Costs – Concepts and Classifications

Cost
- Cash or cash equivalent value sacrificed for goods and services that are expected to bring a current or future benefit to
the organization
- Incurred to produce future benefits in a profit making firm, future benefits usually mean revenue

Classification of Costs
I. Costs classified as to relation to a product
A. Manufacturing Costs / Product Costs
1. Direct Materials
2. Direct Labor
3. Factory Overhead

B. Non-manufacturing Costs / Period Costs

1. Marketing or Selling Expense
2. General or Administrative Expense

II. Costs classified as to variability

A. Variable Costs
B. Fixed Costs
C. Mixed Costs

III. Costs classified as to relation to manufacturing departments

A. Direct Departmental Charges
B. Indirect Departmental Charges

IV. Costs classified as to their nature as common or joint

A. Common Costs
B. Joint Costs

V. Costs classified as to relation to an accounting period

A. Capital Expenditures
B. Revenue Expenditures

VI. Costs for planning, control, and analytical processes

A. Standard Costs
B. Opportunity Costs
C. Differential Costs
D. Relevant Costs
E. Out-of-pocket Costs
F. Sunk Costs
G. Controllable Costs

Direct Materials - Cost of materials that become part of a finished product and can be conveniently and economically
traced to specific product units

Direct Labor - Labor costs for specific work performed on products that can be conveniently and economically traced to
end products

Factory Overhead - Manufacturing costs that cannot be classified as direct materials or direct labor
- Includes indirect materials, indirect labor and other indirect factory costs

Prime Costs = Direct Materials + Direct Labor

Conversion Costs = Direct Labor + Factory Overhead

Marketing or Selling Expenses - Costs necessary to secure customer orders and get finished product or service into the
hands of the customer
- Advertising, shipping, sales travel, sales commissions and sales salaries
General or Administrative Expenses - Include all executive, organizational and clerical expenses that cannot logically be
included under either production and marketing
- Executive compensation, general accounting, secretarial, public relations and general administration

Variable Costs - Items of cost which vary directly in total in relation to volume of production
- As activity changes (volume of production), total variable cost increases or decreases proportionately but unit variable
cost remains the same

Fixed Costs - Items of costs which remain constant in total irrespective of the volume of production
- Cost per unit has inverse relationship on volume of production
- Cost per unit decreases as volume increases and increases as volume decreases

Mixed Costs - Items of costs with fixed and variable components

- Vary with the level of production, though not in direct relation to it
- Example is cost of electricity where there is a basic minimum charge plus a specified cost per kilowatt hour above the
minimum

Direct Departmental Charges

- Costs that are immediately charged to the particular manufacturing department(s) that incurred the costs since the costs
can be conveniently identified or associated with the department(s) that benefited from said costs

Indirect Departmental Charges

- Costs that are originally charged to some other manufacturing department (s) or account(s) but are later allocated or
transferred to another department(s) that indirectly benefited from said costs

Common Costs
- Costs of facilities or services employed in two or more accounting periods, operations, commodities or services
- Just like indirect costs, these costs are subject to allocation

Joint Costs
- Costs of materials, labor and overhead incurred in the manufacture of two or more products at the same time
- They are indivisible and are not specifically identifiable with any of the products being simultaneously produced
- These costs are also subject to allocation

Capital Expenditures - Expenditure intended to benefit more than one accounting periods and is recorded as an asset
- Examples are tangible fixed assets, intangible assets and wasting assets

Revenue Expenditures - Expenditure that will benefit current period only and is recorded as an expense

Standard Costs
- Predetermined costs for direct materials, direct labor and factory overhead based on established information
accumulated from past experiences and data secured from research studies

Opportunity Costs
- The benefit given up when one alternative is chosen over another
- Not recorded in the accounting books but is considered when evaluating alternatives for decision-making

Differential Costs
- Cost that is present under one alternative but is absent in whole or in part under another alternative
- An increase in cost from one alternative to another is known as incremental cost, while a decrease in cost is known as
decremental cost

Relevant Costs
- Future cost that change across alternatives

Out-of-pocket Costs
- Cost that requires payment of money (or other assets) as a result of their incurrence

Sunk Costs
- Cost for which an outlay has already been made and it cannot be changed by present or future decision

Controllable Costs
- Cost where a level of management has power to authorize the cost
Cost Flow for Manufacturing Firm
- (Direct Materials + Direct Labor + Factory Overhead) goes into Work in Process
- Work in Process goes into Finished Goods
- Finished Goods goes into Cost of Goods Sold

- Selling and Administrative goes into Operating Expenses

Cost Flow for Merchandising Firm

- Finished Goods goes into Cost of Goods Sold

- Selling and Administrative goes into Operating Expenses

Cost Flow for Service Firm

- (Direct Materials + Direct Labor + Factory Overhead) goes into Cost of Services

- Selling and Administrative goes into Operating Expenses