. Therefore, prime costs involve direct material costs, direct labor costs and direct expenses. There is only negligible difference between prime and direct cost → all the direct costs form only one prime cost.
Although prime costs are usually associated with direct costs incurred to make a product, it may be related to other cost objects as well – for example a customer, activity or geographical segment. In this case, prime cost may include direct costs related with this cost object.
1.1.1. Direct costs
Direct costs are costs directly
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Production overheads
Production overheads are indirect costs that are incurred during manufacturing of goods or providing service. They include indirect materials, indirect wages and indirect expenses.
o Indirect material costs – e.g. negligible material, where it is difficult to estimate the consumption such as oil used to grease all machines in the factory, cleaning supplies or safety equipment in the production hall o Indirect labor costs –wages and salaries of staff not involved in the production process. For example wages of employees in purchasing department or security guards overseeing the production premises. Among indirect labor costs belong also: o bonuses and benefits paid o idle time of direct workers (e.g. during breakdowns or strikes) o wages of direct workers for time not working directly in production o various premiums (for shifts, overtimes etc.), unless they result from the specific request of a customer to finish his order quickly (odrážky = http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Labour%20costs.aspx?mode=none) o Indirect expenses – other expenses used in production, which cannot be clearly identified with a specific product or service. For example rent, depreciation or insurance of production premises, power for operating more production lines (where difficult to clearly relate the costs with a single
Overhead based on units sold includes only sales and marketing. Sales and marketing will be targeted mostly towards the products that are already on the market, and so units sold is the best way to associate the cost with each product. (Figure A)
The presentation of the material is in dollars only. Overhead is applied to products as a percent of direct labor dollar cost. Factory profit for each year is found by subtracting direct material, direct labor, and direct overhead costs from total sales. The overhead percentage is calculated at the same time budgeting and is applied as a single overhead pool throughout each model year. The consulting company used 435% of direct labor costs in 1987 for their study; the budgeted was actually 437% (OH/DL=107,954/24,682). A similar percentage applies in the following year (109890/25294=434.5%). However in the next two years, after the outsourcing of oil pans and mufflers was enacted, the allocation of overhead in...
Variable costs: “Variable costs are costs that vary with the volume of activity”2 and they are: direct labor, Materials, Material spoilage & direct department expenses.
Firstly, the service supply chain requires low capital investment in equipment and machinery. In comparison, both the manufacturing and the service industries need labor inputs to complete the production processes that are necessary for satisfaction of end consumer utilities (Maxwell 2013). In addition, the businesses in both sectors require various types of inputs from their suppliers. Moreover, capital investments in material are required in both businesses to enable employee render their services. However, most of the labor costs in manufacturing firms are involved in transporting, procuring, and physical material manipulation. On the other hand, labor costs in the service industry are a...
Method of variable costing is a method where costing can be discovered including the variable manufacturing costs. Fixed factory visual projection is delighted as a period cost-it is abstracted along with the selling and administrative expenses in the period deserved. That is,
This is not necessary in process costing environment because in this environment all the unit or products produced are identical or can be regarded as similar to other. So there is no need to distinguish between direct and indirect cost (Atrill and McLaney, 2009).
Variable costs- these are costs that change depending on amount of use and output of sales and the capacity of production e.g. Electricity, parts and materials.
Total cost is all of the expenses incurred in the production of a product, to include fixed and variable costs. Fixed costs, are expenses that are constant and do not change from month to month regardless of the amount of products sold. For instance, the rent of the factory is considered a fixed cost, for the reason that, the rent must be paid whether products are produced and sold or not. Variable costs,
Activity-based costing (ABC) is a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” as well as variable costs. Activity-based costing is mostly used for internal decision making and managing activities while traditional costing method is used to provide data for external financial reports. Most organization uses activity-based costing as an addition system for using traditional absorption costing as sometimes the traditional cost system misleads the product’s profitability. In a company, there are many products on sale, if one product is sold at a high price with low product margin and a product with high product margin at a low price, it may result in a loss. In addition, due to the reason that cost drivers and enterprises business may change, activity-based costing analysis also needs to be revised periodically. This amendment should be prompted to change pricing, product, customer focus and market share strategy to improve corporate profitability.
First and foremost, operating expense is one of the financial factors that affect the service industry. Operating expenses are expenses associated with the maintenance and administration of a business on a day-to-day basis. Operating expenses primarily consist of the money you must put out to stay in business. It includes your office space, utilities, transportation and supplies. Overhead operating expenses often is undervalued because so many costs are indirect and difficult to predict. The cost of gas, for example, changes regularly and
B. Overview of Process Costing. Manufacturing costs are accumulated in processing departments in a process costing system. A processing department is any location in the organization where work is performed on a product and where materials, labor, and overhead costs are added to the product. Processing departments should also have two other features. First, the activity performed in the processing department should be essentially the same for all units that pass through the department.
The second way is to achieve low direct and indirect operating costs is gained by offering high volumes of standard products and offering basic no-frills products. Production costs are kept low by using less parts and using standard components. Limiting the number of models produced to ensure larger producti...
"Both methods estimate overhead costs related to production and then assign these costs to products based on a cost-driver rate. The differences are in the accuracy and complexity of the two methods" (1) , Now we will discuss why ABC can result in more reliable products costs than conventional labor based product costing system . In recent years, the nature of industrial production has fundamentally altered; we will discuss their characteristics. First we have machine production and capital intensive, Now machines are the main tool and at the heart of production; labors maintain machines and supervise them, and machines are the ones that dictates the pace and rate of production. The second characteristic is high level of overheads relative to direct cost; in modern businesses they tend to use overheads in different ways for example: some products need engineering time and some products require machine time so that products will use overheads differently. The third characteristic is highly competitive international market, transportation including fast freight and relatively cheap; one of the advantages is the use of internet ensures that customers can easily and quickly reach and find products and also cheaply, this environment is highly competitive so companies need to know accurately their range of prices in order to use this information to gain competitive advantage over other
Overhead: Overhead cost is an other important cost in the production process. Overhead cost can be by an estimating on the production forecasting, organization discretions. Overhead expenses are all costs on the income statement except for direct labor, direct materials, and direct expenses. It includes accounting fees, advertising, insurance, interest, legal fees, labor burden, rent, repairs, supplies, taxes, telephone bills, travel expenditures, and utilities.
Of greater importance, a job-order costing system needs to accumulate three types of information, which include direct materials, direct labor, and overhead. These factors are essentially highly important because of the significant variations in the products produced. Hence, each product or batch has a job identification number and costs are accumulated by a job number.