Managerial Accounting

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Costs in Managerial Accounting

Module 002: Costs in Managerial Accounting

Course Learning Outcomes:

At the end of this module, the student will be able to know and understand:
1. The definition of cost and cost terms in managerial accounting.
2. Mixed cost and the cost function.
3. Cost accounting and different cost accounting systems.

Definition of Cost
Cost is the monetary measure of the amount of resources given up or used for some purpose.
It is the monetary value of goods and services expended to obtain current or future benefits.

Some Cost Terms Used in Managerial Accounting

 Cost object – is anything for which cost is computed.

Examples: a product, product line, a segment of the organization

 Cost driver – is any variable, such as a level of activity or volume that usually
affects costs over a period of time.

Examples: production, sales, number of hours

 Cost pool – is a grouping of individual cost items. It is an account in which a

variety of similar costs are accumulated.

Examples: work in process, factory overhead control

 Activity – is an event, action, transaction, task, or unit of work with a specified

purpose.

Value adding activities – are activities that are necessary (non-eliminable) to

produce the products.

Example: assembling the different component parts of the product

Non-value adding activities – are activities that do not make the product or
service more valuable to the customer.

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 Example: moving materials and equipment parts from/to the stockroom or a
workstation
Different Costs for Different Purposes
A. As to type
1. Product costs – are 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

2. Period costs – are 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. As to function
1. Manufacturing costs – refer to all the costs incurred in the factory to
convert raw materials into finished goods.
a. Direct manufacturing costs – materials and labor
b. Indirect manufacturing costs – the manufacturing overhead or
factory overhead costs

2. Non-manufacturing costs – are all costs which are not incurred in

transforming materials to finished goods.
a. Research and Development – incurred in designing and bringing
new products to the market.
b. Marketing costs – advertising and promotion expenses
c. Distribution costs – costs incurred in delivering the products to
the customers
d. Selling costs – salaries and commission of sales staff and other
selling expenses
e. 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.
f. 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 – are costs that are related to a particular cost object and
can economically and effectively be traced to that cost object.
2. Indirect costs – are 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. 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
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Costs in Managerial Accounting

a. Incremental cost – increase in cost from one alternative to

another.
b. Decremental cost – decrease in cost from one alternative to
another

3. Opportunity costs – income or benefit given up when one when one

alternative is selected over another.

4. Sunk/Past or Historical costs – already incurred and cannot be changed

by any decision made now or to be made in the future.

E. 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 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.

a. Committed fixed costs – long-term in nature and cannot be

eliminated even for 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.) decisions by management to spend
in certain fixed costs area such as research, advertising, and
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 a fixed component.

4. Step cost – when activity changes, a step cost shifts upward or

downward by a certain interval or step.

* Relevant range – a range of activity that reflects the company’s normal

operating range. Within this relevant range, the aforementioned cost behavior
is valid, i.e.:

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 TOTAL AMOUNT PER COST DRIVER
Varies directly with Constant
VARIABLE COST
cost driver
Constant Varies inversely with
FIXED COST
cost driver

Analysis of Mixed Cost

Mixed Costs or Total Costs – have variable and fixed costs components

TC = FC + VC

where: TC = Total cost

FC = Total fixed cost
VC = Total variable cost

Total variable cost varies directly with the activity level or cost driver.

VC = variable cost per cost driver x cost driver or

VC = bx

where: VC = Total variable cost

b = variable cost per cost driver
x = cost driver

Example:

If the cost driver is number of units and variable cost per unit is P10, then VC =
10x

The total or mixed cost function may be expressed as:

TC = FC + bx

Linearity assumption – within the relevant range, there is a strict linear

relationship between the cost and cost driver.

The Cost Function

Since total cost is linearly related to the activity level or cost driver, the cost
function (cost formula) may be expressed as:

Y = a + bx

where: Y = total cost

a = Total fixed cost
b = variable cost per cost driver
x = activity level or cost driver
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Costs in Managerial Accounting

Cost Accounting Systems

Cost Accounting – is a part of the accounting system that measures costs for decision-
making and financial reporting purposes.
Cost Accounting Processes
1. Cost Accumulation – involves collecting costs by natural classification, such as
materials or labor.
2. Cost Allocation or Cost Assignment – involves tracing and assigning costs to cost
objects, such as departments or products.
Cost Accounting Systems
1. Job-Order Costing
This product costing system is used by firms that provide limited quantities of
products or services unique to a customer’s needs or specifications. Costs are
assigned or traced to individual products.

Examples: automobile repair shops, tailoring/dressmaking business

2. Process Costing
This system is used by firms that produce many units of a single product (or nearly
identical products) for long periods at a time.

In this costing system, costs are accumulated in a particular operation or department

for an entire period (a week, a month, etc.). The total cost incurred in each operation
or department is then divided by the total number of units produced (or the total
equivalent units produced) to determine the average cost per unit of product.

Examples: soft drinks company, toy manufacturers

3. Hybrid Product-Costing System

This costing system incorporates features from two or more alternative product
costing systems, such as job-order and process costing.

One common hybrid-costing system is operation costing, where materials costs are
accumulated using job-order costing while conversion costs are accumulated using
process costing.

Examples: clothing and food processing operations

4. Standard Costing
This can be used with the other cost accounting systems, such as job-order costing
and process costing.

This costing method uses predetermined factors (quantity and price) to compute the
standard cost of materials, labor, and factory overhead, so that such costs may be
assigned to the various inventory accounts and cost of goods sold.
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 5. Backflush Costing
This is a streamlined cost accounting method that simplifies, speeds up, and reduces
accounting effort/procedures in accumulating product costs. Unlike in the traditional
job-order and process costing systems, backflush costing eliminates the detailed
tracking of the cost of work in process.

6. Activity-Based Costing System

This costing system is a two-stage procedure that uses multiple drivers to predict and
allocate costs to products and services.

Stage 1 – Significant activities are identified and costs are assigned to activity cost
pools based on the way resources are consumed by such activities.

Stage 2 – Costs are allocated from each activity cost pool to each cost target (jobs,
products, customers) in proportion to the amount of cost driver consumed by the cost
target.

Type of Activity Levels

1) Unit Level – activity that must be done for each unit of production

2) Batch Level – performed for each batch of product produced, rather than each
unit.
Examples: setup, receiving and inspection, material-handling, packaging,
shipping, and quality assurance
3) Product Level (or Product Sustaining Level) – activities that are needed to
support the entire product line regardless of the number of units and batches
produced.
Examples: engineering costs, product development costs
4) Facility Level (or General Operations Level) – performed in order for the entire
production process to occur.
Examples: plant maintenance, plant management, property taxes, and
insurance

References and Supplementary Materials

Books and Journals
1. Rodelio S. Roque (2016). Management Advisory Services. CM Recto, Manila. GIC
Enterprises and Co., Inc.
2. Leonardo E. Aliling, Ma. Flordeliza L. Anastacio (2015). Management Accounting 1. 856
Nicanor Reyes, Sr. St., CM Recto Avenue, Manila. Rex Book Store, Inc.
3. Franklin T. Agamata (2019). Management Services. Certs Publications. Agdao, Davao
City, Philippines
4. Ray H. Garrison, Eric W. Noreen, Peter C. Brewer, 16th ed. Managerial Accounting. The
McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York
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Costs in Managerial Accounting

Online Supplementary Reading Materials

1. https://www.accountingedu.org/cost-accounting.html; August 16, 2019
2. https://www.accountingformanagement.org/variable-fixed-and-mixed-costs/;
August 16, 2019

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