COST TERMINOLOGIES AND

CLASSFICATIONS

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 Assigning Costs to Cost
Objects
Direct costs Indirect costs
Costs that can be Costs that cannot
easily and be easily and
conveniently
traced to a unit of conveniently
product or other traced to a unit of
cost object. product or other
Examples: direct cost object.
material and direct Example:
labor
manufacturing
overhead

Cost allocation is a process of assigning

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cost for indirect cost.
ACC 2204
 Manufacturing Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product

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 Direct Materials
Those materials that become an integral part of
the product and that can be conveniently traced
to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

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 Direct Labor
Those labor costs that can be easily traced to
individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

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

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 Manufacturing Overhead
Manufacturing costs that cannot be traced directly
to specific units produced.
Costs Related
Indirect Indirect to the
Materials Labor Manufacturin
g Facility

Manufacturing Overhead
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 Manufacturing Overhead
Materials used to support the
Indirect production process.
Materials Examples: lubricants and cleaning
supplies used in the automobile
assembly plant.

Wages paid to employees who are

Indirect not directly involved in production
work.
Labor Examples: maintenance workers,
janitors and security guards.

Costs Related Costs related to the manufacturing

to the facility.
Manufacturin Examples: property taxes, utilities,
g Facility depreciation, insurance, repairs.
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 Nonmanufacturing Costs

Administrative
Costs

All executive,
organizational, and
clerical costs.

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 Classifications of Costs

Manufacturing costs are often

classified as follows:

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Material
Material Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost

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 Nonmanufacturing Costs
Marketing and selling costs . . .
Costs necessary to get the order and
deliver the product.
Administrative costs . . .
All executive, organizational, and clerical
costs.

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1-12

Product Costs Versus Period

Costs
Product costs include Period costs are not
direct materials, included in product
direct labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Cost of
Inventory Goods Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
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 Product cost
Include all the costs that are involved in acquiring or
making a product.
Direct materials, direct labor, and manufacturing
overhead.
Recognized as expenses when the products are sold.
Product costs are also known as inventoriable costs.
All manufacturing costs are treated as product costs.

13 ACC 2204
 Period Cost
Include all selling costs and administrative costs.
Costs are expensed on the income statement in the period
incurred.
All selling and administrative costs are typically
considered to be period costs.
For example:
administrative salary costs are incurred when they are
earned by the employees and not necessarily when they
are paid to employees.

14 ACC 2204
Quick Check
Which of the following costs would be considered a
period rather than a product cost in a manufacturing
company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
 Cost Classifications for
Predicting Cost Behavior
How
How aa cost
cost will
will react
react
to
to changes
changes inin the
the
level
level of
of business
business
activity.
activity.
Total
Total variable
variable costs
costs
change
change when
when activity
activity
changes.
changes.
Total
Total fixed
fixed costs
costs
remain
remain unchanged
unchanged
when
when activity
activity changes.
changes.

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 True Variable Cost Example
A variable cost is a cost whose total dollar
amount varies in direct proportion to
changes in the activity level. Your total
long distance telephone bill is based on
how many minutes you talk.
Total Long Distance
Telephone Bill

17 ACC 2204 Minutes Talked

 Variable Cost Per Unit Example
A variable cost remains constant if
expressed on a per unit basis. The cost per
minute talked is constant. For example, 10
cents per minute.

Telephone Charge
Per Minute

Minutes Talked
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sk0506
 Total Fixed Cost Example
A fixed cost is a cost whose total dollar
amount remains constant as the activity
level changes. Your monthly basic
telephone bill is probably fixed and does
not change when you make more local
Telephone Bill
Monthly Basic

calls.

Number of Local Calls

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 Fixed Cost Per Unit Example
Average fixed costs per unit decrease as the
activity level increases. The fixed cost per
local call decreases as more local calls are
made.

Monthly Basic Telephone

Bill per Local Call

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Number of Local Calls
Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in short-term by current
the short term. managerial decisions

Examples Examples
Depreciation on Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development
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 Cost Classifications for
Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.

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Quick Check
Which of the following costs would be variable
with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
 STEP COST/ SEMI FIXED COST
Cost which remains constant for a range of
activity, then when activity increases still
further, the cost has to be increased by a
significant amount.
Example : Supervision costs

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 Quick Check
Which of the following statements about
cost behavior are true?
a. Fixed costs per unit vary with the level of
activity.
b. Variable costs per unit are constant within the
relevant range.
c. Total fixed costs are constant within the
relevant range.
d. Total variable costs are constant within the
relevant range.
 Mixed Costs
(also called semivariable costs)
A
A mixed
mixed cost
cost contains
contains both
both variable
variable and
and fixed
fixed
elements.
elements. Consider
Consider the
the example
example of
of utility
utility cost.
cost.
Y
Total Utility Cost

o st
d c
xe
al mi
t
To Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
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 Mixed Costs

Y
Total Utility Cost

o s t
e dc
m i x
t al
To Variable
Cost per KW

X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
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 Mixed Costs An Example
If
If your
your fixed
fixed monthly
monthly utility
utility charge
charge is
is $40,
$40, your
your
variable
variable cost
cost is
is $0.03
$0.03 per
per kilowatt
kilowatt hour,
hour, and
and your
your
monthly
monthly activity
activity level
level is
is 2,000
2,000 kilowatt
kilowatt hours,
hours,
what
what is
is the
the amount
amount of of your
your utility
utility bill?
bill?

