ANALYSIS ON COST & OVERHEADS

Submitted by

Swarup Singh Deo

Roll no- 32C

EPGDIB- Hybrid (2019-20)

COST is a measurement, in monetary terms, of the amount of resources used for the purpose
of production of goods or rendering services.
CLASSIFICATION OF COST
It is the process of grouping costs according to their common features. Costs are to be
classified in such a manner that they are identified with cost centre or cost unit.

On the basis of behaviour of cost

Behaviour means change in cost due to change in output. On the basis of behaviour cost is
classified into the following categories:

Fixed Cost
• It is that portion of the total cost, which remains constant irrespective of output up to the
capacity limit.
• It is called as a period cost as it is concerned with period
• It depends upon the passage of time.
• It is also referred to as non-variable cost or stand by cost or capacity cost or ‘’period’ cost.
• It tends to be unaffected by variations in output
• These costs provide consitions for production rather than costs of production.
• They are created by contractual obligations and managerial decisions. Rent of premises,
taxes and insurance, staff salaries constitute fixed cost.

Variable Cost
• This cost varies according to the output
• In other works, it is a cost which changes according to the changes in output.
• It tends of vary in direct proportion to output.
• If the output is decreased, variable cost also will decrease
• It is concerned with output or product. Therefore, it is called as a ‘product’ cost.
• If the output is doubled, variable cost will also be doubled. For example, direct material;
direct labour, direct expenses and variable overheads.

Semi-variable Cost
• This is also referred to as semi-fixed or partly variable cost
• It remains constant upto a certain level and registers change afterwards.
• These costs vary in some degree with volume but not in direct or same proportion.
• Such costs are fixed only in relation to specified constant conditions,. For example, repairs
and maintenance of machinery, telephone charges, maintenance of building, supervision,
professional tax etc.

On the basis of elements of cost Elements means nature of items. A cost is composed of three
elements: material, labour and expenses, Each of these three elements can be direct and
indirect.

Direct Cost
It is the cost, which is directly chargeable to the product manufactured, it is easily identifiable.
Direct cost consists of three elements, which are as follows:

Direct Material
• It is the cost of basic raw material used for manufacturing a product.
• It becomes a part of the product
• No finished product can be manufactured without basic raw materials
• It is easily identifiable and chargeable to the product
• For example, leather in leather wares, pulp in paper, steel in steel furniture, sugarcane for
sugar etc
• What is raw material for one manufacturer might be finished product for another.
• Direct material includes the following:

1. All materials specially purchased for production or the process.

2. All components purchased for production or the process.
3. Material transferred from one cost center to another or one process to another.
4. Primary packing materials, wrappings, cardboard boxes etc., necessary for preservation or
protection of product.
5. Some of the items like nails or thread in the store are part of finished product. They are not
treated as direct materials in view of negligible cost.

Direct Labour or Direct Wages

• It is the amount of wages paid to those workers who are engaged on the manufacturing line
of conversion of raw materials into finished goods.
• The amount of wages can be easily identified and directly charged to the product These
workers directly handle raw material, wip and finished goods on the production line
• Wages paid to workers operating lathers, drilling, cutting machines etc. are direct wages
• Direct wages are also known as productive labour, process labour or prime cost labour.
• Direct wages include the payment made to the following group of workers:
1. Labour engaged on the actual production of the product.
2. labour engaged in aiding the operations viz. supervisor, Foreman, Shop clerks and worker on
internal transport.
3. Inspectors, Analysts needed for such production

Indirect Cost
It is that portion of the total cost, which cannot be identified and charged direct to the product
It has to be allocated, apportioned and absorbed over the units manufactured on a suitable
basis.

OVERHEADS OR ON COST OR BURDEN OR SUPPLEMENTARY COST

Aggregate of indirect cost is referred to as overheads. It arises as a result of overall operation

of a business. According to Weldon over-head means ‘the cost of indirect material, indirect
labour and such other expenses, including services as cannot conveniently be charged direct
to specific cost units. It includes all manufacturing and non-manufacturing supplies and
services.

This cost cannot be associated with a particular product. The principal feature of overheads is
the lack of direct tractability to individual product. It remains relatively constant from period to
period. The amount of overheads is not directly chargeable i.e. it had to be properly allocated,
apportioned and absorbed on some equitable basis.

Classification of Overheads
1.Factory Overheads:
• It is the aggregate of all the factory expenses incurred in connection with manufacture of a
product
• These are incurred in connection with running of factory
• It includes the items of expenses viz., factory salary, work manager’s salary, factory repairs,
rent of factory premises, factory lighting, lubricants, factory power, drawing office salary,
haulage (cost of internal transport) depreciation of plant and machinery unproductive wages,
estimation expenses, royalties loose tools w/off, material handling charges, time office salaries,
counting house salaries etc.

