37
COST DRIVERS COST DRIVERS & & COST BEHAVIOUR COST BEHAVIOUR Dr. Rana Singh Dr. Rana Singh www.ranasingh.or g

Cost Driver

Embed Size (px)

DESCRIPTION

 

Citation preview

Page 1: Cost Driver

COST DRIVERS COST DRIVERS & &

COST COST BEHAVIOURBEHAVIOUR

Dr. Rana SinghDr. Rana Singhwww.ranasingh.org

Page 2: Cost Driver

COST DRIVER - COST DRIVER - DEFINITIONDEFINITION

An activity which generates costAn activity which generates cost A factor such as the level of activity or A factor such as the level of activity or

volume that causally affects cost.volume that causally affects cost. Existence of a cause-and-effect Existence of a cause-and-effect

relationship between a change in the relationship between a change in the level of activity or volume and change in level of activity or volume and change in the level of total costs of that cost object.the level of total costs of that cost object.

Thus cost drivers signify factors, forces Thus cost drivers signify factors, forces or events that determine the costs of or events that determine the costs of activitiesactivities

Page 3: Cost Driver

COST DRIVER - COST DRIVER - IDENTIFIEDIDENTIFIED

Direct costs do not need cost driversDirect costs do not need cost drivers They are themselves cost drivers They are themselves cost drivers

since they can be traced directly to a since they can be traced directly to a product.product.

All other factory or manufacturing All other factory or manufacturing costs need cost drivers.costs need cost drivers.

Page 4: Cost Driver

COST DRIVERS – WHY?COST DRIVERS – WHY?

They are the links between a pool of They are the links between a pool of costs in an activity centre and the costs in an activity centre and the productproduct

Therefore in order to trace overhead Therefore in order to trace overhead costs to products, appropriate cost costs to products, appropriate cost drivers should be identified.drivers should be identified.

Page 5: Cost Driver

COST DRIVER - TYPESCOST DRIVER - TYPES

There are two categories of cost driver:There are two categories of cost driver: Resource Cost Driver: A measure of the Resource Cost Driver: A measure of the

quantity of resources consumed by an quantity of resources consumed by an activity. Used to assign the cost of a activity. Used to assign the cost of a resource to an activity or cost pool.resource to an activity or cost pool.

Activity Cost Driver: Measure of the Activity Cost Driver: Measure of the frequency and intensity of demand, frequency and intensity of demand, placed on activities by cost objects. Used placed on activities by cost objects. Used to assign activity costs to cost objects.to assign activity costs to cost objects.

Page 6: Cost Driver

ACTIVITIES & COST ACTIVITIES & COST DRIVERSDRIVERS

FUNCTIONAL AREAS

ACTIVITIES SUITABLE COST DRIVERS

Materials Management

• Issue of purchase orders

• Number of purchase orders

• Inspection of materials

• Number of purchase orders

Stores Management

• Storing of materials

• Value of materials stored

• Servicing of requisitions

• Number of requisitions

• Inspection & Verification

• Number of times inspected

• Stock Taking • Value of stock

Quality Control

• Testing of Samples • Number of batches produced

Marketing • Demand Creation • Increase in sales

• Advertising • Increase in sales

• Despatches •Number of orders

Page 7: Cost Driver

ACTIVITIES & COST ACTIVITIES & COST DRIVERSDRIVERS

FUNCTIONAL AREAS

ACTIVITIES SUITABLE COST DRIVERS

Personnel Management

• Recruitment of employees

• Number of employees recruited

• Maintenance of leave records & attendance

• Number of employees

Research & Development

• Research • Number of research Projects

Machining • Setup Cost • Number of production runs

• Power cost •Machine hours

Page 8: Cost Driver

ACTIVITIES-ACTIVITIES-CLASSIFICATIONCLASSIFICATION

In manufacturing organizations, In manufacturing organizations, activities are grouped on the basis of activities are grouped on the basis of different levels at which activities are different levels at which activities are performed and hence are identified performed and hence are identified and classified into broadly four and classified into broadly four different categories:different categories:

Page 9: Cost Driver

UNIT LEVEL ACTIVITIESUNIT LEVEL ACTIVITIES

Activities performed each time a unit Activities performed each time a unit is produced.is produced.

