CH 1

Introduction to Cost and

Cost Behavior
 Cost
Measures the economic sacrifice
made to achieve an organization’s goal.
 Cost Object
 Any item for which a measurement
of costs is desired.

Examples:
products, services, hospital patient,
processes, and customers.
1. General Classifications
(Manufacturing and Nonmanufacturing costs)

2. Assigning Costs to Cost Objects

(Direct and Indirect)

3. Prepare Financial Reporting

4. Predicting Cost Behavior
(Variable and Fixed)

5.Making Business Decisions

 1. General Classifications

B) Non-Manufacturing Costs
Called:
Product Costs or
Inventoriable Costs.
Total Manufacturing Costs =
Direct material costs + Direct labor costs + Manufacturing Overhead

OR:
TMC = DM + DL + MOH
Material costs that can be traced directly to
a particular product.

Ex:
Meat in Burger
Wood in a table.
The steel in an automobile.
The circuit board in a radio.
Factory labor costs that can be traced to a
particular product (Touch Labor).

Ex:
- Assembly line workers in an automobile.
- Carpenters in furniture manufacturing.
 Cannot be easily traced to a particular
product.

Examples:
 MOH examples:
Indirect Indirect
materials
+ + Other costs
Labor

Materials used Wages paid to

to support the employees who 
Maintenance and repairs.
production are not directly 
Factory Utilities
process. involved in
production ( Water, Telephone, Electricity).
-Glue, work.  Depreciation of factory
-Solder -Supervisors, buildings and equipment.
-Security guards  Factory rent
 Property Taxes.
 B) Non-Manufacturing Costs:

Called:
Period Costs or
Selling and Administrative Costs
 Non-Manufacturing Costs=
Administrative
Selling costs +
Costs
Costs necessary to secure the order
and deliver the product.
•Executive compensation,
• Public Relations
Advertising,
 Shipping,
Sales commission,
 Sales salaries…etc.
Indicate which of the following would be classified as
DL, DM, MOH, Selling, or an Administrative cost:
1. The cost of a hard drive installed in a computer.
2. The cost of advertising in the Puget Sound Computer User
newspaper.
3. The wages of employees who assemble computers from
components.
4. Sales commission paid to the company’s sales people.
5. The wages of assembly shop’s supervisor.
6. The wages of company’s accountant.
7. Depreciation on equipment used to test assembled computers
before release to customers.
2) Assigning Costs to Cost
Objects

A) Direct cost
B) Indirect cost
 A) Direct cost
 Costs that can be easily traced to a
specific cost object.

Examples:
 Direct material (DM)
Direct labor (DL).
 B) Indirect cost
Incurred to support a number of cost objects.
 These costs cannot be easily traced to a specific
cost object.
Ex:
 Manufacturing overhead (MOH)
= Indirect material + Indirect labor + Other costs
1) Classifying a cost as either direct or indirect depends upon:
A) the behavior of the cost in response to volume changes.
B) whether the cost is expensed in the period in which it is incurred.
C) whether the cost can be easily identified with the cost object
D) whether an expenditure is avoidable or not in the future.

2) All of the following are true EXCEPT that indirect costs:

A) may be included in prime costs
B) are not easily traced to products or services.
C) vary with the selection of the cost object.
D) may be included in manufacturing overhead .

3) Which statement is true?

A) A direct cost of one cost object cannot be an indirect cost of another cost object
B) All variable costs are direct costs
C) A direct cost of one cost object can be an indirect cost of another cost object.
D) All fixed costs are direct costs
4) Stony Electronics Corporation manufactures a portable radio designed for mounting on
the wall of the bathroom. The following list represents some of the different types of costs
incurred in the
manufacture of these radios:
1. The plant manager's salary.
2. The cost of heating the plant.
3. The cost of heating executive offices.
4. The cost of printed circuit boards used in the radios.
5. Salaries and commissions of company salespersons.
6. Depreciation on office equipment used in the executive offices.
7. Depreciation on production equipment used in the plant.
8. Wages of janitorial personnel who clean the plant.
9. The cost of insurance on the plant building.
10. The cost of electricity to light the plant.
11. The cost of electricity to power plant equipment.
12. The cost of maintaining and repairing equipment in the plant.
13. The cost of printing promotional materials for trade shows.
14. The cost of solder used in assembling the radios.
15. The cost of telephone service for the executive offices.
Required:
Classify each of the items above as product (inventoriable) cost or period (noninventoriable)
cost for the purpose of preparing external financial statements.
 Cost Classifications for Predicting
Cost Behavior
Cost behavior refers to:
how costs react to a change in the level of activity.

