COST TERMS,

CONCEPTS AND
CLASSIFICATIONS
BACOSTMX MODULE 1, PART 2
 Describe Cost Management System

Enumerate
and The different classification of costs
discuss
LEARNING
OUTCOMES
Discuss The Product Cost Flow

Statement of Cost of Goods Manufactured, Statement of

Prepare Cost of Goods Sold and Income Statement

COST ACCOUNTING AND CONTROL

 LEARNING OUTCOME 1
DESCRIBE COST
MANAGEMENT SYSTEM

COST ACCOUNTING AND CONTROL

 COST MANAGEMENT SYSTEM is a set of formal
methods developed for planning and controlling an
organization’s cost generating activities relative to its
strategy, goals and objectives.

COST This system is designed to communicate all value chain

functions about product costs, product profitability, cost
MANAGEMENT and management, strategy implementation and
SYSTEM management performance.

Cost concepts and terms have been developed to facilitate

this communication process.

COST ACCOUNTING AND CONTROL

 ENUMERATE AND DISCUSS THE
LEARNING OUTCOME 2
DIFFERENT CLASSIFICATION OF
COSTS

COST ACCOUNTING AND CONTROL

 COST

Monetary measure of
resources given up to
attain an objective
(such as acquiring a
good or delivering a
service)

COST ACCOUNTING AND CONTROL

 Association with cost object

• Cost object is anything for which

management wants to collect or accumulate
costs (e.g. production operations and
COST product lines)
CATEGORIES
Reaction to changes in activity

Classification on the financial

statements

COST ACCOUNTING AND CONTROL

 Association with cost object

Reaction to changes in activity /

Cost Behavior
COST
CATEGORIES Classification on the financial
statements

Cost Classification for Decision

Making

COST ACCOUNTING AND CONTROL

ASSOCIATION WITH A COST OBJECT

 Direct—conveniently and economically traceable to a cost object (e.g. Cost Object:

Tundra car product line – tires, fiberglass, leather, paint)
 Indirect—not conveniently or practically traceable to a cost object (e.g. Cost
Object: Tundra car product line - cost of glue, property tax, janitorial maintenance,
building depreciation costs)
 Treated as overhead
 Allocated

COST ACCOUNTING AND CONTROL

 DIRECT COSTS ARE OFTEN
DIFFICULT TO TRACE TO THE
TRUE OR FALSE
SPECIFIC COST OBJECT
UNDER CONSIDERATION

COST ACCOUNTING AND CONTROL

 Association with cost object

Reaction to changes in activity /

Cost Behavior
COST
CATEGORIES Classification on the financial
statements

Cost Classification for Decision

Making

COST ACCOUNTING AND CONTROL

REACTION TO CHANGES IN ACTIVITY

 Variable – a cost that varies in total in direct proportion to

changes in activity (e.g. costs of materials, hourly wages, and sales
commissions)
 Fixed – a costs that remains constant in total within the relevant
range of activity (e.g. salaries, depreciation using straight-line
method, insurance)
Relevant Range—normal operating range
COST ACCOUNTING AND CONTROL
REACTION TO CHANGES IN ACTIVITY

 Mixed – has both a variable and fixed component. On a per unit basis, it
does not fluctuate in direct proportion to changes in activity, nor does it
remain constant with changes in activity.
 (e.g. electric bill - $5,000/month plus $0.018 per kwh)

COST ACCOUNTING AND CONTROL

 REACTION TO CHANGES IN ACTIVITY

 Step – shifts upward or downward when activity changes by a certain

interval or “step”. Step variable costs have small steps; Step fixed costs
have large steps.
Step Fixed Costs
Step Variable Costs
No. of supervisor No. of workers Supervisor salaries
per gallon gallons
$0.002 Up to 1,000 1 supervisor 10 workers $5,000/supervisor
$0.003 1,001 – 2,000 2 supervisors 15 workers $10,000
$0.005 2,001 – 3,000 3 supervisors 22 workers $15,000
COST ACCOUNTING AND CONTROL
  Common activity measures include
production volume, service and sales
ACTIVITY
volumes, hours of machine time used, pounds
MEASURES of material moved, and the number of
purchase orders processed.

COST ACCOUNTING AND CONTROL

 COST REACTION TO CHANGES IN ACTIVITY

$
$
 Variable cost  Fixed Cost

# of Units # of Units
Within the relevant
range
COST ACCOUNTING AND CONTROL
 COST REACTION TO CHANGES IN ACTIVITY
 Variable cost  Fixed Cost

$ Total
$
Total
# of Units # of Units

Unit $ Unit $

# of Units # of Units
COST ACCOUNTING AND CONTROL
Within the
relevant range
 TOTAL AND UNIT COST BEHAVIOR

Total Cost Unit Cost

Varies in direct Remains constant

Variable
proportion to throughout the
Cost
changes in activity relevant range

Fixed Varies inversely

Remains constant
Cost with changes in
throughout
activity throughout
the relevant range
the relevant range
COST ACCOUNTING AND CONTROL
COST REACTION TO CHANGES IN ACTIVITY

 Step Cost (fixed)  Mixed Cost

variable
$ $
fixed
# of Units # of Units

Within the
COST ACCOUNTING AND CONTROL
relevant range
 A VARIABLE COST IS
CONSTANT IF EXPRESSED
ON A PER UNIT BASIS BUT
TRUE OR FALSE THE TOTAL DOLLAR
AMOUNT CHANGES AS THE
NUMBER OF UNITS
INCREASES OR DECREASES.

