Cost Terms, Concepts, and

Classifications
 2-2

Manufacturing Cost Concepts

Financial Managerial
Accounting Accounting
Cost is a measure of Product costs are the
resources used or costs a company
given up to achieve a assigns to units
stated purpose. produced.
 2-3

Manufacturing Costs

Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

The Product
 2-4

Direct Materials

Those materials that become an integral part

of the product and that can be conveniently
traced directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile
 2-5

Direct Labor
Those labor costs that can be easily traced to
individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers
 2-6

Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work. Examples: lubricants and
Examples: maintenance cleaning supplies used in the
workers, janitors and automobile assembly plant.
security guards.
 2-7

Classifications of Costs

Manufacturing costs are often

combined as follows:
Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labor
Labor Overhead
Overhead

Prime Conversion
Cost Cost
 2-8

Nonmanufacturing Costs

Marketing and selling costs . . .

 Costs necessary to get the order and deliver the
product.
Administrative costs . . .
 All executive, organizational, and clerical costs.
 2-9

Product Costs Versus Period Costs

Product costs include Period costs are not

direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 2-10

Cost Classifications for Predicting

Cost Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.
Total
 Total variable
variablecosts
costs
change
changewhenwhenactivity
activity
changes.
changes.
Total
 Total fixed
fixedcosts
costs
remain
remainunchanged
unchanged
when
whenactivity
activitychanges.
changes.
 2-11

Total Variable Cost

Your total long distance telephone bill is

based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
 2-12

Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
 2-13

Total Fixed Cost

Your monthly basic telephone bill probably
does not change when you make more local
calls.
Telephone Bill
Monthly Basic

Number of Local Calls

 2-14

Fixed Cost Per Unit

The average cost per local call decreases as
more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
 2-15

Cost Classifications for Predicting

Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
 2-16

Quick Check 

Which of the following costs would be variable

with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
 2-17

Direct Costs and Indirect Costs

Direct costs Indirect costs

 Costs that can be  Costs cannot be easily
easily and conveniently and conveniently traced
traced to a unit of to a unit of product or
product or other cost other cost object.
objective.  Example:
 Examples: direct manufacturing
material and direct labor overhead
 2-18

Differential Costs and Revenues

Costs and revenues that differ among

alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is:

$2,000 – $1,500 = $500
 2-19

Differential Costs and Revenues

Costs and revenues that differ among

alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is:

$2,000 – $1,500 = $500
Differential cost is:
$300
 2-20

Opportunity Costs
The potential benefit that
is given up when one
alternative is selected
over another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for one
year is $15,000.
 2-21

Sunk Costs

Sunk costs cannot be changed by any decision.

They are not differential costs and should be
ignored when making decisions.
Example: You bought an automobile that cost
$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it,
trade it, or sell it, you cannot change the
$10,000 cost.
 2-22

Further Classification of Labor

Costs

Treated as
Idle Time
overhead cost

Overtime
Treated as
Premium of Lab
overhead cost
Workers

Labor Fringe Treated as indirect

Benefits labor