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2-2

Summary of the Types of Cost

Classifications

Financial Predicting Cost

Managerial Accounting and Cost Reporting Behavior
Concepts
Chapter 2

Assigning Costs Making Business

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
to Cost Objects Decisions
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-4 2-6

Assigning Costs to Cost Objects Classifications of Manufacturing Costs

Direct costs Indirect costs
• Costs that can be • Costs that cannot be Direct Direct Manufacturing
easily and conveniently easily and conveniently Materials Labor Overhead
traced to a unit of product traced to a unit of product
or other cost object. or other cost object.
• Examples: direct • Example: manufacturing
material and direct labor overhead

Common costs The Product

Indirect costs incurred to support a number
of cost objects. These costs cannot be
traced to any individual cost object.

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Direct Materials Direct Labor

Raw materials that become an integral
part of the product and that can be Those labor costs that can be easily
conveniently traced directly to it. traced to individual units of product.

Example: A radio installed in an automobile

Example: Wages paid to automobile assembly workers

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Manufacturing Overhead Nonmanufacturing Costs

Manufacturing costs that cannot be easily
traced directly to specific units produced.
Administrative
Costs
Examples: Indirect materials and indirect labor

All executive, organizational,

and clerical costs.
Administrative costs can be
either direct or indirect costs.

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Cost Classifications for Preparing

Prime Costs and Conversion Costs
Financial Statements
Manufacturing costs are often
Product costs include Period costs include all
direct materials, direct selling costs and classified as follows:
labor, and administrative costs.
manufacturing Direct Direct Manufacturing
overhead. Material Labor Overhead
Inventory Cost of Good Sold Expense

Sale

Prime Conversion
Balance Income Cost Cost
Income
Sheet Statement Statement

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Cost Classifications for Predicting Cost

Behavior
Variable Cost
Cost behavior refers A cost that varies, in total, in direct proportion to
to how a cost will react changes in the level of activity. Your total texting
to changes in the level bill may be based on how many texts you send.
of activity. The most

Total Texting Bill

common
classifications are:
▫ Variable costs.
▫ Fixed costs.
▫ Mixed costs.
Number of Texts Sent

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Variable Cost Per Unit The Activity Base (Cost Driver)

However, variable cost per unit is constant. The cost per Units Machine
text sent may be constant at 5 cents per text message. produced hours

A measure of what

Cost Per Text Sent

causes the
incurrence of a
variable cost

Miles Labor
Number of Texts Sent driven hours

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Fixed Cost Fixed Cost Per Unit

A cost that remains constant, in total, regardless of However, if expressed on a per unit basis, the average fixed cost per
changes in the level of the activity. Your monthly unit varies inversely with changes in activity. The average fixed cost
contract fee for your cell phone may be fixed for the per cell phone call made decreases as more calls are made.
number of monthly minutes in your contract.

Monthly Cell Phone

Monthly Cell Phone

Contract Fee
Contract Fee

Number of Minutes Used

Number of Minutes Used Within Monthly Plan
Within Monthly Plan

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The Linearity Assumption and the

Types of Fixed Costs
Relevant Range
Economist’s A straight line
closely
Committed
Committed Discretionary
Discretionary Curvilinear Cost approximates a
Function curvilinear
Long-term,
Lon -term, cannot
cannot be
be May be altered
altered in
in the variable cost
significantly
g icantly reduced
reduced in
in short
short term by cu
current
rrent line within the
the
he short term.
signif term. managerial
managerial decisions
decision Relevant
relevant range.

Total Cost
t s Range
Accountant’s Straight-Line
Approximation (constant
Examples Examples
unit variable cost)
Depreciation on Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development Activity

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Fixed Costs and the Relevant Range Fixed Costs and the Relevant Range
The relevant range of activity pertains to fixed cost as
well as variable costs. For example, assume office space 90

Rent Cost in Thousands

is available at a rental rate of $30,000 per year in The
The relevant
relevant range
increments of 1,000 square feet. of activity for a fixed
Relevant
60

of Dollars
cost is the range of
Fixed costs would increase Range activity over which
the graph of the
in a step fashion at a rate of cost is flat.
$30,000 for each additional 30
1,000 square feet. 0
0 1,000 2,000 3,000
Rented Area (Square Feet)

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Cost Classifications for Predicting Cost

Behavior
Mixed Costs
A mixed cost contains both variable and fixed
Behavior of Cost (within the relevant range) elements. Consider the example of utility cost.
Cost In Total Per Unit
Y
Variable Total variable cost Increase Variable cost per unit

Total Utility Cost

and decrease in proportion
to changes in the activity level.
Fixed Total fixed cost is not affected
by changes in the activity
level within the relevant range.
remains constant.
Fixed cost per unit decreases
as the activity level rises and
Variable
increases as the activity level falls.
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge

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Mixed Costs Mixed Costs – An Example

If your ffifixed
IIffyyourour ixxededmonthly
mmoonnthlhlyutility charge
yututiilliittyy is $40,
ccharharggee your
iss $40,$40,
variable cost is $0.03yyourour per kilowatt hour, and your
vavarriiabablactivity
monthly leecoscostt iss$0$0..0303
level is 2,000pperer kikillowowatattt
kilowatt hours, hourhour,,
what is
Y andand yyoouurthe mmontonthl
amount hlyyof
aactcti
your ivviittyyutility
llevelevel
bill?iss 2,2,000000
kkiiloowwatatthourhours,s, wwhathat isstthehe amamountount ofof
Total Utility Cost

yyourour ututiilliittyybibillll??

Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge

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Opportunity Cost Sunk Costs

The potential benefit that is Sunk costs have already been incurred
given up when one alternative and cannot be changed now or in the
is selected over another. future. These costs should be ignored
These
These costs
costs are
are not
not
when making decisions.
usually
usually entered
entered into
into the
the
accounting
accounting records
records of
of an
an
organization,
Example: Suppose you had purchased gold for
organization, but
but must
must bebe
explicitly
explicitly considered
considered in
in all
all $1,100 an ounce, but now it is selling for $950 an
decisions.
decisions. ounce. Should you wait for the gold to reach $1,100
What are the an ounce before selling it? You may say, “Yes” even
opportunity
opportunity costs
costs you
you
incur
incur to
to attend this
this class?
class? though the $1,100 purchase is a sunk costs.