They are repetitive activitiesThey are repetitive activities Example: Direct labour hours, Example: Direct labour hours,

Machine hours, Power are used each Machine hours, Power are used each time a unit is producedtime a unit is produced

Costs of unit level activities vary Costs of unit level activities vary with the number of units producedwith the number of units produced

Page 10: Cost Driver

BATCH LEVEL BATCH LEVEL ACTIVITIESACTIVITIES

Activities performed each time a batch Activities performed each time a batch of goods or products is producedof goods or products is produced

Costs of batch level activities vary Costs of batch level activities vary with the number of batches but are with the number of batches but are fixed with respect to the number of fixed with respect to the number of units in each batchunits in each batch

Example: Machine setups, inspections, Example: Machine setups, inspections, production scheduling, materials production scheduling, materials handlinghandling

Page 11: Cost Driver

PRODUCT LEVEL PRODUCT LEVEL ACTIVITIESACTIVITIES

Activities performed to support the Activities performed to support the production of each different type of production of each different type of productproduct

Example: Maintenance of Example: Maintenance of equipment, engineering charges, equipment, engineering charges, testing routines, maintaining bills of testing routines, maintaining bills of materialsmaterials

Page 12: Cost Driver

FACILITY LEVEL FACILITY LEVEL ACTIVITIESACTIVITIES

Activities needed to sustain a factory’s Activities needed to sustain a factory’s general manufacturing processgeneral manufacturing process

These are common to a variety of These are common to a variety of productsproducts

Most difficult to link to product specific Most difficult to link to product specific activitiesactivities

Examples: Factory management, Examples: Factory management, maintenance, security, plant maintenance, security, plant depreciationdepreciation

Page 13: Cost Driver

EXAMPLESEXAMPLES

Examples of costs driven by activities at each level:Examples of costs driven by activities at each level:

ACTIVITY LEVEL EXAMPLES OF ACTIVITY COST

1. Unit Level • Cost of raw materials• Cost of inserting a component• Utilities cost of operating equipment• Some costs of packaging• Sales Commissions

2. Batch Level • Cost of processing sales order• Cost of issuing and tracking work order• Cost of equipment setup• Cost of moving batch between workstations• Cost of inspection (assuming same number of units inspected in each batch)

Page 14: Cost Driver

EXAMPLES…EXAMPLES…

ACTIVITY LEVEL EXAMPLES OF ACTIVITY COST

3. Product Level • Cost of Product Development• Cost of Product marketing such as advertising• Cost of specialized equipment• Cost of maintaining specialized equipment

4. Facility Level • Cost of maintaining general facilities such as buildings and grounds• Cost of non-specialized equipment• Cost of maintaining non-specialized equipment• Cost of real property taxes• Cost of general advertising• Cost of general administration such as the plant manager’s salary

Page 15: Cost Driver

COST COST BEHAVIOURBEHAVIOUR

Page 16: Cost Driver

COST - CLASSIFICATIONCOST - CLASSIFICATION

Costs can be classified into fixed, Costs can be classified into fixed, variable and Semi-variable costs on variable and Semi-variable costs on the basis of:the basis of:

VariabilityVariability Changes in cost behaviour in Changes in cost behaviour in

relation to change in output, activity relation to change in output, activity or volume where activity may be or volume where activity may be indicated in any form such as units indicated in any form such as units of output, hours worked, sales etc.of output, hours worked, sales etc.

Page 17: Cost Driver

FIXED COSTFIXED COST

Cost which does not change for a given period Cost which does not change for a given period of time despite wide fluctuations in output or of time despite wide fluctuations in output or volume of activityvolume of activity

Also known as standby costs, Capacity costs or Also known as standby costs, Capacity costs or Period Costs.Period Costs.

Accrues with the passage of time and not with Accrues with the passage of time and not with the production of the product or the job, which the production of the product or the job, which is why they are expressed in time such as per is why they are expressed in time such as per day per month and not in terms of unitday per month and not in terms of unit

Examples: Rent, Property Taxes, advertising Examples: Rent, Property Taxes, advertising etc.etc.

Page 18: Cost Driver

CHANGES IN FIXED CHANGES IN FIXED COSTSCOSTS

Fixed costs remain fixed only in the Fixed costs remain fixed only in the short run and so it is improper to say short run and so it is improper to say Fixed Costs do not change.Fixed Costs do not change.

