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Chapter

2
Cost Terms, Concepts, and Classifications
Prepared By: Subika Kaleem (BB-25063) Arsalan Javed (BB-25079) Anora Zfar (BB-25801)

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General Cost Classification

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Product Cost Versus Period Cost


Product cost
It includes all the costs that are involved in acquiring or making a product i.e direct materials, direct labor, and manufacturing overhead costs.

Period cost It includes all the costs that are not involved in the product cost. They are expenses recorded in the income statement period in which they are incurred.
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Cost Classifications for Predicting Cost Behavior


how a cost will react to changes in the level of business activity.
Total variable costs

change when activity changes.


Total fixed costs

remain unchanged when activity changes.

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Total Variable Cost


A cost that varies in total in direct proportion to changes in the level of activity. example: Your total long distance telephone bill is based on how many minutes you talk.
Total Long Distance Telephone Bill Minutes Talked
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Total Fixed Cost


A cost that remains constant in total regardless of changes in the level of activity. example: The cost per long distance minute talked is constant, i.e 10 cents per minute.
Per Minute Telephone Charge Minutes Talked
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Direct Costs and Indirect Costs


Direct costs
Costs that can be

Indirect costs
Costs cannot be easily

easily and conveniently traced to a unit of product or other cost objective.


Examples: direct

and conveniently traced to a unit of product or other cost object.


Example:

material and direct labor

manufacturing overhead

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Differential Costs and Revenues


Costs and revenues that differ among alternatives.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.

Differential revenue is: $2,000 $1,500 = $500

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Differential Costs and Revenues


Costs and revenues that differ among alternatives.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.

Differential revenue is: $2,000 $1,500 = $500 Differential cost is: $300
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Opportunity Costs
The potential benefit that is given up when one alternative is selected over another.
Example: If you were not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000.
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Sunk Costs
Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.

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Thank You !!!

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The McGraw-Hill Companies, Inc., 2000