DIPLOMA IN ENGINEERING

NOWGONG POLYTECHNIC
6TH SEMESTER

INDUSTRIAL MANAGEMENT & ENTREPRENEURSHIP – Hu – 601

UNIT 3 -INTRODUCTION TO COST

COST - DEFINITION

Cost refers to the monetary value of resources sacrificed to produce goods or services. It
includes expenses related to raw materials, labour, and overheads incurred during production
or operations in an industrial setting.

In an industrial setting, cost plays a vital role in decision-making, pricing, budgeting, and
financial planning. Businesses must analyze and control costs to ensure profitability,
efficiency, and competitiveness in the market.

Cost in industrial management is associated with various aspects, such as:

 Manufacturing: Cost is incurred for buying raw materials, labour, and overheads
required for production.
 Administration: For paying the salaries, office expenses, and operational costs.
 Marketing & Distribution: Expenses related to advertising, sales, and delivery are
covered under cost.
 Research & Development (R&D): Investment in innovation and product development
is also taken as cost, even though its kind of an investment in future.

KEY ASPECTS OF COST IN INDUSTRIAL MANAGEMENT

1. Cost Control – Monitoring and regulating expenses to prevent wastage.

2. Cost Reduction – Implementing strategies to lower production and operational costs.
3. Cost Analysis – Evaluating cost components to improve decision-making.
4. Cost Allocation – Distributing costs across different departments or products.
5. Cost Accounting – Keeping records of costs for financial reporting and management.

IMPORTANCE OF COST IN INDUSTRIAL MANAGEMENT

 Pricing Decisions: the total cost incurred helps determine the selling price of products,
by giving an insight to the seller regarding the margin required to get the desired profit.
 Profit Maximization: Knowing and controlling cost enables businesses to optimize
expenses for higher profits.
 Resource Utilization: Cost analysis ensures efficient use of materials, labour, and
capital, due to which optimum utilisation is ensured.
 Financial Planning: Cost analysis aids in budgeting and forecasting future costs,
resulting in better overall operations management.
  Performance Evaluation: Cost analysis assists in assessing efficiency and cost-
effectiveness of the management process undertaken to achieve the organisational
goals.

CLASSIFICATION OF COST

Costs in industrial management can be classified based on various criteria:

1. Based on Element of Cost

A. Material Cost – Cost of raw materials used in production.

B. Labour Cost – Cost associated with wages and salaries paid to workers.
C. Overhead Cost – Overhead cost refers to the indirect costs incurred in the production
and operation of a business that cannot be directly attributed to a specific product or
service. These costs are necessary for the overall functioning of the business but do not
directly contribute to manufacturing. Overhead costs can be constant, fluctuate with
production, or have both components. These may be fixed or semi variable. For
example: costs like electricity, rent, depreciation, etc.

2. Based on Behavior

A. Fixed Cost – Fixed cost refers to the expenses that remain constant regardless of the
level of production or sales. These costs are incurred by a business even if no goods or
services are produced. Unlike variable costs, which fluctuate with production, fixed
costs do not change in the short term. There are various kinds of fixed cost. For
example:

i. Manufacturing Fixed Costs

 Factory Rent – Lease payments for factory space.

 Depreciation – Gradual reduction in the value of machinery and equipment.
 Insurance – Premiums for property, machinery, and employee coverage.
 Salaries of Permanent Staff – Payments to managers and administrative personnel.

ii. Administrative Fixed Costs

 Office Rent – Cost of corporate office space.

 Legal and Accounting Fees – Payments for professional services.
 Software Subscriptions – Fixed charges for business software.

iii. Selling and Distribution Fixed Costs

 Advertising Contracts – Long-term agreements for promotions.

 Salaries of Sales Managers – Fixed wages for sales supervisors.
 B. Variable Cost – Variable costs are expenses that change directly in proportion to the
level of production or sales. Unlike fixed costs, which remain constant, variable costs
increase as production rises and decrease when production falls.