COST ACCOUNTING AND CONTROL

 AS ACTIVITY INCREASES
WITHIN THE RELEVANT
TRUE OR FALSE RANGE, FIXED COSTS
REMAIN CONSTANT ON A
PER UNIT BASIS.

COST ACCOUNTING AND CONTROL

 Association with cost object

Reaction to changes in activity /

Cost Behavior
COST
CATEGORIES Classification on the financial
statements

Cost Classification for Decision

Making

COST ACCOUNTING AND CONTROL

CLASSIFICATION ON THE FINANCIAL STATEMENTS

UNEXPIRED—BALANCE EXPIRED—INCOME
SHEET ASSETS STATEMENT EXPENSES
COST ACCOUNTING AND CONTROL
CLASSIFICATION ON THE FINANCIAL STATEMENTS

Product—inventoriable costs Period—expensed in period

incurred
Prime—direct material and direct labor
Conversion—direct labor and overhead
Product costs are unexpired before sale
Product costs are expired when sold

COST ACCOUNTING AND CONTROL

PRODUCT COSTS
 Product costs
 Direct material—Measurable part of a product; any material that can be easily and
economically traced to a product
 Direct labor—Labor used to manufacture a product or perform a service; time
spent by individuals who work specifically on manufacturing a product or
performing a service
 Overhead—Indirect production cost

 First appear on the balance sheet in inventory accounts

 Transferred to the income statement when product is sold
COST ACCOUNTING AND CONTROL
CLASSIFICATIONS OF COSTS
Manufacturing costs are often
classified as follows:
Direct Direct Manufacturing
Material Labor Overhead

Prime Conversion
Cost Cost
COST ACCOUNTING AND CONTROL
PERIOD COSTS

 Period costs
 Selling and administrative costs
 Distribution costs
 Cost to warehouse, transport, and/or deliver a product or service

 Appear on the income statement when incurred

 Expensed when incurred
COST ACCOUNTING AND CONTROL
PRODUCT COSTS VERSUS PERIOD COSTS

Product costs include Period costs include all

direct materials, direct selling costs and
labor, and administrative costs.
manufacturing
overhead.
Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet
COST ACCOUNTING AND CONTROL
Statement Statement
 THE CONVERSION PROCESS

 Change inputs into outputs

COST ACCOUNTING AND CONTROL

THE CONVERSION PROCESS

Purchase Product or
Input Service Output
raw materials
or supplies

CONVERSION

COST ACCOUNTING AND CONTROL

DEGREES OF CONVERSION
Low Moderate High
Moderate
 High
 Low
 Manufacturing
 Department stores
 Construction
 Gas stations
 Agriculture
 Jewelry stores
 Architecture
 Travel agencies
 Auditing
 Moderate  Mining
 Florists  Printing
 Meat markets  Restaurants
 Oil-change businesses
COST ACCOUNTING AND CONTROL
SERVICE COMPANY

Purchase
Input supplies
Significant amount of labor
Tangible or intangible output

Use supplies,
labor, overhead
to provide service
Output
Sell to
customer
COST ACCOUNTING AND CONTROL
RETAIL COMPANY

Input Output
Purchase Warehouse
products and/or display
for resale

Purchase finished goods Resell Sell to

to customers customer

COST ACCOUNTING AND CONTROL

MANUFACTURER

Input Output
Purchase Finished
raw materials product
and supplies
Production
Center
add labor and Sell to
overhead customer

Significant amount of labor and machinery

COST ACCOUNTING AND CONTROL

Tangible output
COST ACCUMULATION IN A MANUFACTURING COMPANY

Materials
Inventory

Work in Process
Inventory
Finished Goods Cost of
Inventory Goods Sold
Income
Balance Sheet Statement
COST ACCOUNTING AND CONTROL
  Direct Material
 Conveniently and economically traced

PRODUCT
to cost object
 Direct Labor

COST—  To manufacture a product or perform

a service

DIRECT
 Includes wages paid to direct labor
employees, production bonuses, payroll
taxes
 May include holiday and vacation pay,
insurance, retirement benefits

COST ACCOUNTING AND CONTROL

  Overhead—indirect production costs
 Fringe benefits, if cannot be easily

PRODUCT traced to product

 Overtime, if due to random scheduling

COST—  Cost of quality

 Prevention costs

INDIRECT  Appraisal costs

 Failure costs

COST ACCOUNTING AND CONTROL

PRODUCT  Direct Material - Variable

COST  Direct Labor - Variable

BEHAVIOR  Overhead - Variable, fixed, or mixed

COST ACCOUNTING AND CONTROL

 THREAD USED IN THE
PRODUCTION OF
MATTRESSES, AN INDIRECT
TRUE OR FALSE
MATERIAL, IS CLASSIFIED AS
MANUFACTURING
OVERHEAD.

