Present value of a single amount and annuity

In this presentation we will take a look at cost classifications. There's a few different ways that we can classify costs. And they all have their pros and cons. There are benefits to classification in different ways. We're going to classify costs here by behavior. 

Now you may think What does that mean to costs have behavior. And we could say well yeah costs do have behavior in that they act in certain ways in relation to other activities. We're going to classify the two types of costs here being fixed costs and variable costs.

 This type of classification is not included in financial accounting. So if you're going from financial accounting to managerial accounting this is going to be a new concept. And the reason we're going to have cost classifications by behavior is that it really helps with rejection.

 So we have to have this because when we're looking into the future what's really going to be helpful if we can determine how costs act so that we can make projections based on different levels of production. So we have fixed costs. Fixed costs mean that as production level rises the cost remains fixed. So for example if we have the activity down here we'll say this is production if we're making units of something as we make more units of something the cost total remains the same.

 Remember here that we're talking about total cost not cost per unit. We're starting here with total cost. So for example if we're saying that the rent is going to be a thousand dollars a month then it really doesn't matter how many units we make if we're producing things in a warehouse and we make one unit in that warehouse then it still costs a thousand dollars. If we are producing in that warehouse and we make say a hundred things the rent still is a thousand dollars. If we keep producing in that warehouse and we maximize the production of the warehouse let's say it's 5000 things well then units of production whatever we make then it's still going to cost us a thousand dollars no matter what we do the rent is going to be the same.

 And so if you look at that in terms of the fixed costs you're going to say well it's going to be what it is no matter what. So when making projections then we can think of Okay how many units do we have to produce in order to pay off the rent pay off the fixed cost.

 So the other types of behavior that we're going to have a major second group that we're going to have we're going to try to basically break everything out into these two groups even though it's not possible and we're not all costs fit nicely into these two groups we would really like it if they did because that would simplify the world here and we're going to try to do so so that we can make accurate projections. And so the other type is variable costs and variable costs are going to go up with each new unit of production.

 So for example if we're making guitars and this is the cost of wood the total cost of wood and this is the activity how many guitars we're going to make. Well if we make one guitar then it's going to cost more if we make one guitar here. It's going to cost so much. And then if we make two guitars while the activity went up and the cost is going to go up in proportion it's going to be a straight line because the cost is going to go up with the same number of units. Let's say the cost is for wood that's going to go in the guitar.

 We make three guitars well then the cost of wood is going to go up in proportion to the number of guitars that we're making. So so wood or direct material that goes into into the cost of production is going to go up you would at a constant rate and as opposed to something that it's fixed such as the rent if we know those two things then it's really useful for us to then make projections into the future because now we can say okay how many guitars do we need to make in order to get to this level of cost. And of course we'll add into this pretty soon we'll add into it the amount of revenue per guitar we're gonna get. And if we take the revenue minus the variable costs then we can say okay how much are we making over the variable cost to see how many units we then need to have in order to clear the rent price. And that's how we start to kind of think about these things.

 What do we need to produce in order to clear our costs. It's a lot easier to make those types of production projections if we can break all costs up by behavior between fixed costs and variable costs. Now some costs will line up in these two very easily and it won't be a problem if we're talking about wood in a guitar then that's probably pretty straightforward. If we're talking about the rent that's pretty straightforward but we're going to have some things that aren't quite as easy to go into these two components they may have some combination between fixed costs and variable costs and what we're really want to do is break them out between those two. 

For our projection purposes and we'll talk about different methods that we can do that. That's gonna be one of our goals in manager accounting is to break everything out between fixed costs and variable costs. That allowing us to make nice projections into the future. Another way that we can classify costs is by function. What does that cost do.

Why are we incurring this cost so we can have direct costs and indirect costs. Direct costs are going to be costs that are traceable to a cost object. So if we're in a production cycle then direct cost would be things like direct materials and direct labor. These are things that we can trace to a particular unit of inventory that we are producing. So direct materials we know exactly for making guitars for example we can trace the wood in the guitar to a particular guitar that we are producing and allocate the cost of that wood to that piece of inventory to that guitar. If we're talking about direct labor same thing someone's putting together a guitar. We can allocate the cost of the labor that's being put together to a particular piece of inventory a particular guitar. 

On the other hand indirect costs are things that we can't trace are not traceable to a cost object. So examples of that are going to be maintenance costs for four multiple departments or things like glue or things that we we can't put to a particular guitar. We're making one guitar then we can't really have these indirect costs allocated specifically to that guitar.

 It's gonna be indirect. So if we talk about maintenance for multiple departments then possibly the maintenance is gonna be for the entire warehouse and we can't apply the maintenance for example to one particular guitar because we don't know how much to apply to a particular guitar. 

The production process needs maintenance within the warehouse but we can't assign it directly to a particular guitar and we can take that concept to different departments as well offered which we pay for maintenance for multiple departments then the maintenance is there for multiple departments but it's difficult to allocate to a particular department and we would have to figure out some type of way then to allocate these indirect costs.

 That's going to be one of the challenges we have if we have maintenance for multiple departments or multiple units of inventory. How then can we take this information and allocate it to a particular unit a particular unit which we don't really know. 

We have a similar problem. If we're talking about small materials like glue or something for a guitar it might be possible for us to classify glue as a direct material that we can then allocate specifically to a particular guitar that was used it was used in however doing so would be cut not cost effective typically.

 So if we're talking about something like glue or something like that then we might have to use some other type of allocation method. 

We don't know exactly which piece of unit of inventory it was used on. So it's indirect. So we have to find some way then our challenge will be to take these indirect costs these costs that we know need to be allocated in some way in order for us to properly value our inventory and try to allocate them in some way even though we don't know directly where they apply. And that'll typically be the concept of overhead. So anything for example in a factory that we work on will be will if we can't apply it directly direct materials or labor. 

It's probably going to be an indirect cost something that's going to go into overhead that we're then going to have to figure out how can we allocate this to our units of inventory to properly allocate the inventory. So if we're talking about depreciation on a warehouse then that depreciation is part of the cost of making stuff making the guitars. 

But how do we allocate to any particular guitar. We're going have to figure out how we can make those types of allocations. There's a supervisor in the set in the warehouse that's supervising all the guitars we make. How do we know how much time we should put that supervisors time on that particular job. We'll have to figure out how we can make those allocations so that's gonna be one of the challenges we'll have as we work through the manufacturing process as we allocate costs.