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 Analysis of Mixed Costs
Account Analysis and the Engineering Approach

In
In account
account analysis
analysis,, each
each account
account is
is
classified
classified as
as either
either variable
variable or
or fixed
fixed based
based
on
on the
the analyst
analystss knowledge
knowledge ofof how
how
the
the account
account behaves.
behaves.

The
The engineering
engineering approach
approach classifies
classifies
costs
costs based
based upon
upon an
an industrial
industrial
engineers
engineers evaluation
evaluation of
of production
production
methods,
methods, and
and material,
material, labor,
labor, and
and
overhead
overhead requirements.
requirements.
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 SEMI VARIABLE COST

SEMI VARIABLE COST

Variable cost Fixed cost

As fixed cost are the same at both

activity levels, the difference in total
cost between the highest and lowest
activity levels must be attributable to
variable cost entirely.
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 SEMI VARIABLE COST
Are cost which varies with the activity
level but not in direct proportion. These
cost exhibits the characteristics of both
variable and fixed cost. These cost
increase with output but would not fall
to a zero level
Example : Telephone bill and
maintenance cost

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 SEMI VARIABLE COST
HIGH LOW METHOD
Variable cost per unit = Difference in cost
Difference in output

Fixed cost= Total cost (Output x variable cost per

unit)

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 SEMI VARIABLE COST
Example :

Output (units) Cost ($)

2000 $5000

3000 $7000

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 SEMI VARIABLE COST
Variable cost per unit = Difference in cost
Difference in output
=2000
1000
=$2 per unit

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 SEMI VARIABLE COST
Fixed cost= Total cost (Output x variable
cost per unit)
=7000 (3000 X 2 )
= $1000
OR
=5000 (2000 x 2 )
=$1000

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The High-Low Method An
Example
Assume the following hours of maintenance work and the total maintenance costs for six months.
The High-Low Method An
Example
The variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in
hours.
$2,400
= $6.00/hour
400
 The High-Low Method An Example

Total Fixed Cost = Total Cost Total Variable Cost

Total Fixed Cost = $9,800 ($6/hour 850 hours)

Total Fixed Cost = $9,800 $5,100

Total Fixed Cost = $4,700
The High-Low Method An
Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
 Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions areare $10,000
$10,000 when
when
80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when 120,000
120,000
units
units are
are sold.
sold. Using
Using the
the high-low
high-low method,
method, what
what is
is the
the
variable
variable portion
portion of
of sales
sales salaries
salaries and
and commission?
commission?
a.
a. $0.08
$0.08 per
per unit
unit
b.
b. $0.10
$0.10 per
per unit
unit
c.
c. $0.12
$0.12 per
per unit
unit
d.
d. $0.125
$0.125 per
per unit
unit
 Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions areare $10,000
$10,000 when
when
80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when 120,000
120,000
units
units are
are sold.
sold. Using
Using the
the high-low
high-low method,
method, what
what is
is
the
the fixed
fixed portion
portion of
of sales
sales salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
Classification by cost behaviour

Important to predict costs and revenues at different activity levels for many
decisions.

Variable costs vary in direct proportion with activity.

Fixed costs remain constant over wide ranges of activity.

Semi-fixed costs are fixed within specified activity levels, but they eventually
increase or decrease by some constant amount at critical activity levels.

Semi-variable costs include both a fixed and a variable component

(e.g.telephone charges).

Note that the classification of costs depends on the time period involved.In the
short term some costs are fixed,but in the long term all costs are variable.

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Differential Cost and Revenue

Costs and revenues that differ

among alternatives.
Example: You have a job paying $1,500 per month
in your hometown. You have a job offer in a
neighboring city that pays $2,000 per month. The
commuting cost to the city is $300 per month.

Differential revenue is:

$2,000 $1,500 = $500

Differential cost is:

45 ACC 2204 $300
 Identifying Relevant
Costs and Benefits
Sunk
Sunk costs
costs
Costs
Costs that
that have
have already
already been
been incurred.
incurred.
They
They dodo not
not affect
affect any
any future
future cost
cost and
and
cannot
cannot be
be changed
changed byby any
any current
current or
or future
future
action.
action.

Sunk costs are irrelevant to decisions.

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 Opportunity costs
A cost that measures the opportunity that is
lost or sacrificed when the choice of one course
of action requires that an alternative course of
action be given up.

Example
To produce product X requires that an order that
yields 1 000 contribution to profits is
rejected.The lost contribution of 1 000
represents the opportunity cost of producing
product X.

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 Quick Check
Suppose you are trying to decide whether to
drive or take the train to Kuala Lumpur to attend
a concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Kuala Lumpur?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.
Quick Check
Suppose you are trying to decide whether to
drive or take the train to Kuala Lumpur to attend
a concert. You have ample cash to do either, but
you dont want to waste money needlessly. Is
the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
Quick Check
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
 END OF LECTURE

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