UNIT-II

Forms of business organization:

A business organization usually takes the following forms in India:

(1) Sole proprietorship

(2) Partnership

(3) Joint Stock Company

SOLE PROPRIETORSHIP

Sole Proprietorship’ from of business organisation refers to a business enterprise exclusively owned, managed and controlled by a single person with all authority, responsibility and risk

CHARACTERISTICS OF SOLE PROPRIETORSHIP FORM OF BUSINESS ORGANISATION

(a) Single Ownership: The sole proprietorship form of business organisation has a single owner who himself/herself starts the business by bringing together all the resources.

(b) No Separation of Ownership and Management: The owner himself/herself manages the business as per his/her own skill and intelligence. There is no separation of ownership and management as is the case with company form of business organisation.

(c) Less Legal Formalities: The formation and operation of a sole proprietorship form of business organisation does not involve any legal formalities. Thus, its formation is quite easy and simple.

(d) No Separate Entity: The business unit does not have an entity separate from the owner. The businessman and the business enterprise are one and the same, and the businessman is responsible for everything that happens in his business unit.

(e) No Sharing of Profit and Loss: The sole proprietor enjoys the profits alone. At the same time, the entire loss is also borne by him. No other person is there to share the profits and losses of the business. He alone bears the risks and reaps the profits.

(f) Unlimited Liability: The liability of the sole proprietor is unlimited. In case of loss, if his business assets are not enough to pay the business liabilities, his personal property can also be utilised to pay off the liabilities of the business.

(g) One-man Control: The controlling power of the sole proprietorship business always remains with the owner. He/she runs the business as per his/her own will.

MERITS OF SOLE PROPRIETORSHIP FORM OF BUSINESS ORGANISATION

(a) Easy to Form and Wind Up: It is very easy and simple to form a sole proprietorshipform of business organisation. No legal formalities are required to be observed. Similarly,the business can be wind up any time if the proprietor so decides.

(b) Quick Decision and Prompt Action: As stated earlier, nobody interferes in theaffairs of the sole proprietary organisation. So he/she can take quick decisions on thevarious issues relating to business and accordingly prompt action can be taken.

(c) Direct Motivation: In sole proprietorship form of business organisations. The entireprofit of the business goes to the owner. This motivates the proprietor to work hardand run the business efficiently.

(d) Flexibility in Operation: It is very easy to effect changes as per the requirements ofthe business. The expansion or curtailment of business activities does not require manyformalities as in the case of other forms of business organisation.

(e) Maintenance of Business Secrets: The business secrets are known only to theproprietor. He is not required to disclose any information to others unless and until hehimself so decides. He is also not bound to publish his business accounts.

(f) Personal Touch: Since the proprietor himself handles everything relating to business,it is easy to maintain a good personal contact with the customers and employees. Byknowing the likes, dislikes and tastes of the customers, the proprietor can adjust his operations accordingly. Similarly, as the employees are few and work directly underthe proprietor, it helps in maintaining a harmonious relationship with them, and run thebusiness smoothly.

LIMITATIONS OF SOLE PROPRIETORSHIP FORM OF BUSINESSORGANISATION

(a) Limited Resources: The resources of a sole proprietor are always limited. Beingthe single owner it is not always possible to arrange sufficient funds from his ownsources. Again borrowing funds from friends and relatives or from banks has its ownimplications. So, the proprietor has a limited capacity to raise funds for his business.

(b) Lack of Continuity: The continuity of the business is linked with the life of theproprietor. Illness, death or insolvency of the proprietor can lead to closure of thebusiness. Thus, the continuity of business is uncertain.

(c) Unlimited Liability: You have already learnt that there is no separate entity of thebusiness from its owner. In the eyes of law the proprietor and the business are one andthe same. So personal properties of the owner can also be used to meet the businessobligations and debts.

(d) Not Suitable for Large Scale Operations : Since the resources and the managerialability is limited, sole proprietorship form of business organisation is not suitable forlarge-scale business.

(e) Limited Managerial Expertise: A sole proprietorship from of business organization always suffers from lack of managerial expertise. A single person may not be an expertin all fields like, purchasing, selling, financing etc. Again, because of limited financialresources, and the size of the business it is also not possible to engage the professionalmanagers in sole proprietorship form of business organisations.

