02: COST CONCEPTS & CLASSIFICATIONS

DIFFERENT COSTS FOR DIFFERENT PURPOSES (Classification of Costs)

A. ACCORDING TO GENERALLY ACCEPTED ACCOUNTING TREATMENT

1. PRODUCT COSTS – costs incurred to manufacture the product 
 Product costs of the units sold during the period are recognized as expense (cost of
goods sold) in the income statement
 Product costs of the unsold units become the costs of inventory and treated as asset
in the balance sheet 
2. PERIOD COSTS – the non-manufacturing costs that include selling, administrative, and
research and development costs. These costs are expensed in the period of incurrence
and do not become part of the cost of inventory. 

B. ACCORDING TO FUNCTION
1. MANUFACTURING COSTS – all the costs incurred in the factory to convert raw materials
into finished goods
1. Direct Manufacturing Costs – materials and labor
2. Indirect Manufacturing Costs – the manufacturing overhead or factory overhead
costs
b. NON – MANUFACTURING COSTS – all costs which are not incurred in transforming
materials to finished goods
1. Research and Development – incurred in designing and bringing new products to
the market
2. Marketing Costs – advertising and promotion expenses
3. Distribution Costs -  costs incurred in delivering the products to the customers 
4. Selling Costs – salaries and commission of sales staff and other selling expenses 
5. After-sales Costs – costs incurred in dealing with customers after sales. Examples
are warranty, repairs costs and costs incurred in receiving/entertaining/acting on
customers’ complaints 
6. General and Administrative Costs – all the non-manufacturing costs that do not fall
under categories (a) to (e).

C. AS TO TRACEABILITY / ASSIGNMENT TO COST OBJECT

1. DIRECT COSTS – costs that are related to a particular cost object and can
economically and effectively be traced to that cost object.
2. INDIRECT COSTS - costs that are related to a cost object, but cannot practically,
economically, and effectively be traced to such cost object. Cost assignment is done by
allocating the indirect cost to the related cost objects.

D. ACCORDING TO MANAGERIAL INFLUENCE 

1. CONTROLLABLE COST- cost which are likely to respond with the attention devoted to
them by the specified manager.
2. NON-CONTROLLABLE COST- cost which are likely not to respond with the attention
devoted to them by a specified manager

E. ACCORDING TO COMMITMENT TO COST EXPENDITURE

1. DISCRETIONARY COST- cost which management decides to incur in the current
period to enable the company to achieve objectives other than filling of orders placed by
customer
2. COMMITTED COST- cost which are governed mainly by past decisions that establish
the present levels of operating and organizational capacity and which only change
slowly in response to small changes in capacity
 F. FOR DECISION – MAKING 
1. RELEVANT COSTS - future costs that will differ under alternative courses of action.
2. DIFFERENTIAL COSTS – difference in costs between any two alternative courses of
action
1. Incremental Costs – increase in cost from one alternative to another
2. Decremental Costs – decrease in cost from one alternative to another
b. OPPORTUNITY COSTS – income or benefit given up when one alternative is selected
over another
c. SUNK / PAST, OR HISTORICAL COSTS - already incurred and cannot be changed by
any decision made now or to be made in the future.

G. AS TO BEHAVIOR (REACTION TO CHANGES IN COST DRIVER)

1. VARIABLE COST – within the relevant range and time period under consideration, the
total amount varies directly to the change in activity level or cost driver, and the per unit
amount is constant.
2. FIXED COST – within the relevant range and time period under consideration, the total
amount remains unchanged, and the per unit amount varies inversely or indirectly with the
change in the cost driver.
1. Committed Fixed Costs – long term in nature and cannot be eliminated even for a
short period of time without affecting the profitability or long-term goals of the firm.
Example: depreciation of buildings and equipment
b. Discretionary or Managed Fixed Costs – usually arise from periodic (may be annual,
etc.) by management to spend in certain fixed costs area such as research,
advertising, maintenance contracts. Discretionary fixed costs may be changed by
management from period to period or even during (within) the period, if
circumstances demand such change.
Examples: research and development costs, advertising expense, maintenance
costs provided by service contractors 

