CHAPTER :

COST CONCEPTS AND CLASSIFICATION S

COMMON COST vs. JOINT COST

COMMON COST – Cost of facilities or services employed in two or more accounting periods, operations,
commodities or services. Just like Indirect Costs, these accosts are subject to allocation.

JOINT COST – Cost of materials, labor and overhead incurred in the manufacture of two or more products at
the same time. A major difficulty inherent to joint costs is that hey are invisible 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 EXPENDITURES – Expenditure intended to benefit more than one accounting period and is
recorded as an asset. The allocation of the cost to the different periods is- depreciation for fixed tangible
assets, amortization for intangible assets and depletion for wasting assets.

REVENUE EXPENDITURES – Expenditure that will benefit current period only and is recorded as an expense.

DIRECT vs. INDIRECT DEPARTMENTAL CHARGES

DIRECT DEPARTMENTAL CHARGES – Costs that are immediately charged to the particular manufacturing
department(s) that incurred the costs since the costs can be conveniently identified or associated with the
department(s) that benefited from said costs.

INDIRECT DEPARTMENTAL CHARGES – Costs that are originally charged to some other manufacturing
department(s) or account(s) but are later allocated or transferred to another department(s) that indirectly
benefited from said costs.

COSTS FOR PLANNING, CONTROL AND ANALYTICAL PROCESSES

STANDARD COSTS – Predetermined costs for direct materials, direct labor, and factory overhead. They are
established by using information accumulated from past experience and data secured from research studies.
In essence, a standard cost is a budget for the production of one unit of product or service. It is the cost
chosen by the managerial accountant to serve as the benchmark in the budgetary control system.

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. If an asset can be used to perform only one function and
cannot be sold or used in other ways, the opportunity cost of the asset is zero.

DIFFERENTIAL COST – Cost that is present under one alternative but is absent in whole or in part under
another alternative. An increase in cost from one alternative to another is known as incremental cost, while
a decrease in cost is known as decremental cost. Differential cost is a broader term, encompassing both cost
increases (incremental cost) and cost decreases (decremental cost) between alternatives.

The accountant’s differential cost concept is basically the same as the economist’s marginal cost
concept.

1 COST ACCOUNTING – Cost Concepts and Classification

 MARGINAL REVENUE – The revenue that can be obtained from selling one more unit of product.

MARGINAL COST – Cost involved in producing one more unit of product.

Differential costs can be either fixed or variable.

ILLUSTRATION:

Assume that Avon Corp. is thinking about changing its marketing method from distribution through
retailers to distribution by direct sale. Present costs and revenues are compared to projected costs and
revenues in the table.

RETAILER DIRECT SALE DIFFERENTIAL

Distribution Distribution Cost and
(present) (proposed) Revenues
Revenues (V) Php 900,000 Php 1,200,000 Php 300,000
Cost of Goods Sold (V) 450,000 600,000 150,000
Advertising (F) 80,000 45,000 (35,000)
Commission (V) - 40,000 40,000
Warehouse depreciation (F) 50,000 80,000 30,000
Other Expenses (F) 60,000 60,000 -
Total 640,000 825,000 185,000
Net Income Php 260,000 Php 375,000 Php 115,000

V = Variable

F = Fixed

The differential revenue is Php 300,000 and the differential cost total Php 185,000, leaving a positive
differential net income of Php 115,000 under the proposed marketing plan. As noted, those differential costs
representing cost increases could have been referred to more specifically as incremental costs, and those
representing cost decreases could have been referred to more specifically as decremental costs.

RELEVANT COST – A future cost that changes across the alternatives.

In the example above, the relevant costs are cost of goods sold, advertising, commissions, and
warehouse depreciation.

OUT-OF-POCKET COST – Cost that requires the payment of money (or other assets) as a result of their
incurrence.

SUNK COST - is a cost that has already been incurred and cannot be recovered. They are not differential costs,
and therefore they should be used in analyzing future courses of action.

CONTROLLABLE AND NON-CONTROLLABLE COSTS

A cost is considered to be a controllable cost at a particular level of management if that level has
power to authorize the cost.

Example. Entertainment expense would be controllable by a sales manager id he or she had power to
authorize the amount and type of entertainment for customers. On the other hand, depreciation of warehouse

2 COST ACCOUNTING – Cost Concepts and Classification

facilities would not be controllable by the sales manager, since he or she would have no power to authorize
warehouse construction.

Cost that are controllable over the long run may not be controllable over the short run.

Example. Advertising. Once an advertising program has been set and a contract signed, management
has no power to change the amount of spending. But the contract expires, advertising costs can be
renegotiated, and thus management can exercise control over the long run.

COST FLOW – MANUFACTURING FIRMS

Cost Incurrence Expense Category

Direct materials -------}

Direct labor -------------} Work in Finished Cost of goods sold

} Process goods

Factory overhead ------}

Selling and Administrative Operating expense

The essential purpose of any organization is to transform inputs into outputs. Merchandising, Manufacturing
and Service Organizations have many similarities, all require labor and capital as inputs and all transform
them into a product or service for the market. These organization also differ from another in many respects
and these are reflected in their accounting systems.

