COST CONCEPT AND

CLASSIFICATION
COST IS ” A FOREGOING, MEASURED
IN MONETARY TERMS, INCURRED OR
POTENTIALLY TO BE INCURRED TO
ACHIEVE A SPECIFIC OBJECTIVE”
(AMERICAN ACCOUNTING ASSOCIATION)
COST REFERS THE MONETARY MEASURE OF
THE AMOUNT OF RESOURCES GIVEN UP OR
USED FOR SOME SPECIFIC PURPOSE. IT IS
THE VALUE THE GOODS OR SERVICES
EXPENDED TO OBTAIN CURRENT OR FUTURE
BENEFITS.
 TYPES OF COST: COST CLASSIFICATION
• Costs can be classified into different categories for
different purposes. Costs may be categorized
according to their management function,
traceability, timing of charge against revenues,
behavior, and relevance to decision making.
1. COSTS CLASSIFIED AS TO
RELATION TO A PRODUCT
A. MANUFACTURING COSTS/ PRODUCT
COSTS
 DIRECT MATERIALS
• means the materials which from part of
finished output and can be identified with
the finished product easily. The costs of these
materials are direct costs.
 DIRECT LABOR
• Labor services are, in essence, purchased from
employees working in the factory. Direct labor
coats include all labor costs for specific work
performed on products that can be economically
and conviently traced to end products.
 PRIME
COST

Direct Direct Labor Factory

Materials Overhead

CONVERSION
COST
 FACTORY OVERHEAD
• The third manufacturing cost element is a catchall for
manufacturing costs that cannot be classified as direct
materials or direct labor costs. Factory overhead costs
are a varied collection of production-related costs that
cannot be practically or conveniently traced directly or
end products.
NON- MANUFACTURING COSTS/
PRODUCT COSTS
 MARKETING OR SELLING EXPENSE
• Include all costs necessary to secure customer
ordered and get the finished product or service
into the hands of the customer. Since marketing
expenses are often referred to as order-getting
and order-fitting costs.
 ADMINISTRATIVE OR GENERAL EXPENSES
• include all executive, organizational, and electrical
expenses that cannot logically be included under
either production or marketing.
COSTS CLASSIFIED AS TO
VARIABILITY
 VARIABLE COST
• The cost that changes proportionately with the
change in output are knows as variable costs. An
increase in the volume means a proportionate
increase in the total variable costs linear
relationship between volume variable costs. The
per unit variable cost is always constant.
 FIXED COST
• The cost, whose total amount remains, to a certain
capacity is called fixed cost. The level of production
changes, but total amount of fixed cost requirement
constant. Fixed cost is also called capacity cost, periodic
cost, standing cost and burden cost. If the level of
production increases then per unit cost decrease and
vice-versa, but total amounts of fixed cost remain
constant. these cost increase with decrease in output
and vice versa.
 TWO CATEGORIES OF FIXED COSTS:
• Commited Fixed Costs- costs that represent relatively long term
commitments on the part of management as a result of a past
decision

• Manager Fixed Costs (also known as discretionary, programmed, or

planned fixed costs)- costs that are incurred on a short-term basis
and can be more easily modified in response to changes in
management objectives.
 MIXED COSTS
• Items of cost with fixed and variable components.
Mixed costs vary with the level of production,
though not in direct relation to it, probably
because part of the cost is fixed while the rest is
variable.
 TWO TYPES OF MIXED COSTS
• SEMI VARIABLE COST - the costs which are neither perfectly
neither variable nor absolutely fixed in relation to changes
in variable, are called semi-variable or semi-variable costs.
Neither total amount nor per unit semi variable cost
remains constant.
• STEP COSTS - The fixed part of step costs changes
abruptly at various activity levels because these costs are
acquired in indivisible portions. A step cost is similar to
a fixed cost within a very small relevant range.
HIGH LOW POINT METHOD
 66,000 – 45,000
Estimated VC/Unit = -----------------------------
29,000 – 15,000

Estimated VC/Unit = 1.50/ Unit

Activity Cost Per Unit Total Cost

15,000 1.50 22,500

29,000 1.50 43,500
LEAST SQUARE METHOD
 METHOD OF LEAST SQUARE
The three formulas to be used in least square method
are:

