Basic Manufacturing Cost Categories
The term direct labor is reserved for those labor costs that can be essentially traced to individual units of products. Direct labor is sometime called touch labor, since direct labor workers typically touch the product while it is being made. Manufacturing Overhead Cost:
Manufacturing overhead, the third element of manufacturing cost, includes all costs of manufacturing except direct material and direct labor.
Enumerate and define the different classifications of costs On the basis of Nature or Elements: One of the important classification cost is on the basis of nature or elements.
Based on elements, it is classified into Material Cost, Labour Cost and Other Expenses. They can be further subdivided into Direct and Indirect Material Cost, Direct and Indirect Labour Cost and Direct and Indirect Other Expenses. 2) On the basis of Function: The classification of costs on the basis of the various functions of a concern is known as function-wise classification. Here, there are four important functional divisions in the business organization.
Viz. (a) Production Cost (b) Administration Cost (c) Selling Cost and (d) Distribution Cost.
3) On the basis of Variability: On the basis of variability with the volume of production cost is classified into Fixed Cost, Variable Cost and Semi Variable Cost. Fixed Costs are those costs which remain constant with the volume of production.
Rent and rates of office and factory building are some example of fixed cost. Variable costs are those costs incurred directly with the volume of output. For example, cost of materials and wages to workers are the expenses chargeable with direct proportion to the volume of production.
Semi-Variable Costs are those costs incurred partly fixed and partly variable, with the volume of production. Accordingly, it has both fixed and variable features. For example, depreciations and maintenance cost of plant and machinery.
4) On the basis of Normality: Costs are classified into normal costs and abnormal costs on the basis of normality features. Normal costs are those incurred normally within the target output or fixed plan.
5) On the basis of Controllability and Decision Making: Based on the managerial decision making and controllability the classifications are as follows: (a) Controllable Cost, (b) Uncontrollable Cost, (c) Sunk Cost, (d) Opportunity Cost, (e) Replacement Cost, (f) Conversion Cost.
a) Controllable Costs: Controllable Costs are the costs which can be influenced by the action of a specified number of an undertaking. Controllable Costs incurred in a particular responsibility centre which is influenced by the action of the executive heading. For example, direct materials and indirect materials.
b) Uncontrollable Costs: Uncontrollable Costs are those costs which cannot be influenced by the action of a specified number of an undertaking. In fact, no cost is controllable; it is only in relation to a particular individual that may specify a particular cost to either controllable or non-controllable. For example, rent and rates.
c) Sunk cost: These are historical costs which were incurred in the past and are not relevant to the particular decision making problem being considered. While considering the replacement of a plant, the depreciated book-value of the old asset is irrelevant as the amount is a sunk cost which is to be written-off at the time of replacement. Unlike incremental or decremental costs, sunk costs are not affected by increase or decrease of volume. Examples of sunk cost include dedicated fixed assets, development cost already incurred.
d) Opportunity Cost: Opportunity cost means the cost of forgoing or giving up an opportunity. It is the notional value of going without the next best use of time, effort and money. These indicate the income or potential benefits sacrificed because a certain course of action has been taken. An example of opportunity costs is the market value forgone or sacrificed when an old machine is being used.
e) Replacement Cost: Such expenses may be incurred due to factors like change in method of production, an addition or alteration in the factory building, change in flow of production etc. All such expenses are treated as production overheads; when amount of such expenses is large, it may be spread over a period of time.
f) Conversion Cost: Conversion costs are those costs which are incurred while converting materials into semi-finished or finished goods. It is the aggregate of direct wages, direct expenses and overhead costs of converting raw materials into finished products. Differentiate variable and fixed cost
Fixed costs are costs which remain constant within a certain level of output or sales. This certain limit where fixed costs remain constant regardless of the level of activity is called relevant range. Variable costs are costs which change with a change in the level of activity. Examples include direct materials, direct labor, etc.
