Chapter 2:

Cost Concepts and

Classifications

LEARNING OUTCOME
Define Cost.
Distinguish between cost and expenses.
Identify the three integral components of a
product.
Understand the basic concepts of cost and
its different classifications common to
manufacturing operations.

Cost Defined

Cost is the monetary measure of the

amount of resources given up or used for
some purpose or objective. It is measured
by the price paid or required to be paid to
acquire goods or services to attain future
benefits.

Costs and Expenses

Costs and expenses are used synonymously

most of the time. However, expenses
technically differ from costs. As defined in
PAS 1, expenses are gross outflow of
economic benefits during the period in the
course of ordinary activities when those
outflows result in decreases in equity, other
than those relating to distributions to
owners.

Costs on the other hand, are incurred to

produce benefits, i.e. revenues. As costs are
used up in the making of revenues, they are
said to expire. Expired costs are called
expenses which are matched with revenues
to determine income in a given period.
Every expense is a cost, but not all costs
are expenses.

Cost Object

is any item such as product, product line,

customer, project, department, or activity,
for which costs are being accumulated,
measured, assigned or computed. It is also
called the cost objective. Cost object or cost
objective is referred to as the why of cost
accounting because it answers the most
fundamental question about cost: Why do
we incur cost?

Cost Driver

Cost driver is any variable, such as level of activity or

volume, that usually affects cost over a period of time.
Ex: production, sales, and number of hours. Cost driver
is otherwise known as the how of cost accounting
since the amount of cost to be incurred depends on
the level of activity for a given cost driver. For
instance, the amount of product cost for furniture firm
depends on the number of tables the firm wants to
produce. Likewise, the amount of labor cost depends
on the number of hours the workers will consume in
the performance of their work to produce finished
goods.

Cost Pool

Cost pool is a grouping of individual cost

items. It is an account in which a variety of
similar costs are accumulated. It is so-called
because costs are pooled or gathered and
accumulated in this particular account for
proper measurement and assignment. Ex:
Work in Process Inventory account and
Factory Overhead Control account.

CLASSIFICATION OF COSTS
A. Costs in Relation to the Product

1. Manufacturing Costs all costs associated with

the manufacture of goods or provision of service.
These costs are otherwise known as product cost.
This classification of costs includes direct materials,
direct labor and overhead. These costs are
considered unexpired costs and reported in the
statement of financial position classified as inventory
under the assets section until they are sold.

Direct Materials are materials that become a

physical part of a finished product and whose
costs are separately and conveniently traceable
to the finished products. Wood in furniture, sugar
in candies, milk in shakes and flour in bread are
all direct materials.
Direct Labor the compensation of employees
who are directly involved in the production of the
products. The chef in a restaurant, carpenter in a
furniture shop and a driver in a bus company are
considered direct laborers.

Factory Overhead constitutes all other

manufacturing costs other than direct materials
and direct labor. In includes indirect materials,
indirect labor, and other costs such as depreciation
of factory assets, maintenance and power.
Prime Cost the primary cost incurred to produce
a product. It is equal to the sum of direct materials
and direct labor.
Conversion Cost the cost necessary to convert
raw materials into a finished product. It is equal to
the sum of direct labor and overhead.

2. Non-manufacturing Costs all costs which

are not incurred in converting raw
materials
into finished goods. These costs are also called
period costs. These costs are related to the
designing, developing, distribution and general
administration functions of business. These costs
are considered expired costs and reported in the
income statement as expenses. This classification
of costs includes selling expenses, and general
and
administrative
expenses
which
are
automatically charged to expense as incurred.

B. Costs Classified as to Traceability to Cost

Object

Direct Costs costs that are related to a

particular cost object and can economically
and effectively be traced to that cost object.
It is also called traceable costs.

Indirect Costs costs that are related to a

cost object but cannot practically,
economically and effectively be traced to
such cost object.

C. Costs According to its Behavior

Variable Costs costs that change directly in

total in proportion to changes in activity level.

Fixed Costs costs that remain unchanged in

total within a relevant range for a given period
regardless of changes in activity level.

Mixed Costs costs that have both a variable

and a fixed component. It is otherwise known as
semi-variable costs.

D. Costs Associated with Time of Incurrence

Historical Costs costs already incurred in the

past and are normally used in financial accounting.

Replacement Costs the amount of cash

required to replace the same product or service at
present.

Budgeted Costs costs that are planned or

forecasted. Otherwise called as future costs.

E. Costs in Relation to its

Relevance in Decision
Making
1. Relevant Costs
costs that are logically
associated with a particular problem or
decision. Relevant costs are future costs that
differ
among
alternatives
under
consideration.

2. Differential Costs the difference in

costs among alternative courses of action.

a. Incremental Cost increase in cost

from one alternative to another.
b. Decremental Cost decrease in cost

3. Sunk Costs costs that have been

incurred and cannot be changed by any
decision made now or to be made in the
future.

