CHAPTER TWO: COST TERMS, CONCEPTS AND CLASSIFICATIONS

Cost

- Defined as the value foregone or sacrifice of resources for the purpose of achieving some
economic benefit which will promote the profit-making ability of the firm
- Incurred when a resource is used and services that assists in performing operations

A costing system accounts for costs in two basic steps, namely, cost accumulation and cost assignment.

- Cost are also classified differently depending on the type of organization involved, that is,
merchandising, service, or manufacturing

Cost Pools

- Are costs collected into meaningful groups classified as

- (1) by type of cost (labor cost in one pool, materials cost in another)
- (2) by source (department 1, department 2, and so on)
- (3) by responsibility (manager 1, manager 2, and so on) and many more

Cost object

- Is any product, service, or organizational unit to which costs are assigned for some management
purpose
- Products and services are generally cost objects, while manufacturing departments are
considered either cost pools or cost objects, depending on whether management’s main focus is
on the costs of the products or for the production department

Examples of Cost Objects:

1. Program: An athletic program of a university

2. Department: A department within a DENR that studies air emissions standards
3. Activity: A test to determine the quality level of television set
4. Brand Category: All soft drinks sold by a Pepsi-Cola bottling company with “Pepsi” in their name
5. Customer: All products purchased by Landmark (the customer) from Purefoods Inc.
6. Project: A special sports car assembled by Toyota Motors
7. Service: An airline flight from NAIA to Hongkong
8. Product: A motorcycle

Cost Drivers

- Any factor that has the effect of changing the level of total cost
Examples of Cost Driver:

1. In Research and Development: Number of research projects, Manpower hours on a project,

technical difficulties of projects
2. In Design of products, services, and processes: Number of products in design, number of parts
per product, number of engineering hours
3. In Production: Number of units produced, direct manufacturing labor costs, number of setups,
number of engineering change orders

Cost Assignment

- Process of assigning costs to cost pools or from cost pools to cost objects

Cost Allocation

- The assignment of indirect costs to cost pools. Allocation bases are cost drivers used to allocate
costs

Cost Accumulation

- Involved the collection of cost data in some organized way by means of accounting system

CLASSIFICATION OF COSTS

A. Cost classified by Nature or Management Function

Manufacturing Costs

- All costs associated with production of goods

- 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 materials are cost that can directly be related to the end product
- It includes invoice price plus other costs paid to the vendor, shipping costs, sales taxes, duty,
cost of delivery containers and pallets and royalty payment based on direct material quantities.
- Trade and cash discounts reduce direct materials cost
- Routine quality assurance samples that are destroyed are classified as material

Direct labors

- 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

- 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

- Examples include supervision, inspection, maintenance, personnel and material handling

- Direct materials and direct labor are often referred to as PRIME COST

- Direct labor and manufacturing overhead are often called CONVERSION COSTS since they are
the costs of “converting or transforming” raw materials into finished products

Non- manufacturing Cost

- Marketing costs
- General and Administrative costs

B. Costs classified according to the Timing of Recognition as Expense

- An expensed is defined as the cost incurred when an asset is used up or sold for the purpose of
generating revenue
C. Costs classification on Financial Statements
 D. Cost Classification for Predicting Cost Behavior
- Cost behaviors means how cost will react to changes in level of activity

Variable Cost

- Cost that change directly in proportion to changes in activity (volume)

Fixed Costs

- Costs that remain unchanged for a given time period, regardless of change in activity (volume).
E. Cost classified by Types of Inventory
1. Raw Materials Inventory
- Purchased but not used
2. Work-in-process Inventory
- Partially completed
3. Finished goods inventory
- Completed goods that have not been sold
4. Merchandise inventory
- Purchased merchandise by retailers/ wholesales that have not been sold

F. Cost Classification according to Traceability to Cost Objective

G. Cost classification according to Managerial Influence
1. Controllable Cost
- Subject to significant influence by a particular manager within the time period under
consideration
2. Noncontrollable Cost
- Cost over which a given manager does not have significant influence
H. Cost Terminologies used for planning and control
1. Standard costs
2. Budgeted costs
3. Absorption costs
4. Direct costing
5. Information cost
6. Ordering costs
7. Out-of-pocket costs
I. Cost Classification according to a time-frame perspective
1. Committed costs
- Cost that is the inevitable consequences of a previous commitment
2. Discretionary cost (programmed; managed cost)
- Cost for which the size or the time of incurrence is a matter of choice
J. Cost classified according to Time Period for which the cost is incurred
1. Historical Cost
- Costs that were incurred in a past period
2. Future cost
- Budgeted costs that are expected to be incurred in a future period
Future Classifications of Labor Cost