Cost Concepts & Cost Behavior Analysis

Cost - is cash or cash equivalent necessary to attain an objective such as acquiring goods or services, performing a function
or producing and distributing a product.

Cost Accounting - is an expanded phase of financial accounting which informs management promptly with the cost of
rendering a particular service, buying and selling a product, and producing a product. It is the field of accounting that
measures, records and reports information about costs.

MERCHANDISING – MERCHANDISE INVENTORY

MANUFACTURING - RM, WIP, FG

DM + DL + FOH = WIP >>> FG

Cost of Sales, Operating Expenses and Losses

- Cost of sales or costs of goods sold are those production costs incurred related to the units sold.
- Expenses are those incurred in selling goods, distributing goods and managing a business (operating expenses).
- Both costs and expenses give benefits to the business.
- Losses do not give any benefit to the business.

Different Costs for different purposes (Classifications of Costs)

A. As to type
1. Product Costs – costs incurred to manufacture the product. Product costs of the units sold are recognized as
expense (COGS) while product costs of the unsold units become the costs of inventory.
2. Period Costs – non-manufacturing costs that include selling, administrative and research and development costs.
These costs are expensed in the period of incurrence and do not become part of the cost of inventory.

B. As to function
1. Manufacturing Costs – DM, DL, FOH

FOH
• INDIRECT MATERIALS
• INDIRECT LABOR
• OTHERS
o FACTORY BUILDING RENT/DEPRECIATION
o FACTORY UTILITIES
o DEP EXP – FACTORY EQUIPMENT
o INSURANCE EXP – FACTORY ASSETS

2. Non-manufacturing Costs – SE, AE

C. As to traceability
1. Direct Costs – related to a particular cost object and can economically and effectively be traced to that object.
(Direct Materials and Direct Labor)
2. Indirect Costs – related to a cost object, but cannot practically, economically and effectively be traced to such cost
object. Cost assignment is done by allocating the indirect cost to the related cost objects.

DIRECT MATERIALS (wood used to manufacture a wooden chair)

MATERIALS
INDIRECT MATERIALS (paint brush, screws, nails, sandpaper) = FOH

DIRECT LABOR
LABOR
INDIRECT LABOR

D. For decision-making
• RELEVANT
• IRRELEVANT
 ACCEPT OR REJECT A SPECIAL ORDER (OF CUSTOMER)

ACCEPT REJECT
DM XX
DL XX
FOH - VARIABLE XX
TOTAL RELEVANT COSTS XX
FOH – FIXED FOH – FIXED
(unavoidable) - 20,000 (unavoidable) - 20,000
IRRELEVANT IRRELEVANT
TOTAL COST

MAKE OR BUY A COMPONENT OR PART OF A PRODUCT

MAKE (INSOURCE) BUY (OUTSOURCE)

DM 30 PURCHASE PRICE 90
DL 40
FOH - VARIABLE 20
FOH – FIXED 10
(AVOIDABLE)
OPPORTUNITY COSTS 15
TOTAL RELEVANT COSTS 115 TOTAL RELEVANT COSTS 90
DIFFERENTIAL COSTS 20 INCREMENTAL 20 (DECREMENTAL)

RENTAL INCOME OF VACANT FACILITY - 15

1. Relevant Costs – future costs that will differ under alternative courses of action.
2. Differential Costs – difference in costs between any two alternative courses of action.
a. Incremental Cost – increase in cost from one alternative to another.
b. Decremental Cost – decrease in cost from one alternative to another.
3. Opportunity Costs – income or benefit given up when one alternative is selected over another.
4. Sunk, Past or Historical Costs – already incurred and cannot be changed by any decision made now or to be made in
the future.

E. As to relation to an accounting period:

1. Capital Expenditure
2. Revenue Expenditure

F. As to behavior (Reaction to changes in Cost Driver)

1. Variable Cost
2. Fixed Cost
a. Committed Fixed Cost – DEP EXP
b. Discretionary Fixed Cost – ADVERTISING EXP, SALARIES
3. Mixed Cost

1,000 (100% INC.) 500 (25% dec.)

JAN FEB MAR RELATIONSHIP
UNITS PRODUCED 1,000 2,000 1,500
FIXED COST:
TOTAL FC P10,000 P10,000 P10,000 NO
FC PER UNIT P10 P5 6.67 INVERSE

VARIABLE COST: P2,000 (100% inc.) P1,000 (25% dec.)

TOTAL VC P2,000 P4,000 P3,000 DIRECT &
PROPORTIONATE
VC PER UNIT P2 P2 P2 NO

MIXED COST: P2,000 (16.67% INC.) P1,000 (7.14%

DEC)
TOTAL COST P12,000 P14,000 P13,000 DIRECT
TC PER UNIT P12 P7 P8.67 INVERSE
P5 (41.67% DEC.)
Cost Behavior - refers to the way costs change with respect to a change in the activity level, such as production or sales
volume, labor or machine hours, etc. There are costs which remain constant, some change directly or proportionately with
the activity level, and others change in different patterns.

Types of Cost Total amount Amount per unit

1. FIXED Constant Decreases as production increases
2. VARIABLE Increases as production increases Constant
3. MIXED Increases less proportionately (vs. total Decreases less proportionately (vs. fixed cost per
variable costs) as production increases unit) as production increases

Cost Behavior Assumptions

A. Relevant Range Assumption

Relevant range refers to the range of activity within which the cost behavior patterns are valid. Any level of activity
outside this range may show a different cost behavior pattern.

RELEVANT RANGE = 5,000 UNITS TO 15,000 UNITS

MINIMUM MAXIMUM

DEP EXP AT 7,500 UNITS = P10,000

DEP EXP AT 12,500 UNITS = P10,000
DEP EXP AT 15,000 UNITS = P10,000
DEP EXP AT 20,000 UNITS = P10,000????? P14,000

B. Time Assumption
The cost behavior patterns identified are true only over a specified period of time. Beyond this, the cost may show a
different cost behavior pattern.

DL RATE PER HOUR – 2021 P 100 PER HOUR

DL RATE PER HOUR – 2100 P 2,000 PER HOUR

C. Linearity Assumption
The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to show otherwise
over the long run.