Cost Classification

Fixed costs - are expenses that do not change in total regardless of changes in production or
sales volume. These costs remain relatively constant over a specific period, such as a month or a
year.

Examples: Common examples of fixed costs include rent or lease payments for facilities,
insurance premiums, salaries of permanent staff, depreciation of machinery, property taxes, and
certain administrative expenses.

Characteristics:

Fixed costs remain constant within a relevant range of production or sales. For example, if a
company's monthly rent is Php 5,000, that cost remains the same whether the company
produces 100 units or 1,000 units during the month.

Variable Costs - Definition: Variable costs are expenses that change in direct proportion to
changes in production or sales volume. As production or sales increase, variable costs increase,
and as production or sales decrease, variable costs decrease.

Examples: Examples of variable costs include raw materials, direct labor (wages of workers
directly involved in production), packaging materials, sales commissions, and shipping costs.

Characteristics:

Variable costs are tied to the level of activity in a business. For example, if a company
manufactures bicycles, the cost of raw materials and direct labor would increase as more
bicycles are produced.

Direct Cost - Direct costs, also known as variable costs, are expenses that can be traced directly
and specifically to a particular product, project, or department. These costs are directly
attributable to the production of a specific item or the performance of a particular activity.

Examples: Common examples of direct costs include:

 Raw materials used in manufacturing a product.

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  Direct labor costs, such as wages and benefits for workers directly involved in producing
a specific product.
 Components and parts used in the assembly of a product.
 Packaging materials for a specific product.
 Shipping costs for delivering a specific product to a customer.

Characteristics:

Direct costs are variable in nature, as they vary with the level of production or the specific
project being undertaken.

1. These costs are often considered controllable because they can be directly influenced or
managed by making decisions related to production quantities or project scope.

Indirect Cost - also known as overhead costs, are expenses that cannot be traced directly to a
specific product, project, or department. Instead, they are incurred to support the overall
operations of a business and are shared among various cost objects.

Examples: Common examples of indirect costs include:

 Rent or lease payments for a facility used for multiple purposes.

 Utilities (e.g., electricity, water) for a building that houses multiple departments.
 Salaries and benefits of employees who work in shared departments like administration,
accounting, or human resources.
 Depreciation of assets used for general purposes, such as office furniture or equipment.

Characteristics:

Indirect costs are typically fixed or semi-variable, meaning they remain relatively constant or
vary only partially with changes in production or activity levels.

These costs are often considered less controllable because they are shared across multiple cost
objects and cannot be easily attributed to any single product or project.

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Sunk costs - refer to expenditures that have already been incurred and cannot be recovered.
These are costs that have been paid in the past and are no longer relevant to current or future
decisions.

Examples: Common examples of sunk costs include:

 Money spent on a non-refundable ticket for an event you can no longer attend.
 Expenses incurred in a failed business venture.
 Costs associated with a completed project or investment.

Characteristics:

Sunk costs should not influence future decisions because they are irretrievable and irrelevant to
choices going forward.

Making decisions based on sunk costs is often considered a fallacy known as the "sunk cost
fallacy," where people mistakenly continue investing in a project or endeavor simply because
they have already committed resources.

Opportunity costs - represent the potential benefits or value that is foregone when one choice
is made over another. These costs are associated with the benefits or profits that could have
been obtained from the next best alternative.

Examples: Examples of opportunity costs include:

Choosing to attend college instead of working immediately, involves both tuition costs and the
income you could have earned.

Deciding to invest in one stock over another, involves the potential gains you might have made
from the unchosen investment. Allocating time to one project instead of another means giving
up the benefits you could have gained from the alternative project.

Characteristics:

Opportunity costs are forward-looking and consider the value of alternative choices.

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They are relevant in decision-making because they help individuals and businesses assess the
trade-offs between different options.

Costing Methods

Job costing - is a costing method used in accounting and finance to track and allocate the costs
associated with a specific project, job, or task. This method is commonly used in industries
where the production or service delivery process varies significantly from one job to another,
making it necessary to account for costs on an individual job basis. Job costing is particularly
prevalent in construction, manufacturing, custom manufacturing, consulting, and other project-
based businesses.

Process costing - is a costing method used in accounting and finance to allocate costs to
products that are produced in a continuous, repetitive, or standardized manufacturing process.
This method is particularly useful in industries where products are uniform and pass through a
series of sequential or continuous processes, such as chemical manufacturing, food processing,
oil refining, and textile production.

Activity-based costing - (ABC) is a costing methodology used in accounting and management to

assign costs to products, services, or activities based on the resources and activities required to
produce them. Unlike traditional costing methods that allocate costs based on a single factor,
such as direct labor hours or machine hours, ABC recognizes that various activities and
resources contribute to a product's or service's cost. It provides a more accurate and detailed
view of how costs are incurred and helps organizations make better decisions regarding pricing,
cost control, and resource allocation.

Variable costing - also known as direct costing or marginal costing, is an accounting method
used to determine the cost of producing goods or services. It is primarily concerned with
separating costs into two categories: variable costs and fixed costs. Variable costing treats fixed
manufacturing overhead costs as period expenses rather than including them in the cost of
goods sold. This approach provides a clearer understanding of how costs change in relation to
production levels and is often used for internal management purposes and decision-making.

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Absorption costing - also known as full costing, is an accounting method used to determine the
total cost of producing goods or services. It considers both variable and fixed manufacturing
costs as part of the cost of goods sold (COGS). Unlike variable costing, which treats fixed
manufacturing overhead as a period cost, absorption costing assigns a portion of fixed
manufacturing overhead to each unit produced. This approach is often used for external
financial reporting and tax purposes because it aligns with generally accepted accounting
principles (GAAP) and provides a more comprehensive view of product costs.

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