Chapter 1 INTRODUCTION TO COST MANGEMENT

Intended Learning Outcomes:

1. Described the nature of cost.
2. Explained the relationships behavior cost estimation, cost behavior, and cost segregation methods.
3. Identified and explain the various classifications of costs.

WhatdowemeanbyaCost?Expenses?

- A cost may be defined as the sacrifice made, usually measured by the resources given up, to achieve
a particular a particular purpose.
- Technically, costs are those incurred in producing or obtaining resources. These expenditures relate
to the transaction between the company and its suppliers.
- Expenses are those incurred in administering and selling goods and services. These expenditures
relate to the transaction between the company and its customers and those incurred in the
administrative services.

COST POOLS
- Are costs collected into meaningful groups. Cost pools may be classified:
a. by type of cost (labor cost in one pool, materials costs in another)
b. by source (department 1, department 2 and so on)
c. by responsibility (manager 1, manager 2 and so on)

COST OBJECT
- Any product, service or organizational unit to which costs are assigned for some management
purposes. Productsandservicesaregenerallycostobjects,whilemanufacturingdepartmentsare
consideredeithercostpoolsorcostobjects,dependingonwhethermanagement’smainfocusison thecostsoftheproductsorfortheproductiondepartment.

COST ALLOCATION AND CLASSIFICATION

- Cost assignment is the process of assigning costs to pools or from cost pools to cost objects.
- Cost allocation is the assignment of indirect costs to cost pools.
- Allocation bases are cost drivers used to allocate costs.
DISCUSSION:
A. Cost classified by Nature or Management Function

Manufacturing Costs
Manufacturing costs are all the costs associated with production of goods. They are frequently classified as
direct materials, direct labor, and factory overhead.

Direct materials – All raw material costs that become an integral part of the finished product and
that can be conveniently and economically assigned to specific units manufactured.
Direct Labor – All labor costs related to time spent on products that can be conveniently and
economically assigned to specific units manufactured.
Manufacturing Overhead – Includes all costs of manufacturing except direct materials and direct
labor.
Indirect materials, indirect labor, property taxes, insurance, supervisor’s salaries, depreciation of factory
building and factory equipment, and power are examples of factory overhead.

 Indirect materials – include materials and supplies used in the manufacturing operation that
do not become part of the product, such as oil for the machinery and cleaning fluids for the
custodian.
 Indirect labor – Labor costs that cannot be identified or traced to specific units manufactured.
 Other manufacturing overhead costs – include overtime premiums and the cost of idle
time. An overtime premium is the extra compensation paid to an employee who works
beyond the time normally scheduled.

To summarize, manufacturing costs include direct materials, direct labor and manufacturing overhead.
Direct labor and overhead are often called conversion costs since they are the costs of ‘converting or
transforming’ raw material into finished products. Direct materials and direct labor are often referred to
as prime costs.

Non-manufacturing Costs
Non-manufacturing costs generally include costs related to selling and other activities not related to the
production of goods

Marketing costs - Marketing or Selling costs include all costs associated with marketing or selling a
product or all costs incurred by the marketing division from the time the manufacturing process is
completed until the product is delivered to the customer or all costs necessary to secure customer orders
and get the finished product or service into to hands of the customer.

General and administrative costs - include all executive, organizational and clerical costs
associated with the general management of the organization rather with manufacturing, marketing or selling.
Figure1.CostClassifications

Nature or Manufacturing costs

Management Nonmanufacturing
Function costs

Timing of Recognition
as Expense Product (Inventoriable costs)
Period costs

Financial Statements Statement of Financial

Position (Inventory costs)
Income statement (COS/OPC)
Cost Behavior Variable costs
Fixed costs
Types of Inventory Semivariable
costs
Raw materials inventory
Work in process
Cost Data Traceability to Cost inventory Finished goods
inventory

Direct cost Indirect costs

Managerial Influence
Controllable costs
Non-controllable costs

Standard costs
Budgeted
costs
Planning and Control Absorption costing/full costing
Direct costing/variable costing
Information costs
Ordering costs
Out-of-pocket
costs
Time frame/Commitment
to Cost Expenditure Committed costs
Discretionary
costs
Period of Incurrence

Historical costs
Future costs
Decision Making and
Other Analytical Purposes
Relevant costs
Future/Differential
Sunk costs
Opportunity
costs
Marginal costs/Value added costs

B. Costs classified according to the timing of recognition as

expense Product costs

A Product Cost is a cost assigned to goods that were either purchased or manufactured for resale. Also
called inventoriable costs, they are costs that ‘attach’ or cling to the units that are produced and are
reported as assets until the goods are sold. In the period of the sale, the product costs are recognized as
an expense called Cost of goods sold. The product cost of merchandise inventory acquired by a retailer
or wholesaler for resale consists of the purchase cost of the inventory plus any shipping charges. The
product cost of manufactured inventory includes all of the costs incurred in its manufacture.

Period costs

Period costs are all the costs that are identified with accounting periods and not included in product
costs. These costs are expensed on the income statement in the period in which they are incurred.
Period costs are not included as part of the cost of either purchased or manufactured goods.
C. Costs classification on Financial

Statements The Statement of Financial

Position

The statement of financial position of a manufacturing company is similar to that of a merchandising

company. However, the inventory accounts differ between the two types of companies.
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