3. MIXED COST – this cost has both a variable and fixed component.

* RELEVANT RANGE – a range of activity that reflects the company’s normal operating
range. Within this relevant range, the cost behavior given above is valid, i.e.:

TOTAL AMOUNT PER COST DRIVER

VARIABLE COST Varies directly with cost Constant
driver
FIXED COST Constant Varies inversely with cost driver

Splitting Mixed Costs

a. High–low method – based on costs observed at both the high and low levels of activity within
the relevant range.
b. Least square regression – a line of regression is determined by solving two simultaneous
equations which are based on the condition that the sum of deviations above the line equals
the sum of deviations below the line.
Simple regression – only two variables are involved; one dependent variable and one independent
variable.
Multiple regressions – only one dependent variable is involved but more than one independent
variables are considered.

The equations used to determine the equation for the least squares regression line
Ey   = na + bEx
Exy = Exa + bEx 2
 Correlation Analysis – a technique used to measure the strength of the linear relationship
between two or more variables.
Coefficient of Correlation (r) – measures the relative strength of the linear relationship
-1.0 <r  < 1.0
= a value of -1.0 indicates a perfectly inverse linear relationship between x and y
= a value of 0 indicates no linear relationship between x and y
= a value of 1.0 indicates a direct relationship between x and y

Coefficient of Determination (r2) – amount of variation in the dependent variable explained by

the independent variable.

STRAIGHT PROBLEM: COST CLASSIFICATION 

The company began its operation several years ago. The company purchased a building and since
only half of its space is needed for its operation, the remaining space was rented to another firm for a
revenue of P15,000 per month. 

Presented below are Cricket Company’s monthly manufacturing cost data related to its pencil
product.

Depreciation of pencil painting P10,000

machinery
Lead inserted into pencils 1.5/unit
Factory utilities 8,000
Wages of assembly line worker 20,000
Salary of supervisor 10,000
Factory machinery maintenance 7,000
Wood 3/unit
Eraser compound 1/unit

They incurred P16,000 per month to sold its product to the market. The company plans to
liquidate several investments in order to expand production, this investment currently earned return of
P10,000 per year

Instructions
Enter each cost item in the following table, placing an ‘X’ under the appropriate headings.

DM D MO PRODUCT.C PERIO.C VC FC
L
a.  Rental revenue
b. Depreciation of pencil painting
machinery
c. Lead inserted into pencils
d. Factory utilities
e. Wages of assembly line worker
f. Salary of supervisor
g. Factory machinery maintenance
h Wood
i. Eraser compound
j. Marketing cost
MULTIPLE CHOICE QUESTIONS

1. Both direct materials and indirect materials are

A. raw materials.
B. manufacturing overhead.
C merchandise inventory.
.
D sold directly to customers by a manufacturing company.
.

2. The work of factory employees that can be physically and directly associated with converting
raw materials into finished goods is
A manufacturing C indirect labor.
. overhead. .
B indirect materials D direct labor.
. .

3. Which one of the following would not be classified as manufacturing overhead?

A Indirect labor C. Insurance on factory building
.
B Direct D. Indirect materials
. materials

4. Manufacturing costs include

A. direct materials and direct labor only
B. direct materials and manufacturing overhead only.
C direct labor and manufacturing overhead only.
.
D direct materials, direct labor, and manufacturing overhead.
.

5. Which one of the following is not a direct material?

A. A tire used for a lawn mower
B. Plastic used in the covered case for a home PC
C Steel used in the manufacturing of steel-radial tires
.
D Lubricant for a ball-bearing joint for a large crane
.

6. Which one of the following is not a cost element in manufacturing a product?

A Manufacturing overhead C Office salaries
. .
B Direct materials D Direct labor
. .

7. A manufacturing process requires small amounts of glue. The glue used in the production
process is classified as a(n)
A period cost. C. direct material.
 .
B indirect D. miscellaneous expense.
. material.

8. The wages of a timekeeper in the factory would be classified as

A a period cost. C indirect labor.
. .
B direct labor. D compliance costs.
. .

