Chapter 2

Cost Concepts and Classifications

 What is a Cost?

• Cost is a sacrifice of resources.

2-3
 Cost versus Expenses
Cost

Outlay Cost Past, Opportunity Costs

present, or future cash Forgone benefit from the
outflow best alternative course
of action

Expense

Cost charged against revenue

in an accounting period
Classification of Costs
in Relation to a Product
Product costs:

Costs that are recorded as an

asset in inventory when incurred
and expensed as Cost of Goods
Sold when sold

Period costs:

Costs recognized for financial

reporting when incurred
Classification of Costs
in Relation to a Product
Product costs: Period costs:

Costs related to Non-manufacturing

inventory costs related to the
firm

• Direct Materials • Marketing or Selling

• Direct Labor • General or
• Factory Overhead Administrative Exp.
Cost classification In relation to
Manufacturing Departments
Direct Departmental Costs:
Costs that are immediately charged to the
particular/specific manufacturing
department(s).

Indirect Departmental Costs

Costs that are originally charged to some

department(s) or account(s) but are later
allocated.
Cost classification as to common
or Joint
Common Costs:
Costs associated with operating a facility,
product, or segment that is shared
between two or more departments or
users.

Joint Costs
Costs that are incurred from buying or
producing two or more products at the
same time.
Cost classification in relation to
accounting period

Capital Expenditures:

Revenue Expenditures
Cost for planning, control, and
analytical processes

• Standard Costs
• Opportunity Costs
• Differential Costs
• Relevant Cost
• Out-Of-Pocket Costs
• Sunk Cost
• Controllable Cost
LO2
Prime Costs and
Conversion Costs
Prime costs:
The “primary” costs Direct Materials
of the product
Direct Labor

Conversion Costs:

Costs necessary to Direct Labor

“convert” materials Manufacturing
into finished product overhead
Costs classified as to variability

Variable

Fixed Costs

Mixed/Semi-variable Costs
Cost Behavior

Cost behavior:

How costs respond to a change in activity

level within the relevant range

Relevant range:

Activity levels within which a given total fixed

cost or unit variable cost will be unchanged

2-23
 Fixed Costs
• Fixed costs remain unchanged as volume
changes within the relevant range.
• Fixed costs per unit varies inversely to a change
in activity.
• Fixed costs are “fixed” in “total” as activity changes.
Cost (PHP)

Fixed Cost Line

Activity Level

2-24
 Variable Costs
• Costs that change in direct proportion with a
change in the volume within the relevant range
• Variable costs “vary” in “total” as activity changes.
• Variable cost per unit stays constant when
activity changes within the relevant range.
Cost (PHP)
Variable Cost Line

Activity Level
2-25
LO5

Relevant Range

120000
100000
80000
60000
40000
20000
RELEVANT RANGE
0
0 1000 2000 3000 4000 5000 6000

Volume

2-26
 Semivariable Costs
• Costs that have both fixed
and variable components
• Also known as mixed costs
Cost (PHP)

Semivariable Cost

Fixed Cost

Activity Level

2-2
 Step Costs
• Costs that increase in total with steps when
the volume changes to a particular level
• Step costs are also known as semifixed costs.
Cost (PHP)

Activity Level

2-28
 Account Analysis
3C Cost estimation using account analysis
Costs for 360 repair-hours
Variable Fixed
Account Total cost cost
Office rent P 3,375 P1,375 P2,000
Utilities 310 100 210
Administration 3,386 186 3,200
Supplies 2,276 2,176 100
Training 666 316 350
Other 613 257 356
Total P10,626 P4,410 P6,216
Per repair hour P12.25

5-9
 Account Analysis
3C Cost estimation using account analysis

Fixed costs + (Variable cost/unit × No. of units) = Total cost

Cost at 360 repair-hours:

P6,216 + (P12.25 × 360) = P10,626

Cost at 480 repair-hours:

P6,216 + (P12.25 × 480) = P12,096
 Separating Semivariable Cost

• Analyze costs within a relevant range, which is

the limits within which a cost estimate may be valid.

