 Namaste, welcome back to our course on Costs and Management Accounting. In our first session, we discussed about what is cost accounting. There are three steps involved, Assertainment of Costs, where we will record the cost in details, then we will go for analysis of cost. So the total cost is broken down on variety of basis to get the details and then that cost breakup or that analysis is used for preparation of cost statements, which help in cost control. They also help in taking variety of decisions like make or buy decision or like outsource or not type of decisions. This is broadly the cost accounting is, this is the particularly the decision making part of it is particularly for the use of management. That is why we have got an umbrella concept known as management accounting. In this course, our focus is going to be on cost and management accounting mainly on the techniques which are used for decision making. We also discussed what is cost and then we went into classification of costs. So let us start with the cost. I think, So there is no need of any definition. We have to pay for it. We have to incur expense. We have to sacrifice our time or we have to give up an opportunity. All this is added together and is called as a cost. Now the classification, this classification is very important because it leads us to variety of concepts within cost and management accounting and a few of the techniques to control those costs or this classification is used by us for providing the information for decision making. Now the first classification is by elements which we have already discussed. So do you remember now what are the important elements of cost? I think most of you know first one is material, next is labor and third is expenses. This is the oldest form of classifying. So all tangible cost, item related costs are included in material. Human related costs are classified into labor and service purchases related costs are expenses. Now this is a very basic classification from where we have evolved and we go for a further classification as per the function. So important business functions like production, administration, selling distribution, R&D, the business is normally divided into units as per the functions. So the cost is also classified as per the function like production cost, admin cost, marketing cost and so on. Then there is another way of classifying the cost that is by direct and indirect. Do you remember what is direct cost? This is very important for cost control viewpoint. I think you are remembering direct costs are those costs which can be attributed to a particular cost center or a product. At least keep this example of fruit pulp in mind. That cost of fruit going into production of fruit pulp, you can identify it. You know that raw material like mangoes are purchased and you are making mango juice. So the mangoes purchased will be directly charged to production of mango juice. But all costs cannot be directly charged. Remaining costs which cannot be charged directly are considered as indirect costs. Suppose we have a fruit pulp making unit, we have got 4 types of fruits and we make 4 types of pulp. So any fruit purchased we charge to these 4 units. Apart from that what are other costs which are indirect in nature? Suppose for our factory which has these 4 units, we pay common rent. Rent will not be for just for 1 unit. It is the total rent for all the 4 types of pulp units. So it is going to be an indirect cost. Same way security, insurance, maintenance, these are typical examples of indirect costs. What about manpower cost? Is it direct or indirect? Suppose there are employees who work on a specific pulp making unit. Let us say there are 15 employees who are only working in mango unit. Then their cost you know that this is specifically identifiable to mango pulp making, then that will be considered as a direct cost. But the cost of the supervisors who are supervising all the 4 units, it will be an indirect cost. Cost of production manager indirect cost, cost of helper who help in moving items from here to there, but not identifiable to any 1 unit, then that will be an indirect cost. Like that, whether it is material or labour or overheads, those costs now are being reclassified as per directness. If they can be identified exclusively, if it is possible to relate them easily to a cost centre or a product, we will call it as a direct cost. And those which cannot be related very easily like rent or like security, they would be considered as indirect cost. Now we need to charge this indirect cost also. Direct cost we can easily charge, but indirect cost we cannot charge directly. That is why there normally a rate per unit is calculated or a composite rate is calculated. Technically, we call them as absorption rate. So we take total of indirect cost, suppose we divide it by number of hours we will get rate per hour. But this is a very basic method, there are advanced methods like activity based costing. So this is how indirect costs are charged to products or to cost centres. There is another way of classifying, that is classification based on controllability. Now controllable costs are those costs which can be influenced by the action of a specific person. So if you have got a factory manager, who can decide to take purchase or not purchase certain categories of mangoes, who has the authority to decide certain day to day actions, then those costs which can be attributed to his or her decisions would be the controllable cost for that level. Will the rent be a controllable cost? Mostly no because the decision of rent would have been taken already by higher levels. The decision on wage rate might have been taken by higher levels, then those costs will be considered as non controllable cost. Now this particular classification is not very sharp, it will go on changing as per level of activity. Like say supervisor of a particular unit may have certain decisions within his or her power, factory manager