Page 19: Cost Driver

CHANGES IN FIXED CHANGES IN FIXED COSTCOST

Between 20,000 & 80,000 units of production, fixed cost Between 20,000 & 80,000 units of production, fixed cost is Rs. 50,000is Rs. 50,000

In excess of 80,000 units, fixed cost becomes Rs. 60,000. In excess of 80,000 units, fixed cost becomes Rs. 60,000. This assumes that increase in production after a certain This assumes that increase in production after a certain level requires increase in fixed expenses such as level requires increase in fixed expenses such as additional supervision, increase in quality control costs.additional supervision, increase in quality control costs.

Page 20: Cost Driver

CHANGES IN FIXED CHANGES IN FIXED COSTCOST

Between 20,000 & 80,000 units of production, fixed cost Between 20,000 & 80,000 units of production, fixed cost is Rs. 50,000is Rs. 50,000

From 0 units (shut down) to 20,000 units, fixed cost is Rs. From 0 units (shut down) to 20,000 units, fixed cost is Rs. 25,000. If the level of activity comes to less than 20,000 25,000. If the level of activity comes to less than 20,000 units some fixed costs may not be incurred such as costs units some fixed costs may not be incurred such as costs on accounting functions, supplies, staff and so on.on accounting functions, supplies, staff and so on.

Page 21: Cost Driver

EXAMPLEEXAMPLE

Costs of testing personal computers may Costs of testing personal computers may not change with a change in the volume not change with a change in the volume of production and would be fixed in the of production and would be fixed in the short run.short run.

In the long run organization may need to In the long run organization may need to increase/ decrease testing department’s increase/ decrease testing department’s equipment & staff to the levels needed equipment & staff to the levels needed to support future production volumes . to support future production volumes .

So in the long run, volume of production So in the long run, volume of production or activity becomes cost drivers of these or activity becomes cost drivers of these testing & staff costs.testing & staff costs.

Page 22: Cost Driver

FIXED COST-FIXED COST-CLASSIFICATIONCLASSIFICATION

1.1. Committed costs: Incurred to maintain Committed costs: Incurred to maintain Company’s facilities & physical existence. Company’s facilities & physical existence. Management has little or no discretion. Management has little or no discretion. Examples: Plant & equipment Examples: Plant & equipment depreciation, taxes, insurance premium depreciation, taxes, insurance premium rate, rent charges etc.rate, rent charges etc.

2.2. Managed Costs: Related to current Managed Costs: Related to current operations. Paid to ensure the continued operations. Paid to ensure the continued operating existence of the company. operating existence of the company. Example: Management & Staff salariesExample: Management & Staff salaries

Page 23: Cost Driver

FIXED COST-FIXED COST-CLASSIFICATIONCLASSIFICATION

3. Discretionary costs: Result from special 3. Discretionary costs: Result from special policy decisions, management policy decisions, management programmes, new researches etc. programmes, new researches etc. Example: R&D Costs, Marketing Example: R&D Costs, Marketing Programmes, new system development Programmes, new system development costs.costs.

4. Step Costs: Constant for a given 4. Step Costs: Constant for a given amount of output and then increases in amount of output and then increases in a fixed amount after a higher output a fixed amount after a higher output level.level.

Page 24: Cost Driver

STEP COSTS - EXAMPLESTEP COSTS - EXAMPLE

In a manufacturing Company:In a manufacturing Company: One supervisor required at a salary of Rs. 10,000 p.m. for every 50 workers.One supervisor required at a salary of Rs. 10,000 p.m. for every 50 workers. As soon as 51As soon as 51stst worker is employed, cost of supervision increases to Rs. worker is employed, cost of supervision increases to Rs.

20,00020,000 Cost of supervision will go up if more than 100 workers are working.Cost of supervision will go up if more than 100 workers are working.

Page 25: Cost Driver

VARIABLE COSTVARIABLE COST

Costs which vary directly or Costs which vary directly or proportionately with the output.proportionately with the output.

