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CH 1
Introduction to Cost and
Cost Behavior
Cost Object
 Any item for which a measurement
of costs is desired.
Examples:
products, services, hospital patient,
processes, and customers.
1. General Classifications
B) Non-Manufacturing Costs
Cost
Measures the economic sacrifice
made to achieve an organization’s goal.
1. General Classifications
(Manufacturing and Nonmanufacturing costs)
2. Assigning Costs to Cost Objects
(Direct and Indirect)
3. Prepare Financial Reporting
4. Predicting Cost Behavior
(Variable and Fixed)
5.Making Business Decisions
Called:
Product Costs or
Inventoriable Costs.
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Total Manufacturing Costs =

Direct material costs + Direct labor costs + Manufacturing Overhead Material costs that can be traced directly to
a particular product.
OR:
TMC = DM + DL + MOH
Ex:
Meat in Burger
Wood in a table.
The steel in an automobile.
The circuit board in a radio.

Factory labor costs that can be traced to a

 Cannot be easily traced to a particular
particular product (Touch Labor). product.
Ex:
- Assembly line workers in an automobile. Examples:
- Carpenters in furniture manufacturing.

MOH examples:
B) Non-Manufacturing Costs:
Indirect Indirect
+ + Other costs
materials Labor

Materials used Wages paid to

Called:
employees who  Maintenance and repairs.
to support the
production are not directly  Factory Utilities Period Costs or
involved in
process.
production ( Water, Telephone, Electricity). Selling and Administrative Costs
-Glue, work.  Depreciation of factory
-Solder -Supervisors, buildings and equipment.
-Security guards  Factory rent
 Property Taxes.

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Indicate which of the following would be classified as

Non-Manufacturing Costs=
Selling costs
Costs necessary to secure the order
and deliver the product.
Advertising,
 Shipping,
Sales commission,
 Sales salaries…etc.
DL, DM, MOH, Selling, or an Administrative cost:
1. The cost of a hard drive installed in a computer.
2. The cost of advertising in the Puget Sound Computer User
newspaper.
Administrative
+ 3. The wages of employees who assemble computers from
Costs components.
•Executive compensation, 4. Sales commission paid to the company’s sales people.
• Public Relations 5. The wages of assembly shop’s supervisor.
6. The wages of company’s accountant.
7. Depreciation on equipment used to test assembled computers
before release to customers.

2) Assigning Costs to Cost A) Direct cost

Objects  Costs that can be easily traced to a
specific cost object.
A) Direct cost
Examples:
B) Indirect cost  Direct material (DM)
Direct labor (DL).

B) Indirect cost 1) Classifying a cost as either direct or indirect depends upon:

A) the behavior of the cost in response to volume changes.
Incurred to support a number of cost objects. B) whether the cost is expensed in the period in which it is incurred.
C) whether the cost can be easily identified with the cost object
 These costs cannot be easily traced to a specific D) whether an expenditure is avoidable or not in the future.

cost object. 2) All of the following are true EXCEPT that indirect costs:
A) may be included in prime costs
Ex: B) are not easily traced to products or services.
 Manufacturing overhead (MOH) C) vary with the selection of the cost object.
D) may be included in manufacturing overhead .
= Indirect material + Indirect labor + Other costs
3) Which statement is true?
A) A direct cost of one cost object cannot be an indirect cost of another cost object
B) All variable costs are direct costs
C) A direct cost of one cost object can be an indirect cost of another cost object.
D) All fixed costs are direct costs

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4) Stony Electronics Corporation manufactures a portable radio designed for mounting on the wall
of the bathroom. The following list represents some of the different types of costs incurred in the
manufacture of these radios:
1. The plant manager's salary.
Cost Classifications for Predicting
2. The cost of heating the plant.
3. The cost of heating executive offices.
4. The cost of printed circuit boards used in the radios.
Cost Behavior
5. Salaries and commissions of company salespersons.
6. Depreciation on office equipment used in the executive offices.
7. Depreciation on production equipment used in the plant.
Cost behavior refers to:
8. Wages of janitorial personnel who clean the plant.
9. The cost of insurance on the plant building.
how costs react to a change in the level of activity.
10. The cost of electricity to light the plant.
11. The cost of electricity to power plant equipment.
12. The cost of maintaining and repairing equipment in the plant.
Variable Costs
13. The cost of printing promotional materials for trade shows.
14. The cost of solder used in assembling the radios.
15. The cost of telephone service for the executive offices.
Fixed Costs
Required:
Classify each of the items above as product (inventoriable) cost or period (noninventoriable) cost for
the purpose of preparing external financial statements. Mixed Costs

1- Variable Costs Total variable cost

Costs that respond to changes in the activity level: Costs

$ 120,000
The same The same
percentage direction
$ 90.000
.
If the activity level doubles, the total variable cost
also doubles. 3000 4000 volume of activity

If the activity level increases by only 10%, the total

variable cost increases by 10% as well.

