ACCT20001 Lecture Notes - Lecture 2: Indirect Costs, Variable Cost, Opportunity Cost
16 May 2018
School
Department
Course
Professor
Cost Concepts
Cost information
•Useful for decision-making
-Pricing
-Process or product improvement
-Assess profitability (relating to the firm as whole, or segments)
-Inventory valuation
-Allocate resources
-Planning, budgeting and target setting
•Poorly constructed cost information may lead to unfavourable consequences
-E.g. unreasonable targets set cause managers to act unethically
Cost Object
•Anything for which a separate measurement of costs is required.
-Products and/or Services
-Customers
-Projects
-Particular processes
-Segments of the value chain
-Divisions/Departments
-An organisation as a whole
•Change the cost object - change the way the costs might be viewed
Two Cost Measurement Tasks
Two approaches to assignment
Accumulation →
Assignment
•Recording of costs
•To various cost objects
•Organisation into different cost categories (e.g.
direct labour, direct materials)
•There are 2 broad approaches to assign costs
“Trace” (Direct costs)
“Allocate” (Indirect costs)
•More accurate
•Less accurate
•Assignment is by determine the exact quantities
used by each cost object and then multiply by the
price per quantity
•Assignment is via estimation using an allocation
base (need to find a reliable mechanism to treat
them)
•per loaf of bread: cost of flour, cost of packing
•per loaf of bread: cost of gas, electricity, water,
depreciation of equipment
•per haircut: cost of hairdresser labour
•per haircut: cost of hair products
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1. Cost classification depends on whether it is traced to the cost object
•Direct Costs:
-Direct materials - usually these become a physical part of the product
-Direct labour - work does to produce a product or service
•Indirect Costs:
-Indirect materials - e.g. lubricants, cleaning materials, fuel, other items consumed in
manufacturing or delivery
-Indirect labour - supervision, maintenance, security
-Other - licences, rent, insurance, utilities, depreciation of equipment
2. Classifying Costs - Behaviour
•How do costs change in relation to changes in the volume of the units of output?
•Fixed cost - a cost item that does not change in total but changes on a per unit basis
when volume of the cost object changes
•Variable cost - a cost item that does not change on a per unit basis but changes
when the total volume of the cost object changes.
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Sticky Cost
•Cost may not behave the same when activity increases compared to when activity
decreases. i.e. not always a nice neat line.
Why is classifying costs important?
•Direct vs Indirect
-For indirect costs, the organisation would need to decide the best method to allocate
them to the cost object
-The method chosen - implications on the types of data to track/store
•Fixed vs Variable costs
-Help organisations predict what would happen to their total costs when production
volume changes
-Need to conduct Cost-Volume-Profit analysis
-Can give organisation a sense of which costs can possibly be more easily contained
Relevance: two distinct uses
1. Relevant range
•Some cost items may not be fixed or variable over all possible ranges of volume
-Total fixed cost - may change as volume changes
-Variable cost per unit - may change as volume changes
2. Relevant costs and revenues when choosing between alternatives are those
that:
•Will happen in the future; and
•Differ between alternative being considered
Tennis balls
•Direct costs - direct materials, direct labour (usually variable costs)
•Indirects costs - depreciation on machinery, supervisory salaries, utilities, water (usually
fixed costs)
•Sometimes some or all of the fixed cost can be a direct cost
•We need to know the costs of these objects because we want to know:
-How to price the tennis ball
-How to improve the process
-How to reduce costs
-How to decide on a possible outsourcing system
Consulting project: direct vs indirect
•Cost object: Specific project
•Direct costs
-Consultant salaries
-Travel costs (if projects involve a significant amount of travel)
•Indirect costs
-Travel costs (if projects do not involve a significant amount of travel)
-Printing costs
-Equipment depreciation costs (computer, projector)
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Document Summary
Assess pro tability (relating to the rm as whole, or segments) Planning, budgeting and target setting: poorly constructed cost information may lead to unfavourable consequences. E. g. unreasonable targets set cause managers to act unethically. Cost object: anything for which a separate measurement of costs is required. An organisation as a whole: change the cost object - change the way the costs might be viewed. Assignment: recording of costs, to various cost objects, organisation into different cost categories (e. g. there are 2 broad approaches to assign costs direct labour, direct materials) !1: cost classi cation depends on whether it is traced to the cost object, direct costs: Direct materials - usually these become a physical part of the product. Direct labour - work does to produce a product or service: indirect costs: Indirect materials - e. g. lubricants, cleaning materials, fuel, other items consumed in manufacturing or delivery.