PARTNERSHIP

‘Partnership’ is an association of two or more persons who pool their financial and managerialresources and agree to carry on a business, and share its profit. The persons who form apartnership are individually known as partners and collectively a firm or partnershipfirm.

CHARACTERISTICS OF PARTNERSHIP FORM OF BUSINESSORGANISATION

(a) Two or More Persons: To form a partnership firm atleast two persons are required.The maximum limit on the number of persons is ten for banking business and 20 forother businesses. If the number exceeds the above limit, the partnership becomesillegal and the relationship among them cannot be called partnership.

(b) Contractual Relationship: Partnership is created by an agreement among the personswho have agreed to join hands. Such persons must be competent to contract. Thus,minors, lunatics and insolvent persons are not eligible to become the partners. However,a minor can be admitted to the benefits of partnership firm i.e., he can have share in theprofits without any obligation for losses.

(c) Sharing Profits and Business: There must be an agreement among the partners toshare the profits and losses of the business of the partnership firm. If two or morepersons share the income of jointly owned property, it is not regarded as partnership.

(d) Existence of Lawful Business: The business of which the persons have agreed toshare the profit must be lawful. Any agreement to indulge in smuggling, black marketingetc. cannot be called partnership business in the eyes of law.

(e) Principal Agent Relationship: There must be an agency relationship between thepartners. Every partner is the principal as well as the agent of the firm. When a partnerdeals with other parties he/she acts as an agent of other partners, and at the same timethe other partners become the principal.

(f) Unlimited Liability: The partners of the firm have unlimited liability. They are jointlyas well as individually liable for the debts and obligations of the firms. If the assets ofthe firm are insufficient to meet the firm’s liabilities, the personal properties of thepartners can also be utilised for this purpose. However, the liability of a minor partneris limited to the extent of his share in the profits.

(g) Voluntary Registration: The registration of partnership firm is not compulsory. Butan unregistered firm suffers from some limitations which makes it virtually compulsoryto be registered. Following are the limitations of an unregistered firm.

(i) The firm cannot sue outsiders, although the outsiders can sue it.

(ii) In case of any dispute among the partners, it is not possible to settle the disputethrough court of law.

(iii) The firm cannot claim adjustments for amount payable to, or receivable from, anyother parties.

MERITS OF PARTNERSHIP FORM OF BUSINESS ORGANISATION

(a) Easy to Form: A partnership can be formed easily without many legal formalities.Since it is not compulsory to get the firm registered, a simple agreement, either in oral,writing or implied is sufficient to create a partnership firm.

(b) Availability of Larger Resources: Since two or more partners join hands to startpartnership firm it may be possible to pool more resources as compared to soleproprietorship form of business organisation.

(c) Better Decisions: In partnership firm each partner has a right to take part in themanagement of the business. All major decisions are taken in consultation with andwith the consent of all partners. Thus, collective wisdom prevails and there is lessscope for reckless and hasty decisions.

(d) Flexibility: The partnership firm is a flexible organisation. At any time the partnerscan decide to change the size or nature of business or area of its operation after takingthe necessary consent of all the partners.

(e) Sharing of Risks: The losses of the firm are shared by all the partners equally or asper the agreed ratio.

(f) Keen Interest: Since partners share the profit and bear the losses, they take keeninterest in the affairs of the business.

(g) Benefits of Specialisation: All partners actively participate in the business as pertheir specialisation and knowledge. In a partnership firm providing legal consultancyto people, one partner may deal with civil cases, one in criminal cases, another inlabour cases and so on as per their area of specialisation. Similarly two or moredoctors of different specialisation may start a clinic in partnership.

(h) Protection of Interest: In partnership form of business organisation, the rights ofeach partner and his/her interests are fully protected. If a partner is dissatisfied withany decision, he can ask for dissolution of the firm or can withdraw from the partnership.

(i) Secrecy: Business secrets of the firm are only known to the partners. It is not requiredto disclose any information to the outsiders. It is also not mandatory to publish theannual accounts of the firm

LIMITATIONS OF PARTNERSHIP FORM OF BUSINESS ORGANISATION

A partnership firm also suffers from certain limitations. These are as follows:

(a) Unlimited Liability: The most important drawback of partnership firm is that theliability of the partners is unlimited i.e., the partners are personally liable for the debtand obligations of the firm. In other words, their personal property can also be utilized for payment of firm’s liabilities.

