Cost Concepts for management decisions

Cost Concepts for management decisions

1. All planning involves planning but, in practise, some decisions are made without detailed planning

2. Most businesses have a goal to make profit. Therefore, it is important to be aware of the cost of their products & services.

3. Management requires cost information that is both timely & accurate, and includes the performance of all the firm's products, services, processes, activities & customers

4. Outlay costs involve actual financial expenditure to obtain goods & services

5. Opportunity Costs do not represent financial expenditures, but they are measures of the loss of benefits from a forgone alternative

6. Direct costs are those cost items that are capable of being identified with, or traced to, an activity - known as a 'cost object'

   • A cost object is any activity or segment of a firm for which costs are accumulated. Activities can include:
     • A project
     • A good or product
     • A service
     • A sales territory
     • A department
     • An overseas business operation

7. For financial accounting purposes, the cost object is usually the product (or service). Product costs (such as materials, labour & overhead charges) are accumulated by financial accountants to determine:

   • the cost of goods sold in the income statement
   • The gross profit in the income statement
   • The inventory valuation

8. An indirect cost is not readily identifiable (or traceable) to a specific cost object. However, as the cost object is broadened from the product to either the department in which the product is produced or the division of the company, then more costs become direct

9. Variable & fixed costs are classified according to the behaviour of the cost type. A variable total cost will change in direct proportion to the activity level, however, the unit cost will remain the same.

   • The behaviour of costs is usually referred to as their reaction to changes in an activity base.
   • The activity base is also often referred to as the cost driver, because it is the factor that 'drives' movements in the cost item

10. Fixed costs are those that will not change in total within a 'relevant range' of activity

    • The relevant range refers to the range of activity over which the specific function of the fixed costs remains valid

11. Many management planning & control decisions will be made within the output capacity range provided by the organisations fixed facilities

12. Variable costs change in direct proportion to changes in activity levels. Examples of variable costs are direct labour & direct materials

    • Total Variable Costs (TVC) are assumed to be linear functions of the activity level. they may be expressed as: TVC = b.x
      • Where TVC is total Variable Cost, b is the cost per unit of activity base, and x is the level of activity

13. Many costs are neither fully fixed nor fully variable. They are often termed mixed costs or semi-variable costs, as they contain attributes of both fixed and variable elements

    • Semi variable costs may be represented as TSVC = a + b.x, where TSVC is Total Semi Variable Costs, a is the amount of the fixed cost element, b is the per-unit cost of the variable element and x is the level of activity

14. COST-VOLUME-PROFIT ANALYSIS is a simple technique that enables management to predict the probable short-term effect on profit of changes in critical cost & revenue variables.

    • CVP analysis has two main objectives: 1) to determine the 'breakeven level' of operations in the short term & 2) to predict the effect on profit of changes in the level of activity
    • The break-even level or break-even point of operations is the level or point at which total income for the period is just equal to total costs &, hence, profit is zero

15. Assumptions & Limitations of CVP analysis

    • Linearity of cost & revenue reasons
    • Selling prices & cost elements remain unchanged
    • Single product analysis
    • Equal sales & production volumes

16. A major use of cost accounting data is to allow the performance of managers of each segment of the organisation to be evaluated. To achieve this, costs should be identified with the manager responsible for them. This is known as responsibility accounting

17. A distinction must be made between direct costs & indirect costs, and controllable costs (those costs of a responsibility centre that can be changed, influenced or affected by the manager of the centre) & non-controllable costs (those costs of a responsibility centre that cannot be changed, influenced, or affected by the manager of the centre).

18. Engineered costs are costs that have a direct relationship with a level of activity, and are directly determined by that level of activity

19. Committed costs; those costs that are predetermined & inflexible; those costs that an organisation is locked into in the short term

20. Discretionary costs relate to the provision of resources that are not consumed in direct proportion to operations

21. The cost of activities that add value can be termed value adding costs, since they relate to 'value added activities'. The costs of activities that do not add value may be called non value adding costs

22. For product costing, the relationships between the activities and the products, once established, lead to the more accurate allocation of the costs to the products on the basis of the activity demand of each product

23. Sunk costs are costs incurred in the past and will not change as a result on decisions on changes in production volume or product mix, in the short term

24. A relevant cost is a future cost that is expected to change under the decision alternatives. These costs may also be viewed as differential costs (costs that will differ between decision alternatives) or incremental costs (additional costs that will be incurred as a result of of the decision)