Course Title: Cost Accounting

Course Code:441
BBA Program
Lecture-2

Instructor Details:
Md. Rashidul Islam, BBA (Hon’s),MBA (R.U); MSc. (HuD,
UK); Ph.D. Appeared, (DUFE,CN) in Accounting
Assistant Professor of Accounting
Dept. Of Business Administration
East West University
Dhaka-Bangladesh.

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 Cost Concepts: Cost-Asset-Expense Relationship, Classification of Costs,
Preparation of Cost Sheet, Separation of Mixed Costs – High-Low Method &
Regression Analysis

Learning Outcomes:
After completing the lesson, students will be able to
understand
• Cost, expense , and assets relationships
• The different types of costs
• The preparation of cost statements, and how to separate
mixed costs as variable and fixed costs

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 Cost-Expense-Assets Relationships
• It is important to distinguish cost from expense.
• An expense is a cost charged against revenue in an accounting period; hence,
expenses are deducted from revenue in that accounting period.
• We incur costs whenever we give up (sacrifice) resources, regardless of whether we
account for it as an asset or an expense. (We may even incur costs that the financial
accounting system never records as an asset or expense. An example is lost sales.
• If the cost is recorded as an asset (for example, prepaid rent for an office building,
it becomes an expense when the asset has been consumed (i.e., the building has
been used for a period of time after making the prepayment).
Assets Cost Expenses
Assets are tangible or intangible Cost is the amount of Expenses are the part of
economic resources or rights resource given up in assets or cost used up in
owned by an enterprise which have exchange for some goods the accounting period.
ability to generate probable future or services. For example, For example,
economic benefit. For example, material costs, labor depreciation, bad debts
property, plant & equipment, costs, factory costs, written off, lost items,
prepaid expenses, good will etc. spending for inventory. cost of goods sold.

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 Cost Classification

The different bases of cost classification are:

(1) By time (Historical, Pre-determined).
(2) By nature or elements (Material, Labor and Overhead).
(3) By degree of traceability to the product (Direct, Indirect).
(4) Association with the product (Product, Period).
(5) By Changes in activity or volume (Fixed, Variable, Semi-variable).
(6) By function (Manufacturing, Administrative, Selling, Research and development,
Pre-production).
(7) Relationship with accounting period (Capital, Revenue).
(8) Controllability (Controllable, Non-controllable).
9) Cost for analytical and decision-making purposes (Opportunity, Sunk, Differential,
Joint, Common, Imputed, Out-of-pocket, Marginal, Uniform, Replacement).
10) Others (Conversion, Traceable, Normal, Avoidable, Unavoidable, Total).

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 Cost Classification (continued…)

2. Cost Classification by Element of Costs

Element of costs

Material Labor Other expenses

Direct Indirect Direct Indirect Direct Indirect

Prime Costs Overhead Costs

Production/ Selling Overhead Distribution Overhead

Administrative Overhead
Manufacturing overhead

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 Cost Classification by cost elements (continued…)
(1) Material: The substance from which the product is made is known as material. It
can be direct as well as indirect.
Direct material: It refers to those materials which become a major part of the finished
product and can be easily traceable to the units. Direct materials include:
(i) All materials specifically purchased for a particular job/process.
(ii) All material acquired and latter requisitioned from stores.
(iii) Components purchased or produced.
(iv) Primary packing materials.
v) Material passing from one process to another.
Indirect material: All material which is used for purposes ancillary to production and
which can be conveniently assigned to specific physical units is termed as indirect
materials. Examples, oil, grease, consumable stores, printing and stationary material
etc.
(2) Labor: Labor cost can be classified into direct labor and indirect labor.
Direct labor: It is defined as the wages paid to workers who are engaged in the
production process whose time can be conveniently and economically traceable to
units of products. For example, wages paid to compositors in a printing press, to
workers in the foundry in cast iron works etc.

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 Cost Accounting: Meaning

Indirect labor: Labor employed for the purpose of carrying tasks incidental to goods
or services provided, is indirect labor. It cannot be practically traced to specific units
of output. Examples, wages of store-keepers, foreman, time-keepers, supervisors,
inspectors etc.
(3) Expenses: Expenses may be direct or indirect.
Direct expenses: These expenses are incurred on a specific cost unit and identifiable
with the cost unit. Examples are cost of special layout, design or drawings, hiring of a
particular tool or equipment for a job; fees paid to consultants in connection with a
job etc.
Indirect expenses: These are expenses which cannot be directly, conveniently and
wholly allocated to cost center or cost units. Examples are rent, rates and taxes,
insurance, power, lighting and heating, depreciation etc.
It is to be noted that the term overheads has a wider meaning than the term indirect
expenses. Overheads include the cost of indirect material, indirect labor and indirect
expenses. overheads may be classified as (a) production or manufacturing overheads,
(b) administration overheads, (c) selling overheads, and (d) distribution overheads.