9. Which one of the following is not considered as material costs?

A. Partially completed motor engines for a motorcycle plant
B. Bolts used in manufacturing the compressor of an engine
C Rivets for the wings of a new commercial jet aircraft
.
D Lumber used to build tables
.

10. Which of the following is not a manufacturing cost category?

A Cost of goods sold C Direct labor
. .
B Direct materials D Manufacturing overhead
. .

11. As current technology changes manufacturing processes, it is likely that direct

A labor will increase. C. materials will increase.
.
B labor will D. materials will decrease.
. decrease.

12. For the work of factory employees to be considered as direct labor, the work must be
conveniently and
A. materially associated with raw materials conversion
B. periodically associated with raw materials conversion.
C physically associated with raw materials conversion.
.
D promptly associated with raw materials conversion.
.

Reference, for questions 13-15:

Rymore Company would like to classify the following costs according to their cost behavior:

July     August
Sales in 1,500 1,600
units..   
Cost A P35,000 P36,000
Cost B 16,000 16,000
Cost C 67,500 72,000

13. Which of the following classifications best describes the behavior of Cost A?
A Mixed. C Fixed
. .
B Variable. D none of the above.
. .

14. Which of the following classifications best describes the behavior of Cost B?
A Mixed. C Fixed
. .
B Variable. D none of the above.
. .

15. Which of the following classifications best describes the behavior of Cost C?
A Mixed. C Fixed
. .
B Variable. D none of the above.
. .

For questions 16-18:

Belle Company produces and sells rattan baskets. The number of units produced and the
corresponding total production costs for 6 months, which are representatives for the year, are as
follows:

Month Units Produced Production Costs

April 500 P4,000
May 700 8,000
June 900 6,000
July 120 900
August 800 8,500
Septembe 550 7,250
r
October  600 7,500

Based on the given information and using the least squares method of computation, select the best
answer for each question.

16. If the high-low points method is used, compute for the variable cost per unit.

A P5 C. P4.5
.
B P4 D. P3.70
.

17. If the high-low points method is used, compute the total fixed cost.
A P3000 C P5,500
. .
B P6,500 D P7,200
. .

18. If the company is planning to produce 800 units for the month of November, compute the
estimated production cost
 A P900 C. P1,5000
.
B P2,000 D. P1,750
.

For questions 19-22:

The following activity and cost data were provided by Hammer Corp., which would like help in
estimating its future maintenance costs:

Unit Maintenance Cost

s
3 P450
7 530
11 640
15 700

Where:
Y = total monthly production costs
X = number of units produced per month
A = fixed production cost per month
B = variable production cost per unit
N = number of month
∑ = summation

19. If the least squares method is to be used to segregate the variable and fixed cost components
of the total production costs, the equation(s) required to express the relationship between fixed
and variable costs are
A. ∑y = na = b∑x and ∑xy = a∑x +b∑x 2

B. ∑xy = a∑x + b∑x 2

C ∑y = na + b∑x
.
D Y =a + b∑x and ∑y na +b∑x
2

20. Using the least squares method, the variable maintenance cost per unit is approximately
A P21.5 C. P22
.
B P23.5 D. P19.5
.
21. Using least squares method, the monthly fixed maintenance cost is approximately
A P300 C P455
. .
B P386.5 D P235.5
. .

22. Using the least-squares regression method to estimate the cost formula, the expected total
cost for an activity level of 10 units would be closest to:
A P612.50. C P595.84.
. .
B P581.82. D P601.50.
. .
 23. Average maintenance costs are P1.50 per machine-hour at an activity level of 8,000 machine-
hours and P1.20 per machine-hour at an activity level of 13,000 machine-hours. Assuming that
this activity is within the relevant range, total expected maintenance cost for a budgeted
activity level of 10,000 machine-hours would be
A P16,128. C P13,440.
. .
B P15,000. D P11,433.
. .

24. Total production costs for Jordan, Inc. are budgeted at P2,300,000 for 50,000 units of
budgeted output and P2,800,000 for 60,000 units of budgeted output. Because of the need for
additional facilities, budgeted fixed costs for 60,000 units are 25 percent more than budgeted
fixed costs for 50,000 units. How much is Jordan’s budgeted variable cost per unit of output?

