COST TERMINOLOGY, CONCEPTS, CLASSIFICATIONS AND COST BEHAVIOR

INTRODUCTION

• No product can be produced without the incurrence of costs for material, labor, and overhead.
At a minimum, no service can be produced without the incurrence of costs for labor and
overhead; a cost for material may or may not be involved.

• However, the term cost must be defined more specifically before “the cost” of a product or
service can be determined and communicated to others.

• Thus, a clarifying adjective is generally used to specify the type of cost being considered.

• For example, the balance sheet value of an asset is an unexpired cost, but the portion of an
asset’s value consumed or sacrificed during a period is an expense or expired cost, which is
shown on the income statement.

• To effectively communicate information, accountants must clearly understand the differences

among various types of costs, how those costs are computed, and how those costs are used.

• The chapter also presents cost flows and the process of cost accumulation in a production
environment.

NATURE OF COST

• All types of businesses, whether service, manufacturing or trading, require cost accounting to
track their activities.

• Accounting costs are classified in numerous ways. To prepare financial statements, accountants
must associate costs with specific time periods. The classification of costs into product and
period costs allows accountant to do that.

• In managerial accounting, the term cost may be used in different ways because there are many
types of costs that may be classified differently according to the immediate needs of
management.

• For instance, external financial reports require the use of historical data whereas decision
making may require current cost data.

• Costs are also classified differently depending on the type of organization involved, that is,
merchandizing, service, or manufacturing. Cost data that are classified and recorded in a
particular way may be inappropriate for another use.

• Cost reflects the monetary measure of resources used to attain an objective such as making a
good or performing a service.

• Cost may be 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.

• It is also an outlay or expenditure of money to acquire goods and services that assist in
performing operations.
 • A costing system accounts for costs in two basic steps, namely, cost accumulation and cost
assignment.

COST MANAGEMENT SYSTEM

• A 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.

• This system is designed to communicate all value chain functions about product costs, product
profitability, cost management, strategy implementation, and management performance.

• Cost concepts and terms have been developed to facilitate this communication process.

• Cost Management System is a guide on the correct measurement of costs and consists of cost
accumulation and cost assignment to a cost object.

• These are important to managers for their planning and control and for their decision making
purposes.

COST CLASSIFICATION CATEGORIES

COST POOLS

• Cost pools are costs collected into meaningful groups. Cost pools maybe 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

• Cost Object is anything that management needs to accumulate or collect cost.

• A cost object is any product, service or organizational unit to which costs are assigned for some
management purpose.

• Here are different “cost objects” of different organizations.

COST OBJECT ILLUSTRATION

Program An athletic program of a university.

Department A department within DENR that studies air emission standards

Research and Development Department, Human Resource Department

Activity A test to determine the quality level of television set

Development and updating of accounting software

Brand Category All soft drinks sold by a Pepsi-Cola Bottling Company with “Pepsi” in their name

Sunsilk, Safeguard, Gap, Coke

Customer All products purchased by Landmark (the customer) from Purefoods, Inc.

Project A special sports car assembled by Toyota Motors

Service An airline flight from NAIA to Hongkong

Product A motorcycle, Shampoo, soap, bread, softdrink, etc.

EXAMPLES OF COST OBJECTS

COST OBJECT

• 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.

• Any item to where costs can be traced and that has a key role in management strategy can be
considered a cost object.
• Production operations and product lines are common cost objects.

• Costs related to the making of a product or performance of a service are appropriately labeled
product or service costs.

• The costs associated with any cost object can be classified according to their relationship to the
cost object.