LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.

Strategic Cost Management

MIDTERM 1.3
 Cost accounting is most relevant when it comes to manufacturing businesses and
businesses involved in the distribution of physical products. This is because these
businesses revolve around the cost of production.
 The primary purpose of cost accounting is that it can help a company to budget and
increase its profitability. It also allows for easier accounting in many respects. But keep in
mind that the following categories can overlap in many regards.
 What is a cost – A cost reflects the amount of resources sacrificed in order for
the company to achieve a certain objective such as creation of goods or
rendering of services in order to earn revenues.
Costs as to classification in the Financial Statement (FS).
Product Cost – are identified and incurred by an entity to manufacture a product. It includes all
raw materials used, labor cost incurred and all other indirect costs.
Product Cost has three components: MATERIALS, LABOR, and OVERHEAD.
Materials – all raw materials and other supplies used in the manufacturing process. And materials
has two elements (Direct and Indirect materials)
Labor – are salaries and other benefits provided to all workers? And like Materials, labor has
elements (Direct and Indirect labor).
Overhead – All indirect costs necessary for product conversion that are not direct materials and
direct labor.

Components of Product Cost

Direct Material + Direct Labour = Prime Cost

Direct Cost + Factory/Works Overheads

Conversion Cost
=
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 LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.
Strategic Cost Management
MIDTERM 1.3

EQUATION: Direct Materials + Direct Labor + Manufacturing Overhead = Total Manufacturing Cost

*Cost Behavior
Variable Cost Fixed Cost
- Constant on a per unit basis - constant when presented as a total
- Varies when presented as a total. - varies on a per unit basis
Analyze:
- Assume an entity’s normal manufacturing process with a range of 5,000 to 7,000 units of
good with a variable cost per unit of 20 pesos and 15,000 fixed costs.
Variable Cost VC / unit Total Variable Fixed Cost Fixed Cost
Cost Per Unit
5,000 units 20 pesos 100,000 5,000 15000 3 pesos
6,000 units 20 pesos 120,000 6,000 15000 2.50 pesos
7,000 units 20 pesos 140,000 7,000 15000 2.14 pesos

Example:

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 LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.
Strategic Cost Management
MIDTERM 1.3

Mixed Cost – refers to costs that has both variable and fixed components. Ex: Utilities –since
these are charge with a base amount and goes higher with any usage over the base amount.
Step Costs – Costs that are constant on a certain level of activity but increase on another certain
level of activity.
Separating Mixed Cost –In separating mixed costs, there can be two method:
1. High – Low Method- 2. Least Square Regression Method
Example;
Jimin Corporation builds tabletop replicas of some of the most famous tourist attraction in Seoul.
The company is highly automated where maintenance costs shows as a significant expense. The
owner decided to use machine hour as the basis of predicting maintenance costs and has
gathered the following data for the following eight weekly operations;
Week Machine Hours Maintenance Cost
1 3,000 9800
2 4500 12900
3 8000 18100
4 6000 13500
5 9000 24800
6 3500 10400
7 5500 13000
8 7000 16000
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 LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.
Strategic Cost Management
MIDTERM 1.3

Using the high-low method, determine the following:

A, Variable Cost Per unit
b. Total Fixed Cost
c. Total expected maintenance cost on 8,200machine hours.
Step 1. Determine the highest and lowest activity and the cost associated there unto:
Highest Activity – 9,000 / 24,800
Lowest Activity –3,000 / P 9,800

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 LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.
Strategic Cost Management
MIDTERM 1.3

COST TERMINOLOGIES:
1. Direct Costs - costs are among the most common. They are the direct cost associated with
the production of a product. Direct costs would include labour, overhead and materials.
Direct costs are the same as Cost of Goods Sold.
2. Indirect Costs - Indirect costs are a little more difficult to trace. Indirect costs often cannot
be traced back to an individual department. These costs are indirect and are used all over
the plant. They are indirect but still highly relevant to the business and the end product.
3. Fixed Costs - The cost which remains same, regardless of the volume produced, is known
as fixed cost.
Example:Rent of facilities
-Constant when presented as a total
- Varies on a per unit basis.
4. Variable Cost - Variable cost varies with the variations in the volume, i.e. when there is an
increase in the production, variable cost will also increase proportionately with the same
percentage and when there is no production there will be no variable cost. The Variable cost
is directly proportional to the units produced by the enterprise. Example: Cost of materials,
Cost of direct Labour computed per piece.
- Constant on a per unit basis
- Varies when presented as a total.
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 LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.
Strategic Cost Management
MIDTERM 1.3

5. Operating or Period Costs - These are sometimes referred to as operating expenses. These
can be either fixed or variable. Operating costs are costs that are associated with daily
business activity but are distinct from indirect costs. Marketing,selling and distribution and
administrative expenses are typical examples of operating costs. They are essential for
business operations but are not involved in the manufacturing process directly or
indirectly.
6. Opportunity cost -refers to the advantage in mea.suable terms which might have been
foregone on account of not using the facilities in the manner originally planned. For
example, if an owned building is proposed to be utilised for housing a new project plant,
likely revenue which the building could fetch if rented out, is the opportunity cost which
should be taken into account while evaluating the profitability of the project.

7. Sunk Costs - which have been incurred as a result of decision taken in the past to set up the
infrastructure facilities. Such costs cannot be reversed or revised by subsequent decisions.
Investment made in- Plant and machinery & Building etc. are prominent examples of such
costs.
8. Committed Cost – Cost resulting from organizational structure or use of facilities.
9. Discretionary Cost – Cost arising from managerial decisions.
10. Controllable cost – Cost that are able to be influence on how much shall be spent,
11. Non controllable cost – Cost that cannot be controlled or influenced.

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 LADY OF LOURDES HOSPITAL & COLLEGES OF CAYBIGA, INC.
Strategic Cost Management
MIDTERM 1.3

Elements of Cost
Direct Material – It refers to a material out of which a product is to be produced or manufactured.
The cost of direct material is varying according to the level of output.
Example - Materials or primary components specifically purchased produced or requisitioned for
the specific product. “Milk is the direct material of butter.

Indirect Material – it refers to a material required to produce a product but not directly or does not
form a part of a finished product.
Example: Nails are used in furniture. The cost if indirect material is not varying in direct proportion
of product.

Direct Labour – It refers to the amount paid to the workers who are directly engaged in the
production of goods. It varies directly with the output.

Indirect Labour – It refers to the amount paid to workers who are indirectly engaged in the
production of goods. It does not vary directly with the output.

Overhead – It is the combination of an indirect cost (materials, labour) necessary for product
conversion that are not direct materials and direct labour,

 Factory overhead – It is otherwise called Production Overhead or Works Overhead. It refers

to the expenses that are incurred in the production place or within factory premises. For
example: Indirect material, rent, rate and taxes of factory, canteen expenses etc.
 Administration or Administrative Overhead- called also as Office Overhead. It refers to the
expenses that are incurred in connection with the general administration of the company.
For Example; Salary of Administrative Staff.
 Selling and Overhead – It refers to all expenses incurred in connection with sales,
commissions, Advertisement, etc.
 Distribution Overhead – It refers to all expenses incurred in connection with the delivery or
distribution of goods and services from the producer to the consumer. Loading / unloading.
Customs, delivery man etc.
 Factory utilities, Maintenance and Repair of Equipment, Depreciation of equipment in the
factory, Insurance of the factory.
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