COSTS – CONCEPT

AND
CLASSIFICATIONS
Chapter 2
LEARNING
OBJECTIVES

Distinguish between cost, expenses, and losses.

Distinguish between direct and indirect costs.

Define the three integral components of a product.

Define prime costs and conversion costs.

Define variable, fixed, mixed costs and discuss the effect of changes
in volume on these costs.

Distinguish between common costs and joint costs.

Distinguish between capital expenditures and revenue expenditures.

Identify the cost for planning, control, and analytical procedures.

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 COST

 The monetary measure of the amount of resources given up

or used for some purpose.
 The monetary value of goods and services expended to
obtain current or future benefits.

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CLASSIFICATION
S OF COSTS
 AS TO TYPE

1. Product Costs – costs incurred to manufacture the product. These are recognized as expense when
sold (COGS) and treated as asset when still unsold.

2. Period Costs – non-manufacturing costs that include selling, administrative, and research and
development costs. These are recognized as expense in the period of incurrence.

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 AS TO FUNCTION

1. Manufacturing Costs – includes all the costs incurred in the factory to convert raw materials into
finished goods.
a. Direct Manufacturing Costs – Materials and Labor
b. Indirect Manufacturing Costs – Factory Overhead Costs.

2. Non-Manufacturing Costs – refers to all costs which are not incurred in transforming materials to
finished goods.
a. Research and Development – costs related to the design and creation of new products.
b. Marketing Costs – refer to advertising and promotion costs.
c. Distribution Costs – refer to delivery costs.
d. Selling Costs – refer to the salaries, commissions, and other sales-related costs.
e. After-Sales Costs – refer to warranties and repair costs.
f. General and Administrative Costs – refers to all other non-manufacturing costs not included
above.

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 FOR DECISION-MAKING

1. Relevant Costs – these are costs that will differ under alternative courses of
action.

2. Differential Costs – these are the differences in costs between any two
alternative courses of actions.
a. Incremental Costs – refer to increase in the costs from one alternative
to another.
b. Decremental Costs – refer to decrease in the costs from one
alternative to another.

3. Opportunity Costs – refer to income or benefit given up when one

alternative is selected over another.

4. Sunk Costs – these are costs that were already incurred and cannot be
changed by any decision made in the present or to be made in the future.

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 AS TO BEHAVIOR
(REACTION TO CHANGES IN COST DRIVER)

1. Variable Costs – these are costs, that within the relevant range and time period under consideration,
that the total amount varies directly to the change in activity level or cost driver, and per unit amount
is constant.

2. Fixed Costs – these are costs, that within the relevant range and time period under consideration,
that the total amount remains unchanged, and the per unit amount varies inversely with the change
in the cost driver.

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 ANALYSIS OF MIXED COSTS

 Mixed Costs – are those costs that contain both fixed and variable costs elements.

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 COST SEGREGATION TECHNIQUES

1. High-Low Method – refers to the method of analyzing mixed costs based on costs observed at both the
high and low levels of activity within the relevant range.

 Variable Cost Rate (or Per Unit) = Cost of Highest Activity – Cost Lowest Activity
Highest Activity – Lowest Activity

 Fixed Cost = Total Cost at Highest Activity – (Variable Costs/Unit x Highest Activity in units)
 Fixed Cost = Total Cost at Lowest Activity – (Variable Costs/Unit x Lowest Activity in units)

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 2. Scatter Graph or Visual Fit – refers to the rough guide for
COST SEGREGATION
cost estimation which plot the cost against past activity
TECHNIQUES
levels.

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 COST SEGRAGATION TECHNIQUES

THREE FORMULAS TO BE
LEAST-SQUARE USED IN LEAST-SQUARE
REGRESSION METHOD METHOD

 A statistical technique which is often used  Equation 1. Y = a + bx

in separating mixed costs into their fixed
 Equation 2. ΣY = na + bΣx
and variable components.
 Equation 3. ΣXY = Σxa + bΣx²
 Where:
 Y = Costs; and
 X = Activity Level.

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THANK YOU
Joshua F. Abad, CPA

abad.joshua@gordoncollege.edu.ph

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