CH 2 Cost concepts

Cost

Accountants define cost in terms of resources consumed. Accounting costs reflect changes in stocks (reductions in good things, increases in bad things) over a fixed period of time.

reflects the monetary measure of resources used to attain an objective such as making a good or performing a service.

Cost classification according to function

Manufacturing cost

Non manufacturing cost

Manufacturing cost

incurred in the factory to convert raw materials into finished goods. It includes cost of raw materials used (direct materials), direct labor, and factory overhead.

Non manufacturing cost

not incurred in transforming materials to finished goods. These include selling expenses (such as advertising costs, delivery expense, salaries and commission of salesmen) and administrative expenses (such as salaries of executives and legal expenses).

Direct materials

direct labor

factory overhead

Manufacturing costs

Direct materials

cost of items that form an integral part of the finished product. They refer to the major parts or ingredients. Examples include wood in furniture, steel in automobile, water in bottled drink, fabric in shirt, etc.

Direct labor

cost of labor expended directly upon the materials to transform them into finished goods. Direct labor refers to salaries and wages of employees who work to convert the raw materials to finished goods.

Factory overhead

also called manufacturing overhead, refers to all costs other than direct materials and direct labor spent in the production of finished goods. This includes indirect materials such as cost of nails, thread, glue, etc.; indirect labor such as salary of the supervisor; and factory expenses such as rent of the factory space, depreciation of factory equipment, utilities expense of the factory, factory supplies, etc.

Direct cost

Indirect cost

Cost classification according to ease of traceability

Direct cost

those that can be traced directly to a particular object of costing such as a particular product, department, or branch. Examples include materials and direct labor. Some operating expenses can also be classified as direct costs, such as advertising cost for a particular product.

Indirect cost

those that cannot be traced to a particular object of costing. They are also called common costs or joint costs. include factory overhead and operating costs that benefit more than one product, department, or branch.

Product cost

Period cost

Cost classification according to timing of charge against revenue

Product cost

are inventoriable costs. They form part of inventory and are charged against revenue, i.e. cost of sales, only when sold. All manufacturing costs (direct materials, direct labor, and factory overhead) are _____-.

Period costs

are not inventoriable and are charged against revenue immediately. Period costs include non-manufacturing costs, i.e. selling expenses and administrative expenses.

Variable cost

Fixed cost

Mixed cost

Step cost

Cost classification according to behavior in accordance with activity

Variable cost

vary in total in proportion to changes in activity. Examples include direct materials, direct labor, and sales commission based on sales.

Fixed cost

Costs that remain constant regardless of level of activity. Examples include rent insurance depreciation using straight line method.

Mixed cost

costs that vary in total but not in proportion to changes in activity. It basically includes a fixed cost potion plus additional variable costs. An example would be electricity expense that consists of a fixed amount plus variable charges based on usage.

Step cost

shifts upward or downward when activity changes by a certain interval or “step.” A step cost can be variable or fixed. Step variable costs have small steps; step fixed costs have large steps.

Relevant cost

Standard cost

Opportunity cost

Sunk cost

Controllable cost

Cost classification according to relevance to decision making

Relevant cost

cost that will differ under alternative courses of action. In other words, these costs refer to those that will affect a decision.

Standard cost

predetermined cost based on some reasonable basis such as past experiences, budgeted amounts, industry standards, etc. The actual costs incurred are compared to standard costs.

Opportunity cost

benefit forgone or given up when an alternative is chosen over the other/s. Example: If a business chooses to use its building for production rather than rent it out to tenants, the opportunity cost would be the rent income that would be earned had the business chose to rent out.

Sunk cost

historical costs that will not make any difference in making a decision. Unlike relevant costs, they do not have an impact on the matter at hand.

Controllable cost

refer to costs that can be influenced or controlled by the manager. Segment managers should be evaluated based on costs that they can control.

Cost object

anything for which management wants to collect or accumulate costs.

• Ex. Production operations, product lines

Cost driver

a variable that causally affects costs over a given time span

Relevant range

the band of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and a given cost

• For example, fixed costs are considered fixed only within the relevant range.