4. Out-of-Pocket-Costs costs that are

not budgeted or planned.

5. Opportunity Costs income or benefit

given up when one alternative is selected
over another.

F. Costs Classified as to
Extent of Managerial
Influence

1. Controllable Costs costs which are

subject to significant influence by a
particular manager with the time period
under consideration.

2. Non-controllable Costs costs over

which a given manager doesnt have a
significant influence.

Exercise
s

1. Classify the following costs as

product or period and variable or fixed
by marking X on the appropriate
column.

Cost

Product

Period

Insurance cost for CocaCola Manufacturing Plant

Pineapple used in the
manufacture of Del Monte
Pineapple Chunks
Motherboard included as
part
of
Samsung
Electronics
laptop
computer product
Administrative salaries for
executives of Robinsons
Land Holdings, Inc.
Shipping charges incurred
by Nation Paper Products
Corporation on out-going
orders of bond papers

Variabl
e

Fixed
x

Wages of assembly-line
workers at Toyota Plant
Philippines
Straight-line
depreciation of mixing
equipment
of
International
Marketing
expenditures
Pharmaceuticals,
Inc.
of Elena Home-baked
Products
Commissions paid to
Pepsi-Cola Companys
salespeople
Salaries
paid
to
security
guards
of
McDonalds Tacloban

Salaries
of
delivery
personnel of Jollibee
Tacloban
Zamora
Salary
branch paid to the
secretary
of
the
President of YKS Oil
The
amount Plant
paid to
Manufacturing
LEYECO
II
for
the
electricity consumption
in the factory of TBK
Manufacturing
Corporation
for
the
month of May

CALCULATOR
CHALLENGE

2. New Leyte Edible Oil Manufacturing

Corporations accounting records showed the
following costs for 2013:

Direct materials

P350,000

Direct labor

285,000

Indirect materials

315,250

Indirect labor

176,115

Factory utilities

75,640

Factory rent

70,000

Factory insurance

25,000

Freight in

64,000

Sales commissions

210,000

Legal expenses

31,335

Advertising expenses

36,125

Depreciation factory building

21,500

Depreciation office building

15,000

Doubtful accounts expense

23,000

Salary of the presidents secretary

28,000

A. What is the prime cost for

Direct materials

P350,000

Direct labor

285,000

Indirect materials

315,250

Indirect labor

176,115

Factory utilities

75,640

Factory rent

70,000

Factory insurance

25,000

Freight in

64,000

Sales commissions

210,000

Legal expenses

31,335

Advertising expenses

36,125

Depreciation factory building

21,500

Depreciation office building

15,000

Doubtful accounts expense

23,000

Salary of the presidents secretary

28,000

B. What is the conversion cost for 2013?

Direct materials

P350,000

Direct labor

285,000

Indirect materials

315,250

Indirect labor

176,115

Factory utilities

75,640

Factory rent

70,000

Factory insurance

25,000

Freight in

64,000

Sales commissions

210,000

Legal expenses

31,335

Advertising expenses

36,125

Depreciation factory building

21,500

Depreciation office building

15,000

Doubtful accounts expense

23,000

Salary of the presidents secretary

28,000

C. What is the total product cost for

2013?

Direct materials

P350,000

Direct labor

285,000

Indirect materials

315,250

Indirect labor

176,115

Factory utilities

75,640

Factory rent

70,000

Factory insurance

25,000

Freight in

64,000

Sales commissions

210,000

Legal expenses

31,335

Advertising expenses

36,125

Depreciation factory building

21,500

Depreciation office building

15,000

Doubtful accounts expense

23,000

Salary of the presidents secretary

28,000

D. What is the total period cost for 2013

3. KanGara Sundang, Inc. manufactures knives.

Following are some costs incurred in the factory in
2010 for knife production:

Materials Costs:
Stainless Steel
P400,000
Equipment Oil and Grease
3,000
Plastic and Fiber Glass for Handles

Labor Costs:
Equipment Operators
Equipment Mechanics
Factory Supervisors

2,800

P250,000
41,000
136,000

a. Compute for the direct material cost

for 2010.

3. KanGara Sundang, Inc. manufactures knives.

Following are some costs incurred in the factory in 2010
for knife production:

Materials Costs:
Stainless Steel
P400,000
Equipment Oil and Grease
3,000
Plastic and Fiber Glass for Handles

Labor Costs:
Equipment Operators
Equipment Mechanics
Factory Supervisors

2,800

P250,000
41,000
136,000

b. Compute for the direct labor cost for

2010.

3. KanGara Sundang, Inc. manufactures knives.

Following are some costs incurred in the factory in
2010 for knife production:

Materials Costs:
Stainless Steel
P400,000
Equipment Oil and Grease
3,000
Plastic and Fiber Glass for Handles

Labor Costs:
Equipment Operators
Equipment Mechanics
Factory Supervisors

2,800

P250,000
41,000
136,000

c. What is the total overhead cost for

2010?

THANK YOU !