Cost Terms, Concepts, and

Classifications
 2-2

Meaning of Cost

The amount of expenditure incurred on or to

attributable to a specified thing or activity”. The specific
thing may be a product, job, services, process or any
activity.
 2-3

MEANING OF COST ACCOUNTING

 MEANING OF COST ACCOUNTING

Cost accounting is a system of classifying, recording &
appropriate allocation of expenditure in such a manner so that per
unit & total cost of goods produced or services rendered can be
computed correctly.

 DEFINATION OF COST ACCOUNTING

“ Cost accounting is the technique & process of ascertainment of

cost”
.
 2-4

Scope of cost accounting

The scope of cost accounting includes the following:
1. Cost ascertainment
It deals with the collection and analysis of expenses, the measurement of
production of the different products at different stages of manufacture and
the liming up of the production with the expenses.
2. Cost determination
It is the process of accounting for cost which begins with recording of
expenditure and ends with the preparation of statistical data. It is formal
mechanism by means of which costs of products or services are
ascertained and controlled.
3. Cost control
It is the guidance and regulation by executive action of the costs of
operating an undertaking. It aims at guiding the actual towards the line of
targets
 2-5

Objective of Cost Accounting

1. To ascertain the cost per unit of the different products
manufactured by a business concern
2. To provide a correct analysis of cost both by process or
operations and by different elements of cost
3. To disclose sources of wastage whether of material, time or
expense or in the use of machinery, equipment and tools and to
prepare such reports which may be necessary to control such
wastage
4. To provide requisite data and serve as a guide to price fixing of
products manufactured or services rendered
5. To ascertain the profitability of each of the products and advise
the management as to how these profits can be maximized. 
 2-6

Continue….
6. To present and interpret data for management planning, evaluation
of performance and control
7. To help in the preparation of budgets and implementation of
budgetary control
8. To guide management in the formulation and implementation of
incentive bonus plans based on productivity and cost savings;
9. To supply useful data to management for taking various financial
decisions such as introduction of new products, replacement of
labour by machines. 
2-7
 2-8

Cost Object

 It is an activity or item or operation for

which a separate measurement of costs
is desired
 E.g. the cost of operating the personnel
department of a company, the cost of a
repair fob, and the cost for control
 2-9

Cost

 It is the amount of expenditure incurred

on a specific cost object
 Total cost = quantity used * cost per unit
(unit cost)
 2-10

Cost unit

 It is a quantitative unit of product or

service in which costs are ascertained,
e.g. cost per table made, cost per metre
of cloth
 2-11

Cost Centre

 It is a location or function of an
organization in respect of which costs are
ascertained
 E.g. the rent, rates and maintenance of
buildings; the wages and salaries of
storekeepers
 2-12

Classification of Cost on
the basis of Function
 2-13

Product cost / Manufacturing Cost

 Product cost are related to the goods
purchased or produced for resale
 If the products are sold, the product cost will be
included in the cost of goods sold and
recorded as expenses in current period
 If the products are unsold, the product costs
will be included in the closing stock and
recorded as assets in the balance sheet
 2-14

Classifications of Costs

Manufacturing costs are often

combined as follows:
Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
 2-15

Manufacturing Costs

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

The Product
 2-16

Direct Materials

Those materials that become an integral part

of the product and that can be conveniently
traced directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
 2-17

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
 2-18

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

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work. Examples: lubricants and
Examples: maintenance cleaning supplies used in the
workers, janitors and automobile assembly plant.
security guards.
 2-19

Period cost / Nonmanufacturing

Cost
 Period cost related to the operation of a
business
 They are treated as fixed cost and
charged as expenses when they are
incurred
 They should not be included in the stock
valuation
 2-20

Nonmanufacturing Costs

Marketing and selling costs . . .

 Costs necessary to get the order and deliver the
product.
Administrative costs . . .
 All executive, organizational, and clerical costs.
 2-21

Quick Check 

Which of the following costs would be

considered manufacturing overhead at Boeing?
(More than one answer may be correct.)
A. Depreciation on factory forklift trucks.
B. Sales commissions.
C. The cost of a flight recorder in a Boeing 767.
D. The wages of a production shift supervisor.
 2-22

Product Costs Versus Period Costs

Product costs
Period costsinclude direct
are not materials,
included in direct labor,
product
and manufacturing overhead.
costs. They are expensed on the income
statement.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 2-23

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.
 2-24

Cost Accumulation
• Prime cost = direct materials + direct labour + direct
expenses
• Production cost = Prime cost + factory overhead
OR
= Direct materials + Conversion cost
*Conversion cost is the production cost of converting raw materials into
finished product
• Total cost = Prime cost + Overheads (admin, selling,
distribution cost)
OR
= Production cost + period cost (administrative, selling,
distribution and finance cost)
• Period cost is treated as expenses and matched against sales for
calculating
profit, e.g. office rental
 2-25

Classification of Cost on
the basis of Behavior
 2-26

Cost Classifications for Predicting

Cost Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.
Total
 Total variable
variablecosts
costs
change
changewhenwhenactivity
activity
changes.
changes.
Total
 Total fixed
fixedcosts
costs
remain
remain unchanged
unchanged
when
when activity
activitychanges.
changes.
 2-27

Variable Cost

 It increases or decreases in direct

proportion to levels of activity, but the unit
variable cost remains constant.
 E.g. cost of food served in a restaurant
 2-28

Total Variable Cost

Your total long distance telephone bill is

based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
 2-29

Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
 2-30

Fixed Cost

 Total fixed cost remains constant over a

relevant range of activity level but unit
fixed cost falls with an increase in activity
volume
 2-31

Total Fixed Cost

Your monthly basic telephone bill probably
does not change when you make more local
calls.
Monthly Basic
Telephone Bill

Number of Local Calls

 2-32

Fixed Cost Per Unit

The average cost per local call decreases as
more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
 2-33

Semi-variable cost

 It processes characteristics of both fixed

and variable cost
 It increases or decreases with activity
level but not in direct proportion
 2-34

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.
 2-35

Quick Check 

Which of the following costs would be variable

with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
 2-36

Cost Classification on the

basis of Cost Objective
 2-37

Direct Costs and Indirect Costs

Direct costs Indirect costs

 Costs that can be  Costs cannot be easily
easily and conveniently and conveniently traced
traced to a unit of to a unit of product or
product or other cost other cost object.
objective.  Example:
 Examples: direct manufacturing
material and direct labor overhead, Indirect
Material, Indirect Labor
 2-38

Differential Costs and Revenues

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
 2-39

Differential Costs and Revenues

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:
$300
 2-40

Quick Check 

Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t 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.
 2-41

Quick Check 

Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the depreciation on your car relevant in this
decision?
A. Yes, the depreciation is relevant.
B. No, the depreciation is not relevant.
 2-42

Opportunity Costs
The potential benefit that
is given up when one
alternative is selected
over another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for one
year is $15,000.
 2-43

Sunk Costs

Sunk costs cannot be changed by any decision.

They are not differential costs and should be
ignored when making decisions.
Example: You bought an automobile that cost
$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it,
trade it, or sell it, you cannot change the
$10,000 cost.
 2-44

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.
 2-45

Other Type of Cost

 Relevant cost
 Standard Cost
 Historical Cost