Costs and its elements, System of ascertainment of Cost

Costs refer to the expenses incurred in the process of producing goods or services.

Costs in cost accounting can be classified into different categories, including direct costs, indirect costs, fixed costs, and variable costs. Direct costs are costs that can be directly traced to a specific product or service. Indirect costs, on the other hand, are costs that cannot be directly attributed to a specific product or service. Fixed costs are costs that do not change with changes in the level of production or sales, while variable costs are costs that vary with changes in the level of production or sales.

Understanding costs in cost accounting is essential for businesses to make informed decisions about pricing, product mix, cost control, and profitability. By analyzing the costs associated with various business operations, businesses can identify opportunities for cost savings, improve the efficiency of their operations, and ultimately increase their profitability.

There are several elements that contribute to the costs of producing goods or services.

• Direct Materials: These are the raw materials used in the production process. Examples of direct materials include wood, steel, and plastic.
• Direct Labor: This includes the wages paid to the workers who are involved in the production process. It can also include the cost of benefits such as insurance and retirement plans.
• Overhead: Overhead costs refer to the expenses that are not directly related to the production of goods or services but are necessary for the operation of the business. Examples of overhead costs include rent, utilities, and insurance.
• Manufacturing or Production Costs: These include the costs of producing the goods or services, such as depreciation on equipment, maintenance costs, and the cost of operating machinery.
• Selling, General and Administrative (SG&A) Costs: These include the expenses incurred in running the business, such as salaries for administrative staff, marketing expenses, and office supplies.
• Research and Development Costs: These are the expenses associated with developing new products or improving existing products. Examples of research and development costs include salaries for scientists and engineers, lab equipment, and supplies.
• Depreciation: This refers to the reduction in the value of an asset over time. Depreciation is a non-cash expense that is calculated based on the useful life of the asset.

System of ascertainment of cost

The system of ascertainment of cost refers to the method used to determine the cost of producing goods or services in a business.

There are several methods of cost ascertainment, including:

Job Costing:

This method of costing is used when the production process is specific or customized. The cost of each job is determined separately, and the total cost of production is calculated by adding up the costs of all the jobs. The formula for job costing is:

Total Cost of Job = Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead

Example:

Suppose that a furniture manufacturer produces custom-made furniture for clients. The company uses job costing to track the cost of producing each order. Let’s say the company receives an order to produce a custom-made wooden dining table for a client. The following costs are associated with the production of the table:

Direct Materials:

• Wooden planks: $400
• Finishing materials: $50
• Hardware: $20

Total Direct Materials Cost: $470

Direct Labor:

• Carpenter: 20 hours x $25 per hour = $500

Manufacturing Overhead:

• Factory rent: $1,500 per month
• Utilities: $500 per month
• Depreciation on factory equipment: $200 per month
• Other indirect costs: $300 per month

Total Monthly Overhead Costs: $2,500

The company estimates that it will take 20 hours of labor to produce the table, and it will take one month to complete the job. The company uses a predetermined overhead rate of $10 per direct labor hour to allocate manufacturing overhead costs.

Using job costing, the cost of producing the custom-made wooden dining table can be calculated as follows:

• Direct Materials Cost: $470
• Direct Labor Cost: $500
• Manufacturing Overhead Cost: (20 x $10) x $2,500 = $5,000

Total Job Cost: $6,970

The company can then use this information to determine the price to charge the client for the custom-made dining table. For example, if the company adds a 20% markup to the total job cost, the price to charge the client would be:

Price = $6,970 + (20% x $6,970) = $8,364

Therefore, the company would charge the client $8,364 for the custom-made wooden dining table, based on the job costing information.

Process Costing:

This method of costing is used when the production process is continuous and uniform. The total cost of production is spread over the total number of units produced to determine the cost per unit. The formula for process costing is:

Cost per Unit = Total Cost of Production / Total Number of Units Produced

Example:

Let’s say a company produces 10,000 units of a product and incurs total costs of $50,000. Using the process costing method, the cost per unit can be calculated as follows:

Cost per Unit = Total Cost of Production / Total Number of Units Produced

Cost per Unit = $50,000 / 10,000 units

Cost per Unit = $5

Therefore, the cost per unit for the product using the process costing method is $5.