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 Test your understanding

Discuss:
Different types of cost based on cost of product elements

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 Problem of Cost Sheet Preparation
XYZ Corporation
Schedule of Cost of Goods Manufactured
For the year ended December31

Particulars Amount $ Amount $ Amount $ Amount $

Direct Materials:
Beginning Raw Material inventory ***
Add: Purchase of R.M ***
R.M available for use ***
Less: Closing R.M (***)
R.M used in the production ***
Add: Direct Labor ***
Prime costs ***
Add: Manufacturing Overhead
Utilities, factory ***
Depreciation, factory ***
Supplies,factory ***
Maintenance, factory ***
Indirect labor ***
Indirect material ***
Others factory costs ***
Total manufacturing overhead ***
Total manufacturing/ production costs ***
Add: Work in process (beginning) ***
Less: Work in process (ending) (***)
Cost of goods manufactured (finished goods in inventory) ***
Add: Beginning goods inventory ***
Goods available for sale ***
Ending finished goods inventory (***)
Costs of goods sold ***

Note: Direct Labor costs+ Manufacturing overhead costs also called conversion costs.

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 Problem of Cost Sheet Preparation
Requirement-1.
Skyler Company
Schedule of Cost of Goods Manufactured
For the month ended June,30 Problem:
Skyler Company was organized on November 1 of the previous year. After seven months of start-up
Particulars Amount $Amount $ Amount $ Amount $ losses, management had expected to earn a profi t during June, the most recent month. Management
was disappointed, however, when the income statement for June also showed a loss. June’s income
Direct Materials: statement follows:
Beginning Raw Material inventory 17000
Add: Purchase of R.M 190000 Skyler Company
R.M available for use 207000 Income Statement
Less: Closing R.M 42000 For the Month Ended June 30
R.M used in the production 165000 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $600,000
Add: Direct Labor 90000 Less operating expenses:
Prime costs 255000 Selling and administrative salaries . . . . . . . $35,000
Add: Manufacturing Overhead Rent on facilities . . . . . . . . . . . . . . . . . . . . . . 40,000
Rent 40000*.8 32000 Purchases of raw materials . . . . . . . . . . . . . 190,000
Utilities, factory 50000*.9 45000 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Depreciation, factory 12000 Depreciation, sales equipment. . . . . . . . . . . 10,000
Supplies,factory *** Utilities costs . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Maintenance, factory 7000 Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . 108,000
Indirect labor 108000 Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000
Indirect material *** Depreciation, factory equipment . . . . . . . . . 12,000
Insurance 8000*.75 6000 Maintenance, factory. . . . . . . . . . . . . . . . . . . 7,000
Others factory costs *** Advertising. . . . . . . . . . . . . . . . . . . . . . . . . . . 80,000
Total manufacturing overhead 210000 630,000
Total manufacturing/ production costs 465000 Net operating loss. . . . . . . . . . . . . . . . . . . . . . . ($30,000)
After seeing the $30,000 loss for June, Skyler’s president stated, “I was sure we’d be
Add: Work in process (beginning) 70000 profi table within six months, but after eight months we’re still spilling red ink. Maybe it’s time
Less: Work in process (ending) -85000 for us to throw in the towel and accept one of those offers we’ve had for the company. To make
Cost of goods manufactured (finished goods in inventory) 450000 matters worse, I just heard that Linda won’t be back from her surgery for at least six more
Add: Beginning goods inventory 20000 weeks.”
Goods available for sale 470000 Linda is the company’s controller; in her absence, the statement above was prepared by a new
Ending finished goods inventory -60000 assistant who has had little experience in manufacturing operations. Additional information about the
Costs of goods sold 410000 company follows:
a. Only 80% of the rent on facilities applies to factory operations; the remainder applies to selling
Requirement-2. and administrative activities.
b. Inventory balances at the beginning and end of the month were as follows:
Skyler Company 1-Jun 30-Jun
Income Statement Raw materials. . . . . . . . . . . $17,000 $42,000
For the month ended June,30 Work in process . . . . . . . . . $70,000 $85,000
Particulars Amount$ Amount$ Finished goods. . . . . . . . . . $20,000 $60,000
Sales 600000
Less: Cost of Goods Sold -410000 c. Some 75% of the insurance and 90% of the utilities cost apply to factory operations; the remaining
Gross Profit 190000 amounts apply to selling and administrative activities.
Less: Selling and Distribution Costs The president has asked you to check over the above income statement and make a recommendation
Selling and Administration salaries 35000 as to whether the company should continue operations.
Depreciation sales equipment 10000 Required:
Advertizing 80000 1. As one step in gathering data for a recommendation to the president, prepare a schedule of cost
Rent 40000*.2 8000 of goods manufactured for June.
Utilities 50000*.1 5000 2. As a second step, prepare a new income statement for the month.
Insurance 8000*.25 2000 3. Based on your statements prepared in (1) and (2) above, would you recommend that the company
Total Selling and Administration Costs 140000 continue operations?
Net Profit 50000