(b) Instability: Every partnership firm has uncertain life. The death, insolvency, incapacityor the retirement of any partner brings the firm to an end. Not only that any dissentingpartner can give notice at any time for dissolution of partnership.

(c) Limited Capital: Since the total number of partners cannot exceed 20, the capacityto raise funds remains limited as compared to a joint stock company where there is nolimit on the number of share holders.

(d) Non-transferability of share: The share of interest of any partner cannot betransferred to other partners or to the outsiders. So it creates inconvenience for thepartner who wants to transfer his share to others fully and partly. The only alternativeis dissolution of the firm.

(e) Possibility of Conflicts: You know that in partnership firm every partner has anequal right to participate in the management. Also every partner can place his or heropinion or viewpoint before the management regarding any matter at any time. Becauseof this, sometimes there is friction and quarrel among the partners. Difference of opinionmay give rise to quarrels and lead to dissolution of the firm.

TYPES OF PARTNERS

(i) Active Partners (ii) Sleeping Partners (iii) Nominal Partners (iv) MinorPartners(v) Limited Partners (vi) General Partners (vii) Secret partners.

FORMATION OF PARTNERSHIP FORM OF BUSINESS ORGANISATION

The following steps are to be taken in order to form a partnership firm:

(a) Minimum two members are required to form a partnership. The maximum limit is tenin banking and 20 in other businesses.

(b) Select the like-minded persons keeping in view the nature and objectives of thebusiness.

(c) There must be an agreement among the partners to carry on the business and sharethe profits and losses. This agreement must preferably be in writing and duly signed bythe all the partners. The agreement, i.e., the partnership deed must contain the following:

The following steps are to be taken in order to form a partnership firm:

(a) Minimum two members are required to form a partnership. The maximum limit is tenin banking and 20 in other businesses.

(b) Select the like-minded persons keeping in view the nature and objectives of thebusiness.

(iii) The filled in form along with prescribed registration fee must be deposited in theoffice of the Registrar of Firms.

(iv) The Registrar will scrutinise the application, and if he is satisfied that all formalitiesrelating to registration have been duly complied with, he will put the name of thefirm in his register and issue the Certificate of Registration.

(c) There must be an agreement among the partners to carry on the business and sharethe profits and losses. This agreement must preferably be in writing and duly signed bythe all the partners.

Private Limited Companies

Private Limited Companies have separate legal identities to their owners, and thus their owners have limited

liability. The company has continuity, and can sell shares to friends or family, although with the consent of all

shareholders. This business can now make legal contracts. Abbreviated as Ltd (UK), or Proprietary Limited,

(Pty) Ltd.

Pros: The sale of shares make raising finance a lot easier.

Shareholders have limited liability, therefore it is safer for people to invest but creditors must be cautious because if the business fails they will not get their money back.

Original owners are still able to keep control of the business by restricting share distribution.

Cons:

 Owners need to deal with many legal formalities before forming a private limited company:

o The Articles of Association: This contains the rules on how the company will be managed. It states the rights

and duties of directors, the rules on the election of directors and holding an official meeting, as well as the

issuing of shares.

o The Memorandum of Association: This contains very important information about the company and directors.

The official name and addresses of the registered offices of the company must be stated. The objectives of the

company must be given and also the amount of share capital the owners intend to raise. The number of shares

to be bought b each of the directors must also be made clear.

Public Limited Companies

Public limited companies are similar to private limited companies, but they are able to sell shares to the public.

A private limited company can be converted into a public limited company by:

1. A statement in the Memorandum of Association must be made so that it says this company is

a public limited company.

2. All accounts must be made public.

3. The company has to apply for a listing in the Stock Exchange.

A prospectus must be issued to advertise to customers to buy shares, and it has to state how the capital raised

from shares will be spent.

Pros: Limited liability.

Continuity.

Potential to raise limitless capital.

No restrictions on transfer of shares.

High status will attract investors and customers.

Cons:

Many legal formalities required to form the business.

Many rules and regulations to protect shareholders, including the publishing of annual accounts.

Selling shares is expensive, because of the commission paid to banks to aid in selling shares and costs of printing the prospectus.

Difficult to control since it is so large.

