INTRODUCTION TO COST ACCOUNTING ASSIGNING COSTS TO COST OBJECTS

• Direct costs – costs that can be easily and

DIFFERENCE BETWEEN FINANCIAL AND COST conveniently traced to a unit of product or other
ACCOUNTING cost object.
• Financial accountants provide information to Examples: direct materials and direct labor.
external parties • Indirect costs – costs that cannot be easily and
- Investors conveniently traced to a unit of product or other
- Creditors cost object.
- Regulators Example: manufacturing overhead.
- Donors
• Managerial accountants provide information to CLASSIFICATIONS OF MANUFACTURING COSTS
internal users a. Direct Materials – are raw materials that become an
- Managers integral part of the product and that can be
• Cost accountants provide information to both conveniently traced directly to it.
internal and external users Example: A radio installed in an automobile.
- Product cost information
b. Direct Labor – consists of labor costs that can be
ACCOUNTING DIFFERENCES easily traced to individual units of product.
Financial Managerial Example: Wages paid to automobile assembly workers.
• External focus • Internal focus c. Manufacturing Overhead – includes all
• Whole • Segments or divisions manufacturing costs except direct material and
organization direct labor. These costs cannot be readily traced to
• Historical • Current or projected finished products.
• Quantitative • Qualitative or quantitative - Includes indirect materials that cannot be
• Monetary • Monetary & nonmonetary easily or conveniently traced to specific units
• Verifiable • Timely or reasonable of product.
estimates - Includes indirect labor that cannot be easily
• GAAP • Benefits exceeds cost or conveniently traced to specific units of
• Formal • Formal and informal product.
recordkeeping recordkeeping - Only those indirect costs associated with
operating the factory are included in
RELATIONSHIP OF FINANCIAL, MANAGEMENT, AND COST manufacturing overhead.
ACCOUNTING
PRIME COSTS AND CONVERSION COSTS
Manufacturing costs are often classified as follows:
Financial Management • Prime cost
Accounting Accounting - Direct materials.
- Direct labor.
• Conversion cost
- Direct labor.
- Manufacturing overhead
COST TERMINOLOGIES
• Cost – monetary value that a company spent in order NONMANUFACTURING COSTS / PERIOD COSTS
to produce a certain product • Selling costs – the costs incurred to secure customer
• Cost Object – a product or a department of which orders and get the finished product to the customer.
costs are accumulated Selling costs can be either direct or indirect costs.
Example: Direct Material costs, Direct labor costs, and
• Administrative costs – the costs associated with the
overhead costs are accumulated cost in producing a T-
general management of an organization rather than
shirt for example, hence, the cost object is the T-shirt.
with manufacturing or selling. Administrative costs
• Cost of maintenance supplies and cost of salary of can be either direct or indirect costs.
maintenance employees are cost accumulated under
Maintenance Department, hence, cost object is the PRODUCT COSTS
Maintenance Department. • Product costs include all the costs involved in
acquiring or making a product.
 • Product costs “attach” to a unit of product as it is • Cost behavior refers to how a cost will react to
purchased or manufactured, and they stay attached changes in the level of activity.
to each unit of product as long as it remains in • The most common classifications are:
inventory awaiting sale. - Variable costs.
- Fixed costs.
MANUFACTURING PRODUCT COSTS - Mixed costs.
• Raw materials include any materials that go into the
final product. VARIABLE COST
• A variable cost varies, in total, in direct proportion to
• Work in process consists of units of product that are
changes in the level of activity.
only partially complete and will require further work
• A variable cost per unit is constant.
before they are ready for sale to the customer.
• Finished goods consist of completed units of product COST DRIVER
that have not yet been sold to customers. • A cost driver is a measure of what causes the
incurrence of a variable cost.
TRANSFER OF PRODUCT COSTS - Units produced.
- Machine hours.
Raw Work in Finished Cost of Goods - Miles driven.
Materials Process Goods Sold - Labor hours.
• When direct materials are used in production, their FIXED COST
costs are transferred from Raw Materials to Work in
• A fixed cost is a cost that remains constant, in total,
Process.
regardless of changes in the level of the activity.
• Direct labor and manufacturing overhead costs are
• If expressed on a per unit basis, the average fixed
added to Work in Process to convert direct materials
into finished goods.
cost per unit varies inversely with changes in activity.