COST ACCOUNTING AND CONTROL

 Association with cost object

Reaction to changes in activity /

Cost Behavior
COST
CATEGORIES Classification on the financial
statements

Cost Classification for Decision

Making

COST ACCOUNTING AND CONTROL

DIFFERENTIAL COST AND REVENUE

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: Differential cost is:

$2,000 – $1,500 = $500 $300

COST ACCOUNTING AND CONTROL

OPPORTUNITY COST

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.

COST ACCOUNTING AND CONTROL

SUNK COSTS

Sunk costs have already been incurred and cannot be changed now or in
the future. These costs 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.

COST ACCOUNTING AND CONTROL

 ALL OF THE FOLLOWING ARE EXAMPLES
OF OPPORTUNITY COSTS: SALARY
GIVEN UP TO START A BUSINESS; RENTAL
INCOME GIVEN UP WHEN YOU LIVE IN A
TRUE OR FALSE HOUSE YOU OWN; INTEREST INCOME
THAT COULD BE EARNED ON MONEY
SPENT FOR A CAR.

COST ACCOUNTING AND CONTROL

 DISCUSS THE PRODUCT
LEARNING OUTCOME 3
COST FLOW

COST ACCOUNTING AND CONTROL

COST ACCOUNTING AND CONTROL
  Raw Materials Inventory XXX
 Accounts Payable XXX

FLOW OF  Work in Process Inventory XXX

PRODUCT
 Raw Materials Inventory XXX

COSTS
 Work in Process Inventory XXX
 Variable Overhead Control XXX
 Fixed Overhead Control XXX
 Salaries/Wages Payable XXX
FLOW OF  Variable Overhead Control
 Fixed Overhead Control
XXX
XXX

PRODUCT  Utilities Payable

 Supplies Inventory
XXX
XXX

COSTS 

Accumulated Dep.–Equipment
Other accounts
XXX
XXX
  Work in Process Inventory XXX
 Variable Overhead Control

FLOW OF
XXX
 Fixed Overhead Control
XXX
PRODUCT
COSTS
 Finished Goods Inventory XXX
 Work in Process Inventory
XXX
 Flow of Product Costs

Accounts Receivable XXX Matches

Sales XXX revenues and
expenses on
Cost of Goods Sold XXX the income
Finished Goods Inventory XXX statement
 PREPARE STATEMENT OF
COST OF GOODS
LEARNING OUTCOME 4
MANUFACTURED, STATEMENT
OF COST OF GOODS SOLD
AND INCOME STATEMENT

COST ACCOUNTING AND CONTROL

 STATEMENT OF COST OF GOODS
MANUFACTURED—RAW MATERIALS USED

 Beginning balance $ 73,000

 Purchases of materials 280,000
 Raw materials available $353,000
 Ending balance <69,000>
 Total raw materials used $284,000

To Statement of Cost of Goods Manufactured

COST ACCOUNTING AND CONTROL
 STATEMENT OF COST OF GOODS
MANUFACTURED
 Beginning work in process $145,000
 Raw materials used $284,000
 Direct labor 436,000
 Variable overhead 115,200
 Fixed overhead 98,880
 Current period manufacturing costs 934,080
 Total costs to account for $1,079,080
 Ending work in process <20,880>
 Cost of goods manufactured
COST ACCOUNTING AND CONTROL
$1,058,200
 SCHEDULE OF COST OF GOODS SOLD

 Beginning Finished Goods $ 87,400

 Cost of Goods Manufactured 1,058,200
 Cost of Goods Available for Sale $1,145,600
 Ending Finished Goods <91,600>
 Cost of Goods Sold $1,054,000

From Schedule of Cost of Goods Manufactured

COST ACCOUNTING AND CONTROL

INCOME STATEMENT

 Revenue XXXX
 Cost of Goods Sold <1,054,000>
 Gross Profit XXXX
 Operating Expenses <XXXX>
 Operating Income XXXX

From Schedule of Cost of Goods Sold

COST ACCOUNTING AND CONTROL

 THE COST OF GOODS SOLD OF
A MANUFACTURING COMPANY
EQUALS BEGINNING FINISHED
TRUE OR FALSE GOODS INVENTORY + COST OF
GOODS MANUFACTURED -
ENDING FINISHED GOODS
INVENTORY.

COST ACCOUNTING AND CONTROL

  Psalms 28:7
 The Lord is my strength and my shield; my
VERSE OF THE DAY heart trusted in Him, and I am helped:
therefore my heart greatly rejoice; and with
my song will I praise Him.

COST ACCOUNTING AND CONTROL

REFERENCES:

 Raiborn and Kinney (2011) Cost Accounting: Foundations and Evolution 8th edition,
Cengage Learning
 Hansen, Don R. and Mowen, Maryanne M. (2018) Cost Accounting and Control.
Cengage Learning: Boston, USA.
 Garrison, Noreen, and Brewer (2010) Cost Accounting and Control 13th edition,
McGraw-Hill

COST ACCOUNTING AND CONTROL