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 Separation of Mixed Costs

• A mixed cost contains both variable and fixed cost elements. Mixed costs are also
known as semi variable costs. The following equation for a straight line can be
used to express the relationship between a mixed cost and the level of activity:
• Y= a+ bX
In this equation,
Y is the total mixed cost
a is the total fixed cost (the vertical intercept of the line)
b is the variable cost per unit of activity (the slope of the line)
X is The level of activity.

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 Segregation of fixed and variable costs
Problem-1.

Speedy Parcel Service operates a fl eet of delivery trucks in a large metropolitan area. A careful study
by the company’s cost analyst has determined that if a truck is driven 120,000 miles during a year, the
average operating cost is 11.6 cents per mile. If a truck is driven only 80,000 miles during a year, the
average operating cost increases to 13.6 cents per mile.
Required:
1. Using the high-low method, estimate the variable and fi xed cost elements of the annual cost of
truck operation.
2. Express the variable and fi xed costs in the form Y = a + bX.
3. If a truck were driven 100,000 miles during a year, what total cost would you expect to be incurred?

Solution:
Req-1. Eastimation of varibale and fi xed costs elements using high-low point method.

Activity Miles Costs (Cents)

High level activity 120000 1392000

Low level Activity 80000 1088000
Change ` 40000 304000

Change per mile 304000/40000 7.6 Cents

Activity Miles Costs (cents)

High level activity 120000 1392000
Variables costs (120000*7.6) 912000
Fixed costs ( Balancing Figure) 480000

Req-2. Expression of variables and fi xed costs in the form of Y=a+bx or , Y=480000+7.6x

Req-3. If the truck drives 100,000 miles the total cost would be, Y=a+bx
Y= 480000+7.6*100000 or 1240000 Cents

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 Separation of Mixed Costs
Problem: Solution:
Golden Company’s total overhead cost at various levels of activity are presented below: Req-1 Calculation of maintenance cost using high and low point method
Machine Total
Months: Hours Costs$ Total overhead costs 241600
March . . . . . . . . 50,000 $194,000 Less: utilities 52000/40000*70000 91000
April . . . . . . . . . 40,000 $170,200 Less: Supervisor Salary (Fixed) 60000
May . . . . . . . . . 60,000 $217,800 Maintenance (balancing fiqure) 90600
June . . . . . . . . . 70,000 $241,600
Req-2. Calculation of variable and fixed portion of maintenance costs
Assume that the overhead cost above consists of utilities, supervisory salaries, and maintenance. The
breakdown of these costs at the 40,000 machine-hour level of activity is as follows: Activity Hours Costs
Utilities (variable) . . . . . . . . . . . . . . . . $52,000 High level activity 70,000 90600
Supervisory salaries (fixed) . . . . . . . . 60,000 Low level activity 40000 58200
Maintenance (mixed) . . . . . . . . . . . . . 58,200 Change 30,000 32400
Total overhead cost. . . . . . . . . . . . . . . $170,200 Change per hour 32400/30000 1.08 Per hour
Amout$
The company wants to break down the maintenance cost into its variable and fi xed cost elements. Total maintenance cost at 70000 MH activity 90600
Required: Less variable portion (1.08*70000) 75600
1. Estimate how much of the $241,600 of overhead cost in June was maintenance cost. (Hint: To do Fixed portion 15000
this, it may be helpful to fi rst determine how much of the $241,600 consisted of utilities and
supervisory salaries. Think about the behavior of variable and fixed costs within the relevant Cost formula for maintenance Y=a+bx
range.) or Y=15000+1.08x
2. Using the high-low method, estimate a cost formula for maintenance.
3. Express the company’s total overhead cost in the form Y= a + bX. Req-3. Calculation of total overhead costs for 45,000 machine hours
4. What total overhead cost would you expect to be incurred at an activity level of 45,000 machinehours The cost formula is Y=a+bx
Or, Y =75000+2.38*45000 182100

Workings Workings:
2.Calculation of variable and fixed costs of total overhead costs 1. Calculation of per unit variable costs for total overhead

Total maintenance costs at 70000 MH 241600 Activity Hours Costs

Less Variable 2.38*70000 166600 High Level Activity 70000 241600
Fixed overhead costs 75000 Low level Activity 40000 170200
30000 71400
Per chage in per unit 71400/30000 2.38 Per hour

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 Thank you for your attention !!!

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