Owners lose control, when the original owners hold less than 51% of shares.

Control and ownership in a public limited company:

The Annual General Meeting (AGM) is held every year and all shareholders are invited to attend so that they

can elect their Board of Directors. Normally, Director are majority shareholders who has the power to do

whatever they want. However, this is not the case for public limited companies since there can be millions of

shareholders. Anyway, when directors are elected, they have to power to make important decisions. However,

they must hire managers to attend to day to day decisions. Therefore: Shareholders own the company

Directors and managers control the company

This is called the divorce between ownership and control.

Because shareholders invested in the company, they expect dividends. The directors could do things other than

give shareholders dividends, such as trying to expand the company. However, they might loose their status in

the next AGM if shareholders are not happy with what they are doing. All in all, both directors and

shareholders have their own objectives.

I N T R O D U C T I O N T O B R E A K - E V E N A N A LY S I S

Introduction

Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).

Total variable and fixed costs are compared with sales revenue in order to determine the  level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").

The Break-Even Chart

In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:

In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.

Fixed Costs

Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.

Examplesoffixedcosts:Rent,rates,Depreciation

Variable Costs

Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.

A distinction is often made between "Direct" variable costs and "Indirect" variable costs.

Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples.

Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.

Semi-Variable Costs

Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when

output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.

Cost concepts

COST: MEANING AND ITS ELEMENTSThe term ‘cost’ means the amount of expenses [actual or notional] incurred on or attributable to specified thing or activity. As per Institute of cost and work accounts (ICWA) India, Cost is ‘measurement in monetary terms of the amount of resources used for the purpose of production of goods or rendering services. Elements of costCost of production/manufacturing consists of various expenses incurred on production/manufacturing of goods or services. These are the elements of cost which can be divided into three groups: Material, Labour and Expenses.

MaterialTo produce or manufacture material is required. For example to manufacture shirts cloth is required and to produce flour wheat is required. All material which becomes an integral part of finished product and which can be conveniently assigned to specific physical unit is termed as “Direct Material”. It is also described as raw material, process material, prime material, production material, stores material, etc. The substance from which the product is made is known as material. It may be in a raw or manufactured state. Material is classified into two categories:Direct Material Indirect Material

Direct materialDirect Material is that material which can be easily identified and related with specific product, job, and process. Timber is a raw material for making furniture, cloth for making garments, sugarcane for making sugar, and Gold/ silver for making jewellery, etc are some examples of direct material.

Indirect materialIndirect Material is that material which cannot be easily and conveniently identified and related with a particular product, job, process, and activity. Consumable stores, oil and waste, printing and stationery etc, are some examples of indirect material. Indirect materials are used in the factory, the office, or the selling and distribution department.

LabourLabour is the main factor of production. For conversion of raw material into finished goods, human resource is needed, and such human resource is termed as labour. Labour cost is the main element of cost in a product or service. Labour can be classified into two categories:Direct Labour, andIndirect labour

Direct labourLabour which takes active and direct part in the production of a commodity. Direct labour is that labour which can be easily identified and related with specific product, job, process, and activity. Direct labour cost is easily traceable to specific products. Direct labour costs are specially and conveniently traceable to specific products. Direct labour varies directly with the volume of output. Direct labour is also known as process labour, productive labour, operating labour, direct wages, manufacturing wages, etc. Cost of wages paid to carpenter for making furniture, cost of a tailor in producing readymade garments, cost of washer in dry cleaning unit are some examples of direct labour.

Indirect labourIndirect labour is that labour which can not be easily identified and related with specific product, job, process, and activity. It includes all labour not directly engaged in converting raw material into finished product. It may or may not vary directly with the volume of output. Labour employed for the purpose of carrying out tasks incidental to goods or services provided is indirect labour. Indirect labour is used in the factory, the office, or the selling and distribution department. Wages of store-keepers, time-keepers, salary of works manager, salary of salesmen, etc, are all examples of indirect labour cost.

