Costs and Cost Terminology

Definitions of cost:

• Cost – a resource sacrificed or foregone to achieve a specific objective

• Cost (such as direct materials or advertising) is usually measured as the monetary amount that must be paid to acquire goods or services

• Actual cost – the cost incurred (historical)

• Budgeted cost – a predicted or future cost

Stages of determining the cost of various cost objects:

• Cost object – anything for which cost measurement is desired. This maybe a product, service, project, an activity, or a program.

• Cost accumulation – the collection of cost data in some organized way by means of an accounting system

• Assignment of accumulated costs to designated cost objects

Cost Classification Categories

• As to time of incurrence –a. Historical cost - resource sacrificed or

foregone

b. Budgeted cost – planned or predetermined amount

c. Replacement cost – the amount of cash required to replace the same product or service at present

Cost Classification Categories• Cost based on reaction to activity level

a. Fixed cost – does not change in direct relation to change in volume within the relevant range (specified range of activity over which a variable cost remains constant per unit or fixed cost remains fixed in total)

b. Variable cost – changes in direct proportion to change in volume

c. Semi-variable/semi-fixed – cost which is fixed up to a certain point, beyond this point, it becomes variable

Cost Classification Categories

• Based on FS presentationa. Expired costs – costs for which benefits

have been received and therefore shown in the income statement as expenses (salaries, supplies, transportation, etc.)

b. Unexpired costs – constitute prepayments and are shown as assets in the balance sheet as prepaid expenses (prepaid rent, prepaid insurance, etc.)

Cost Classification Categories• With respect to impact on decision-making

a. Relevant cost – quantitative or qualitative that is pertinent to a specific problem or decision

b. Out-of-pocket cost – amount paid for a particular product or service or activity

c. Sunk cost (historical cost) – cost incurred in the past and is not relevant to any future courses of action

d. Quality cost – cost associated with conforming to standards.

Cost Classification Categories• Cost in relation to a product (operating

costs)a. Manufacturing costs

- Indirect materials – not easily traceable to a product

- Indirect labor – wages paid to factory helpers, supervisors, timekeepers

b. Commercial expenses – selling and administrative expenses such as advertising, sales commissions, and other general expenses

Cost Classification Categories

• Costs in relation to accounting period

a. Capital expenditures – relate to the use of resources for future benefits (i.e. major repairs of building, purchase of equipment)

b. Revenue expenditures – benefit only the current period and therefore recorded as expenses

Cost Classification Categories

• Direct materials – materials that can easily be identified with or seen in the finished product (i.e. wood for furniture, leather for shoes, textile for clothes).

• Direct labor – wages paid to factory workers who have direct hand in the conversion of raw materials to finished goods.

• Factory overhead – constitutes all the other manufacturing costs aside from direct materials and direct labor.

Cost Classification Categories

• Product cost – the sum of the costs assigned to an item

– For a merchandising firm

PC = invoice price - discounts,returns +

transport cost- For a manufacturing firm

PC = materials + labor + factory overhead

Types of Inventories• For merchandising company

– Merchandise Inventory – represents unsold merchandise at the end of the accounting period

• For manufacturing company– Direct materials inventory – direct materials in stock

and awaiting use in the manufacturing process

(ex. Computer chips and components for cell phones– Work-in-process Inventory – goods partially worked

on but not yet completed – Finished goods inventory – goods completed but

not yet sold