Chapter 2 : Cost Concepts, Classifications and Cost -Product Cost

Behavior Cost assigned to products until they are sold.

●​ Goods not yet completed – WIP inventory
Cost ●​ Goods completed – FG inventory
●​ A cost reflects the amount of resources sacrificed ●​ Goods sold – Cost of goods sold
in order for the company to achieve a certain ●​ What are the costs that we include as product
objective such as creation of goods or rendering cost that, in turn, becomes an inventoriable cost,
of services in order to earn revenues. and becomes cost of goods sold when sold to
●​ A service provider needs to purchase supplies customers?
and materials and pay salaries to employees in
order to render service and earn revenues. -Period Cost
●​ A merchandiser has to first purchase the goods Costs incurred and recognized based on time periods.
that they need to sell in order to earn revenues. ●​ Operating expenses like rent, salaries and other
●​ A manufacturer spends for materials, labor administrative and general expenses.
payroll, and other factory burden to transform ●​ Is there a proper segregation of payroll as to
raw materials to finished goods and eventually laborers and payroll as to office staff?
sells those goods to earn revenue. ●​ Is there a proper segregation of factory facility
rent and office rent?
Cost based on functional areas ●​ What costs shall be reviewed that should be
included as product costs rather than as period
-Manufacturing Cost costs and vice-versa?
Cost that is incurred in the entity’s operations on
producing products and services. Cost Traceability
●​ Direct materials
●​ Direct labor -Direct Cost
●​ Manufacturing overhead Costs that are traceable to a particular product line,
●​ How can we lower down our costs of segment, department, division or branch.
production? ●​ Assuming an entity reviews all costs incurred in a
●​ What is the standard labor hours in the specific department, all material and labor costs
production of Product b? identified in that department are direct costs.
●​ How many units of Material Y shall we purchase Salaries of supervisors in that department is still
next period to avoid production delays? a direct cost in that certain department (because
its traceable there).
-Nonmanufacturing Cost
Cost that is incurred in the entity’s operations on making -Indirect Cost
the product known, selling them and other Costs that are not directly traceable to a particular line,
administrative expenses. segment, department division or branch.
●​ Operating expenses like marketing and ●​ If all product lines has only one production head,
advertisement, administrative expenses, selling the salary of the production head will be
expenses. allocated to the different product lines, which
●​ What can we do to eliminate other operating makes it indirect. However, the salary of the
expenses that does not add value to company? production head is still a direct cost if we will be
●​ Are there other expenses we need to consider talking about the whole production department.
that could help in our operations?
●​ Our office rent increased this month as Cost Controllability
compared to last month , what is the reason?
-Controllable Cost
Cost based on timing of matching with revenues Costs that can be influenced by the manager on how it
will be incurred and be altered in the short run.
 ●​ Power or authority to incur costs. materials. However, whatever production cycle, fixed
●​ Manager has freedom to set levels and decide cost will amount to P40,000.
for price, quality, and quantity, and even the ●​ P56/unit of materials is relevant in production
supplier of materials and other inputs. cycle A.
●​ Direct materials and direct labor ●​ P60/unit of materials is relevant in production
●​ Donations and other contributions cycle B.
●​ Training costs ●​ P40,000 is irrelevant since both alternatives will
●​ Bonuses incur the same fixed cost.

-Uncontrollable Cost -Marginal Cost

Costs that cannot be influenced by the manager on how Extra cost incurred when one additional unit is produced.
it will be incurred. It can be altered in the long run. It determines the quantity most efficient to produce.
●​ Allocated to the department under his ●​ Marginal cost of production is an important
leadership. concept in managerial accounting, as it can help
●​ Costs incurred traceable to the specific an organization optimize their production.
department but is incurred because it is decided ●​ Fixed costs are constant regardless of production
by the higher authority or management. levels, so higher production leads to a lower fixed
●​ Depreciation cost per unit as the total is allocated over more
●​ Insurance units.
●​ Allocated overhead ●​ Variable costs change based on production
●​ Allocated rent levels, so producing more units will add more
variable costs.

Average Cost per unit

Costs as to Decision Making
Total cost to produce divided by the total number of
units manufactured.
-Opportunity Cost
Variable cost – P40 per unit
These are the benefits forgone in choosing one
Fixed cost – P5,000
alternative over the other course of action.
●​ Spending for a cheeseburger for P50 per day for
the next ten years would have accumulated to
P182,500 worth of saving if you chose to save.
●​ An entity has chosen to rent a facility. The
payment for the rent could have been spent on
other aspects of the operations of the business.