Equation 1 Y = a + bx
Equation 2 ∑y = na + b∑x
Equation 3 ∑xy = ∑xa + b∑x²
 COMMON COSTS
• Costs of facilities or services employed in
terms or more accounting commodities or
services. Just like indirect costs, these costs
are subject to allocation.
 JOINT COSTS
• Costs of materials, labor, and overhead incurred in the
manufacture of two or more products at the same
time. A major difficulty to inherent to joint costs is
that the are indivisible and they are not specifically
identifiable with any of the products being
simultaneously produced. These costs are also subject to
allocation.
 CAPITAL EXPENDITURE VS. REVENUE EXPENDITURE
CAPITAL EXPENDITURE REVENUE EXPENDITURE
• Expenditure intended to • Expenditure that will
benefit more than one benefit current period
accounting periods and
only and is recorded
is recorded as an asset.
as an expense.
 DIRECT VS. INDIRECT DEPARTMENTAL CHARGES
DIRECT DEPARTMENTAL CHARGES INDIRECT DEPARTMEMTAL CHARGES
• Direct costs are traceable to • Indirect costs may be
the production of a specific necessary to production, but
good or service. The they are not traceable to the
operative word is "specific." act of production. Indirect
costs are those necessary to
keep your business in
operation.
COSTS FOR PLANNING, CONTROL AND
ANALYTICAL PROCESSES
 STANDARD COSTS
• A standard cost is described as a predetermined
cost, an estimated future cost, an expected cost, a
budgeted unit cost, a forecast cost, or as the
"should be" cost. Standard costs are often an
integral part of a manufacturer's annual profit
plan and operating budgets.
 OPPORTUNITY COSTS
• The benefit given up when one alternative is chosen
over another. Opportunity costs are not usually
recorded in the accounting system. However,
opportunity costs should be considered when
evaluating alternatives for decision making.
 DIFFERENTIAL COSTS
• Differential cost is the difference between the cost of two
alternative decisions, or of a change in output levels. The
concept is used when there are multiple possible options to
pursue, and a choice must be made to select one option
and drop the others. An increase in cost from one
alternative to another is called incremental and a decrease
is a decremental cost.
 RELEVANT COST
• A future cost that change across the alternatives.
Relevant cost is a managerial accounting term that
describes avoidable costs that are incurred only
when making specific business decisions.
 OUT-OF-POCKET COST
• Cost that requires the payment of money (or
other assets) as a result of their incurrence.
 SUNK COST
• A cost for which an outlay has already been made and
it cannot be changed by present or future decision.
Sunk costs cannot be changed by any present or future
decisions but it is used in analyzing future courses of
action.
 CONTROLLABLE AND NON-CONTROLLABLE COSTS
• Controllable Costs are those • Uncontrollable Costs are
costs which may be influenced those which are not
by the decision taken by a influenced by the actions
specified member of the taken by any specific
administration of the firm or, it member of the management.
may be stated, that the costs
which at least partly depend on
the management and is
controllable by them.
 A MANUFACTURING ORGANIZATION IS A BUSINESS
THAT USES PARTS, COMPONENTS, OR RAW MATERIALS TO
PRODUCE FINISHED GOODS. THESE FINISHED GOODS
ARE SOLD EITHER DIRECTLY TO THE CONSUMER OR TO
OTHER MANUFACTURING FIRMS THAT USE THEM AS A
COMPONENT PART TO PRODUCE A FINISHED PRODUCT.
MANUFACTURING CASH FLOWS
 A MERCHANDISING FIRM IS ONE OF THE MOST COMMON
TYPES OF BUSINESSES. A MERCHANDISING FIRM IS A BUSINESS
THAT PURCHASES FINISHED PRODUCTS AND RESELLS THEM TO
CONSUMERS. CONSIDER YOUR LOCAL GROCERY STORE OR RETAIL
CLOTHING STORE. BOTH OF THESE ARE MERCHANDISING FIRMS.
OFTEN, MERCHANDISING FIRMS ARE REFERRED TO AS RESELLERS
OR RETAILERS SINCE THEY ARE IN THE BUSINESS OF RESELLING A
PRODUCT TO THE CONSUMER AT A PROFIT.
COST FLOW FOR A MERCHANDISING COMPANY
 A SERVICE ORGANIZATION IS A BUSINESS
THAT EARNS REVENUE BY PROVIDING
INTANGIBLE PRODUCTS, THOSE THAT HAVE NO
PHYSICAL SUBSTANCE.