COST CONCEPTS

Group 1 (Chris Alcantara & Tin Llenaresas)

Objectives
 To determine different classification of cost
 To determine relationships of cost in a
manufacturing company
 Be able to prepare schedule of cost of goods
manufactured and cost of goods sold of a sample
manufacturing company
 To differentiate product costs with period costs
What is cost?
 COST is a resource that is consumed to attain an
objective.
Actual Cost – incurred
Budgeted cost- forecasted
 Cost is determined for something called cost object.
(product, service, time or any combination thereof etc.)

 Cost object – anything for which cost data are desired

Examples: products, customers, jobs, and parts of organization
 Different Cost Classifications
Purpose of Cost Classification
• Assigning costs to cost objects
• Accounting for costs in
manufacturing companies
• Preparing financial statements
• Predicting cost behavior in
response to changes in activity
• Making decisions
Cost Classifications
• Direct cost (can be easily traced)
• Indirect cost (cannot be easily traced)
• Manufacturing costs
• Direct materials
• Direct labor
• Manufacturing Overhead
• Non-manufacturing costs
• Selling costs
• Administrative costs
• Product costs (inventoriable)
• Period costs (expensed)
• Variable cost (proportional activity)
• Fixed cost (constant in total)
• Mixed cost (has variable and fixed elements)
• Differential cost (differs between alternatives)
• Sunk cost (should be ignored)
• Opportunity cost (foregone benefit)
Cost Classifications according to Traceability

Direct
Materials
Traceable/
Direct
Direct Work in Finished
Labor Process Goods

Indirect Overhead to
be Assigned
?
Cost Classifications according to Traceability

Direct costs Indirect costs

 Costs that can be
easily and conveniently
traced to a unit of product
or other cost objective.
 Examples: direct material
and direct labor
 Costs cannot be easily and
conveniently traced to a
unit of product or other
cost object.
 Example: manufacturing
overhead
PRIOR COST RELATIONSHIPS: MANUFACTURING COMPANY
PERIOD

Fin Goods
WIP (Beg)
(Beg)
Direct Mat.
(Beg)
Direct Mat.
Used + +
+
+
Direct Mat. Direct labor Tot. Mfg. Costs Cost of Goods Cost of Goods
Purchases incurred incurred Mfg. Sold

- +
- -
Overhead costs
Direct Mat. applied
(End)
Fin Goods
WIP (End) (End)

NEXT
PERIOD
 COST FLOWS IN A MANUFACTURING
COMPANY
RAW MATERIALS INVENTORY
Beg. Bal. - RM Materials used in Production (DM)
Materials Purchased

End. Bal. - RM

WORK IN PROCESS INVENTORY

Beg. Bal. - WIP Cost of Goods Manufactured
DM (COGM)
DL
OH

End. Bal. - WIP

FINISHED GOODS INVENTORY

Beg. Bal. - FG Cost of Goods Sold (COGS)
COGM

End. Bal. - FG
 THE INVENTORY EQUATION

Beginning Inventory Ending Inventory

+ = +
Additions to Inventory Items Removed from Inventory

 The inventory equation allows us to put together the following schedules:

Schedule of Total Manufacturing Costs Schedule of Cost of Goods Manufactured

(of the period)
Cost Classifications for Manufacturing Companies

 Manufacturing Costs
 Direct Materials
 Raw materials that become an integral part of the finished product and
whose costs can be conveniently traced to finished product

Baseoils and Packaged Additives Packaging Materials

Bulk Additives (caps, bottles, labels, drums, pails)
Cost Classifications for Manufacturing Companies

 Manufacturing Costs
 Direct Labor
 Labor cost that can be easily traced to individual units of product

Filling Line Operators

Further Classification of Labor Costs

Treated as overhead
Idle Time
cost

Overtime
Treated as overhead
Premium of
cost
Workers

Labor Fringe Treated as indirect

Benefits labor
Cost Classifications for Manufacturing Companies

 Manufacturing Costs
 Manufacturing Overhead
Indirect Materials Indirect Labor

Tapes Utility Personnel Operation Support

Stretch Films Ink for BN Printing Inventory, LOW, and QC Staff

Cost Classifications for Manufacturing Companies

 Manufacturing Costs
 Manufacturing Overhead

Others
Cost Classifications for
Predicting Cost Behaviour
Utilities Variable Cost
Lube Oil Utilities
Depreciation on manufacturing facilities
Lube Oil Baseoil, Bulk additives
Property taxes on factory buildings Fixed Cost Packaging materials

Insurance
 Cost Classifications for Manufacturing Companies

 Non-Manufacturing Costs

Selling Costs Administrative Costs

All costs incurred to secure customer All costs associated with the general
orders and get the finished product management of an organization rather
to customers than with manufacturing or selling

Executive compensation
Advertising
General accounting

Dep’n of delivery Public relations

equipment & FG
warehouses Depreciation of office
equipment
Cost Classifications for Preparing Financial Statements

 Product Cost (Inventoriable Costs)

 Treated as expense (cost of goods sold) on the period that products
are sold
 Direct Materials
Prime Cost
 Direct Labor
Conversion Cost
 Manufacturing Overhead

 Period Cost
 All costs that are not product cost, expensed in the period in which it
is incurred
 All selling and administrative expenses
Cost Classifications for Preparing Financial Statements

Product costs include direct Period costs are not included in

materials, direct labor, and product costs. They are expensed
manufacturing overhead. on the income statement.