ExpensesAll cost incurred in the production of finished goods other than material cost and labour cost are termed as expenses. Expenses are classified into two categories:Direct expenses, andIndirect expenses (An item of overheads)

Direct expensesThese are expenses which are directly, easily, and wholly allocated to specific cost center or cost units. All direct cost other than direct material and direct labour are termed as direct expenses. Direct expenses are also termed as chargeable expenses. Some examples of the direct expenses are hire of special machinery, cost of special designs, moulds or patterns, feed paid to architects, surveyors and other consultants, inward carriage and freight charges on special material, Cost of patents and royalties.1. Cost center means a location, person, or item of equipment or group of these for which costs may be ascertained and used for the purpose of cost control.2. Cost object is anything for which a separate measurement of cost is desired. It may be a product, service, project, or a customer.

Indirect expensesThese expenses cannot be directly, easily, and wholly allocated to specific cost center or cost units. All indirect costs other than indirect material and indirect labour are termed as indirect expenses.

Thus, Indirect Expenses = Indirect cost – Indirect material – Indirect labour.Indirect expenses are treated as part of overheads. Rent, rates and taxes of building, repair, insurance and depreciation on fixed assets, etc, are some examples of indirect expenses.

OVERHEADS: MEANING

The term overhead has a wider meaning than the term indirect expenses. Overheads include the cost of indirect material, indirect labour and indirect expenses. This is the aggregate sum of indirect material, indirect labour and indirect expenses.

Overhead = Indirect material + Indirect labour + Indirect expensesOverheads are classified into following three categories:

(i) Factory/works/ production overheads

(ii) Office and administrative overheads(iii) Selling and distribution overheads

Factory/works overheadsAll indirect costs incurred in the factory for production of goods is termed as factory/works overheads. Such costs are concerned with the running of the factory or plant. These include indirect material, indirect labour and indirect expenses incurred in the factory. Some examples are as follows:

Indirect materials:(i) Grease, oil, lubricants, cotton waste etc.(ii) Small tools, brushes for sweeping, sundry supplies etc.(iii) Cost of threads, gum, nails, etc.(iv) Consumable stores(v) Factory printing and stationery

Indirect wages(i) Salary of factory manager, foremen, supervisors, clerks etc.(ii) Salary of storekeeper(iii) Salary and fee of factory directors and technical directors(iv) Contribution to ESI, PF., Leave pay etc. of factory employee.

Indirect expenses

(i) Rent of factory buildings and land(ii) Insurance of factory building, plant, and machinery

(iii) Municipal taxes of factory building

(iv)Depreciation of factory building, plant and machinery, and their repairs and maintenance charges

(v) Power and fuel used in factory

(vi)Factory telephone expenses.

Office and administrative overheadsThese expenses are related to the management and administration of the business. They are incurred for the direction and control of an undertaking. These represent the aggregate of the cost of indirect material, indirect labour, and indirect expenses incurred by the office and administration department of an organisation. Some examples are as follows:Office printing and stationery, Cost of brushes, dusters etc. for cleaning office building and equipments, Postage and stamps. Salary of office manager, clerks, and other employees, Salary of administrative directors, Salaries of legal adviser, Salaries of cost accountants and financialaccountants, Salary of computer operator. Rent, insurance, rates and taxes of office building, Office lighting, heating and cleaning, Depreciation and repair of office building, furniture, and Equipment etc., Legal charges, Bank charges, Trade subscriptions, Telephone charges, Audit fee etc.

Selling and distribution overheadsSelling and distribution overheads are incurred for the marketing of a commodity, for securing order for the articles, dispatching goods sold or for making efforts to find and retain customers. These expenses represent the aggregate of indirect material, indirect labour, and indirect

expenses incurred by the selling and distribution department of the organisation. These overheads have two aspects (i) procuring orders (ii) executing the order. Based upon this concept the selling and distributions are studied separately.

I. Selling overheadsIndirect costs incurred in relation to the procurement of sale orders are termed as selling overheads. Some of the examples of selling overheads are as follows:

Indirect material(i) Catalogues, price list (ii) Printing and stationery(iii) Postage and stamps (iv) cost of sample

Indirect wages(i) Salaries of sales managers, clerks and other employees(ii) Salaries and commission of salesmen and technical representatives(iii) Fees of sales directors

Indirect expenses(i) Advertising(ii) Bad debts(iii) Rent and insurance of showroom(iv) Legal charges incurred for recovery of debts(v) Travelling and entertainment expenses(vi) Expenses of sending samples(vii) Market research expenses.

