Introduction to Cost Management

1. Introduction to Cost Management

2. Course Objectives Introduction to cost management Basic cost management concepts Cost behaviour Activity – based costing Product and service costing – A process systems approach Product and service costing – Job order system Allocating costs of support department and joint products Budgeting for planning and control Standard costing – A functional based control function Decentralization – Responsibility accounting performance evaluation and transfer pricing

3. Introduction Tasty Bites is a newly started organization engaged in manufacturing of food products Let us see the cost involved in the production of these potato wafers CLICK HERE! Recently they have two varieties of potato wafers On an average 10,000 packets are produced every month

4. Introduction The selling price is $15 per packet which means the company earns a profit of $2 per packet Now move on to next page to see what company is thinking CLICK HERE! The designing of wrappers and packing is currently outsourced to third party who charge $6 per packet

5. Introduction The company is considering to somehow reduce the cost and earn more profit without altering the selling price They approach Samuels, a cost accountant and discuss about their ideas

6. Introduction Currently, for designing and packing, the company pays $60,000 every month (10,000 packets x $6 per packet) Samuel’s idea is, instead of outsourcing, if the company itself recruit 2 people to design the wrappers and 3 more people to pack the item the company will be incurring much less cost • So, his workings are below: • Salary for 2 designers to design the wrapper = $18,000 ($9,000 per designer) • Salary for three packers = $12,000 ($4,000 per packer)

7. Goals of cost management Develop reasonably accurate product/service cost Assess product/service life cycle performance Improve understanding of processes and activities Control costs Measure performance

8. Contemporary cost management tools • Activity – Based management (ABM) • Activity Based Management focuses on reducing the costs and improving activity performance. In this approach there is a five-step process • Identifying the process objectives • Charting activities • Classifying activities • Continuously improving processes • Eliminating activities whose costs go beyond their value

9. Indirect and direct costs Direct costs Indirect costs Direct costs can be traced easily and accurately to a cost object Indirect costs are the costs that cannot be traced easily and accurately to a cost object

10. Types of costs Let us see how costs can be classified based on their behavioral pattern. The classification is as follows: 1. Fixed cost 2. Variable cost 3. Semi-variable (semi-fixed) cost Let us discuss each one with examples in the next few slides 4. Stepped-fixed cost

11. Fixed costs per unit If the cost is fixed for an item, the cost per unit has to come down or decrease when the volume or activity level increases. Look at the diagram below Cost $ Fixed costs per unit 0 Activity level (no of widgets produced)

12. Variable costs George: Richard, have you heard of variable costs? Richard: Yes George, but can you please explain this to me clearly with examples?

13. Example Two products A and B are produced by a company. The cost estimation is as follows:- Product A Product B • Direct materials costs (per unit) • Direct labor hours (per unit) • Direct labor cost (per hour) • Variable overhead costs (per hour) $14 1.5 hours $10 $2 $12 2.5 hours $10 $2 Expected fixed cost is $220,000. 5,000 units of Product A and 2,000 units of Product B will be produced Click here to know the answer Calculate the total expected costs

14. Solution Product A Product B Total 5,000 units 2,000 units $ $ $ Variable costs • Direct materials • Direct labor • Variable overhead costs 70,000 75,000 15,000 24,000 50,000 10,000 94,000 125,000 25,000 Total variable costs 160,000 84,000 244,000 Fixed costs 220,000 Total costs 464,000

15. Activity-Based Costing methodology • ABC costs the products based on the activities that go into it. This helps to: • Position their products better • Facilitate better Product mix for the market • Enhance the bargaining power with the customer Product Profitability

16. Manufacturing firms vs. Service firms Manufacturing Service Manufacturing consists of combining direct material, direct labor, and overhead to create a new product. They are tangible in nature and can be moved from one place to another A service is intangible in nature. It can’t be separated from the customers. A pure service has no raw materials and tangible items for its customers

17. What is Zero-based budgeting? Zero-based budgeting is a method in which all the expenditures for a new period should be justified. It starts from a “zero base” and the needs and costs of each and every function in a firm is analyzed. Budgets are then constructed around the required resources for the upcoming period regardless of how it compares with the previous budget in terms of its size

18. Standard costing system A standard costing system initially notes down the cost of production at the standard. Inventory units flow through the inventory accounts (from work-in-progress to finished goods to cost of goods sold) at their per-unit standard cost When actual costs become evident, adjusting entries are created which restate every account balance from standard to actual (or approximates such a restatement) The constituents of this adjusting entry provide information regarding the performance of the company for a period, particularly with respect to production efficiency and cost control

19. This is a DEMO Course On – Cost Management. • Register Today and Get Access to 5 FREE Courses. • What Do you Get: • View All Courses Online. • Download Powerpoint Presentation for Each Course. • Do the Knowledge Checks for Each Course. ManagementStudyGuide.com