COST TERMS,

CONCEPTS &
CLASSIFICATION
Outline
• What is a cost?
• What is a cost pool?
• What is a cost object?
• What is a cost driver?
• Classification of costs
What is a cost?
• It is value foregone or sacrifice of resources for the
purpose of achieving some economic benefit which will
promote the profit-making ability of the firm.
• No economic benefit = loss
• Negligence, mismanagement, internal failure = loss
What is a cost pool?
Cost collected into meaningful groups.
• By type of cost
• By source
• By responsibility
Examples
• Classifying costs as direct materials, labor, overhead
• If you are attending a seminar and you separate your expenses on a per day basis
• A chef who separates the cost of ingredients by product
What is a cost object?
A product, or service, or organizational unit to which costs are
assigned
• The different types of bread produced by a bakery
• The different colleges of CvSU
• The buses of a bus company
What is cost driver?
A factor that affects the level of total cost.
Examples:
• Tuition fees – Number of units taken
• Fuel – number of kilometers traveled
• Electricity – Machine hours
• Flour (raw materials) – number of bread produced
END OF PART 1 OF 3
CLASSIFICATION OF
COSTS
According to nature or management
function
1. Manufacturing costs (factory costs) – associated with production of
goods.
• Direct materials
• Direct labor
• Manufacturing overhead
2. Non-manufacturing costs – related to selling and non-manufacturing
activities
• Marketing costs (selling costs / distribution costs)
• General and administrative costs
Timing of recognition as expense
1. Product cost (inventoriable cost) – reported as inventory until
sold
2. Period cost – recognized as expense immediately
Financial Statements
1. Statement of Financial Position – costs that are included in inventory
2. Income Statement – cost of goods sold and expenses
Cost Behavior
1. Fixed – costs that remain unchanged in total regardless of
change in volume. Ex: Rent, insurance
2. Variable – costs whose total changes in direct proportion with
change in volume
Ex: Direct materials, direct labor
3. Mixed (semi-variable) – contain both fixed and variable
component
Ex: Salary of P10,000 plus commission of 5% of sales
Types of Inventory
1. Raw materials inventory – raw materials (direct and indirect) purchased but
unused
2. Work-in-Process Inventory – partially-completed goods
3. Finished Goods Inventory – Completed but unsold goods
4. Merchandise Inventory – Purchased ready-to-sell goods of a merchandiser
Traceability to Cost Object
1. Direct cost (traceable cost / separable cost) – can be
economically traced to a single cost object
Ex.: The salary of the dean of CEMDS can be directly attributed
to CEMDS
2. Indirect cost = cannot be easily traced to a cost object
Ex.: The salary of the security guards of CvSU cannot be easily
traced to a specific college
END OF PART 2 OF 3
Management Influence
1. Controllable cost – subject to significant influence by a
manager
Example: A factory supervisor to the amount of raw materials
consumed
2. Non-controllable cost – cannot be significantly influenced by a
manager
Example: A factory supervisor to the amount of factory rent
Time-frame perspective
1. Committed Costs – inevitable consequence of a
previous commitment.
Example: Rent, insurance
2. Discretionary costs – the amount and timing is a
matter of choice
Example: Bonuses
Time Period of Incurrence
1. Historical Costs - incurred in the past
2. Future Costs – budgeted for the future
For Decision-Making and Analytical
Procedures
Opportunity cost – benefits foregone because of choosing another alternative
Situation: Let us say you have just enrolled in a university and is now contemplating
whether to be a full-time student or to be a working student. If you will work, you
will earn P2,000 per month. Let us say you decided to become a full-time student.
The opportunity cost here is the P2,000 monthly income that you won’t enjoy
because you decided to become a full-time student.
For Decision-Making and Analytical
Procedures
Marginal cost – cost associated with the next unit of or the next project.
Incremental cost – difference in cost between alternatives.
Situation: Assume that the university you are enrolled in asks P40 per unit of course
(subject). You are considering to add a three-unit subject for a total of P120.

P40 is the marginal cost for every additional unit enrolled.

Between the two alternatives – to add and not to add the subject – there is a cost
difference of P120. This is the incremental cost of adding the subject.
For Decision-Making and Analytical
Procedures
Relevant costs – future costs that are different between alternatives.
Sunk costs – past costs that cannot be changed anymore and is therefore
irrelevant.
Situation: Let us say you are at the foot of the MRT Station in EDSA-Taft. You
spent P100 to get there from your residence. You have to get to Camp
Aguinaldo and you are considering taking the MRT for P40, a bus for P35, a
jeepney for P30 and a taxi for P150.
The P100 you spent to get to EDSA-Taft is sunk cost.
All the remaining costs are relevant.
For Decision-Making and Analytical
Procedures
Value-added costs – costs that add value to the product
Example: In a bakery, the ingredients and the cost of
operating the oven are value-added costs since these are
necessary to satisfy the customer’s demand for quality.
On the other hand, cost of inspection is a non-value
added activity because this does not in any way
contribute to the improvement of the product.