Examples : Variable cost per unit is constant

- Direct material (DM) although the volume of activity is
- Direct labor (DL)
- Direct expenses changing.

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Total variable Units of Variable Cost Cost (per unit) Variable cost per unit
cost production per unit
50
(1) (2) (1)÷(2) 40
30
$ 90,000 3,000 units $ 30
20
10
$ 120,000 4,000 units $ 30
3000 4000 5000 6000 volume of activity
$ 150,000 5,000 units $ 30

$ 180,000 6,000 units $ 30

Change Constant

2- Fixed Costs Total fixed cost

Costs
Refer to costs with zero response to
change in volume of activity

Examples include: 120,000 × ×

 Property taxes
 Insurance
 Rent
 Depreciation on buildings and volume of activity
3000 4000
equipment

Total Fixed Units of Fixed Cost per

Fixed cost per unit costs production unit
Changed (1) (2) (1) ÷ (2)

Increase Decrease $ 120,000 3,000 units $ 40

$ 120,000 4,000 units $ 30

When the volume of When the volume of $ 120,000 5,000 units $ 24
activity decrease activity increase
$ 120,000 6,000 units $ 20

Zero Response Reverse relation

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Exercise
Fixed cost per unit
Cost (per unit)
Listed below a number of costs that might be found in a
merchandising, or manufacturing company:
40 1) Property taxes, factory building
30 2) Sales commissions.
24 3) Supervisor’ salary
4) Depreciation, straight-line method
20 5) Salary of workers in the assembling department.
6) “Chips” used in producing calculators.
7) Insurance, factory
3000 volume of activity 8) Factory labor.
4000 5000
9) Direct materials used.
10) utilities, factory.
11) Lease cost, factory equipment
12) Administrative office salaries

E2-10 P. 56
Required:
For each cost item, indicate whether it would classify as variable.
or fixed in behaviour. Prepare your answer in a sheet with
column headings as shown below:

Cost Item Variable. Fixed

COST Behavior Selling or Administrative Product Cost

Cost
Cost Item Variable Fixed Direct Indirect

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Mixed Cost Costs

5,000
Includes both variable and fixed cost elements. 4,000

3,000 Variable component L.E. 3,000

Ex: 2,000

Telephone costs. 1,000 Fixed component L.E. 2,000

Volume of activity
Maintenance Cost 1,000 2,000 3,000 4,000

Example:
Total Mixed Cost = Total Fixed Costs + Total Variable Costs Assume that:
Fixed monthly utility charge= $4000,
Variable cost= $3 per kilowatt hour,
Y= a + bX Monthly activity level= 20,000 kilowatt hours,

The variable Activity level

what is the amount of your utility bill?
cost per unit

“Cost Function”

Analysis of Mixed
Solution: Costs:
Y = a + bX By Using:
Y = $4000 + $3×20,000 kilowatt The High-Low method.
Total utility cost=4,000 + 60,000
= $64,000

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Example (1): Required:

Given the following information about the Use the high-low method to estimate the
maintenance costs: variable and fixed components of
Month Activity Level Maintenance Cost maintenance cost?.
Jan. 5600 units $7900 OR
Feb. 5000 $7400 Estimate a cost function for maintenance cost?
March 7100 $8500
April 8000 $9800

Contribution Traditional
Format Income Income
Contribution Format Statement Statement
Income Statement Used as an internal Used for external
planning and decision reporting purposes.
making tool.

Traditional income statement The Contribution Format Income Statement

(Costs organized by function) (Costs organized by behavior)
Sales $12000 Sales ………………………. $12000
Less: *Cost of Goods Sold 6000 Less: Variable Expenses:
Cost of goods sold $2000
Gross margin 6000 (-)
Variable selling 600
Less: Operating Expenses: Variable administrative 400
Selling expenses $3100 3000
Administrative expenses 1900 Contribution Margin …..…….…………. 9000
5000 Less: Fixed Expenses: (-)
Net income $1000 Fixed selling 4000
Fixed administrative 2500
* Cost of Goods Sold= Beg. Inv.+ Purchases - End. Inv.
1500 8000
OR
= Number of units sold × Unit cost Net income $1000

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* Cost of Goods Sold= Beg. Inv.+ Purchases - End. Inv.

OR
= Number of units sold × Unit cost