Costs

BEATRICE LEUSTEAN
The Accountants define
the cost as a sacrifice or a
waiver of a resource in
order to achieve a specific
objective.
About costs in general
Actual cost is an incurred cost (a historical cost), contrary to the budgeted cost (or forecasted).

The object of recording and calculating costs (or ,simpler , cost object or cost carrier) can be any
element for which a quantification of costs is desired.

A system of evidence and calculation of costs processes the information related to costs in two basic
stages: accrual (that is accumulation), followed by imputation.

Accumulation (accrual) consists of collecting cost data in an organized manner through an accounting
system.

Costs support the decision-making process.

Examples of evidence and cost calculation at P&G
Direct and indirect costs
The direct costs of a cost The indirect costs of a cost
object are related to the object are related to the
cost object in question and cost object in question but
can be directly attributed to cannot be directly
it in an economically attributed to it in an
feasible (efficient) way. economically flexible
(efficient) way.
Cost object
Or Object of calculation
Main reasons for cost calculation

The goal of managers is to impute as accurately as possible the costs on cost objects.

Inaccurate product costs will give managers a misleading picture of the profitability of
different selling products, as a result, managers risk promoting unprofitable products
and, at the same time, to reduce the attention paid to profitable products.
General rules

managers are more confident in the accuracy indirect costs are more problematic
of direct costs assigned to cost objects
Factors affecting 1. The relative importance of the cost in question.
The more significant the monetary expression of a
direct/indirect cost is, the greater the likelihood that this cost can be
directly attributed to a particular cost object in an
cost economically feasible way.
classifications
2.The available information collection
There are several factors that technologies. Due to the continuous improvement of
influence the classification of a cost information collection technologies, more and more
as direct or indirect types of costs can be classified as direct.

3. The design of production operations. Classifying

a direct cost is easier if a company's production space
is used exclusively for a specific cost object, such as a
specific product or a specific customer.
Cost evolution models: Variable
costs and fixed costs
A variable cost evolves as a total proportional
to the evolution of the corresponding level of
activity or total production volume.
A fixed cost remains unchanged as a total over
a given period of time, regardless of whether
the corresponding level of activity or total
production volume registers wide-ranging.
Costs are defined as variables or fixed in
relation to a specific cost object and for a
given period of time.
Cost determinants
A cost determinant (or inductor, cost generator) is a variable such as the level of activity or the volume
of production, which causally affects costs within a given time frame. In other words, there is a cause-
effect relationship between a change in activity level or production volume and a change in the level of
total costs. The determinant of a variable cost is the level of activity or production volume whose
change causes a proportional change in costs (variable).

Costs that are fixed in the short term have no short-term determinants, but could have long-term
determinants.
Relevant range
The relevant range represents the "band" of normal activity or normal production volume within
which there is a specific relationship between the level of activity or the volume of production and the
cost in question. For example, a fixed cost is fixed only in relation to a certain range (usually broad) of
activity or total production volume (the level at which the company expects to operate) and only for a
given period of time (usually a certain budget period).
  Imputation of costs by cost objects

  Direct Indirect

Variable cost Object of cost: Ford Windstar, Object of cost: Ford Windstar,
Example: Tires used for car assembly Example: Electricity costs at the Detroit plant. Electricity
consumption is billed at the level of the entire plant, where several
products are assembled.
Cost evolution model

Fixed cost Object of cost: Ford Windstar, Object of cost: Ford Windstar,
Example: Salary of the supervisor of the assembly line of the Ford Example: Annual Detroit plant rental costs. The rent is paid for the
Windstar model. entire plant, where several products are assembled.
 Total costs and unit (average) costs
A unit cost, also called an average cost, is calculated by dividing a given amount of the total cost by the corresponding number
of units. These units can be expressed in various ways. Examples include: assembled cars, packages delivered or hours worked.
Suppose 500,000 mobile phones were manufactured, Tennessee Products' Memphis plant generated production costs of
$40,000,000 in 2004. In this case, the unit cost is $80, calculated as follows:

Total Cost production = 40000000$ = 80$ per unit

Number of units manufactured 500000 units

If 480,000 units are sold and 20,000 remain in stock at the end of the year, then the concept of unit cost helps to determine the
total costs to be recorded in the Results Account and in the Balance Sheet, thus:

Cost of goods sold in the Results Account, 480000 x 80$ per unit 38400000$
Final stock in The Balance Sheet, 20000 units x 80$ per unit 1600000$
Total production costs for 500,000 units 40000000$

Unit costs are found in all segments of the value chain-e.g. unit cost of product design, commercial displacements or customer
service.
Use unit costs with
caution!
I N M A N Y D E C I S I O N S , M A N A G E R S S H O U L D B A S E T H E I R R E A S O N S O N T O TA L C O S T S A N D
NOT ON UNIT COSTS, BECAUSE THE UNIT FIXED COSTS CHANGE WHEN THE
C O R R E S P O N D I N G V O L U M E O F T O TA L P R O D U C T I O N C H A N G E S . C O N S E Q U E N T LY, U N I T
C O S T S S H O U L D B E I N T E R P R E T E D W I T H C A U T I O N W H E N T H E Y C O N TA I N A F I X E D C O S T
C O M P O N E N T.
Product units Variable cost per unit Total variable costs Total fixed costs Total costs Unit cost

100000 60$ 6000000$ 10000000$ 16000000$ 160,00$

200000 60$ 12000000$ 10000000$ 22000000$ 110,00$

500000 60$ 30000000$ 10000000$ 40000000$ 80,00$

800000 60$ 48000000$ 10000000$ 58000000$ 72,50$

1000000 60$ 60000000$ 10000000$ 70000000$ 70,00$

The companies in the productive,
commercial and service sectors
Companies in the productive sector buy raw materials and components and turn them into various
finished products.