Variable Costs
Fixed Costs

Mixed Costs
 1- Variable Costs
Costs that respond to changes in the activity level:

The same The same

percentage direction
.
If the activity level doubles, the total variable cost
also doubles.

If the activity level increases by only 10%, the total

variable cost increases by 10% as well.
 Total variable cost
Costs

$ 120,000

$ 90.000

3000 4000 volume of activity

 Examples :

- Direct material (DM)

- Direct labor (DL)
- Direct expenses
Variable cost per unit is constant
although the volume of activity is
changing.
Total variable Units of Variable Cost
cost production per unit
(1) (2) (1)÷(2)
$ 90,000 3,000 units $ 30

$ 120,000 4,000 units $ 30

$ 150,000 5,000 units $ 30

$ 180,000 6,000 units $ 30

Change Constant
Cost (per unit) Variable cost per unit

50
40
30
20
10

3000 4000 5000 6000 volume of activity

 2- Fixed Costs
Refer to costs with zero response to
change in volume of activity

Examples include:
 Property taxes
 Insurance
 Rent
 Depreciation on buildings and
equipment
 Total fixed cost
Costs

120,000 × ×

volume of activity
3000 4000
 Fixed cost per unit
Changed

Increase Decrease

When the volume of When the volume of

activity decrease activity increase
 Total Fixed Units of Fixed Cost per
costs production unit
(1) (2) (1) ÷ (2)

$ 120,000 3,000 units $ 40

$ 120,000 4,000 units $ 30

$ 120,000 5,000 units $ 24

$ 120,000 6,000 units $ 20

Zero Response Reverse relation

 Fixed cost per unit
Cost (per unit)

40
30
24
20

3000 4000 5000 volume of activity

 Exercise
Listed below a number of costs that might be found in a
merchandising, or manufacturing company:
1) Property taxes, factory building
2) Sales commissions.
3) Supervisor’ salary
4) Depreciation, straight-line method
5) Salary of workers in the assembling department.
6) “Chips” used in producing calculators.
7) Insurance, factory
8) Factory labor.
9) Direct materials used.
10) utilities, factory.
11) Lease cost, factory equipment
12) Administrative office salaries
Required:
For each cost item, indicate whether it would classify as variable.
or fixed in behaviour. Prepare your answer in a sheet with
column headings as shown below:

Cost Item Variable. Fixed

E2-10 P. 56
 COST Behavior Selling or Administrative Product Cost
Cost
Cost Item Variable Fixed Direct Indirect
 Mixed Cost

Includes both variable and fixed cost elements.

Ex:
Telephone costs.
Maintenance Cost
Costs

5,000

4,000

3,000 Variable component L.E. 3,000

2,000

1,000 Fixed component L.E. 2,000

Volume of activity
1,000 2,000 3,000 4,000
Total Mixed Cost = Total Fixed Costs + Total Variable Costs

Y= a + bX
The variable Activity level
cost per unit

“Cost Function”
Example:
Assume that:
Fixed monthly utility charge= $4000,
Variable cost= $3 per kilowatt hour,
Monthly activity level= 20,000 kilowatt hours,

what is the amount of your utility bill?

 Solution:

Y = a + bX
Y = $4000 + $3×20,000 kilowatt
Total utility cost=4,000 + 60,000
= $64,000
Analysis of Mixed
Costs:
By Using:
The High-Low method.
Example (1):
Given the following information about the
maintenance costs:
Month Activity Level Maintenance Cost
Jan. 5600 units $7900
Feb. 5000 $7400
March 7100 $8500
April 8000 $9800
 Required:
Use the high-low method to estimate the
variable and fixed components of
maintenance cost?.
OR
Estimate a cost function for maintenance cost?
Contribution Format
Income Statement
 Contribution Traditional
Format Income Income
Statement Statement
Used as an internal Used for external
planning and decision reporting purposes.
making tool.
 Traditional income statement
(Costs organized by function)
Sales $12000
Less: *Cost of Goods Sold 6000
Gross margin 6000
Less: Operating Expenses:
Selling expenses $3100
Administrative expenses 1900
5000
Net income $1000
* Cost of Goods Sold= Beg. Inv.+ Purchases - End. Inv.
OR
= Number of units sold × Unit cost
 The Contribution Format Income Statement
(Costs organized by behavior)
Sales ………………………. $12000
Less: Variable Expenses:
Cost of goods sold $2000
Variable selling 600 (-)
Variable administrative 400
3000
Contribution Margin …..…….…………. 9000

Less: Fixed Expenses: (-)

Fixed selling 4000
Fixed administrative 2500
1500 8000
Net income $1000
* Cost of Goods Sold= Beg. Inv.+ Purchases - End. Inv.
OR
= Number of units sold × Unit cost