Cost: It is defined as the “value” sacrificed to acquire goods or services that is measured in money, through the reduction of assets (Disbursement) or by incurring liabilities at the time the benefits are obtained (Acquisition of debt).
From this perspective, two types of costs must be analyzed:
Cost to Buy and Sell: The cost in this case is the net purchase price, which is paid for a certain good, adding the necessary disbursements (generally freight) until it is put up for sale. An example of this type of cost is that of a supermarket that carries out buying and selling operations.
Manufacturing Cost: Other elements are incorporated into the manufacturing or transformation process. Here, an additional process is generally incorporated into the raw material and a different product is obtained from the one that had been purchased. Each company, when making its own products, then owns the Manufacturing Cost, which is generated in the production process of a certain product.
3.2 Cost Elements
The elements of the cost of a product or its components are materials, labor, and manufacturing overhead. This classification provides management with the information necessary to measure income and price the product.
Materials: These are the main resources used in production, these are transformed into finished goods with the addition of direct labor and indirect manufacturing costs. The cost of materials can be divided into direct and indirect materials, as follows:
Direct materials: They are all those that can be identified in the manufacture of a finished product, are easily associated with it and represent the main cost of materials in the manufacture of the product. An example of a direct material is lumber used in the manufacture of a bunk bed.
Indirect materials: They are those involved in the elaboration of a product, but they are not direct materials. These are included as part of the manufacturing overhead. An example is the glue used to build a bunk bed.
Labor: It is the physical or mental effort used in the manufacture of a product. Labor costs can be divided into direct labor and indirect labor, as follows:
Direct Labor: It is that directly involved in the manufacture of a finished product that can be easily associated with it and that represents a significant cost of labor in the elaboration of the product. The work of machine operators in a manufacturing company is considered direct labor. O Person who polishes the wood and assembles the bunk.
Indirect Labor: It is that involved in the manufacture of a product that is not considered direct labor. Indirect labor is included as part of manufacturing overhead. The job of a plant supervisor is an example of this type of workforce. (Shift Manager at the furniture store)
Indirect Manufacturing Costs: Used to accumulate indirect materials, indirect labor and other indirect manufacturing costs that cannot be directly identified (in the final product) with the specific products. Examples of other indirect manufacturing costs are leasing, power and heating, depreciation of factory equipment.
Example: A company incurs the following costs in the manufacture of wooden tables.
Materials:
Oak wood $ 150,000
Pine wood $ 110,000
Glue $ 800
Screws …………………………………………………………. $ 1,000
Total ……………………………………………………….. $ 261,800
Workforce:
Wood cutters $ 180,000
Table assemblers …………………………………….. $ 190,000
Sanders …………………………………………………………. $ 170,000
Supervisor ……………………………………………………….. $ 20,000
Goalkeeper …………………………………………………………… $ 10,000
Total ………………………………………………………… $ 570,000
Others:
Factory lease …………………………………………… $ 70,000
General Factory Services ……………………………… $ 20,000
Office lease ………………………………………………. $ 16,000
Office salaries ………………………………………………. $ 80,000
Depreciation of factory equipment …………………………… $ 21,000
Depreciation of office equipment …………………………… $ 8,000
Total ………………………………………………………… $ 215,000
Grand Total……………………………………………………. $ 1,046,800
Product elements
Materials Labor Indirect costs Total cost
Direct Direct Manufacturing Production
Oak wood $ 150,000 $ 150,000
Pine wood $ 110,000 $ 110,000
Glue $ 800 $ 800
Screws $ 1,000 $ 1,000
Wood cutters $ 180,000 $ 180,000
Table assemblers $ 190,000 $ 190,000
Sanders $ 170,000 $ 170,000
Supervisor $ 20,000 $ 20,000
Goalkeeper $ 10,000 $ 10,000
Factory lease $ 70,000 $ 70,000
General factory services $ 20,000 $ 20,000
Depreciation of factory equipment $ 21,000 $ 21,000
Total $ 260,000 $ 540,000 $ 142,800 $ 942,000
conclusion
Based on the above figures, the cost of direct materials would be $ 260,000.-, direct labor would be $ 540,000.-, and indirect manufacturing costs $ 142,800.-. These figures represent the elements of the product, as detailed above. The office lease, office salary and depreciation of office equipment are not included as product costs because they are not cost elements of the product. They generally appear as deductions from gross profit in the income statement as Selling and Administrative Expenses. The $ 942,000.- of the total cost of the product will appear as the main component in the statement of the cost of manufactured goods of a manufacturer.
