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The use of job costing as a tool for the pricing and cost control decisions in the printing industry: the case of Société de Presse et d'Editions (SOPECAM)


par Christian Kuiate Sobngwi
University of Buea - Bachelor of Science 2003
  

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6. Cost classifications

There are a variety of reasons why we need to classify costs. Among the most important are the prediction of their behaviour, the tracing of these costs to the various cost units or cost centres or the valuation of inventories. Depending on the kind of company under study, we have different types of costs in the picture; the costs identified in a manufacturing company may not be the same as those of a service company, a retailer may not have the same costs as his supplier dealing in the wholesale business.

In order to provide management with accurate information about costs we therefore need to analyse them into logical sections that will be more meaningful than the current bulk of data.

The three major ways of classifying costs use three parameters, namely: the nature, function and behaviour.

COSTS CLASSIFIED ACCORDING TO THEIR NATURE

The nature of a cost is related to its traceability, relevance, and its sensitivity to management actions in the decision making process. Here is a brief description of the different types of costs listed according to their nature.

Direct cost:

This is an expression used to describe costs that can be easily and conveniently traced to the particular cost object under consideration. (Garrison & Noreen 2003). It is generally used along side with the concept of indirect cost.

Indirect cost:

This is simply the contrary of the direct cost and Garrison and Noreen (2003) refer to it as the cost that cannot be easily and conveniently traced to the particular cost object under consideration.

Costs are generally classified as direct or indirect when we need to devise a means for the assignment of costs to the cost objects. This is very helpful as it gives the manager the opportunity to evaluate either the profitability or implement cost control programmes for the cost object concerned, as he will have valid information on the amount of resources consumed by that cost object.

Product and period costs:

The nature of the cost here relate to the timing of their liquidation as expenses on the income statement. This distinction between product and period costs is mainly due to the Matching principle of financial accounting, Drury (1992). This principle is based on the accrual concepts and it states that: «Costs incurred to generate a particular revenue should be recognised as expenses in the same period that the revenue is recognised.» So the difference between product and period cost will be due to the purpose for which the costs are incurred; if it is a cost used to produce or acquire an item that may be sold then it will be considered as product cost otherwise it is a period cost. We can therefore agree with the definition of Garrison and Noreen (2003), that a product cost includes all costs that are involved in the acquisition or making of a product. Taking the example of a manufacturing company, product costs are the direct materials, direct labour and manufacturing overhead costs that are used to manufacture a particular item.

These costs have a double treatment according to the time and financial account. Since these costs are incurred while acquiring or making a product, they will be used in the valuation of the stocks of that product until it is sold. This means that, before the sale, these costs are treated as assets in the balance sheet of the company. Once the sale has been performed, the revenue earned from their sales must be matched against the costs incurred for during their production; these costs are then treated as expenses on the income statement to match them to the sales revenues and obtain the margin or contribution to the overall profits of the company. So these can be called inventoriable costs as they are used for stock valuation purposes.

Garrison and Noreen (2003) define a period cost as all the costs that are not included in product costs. Since these costs are not used for acquiring or making products, the company considers them as expenses in the period in which they are incurred. Some examples of this type of costs include selling and administrative costs, office rent or financial charges.

To better illustrate the concept of product and period cost, let us draw a diagram that will show how costs may be classified and how they flow into the various accounts of a company.

Figure 2-2: COST FLOW AND CLASSIFICATIONS IN A MANUFACTURING COMPANY

Finished goods inventory

Raw materials inventory

Product costs

Work in progress inventory

Selling and administrative expenses

Goods completed (cost of goods manufactured)

Direct materials used in production

BALANCE SHEET

COSTS

Raw materials purchases

Direct labour

Manufacturing overhead

Period costs

Cost of goods sold

INCOME STATEMENT

Selling and administrative

Source: Garrison R. H., Noreen E. W., Managerial Accounting, Mc-Graw Hill, New York, 2003, p 50

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