Cost classification

Product vs Period cost Direct vs Indirect cost Fixed vs Variable cost

Direct costing
Direct costing vs Absorption costing Income analysis under direct costing and absorption costing

Uses of direct costing

Cost controlling Product pricing Profit planning Production planning Analyzing contribution margin

Product cost
All costs incurred in getting product to saleable condition Three main elements:
Raw Materials Labor Factory overheads

Period cost
All costs incurred for a period of time regardless of production Sometimes classified into:
Marketing expenses General (administrative) expenses Financial expenses

Direct Costs
Major costs that can be directly attributable to the final product or service Includes:
Direct materials Direct labour Other: subcontractors, tender document preparation

Indirect Costs
All other costs that cannot be directly attributable to the final product or service. Includes
Indirect materials: factory supplies, small items of material Indirect labour: admin, cleaning or security staff Factory overheads; rates, rent, insurance, telephone, stationery

 Fixed

costs

Those costs that in total will remain the same for a period of time and over a relevant range or output Includes:
Rent, rates, insurance, depreciation
Variable

costs

Those costs that in total will tend to increase as output level increase Includes:
Direct Materials and Direct Labour

Used for External financial reporting

Includes Direct material, Direct labor, variable factory overhead and fixed factory overhead as a part of total product cost

Used for internal planning and decision making Does not include Fixed factory overhead as a product cost

 Alternative

method of costing

Relatively new More useful costing method for management

planning and decision making

Also know as variable costing as most direct costs are variable with respect to level activities

Main difference between absorption costing and

direct costing is in the treatment of fixed

manufacturing overhead

Fixed manufacturing costs is not treated as a product cost instead it is treated as a period cost
That is, it is written off (expensed) in the period in which it is incurred rather than included as a cost when determining the cost of inventory

If fixed manufacturing costs are excluded from the cost of inventory when using direct costing then inventory at end of an accounting period will be lower than the value is using absorption costing this will effect both the balance sheet and profits

Absorption Costing
Cost of Goods Manufactured Direct Materials Direct Labor Variable Factory OH Fixed Factory OH Period Expense

Cost of Goods Manufactured

Direct Costing

Faisal Manufacturing Company has no beginning inventory and sales are estimated

to be 20,000 units at $75 per unit,

regardless of production levels

Proposal 1: 20,000 Units to Be Manufactured and Sold

Total Cost Manufacturing costs: Variable $ 700,000 Fixed 400,000 Total costs $1,100,000 Selling and administrative exp. Variable ($5 per unit sold) $ 100,000 Fixed 100,000 Total expenses $ 200,000

Unit Cost $35 20 $55

Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold

Total Cost Manufacturing costs: Variable $ 875,000 Fixed 400,000 Total costs $1,275,000 Selling and administrative exp. Variable ($5 per unit sold) $ 100,000 Fixed 100,000 Total expenses $ 200,000

Unit Cost $35 16 $51

Faisal Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55)

$1,100,000

Faisal Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55) (25,000 units x $51)

$1,100,000

$1,275,000

Faisal Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55) (25,000 units x $51) Less ending inventory: (5,000 units x $51) Cost of goods sold Gross profit Selling and administrative expenses ($100,000 + $100,000) Income from operations

$1,100,000

$1,275,000
255,000 $1,020,000 $ 480,000 200,000 $ 280,000

$1,100,000 $ 400,000 200,000 $ 200,000

Faisal Manufacturing Company Direct Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35) $ 700,000 (25,000 units x $35)

$ 875,000

Faisal Manufacturing Company Direct Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000

Sales Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35) $ 700,000 (25,000 units x $35) Less ending inventory: (0 units x $35) 0 (5,000 units x $35) Variable cost of goods sold $ 700,000 Manufacturing margin $ 800,000
Continued

$ 875,000

175,000 $ 700,000 $ 800,000

Faisal Manufacturing Company Direct Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured

Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Income from operations

$ 800,000
100,000 $ 700,000 $ 400,000 100,000 $ 500,000 $ 200,000

$ 800,000
100,000 $ 700,000 $ 400,000 100,000 $ 500,000 $ 200,000

Faisal Manufacturing Company Direct Costing Income Statements

Suppose 30000 units were manufactured

30,000 Units Manufactured

Sales Variable cost of goods sold: Variable cost of goods manufactured: (30,000 units x $35) Less ending inventory: (10,000 units x $35) Variable cost of goods sold Manufacturing margin
Continued

$1,500,000

$1,050,000 350,000 $ 700,000 $ 800,000

Faisal Manufacturing Company Direct Costing Income Statements 30,000 Units Manufactured

Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Income from operations

$ 800,000
100,000 $ 700,000 $ 400,000

100,000 $ 500,000 $ 200,000

Cost controlling Product pricing

Profit planning
Decision making