Question

It is budget time and the CEO has asked you to develop a presentation on cost concepts and how it is used in decision making. As the Director of Budgeting and Finance, you have been tasked to present the presentation to all directors, supervisors and physicians. The CFO has ask you to address the following:

• How and why do we classify cost?
• Discuss the four major categories of direct and indirect cost and explain each. Give examples of each.
• What is the difference between controllable and uncontrollable cost, give an example of each.

PLEASE USE EXAMPLES AND DETAILS

Answer 1

The first step is to determine which costs are relevant to the decision and which are not Costs fall into the following categories Future costs: Any future cash expense that is different for each alternative and will be incurred as a result of the decision is a relevant cost. .Opportunity costs: Any cash inflows that will be forfeited as a result of the decision are relevant costs Sunk costs: Money that has already been spent is not a factor in the decision . Common costs: A future cost that is the same for all alternatives will not have an effect on the decision and should not be considered Committed costs: A future expense that is already obligated is not a consideration. It will be spent regardless of the decision Noncash expenses: Any expense, such as depreciation, that does not affect the cash flow of the business is not relevant The separation of expenses into different category. For example, cost classification in economics might involve categories of fixed, variable, opportunity, production and sunk costs. On the other hand, accounting costs can be classified as either direct or indirect or a business Direct costs can be traced to specific cost objects. A cost object is something for which a cost is compiled, such as a product, service, customer, project, or activity. These costs are usually only classified as direct or indirect costs if they are for production activities, not for administrative activities.Direct cost analysis can also be used outside the production department. For example, subtract the direct cost of goods sold to individual customers from the revenues generated by them, which yields the amount customers are contributing toward the company's coverage of overhead costs and profit. Based on this information, management may decide that some customers are unprofitable, and should be dropped Direct Cost Examples The typical business has very few direct costs. The most common ones are . Direct materials Freight in and freight out . Commissions Consumable supplies Indirect costs are costs that are not directly accountable to a cost object (such as a particular project, facility, function or product). Indirect costs may be either fixed or variable. Indirect costs include administration, personnel and security costs. These are those costs which are not directly related to production. Some

indirect costs may be overhead. But some overhead costs can be directly attributed to a project and are direct costs There are two types of indirect costs. One are the fixed indirect costs which contains activities or costs that are fixed for a particular project or company like transportation of labor to the working site, building temporary roads, etc. The other are recurring indirect costs which contains activities that repeat for a particular company like maintenance of records or payment of salaries Costs either charged directly or allocated indirectly Directors Salary (this is usually an indirect cost) Electricity (mostly if it needs allocation it is always indirect) Costs usually allocated indirectly Indirect costs related to transport Administration cost Selling & distribution cost Office cost Security cost Controllable Overheads Controllable overheads are the indirect expenses which the management of a manufacturing concern can keep under its control, as they are influenced by its decisions. Therefore those overheads which vary due to the management decisions are called controllable overheads. The examples of controllable overheads are indirect materials, power expenses and lighting expenses 2. Uncontrollable Overheads Those indirect expenses which are beyond the control of the management are known as uncontrollable overheads. The management cannot influence such expenses by its decisions and therefore, they are uncontrollable. The examples of uncontrollable overheads are fixed overheads like factory rent, office salaries, depreciation, and legal expenses