Cost concept
Cost is "a foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a specific objective" (American Accounting Association).
Cost refers the monetary measure of the amount of resources given up or used for some specified purpose. It is the value the goods or services expended to obtain current or future benefits.
All types of organizations incurred costs─governmental, not-for-profit, manufacturing, retail and service. Generally the kinds of costs that are incurred and the way in which these cost are classified depend on the type of organization such as─
- manufacturing
- merchandising, and
- service.
Cost Classifications
Costs can be classified in different ways. There are manufacturing costs and non-manufacturing costs, direct and indirect costs, product and period costs, fixed and variable, sunk and opportunity costs, etc.
Management accountants need to understand cost concepts because they are vital in many areas of planning, control, and decision-making. In this unit, we will learn about the different types of costs and product costing systems.
Costs may be categorized according to their:
-management function,
-ease of trace ability,
-timing of charge against revenue,
-behavior in accordance with activity, and
-relevance to decision making.
Cost concept
Cost is "a foregoing, measured in monetary terms, incurred or potentially to be incurred to achieve a specific objective" (American Accounting Association).
Cost refers the monetary measure of the amount of resources given up or used for some specified purpose. It is the value the goods or services expended to obtain current or future benefits.
All types of organizations incurred costs─governmental, not-for-profit, manufacturing, retail and service. Generally the kinds of costs that are incurred and the way in which these cost are classified depend on the type of organization such as─
- manufacturing
- merchandising, and
- service.
Cost Classifications
Costs can be classified in different ways. There are manufacturing costs and non-manufacturing costs, direct and indirect costs, product and period costs, fixed and variable, sunk and opportunity costs, etc.
Management accountants need to understand cost concepts because they are vital in many areas of planning, control, and decision-making. In this unit, we will learn about the different types of costs and product costing systems.
Costs may be categorized according to their:
-management function,
-ease of trace ability,
-timing of charge against revenue,
-behavior in accordance with activity, and
-relevance to decision making.
According to Management Function
1. Manufacturing costs - incurred in the factory to convert raw materials into finished goods. It includes cost of raw materials used (direct materials), direct labor, and factory overhead.
2. Non-manufacturing costs - not incurred in transforming materials to finished goods.
Non-manufacturing cost are often divided into tow categories . These are -
⇒selling costs -includes advertising costs, delivery expense, salaries and commission of salesmen.
⇒administrative costs- salaries of executives and legal expenses.
According to Ease of Trace ability
1. Manufacturing costs - incurred in the factory to convert raw materials into finished goods. It includes cost of raw materials used (direct materials), direct labor, and factory overhead.
2. Non-manufacturing costs - not incurred in transforming materials to finished goods.
Non-manufacturing cost are often divided into tow categories . These are -
⇒selling costs -includes advertising costs, delivery expense, salaries and commission of salesmen.
⇒administrative costs- salaries of executives and legal expenses.
According to Ease of Trace ability
1. Direct costs - those that can be traced directly to a particular object of costing such as a particular product, department, or branch.
Examples include materials and direct labor. Some operating expenses can also be classified as direct costs, such as advertising cost for a particular product.
2. Indirect costs - those that cannot be traced to a particular object of costing. They are also called common costs or joint costs.
Indirect costs include factory overhead and operating costs that benefit more than one product, department, or branch.
1. Direct costs - those that can be traced directly to a particular object of costing such as a particular product, department, or branch.
Examples include materials and direct labor. Some operating expenses can also be classified as direct costs, such as advertising cost for a particular product.
2. Indirect costs - those that cannot be traced to a particular object of costing. They are also called common costs or joint costs.
Indirect costs include factory overhead and operating costs that benefit more than one product, department, or branch.
According to Timing of Charge against Revenue
1. Product costs - are inventoriable costs. They form part of inventory and are charged against revenue, i.e. cost of sales, only when sold.
All manufacturing costs (direct materials, direct labor, and factory overhead) are product costs.
2. Period costs - are not inventoriable and are charged against revenue immediately.
Period costs include non-manufacturing costs, i.e. selling expenses and administrative expenses.
3. Prime cost- the sum of direct materials and direct labor cost.
4. Conversion cost- the sum of direct labor cost and manufacturing overhead cost.
1. Product costs - are inventoriable costs. They form part of inventory and are charged against revenue, i.e. cost of sales, only when sold.
All manufacturing costs (direct materials, direct labor, and factory overhead) are product costs.
2. Period costs - are not inventoriable and are charged against revenue immediately.
Period costs include non-manufacturing costs, i.e. selling expenses and administrative expenses.
3. Prime cost- the sum of direct materials and direct labor cost.
4. Conversion cost- the sum of direct labor cost and manufacturing overhead cost.
According to Behavior in Accordance with Activity
1. Variable costs - vary in total in proportion to changes in activity.
Examples include direct materials, direct labor, and sales commission based on sales.
2. Fixed costs - costs that remain constant regardless of the level of activity.
Examples include rent, insurance, and depreciation using the straight line method.
3. Mixed costs - costs that vary in total but not in proportion to changes in activity. It basically includes a fixed cost potion plus additional variable costs.
An example would be electricity expense that consists of a fixed amount plus variable charges based on usage.
1. Variable costs - vary in total in proportion to changes in activity.
Examples include direct materials, direct labor, and sales commission based on sales.
2. Fixed costs - costs that remain constant regardless of the level of activity.
Examples include rent, insurance, and depreciation using the straight line method.
3. Mixed costs - costs that vary in total but not in proportion to changes in activity. It basically includes a fixed cost potion plus additional variable costs.
An example would be electricity expense that consists of a fixed amount plus variable charges based on usage.
According to Relevance to Decision Making
1.Differential cost and Revenue- A difference in costs between any two alternatives is known as a differential cost. A differential cost is also known as incremental costs.
A difference in revenues between any two alternatives is known as a differential revenue.
2.Opportunity cost - benefit forgone or given up when an alternative is chosen over the others.
Example: If a business chooses to use its building for production rather than rent it out to tenants, the opportunity cost would be the rent income that would be earned had the business chose to rent out.
3. Sunk costs - historical costs that will not make any difference in making a decision. Unlike relevant costs, they do not have an impact on the matter at hand.
1.Differential cost and Revenue- A difference in costs between any two alternatives is known as a differential cost. A differential cost is also known as incremental costs.
A difference in revenues between any two alternatives is known as a differential revenue.
2.Opportunity cost - benefit forgone or given up when an alternative is chosen over the others.
Example: If a business chooses to use its building for production rather than rent it out to tenants, the opportunity cost would be the rent income that would be earned had the business chose to rent out.
3. Sunk costs - historical costs that will not make any difference in making a decision. Unlike relevant costs, they do not have an impact on the matter at hand.
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