The cost classification that is based on the relationship to the product will change as the product and / or service varies. For example, lumber is a direct material cost when used in the manufacture of wooden furniture. However, lumber is an indirect material cost when used in packaging for shipping equipment. The maintenance personnel (doorman, watchman) of a manufacturing plant is an indirect labor cost, its function is not directly related to production. However, in a company that provides maintenance service to other people, maintenance personnel is considered a direct labor cost.
Exercise: Chocolates Chip Company, uses the following costs to produce its chocolate chip cookie. Determine direct and indirect materials, direct and indirect labor and manufacturing costs, also show them as elements of a product.
White flour $ 25,000.- Sugar $ 20,000.- Chocolate flakes $ 18,000.- Solvent to clean machines $ 5,500.- Master Pastry Chef $ 15,000.- Partially hydrogenated soybean oil $ 4,500.- Lubricants for machines $ 1,200.- Assistant Confectioner $ 6,000.- Eggs $ 10,000.- Self-adhesive for cookie boxes $ 4,000.- Local Rent $ 45,000.- Depreciation of Machines $ 15,000.- Skim Milk $ 7,500.- Local Seller $ 9,000.-
Materials:
$
$
$
$
Total ……………………………………………………….. $
Workforce:
$
$
$
$
$
Total ………………………………………………………… $
Others:
$
$
$
$
$
$
Total ………………………………………………………… $
Grand Total……………………………………………………. $
Product elements
Materials Labor Indirect costs Total cost
Direct Direct Manufacturing Production
Total $ $ $ $
3.3 Types of Costs
Relationship with Production: Costs can be classified according to the relationship with production, this classification is closely related to the elements of the cost of a product and the main objectives of planning and control.
The two categories, based on their relationship to production, are prime costs and conversion costs.
Premium Costs: They are direct materials and direct labor. These costs are directly related to production.
Conversion costs: Are those related to the transformation of direct materials into finished products. Conversion costs are direct labor and indirect manufacturing costs.
Relationship to Volume: Costs vary according to changes in production volume. Understanding their behavior is vital in almost every aspect of product costing, performance evaluation, and managerial decision-making. Costs with respect to volume are classified as variable, fixed and mixed.
Variable Costs: They are those in which the total cost changes in direct proportion to the changes in volume, or production, within the relevant range, while the unit cost remains constant.
Fixed Costs: These are those in which the total fixed cost remains constant within a relevant range of production, while the fixed cost per unit varies with production.
MIXED COSTS: These costs have the characteristics of fixed and variable, along various relevant ranges of operation. There are two types of mixed costs: semi-variable costs and tiered costs.
Semi-variable costs: The fixed part of a semi-variable cost usually represents a minimum charge when making a certain item or service available. The variable part is the cost charged for actually using the service. For example, most charges for telephone services consist of two elements, a fixed charge for allowing the user to receive or make telephone calls, plus an additional or variable charge for each telephone call made.
Example: A company leases a delivery truck with a constant charge of $ 2,000.- per year plus $ 0.15 for each km traveled. If you travel 10,000 km. In a month, the total annual cost of the delivery truck will be calculated as follows:
Fixed charge (fixed component) …….. ……………………………………… $ 2,000.-
Charge per Km (variable component) (10,000 x $ 0.15) ………… $ 1,500.-
Total Cost …………………………………………………………… $ 3,500.-
Step cost: The fixed part of step costs changes abruptly at different levels of activity since these costs are acquired in indivisible parts.
Example: The salary of a supervisor is $ 30,000.- for every 10 workers. If 15 workers are employed, two supervisors will be needed, however, if the number of workers is increased to 23, three supervisors would be needed.
Workers Supervisor Tiered Cost
10 1 $ 30,000.-
15 2 $ 60,000.-
17 2 $ 60,000.-
21 3 $ 90,000.-
24 3 $ 90,000.-
CAPACITY TO ASSOCIATE COSTS
According to the degree of intervention in the manufacturing processes, two types of costs are distinguished:
Direct Costs: These are those that the company is able to associate with specific items or areas, they are directly involved in the production process. The direct materials and direct labor costs of a given product.
Indirect Costs: They are those that are not directly identified with the production process, but that are necessary for the product to be finished.
PERIOD IN WHICH THEY ARE CHARGED TO INCOME
They can also be classified based on when they are charged against income. The two categories used are product costs and period costs.