Examples of Variable Costs

i. Manufacturing Variable Costs

 Raw Materials – Steel for cars, flour for bread, cotton for textiles.
 Direct Labor – Wages paid to factory workers based on output.
 Electricity for Machines – Power consumption per unit produced.
 Fuel Costs – Used for operating machinery and transportation.

ii. Selling & Distribution Variable Costs

 Sales Commissions – Payments to sales agents based on sales volume.

 Packaging Costs – Boxes, wrapping, and labels for products.
 Shipping & Delivery – Freight charges per unit sold.

iii. Administrative Variable Costs

 Office Supplies – Paper, ink, and other consumables used as needed.

 Transaction Fees – Costs incurred per financial transaction

Semi-Variable Cost – Semi-variable costs (also called semi-fixed or mixed costs) are
expenses that have both fixed and variable components. These costs remain partially
constant but also change with production volume.

Key Characteristics of Semi-Variable Costs

✅ Has a fixed component – A base cost that remains constant regardless of production.
✅ Has a variable component – An additional cost that fluctuates with production levels.
✅ Partially controllable – Fixed portion is unavoidable, but variable portion can be
managed.

Examples of semi variable cost:

Examples of Semi-Variable Costs

i. Manufacturing Semi-Variable Costs

 Electricity Bill – Fixed charge + variable charge based on usage.

 Machine Maintenance – Regular servicing (fixed) + additional repairs (variable).
 Supervisor Salary – Basic salary (fixed) + overtime pay (variable).

ii. Selling & Distribution Semi-Variable Costs

 Telephone Bill – Fixed rental + extra charges based on usage.

 Vehicle Expenses – Monthly lease payment (fixed) + fuel costs (variable).
  Salesperson Salary – Basic pay (fixed) + sales commission (variable).

iii. Administrative Semi-Variable Costs

 Internet Charges – Fixed monthly fee + extra charge for additional data.
 Office Maintenance – Routine cleaning (fixed) + special repairs (variable).

3. Based on Function

 Production Cost – Costs incurred in manufacturing goods.

 Administrative Cost – Expenses related to management and office operations.
 Selling and Distribution Cost – Costs related to marketing, sales, and distribution of
products.

4. Based on Controllability

 Controllable Cost – Costs that management can regulate (e.g., raw material usage).
 Uncontrollable Cost – Costs that are beyond direct control (e.g., government taxes,
inflation).

5. Based on Decision-Making Purpose

 Opportunity Cost – The cost of forgoing the next best alternative.

 Sunk Cost – Costs already incurred and cannot be recovered.
 Marginal Cost – Additional cost incurred for producing one extra unit.
 Replacement Cost – The cost of replacing an asset at current market prices.

6. Based on Time Period

 Historical Cost – Actual costs incurred in the past.

 Standard Cost – Pre-determined cost used for cost control and variance analysis.

7. Based on Process Flow

 Direct Cost – Costs that can be directly attributed to a product or process (e.g., direct
materials, direct labour).
 Indirect Cost – Costs that are spread across multiple products or services (e.g., factory
rent, administrative salaries).

ELEMENTS OF COST IN THE CONTEXT OF INDUSTRIAL MANAGEMENT

In industrial management, cost is broadly classified into different elements to help businesses
understand, analyze, and control expenses efficiently. The three main elements of cost are:

1. Material Cost
2. Labour Cost
3. Overhead Cost

These elements collectively represent the total cost incurred in manufacturing a product or
providing a service. Let’s examine each element in detail.
1. Material Cost

Definition

Material cost refers to the cost of raw materials and components used in the production process.
It includes both direct materials and indirect materials.

Types of Material Cost

 Direct Material Cost:

o Cost of raw materials that can be directly traced to the finished product.
o Example: Steel used in automobile manufacturing, flour used in baking.
 Indirect Material Cost:
o Cost of materials that support production but are not directly part of the finished
product.
o Example: Lubricants for machines, office stationery.

Significance in Industrial Management

 Helps in cost estimation and pricing.

 Directly affects the quality of the final product.
 Requires proper inventory management to minimize wastage.

