Lecture no27 classification of costs

Chapter Opening Story: What Does It Cost to Make an iPhone?. Classifying Costs for the Financial • Period costs : Those costs that are matched against revenues on a time period basis •

Classification of Costs

Lecture No 27 Chapter 8 Contemporary Engineering Economics

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Chapter Opening Story: What Does It Cost

to Make an iPhone?

Apple’s 16GB iPhone 6 is priced

at $649 Do you know the profit

margin for Apple from selling

an iPhone 6?

At Issue : The 16GB iPhone 6

costs Apple about $200 to

build How does Apple come up

with such an estimate of

various component costs before

General Cost Terms in Manufacturing Setting

Components of Manufacturing Cost

Classifying Costs for the Financial

• Period costs : Those costs that are matched

against revenues on a time period basis

• Product costs : Those costs that are matched

• Direct material costs

• Direct labor costs

• Manufacturing overhead

How the Period Costs and Product Costs Flow

Through the Financial Statements

Cost Flows and Classifications of a

Manufacturing Company

Example 8.1: Classifying Costs for Uptown Ice Cream

Shop

• Given : Breakdown of unit

cost items

• Find : Classify the cost items

to product costs and period

costs.

Cost Classification for Predicting Cost

Volume Index

• Definition : The unit measure

used to define “volume”

Remains constant over

the relevant range

Mixed Costs

• Definition: Costs are

fixed for a set level of

Average Unit Cost

•Definition: activity cost per unit basis

both the constant and variable elements.

Example 8.2: Average Driving Cost per Mile

• Given : Owning and

Operating a 4WD

Sport-Utility vehicle

• Find : Average driving

cost per mile as a

function of mileage

Solution

Cost-Volume Chart

Average Cost Per Mile

Future Costs for Business Decisions

•Differential (incremental) cost

•Opportunity cost

•Sunk cost

•Marginal cost

Differential (Incremental) Costs

• Definition : Costs that represent the

difference in total costs, which results from selecting one alternative instead of another

• Cost behavior : Increases or decreases with the overall change that a company

experiences by producing one additional

unit of goods

Opportunity Costs

•Definition: The potential benefit that

is given up as you seek an alternative course of action

•Example: When you decide to pursue

a college degree, your opportunity

cost would include four-years’

potential earnings given up.

Marginal Costs

• Definition : Added costs that

result from increasing rates

of output, usually by a single

unit

• Example : Cost of electricity

—decreasing marginal rate