An Introduction to Cost Terms and Purposes

Basic Cost Terminology

Cost
 a resource sacrificed or foregone to achieve a specific
objective(Example: Recording acquisition of a long term
resources as fixed asset or inventory )
Cost Object
 Anything for which a separate measurement of cost is
made.
example: product, number of class, machine, service
or process, project, and program
 cost objects can vary in size from an entire company, to a
division or program within the company, or down to a
single product or service
 Basic Cost Terminology
 Cost accumulation – which is the process of
collecting, organizing of cost related
information/data in an organized manner
 Cost assignment – a general term that includes
tracing and allocating the accumulated . This
includes:
 Tracing: assigning direct costs (costs with a direct
relationship to the cost object)
 Allocating: assigning indirect costs (costs with an
indirect relationship to a cost object) or it is
subjective
Direct & Indirect Costs
 Direct costs – can be conveniently and economically
traced (tracked) to a cost object
 Direct Costs for 3F Furniture examples:
=>Wood & Metal(DMC)
=> Salary of Woodworker (DLC)
 Indirect costs – cannot be conveniently or
economically traced (tracked) to a cost object.
 Instead of being traced, these costs are allocated to
a cost object in a rational and systematic
manner.(Usually it is Subjective)
 Indirect Costs for 3F furniture examples:
=>Electricity,
=>Rent and Property taxes
Factors Affecting Direct / Indirect Cost Classification
 Cost Materiality=if it is significant the cost goes to
direct cost

 Availability of information-gathering technology

 based on the availability of information we can decide
this one is direct or indirect. But, sometimes we may
not have information about whether the cost are
specifically related to the object, at this time the
management will be decide it
 Operational Design based on the relation to the
production or operation we can decide it wether direct
or indirect cost

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Cost Behavior
 Variable costs – is the cost which is vary
the changes of level of proportion to
changes in the related level of activity or
volume
 Fixed costs – remain unchanged in total
regardless of changes in the related level
of activity or volume
 To be Costs are fixed or variable only with
respect to a specific activity or a given
time period
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Cost Behavior, continued
 Variable costs per unit – are constant on a per-unit
basis. If a product takes 5 pounds of materials each, it
stays the same per unit regardless of one, ten or a
thousand units are produced
 Fixed costs per unit – are Vary/change inversely with
the level of production. As more units are produced, the
same fixed cost is spread over more and more units,
reducing the cost per unit
Fixed cost per-unit = total fixed cost /total production level

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Cost Behavior, continued

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Cost Behavior Visualized

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Other Cost Concepts
 Cost Driver – is also called a cost generator or
cost determination) is a variable, such as the
level of activity or volume that causally
affects costs over a given time span.
 Example: An Activity is an event, tasks, or
units of work with a specific purpose
Other Cost Concepts Cost Driver ….
Different Types of Firms
Manufacturing-sector companies –
create and sell their own products
Merchandising-sector companies –
product resellers
Service-sector companies – provide
services (intangible products)
Types of Manufacturing Inventories
 Direct Materials – resources in-stock and
available for use
 Work-in-Process (or progress) – products
started but not yet completed. Often
abbreviated as WIP
 Finished Goods – products completed
and ready for sale
Accounting Distinction Between Costs
Period Costs/ Non Manufacturing Costs)
 have no future value and are expensed as incurred.
 are expensed on the income statement as they are
incurred
 also called operating costs (excluding cost of goods
sold)
 examples: selling, general and administrative costs
Product Costs/Manufacturing Cost)
 Are capitalized as assets (inventory) until they are sold
and transferred to Cost of Goods Sold
 Expensed only when the product or service is sold
 Examples: materials and labour (manufacturing)
Types of manufacturing/Product Costs
 Also known as Inventoriable Costs
 Direct Materials
 Direct Labor
 Indirect Manufacturing – factory costs
that are not traceable to the product.
Other common names for this type of
cost include Manufacturing Overhead
costs or Factory Overhead costs.
Other Cost Considerations
 Prime cost(PC): is a term referring to all direct
manufacturing costs (labor and materials)
 PC= DM cost + DL cost
 Conversion cost(CC): is a term referring to direct labor
and factory overhead costs, collectively
 CC= DL + MOH
 Overtime labor costs are considered part of overhead
due to the inability to precisely know the true cause of
these costs

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Cost Flows
 The Cost of Goods Manufactured and
the Cost of Goods Sold section of the
Income Statement are accounting
representations of the actual flow of
costs through a production system.
 In short: CG manufacturing=>CGS=>Income
statement =>net income/loss

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Three Common Features of
Cost Accounting & Cost Management
1. Calculating the cost of products, services, and other
cost objects
2. Obtaining information for planning & control, and
performance evaluation
3. Analyzing the relevant information for making
decisions

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CGS (separate Schedule of Cost of Goods )
Multiple Income Statement format for Manufacturing Company
illustration 1:
 Ayesha Products Limited purchased materials of $
440,000 and incurred direct labor of $ 320,000
during the year ended June 30, 2022. Total factory
overheads for the year were $280,000.
 The inventory balances are as follows:
July 1, 2021 June 30, 2022
Finished goods $ 90,000 $105,000
Work in process 121,000 110,000
Materials 100,000 105,000
 Required: determine
1) Direct Material Used? =BDM+DMP-EDM
2) The Cost Of Goods Manufactured? =TWIP -EWIP
2) The Cost Of Goods sold? CGAFS-EFG
illustration1 Solution
 illustration 2:
Assume XYZ Company has the following information about
the year 2019 to see how costs flow in the manufacturing firm
 Revenue $ 210,000
 Direct materials purchased 73,000
 Period costs (non Manufacturing cost) 70,000
 Direct manufacturing labor cost 9,000
 Manufacturing overheads 20,000
Inventories Jan 1, 2019 Dec 31, 2019

DM $ 11,000 $8,000
WIP 6,000 7,000
FG 22,000 18,000
Required: prepare xyz company’s Cost flow in manufacturing
means prepare Income Statement
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illustration 2: Solution

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illustration 2: Solution

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Home take Exercise

 Assume the following information is available for the HH Company for February 200X.
Indirect manufacturing costs:
Beginning inventories: Indirect materials $15,000
Direct materials $10,000 Indirect labor 40,000
Work in process 30,000 Depreciation 50,000
Finished goods 26,000 Electric power 60,000
Ending inventories: Property taxes & Insurance 5,000
Direct materials 20,000 Repair and maintenance 25,000
Work in process 40,000 Miscellaneous 8,000
Finished goods 20,000

Selling and Administrative expenses 45,000

Direct materials purchased 90,000 Sales 650,000

Direct labor used 100,000

Required
Assume full absorption costing is used prepare an Income Statement and separate Schedule of
Cost of Goods Manufactured for the HH Company for February.

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End of chapter One

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