2. Labor Cost

Definition

Labor cost refers to the wages and salaries paid to employees involved in production and other
business operations. It includes direct labor and indirect labor costs.

Types of Labor Cost

 Direct Labor Cost:

o Wages paid to workers directly involved in manufacturing.
o Example: A welder in a car factory, a tailor in a garment factory.
 Indirect Labor Cost:
o Salaries of employees who support production but do not directly manufacture
the product.
o Example: Supervisors, maintenance workers, security personnel.

Significance in Industrial Management

 Impacts production efficiency and overall cost structure.

 Requires workforce planning and productivity monitoring.
 Proper wage policies help retain skilled workers and enhance productivity.

3. Overhead Cost

Definition
Overhead cost includes all indirect expenses incurred in the production process but not directly
linked to material or labor. It is further divided into three categories: factory overheads,
administrative overheads, and selling & distribution overheads.

Types of Overhead Costs

 Factory Overhead (Manufacturing Overhead)

o Costs incurred in running the production facility.
o Example: Machine depreciation, electricity, rent of factory buildings.
 Administrative Overhead
o Expenses related to business administration and management.
o Example: Office rent, salaries of managerial staff, telephone expenses.
 Selling & Distribution Overhead
o Costs associated with marketing, sales, and delivery of products.
o Example: Advertising costs, transportation expenses, commission to sales
agents.

Significance in Industrial Management

 Overhead costs affect pricing and profitability.

 Effective cost control reduces unnecessary expenditures.
 Proper budgeting helps allocate overhead costs efficiently.

BREAK EVEN ANALYSIS

This activity refers to a system of determination of that level of activity where total cost equals
total selling price. It portrays the relationship between cost of production, volume of production
an sales value.

In other words, Break-even Point (B.E.P) is the level of sales that equals all the expenses
required for generating that revenue. It is not more than the expenses nor it is less than the
expenses.

So, at B.E.P.,

Total Revenue = Total Expenses

i.e. (Quantity sold x Unit Price) = (Quantity Sold x Unit Cost) + Fixed Expenses

or Quantity Sold x (Unit Price – Unit Cost) = Fixed Expenses

or Quantity Sold x Gross Profit Per Unit = Fixed Expenses

Example:
The following information relates to a company selling a single product
Direct labour cost per unit Rs 22
Direct materials cost per unit Rs 12
Variable overheads per unit Rs 6
 Fixed cost Rs 400000
Selling price per unit Rs 60

Use the figures above to show that minimum number of units that must be sold for the
company to break even.
Soln: Variable cost per unit = Direct labour cost + Direct material cost per unit + Variable
overheads per unit
= 22 + 12 + 6
= Rs 40 per unit
Selling price = Rs 60, (given)
Thus, Grosss margin per unit = Fixed Overheads/ Gross margin per unit
BEP in units = 400000/20
= 20000 units
BEP in Rupees = B.E.P in units x Unit Price
= 20000 X 60
= Rs 120000
IMPORTANT FORMULAS
 Unit Price = Total Revenue / Unit of Sales
 Unit of sales = Total Revenue / Unit of sales
OR
Total Cost of Goods sold / Unit Cost

 Unit Cost = Total Cost of Goods sold / Unit of sales

 Total Revenue = Unit Price x Unit of sales or Quantity sold
 Gross Profit per unit or Contribution Per unit = Unit Price – Unit cost
 Fixed expenses = Unit of sales x (Unit Price – Unit Cost)
OR
Unit of sales x Gross Margin per unit
 B.E.P in units = Fixed Cost / Gross Margin per unit
 B.E.P in rupees = B.E.P in units x Unit Price

QUESTIONS FOR PRACTICE:

1. Mohan who manufactures a toy car using non toxic components, wants to compute his
break even point. His fixed expense in the form of rent, depreciation and salaries of
 administrative staff amount to Rs 25000 per month. He sells the car for Rs 200 and his
variable cost per car is Rs 150. Find his B.E.P.
2. A company makes a product with a selling price of Rs 20 per unit and variable cost of
Rs 12 per unit. The BEP is 5000 units. Find the Fixed Cost.