may have more decisions, a general manager may have more level of authority to take more decisions. So for each level of management, the controllable cost changes. Now the advantage of this classification is, when we segregate controllable cost we can make that particular person responsible only for those costs which are controllable within his or her decisions. Otherwise, every manager will say I do not have much authority, seniors are taking decision, other departments are incurring more expenses, so I cannot control my expenses. So out of all these costs, most of the costs, so the controllability becomes identifiable and classification of control becomes difficult. That is why under controllability classification, all costs related to that department or unit are classified into two types, one which are controllable, others which are not controllable. And we will try to hold that particular person responsible only for controllable costs. As the name suggests, this technique is very much useful for cost control purposes. Now the next is classification as per normality. Now for a certain level of output, certain costs are considered as normal. But if the cost exceed that level, then that will be considered as abnormal. For example, if you go to petrol pump, they are dealing with petrol or diesel. Now these items are meant to be evaporated. So suppose 50,000 liters of petrol is sold in a day, it is known that 0.3 percent of that is likely to be evaporated. That is considered as a normal evaporation. So whoever is in charge of sale of petrol, nobody will ask if the loss of petrol is limited to 0.3 percent. But if actual loss exceeds that, then the person will be questioned whether there was any unbuilt sale or something like that. So any extra loss will be considered as an abnormal loss. Same thing is true also for goods which are kept in storage. So for different types of losses, we divide them into normal and abnormal and normal losses are treated differently. They are charged to good units produced because they are bound to happen. Whereas if there is an abnormal loss in excess of that normal percentage, we will charge it to that particular department or to the manager, we cannot charge it to the customers. Now the next type of classification is as per variability. Now here the base of classification is slightly different. The earlier classifications which we studied were mainly for cost control purposes. Now classification as per variability is mainly useful for decision making purposes. So how will you classify this cost? The cost will be classified into fixed variable and semi variable. As the name suggests, variable costs are those costs which change or vary. Here when we say vary, what we are thinking of is variation as per level of output. More the usage or more the production, that cost goes up in a linear proportion that is called as a variable cost. Costs are direct wages, direct materials. If a vehicle is being operated normally as per the use in kilometers, the petrol cost would go up or fuel cost will go up. So that will be considered as a variable cost. As against this, there are certain costs which are known as fixed costs. Fixed costs are those costs which are related to time and they do not change with volume or with the level of activity. For example, if we take example cost of the car, more the operation or more the running of car, fuel cost will change, it is a variable cost. And the insurance cost is most likely not going to change or depreciation cost of the car is not likely to change, hence that comes as a fixed cost. Other examples as you can see here include rent or property or taxes. These are also examples of fixed costs. Now this table gives a summary classification. So variable cost in total change with the level of activity. If you calculate it on per unit basis, they would remain constant on per unit basis. As far as fixed costs are concerned, they are going to be constant at a total. But on per unit basis, they go on reducing for every extra unit because they are common in total, they will go on reducing for more units, got it? Now there are certain costs which are in between. They have some component of variability, some component of fixed. So that is called as a semi-variable cost. Example is telephone bill. Nowadays, I think most would not even have seen this type of telephones. These are old fixed line telephones, not like mobile phones which we use now. They used to have a fixed rent and for every call you have to pay extra. That is why it is a semi-variable cost. The rent part is fixed, call charges are variable. Even today, even for mobile phones, normally there could be a fixed charge and extra amount if it increases as per calls, it becomes a variable cost. Of course, if you have got unlimited calling plan, then variable cost is 0. You only have fixed costs. Similarly for electricity or for maintenance also, there will be a fixed component and variable component. So total cost will vary but not in the direct proportion. So it is considered as a semi-variable cost. Now here is an example. Now for 2 months, let us say July and August, for first month the units are 1000, for next month it is 2000. Now you can see here costs are given and you have to identify them as fixed variable or semi-variable. Now the first item is direct material. It will fall in which category? As you can see, the cost of material has increased from 50000 to 10000. So it has doubled. Number of units have doubled, the cost has also doubled. That means it is an example of variable cost. Direct labor, again same, 28, 56, so it has doubled, it is a variable cost. Second of the factory unchanged, so it is a fixed cost, power 35000, 50000, it has changed but not in the direct proportion. It has not become 35 and 70, so it is not variable, neither it is fixed, it is a semi-variable. Maintenance same way 17 and 26, so it is a semi-variable cost. Are you getting? It is simple but this classification is going