Understanding Costing

UNDERSTANDING COSTS

Cost : The amount of money expended to produce or acquire a product is counted as cost.

Costs are either Manufacturing costs or non-manufacturing costs

Manufacturing Costs VS. Non-manufacturing costs

Manufacturing Costs are those costs that are directly involved in manufacturing of products. Examples of manufacturing costs include raw materials costs and charges related workers. Manufacturing cost is divided into three broad categories:

1. Direct materials cost.
2. Direct labor cost.
3. Manufacturing overhead cost.

Non-manufacturing Costs are those costs that are not directly incurred to manufacture a product. Examples of such costs are salary of sales personnel and advertising expenses. Generally non-manufacturing costs are further classified into two categories:

1. Selling and distribution Costs.
2. Administrative Costs.

UNDERSTANDING COSTING

Cost Unit: Cost unit is a unit quantity of the product, services or time in relation to which costs are ascertained or expressed.

Cost Center: A cost center is part of an organization that does not produce direct profit and adds to the cost of running a company. Examples of cost centers include research and development departments, marketing departments, help desks and customer service/contact centers. Although not always demonstrably profitable, a cost center typically adds to revenue indirectly or fulfills some other corporate mandate. Money spent on research and development, for example, may yield innovations that will be profitable in the future. Investments in public relations and customer service may result in more customers and increased customer loyalty.

Profit Center : The branch or division of a company that creates profits individually and separately from the main organization. The profit center's revenues and expenses are held separate from the main company's in order to determine their profitability.

An investment center is a classification used for business units within an enterprise. The essential element of an investment center is that it is treated as a unit which is measured against its use of capital, as opposed to a cost or profit center, which are measured against raw costs or profits. The advantage of this form of measurement is that it tends to be more encompassing, since it accounts for all uses of capital.

Cost Allocation and Cost Apportionment

Cost Allocation:

• Allocation means the allotment of whole items of cost to cost centers or cost units.
• It deals with the whole items of cost.
• Cost is directly allocated to any cost center or cost units.
• Cost is allocated when the cost centre uses whole of the benefits of the expenses.

Cost Apportionment:

• Apportionment means allotment of proportion of items of cost to cost centers or cost units.
• It deals with only proportion of items of cost.
• It needs a suitable basis for subdivision of cost by cost centers or cost units. Thus it is indirect process of allotment.
• Cost is apportioned when cost centers use only a proportion of the benefits of the whole expenses.

Cost reduction and Cost Control:

Cost control is operated through setting standards of targets and comparing actual performance therewith, with a view to identify deviations from standards or norms and taking corrective action in order to ensure that future performance conforms to standards or norms.

Cost reduction is a continuous process of critical cost examination, analysis and challenge of standards. Each aspect of business viz., products, process, procedures, methods, organization, personnel, etc. is critically examined and reviewed with a view of improving efficiency and effectiveness and reducing the costs. Cost control lacks the dynamic approach which planned cost reduction demands. In cost reduction, standards which are the basis of control are constantly challenged for improvement.

The points of distinction between Cost reduction and Cost control are as follows:

Cost reduction	Cost control
1. It aims at achieving a reduction in unit cost of goods manufactured or services rendered without impairing their suitability for the use intended.	1.It aims at achieving the pre-determined cost targets and ends when the targets are achieved.
2. It does not recognise any condition as permanent and believe that by waste reduction, expense reduction and increased production cost reduction objective can be achieved	2.It entails target setting, ascertaining the actual performance and comparing it with the targets, investigating the variances and taking remedial measures.
3. It assumes existence of concealed potential savings and challenges the norm.	3.It does not challenges norms or standards established for the purpose.
4. It is a corrective function.	4. It is a preventive function.

.

Classification of  Costs

Costs are classified according to the nature of their occurrences.  There are various classifications by which costs are differentiated.

1.       Classification by nature  - Material, Labour and Overhead cost

2.      Functional Classification – Production, Marketing, Selling and Distribution, Research and Development

3.      Classification by Identity – Direct cost and Indirect Cost

4.      Classification by behavior – Fixed, Variable and Semi-Variable costs

5.      Classification by normality – Normal Costs and Abnormal Costs

6.      Classification by time – Historical costs and Predetermined costs

Predetermined costs are again classified into –Estimated costs and Standard Costs

7.      Classification by Decision Making – a. Opportunity Costs

b. Sunk Costs

c. Out of Pocket Costs

d. Imputed Costs

e. Differential Costs

f. Replacement costs