-Differential Cost
Differences of costs under alternative actions or
decisions.
●​ Incremental or decremental costs or profits -Sunk Cost
(losses) in deciding whether to make or buy, Cost that has been already incurred that will not affect
shutdown or continue, sell as is or process future costs since they are already paid for or incurred
further, and drop a product line or not. and cannot be changed by any future action.
●​ A company spends P100,000 training its
-Relevant Cost employees to use a new ERP system. The
Cost incurred in one alternative that will not be software turns out to be heavily confusing and
encountered in the other alternative. unreliable. The senior management team wants
Choosing production cycle A involves P56/unit of to discontinue the use of the new ERP system.
materials. Production cycle B involves P60/unit of The P100,000 spent to train employees is a sunk
 cost and should not be considered in the
decision of discontinuing the new ERP system.
-Fixed Cost
At whatever level of production within the relevant
-Out-of-pocket cost
range, this cost does not change. It is dependent of the
Costs or expenses that require a cash payment in the
level of production.
current period or during a project.
●​ The wages of the person setting up a machine for Examples:
a new production run are out-of-pocket cost. ●​ Rent of facilities
However, the cost of the lost opportunity to be ●​ Depreciation of equipment
producing profitable output during the set-up ●​ Constant when presented as a total
time is not an out-of-pocket cost. ●​ Varies on a per unit basis.
●​ Payment of rent, wages, or interest. Assume an entity’s normal manufacturing
process with a range of 5,000 to 7,000 units of
Relevant Range goods with a variable cost per unit of P20 and
The range of production activity that presents the P15,000 fixed costs
entity’s normal operating levels where relationships of
cost behaviors are deemed acceptable. Fixed Costs FC/ unit

Cost Behavior at 5,000 ₱ ₱ 3.00

How a cost will respond according to changes in the units 15,000.0
production process or level of activity. 0
-Variable Costs
They are costs that change as the quantity of the at 6,000 15,000.0 2.50
goods produced changes. Total amount of variable cost is units 0
dependent to the level of production.
Examples: at 7,000 15,000.0 2.14
●​ Cost of materials units 0
●​ Cost of direct labor computed per hour
●​ Constant on a per-unit basis
●​ Varies when presented as a total
Assume an entity’s normal manufacturing Cost Behaviors
process with a range of 5,000 to 7,000 units of -Cost Equation
goods with a variable cost per unit of P20 and
P15,000 fixed costs. y = a + bx

y = total cost
VC/Unit Total Variable Costs
a = total fixed cost
at 5,000 ₱ ₱ 100,000
b = variable cost per unit
units 20.0
0 x = volume of activity

-Mixed Costs
at 6,000 20.0 120,000
Refers to costs that has both variable and fixed
units 0
components.
Examples:
at 7,000 20.0 140,000
●​ Utilities and maintenance costs, since these are
units 0
charged or is incurred with a base amount and
goes higher with any usage over the base
amount.
-Step Costs b. Total fixed cost
c. Total expected maintenance cost on 8,200
Costs that are constant on a certain level of activity but
machine hours
increases on another certain level of activity.
Step 1. Determine the highest and lowest activity and the
Examples:
costs associated thereunto.
●​ Salaries and commission of agents that goes
Step 2. Obtain the variable cost per unit by dividing the
higher with different ranges of activity e.g.,
change in cost over the change in activity.
people or customers served.
Step 3. Obtain the total fixed costs by removing the
variable cost component in the total costs.
Separation of Mixed Costs

It might be difficult for managers to be able to plan, ●​ Least Square Regression Method
control, or make a decision when the set of cost Using the high-low method, determine the
information has mixed costs. Therefore, it will be helpful following:
in managerial decision making to be able to see both the a. Variable cost per unit
variable cost and fixed cost component in a set of b. Total fixed cost
observations. Therefore, there are three methods to be Step 1. Prepare a table calculating x (activity), y (total
employed in separating mixed costs: cost) xy, and x²
Step 2. Substitute the computed amounts in the
●​ High-low Method following equation to get VC/unit.
Dahyun Company builds tabletop replicas of y = a + bx
some of the most famous tourist attractions in Ʃy = na + b Ʃx
Seoul. The company is highly automated where Ʃxy = Ʃx a + b Ʃ x²
maintenance costs shows a significant expense. Step 3. Substitute b to any equation to get a (fixed cost)
The owner decided to use machine hours as the ●​ Scatter Diagram
basis of predicting maintenance costs and has a graphical technique of separating fixed and
gathered the following data for the following variable components of mixed cost by plotting
eight weekly operations: activity level along x-axis and corresponding total
cost (i.e., mixed cost) along y-axis.
Week Machine Maintenance
-A regression line is drawn on the graph by visual
Hours Cost
inspection.
1 3,000 ₱ 9,800 -The line thus drawn is used to estimate the total
fixed cost per unit.
2 4,500 12,900 -The point where the line intercepts y-axis is the
estimated fixed cost, and the slope of the line is
3 8,000 18,100 the average variable cost per unit.
-Since the visual inspection does not involve any
4 6,000 13,500
mathematical testing, therefore, this method
5 9,000 24,800 should be applied with great care.

6 3,500 10,400

7 5,500 13,000

8 7,000 16,000

Using the high-low method, determine the

following:
a. Variable cost per unit