Product costs: They are those that are identified directly and indirectly with the product. These are direct materials, direct labor, and manufacturing overhead. These costs do not provide any benefit until the product is sold, therefore they would be inventoried until the product is finished. When products are sold, their total costs are recorded as an expense, called cost of goods sold. (Cost of sale). The cost of goods sold is compared with the income of the period in which the products are sold.
Period costs : These costs, which are not directly or indirectly related to the product, are not inventoried. The costs for the period are written off immediately, since no relationship between cost and income can be determined. The following are examples of the costs of the period, the salary of an accountant (administrative expenses), Electricity, Water, Telephone (general expenses), etc.
Exercises to do in Classes
No. 1) Sony SA produces car radios. The following cost information is available for the period ended December 31, 2003.
- a) Materials used in production: $ 120,000.- of which $ 80,000.- were for direct materials.
- b) Factory labor costs for the period: $ 90,000.-, of which $ 25,000.- were for indirect labor.
- c) Indirect manufacturing costs for general services: $ 40,000.- d) Selling, general and administrative expenses: $ 60,000.-
Calculate: Premium Costs, Conversion Costs, Product Costs, Period Costs.
Development:
Prime costs:
Direct materials $
Direct labor $
Total prime costs $
Conversion costs:
Direct labor $
Indirect manufacturing costs $
Total conversion costs $
Product costs:
Direct material costs $
Direct labor cost $
Indirect manufacturing costs:
Indirect materials
Indirect labor
General services $
Total product costs $
Period costs:
Selling, general and administrative expenses. $
Nº 2) Soprole presents the following information: relevant range of the factory 10,000 to 50,000 gallons of yogurt per month.
Monthly production (gallons)
January $ 10,000
February $ 15,000
March $ 20,000
April $ 22,000
May $ 27,000
June $ 40,000
Variable cost per gallon $ 5
Fixed monthly cost $ 100,000.-
Calculate: Total and unit variable cost, Total and unit fixed cost.
Nº 3) Todo Pieles SA manufactures wallets and has the following cost information for the period that ended on December 31, 2003.
Materials used in production $ 82,000.- of which $ 78,000.- were considered in direct materials.
Labor for the period $ 71,500.- of which $ 12,000.- corresponded to indirect labor.
Indirect manufacturing costs due to depreciation of the factory $ 50,000.-
Selling, general and administrative expenses for $ 62,700.-
Calculate: Prime costs, conversion costs, product costs, and period costs.
3.4 Methods of Assignment or How they should be attributed to the Product
To carry out a correct allocation of costs, it is necessary to bear in mind the aforementioned concepts, that is, those direct and indirect costs, and even more so the exhaustive separation that exists between cost and expense, which will be explained below.
- Cost: Disbursement that is recovered with the sale of the product, since its elements have to be incorporated in the sale price.
-Expenditure: Disbursement that is not recovered (loss), since it is a concept that does not constitute a cost element. For example, the telephone expense.
Allocation of Materials: They must be assigned to the cost of the product through the acquisition price, that is, its cost will be the cost of buying, plus freight and other disbursements until it is made available for production.
Labor Assignment: Labor must be assigned by man hour, which will be calculated from the total paid to each production person, divided by the hours worked in the month. This result gives us the value of the hour of work per worker. Then the total time used in manufacturing will be multiplied by the hour value and the cost per labor will be taken. This element becomes highly relevant when a product that means a long period of work is quoted.
Indirect Cost Allocation: These are difficult to qualify, since their consumption is not truly accurate. But the same criterion of labor will be followed, therefore its allocation will be through the hour of work or consumption. Thus, the value per machine hour and hourly value of energy and leases will be determined.
ASSIGNMENT OF COSTS AND EXPENSES TO THE RESULTS OF THE COMPANY
(See PDF)
3.5 Cost of a kilo of ordinary bread.
materials
It is based on the production of a quintal of flour with an average yield of 67 kg -in one hour of work.