II. Distribution overheadsIndirect costs incurred in relation to the execution of the sales order is termed as distribution overheads. Some of the examples of distribution overheads are as follows:

Indirect material(i) Cost of packing material(ii) oil, grease, spare parts etc. for maintaining delivery vans

Indirect wages(i) Salaries of godown employees(ii) Wages of drivers of delivery vans(iii) Wages of packers and dispatch staff.

Indirect expenses(i) Packing expenses(ii) Godown rent, insurance, depreciation, and repair etc.(iii) Freight carriage outwards and other transport charges.(iv) Running expenses of delivery vans, repair, and depreciation. (v) Insurance in transit etc.

CLASSIFICATION OF COSTCosts are classified into following categories:1. Cost behavior basis(a) Fixed Cost(b) Variable cost(c) Semi-variable cost

2. Cost inventory basis(a) Product cost and(b) Period cost

3. Cost Relation to Cost Centre basis(a) Direct and(b) Indirect costs4. Cost Classifications for Decision-Making(a) Differential cost(b) Opportunity cost(c) Sunk cost 1. Cost behavior basis(a) Fixed CostA cost that remains constant within a given period of time and range of activity in spite of fluctuations in production. Per unit fixed cost varies with the change in the volume of production. If the production increases, fixed cost per unit decreases and as there is decrease in production, the fixed cost per unit increases. Rent and insurance of building, depreciation on plant and machinery, salary of employees etc., are some examples of fixed costs.

(b) Variable costVariable costs are those cost which vary directly in proportion to change in volume of production/output. The cost which increases or decreases in the same proportion in which the units produced is termed as variable cost. Direct material, direct labour, direct expenses, variable overheads are some examples of variable cost.

(c) Semi-variable costA cost contains both fixed and variable component and which is thus partly affected by fluctuations in the level of activity. Semi-variable costs is that cost of which some part remains fixed at the given level of production and other part varies with the change in the volume of production but not in the same proportion of change in production

2. Costs by inventory:Product cost and period costProduct costs are those cost which are charged and identified with the product and included in stock value. In other words, the costs that are the cost of manufacturing a product are called product cost. Product cost includes direct material, direct labour, direct expenses, and manufacturing overheads. Period costs are those costs which are not charged to products but are written off as expenses against revenue of the period during which these are incurred. They are not transferred as a part of value of stock to the next accounting year. They are charged against the revenue of the relevant period. Period costs include all fixed costs and total administration, selling and distribution costs.

3. Cost Relation to Cost Centre: Direct and Indirect costsAll costs are subdivided into direct and indirect costs. The concept of direct and indirect cost is of basic importance in costing. Costs which are easily and directly allocated to products or units are termed as direct cost. Direct costs include all traceable costs. In the process of manufacturing of a product, materials are purchased, wages are paid to labour, and certain other expenses are also incurred directly. All these expenses are called as direct costs. The expenses incurred on those items which are not directly charged to a single product because they are incurred for many products are termed as indirect Costs. The example of indirect costs are Oil and scrap materials,

[indirect materials], salary of factory supervisors [indirect labour],rent rates and depreciation [indirect expenses]. Indirect costs, often referred to as overheads have to be apportioned to different products on suitable criterion/criteria.

4. Cost Classifications for Decision-Making. Every decision involves choosing from among at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in making the selection. This concept is explored in greater detail in the chapter on relevant costs. However, decision-making contexts crop up from time to time in the text before that chapter, so it is a good idea to familiarize students with relevant cost concepts.

1. Differential Costs. A differential cost is a cost that differs between alternatives. The cost may exist in only one of the alternatives or the total amount of the cost may differ between the alternatives. In the latter case, the differential cost would be the difference between the cost under one alternative and the cost under the other. Differential costs are also called incremental costs. Differential costs and opportunity costs should be the focus of decision-making. They are the only relevant costs and all others should be ignored.

2. Opportunity Costs. An opportunity cost is the potential benefit that is given up by selecting one alternative over another. The concept of an opportunity cost is rather difficult for students to understand because it is not an actual expenditure and it is rarely (if ever) shown on the accounting books of an organization. It is, however, a cost that must be considered in decisions.

3. Sunk Cost. A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed and therefore cannot be differential costs, they should be ignored in decision making. While students usually accept the idea that sunk costs should be ignored on an abstract level, like most people they often have difficulty putting this idea into practice.