• Once units of product are completed, their costs are
transferred from Work in Process to Finished Goods.
• When a manufacturer sells its finished goods to
customers, the costs are transferred from Finished
Goods to Cost of Goods Sold.
THE LINEARITY ASSUMPTION AND THE RELEVANT RANGE
COST CLASSIFICATIONS FOR PREPARING FINANCIAL
STATEMENTS
• Product costs include direct materials, direct labor,
and manufacturing overhead.
• Types of Fixed Costs
- Committed – long term, cannot be
significantly reduced in the short term.
- Discretionary – may be altered in the short
term by current managerial decisions.
• The relevant range of activity pertains to fixed cost
as well as variable costs. For example, assume office
space is available at a rental rate of $30,000 per year
in increments of 1,000 square feet.
• Fixed costs would increase in a step fashion at a rate
of $30,000 for each additional 1,000 square feet.
• Relevant Range: Graphic

• Period costs include all selling costs and

administrative costs.
The relevant range of activity for a fixed cost is the
range of activity over which the graph of the cost is flat.

COMPARISON OF COST CLASSIFICATIONS FOR

PREDICTING COST BEHAVIOR
Cost In total Per unit
Fixed Increases/ Constant
Decreases
COST CLASSIFICATIONS FOR PREDICTING COST BEHAVIOR Variable Constant Increases/
Decreases
 OPPORTUNITY COST
• Opportunity cost is the potential benefit that is
MIXED COSTS given up when one alternative is selected over
• A mixed cost contains both variable and fixed another.
elements. Consider the example of utility cost. • These costs are not usually found in accounting
records but must be explicitly considered in every
decision.
• For students: What is the opportunity cost you
incur by attending class?

THE TRADITIONAL AND CONTRIBUTION FORMATS

• The total mixed cost line can be expressed as an

equation: Y = a + bX
Where:
Y = The total mixed cost
a = The total fixed cost (the vertical intercept of the
line)
b = The variable cost per unit of activity (the slope of • Traditional format  Used primarily for external
the line) reporting
X = The level of activity • Contribution format  Used primarily by
management
Example
If your fixed monthly utility charge is $40, your variable
USES OF THE CONTRIBUTION FORMAT
cost is $0.03 per kilowatt hour, and your monthly
The contribution format income statement is used as
activity level is 2,000 kilowatt hours, what is the
an internal planning and decision-making tool. We will use
amount of your utility bill?
Y = a + bX this approach for:
Y = $40 + ($0.03 × 2,000) 1. Cost-volume-profit analysis (Chapter 6).
Y = $100 2. Segmented reporting of profit data (Chapter 7).
3. Budgeting (Chapter 8).
COST CLASSIFICATIONS FOR DECISION MAKING 4. Special decisions such as pricing and make-or-buy
• Decisions involve choosing between alternatives. analysis (Chapter 11).
The goal of making decisions is to identify those
costs that are either relevant or irrelevant to the
decision.
• It is important to understand the terms differential
cost and revenue, sunk cost, and opportunity cost.

DIFFERENTIAL COSTS
• Differential cost (or incremental cost) is the
difference in cost between any two alternatives.
• A difference in revenue between two alternatives
is called differential revenue.
• Both are always relevant to decisions.
• Differential costs can be either fixed or variable.

SUNK COSTS
• Sunk costs have already been incurred and cannot
be changed by any decision made now or in the
future.
• These costs should be ignored when making
decisions.