Materials: It is valued according to recipe: (Example)
1 qq. Flour $ 5.300
Salt $ 500
Butter $ 2,000
Total Materials $ 7,800
Labor (working time 72 hours)
Master Man Cost 1 x $ 469 $ 469
1 x 417 Helper Man Cost $ 417
Total Labor $ 886
Indirect costs (working time 72 hours)
Depreciation $ 260 x 1 hour $ 260
Electricity $ 31 x 1 hour $ 31
Total Indirect Cost $ 291
Total Cost of the Mix $ 8,977
Unit cost $ 8,977 / 67 $ 134
Calculation of the Marketing margin
Sale price $ 360
(-) Total cost $ (134)
Profit $ 226
Marketing Margin in% 169% Formula: Profit x 100
Total cost
In this hypothetical case, a margin of 169% over the cost has been determined, but in practice it was possible to calculate a margin of 70% for ordinary bread and 69% for Easter bread.
3.6 Balance Point:
It is that point in which there is no utility, at that point the total income is equal to the total costs.
Then the following equality can be established:
TOTAL INCOME = TOTAL COSTS
Three fundamental conclusions can be drawn from this:
a) If in a period of time there has been income for $ 1,500,000.- and the total costs have been $ 1,500,000. - It means that absolutely nothing has been gained.
IT = CT, then 1,500,000 = 1,500,000
b) Now if the income continues to be $ 1,500,000.- and the costs reached $ 500,000.-, it means that the company has earned $ 1,000,000.-
1,500,000 = 500,000, so 1,000,000 corresponds to profit.
c) Finally, if the total costs have been $ 2,000,000.-, our company has lost $ 500,000.-
1,500,000. = 2,000,000, so 500,000 corresponds to loss.
The determination of the equilibrium point is of vital importance, since the employer must bear in mind the volume of sales or minimum income to be generated in a period of work.
Breakeven analysis
A simple example will be used to present break-even analysis and cost-volume-profit analysis. Mrs. Maria Ramos, a housewife, wants to start a business in which she would sell a cosmetic case, developed and patented by her.
Ms. Maria did a good job of research to determine if the business would be profitable. With regard to costs and based on her conversations with real estate brokers, she discovered that the cost of renting an office suitable to meet her business needs would be approximately $ 1,200 per month, or $ 14,400 per year. The lease will include all services, except for telephone expenses and office furniture. She estimated that telephone expenses would be about $ 1,800 per year, this cost does not vary with the level of sales as long as sales do not exceed $ 100,000 per year. She also estimated that it would cost $ 13,800 a year to hire one person on Fridays to do all the secretarial duties and keep the books.An independent manufacturer of cosmetic products has agreed to manufacture their cosmetic case for $ 1 a unit. Maria was confident that she could sell each unit for $ 9.
Maria now has to make the decision whether or not to start her business. Although she has a great talent for cosmetics, she is not confident in her ability to make business decisions, so she decided to seek professional help from her nephew, Mario, who is an accountant.
She summarized all the information for Mario as follows:
Annual rent $ 14,400
Annual telephone expenses $ 1,800
Employee cost on Fridays $ 13,800
Cost per case $ 1
Retail price per case $ 9
Mario was a very skilled accountant, his answer was that he could not recommend starting her business without knowing approximately the number of compact cases she expected to sell.
Why? She said, Mario explained to her aunt that regardless of how many cases she sold, she would incur the fixed cost of the annual rent, the phone bill, and the employee cost on Fridays. This total annual fixed cost would be $ 30,000 ($ 14,000 for rent + $ 1,800 for telephone + $ 13,800 for secretary). Since $ 9 in revenue would be received from the sale of each kit and the cost of purchasing a unit is $ 1, this means that a “profit” of $ 8 would be achieved for each unit sold.
Profit / Loss = Total Income - Total Cost
Profit / Loss = 9 - 1
Utility = 8
In order to break even, 3,750 units (30,000 / 8) must be sold to cover the total annual value of the fixed cost of $ 30,000.
Break-even point = Total Fixed Costs
(In units) Sales price per unit - Variable cost per unit
= 30,000
9 - 1
= 3,750 units
Contribution Margin per unit
It is the surplus available to cover the fixed cost and perhaps provide a profit after the sales have been used to cover the variable cost. (Sales price per unit - Variable cost per unit)
To show that 3,750 is indeed the number of units that would not generate a profit, a simple income statement can be developed:
Total income ($ 9 x 3,750) $ 33,750
(-) Costs:
Total variable costs ($ 1 x 3,750) $ 3,750
Total fixed costs $ 30,000
Total Costs $ (33,750)
Profit $ 0
Ms. Maria was delighted, she was confident that she could easily sell more than $ 3,750 cosmetic cases that were required to break even. Mario said "there is something else that we must analyze before you make your decision."
