BASIC COST CONCEPTS AND CLASSIFICATION

COST
 Monetary measure of the amount of resources given up or used for some purpose.
 Any sacrifice that we entail in order to receive a benefit. All expenses are expired costs.
 All expenses are costs, but not all costs are expenses.
 A cost object is any item such as products, departments, customers, and activities for which costs are
measured and assigned.

Cost Classifications
A. As to type
a. Period Costs are cost which benefits only the current period.
b. Product Costs are those which are directly attributed to the goods produced that it
remains an asset until the goods are sold. These are inventoriable costs, identified
as part of inventory on hand.
B. As to function
a. Manufacturing cost are those that are attributed with the manufacturing activities of
the company.
i. Direct materials – all materials that become an integral part of the finished
product.
ii. Direct labor – labor that is directly involved in the production of the finished
product.
iii. Manufacturing overhead- all costs, which are not both direct materials and
direct materials, which are related to the manufacturing process of the
finished product.
b. Non- manufacturing cost or operating expenses are costs which are not related to
the manufacturing cost of the company.
i. Selling expense – expenses attributed with the selling and delivery of the
product
ii. Administrative expense – expenses which are incurred in connection with
performing general and administrative activities.
C. As to traceability
a. Direct Cost are those costs that can be directly traced to the costing object. The
more costs that can be traced to a cost object, the more accurate are the cost assignments.

b. Indirect Cost are costs which are difficult to trace directly to a specific costing
object.
D. For decision making
a. Relevant cost – in order for costs to be relevant it should meet the following:
i. The cost must be an expected future cost
ii. Cost must differ between two alternatives.
b. Differential cost – cost that change due to selecting of other alternatives
c. Opportunity Cost – represents forgone benefits or benefits sacrificed due to
selection of a particular decision
d. Sunk Cost – cost which cannot be recovered anymore regardless of whatever future
decision made
E. As to behaviour
a. Variable cost - those which vary in amount depending on the volume of activity
b. Fixed cost - those which do not change in total amount even if there may be
changes in the level of activity
i. Committed fixed cost – long term in nature and cannot be eliminated even for
short term without affecting the profitability of long term goals (i.e.
depreciation)
 ii. Discretionary fixed cost – usually arises from periodic decisions made by
management to spend in certain activities. These costs may be changed by
management from time to time.
c. Mixed Cost – composed of both variable and fixed costs
d. Step Cost – when activity changes, shifts upward or downward by certain interval.
F. Quality Cost
a. Conformance cost- incurred to keep defective products from falling into the hands of
customers
i. Prevention cost – cost relating to any activity that minimizes the number of
defects in products and services. (i.e. quality training, technical support given
to suppliers, systems development)
ii. Appraisal cost – cost related to the inspection to ensure products meet
quality standards (i.e. inspection cost, maintenance of inspection equipment,
product quality standards)
b. Nonconformance cost- incurred because defects were produced despite efforts to
prevent them
i. Internal failure -cost arises from identification or discovery of defects during
the appraisal and inspection process (i.e. cost of spoilage, rework cost,
disposal of defective products)
ii. External failure cost- arises when defective products are delivered to
customers (i.e. repair cost, returned products, warranty claims, lost sales due
to reputation of poor quality)
G. As to time of incurrence
a. Historical cost- costs which are incurred in the past
b. Replacement cost – amount a company may need to spend today if it were to
purchase a very similar asset it already owns
c. Budgeted cost – refer to future, possible expenditures set up using estimates and
historical costs.
H. As to responsibility
a. Controllable
b. Uncontrollable
I. As to avoidability
a. Avoidable cost - which are incurred only when an activity is engaged in. Once this
activity is discontinued, avoidable costs are also rid of.
b. Unavoidable cost – expensed, no matter what happens. Example, rent expense
J. Other cost concepts
a. Out of pocket costs - These are costs that require current or near future cash outlays
b. Joint cost - Costs incurred in simultaneous processing or manufacturing two or more
products which are difficult to identify as distinct from each other. Before they are
split, will be the stage of joint process. Usually, these are irrelevant costs.
c. Postponable cost - Costs which may be shifted to the future with little or no effect on
the efficiency of current operations.
d. Imputed cost - Costs that do not involve at any time actual cash outlay and which
do not, as a consequence - appear in the financial records; nevertheless, such -
costs involve a foregoing on the part of the person or persons whose costs are being
calculated.