Before exploring the two bodies of knowledge, the current status in literature of cost classification will be explored. It follows the principle that acquired assets and services are recorded at their actual costs (Horngren, Harrison, & Oliver, 2012). The comprehensive understanding of the concepts presented in this section provides the necessary foundation for the rest of the dissertation. An accounting information system consists of two major subsystems (Hansen & Mowen, 2006): (1) the financial accounting information system and (2) the cost management system. The first one is primarily concerned with producing outputs for external users (e.g. auditors, business partners, shareholders, tax authorities). The second one is primarily concerned with producing outputs for internal users utilizing it as inputs for the processes to reach management objectives. The dissertation used the first system for the income statement analyses, the second for qualitative interviews. It is worthwhile to mention that the two systems are not independent of each other. On the contrary, they utilize the same records from the databases and are integrated within the same ERP system. It depends solely on the purpose of the data: either external/official reporting or internal/tactical decision making.
Additionally, the strategic/tactical direction of the enterprise dictates the setup of the classification of costs (Heimerl & Tschandl, 2014). This direction shifts the focus to the elements that need proper monitoring in order to fulfill the enterprise’s objectives. The cost management system helps to perform carefully crafted make-or-buy decisions, although with the pre-condition that the right granularity-level of cost elements is available. This means that if a product or a service is made by the enterprise, the needed structure for monitoring costs looks different compared to the scenario in which the product/service is bought from outside the enterprise. From an overhead costs point of view, the total cost classification is the proper
starting point as it captures the entire costs. The classification helps to identify the cost items which are directly linked to the activity level; and it determines the cost items with no direct link to the activity level, referred to as indirect costs or overhead costs.
The classification of the used cost elements is depicted below:
Figure 4: Classification of costs Source: Own depiction
Figure 4 explains the structure of total costs, which consist of direct costs and indirect costs. Direct costs are inseparably linked with the cost object (i.e. products, customers, departments, projects, or activities). They comprise of variable and fixed costs. Direct variable costs fluctuate corresponding to the level of activity; the variability is proportional to production. Direct fixed costs remain constant irrespective of changes in the level of activity.
Overhead lumps all costs other than direct material and direct labor into one category called indirect costs. Again, there is a differentiation between variable and fixed costs. Indirect variable costs rise and fall corresponding to the level of activity but are not directly linked to the cost object. Indirect fixed costs occur regardless of the activity level. The adjustment of overhead is a mid- to long-term effort, which means it takes more than one year to see noticeable change. (Hansen & Mowen, 2015; ICAI, 2012).
Overhead costs are indirect costs and are needed expenses for operating a business (i.e.
costs not directly related to the sellable cost object – in a broader sense, the manufactured product or the delivered service and not variable during the period of one year) that range from
rent to administrative costs to marketing costs. Overhead costs refer to all indirect non-labor expenses required to operate the business.
Figure 5: Concepts of prime costs and conversion costs Source: Own depiction
Figure 5 groups elements of direct and indirect costs into prime costs, overhead, and conversion costs. Prime costs add up by direct material and direct labor. Both can immediately be assigned to the cost object being sold. Overhead consists of indirect materials, indirect labor and any other fixed & variable overhead; it requires driver-tracing or allocation to assign the overhead to the cost object. Conversion costs consist of direct labor and overhead costs; for a manufacturing firm, it can be interpreted as the cost of converting raw material into a final product (Hansen & Mowen, 2015; Horngren, Datar, & Rajan, 2015).
The product cost calculated in accordance with the Generally Accepted Accounting Principles (GAAP) are needed to evaluate the inventories of the different states of the products (i.e. raw, WIP, finish goods; MRO supplies) for the balance sheet; and to calculate the cost of goods sold on the income statement.
Table 1: Summary of different types of costs
Cost types Meaning/relevance for the dissertation Source
Conversion costs It is the sum of direct labor and overhead costs. Cornerstones of Cost Management (Hansen &
Mowen, 2015)
Opportunity costs The profit missed by choosing one alternative instead of another; the net return that could be earned if a resource were brought to its best alternative usage.
Business Research (Günther, 2014)
Overhead All costs other than direct materials and direct labor are lumped into one category called overhead.
Cost and Management Accounting (ICAI, 2012)
Prime costs It is the sum of direct material costs and direct labor costs.
A differential cost for a particular decision that changes if an alternative decision is chosen.
Cost and Management Accounting (ICAI, 2012)
Sunk costs Already incurred costs; sunk costs are irrelevant for all decisions, because they cannot be changed.
Effektives
Gemein-kostenmanagement (Gleich &
Marfleet, 2013)
Sources: see table, third column
Table 1 concludes the different types of costs in context to the dissertation. This insight influenced and inspired the elaborated design of the conceptual framework in Chapter 2.6.
Overhead costs is an imprecise term with respect to meaning and clarity, which will become apparent during the analysis of the income statements of the involved companies in Chapter 4.7. In the next section, the evolution of overhead costs management is examined for the research topic.