Marginal Costing:

This method of costing focuses on the cost of producing one additional unit of a product or service. It helps businesses to determine the minimum price at which a product or service can be sold to cover the variable costs of production. The formula for marginal costing is:

Marginal Cost per Unit = Variable Cost per Unit

Example:

Let’s say a company produces 1,000 units of a product and has variable costs of $3 per unit. Using the marginal costing method, the minimum selling price can be calculated as follows:

Marginal Cost per Unit = Variable Cost per Unit

Marginal Cost per Unit = $3

Minimum Selling Price per Unit = Marginal Cost per Unit + Desired Profit per Unit

Minimum Selling Price per Unit = $3 + $2

Minimum Selling Price per Unit = $5

Therefore, the minimum selling price per unit for the product using the marginal costing method is $5.

Standard Costing:

This is a method of costing that involves the establishment of standard costs for each element of production. These standard costs are then used to compare with actual costs to determine the variances and identify areas where cost savings can be made. The formula for standard costing is:

Standard Cost per Unit = Standard Quantity x Standard Price

Example:

Let’s say a company establishes standard costs for each element of production for a product. The standard quantity of materials required for each unit of the product is 10 kilograms, and the standard price per kilogram is $5. Using the standard costing method, the standard cost per unit can be calculated as follows:

Standard Cost per Unit = Standard Quantity x Standard Price

Standard Cost per Unit = 10 kg x $5 per kg

Standard Cost per Unit = $50

Therefore, the standard cost per unit for the product using the standard costing method is $50.

These are just a few examples of how different methods of ascertainment of cost can be used to calculate the cost of producing goods or services. The method used by a business will depend on the nature of the production process and the type of product or service being produced.

Activity-Based Costing (ABC):

This is a method of costing that identifies the activities involved in the production process and assigns costs to each activity. It helps businesses to understand the cost drivers of each activity and identify areas where cost savings can be made. The formula for activity-based costing is:

Cost per Unit = (Cost Driver Rate x Activity Consumption per Unit) + Other Costs

Let’s say a company produces two types of bicycles: Mountain Bike and Road Bike. The company has identified three cost pools: Materials, Labor, and Overhead. The company has also identified four activities that consume resources: Material Handling, Machine Setup, Bicycle Assembly, and Quality Control. The following information is available for each activity:

The following information is available for each type of bicycle:

Using the ABC method, the cost of producing one Mountain Bike can be calculated as follows:

Calculate the cost of each activity per unit of cost driver:

• Material Handling: $20,000 / 200 parts = $100 per part
• Machine Setup: $40,000 / 7 setups (5 for Mountain Bike + 2 for Road Bike) = $5,714.29 per setup
• Bicycle Assembly: $120,000 / 30 labor hours (20 for Mountain Bike + 10 for Road Bike) = $4,000 per labor hour
• Quality Control: $30,000 / 3 inspections (2 for Mountain Bike + 1 for Road Bike) = $10,000 per inspection

Calculate the total cost of each type of bicycle by adding up the cost of each activity:

• Mountain Bike: (200 x $100) + (5 x $5,714.29) + (20 x $4,000) + (2 x $10,000) = $194,285.80
• Road Bike: (100 x $100) + (2 x $5,714.29) + (10 x $4,000) + (1 x $10,000) = $118,571.45

Calculate the cost per unit for each type of bicycle by dividing the total cost by the number of units produced:

• Cost per Mountain Bike = $194,285.80 / 200 = $971.43
• Cost per Road Bike = $118,571.45 / 100 = $1,185.71

Therefore, using the ABC method, the cost of producing one Mountain Bike is $971.43, and the cost of producing one Road Bike is $1,185.71. This information can be used by the company to make informed decisions about pricing, cost control, and profitability.