A P7.50 C P30.00
. .
B P16 D P62.50
. .

25. A cost driver is:

A. the largest single category of cost in a company.
B. a fixed cost that cannot be avoided.
C a factor that causes variations in a cost.
.
D an indirect cost that is essential to the business.
.

26. An example of a cost that is variable with respect to the number of units produced and sold
is:
A. insurance on the headquarters building.
B. power to run production equipment.
C supervisory salaries.
.
D depreciation of factory facilities.
.

(For items 27-29) In the O'Donnell Manufacturing Company, at an activity level of 80,000 machine
hours, total overhead costs were P223,000. Of this amount, utilities were P48,000 (all variable) and
depreciation was P60,000 (all fixed). The balance of the overhead cost consisted of maintenance
cost (mixed). At 100,000 machine hours, maintenance costs were P130,000.
Assume that all of the activity levels mentioned in this problem are within the relevant range.

27. The variable cost for maintenance per machine hour is:
A P1.30. C P0.75.
. .
B P1.44. D P1.35.
. .

28. The total fixed overhead cost for O'Donnell is:

A P115,000. C P 60,000.
. .
B P130,000. D P 55,000.
. .
 29. If 110,000 machine hours of activity are projected for next period, total expected overhead
cost would be:
A P256,000 C. P306,625.
.
B P263,500 D. P242,500.
. .

30. At 40% capacity, overhead cost is P 1,450; at 75% capacity, overhead cost is P 2,150.
Determine the variable overhead cost at 80% capacity.
A P 20 C. P 1,600
.
B P 650 D. P 2,250
.

31. Why is equity capital generally more expensive than debt financing?
A. Interest on bonds is a legal obligation
B. Dividends fluctuate more than interest rates
C Investors expect to be paid more for exposure to higher risk
.
D Investors have a greater demand for equity investments than for debt investments
.

32. In standard regression equation Y=a + bx. The letter b is best described as a(n):
A Independent C. Constant coefficient
. variable
B Dependent variable D. Variable coefficient 
.

33. The letter X in the standard regression equation is best described as a (an):
A Independent C Constant coefficient
. variable .
B Dependent variable D Constant coefficient of determination
. .

Items 34 to 38 are based on the following information:

As part of a cost study, the cost accountant of Shinly Corporation has recorded the cost of operations
at seven different levels of materials usage. The records show the following:

Kilos of Costs of Operation

Materials
80 P 800
60 480
20 320
120 1,200
140 1,280
40 480
 100 1,040

Sum of the kilos (∑x) 560

Sum of the costs (∑y) P5,600
Sum of the kilos multiplied by the costs P545,600
(∑xy)
Sum of the kilos squared (∑x ) 2
56,000

34. Using the high-low points method, the variable cost of operations per kilo of materials used is
A P8.00 B. P9.14 C P16 D. P10
. .

35. Using the same high-low points method, the fixed cost of operations is
A P320 B. P103 C. P160 D P206
. .

36. Using the least squares method, the average rate of variability per kilos of materials used is
A P8.00 B P0.11 C P10.0 D. P8.71
. . . 0

37. Using the least squares method, the fixed portion of the cost is
A P320 B. P103 C. P160 D P206
. .

38. The projected cost of operations for 90 kilos of materials is

A. P886.90 if the high-low points method is used
B. P880.00 if the method of least squares is used
C P886.90 if the method of least squares is used
.
D P880.00 regardless of the method used
.

39. Which of the correlation coefficients represents the weakest relationship between two
variables?
A + 0.50 C -0.05
. .
B -0.80 D +1.05
. .

40. The coefficient of correlation that indicates the strongest linear association between the
dependent and independent variables is
A -0.08 C. -0.80
.
B 0.40 D. 0.04
.

41. In cost accounting, the term relevant range refers to the range over which
A. Relevant costs are incurred
B. Production should be confined
C Total fixed cost fluctuate
.
D Cost relationships are valid
.

42. Depreciation computed using the straight-line method is classified as

A Variable cost C Relevant cost
. .
B Fixed cost D Opportunity cost
. .

