Cost refers to the expenditure incurred to manufacture product or provide a service. Since a number of cost are incurred during production process these costs are required to be bifurcated based on their usage, frequency etc.
Difference between cost of goods sold and cost of goods manufactured:
1. Cost of goods sold is total cost of producing a product or service hence , it includes the total cost, whereas cost of goods manufactures includes the production cost only.
2. Cost of Goods sold is the cost that is transferred to the income statement at the time of sale of a product. And cost of goods manufactured is cost of goods completed during the period and shifted to the finished goods inventory from work-in-progress inventory.
3. Cost of goods sold is calculated after the calculation of cost of goods manufactured.
4. Cost of goods sold includes selling administrative expenses in addition cost of goods manufactured.
Indirect Costs are not directly traceable to the product and hence allocated on the basis of some pre determined allocation base.
These allocation bases should be appropriate so that organization can arrive at the accurate cost of the product.
A cost driver is any factor which causes changes in the activity's cost. Cost driver is used to allocate indirect cost (overhead costs) to the product. Hence, cost driver is nothing but the allocation base on the basis of which indirect cost is allocated to the product.
Cost drivers should be chosen after in depth analysis of the activity and the corresponding driver. Otherwise it can lead to inaccurate allocation of indirect cost and in turn inaccurate total cost.
Example of cost driver is no of setups for set up activity or no of machine hours for machining activity.
Cost Driver: A cost driver can be described as unit of an activity that brings changes in the cost of that activity.
In simple terms, it can be described as the cost of an activity is dependent of the cost driver of such activity. Example of cost drivers are: labor Hours or machine hours.
Effect of change in cost driver on:
1. Total variable cost: Total variable cost will change directly in proportion of cost driver i.e. any increase in cost driver will lead to increase in total variable cost and vice- versa.
2. Total Fixed cost: Total fixed costs remain constant with respect to any change in cost driver because fixed cost remain fixed for any level of activity and hence, will not be affected by any changes in cost driver.
3. Average variable costs: Average variable costs remain constant with any changes in cost drivers because variable cost changes directly in proportion of cost drivers and such effect will be nullified while calculating the average variable costs.
4. Average fixed cost: Average fixed cost will change adversely in proportion of cost driver because fixed cost remains constant for a period of time.