Mario explained to his aunt that 3,750 was the amount needed to break even, but he hoped that she would be interested in making a profit. Mrs. Maria replied that she expected to make at least $ 40,000 a year, or wasting time starting this business would not be justified. How much do I have to sell to obtain a profit of $ 40,000 before tax? Mario explained that the sale of 3,750 units would be necessary to break even, but 5,000 additional units would have to be sold to generate a profit of $ 40,000 before of tax. This means that sales must be at least 8,750 units to generate a profit of $ 40,000 before tax.
Therefore, the number of units that must be sold in order to generate a target profit is as follows:
Sales to Achieve = Target Profit + Total Fixed Costs
A target profit Contribution Margin per unit
(In units)
Sales to achieve = $ 40,000 + $ 30,000
A target profit $ 9 - $ 1
(In units
= 8,750 units
To show that 8,750 is, in effect, the number of units that would generate $ 40,000 of profit before tax, a simple income statement can be developed:
Total income ($ 9 x 8,750) $ 78,750
(-) Costs:
Total variable costs ($ 1 x 8,750) $ 8,750
Total fixed costs $ 30,000
Total Costs $ (38,750)
Profit $ 40,000
Income Tax Adjustments
It is easy to include income taxes in the analysis. The income tax rate constitutes a determined percentage of profit before tax. The formulas for the cost-volume-profit analysis presented above can be modified to include income taxes, as follows:
Profit after tax
Sales to make a profit = 1 -% Taxes + Total Fixed Costs
Target after tax Contribution Margin per unit
(In units)
40,000
= 1 - 0.15 + 30,000
- - one
= 9,632
To show that 9,632 is, in fact, the number of units that would generate $ 40,000 of after-tax profit, a simple income statement can be developed:
Total income ($ 9 x 9,632) $ 86,688
(-) Costs:
Total variable costs ($ 1 x 9,632) $ 9,632
Total fixed costs $ 30,000
Total Costs $ (39,632)
Profit before Tax $ 47,056
15% income tax $ 7,058
Profit after Tax $ 39,998
Risk and Utility Analysis
A useful measure for management in profit planning is the maximum percentage by which expected sales can decrease and even generate a profit. This is known as the Safety Margin and is calculated as follows:
Margin of Safety = Expected Sales - Sales at Break-Even Point
Expected sales
For example, Ms. Maria expected to sell 7,000 units. Since the breakeven point is 3,750 units, the safety margin is:
Safety margin = 7,000 - 3,750
7,000
= 0.46 or 46%
therefore, as long as actual sales are not less than 46% of what was expected, Mrs. Maria will make a profit.
Exercises to do in class:
# 1) ABC asked you to determine the level of sales you must achieve to cover your fixed and variable costs. The selling price is $ 5, the total fixed costs are $ 160,000, and the variable cost per unit is $ 3.
Determine the breakeven point in units, and the simple Income statement.
- What is the breakeven point in units? Prepare the income statements when sales are $ 500,000 and $ 000 (ignore taxes) Determine the amount of sales in units to get an after-tax profit of $ 289,000. What is the margin of safety for the company whose breakeven point was calculated, if the expected sales are 000 units?
No. 2) A company knows that its variable costs per unit are $ 0.10 and its selling price is $ 0.50. total fixed costs are $ 50,000.-
- What is the breakeven point in units? Prepare the income statements when the sales are $ 31,250 and $ 750 (ignore taxes) Determine the amount of sales in units to make an after-tax profit of $ 30,000. What is the margin of safety for the company whose breakeven point was calculated, if the expected sales are 000 units?
3.7 What are the costs for?
It is important to keep in mind that the unit costs of the different products whether they are manufactured or not. They represent only a reference parameter for decision-making, especially in sales prices and discount policies.
The determination of a manufacturing cost should allow the entrepreneur, among other things, the following:
- Set sales prices with certainty Know your marketing margin Know how much you are allocating to finance non-cost expenses Establish an adequate cost control and reduction policy It allows a correct valuation of finished product inventories An adequate valuation of its elements for each cost item.
BIBLIOGRAPHY
- Ralp S. Polimeni and Frank J. Fabozzi COST ACCOUNTING. Third Edition Concepts and Applications for Managerial Decision Making_____________________
To continue learning about the basic concepts of costs, we leave you with the following video-course taught by Jorge Ignacio Lardizábal, Professor of Costs at the Austral University, in which the essential elements of cost accounting are presented. (15 videos, 6 hours)
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