Question

8 identify and describe cost behaviour characteristics for the different cost elements of a product or service

Answer 1

The total cost of product includes following 5 elements:-

1. Direct Material:

Direct materials refers to the cost of the materials which becomes a major part of the finished product. They are raw materials that are an integral part of the finished product.

2. Direct Labour:

Direct Labour is defined as the labour of those workers who are engaged in the production process. It is the labour costs for specific work performed on products that is conveniently and economically traceable to end products. Direct labour is expended directly upon the materials comprising the finished product.

3. Direct Expenses:

These include any expenditure other than direct material and direct labour directly incurred on a specific cost unit (product or job). Such special necessary expenses can be identified with cost units and are charged directly to the product as part of the prime cost. These expenses are sometimes known as chargeable expenses.

The direct expenses are incurred for a product or job and therefore are a part of the prime cost.

The total of the above three elements of costs:

(i) Direct materials,

(ii) Direct labour and

(iii) Direct expenses, are prime cost.

4. Factory Overhead:

Factory overhead also called manufacturing expenses may be defined as the cost of indirect materials, indirect labour and indirect expenses.

The total of (i) prime cost and (ii) factory overhead is known as ‘Factory Cost.’ Direct labour and factory overhead together are known as conversion costs because they are the costs of converting raw materials into finished products.

5. Selling and Distribution and Administrative Overheads:

Selling and distribution overheads usually begin when the factory costs end. Such expenses are generally incurred when the product is in saleable condition. It covers the cost of making sales and delivering products. These costs include advertising, salesman’s salaries and commissions, packing, storage, transportation, and sales administrative costs.

The sum of (i) Prime Cost, (ii) Factory Overhead and (iii) Selling and Distribution and Ad­ministrative Overhead is the Total Cost i.e., the cost” to make and sell”.

Cost behavior refers to the way different types of production costs change when there is a change in level of production.

There are three main types of costs according to their behaviour:

Fixed Costs:

Fixed costs are those which do not change with the level of activity within the relevant range. These costs will incur even if no units are produced. For example rent expense, straight-line depreciation expense, etc.

Fixed cost per unit decreases with increase in production. Following example explains this fact:

Total Fixed Cost	$30,000	$30,000	$30,000
÷ Units Produced	5,000	10,000	15,000
Fixed Cost per Unit	$6.00	$3.00	$2.00

Variable Costs:

Variable costs change in direct proportion to the level of production. This means that total variable cost increase when more units are produced and decreases when less units are produced. Although variable in total, these costs are constant per unit. For example

Total Variable Cost	$10,000	$20,000	$30,000
÷ Units Produced	5,000	10,000	15,000
Variable Cost per Unit	$2.00	$2.00	$2.00

Mixed Costs:

Mixed costs or semi-variable costs have properties of both fixed and variable costs due to presence of both variable and fixed components in them. An example of mixed cost is telephone expense because it usually consists of a fixed component such as line rent and fixed subscription charges as well as variable cost charged per minute cost. Another example of mixed cost is delivery cost which has a fixed component of depreciation cost of trucks and a variable component of fuel expense.

Since mixed cost figures are not useful in their raw form, therefore they are split into their fixed and variable components by using cost behavior analysis techniques such as High-Low Method, Scatter Diagram Method and Regression Analysis.