Unit 3 Management Accounting Assignment
LO1. Be able to analyze cost information within the business to the task specified
1.1- Classify the different types of cost. How are the costs classified in the case study?
a) Classification of Cost
Classification of Cost can be made in a number of ways. For different classifications manufacturing & service providing units use different costing techniques.
The different costing classification can be summarized as under:
Materials: Materials can be broadly classified as:-
Direct Material & Indirect Materia
Wages: – Wages can be classified as:
Direct wages & Indirect Wages
Direct Expenses & Indirect Expenses
- Direct Material, Direct Wages & Direct Expenses together comprises of Prime Cost and Indirect Material,Indirect Wages & Indirect Expenses together is called overhead.
- Direct Materials are the materials which are directly relates to production.
- Direct Wages are the cost of labor which is directly related with production.
- Direct expenses are the cost which directly varies with the production units such as lighting & heating, fuel & power etc.
- Overhead Expense can be broadly classified as Function Wise &Behavior wise.
Function Wise Classification:
- Factory/Works/Manufacturing Overhead – It includes all the indirect expenses incurred inside the factory building such as repairing parts for the manufacturing equipment, depreciation of manufacturing equipment, electricity, rent& rates etc.
- Administrative/General/Office Overhead – It related to the expenses which are incurred in relation to general administration. It includes salary of office staff, electricity of administrative building, office equipment, office stationery etc. (Innes and Mitchell, 1993)
- Selling Overhead- Selling overhead are the expenses which are incurred in relation to sales. It comprises of salary & Commission of sales staff, advertisement, promotions etc.
- Distribution Overhead – The expenses which are incurred in connection with delivery of the product such as delivery van expense, salary of deliver boy, etc.
Behavior wise classification:
Variable overhead are the expenses which proportionately vary with production units such as indirect material, indirect labor, indirect expenses which cannot be directly allocated to a specific product. Fixed Overheads are the expenses which remains fixed irrespective of the production volumes which consist of rent and rates, depreciation on factory equipment,insurance, office expenses etc. The expenses which partly remains fixed and partly variable with the production output is called Semi Variable or Semi Fixed overhead.
The following formula can be used for calculating Semi-variable overhead: Y = a + bX
Where Y = total mixed cost
- a = total fixed cost
- b = variable costs per unit
- x = levels of the activity
Some examples of semi variable overheads are telephone expenses, salary inclusive of bonus etc.
Marginal Costing distinguishes between the fixed and the variable cost of a product. The cost of producing one additional unit is termed as marginal costing. In producing one additional unit there is no change in the fixed cost. It is to be noted that the fixed and variable cost are short term concept. In the long run all costs are variable.
Classification of cost can also be made in relation to Accounting Period. The benefit which is derived in future periods is termed as Capital cost. Such costs have to be a mortised in a number of years. On the other hand, the costs which are incurred solely for a particular year are called Revenue Costs. It forms the part of the Total Cost which is incurred solely for that particular year. Classification of Cost can also be made according to the decision-making process such as opportunity cost, sunk cost, controllable &uncontrollable cost, joint cost, differential cost etc.
Standard costs are associated with the manufacturing companies cost of direct material, direct labor &direct expenses. Variance analysis is an important part of Standard costing which shows the actual differences between the actual cost and the standard cost. Some of the major variances are volume variation, material cost variation, labor cost variation, etc.
Value of Classification:
The following are the value of classification which are given as under:
- Cost control and Cost reduction – Cost control and cost reduction is a very important tool for an organization to work efficiently and effectively. Cost reduction aims at reducing the unit cost of goods manufactured or service rendered. While on the other hand cost control aims at achieving the pre-determined cost targets.
- Pricing of output – Sometime the firm has to sell their products at marginal cost in order to be in the market. Cost classification helps in taking such decision.
- Absorption of overhead – Recovery of overhead is another name of Absorption of overhead. It is the process of sharing the overhead cost by all the products of a particular department. It is the allocation of overhead to each unit of output.
- Make or buy decisions – In order to cut down the cost some times the quality management of the organizations has to decide whether to make of buy any particular component in the manufacturing of a product. Due to large availability of production capacity such decisions has to be made. Classification of cost helps in taking such decisions.
- Product diversification/expansion/discontinue a product-line – Depending upon the profitability of the firm the management has to decide whether to diversify their product or not. After a particular span of time the management of the firm should take initiative for expansion in order to respond to rival firm’s action.
- he manufacturing entity uses a separate method for costing of employment in respect of each part.