Cost of
Inventory Goods Sold
Expense

Sale

Balance Income Income

Sheet Statement Statement
 Cost Classifications on Financial Statements

Balance Sheet

Lube Manufacturing Plant

Beginning Balance Ending Balance
Raw Materials MMP 500 MMP 300
Work in Process 250 300
Finished Goods 290 300
Total Inventory Accounts 1,040 900

Lube Distributor
Beginning Balance Ending Balance
Lube Oil Inventory MP 750 MP 900
 Cost Classifications on Financial Statements

Income Statement
Lube Manufacturing Plant
Sales .................................... MMP 3,000
Cost of goods sold:
Schedule of Cost of Goods Manufactured
Beg FG Inv .................... MMP 290 Direct Materials:
Cost of Goods Manufactured
Beg raw mat’l inv ........................ MMP 500
Add: Cost of goods
manufactured ................
1,830 Cost
Add: of goods
Purchases brought
of raw mat’l .... to completion
1,200 during
Rawthemat’ls
accounting
availableperiod
for use .... 1,700
Goods available for
2,120 Deduct: Ending raw mat’ls inv .. 300
sale..................................
Raw mat’ls used in prod’n ......... MMP1,400
Deduct: Ending FG Inv . 300 1,820
Gross Margin .....................
CostLabor
Direct of Goods Sold
.................................... 200
1,180
Cost related to the quantity of finished goods
Selling and Admin
sold to customers
Manufacturing overhead ............. 280
Expenses .............................
Selling Expense ............ 150 Total manufacturing cost ............ 1,880
Administrative Add: Beg work in process inv ..... 250
180 330 2,130
Expenses ........................
Deduct: Ending work in process .. 300
Net Operating Income.... MMP 850 Cost of goods manufactured .... MMP1,830
 Cost Classifications on Financial Statements

Income Statement
Lube Distributor
Sales ................................................................. MP 15,000

Cost of goods sold:

Beginning merchandise inv ...................... MP 750

Add: Purchases .......................................... 8,000

Goods available for sale ........................ 8,750

Deduct: Ending merchandise inv ............. 900 7,850

Gross margin ................................................... 7,150

Selling and Admin Expenses :

Selling Expense .......................................... 1,800

Administrative Expenses ........................... 2,000 3,800

Net Operating Income ................................... MP 3,350

 RAW MATERIALS BLENDING / FILLING PLANT FINISHED GOODS

Baseoil Bulk
Additives

Drummed Additives

BI (RM) EI (RM)
BWIP EWIP

Blending
Tank
Direct Labour

BI (FG) EI (FG)

Filling Plant
Manufacturing Overheads
Cost Classifications for Decision Making

 Differential Cost
Example: A manager has to decide whether to close a branch that is
not meeting its sales quota or keep it open even if sales have not hit
the breakeven point for several months. Closing the branch will
eliminate all other costs but rental of P200,000 per month will
continue for the next six months. On the other hand, keeping the
branch open until the expiration of the lease will result in a net loss
of P80,000.

Closing
Keep the Differential
unprofitable
branch open Cost
branch
Monthly Rental/Monthly
P200,000 P80,000 P120,000
Net loss
Cost Classifications for Decision Making

 Opportunity Cost
 Potential benefit that is given up when one alternative is selected
over another
Example:
Store owner that has a vacant rack in front of the counter that he wants
to fill with merchandise.
If he filled the rack with apples-est. sales for one week would be
P4,500.
If he filled the rack with candies-est. sales for one week would be
P6,750.

If he chose to fill the rack with apples, the opportunity cost or cost
foregone would be P6,750. If he chose candies, his opportunity cost
would be P4,500.
Cost Classifications for Decision Making

 Sunk Cost
 Cost that has already been incurred and that cannot be changed
by any decision made now or in the future
Example
Signing bonus of P100,000 paid to newly hired employee. If the
employee proves to be unreliable, the P100,000 payment should be
considered sunk cost when deciding whether the individual’s
employment should be terminated.
Summary of Cost Classifications
1. Cost according to traceability
a) Direct Cost(can be easily traced)
b) Indirect Cost (cannot be easily traced)
2. Cost according to behavior
a) Variable cost (proportional to activity)
b) Fixed cost (constant in total)
c) Mixed cost (has variable and fixed elements)
3. Cost according to function
a) Manufacturing costs (Direct Materials, Direct Labor & Overhead) or Product
Costs
b) Nonmanufacturing cost (Selling and Administrative cost) or Period Costs
4. Cost relevant to decision-making
a) Differential cost (differs between alternatives)
b) Opportunity cost (foregone benefit)
c) Sunk cost (should be ignored)
Questions?