COSTS AND COST CONCEPTS MANAGEMENT ADVISORY SERVICES

Cost - a measurement, in monetary terms, of the amount of resources used for some purpose. When
notiied
notiied by a term
term that deines
deines the purpose,
purpose, cost
cost becomes operational, e.g., selling cost,
acquisition cost, variable cost, etc.

Cost Pool - an account in which a variety of similar costs are accumulated prior to allocation to cost 
objects. It is a group of costs associated with an activity. Example:  overhead account.

Cost object - the intermediate and inal disposition of cost pools.

Example:  product, job, process

Cost driver - a factor that causes a change in the cost pool for a particular activity. It is used as a
basis for cost allocation; any factor or activity that has a direct cause-effect relationship

 Activity - any event, action, transaction, or wor sequence that incurs costs when producing a
product or providing a service.
Valueaddi!" Activities  ! activities that are necessary to produce the products
No!-ValueAddi!" Activities  ! activities that do not mae the product or services valuable
to customers.

COSTS C#ASSI$ICATION
 A. As to type
". Product Costs ! costs incurred to manufacture a product.
#. Period Costs ! costs that are e$pensed in the period of incurrence and do not become
part of the cost of inventory.

B. As to func
functi
tion
on
". Manufacturing Costs  ! all costs incurred in the factory to convert raw materials into
inished goods.
#. Non-manufacturing Costs ! all costscosts which
which are notnot incur
incurre
red
d to transf
transfor
orm
m raw
raw
materials into inished goods.

C. As to
to trace
traceabi
abilit
lity
y to cost
cost obje
object 
ct 
". Direct Costs ! costs that are related to a particular cost object and can economically
and effectively be traced to that cost object.
#. Indi
Indire
rect Costss ! costs
ct Cost costs that
that are
are relat
related
ed to a cost
cost objec
objectt but canno
cannott pract
practica
icall
lly
y,
economically and effectively be traced to such cost object.

D. As to beha
behavi
vior 
or 
". Fixed Costs - in total% constant within the relevant range as activity output changes;
per unit% changes as activity level changes.
a. Committed Fixed Costs ! long-term in nature and cannot be eliminated even
for short period of time without affecting the proitability or long-term goals
of the irm.
b. Discretion
Discretionary
ary Fixed
Fixed Costs
Costs ! arise from periodic decision by management to
spend in certain i$ed cost area and may be changed by management from
perio
periodd to perio
period d or even
even durin
during
g &with
&within'
in' the perio
period,
d, if circum
circumsta
stanc
nces
es
demand such change.
#. Variable Costs - in total% varies in direct proportion to changes in activity output; per
unit% remains constant 
(. Mixed Costs - has both i$ed and variable components.

E. For deci
decisi
sion
on-m
-mak
akin
ingg
". Releant Costs ! future costs that will differ under alternative courses of actions.
COST %E&AVIOR

+/ 01234I5 - describes how a cost behaves or changes as the amount of cost driver changes.

COST %E&AVIOR ASS'MPTIONS(

1. 5elevant 5ange 3ssumption
5elevant range refers to the band of activity within which the identiied cost behavior
patterns are valid. 3ny level of activity outside this range may have a different cost 
behavior pattern.
2. /ime 6eriod 3ssumption
/he cost behavior patterns identiied are true only over a speciied period of time.
0eyond this, the cost may show a different behavior.

SEGREGATION O$ $I)ED AND VARIA%#E E#EMENTS O$ MI)ED COSTS(

". %ig&'(o) Points Met&od '  the i$ed and variable elements of the mi$ed costs are computed
from two data points &periods'7the high and low periods as to activity level or cost driver.

#. "tatistical "cattergrap& Met&od   - various costs &the dependent variable' are plotted on a
vertical line &y-a$is' and measurement igures &cost drivers or activity levels' are plotted on
a hori8ontal line &$-a$is'. 3 straight line is drawn through the points and, using this line, the
rate of variability and the i$ed cost are computed.

(. Met&od of (east "*uares +Regression ,nalysis- - mathematically determines a line of best it 
or a linear regression line through a set of plotted points so that the sum of the squared
deviations of each actual plotted point from the point directly above or below it on the
regression line is at minimum.

/his method uses the following equations in computing for the values of unit variable cost 
and i$ed cost%

1quation "% 9:  na < b9$

1quation #% 9$y  a9$ < b9$ #

+/ =5*>?3% y * a + b,
Where% @y@ denotes total cost. It is called the dependent variable because it is dependent on
the value of another variable, the activity level $.
@a@ is an estimate of the i$ed cost 
@b@ is an estimate of the variable cost per unit of activity.

CORRE#ATION ANA#YSIS

Correlatio! ! measure the co-variation between the dependent and independent variable.

Coe-.icie!t o- Correlatio! /r0 ! the measure of the e$tent of the linear relationship between two
variables.

