The identification and measurement of costs are of great importance for the company, since they are closely linked with planning, control and decision-making.
Standard costs and budgeted costs:
Standard costs are those that should be incurred in a given production process under normal conditions. Costing is usually related to the unit costs of direct materials, direct labor, and indirect manufacturing costs; they serve the same purpose of a budget.
Budgets show forecast activity on a total cost basis rather than on a unit cost basis. Management uses standard costs and budgets to plan future performance, and then to control actual performance by analyzing variations, that is, the difference between expected and actual quantities.
Cost accounting:
This is mainly related to the accumulation and analysis of cost information for internal use, in order to assist management in planning, control and decision making.
Controllable and uncontrollable costs:
Controllable costs are those that may be directly influenced by unit managers in a given period. For example where managers have the authority of acquisition and use, the cost can be considered controllable by them. Uncontrollable costs are those that are not directly administered by a certain level of management authority.
Committed fixed costs and discretionary fixed costs:
A committed fixed cost arises out of necessity when you have a basic organizational structure, that is, property, plant and equipment, salaried personnel and others. It is a long-term phenomenon that generally cannot be adjusted downward without adversely affecting the organization's ability to operate, even at a minimum level of productive capacity.
A discretionary fixed cost arises from annual allocation decisions for repair and maintenance costs, advertising costs, training for executives and employees etc. It is a short-term term phenomenon that can generally be adjusted downward, thus allowing the organization to operate at any desired level of productive capacity, taking into account authorized fixed costs.
Relevant and irrelevant costs:
Relevant costs are expected future costs that differ between alternative courses of action and can be discarded if any economic activity is changed or eliminated.
Irrelevant costs are those that are not affected by the actions of management. Sunk costs are an example of irrelevant costs. These are past costs that are now irrevocable, like depreciation of machinery. When confronted with a selection, they are no longer relevant and should not be considered in a decision-making analysis, except for the possible tax effects on their provisions.
Relevance is not an attribute of a particular cost, the same cost may be relevant in one circumstance and irrelevant in another. The specific facts of a given situation will determine which costs are relevant and which are irrelevant.
A budget is a quantitative expression of management objectives and is a means of controlling development toward achieving those ends.
Essential components:
* Standard and budgeted costs
* Controllable and uncontrollable costs
* Committed and discretionary costs
* Relevant and irrelevant costs
* Differential costs
* Opportunity costs
* Plant closing costs
Differential costs:
A differential cost is determined by the difference between the costs of alternative courses of action on an element-by-element basis. If the cost increases from one alternative to another, it is called an incremental cost; if the cost decreases from one alternative to another, it is called the decremental cost.
When analyzing a specific decision, the key is the differential effects of each option on the company's profits. Variable and incremental costs are often the same. However, in case of a special order, for example, the production is extended beyond the relevant range, the variable costs will be increased as well as the total fixed costs. In that case, the differential of the fixed costs should be included in the decision-making analysis together with the differential of the variable costs.
Opportunity costs:
When a decision is made to pursue a certain alternative, the benefits of other options are abandoned. The benefits lost in ruling out the next best alternative are the opportunity costs of the chosen action.
Since opportunity costs are not actually incurred, they are not included in the accounting records. However, they are relevant costs for decision-making purposes and must be taken into account when evaluating a proposed alternative.
Plant closing costs:
They are the fixed costs that would still be incurred if there were no production. In a seasonal business, management often faces decisions about whether to suspend operations or continue operating during the off-season. In the short term, it is advantageous for the firm to continue operating to the extent that sufficient sales revenue can be generated to cover variable costs and contribute to recovering fixed costs.
The usual plant closure costs to consider when deciding whether to close or stay open are:
- Leases. Layoff compensation. Storage and warehousing costs. Insurance. Staff salaries.
Bibliography:
Nature, concepts and classification of cost accounting. Part One. Costs I.
