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Summary for ACF2 Han ISB
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Finance II Summary (B-Cluster HAN 2020/21)Chapter 2(6) : An introduction to Cost Terms and Purposes
What is a cost?
Cost is a sacrificed or forgone resource to achieve a specific objective. It is usually measured as the
monetary amount that must be paid to acquire goods or services.
A cost that has
Actual occured (can only
Cost be calculated at the
end of period)
A predicted Cost (can
be calculated at the
Budgeted
beginning and used
Cost
for estimating cost
prices)
Cost Anything for which a
Object cost object is desired.
Costs can also be classified as the following:
Direct Costs: Can be conveniently and economically traced to a cost object. (For example, Material,
Labor, etc.)
Indirect Costs: Can’t be traced, instead those costs are allocated to a cost object in a rational and
systematic manner. (For example, Manager’s salaries, Electricity bills, etc.)
,There are 2 different kind of costs-behavior patterns:
Variable Costs: Changes in total in proportions to changes in the related level of total activity or
volume of output produced. (remains the same p/unit).
Fixed Costs: Remains unchanged in total for a given time period, despite wide changes in the related
levels of total activity or volume of output produced.
Note that costs are defined as variable or fixed for a specific activity and for a given time period.
Variable costs are constant on a per unit basis.
$5 p/unit x 10 units: $50
$5 p/unit x 1000 units: 5000
Fixed costs per unit changes inversely with the level of production. As more units are produced, the
same fixed cost is spread over more units, reducing the cost per unit.
$3000 fixed cost / 10 units: $300 p/ unit.
$3000 fixed cost / 1000 units: $3 p/ unit.
This means that the higher the output, the lower the fixed cost p/unit.
, Although unit costs are regularly used in financial reports and for making product mix and pricing
decisions, manager should think in terms of total costs rather than unit costs for making many
decisions.
Relevant Range:
Relevant range is the band or range of normal activity level or volume in which there is a specific
relationship between the level of activity or volume and the cost in question. For example, a fixed
cost is fixed only in relation to a given wide range of total activity or volume (at which the company is
expected to operate) and only for a given time span (usually a particular budget period).
Type of firms:
Manufacturing Sector: Purchases materials and components and converts them into various finished
goods.
Merchandising Sector: Purchases and then sells tangible products without changing their basic form.
Service Sector: Provides services like legal advice or audits.
Type of Inventories:
Direct Materials: Resources in stock and available for use
Work in Progress (WIP): Goods that are not yet completed
Finished Goods: Goods completed bur not yet sold
Note that merchandising-sector companies hold only one type of inventory: Merch inventory.
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