• Relevant range for a projection is usually between

the upper and lower limits (bounds) of past activity
levels for which data is available.
 Overhead Cost Estimation for 3C
Overhead Repair-
Month costs hours
1 P 9,891 248
2 P 9,244 248
3 P13,200 480
4 P10,555 284 These data will be used
5 P 9,054 200 to estimate costs.
6 P10,662 380
7 P12,883 568
8 P10,345 344
9 P11,217 448
10 P13,269 544
11 P10,830 340
12 P12,607 412
13 P10,871 384
14 P12,816 404
15 P 8,464 212
5-13
 Scattergraph
Manufacturing Overhead
P14,000
P12,000
P10,000
P8,000
P6,000
P4,000
P2,000
P0
0 100 200 300 400 500 600
Repair-Hours

Does it look like a relationship exists

between repair-hours and overhead costs?
 Scattergraph

We use “eyeball judgment” to determine the

intercept and slope of the line.
 Hi-Low Cost Estimation
• This is a method to estimate cost based on two cost
observations, the highest and lowest activity level.

Overhead Repair-
Month costs hours
High P12,883 568
Low P 9,054 200
Change P 3,829 368
 Hi-Low Cost Estimation
Variable cost per unit (V) =
(Cost at highest activity level - Cost at lowest activity level)
(Highest activity level - Lowest activity level)

Fixed cost (F) =

Total cost at
- (Variable cost × Highest activity level)
highest activity

Total cost at
- (Variable cost × Lowest activity level)
lowest activity
 Hi-Low Cost Estimation
Variable cost (P12,883 - P9,054) P3,829 10.40
= =
per RH (V) 568 RH - 200 RH 368 RH = per RH

Fixed costs (F) = (P12,883 - (P10.40 × 568 RH) = P6,976

Fixed costs (F) = (P9,054 - (P10.40 × 200 RH) = P6,974

Rounding
difference
Hi-Low Cost Estimation
• How do we estimate manufacturing
overhead with 480 repair-hours?

(Y = a + bX) or TC = F + VX

TC = P6,976 + (P10.40 × 480) = P11,968

5-19
 Method of Least Square
Regression Analysis
• Regression is a statistical procedure to
determine the relation between variables.

• It helps managers determine how well the

estimated regression equation describes
the relations between costs and activities.
Method of Least Square
• Hi-low method:
Uses two data points

• Least square method:

Uses all of the data points
 Method of Least Square

Y = a + bX

a – Intercept or total fixed cost

b – Slope or unit variable cost

Y = fixed + (unit variable cost × X)

For 3C:
OH = Fixed costs + (V × Repair-hours)
 Method of Least Square
Month Cost Repair Hrs.
n Y X (Y - `Y) (X -`X) (X -`X) (Y -`Y) (X -`X)2
1 9,891.00 248.00 - 1,169.53 - 118.40 138,472.75 14,018.56
2 9,244.00 248.00 - 1,816.53 - 118.40 215,077.55 14,018.56
3 13,200.00 480.00 2,139.47 113.60 243,043.41 12,904.96
4 10,555.00 284.00 - 505.53 - 82.40 41,655.95 6,789.76
5 9,054.00 200.00 - 2,006.53 - 166.40 333,887.15 27,688.96
6 10,662.00 380.00 - 398.53 13.60 - 5,420.05 184.96
7 12,883.00 568.00 1,822.47 201.60 367,409.28 40,642.56
8 10,345.00 344.00 - 715.53 - 22.40 16,027.95 501.76
9 11,217.00 448.00 156.47 81.60 12,767.68 6,658.56
10 13,269.00 544.00 2,208.47 177.60 392,223.68 31,541.76
11 10,830.00 340.00 - 230.53 - 26.40 6,086.08 696.96
12 12,607.00 412.00 1,546.47 45.60 70,518.88 2,079.36
13 10,871.00 384.00 - 189.53 17.60 - 3,335.79 309.76
14 12,816.00 404.00 1,755.47 37.60 66,005.55 1,413.76
15 8,464.00 212.00 - 2,596.53 - 154.40 400,904.75 23,839.36
Average 11,060.53 366.40
Sum 2,295,324.80 183,289.60

(X - `X) (Y - `Y) 12.52

b=
(X - `X)2

a= 6,472.13
Therefor
Budgeted OH at 480 repair hours would be 6,472.13 + 12.52 X 480 12,483.14