2. Administrative Overheads or Office Overheads:

• It is the aggregate of all the expenses as regards administration
• It is the cost of office service or decision making
• It consists of the following expenses: Staff salaries, office premises, office conveyance,
printing and stationery and repairs and depreciation of office premises and furniture etc.

3. Selling and Distribution Overheads:

• It is the aggregate of all the expenses incurred in connection with sales and distribution of
finished product and services
• It is the cost of sales and distribution services.
• Selling expenses are such expenses, which are incurred in acquiring and retaining customers.
It includes the following expenses:
a) Advertisement b) Show room expenses c) Traveling expenses
d) Commission to agents) Salaries of Sales office f) Cost of catalogues
g) Discounts allowed h) Bad debts written off i) Commission on sales
j) Rent of Sales Room
4.Distribution expenses
• It includes all those expenses, which are incurred in connection with making the goods
available to customers. These expenses include the following:
a) Packing charges b) Loading charges c) Carriage on sales d) Rent of warehouse e) Insurance
and lighting of warehouse f) Insurance of delivery van g) Expenses on delivery van h) Salaries
of Godown keeper, drivers and packing staff.

DETERMINATION OF TOTAL COST

Cost of product is determined as per cost attach concept. Total cost of a product consists of
various elements of cost, which have the quality of coherence. All the elements of cost can be
grouped and regrouped. Grouping and re-grouping of the various elements of costs leads to
significant divisions of cost.

NON-COST ITEMS
Non-cost items are those items, which do not form part of cost of a product. Such items should
not be considered while ascertaining cost of a product. These are items included in profit and
loss A/c as per principles of Financial Accountancy but not related to product. For example,
Income-tax paid, provision for Income-tax, interest on capital, interest on loan, profit on sale of
fixed assets, loss on sale of fixed assets, transfer fees received, transfer to reserves, any other
appropriation of profit, commission to Managing Director or Partners, capital loss, donations,
capital expenditure, discount on shares and debentures, Goodwill written off, Preliminary
expenses written off, brokerage, pure financial expenses or losses and expenses not related to
the business, wealth tax, bonus to directors and employees, if it is based on profit, expenses of
raising capital, penalties and fines.
COST SHEET
For determination of total cost of production a statement showing the various elements of cost
is prepared. This statement is called as a ‘statement of cost’ or ‘cost sheet.’ Cost sheet is a
statement, which provides for the assembly of the detailed cost of the total cost of job
operation or order. It brings out the composition of total cost in a logical order, under proper
classifications and sub-divisions. The period covered by the cost sheet may be a week, a
month or so. Separate columns are provided to show the total cost and cost per unit. In case of
multiple products a separate cost sheet may be prepared for each product. Alternatively,
separate columns of total cost and unit cost may be provided for each product in the same cost
sheet. A cost sheet is prepared under output or unit costing method.

Purposes of cost sheet

Cost sheet serves the following purposes:
1. It gives the break up of total cost under different elements.
2. It shows total cost as well as cost per unit
3. It helps comparison with previous years.
4. It facilitates preparation of tenders or quotations
5. It enables the management to fix up selling price
6. It controls cost.

Activity-Based Costing (ABC)

An activity’s costs can be allocated to a particular production lot, and this makes activity-based
costing an accurate way of allocating both direct and indirect costs. It is a method of
computing costs associated with each product or line of production in a company based on the
amount of resources consumed by each activity.

As a result, cost drivers are most relevant in the ABC costing system.  The cost of each activity
is apportioned to specific products or lines of production, based on resources consumed by
cost drivers. A cost driver is a factor that creates or drives the cost of the activity. It is the root
cause of why a particular cost occurred.

Activities consume resources while customers, products, and channels of production consume
activities. Understanding this is fundamental to the cost allocation concept using cost drivers.
The profitability of each customer can also be easily evaluated using cost drivers, and in cases
of resource constraints, the less profitable order can be eliminated. Resources should be
allocated to the most profitable activities or in proportion to profitability.

 Example of a Cost Allocation Based on Cost Drivers

The main challenge of ABC costing is that it allocates fixed costs as if they were
variable. Because of this fact, it may give an inaccurate figure of the total cost, and the
inaccuracy depends on the period of time required to recoup back the initial fixed cost. If the
cost is high, there are likely to be lower profits in the first years of operation, and more profit
as more costs are absorbed.

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