43. Within the relevant range, unit variable costs

A. Are constant per unit, regardless of units produced or sold.
B. Vary directly with the activity level.
C Vary inversely with the activity level.
.
D Vary inversely with the activity level.
.

“It always seems impossible until its done”

-Nelson Mandela

QUIZZER

1. Which of the following is not classified as direct labor?

A Bottlers of beer in a brewery C Wages of supervisors
. .
B Copy machine operators at a copy D Bakers in a bakery
. shop .

2. Cotter pins and lubricants used irregularly in a production process are classified as
A miscellaneous expense. C. indirect materials.
.
B direct materials. D. nonmaterial materials.
.

3. Which of the following is not another name for the term manufacturing overhead?
A Factory overhead C. Burden
.
B Pervasive costs D. Indirect manufacturing costs
.

4. Because of automation, which component of product cost is declining?

A Direct labor C Manufacturing overhead
. .
B Direct D Advertising
. materials .

5. The product cost that is most difficult to associate with a product is

A direct C. manufacturing overhead.
. materials.
B direct labor. D. advertising.
.

6. Manufacturing costs that cannot be classified as either direct materials or direct labor are
known as
A period costs. C. selling and administrative expenses.
.
B nonmanufacturing D. manufacturing overhead.
. costs.

7. Which one of the following is an example of a period cost?

A. A change in benefits for the union workers who work in the New York plant of a Fortune 1000
manufacturer
B. Workers' compensation insurance on factory workers' wages allocated to the factory
C A box cost associated with computers
.
D A manager's salary for work that is done in the corporate head office
.

8. Which one of the following costs would not be inventoriable?

A Period costs C Indirect materials
. .
B Factory insurance D Indirect labor costs
. costs .

Items 9 to 11 are based on the following information:

Meng Company is preparing a flexible budget for next year and requires a breakdown of the factory
maintenance cost into the fixed and variable elements.

The maintenance costs and machine hours (the selected cost driver) for the past six months are as
follows:

Maintenance costs Machine hours

January P15,500 1,800
February   10,720 1,230
March   15,100 1,740
April   15,840 2,190
May   14,800 1,602
June   10,600 1,590
 9. If Meng Company uses the high-low method of analysis, the estimated variable rate of
maintenance cost per machine hour is
A P7.23 B P8.73 C P5.46 D. P5.33
. . .

10. The average annual fixed maintenance cost amounts to

A P4,16 B. P8,32 C. P49,920 D P5,120
. 0 0 .

11. What is the average rate per hour at a level of P1,500 machine hours?
A P5.33 B P8.11 C P7.23 D. P5.46
. . .

Items 12 to 13 are based on the following information:

For budgeting and control purposes, the controller of Mabun Manufacturing Co. is in the process of
estimating the variable cost per hour and the fixed cost per month of operating automated equipment.
Data for the past 12 months of operations have been gathered as follows:

Number of observations 12
Sum of the hours (x) 840
Sum of the costs (y) P9,000
Sum of the hours multiplied by the costs 655,000
(xy)
Sum of the hours squared (x ) 2
63,800

Using the least-squares method in cost segregation:

12. What was the variable cost per hour to operate the machine?
A P5.25 C. P5.00
.
B P10.2 D. None of these
. 5

13. What was the fixed cost per month?

A P360 C. P90
.
B P400 D. None of these
.

14. An income or benefit that is given up when one alternative is selected over another is called
A Loss C. Relevant cost
.
B Opportunity D. Differential costs
. loss

15. For decision-making purposes, relevant costs are

A. Variable past costs
B. All fixed and variable costs.
C Anticipated future costs that will differ among various alternatives.
.
D Costs incurred within the relevant range of production.
.

16. Differential costs

A. Are variable costs
B. Are anticipated future costs that will differ among various alternatives
C Are the differences in costs between any two alternative courses of action
.
D Are costs that differ under alternatives
.

17. Which of the following costs would be considered relevant in short-term decision-making?
A. Production costs of goods available for sale
B. Incremental fixed costs
C Acquisition cost of idle asset to be used in a proposed project
.
D Variable costs
.