Lecture no27 classification of costs

Classification of Costs Lecture No 27 Chapter Contemporary Engineering Economics Copyright © 2016 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Chapter Opening Story: What Does It Cost to Make an iPhone? Apple’s 16GB iPhone is priced at $649 Do you know the profit margin for Apple from selling an iPhone 6? At Issue: The 16GB iPhone costs Apple about $200 to build How does Apple come up with such an estimate of various component costs before pricing their product? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved General Cost Terms in Manufacturing Setting Manufacturing Costs Direct Raw Materials Direct Labor Manufacturing Overhead Nonmanufacturing Costs Overhead Marketing Administrative Functions Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Components of Manufacturing Cost Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Classifying Costs for the Financial Statements • Matching concept: The costs incurred to generate particular revenue should be recognized as expenses in the same period that the revenue is recognized • Period costs: Those costs that are matched against revenues on a time period basis • Product costs: Those costs that are matched against revenues on a product basis Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example • Period costs • General and administrative expenses • Marketing expenses • Insurance premiums • Income taxes • Nonmanufacturing costs • Product costs • Direct material costs • Direct labor costs • Manufacturing overhead Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved How the Period Costs and Product Costs Flow Through the Financial Statements Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Cost Flows and Classifications of a Manufacturing Company Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 8.1: Classifying Costs for Uptown Ice Cream Shop • Given: Breakdown of unit cost items • Find: Classify the cost items to product costs and period costs Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Solution • Breakdown of unit cost items • Product costs • Period costs Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Cost Classification for Predicting Cost Behaviors Volume index Cost behaviors o o o Fixed costs Variable costs Mixed costs Average unit costs Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Volume Index • Definition: The unit measure used to define “volume” • Examples • Automobile • Miles driven • Generating plant • kWh produced • Stamping machine • “Parts” stamped • Assembly plant • Units assembled Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Fixed Costs • Definition: The costs of providing a company’s basic operating capacity • Cost behavior: Remains constant over the relevant range Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Variable Costs • Definition: Costs that vary depending on the level of production or sales • Cost behavior: Increases or decreases proportionally according to the level of volume Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Mixed Costs Contemporary Engineering Economics, th edition Park Mixed cost behavior Depreciation Expenses ($) • Definition: Costs are fixed for a set level of production or consumption, becoming variable after the level is exceeded • Cost behavior: Increases or decreases after maintaining a fixed level of expense 6000 5000 4000 3000 2000 1000 15 25 Miles Driven (Unit: 1,000) Copyright © 2016 by Pearson Education, Inc All Rights Reserved Average Unit Cost • Definition: activity cost per unit basis • Cost behaviors: • Fixed cost per unit varies with changes in volume • Variable cost per unit of volume is a constant • Mixed cost per unit of volume contains both the constant and variable elements Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 8.2: Average Driving Cost per Mile • Given: Owning and Operating a 4WD SportUtility vehicle • Find: Average driving cost per mile as a function of mileage Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Solution Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Cost-Volume Chart Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Average Cost Per Mile Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Future Costs for Business Decisions •Differential (incremental) cost •Opportunity cost •Sunk cost •Marginal cost Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Differential (Incremental) Costs • Definition: Costs that represent the difference in total costs, which results from selecting one alternative instead of another • Cost behavior: Increases or decreases with the overall change that a company experiences by producing one additional unit of goods Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Opportunity Costs • Definition: The potential benefit that is given up as you seek an alternative course of action • Example: When you decide to pursue a college degree, your opportunity cost would include four-years’ potential earnings given up Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Sunk Costs • Definition: Cost that has already been incurred by past actions • Economic implications: Not relevant to future decisions • Example: $500 spent to replace brakes last year—not relevant to making a sales decision in the future Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Marginal Costs • Definition: Added costs that result from increasing rates of output, usually by a single unit • Example: Cost of electricity —decreasing marginal rate Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved ... Period costs • General and administrative expenses • Marketing expenses • Insurance premiums • Income taxes • Nonmanufacturing costs • Product costs • Direct material costs • Direct labor costs. .. know the profit margin for Apple from selling an iPhone 6? At Issue: The 16GB iPhone costs Apple about $200 to build How does Apple come up with such an estimate of various component costs before... Breakdown of unit cost items • Product costs • Period costs Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Cost Classification