Commercial companies buy and then resell tangible products without changing their basic form. Eg.
Bookstores and supermarket stores.

Companies in the services sector provide their clients with intangible services or products - e.g. legal
advice or audit.
The financial reports, inventory costs and
annual costs (the costs of fiscal exercise)
Stocks categories

Productive costs classification

Inventory costs

Costs related to the financial year (economic exercise’s costs)

Primary costs and processing costs

Stocks – inventory costs
Stock of direct raw materials: contains direct raw materials stored and waiting to be used in the
production process (e.g. processors and electronic components necessary for the manufacture of
mobile phones).

Stock of products being manufactured: contains products that are partially processed but are not yet
fully finished (e.g. mobile phones in different stages of finishing the production process); are also
called manufactured or semi-manufactured products.

Stock of finished products: contains products (mobile phones, for example) completely finished, but
still unsold.
 Plan A: Results account
Plan A: Results Account

Cellular Products
Results account
for the exercise ended December 31, 2004 (in thousands of dollars)

Income $210000
Cost of goods sold:
Initial stock of finished products ,January 1, 2004 $22000
Cost of goods produced (see Plan B) 104000
Cost of goods available for sale 126000
Final stock of finished products, December 31, 2004 18000
Cost of goods sold 108000
Gross margin (or gross profit) 102000
Operating expenses:
Marketing, distribution and customer service 70000
Total operating expenses 70000
Operating profit $32000

Plan B: The cost situation of the goods produced

Cellular Products
The cost situation of the goods produced
for the exercise ended December 31, 2004 (in thousands of dollars)

Direct raw materials:

Initial stock, January 1, 2004 $11000
Purchases of direct raw materials 73000
Cost of direct raw materials available for use 84000
Final stock, December 31, 2004 8000
Direct raw materials used $76000
Direct productive work 9000
Indirect production costs
Indirect productive work 7000
Consumable 2000
Heating, electricity 5000
Depreciation-building, plant 2000
Depreciation-equipment plant 3000
Different 1000
Total indirect production costs 20000
Production costs generated during 2004 105000
Plus initial stock of products being manufactured, January 1, 2004 6000
Total production costs to be accounted for 111000
Minus final stock of products being manufactured, December 31, 2004 7000
Cost of goods produced (reported in The Results Account) $104000
Typical classifications of
production costs
The direct costs of the raw materials include all expenses related to the purchase of raw materials which
will eventually form an integral part of the cost object (products being manufactured, then finished
products) and which can be attributed directly to the cost object in question in an economically feasible way.

The direct costs of productive work include all expenses related to the remuneration of production staff
that can be charged directly to the cost object (products being manufactured, then finished products) in an
economically feasible way.

Indirect production costs include all production costs related to the cost object (products being
manufactured, then finished products), but cannot be directly charged to this cost object in an economically
feasible way. Costs in this category are also called general production or production overheads.
Inventory costs
Inventory costs (or related to stocks) include all expenses related to a product that are classified as
assets when generated, then become "cost of goods sold" (are passed on to expenses) when that
product is marketed.

For companies in the productive sector, all production costs are inventory costs.

For commercial companies, inventory costs are costs related to the purchase of goods that are then
resold in the same form.

In the case of companies in the service sector, the absence of stocks means that there are no inventory
costs.
Costs related to the financial
year
Costs related to the financial year (or accounting year) include all expenses in the Results Account
other than those included in the "cost of goods sold".

In the case of companies in the productive sector, the costs of the year recorded in the Results Account
include all non-production expenses (non-productive expenses such as design or distribution).

For commercial companies, the costs of the year recorded in the Results Account include all expenses
that are not directly related to the cost of the goods purchased for resale. Examples of costs related to the
accounting year can be mentioned expenses for the salaries of commercial staff and marketing expenses.

Since companies in the service sector do not have inventory costs, all their expenses in the Results
Account are costs related to the accounting year.
The accounting circuit of Cellular Products'
production costs through the T-accounts

Stock of products in the process of manufacture Stock of finished products Cost of goods sold

Balance 1 January 2004 Cost of goods sold

22000

Balance 1 January 2004 6000 Cost of goods produced 104000 104000 108000 108000

Direct raw materials 76000

Balance 31 December 2004

Direct productive work 9000 18000

Indirect production costs 20000

Balance 31 December 2004 7000

Primary costs and transformation
(processing) costs
Primary costs include all direct production costs.

Transformation costs include all the production costs other than the direct costs of raw materials.
QUANTIFICATION OF COSTS
NEEDS REFLECTION
Quantifying costs requires reflection, as there are many

alternative ways of defining and classifying costs. Different companies or sometimes

even different subunits of the same company could define and classify costs into different manners.
 Case study- Quantifying labor
costs
Direct productive work (work that can be directly attributed to specific products)

Production management (examples of essential components related to the labor force

included in these general expenses follows):

Indirect work (remuneration)

Forklift operators (transport of raw materials inside plant)

The staff responsible for cleaning the factory

Plant safety personnel

Reconditioning work (time spent by directly productive staff to reprocess defective products)

Premiums for overtime paid to factory workers (explained lower)

Idle time (explained below)

Salaries of managers, department heads and production inspectors

Auxiliary salary expenses (for example, health insurance premiums, pension contributions)
Premiums for overtime
Direct service work: 44 hours x $ 20 / hour Direct service work: 41 hours x $ 20 / hour

$ 880 $ 820

Premium for overtime: 4 hours x $ 10 / hour $ 60 Downtime (service direction): 3 hours x $

20 / hour
Total remuneration for 44 hours
Premium for overtime: 4 hours x $ 10 / hour
$ 920.
Total remuneration for 44 hours

$ 920