Cost Concepts and

Classifications

Nature of Cost

Cost is 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.

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.

Classification of Costs
Costs may be classified into various categories as follows:
1. Costs classified by nature
2. Costs classified by Variability
3. Costs classified by Types of Inventory
4. Costs classification according to Traceability to Cost Objective
5. Costs classification according to managerial influence
6. Cost classified according to the generally accepted accounting
treatment
7. Costs terminologies for planning and control
8. Cost classification according to a Time-frame perspective
9. Cost classified according to time period for which the cost is incurred
10.Costs classifications for other analytical purposes

Cost classified by Nature

1. Manufacturing Costs Manufacturing costs are frequently classified as direct
materials, direct labor, and factory overhead. Since costs attached to the
products or groups of products as they are manufactured, expenditures,
regardless of their nature, usually are capitalized as inventory assets and do not
become expired costs or expenses until the goods are sold.
a. Direct Materials All raw materials that become an integral part of the
finished product and that can be conveniently and economically assigned to
specific units manufactured.
b. Direct Labor All labor costs related to time spent on products that can be
conveniently and economically assigned to specific units manufactured.
c. Factory Overhead Indirect materials, indirect labor, property taxes,
insurance, supervisors salaries, depreciation of factory building and factory
equipment, and power are examples of factor overhead.

2. Nonmanufacturing costs Include costs related to selling and other

activities not related to the production of goods.
a. Marketing or Selling costs all costs associated with marketing or
selling a product or all costs incurred by the marketing division from the
time the manufacturing process is completed until the product is delivered
to the customer or all costs necessary to secure customer orders and get
the finished product or service into to hands of the customer; also called
order getting and order-filing costs.
b. General Administrative costs all organizational and clerical costs
associated with the general management of the organization
3. Common costs Costs that benefit two or more operations, products, or
services. Thus, the electricity used to head a building where several
products are manufactured is a common cost.

Costs Classified by Variability

1. Variable costs Costs that change directly in proportion to changes in
activity (volume). Direct labor and direct materials are examples of
variable costs.
2. Fixed Costs Costs that remain unchanged for a given time period
regardless of the change in activity (volume). Rent, insurance on
property, maintenance, and repairs of buildings, and depreciation of
factory equipment as examples of fixed costs.
3. Semivariable Costs costs that contain both fixed and variable
elements.

Costs Classified by Types of Inventory

1. Raw Materials Inventory the cost of all raw materials and production
supplies that have been purchased but not used at the end of the
period.
2. Work-in-process Inventory the cost associated with goods partially
completed at the end of the period.
3. Finished Goods Inventory Cost of completed goods that have not been
sold at the end of the period.

Costs classified according to

Traceability to Cost Objective
1. Direct costs (traceable; separable Costs that can be economically
traced to a single cost object.
2. Indirect costs costs that are not directly traceable to the cost object.

Costs classification according to

Managerial Influence
1. Controllable cost Cost that is 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 a
significant influence.

Cost Classified according to Generally

Accepted Accounting Treatment
1. Product Costs All costs that attach or cling to the units that are
produced and are reported as assets until the goods are sold.
2. Period Costs A cost that must be charged against income in the period
incurred an cannot be inventoried.

Cost Terminologies Used for Planning

and Control
1. Standard Costs A predetermined cost estimate that should be attained;
usually expressed in terms of cost per unit.
2. Budgeted Cost used to represent the expected/planned cost for a
given period.
3. Absorption Costing A costing method that includes all manufacturing
costs direct materials, direct labor and both variable and fixed
manufacturing overhead in the cost of a unit of product. It is also
referred to as the full cost method.
4. Direct Costing a type of product costing where fixed costs are charged
against revenue as incurred and are not assigned to specific units of
product. Also referred to a variable costing.

5. Information costs Costs of obtaining information.

6. Ordering Costs Costs that increase with the umber of orders placed for
inventory.
7. Out-of-pocket costs Costs that must be met with a current expenditure
or cash outlay.

Cost classification according to a

Time-frame perspective
1. Committed cost Cost that is inevitable consequence of a previous
commitment.
2. Discretionary Cost (programmed; management cost) Cost for which
the size or the time of incurrence is a matter of choice.

Costs Classified according to Time

Period for which the Cost is Incurred
1. Historical costs (past costs) Costs that were incurred in a past period.
2. Future costs Budgeted costs that are expected to be incurred in a
future period.

Costs Classifications for other

Analytical purposes
1. Relevant Costs Future costs that are different under one decision alternative
than under another decision alternative.
2. Incremental Costs The difference in cost between two or more alternatives.
3. Sunk costs past costs that have been incurred and are irrelevant to a future
decision.
4. Opportunity costs the value of the best alternative foregone as the result of
selecting a different use of resource or by choosing a particular strategy.
5. Marginal Costs Costs associated with the next unit or the next project or
incremental cost associated with an additional project as opposed to the next
discrete unit.
6. Value Added Costs cost that add value to the product. These costs result
from activities that are necessary to satisfy the requirements of the customer.