Direct materials cost & direct labour cost Direct materials cost & direct labour cost are the costs which are generally variableare the costs which are generally variable

Total variable costs change as more units Total variable costs change as more units are produced, per unit variable cost are produced, per unit variable cost remains constantremains constant

Example: factory supplies, indirect Example: factory supplies, indirect materials, sales commission, office materials, sales commission, office suppliessupplies

Page 26: Cost Driver

VARIABLE COSTVARIABLE COST

If a factory is shut down, variable If a factory is shut down, variable costs are eliminatedcosts are eliminated

Expressed in terms of units or Expressed in terms of units or percentage of volumepercentage of volume

Cannot be stated in terms of timeCannot be stated in terms of time

Page 27: Cost Driver

VARIABLE COST-VARIABLE COST-BEHAVIOURBEHAVIOUR

Behaviour pattern of direct material costBehaviour pattern of direct material cost

For every increase in units produced, there is a For every increase in units produced, there is a proportionate increase in costsproportionate increase in costs

Cost of direct materials increases at a constant rate of Cost of direct materials increases at a constant rate of Rs. 50 per unit.Rs. 50 per unit.

Page 28: Cost Driver

VARIABLE COST – VARIABLE COST – LINEAR?LINEAR?

Variable cost may be linear only over Variable cost may be linear only over the normal range of activity levelsthe normal range of activity levels

Beyond the normal range of activity, Beyond the normal range of activity, variable cost per unit may show non-variable cost per unit may show non-linear or curvi-linear line implying linear or curvi-linear line implying variable costs are not varying in variable costs are not varying in direct proportion to output or direct proportion to output or activity changesactivity changes

Page 29: Cost Driver

VARIABLE COST - VARIABLE COST - CONVEXCONVEX

Where each extra unit of output Where each extra unit of output causes a less than proportionate causes a less than proportionate increase in cost i.e., economies of increase in cost i.e., economies of scale operatescale operate

Page 30: Cost Driver

VARIABLE COST - VARIABLE COST - CONCAVECONCAVE

Where each extra unit of output Where each extra unit of output causes a more than proportionate causes a more than proportionate increase in cost i.e., diminishing increase in cost i.e., diminishing returns operatereturns operate

Page 31: Cost Driver

VARIABLE COST–CURVI VARIABLE COST–CURVI LINEAR ?LINEAR ?

In some production process, the amount of In some production process, the amount of waste materials remain more & more constantwaste materials remain more & more constant

So when production increases, unit variable So when production increases, unit variable cost for material decreases due to economies cost for material decreases due to economies of scaleof scale

On the other hand:On the other hand: Diminishing returns will operate when it Diminishing returns will operate when it

becomes necessary to pay increasing becomes necessary to pay increasing differential piece rates to increase productiondifferential piece rates to increase production

A form of concave curvi–linear relationship A form of concave curvi–linear relationship will emerge.will emerge.

Page 32: Cost Driver

MIXED COSTMIXED COST

Combination of semi-variable and Combination of semi-variable and semi fixed costs.semi fixed costs.

Because of variable component – Because of variable component – fluctuate with volumefluctuate with volume

Because of fixed component – do not Because of fixed component – do not change in direct proportion to change in direct proportion to output.output.

Page 33: Cost Driver

SEMI-FIXED COSTSSEMI-FIXED COSTS

Costs which remain constant upto a Costs which remain constant upto a certain level of output after which certain level of output after which they become variable.they become variable.

Page 34: Cost Driver

SEMI-VARIABLE COSTSSEMI-VARIABLE COSTS

Cost is basically variable but whose Cost is basically variable but whose slope may change abruptly when a slope may change abruptly when a certain output level is reached.certain output level is reached.

Page 35: Cost Driver

MIXED COSTSMIXED COSTS

Mathematically mixed costs can be Mathematically mixed costs can be expressed as follows:expressed as follows:

Page 36: Cost Driver

EXAMPLEEXAMPLE

Worker is paid a salary of Rs. 1500 per Worker is paid a salary of Rs. 1500 per week (fixed) plus a bonus of Re 1 for each week (fixed) plus a bonus of Re 1 for each unit completed (variable). If he increases unit completed (variable). If he increases his weekly output from 1000 units to 1500 his weekly output from 1000 units to 1500 units what is the effect on his earnings?units what is the effect on his earnings?

Units produced

1,000 1,500

Fixed Component

Rs. 1,500 Rs. 1,500

Variable Component

Rs. 1,000 Rs 1,500

Total Rs. 2,500 Rs. 3,000

Page 37: Cost Driver

THANK YOUTHANK YOU