Coe-.icie!t o- Deter1i!atio! /r 20 ! represents the percentage of the total variation in the

dependent variable y that is e$plained or accounted for by the regression equation.

Sta!dard Error o- Esti1ate  ! the standard deviation about the regression line, which serve as the
conidence interval or acceptable range of tolerance, for use in e$ercising control over the
costs.
". lassify the following costs as i$ed, variable, or semivariable
a. Aepreciation ! straight line method f. 5ent  
b. Airect materials g. 5epairs to machinery
c. =actory insurance h. 4alue added ta$
d. 1lectricity i. +uperintendence
e. Indirect materials j. Washroom supplies

#. >nder which subheading of the elements of cost should each of the following costs be
classiiedB
a. +andpaper used in furniture manufacturing f. InspectorCs salary
b. Aepreciation of factory g. ?egal e$penses
c. 1arnings of machinist h. ?ubricating oil
d. +upervisorCs wages i. 0ags in lour mills
e. *il to mae ice cream j. Wages of factory crane operator

(. Ryan V. Company reports the following total costs at two levels of 
production:
Cost Item 23444 u!its 53444 u!its
Indirect labor 6", 6#,
6roperty ta$es D, D,
Airect labor "E, ),
Airect materials "#, (,
Aepreciation ", ",
>tilities #, (,D
*aintenance (, E,

51F>I51A% lassify each cost as variable, i$ed, or mi$ed.

). Lemsolano Company wants to find an equation to estimate monthly utility

costs. Lemsolano has been in business for one year and has collected the following
cost data for utilities:
*onth 1lectricity Gwh used /elephone /elephone Water bill Hallons of 
0ill 0ill *inutes water
>sed used
anuary 6(E ",# 6J#. "," 6E (,DE
=ebruary 6)# ",) 6J".# ",E 6E #E,K
*arch 6D)J ",K( 6J).K ",#) 6E (",)D
3pril 6)D ",(D 6KJ.E JK 6E #J,JED
*ay 6DKK ",JE 6JK. ",) 6E (,DEK
une 6E#) #,K 6JK.K ",)) 6E #D,D)
uly 6D## ",L) 6J(.) ","L 6E (#,EJ
3ugust 6DJL ",JJ 6JE.# ",(" 6E (",###
+eptember 6E( #," 6JD.E ",#K 6E ((,D)
ctober 6E"D #,D 6J(.K ","J 6E (",JL
Movember 6DJ) ",JK 6J". ",D 6E #K,E
Aecember 6E(( #,"" 6JL. ",(D 6E (),"

51F>I51A%
". Which of the preceding costs is variableB =i$edB *i$edB 1$plain.
#. >sing the high-low method, determine the cost function of each cost.
(. ombine the preceding information to get a monthly utility cost function for ?emsolano
). Me$t month, ?emsolano e$pects to use #,# Gwhs of electricity, mae ",D minutes of telephone
calls, and use (#, gallons of water. 1stimate total cost of utilities ne$t month.
 Mumber of units produced E, J,
ost of goods manufactured 6"EK, 6#DL,
Wor in process inventory, beginning 6J, 6(#,
Wor in process inventory, ending 6"D, 6#",
Airect materials cost per unit 6E 6E
Airect labor cost per unit 6" 6"
*anufacturing overhead cost, total B B

/he companyCs manufacturing overhead consists of both variable and i$ed cost elements. /o have
data available for planning, management wants to determine how much of the overhead cost is
variable with units produced and how much of it is i$ed per month.

5equired%
". =or both *arch and une, estimate the amount of manufacturing overhead cost added to
production. /he company had no underapplied or overapplied overhead in either month.
#. >sing the high-low method, estimate a cost formula for manufacturing overhead. 1$press the
variable portion of the formula in terms of a variable rate per unit of product.
(. If L, units are produced during a month, what would be the cost of goods manufacturedB
&3ssume that the wor in process inventories do not change and there is no underapplied or
overapplied overhead cost for the month.'

"(. Velman Company wants to determine the factors that are associated with
overhead. 'he controller for Velman constructed a multiple regression equation
using the following independent variables: direct labor hours# number of setups#
and number of purchase orders. 'he analysis was run using the past $" months of 
data. /rom the printout# the following data were obtained:
6arameter 1stimate
Intercept 6D,
5ates of variability
Airect labor hours &2' 6"
Mumber of setups &+' 6J
Mumber of purchase orders &6' 6#
Mumber of observations D

r#  .JD

51F>I51A%
". Write out the cost formula for monthly overhead for 4elman ompany.
#. If 4elman budgets the following for ne$t month, what is the budgeted overhead costB
Airect labor hours )
Mumber of setups (
Mumber of purchase orders "D
(. +uppose that 4elmanCs engineers found a way to reduce the number of setups by # percent 2ow
much would be saved in overhead cost for the following monthB

No CP, eer became one by 0ust dreaming1 ,ction needs to be done1

-end-