A merchandising organization starts with a finished product and markets it. Because inventory is
acquired in finished form, its cost is easily ascertained.

The accounting system for a manufacturing organization is more complex because direct materials
are first acquired and then converted to finished product. A manufacturer’s accounting system focuses on
work in process, which is the account that reflects the costs involved in transforming input materials into
finished goods.

Service organization have no inventory of goods for sale. Costs are charged to responsibility centers
for performance evaluation. Costs are also charged to jobs. The assignment of cost facilities performance
evaluation. The manager of each department is held responsible for the cost of that job.

Of the three kinds of operations, manufacturers require the most complex and comprehensive cost
accounting system. All three uses information for decision making and performance evaluation. But in
addition, manufacturers need product costing for inventory valuation and to measure cost of goods sold
reported on external financial statements. Many manufacturers also have service and merchandising
activities, costs of which must be recorded.

SUMMARY OF IMPORTANT FORMULAS

1. Total variable costs= Variable cost per unit x total output

2. Total cost = Total variable cost total fixed cost

3 COST ACCOUNTING – Cost Concepts and Classification

 3. Variable rate = highest point cost- lowest point cost
Highest output – Lowest output
4. Fixed cost = Total cost at highest – (variable rate x output at highest point) or
5. Fixed cost = Total cost at lowest – (variable rate x output at lowest point)

TRUE-FALSE QUESTIONS

Indicate whether the following statements are true or false by inserting in the blank space provided a capital
“T” for true or “F” for false.

___ 1. The materials, labor, and overhead costs incurred to produce a product are called period costs.

___ 2. Marketing, Selling, and Administrative Cost are the three broad classifications of costs incurred by a
manufacturing company.

___ 3. Lumber can be both a finished product and a material.

___ 4. Product cost consists of the sum of prime cost and conversion cost.

___ 5. Total fixed cost decrease with increase in the number of its units produce

___ 6. Period costs are found in both merchandising and manufacturing firms.

___ 7. The three cost elements of manufactured goods are direct materials, direct labor, and marketing costs.

___ 8. A cost that is present under one alternative but absent in whole or part under another alternative is
known as a differential cost.

___ 9. Like product costs, period costs are not necessarily treated as expenses in the period in which they are
incurred.

___ 10. Variable Costs are costs that change, in total, in direct proportion to changes in the level of activity.

___ 11. The salary paid to the manager in charge of a warehouse is probably a variable cost.

___ 12. Indirect materials/factory supplies are classified as administrative expense.

___ 13. The salary paid to a factory foreman is classified as factory overhead.

___ 14. In a manufacturing setting, prime cost is fixed.

___ 15. Foxed cost remains constant if expressed on a unit basis.

___16. Differential costs can be either fixed or variable

___ 17. A fixed cost is constant per unit of product

___18. A decrease in production will ordinarily result in an increase in fixed production cost per unit.

___ 19. A factory supervisor’s salary would be classified as a direct cost of a unit of product.

___ 20. Factory rent is included in manufacturing overhead, but office rent is a period cost.

___ 21. Product costs are also known as manufacturing costs.

___ 22. Prime costs are always variable

___ 23. Cost accounting is not needed by a merchandising entity

4 COST ACCOUNTING – Cost Concepts and Classification

___ 24. The statement of financial position of a service business is the same as that of a manufacturing
business

___ 25. Selling and administrative expenses are sometimes called non-manufacturing costs

Multiple Choice – Problem

The following costs relate to Antonio Industries for the last quarter:

Conversion Cost Php 435,000

Direct Materials Php 215,000
Manufacturing Overhead Php 190,000
Selling and Administrative Expense Php 185,000

1. What is Antonio’s prime cost for last quarter?

a. Php 460,000
b. Php 410,000
c. Php 405,000
d. Php 375,000

2. Antonio’s total manufacturing cost is

a. Php 460,000
b. Php 645,000
c. Php 650,000
d. Php 840,000

3. Antonio’s total period cost is

a. Php 185,000
b. Php 275,000
c. Php 400,000
d. Php 620,000

Milktopia, Inc. produces and sells milk flavored bubble gum. Over the last five months Milktopia had the
following production costs and production volume ..

Month Cost Volume (in cases)

March Php 6,000 12
April Php 6,659 14
May Php 8,370 18
June Php 8,800 19
July Php 8,050 17

4. Using the high-low method, what is the fixed cost per month for bubble gum production?
a. Php 400
b. Php 1,200
c. Php 4,800
d. Php 7,600

5. The variable cost per case is

a. Php 400
b. Php 600
c. Php 1,200
d. Php 2,800

5 COST ACCOUNTING – Cost Concepts and Classification

Justine Co. produced 5,500 outdoor chairs for Job Order No. 610. Total material cost was Php 51,700. Each
chair required 2.2 hours of direct labor at Php 8.90/ hour. A total of Php 53,845 of factory overhead was
traced to Order 610.

