Introduction to Cost Accounting, Cost Concepts, Cost
Behavior Analysis and Cost Accounting Cycle
Cost Defined
 Cost is a cash or cash equivalent necessary
to attain an objective such as acquiring
goods or services performing a function or
producing and distributing product
 Refers to the amount of resources given up
in exchange for some goods or services
Cost of Sales,
Operating Expenses
and Losses
 Cost of Sales
o Also known as cost of goods sold
o Productions costs incurred related to the
units sold
 Expenses
o Those incurred in selling goods,
distributing goods and managing a
business (operating expenses)
 Both costs and expenses give benefits to the
business
 Losses do not give any benefit to the
business
Cost Accounting
 Is an expanded phase of financial
accounting which informs management
promptly with the cost of rendering a
particular service, buying and selling a
product, and producing a product
 It is a field of accounting that measures,
records, and reports information about costs
Types of Costs
Product Costs
 Merchandising - Costs incurred to acquire
the merchandise that include the purchase of
the merchandise, the transportation costs,
insurance etc.
 Manufacturing – Costs incurred to
manufacture the product
o Include materials, labor and factory
overhead
o Product costs of the units sold are
recognized as expenses (as Cost of Goods
Sold) while product costs of the unsold
units become the costs of the inventory
o Direct materials, direct labor and factory
overhead are examples of product costs
o Where
 DM = Direct Material
DL = Direct Labor
Period Costs
FOH = Factory Overhead
 Non-manufacturing costs
 Includes selling, administrative, and
research and development costs
 There are costs that are expensed in the
period of incurrence and do not become part
of the cost of inventory
Functions of Costs
Manufacturing Costs
 Manufacturing costs are those costs needed
to manufacture the products
 Includes the costs of raw materials, labor
and factory overhead
Non-Manufacturing Costs
 Are not related to the manufacturing
processes
 Includes selling expenses, administrative
expenses, finance costs
Traceability of
Costs
Direct Cost
 Related to a particular cost object and can
economically and effectively be traced to
that object
 Examples: Direct Materials, Direct Labor
 Note that a cost object can be a product or a
division in an entity
 If a cost object is a product, for instance, a
chair, the wood which is a direct material
 can be traced directly that it is used solely to o Costs to purchase non-current assets such
manufacture the chair and not to other as land, building and equipment
product Revenue Expenditures
 Factory overhead can be direct and indirect  Costs incurred to benefit only one period
costs depending on the cost object  For short term purposes only
o If a cost object is a division in an entity,  Examples
for instance, the production department, o Costs of goods sold
the salary of the supervisor of this o Operating expenses
department which is a factory overhead  Called “Revenue Expenditures" because
can be either direct or indirect costs these are charged or deducted in the revenue
o But if the cost object is the production earned during the period to arrive at the
department, the salary is considered a profit or loss for the period
direct cost of the department because it
can be effectively traced that it is
incurred solely in this department
Behavior (Reaction
Indirect Costs
 Also related to a cost object to Changes in Cost
 Cannot practically, economically and
effectively be traced to such cost object
 Cost assignment is done by allocating the
Driver)
indirect cost to the related cost objects  Cost Driver is anything that causes the
 Examples incurrence of a cost
o “Some” factory overhead items that o Units of product
cannot be economically and effectively o Direct labor cost
traced to a cost object (indirect factory o Direct labor hours
overhead) o Units of materials
o Machine hours
Decision Making  Not all types of cost will automatically
react/change whenever there is a change in
 Relevant Costs – Future costs that will the cost driver. It depends whether it is a
differ under alternative courses of action variable or a fixed cost or a combination of
 Differential Costs – Differences in costs these two
between any two alternatives courses of Variable Cost
action  Remains constant on a per-unit basis but
o Incremental Cost – Increase in cost from varies in total with changes in activity
one alternative to another  Examples
o Decremental Cost – Decrease in cost o Direct material
from one alternative to another o Direct labor
 Opportunity Costs – Income or benefit Fixed Cost
given up when on alternative is selected  Remains constant in total but varies on a per
over another unit basis with changes in activity
 Sunk, Past or Historical Costs – Already  Examples
incurred and cannot be changed by any o Straight-line depreciation
decision made now or to be made in the
o Insurance
future
o Supervisor’s salary
Accounting Periods  Committed Fixed Cost
o Results from an organization’s ownership
Capital Expenditures or use of facilities and its basic
 Costs incurred to benefit several periods organizational structure (e.g. property
 For long-term purposes taxes, depreciation)
 Examples
 o Called committed because an  Advertising costs
organization cannot avoid the incurrence  Contributions to charitable institutions
of this type of cost  Mixed Cost
o If an organization purchased machinery, o Combination of variable and fixed costs
the depreciation of this asset is o Partly variable and partly fixed
committed to the incurred until the end of o Example: Electricity bills
its useful life
 Discretionary Fixed Cost
o Is a cost that can be cut back easily in bad
Cost Behavior
 Refers to the way costs change with respect
economic times without doing serious
to a change in the activity level (sometimes
harm to organizational goals and
called cost driver), such as production or
objectives
sales volume, labor or machine hours, etc.
o Called discretionary because the
 There are costs which remain constant, some
incurrence of this cost depends on the
change directly or proportionately with the
discretion of the management, therefore,
activity level and other change in different
not committed
patterns
o Examples
Types of Cost Total Amount Amount Per Unit
Fixed Constant Decreases as production increases
Variable Increases as production increases Constant
Increases less proportionately (vs. Decreases less proportional (vs.
Mixed total variable costs) as production fixed cost per unit) as production
increases) increases

Cost Behavior
Assumptions
Relevant Range Assumptions
 Range of activity over which a variable cost
remains constant on a per unit basis and a
fixed cost remains constant in total
 Managers can review the various ranges of
activity and the related effects on variable
costs (per-unit) and fixed cost in (in total) to
determine how a change in the range will
affect costs and, thus, the firm’s profitability
 For instance, a company sets the relevant
range as 5,000 units to 15,000 units. 5,000
units means the lowest level of activity and
15,000 units is the highest level of activity
o At this range, the company can expect the
assumptions for total fixed cost and
variable cost per unit. Any activity level
below or above the relevant range can
changes these assumptions (e.g., total
fixed costs or variable costs many
change)
o To explain further, using the relevant
range 5,000 units to 15,000 units, 15,000
units means the maximum capacity or the
maximum number of units the company
can produce for a certain period. A
company desires to produce 20,000units
for the next period
o Obviously, this will be impossible to
happen using its present machinery,
facility etc.
o Therefore, the company will be
committed to purchase additional
machinery or rent additional facility to
produce the additional 5,000 unit. And if
there is additional machinery, there will
be additional depreciation that results to
additional fixed costs. Or if there is
additional facility to rent, there will also
be additional rent expenses that leads to
additional fixed cost again
Time Assumption
 The cost behavior patterns identified are true
only over a specified period of time
 Beyond this, the cost may show a different period of time even within the relevant
cost behavior pattern range
 Meaning to say for example, prices of direct
materials and wages paid to direct labor are Linearity Assumption
not expected to remain constant over a long
 The cost is assumed to manifest a linear
relationship over a relevant range despite its
tendency to show otherwise over the long
run