Budget preparation or decision making it is necessary

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Unformatted text preview: n or decision making it is necessary to analyze and classify costs. Costs can be classified as follow: Behaviour Function Controllability Normality Cost units BEHAVIOUR Costs may or may not vary with the level of activity. The level of activity usually refers to volume of production or number or value of items sold. There are four types of costs that are classified on the basis of behaviour. They are: 1. Fixed Costs: these are costs that will not change over a given range of activity (volume) and within a given period of time. Examples of fixed costs include insurance, depreciation and director’s salary. Since fixed cost relates to a time span it is also referred to as period cost. Total cost RM ‘000 20 10 Fixed Cost 0 10 20 30 40 Activity (hours) 3 2. Variable costs: these are costs that vary in direct proportion to changes in the level of activity (volume). If a factory shuts down and stops production completely, no variable costs will be incurred. Examples of variable costs include direct materials (flour in bread), direct wages (payment to production employees for time spent working), direct expenses (maintenance costs of production machine) and petrol consumption by vehicles. Total cost RM ‘000 30 20 10 Variable Cost 0 5 10 15 20 Activity (number of units) The total variable costs increase as activity (number of units) increases. 3. Semi-variable or Semi-fixed Costs: these are costs that contain both fixed and variable costs. In other words, the costs are not perfectly fixed or perfectly variable. Telephone costs, for instance, contains a fixed sum as rental for a period, say one month, and variable costs for metered calls. Total cost RM ‘000 Variable Cost 20 10 Fixed Cost 0 5 10 15 20 Activity (number of units) The semi-variable cost is made up of a fixed and a variable cost element. 4 4. Step Costs: these costs are fixed over a range of activity and then rise to a new level as activity changes. For instance, a production supervisor may supervise a given number of workers. As the number of workers increase due to increased production it is necessary to hire another supervisor. Therefore, the supervisory salaries are step costs. Most fixed costs are in fact step costs. For instance, rent will increase as the level of activity increases as more space is required. Again, depreciation on machines may increase with an increase in the level of activity as more machines are required. Some variable costs may be step costs. Labour cost, for instance, increases suddenly at different levels of activity as their recruitment comes in lumps. Total Cost RM ‘000 30 20 10 Step Cost 0 20 40 60 80 Activity (hours) Step costs remain fixed over a range of activity. FUNCTION Costs are classified by function to which they relate. a) b) c) d) e) f) Production Costs: are costs incurred from the time of acquisition of material until the despatch of completed items to store or warehouse. Administration Costs: are costs incurred in the general administration inclu...
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