to be very much useful when we go for variety of decisions and in coming sessions we are going to in-depth look into those use of this classification. But right now we will go to the next classification that is as per the relevance. Now relevant costs are those future costs which differ between alternatives. So if you take a particular decision, it changes certain costs in future. Those costs will be called as relevant. While sunk costs are the costs in the past, irrespective of decision they cannot change, so we call them as sunk cost. Now what is an example? Suppose you have developed a product P, for development of the product you have incurred research and development cost of 10 lakhs. Now the question is shall we launch the product or not launch? If we launch the product the cost of manufacture will be 25 lakhs and we are expecting a revenue of 30 lakhs. I will just repeat the figures again, R and D cost is 10 lakhs, manufacturing cost is 25 lakhs, the revenue likely to be generated is 30 lakhs. Now shall we launch the product? What is a relevant cost and what is a sunk cost? I think most of you are getting it, we should launch the product because relevant cost is a manufacturing cost which is 25 lakhs, we are going to get 30 lakhs from the sale. That means we are making a profit of 5 lakhs, sunk cost is 10 lakhs which we have incurred on R and D. SABM product, that is why it is a sunk cost. So R and D is a sunk cost, manufacturing cost which we are going to incur, we may or may not incur because of the decision of launching or not launching. That is why this launch, this manufacturing cost becomes a relevant cost. Now while taking decisions you should only look at the relevant cost and not look at sunk cost, are you getting it? So this classification is very much useful for decision making, it is not very much useful for control purposes, they are different classifications which we have seen earlier like direct, indirect or controllable, non controllable, this is primarily for decision making. There is another variant of this cost that is known as differential cost. So if you have two alternatives and if you are going to incur any extra expense by that alternative then it is called as a differential cost. So if we take route A the cost is 100 rupees, if we go by route B the cost is 120 rupees. So difference between the two alternatives is 20 rupees, that is a differential cost. This is also useful in decision making. Now the opportunity cost, now opportunity cost is not something which you pay in cash, that is why many people get confused. This is the cost of lost benefit. So if something is in short supply, we choose alternative A, we cannot go for alternative B. So the benefit from B is lost, that is the opportunity cost. So suppose you can either watch the video of this course that is alternative A, alternative B is you watch, you can watch a movie. So which one will you choose? Aplo Becher is scholarly student, so you have chosen to watch this boring video. So you have sacrificed watching a movie, that is opportunity cost of seeing this video. Are you getting me? Maybe you are not paying anything in cash but your time is limited. See time may up video dek sakte te, you are sacrificing it, that is the opportunity cost of this. Suppose you join a college and you are paying fees of 50,000, if it is a MBA college maybe 5 lakhs. So you are paying a fees of 5 lakhs for 2 years, so 5 lakhs into 5 lakhs, it is a 2 year MBA course. What is the cost of doing MBA? In monetary terms it is 5 into 2 10 lakhs plus maybe some other expenses of 2 lakhs, so 12 lakhs but you also have an opportunity cost. If you are doing a job and you are getting a package of say 10 lakhs, then 2 years 10 lakhs you are losing. So 10 into 2 you are losing 20 lakhs that is the opportunity cost. So cost of doing MBA is opportunity cost of 20 lakhs plus cash cost of 12 lakhs. So total cost of doing MBA is 32 lakhs. Now if you are getting commensurate benefit you should take a decision to do MBA, otherwise maybe you can go for a part time MBA where your fees is a cost but you are not losing on your job or on your salary. So that is how for making variety of decisions, we need to consider the benefit which you have lost and that is called as a opportunity cost, are you getting? Now here is an example that suppose you want to start a business and if you go for doing it from your own premises from your own house maybe, you are not paying any salary now sorry you are not paying any rent now, so rent cost budget that becomes an opportunity cost for you got it. Now the next one is marginal cost, this is the cost of making one extra unit, later on we are going to study marginal costing where this will be very much useful. So for 100 units if cost is 1000 rupees, if you make 101 unit and the cost is 1000 phi then for 1 unit the extra cost is 5 rupees that is a marginal cost of 1 unit then there is average cost. So you take the total cost divided by number of units you get average cost, this is also useful but mainly for control purposes. Now the last classification is product cost versus period cost, if you calculate the total cost for manufacturing or for purchase of a product it becomes a product cost, it is inventoriable because you can add it to the inventory as against this there are period costs these are more related to time for example rent for example salary, it is being incurred for certain time not much for the number of units so they are considered as period cost. So today we have discussed important cost classifications starting from elements that is material labour overheads then we have seen control related classifications we have also seen decision making related like relevant cost or like variable cost or differential cost etc. Now these classifications are very much useful and in coming sessions we will be solving certain problems or solving certain cases using this classification right now let us stop here. Namaste. Thank you.