6. What is the prime cost per unit of this order?

a. Php 19.58
b. Php 28.98
c. Php 29.37
d. Php 38.77

7. What is the conversion cost per unit of this order?

a. Php 19.58
b. Php 28.98
c. Php 29.37
d. Php 38.77

8. What is the unit cost of this order?

a. Php 37.88
b. Php 38.77
c. Php 28.09
d. Php 36.99

During the month of August, Amer Corporation produces 12,000 units and sold them for Php 20 per unit.
Total fixed cost for the period were Php 154,000, and the operating profit was Php 26,000.

9. Based on the foregoing information, the variable cost per unit is

a. Php 4.50
b. Php 5.00
c. Php 6.00
d. Php 7.17

Data to be used in applying the high-low method shows the highest cost of Php 69,000 and the lowest cost of
Php 52,000. The data shoe Php 148,000 as the highest level of sales and Php 97,000 as the lowest level.

10. What is the variable cost per peso sale?

a. Php 0.33
b. Php 0.47
c. Php 0.54
d. Php 3.00

Ravena Company manufactures office furniture. During the most productive moth of the year, 3,500 desks
were manufactured at a total cost of Php 84,400. In its slowest month, te company made 1,100 desks at a cost
of Php 46,000.

11. Using the high-low method of cost estimation, the total fixed cost are:
a. Php 56,000
b. Php 28,400
c. Php 17,600
d. Php 38,400

6 COST ACCOUNTING – Cost Concepts and Classification

 12. The variable cost per unit is
a. Php 16.00
b. Php 15.00
c. Php 14.00
d. Php 17.00

Last year, Abner Company incurred the following costs

Direct Materials Php 50,000

Direct Labor Php 20,000
Factory Overhead Php 130,000
Selling Expense Php 40,000
Administrative Expense Php 36,000

Units produced and sold 10,000 units at a price Php 31 each.

13. Prime Cost per unit is

a. Php 7.00
b. Php 15.00
c. Php 5.00
d. Php 20.00

14. Conversion Cost per unit is

a. Php 7.00
b. Php 15.00
c. Php 20.00
d. Php 26.00

15. Cost of goods sold per unit is

a. Php 7.00
b. Php 15.00
c. Php 20.00
d. Php 26.00

16. Gross profit per unit is

a. Php 11.00
b. Php 15.00
c. Php 16.00
d. Php 24.00

17. Operating Income is

a. Php 24,000
b. Php 110,000
c. Php 74,000
d. Php 110,000

Norman Company produced 1,000 units of a product which was sold at a price of Php 95.00 each. Total selling
and administrative incurred Php 30,000

Direct Materials Php 25.00

Direct Labor Php 16.00
Factory Overhead Php 19.00

7 COST ACCOUNTING – Cost Concepts and Classification

 18. Conversion Cost per unit is
a. Php 41.00
b. Php 44.00
c. Php 35.00
d. Php 45.00

19. Cost of goods sold per unit is

a. Php 41.00
b. Php 44.00
c. Php 35.00
d. Php 60.00

20. Gross profit per unit is

a. Php 54.00
b. Php 51.00
c. Php 60.00
d. Php 35.00

PROBLEM SOLVING

Problem – Mother Goose Company

The financial statements of Mother Goose Company included these items:

Marketing costs P160,000

Direct labor cost 245,000

Administrative cost 145,000

Direct Materials Used 285,000

Fixed factory overhead costs 175,000

Variable factory overhead costs 155,000

Compute for the following

1. Prime Cost
2. Conversion Cost
3. Total inventoriable/product cost
4. Total Period Cost

Problem – Johnson Corporation

Johnson Corporation is preparing a flexible budget and desires to separate its electricity expense,
which is semi-variable and fluctuates with total machine hours, into its fixed and variable
components. Information for the first three months of 2009 is as follows:

8 COST ACCOUNTING – Cost Concepts and Classification

 Machine Hours Electricity Expense

January 3,500 P31,500

February 2,000 20,000

March 4,000 35,600

Requirements:

1. Compute the variable rate per machine hour.

2. Compute the fixed portion of Johnson’s electricity expense
3. Compute the total manufacturing cost if Johnson’s actual machine hours is 4,500

Problem – Valdez Motors Co.

Valdez Motors Co. makes motorcycles. Management wants to estimate overhead costs to plan its
operations. A recent trade publication revealed that overhead costs tend to vary with machine
hours. To check this, they collected the following data for the past 12 months.

Month No. Machine Hours Overhead Cost

1 175 P4,500

2 170 4,225

3 160 4,321

4 190 5,250

5 175 4,800

6 200 5,100

7 160 4,450

8 150 4,200

9 210 5,475

10 180 4,760

11 170 4,325

12 145 3,975

Requirements

1. Use the high-low method to estimate the fixed and variable portion of overhead costs based
on machine hours.
2. If the plant is planning to operate at a level of 200 machine hours next period, what wpuld
be the estimated overhead costs?
3. Use the method of least squad to estimate the fixed and variable portion of overhead costs
based on machine hours.

9 COST ACCOUNTING – Cost Concepts and Classification

10 COST ACCOUNTING – Cost Concepts and Classification