TOPIC 2

COST: CONCEPT,
CLASSIFICATION
AND COMPONENT
 THE IMPORTANCE OF COST INFORMATION

➢ To enable management to carry out management

functions in an organization, for example

planning, directing and controlling.

➢ Managers need to have deep knowledge about costs

and cost classification in order to be able to

control and manipulate costs so that the company

can achieve maximum performance.

DIFFERENCES BETWEEN COSTS AND EXPENSES

Costs Expenses
Costs are the sacrifice Expenses are the
of resources to acquire sacrifice of resources to
products or services obtain benefit in the
which will benefit in the current period.
future.
Example: Cost to acquire Example: Cost of
assets such as cost in operational or non-
purchasing machinery. operational expenses such
as the amount of
Utilities Expense.

2-1
 COST CLASSIFICATIONS

I. FUNCTION
MANUFACTURING COST

Costs Explanation

Direct • Cost of main direct materials that

materials is used in producing products and
cost can be traced to the finished
product.

• Example: Cost of wood used in the

making of wooden tables.
Direct labour • Salaries or wages paid to labour
cost directly involved in converting
direct materials into finished
product.

• Example: Wages paid to assembly-line

worker.
Manufacturing • All manufacturing costs except
overhead direct materials cost and direct
costs labour cost.

• Example: Cost of indirect materials

such as screws, nails used in the
making of wooden tables.
 COST CLASSIFICATIONS

I. FUNCTION
MANUFACTURING COST

Costs Explanation

Manufacturing ➢ All manufacturing costs except

overhead direct materials cost and direct
costs labour cost.

➢ Example: Cost of indirect

materials such as screws, nails
used in the making of wooden
tables.
Prime costs ➢ Main costs involved in the process
of producing products.

➢ Consist of direct materials cost

and direct labour cost.
Conversion ➢ Costs involved in the process of
costs converting direct materials into
finished products (finished
goods).

➢ Consist direct labour cost and

manufacturing overhead costs.
NON-MANUFACTURING COST

SELLING EXPENSES AND ADMINISTRATION EXPENSES

✓ Also known as non-manufacturing costs.

✓ Costs incurred in the process of selling

products and administrating the business such

as Advertising Expense, Salaries of Sales and

Administrative and Depreciation Expense of

Office Equipment.

✓ Also known as operational expenses or period

costs and will be reported in the Statement

of Profit or Loss or Statement of

Comprehensive Income.
 II. BEHAVIOUR

Costs Explanation

Variable Costs that vary in total as the activity

Cost changes and variable cost per unit is

constant.

Fixed Costs that do not change even though the

Cost activity changes and fixed cost per unit

changes inversely to the change of the

activity.

Mixed Costs that contain both variable cost and

Costs fixed cost elements.

 III. OTHER CLASSIFICATION

Costs Explanation
Direct ➢ Costs involved directly in the
Cost production process and can be traced to
the product such as direct materials
cost and direct labour cost.

➢ Also known as prime costs.

Indirect ➢ Costs that cannot be traced to a cost
Cost object.
➢ Can be categorised into indirect
manufacturing costs and indirect non-
manufacturing costs.
➢ Indirect manufacturing costs are costs
involved indirectly in the production
process and cannot be traced to the
product, also known as manufacturing
overhead costs, consisting of indirect
materials cost, indirect labour cost
and manufacturing overhead costs.

➢ Indirect non-manufacturing costs are

referred to as selling and
administrative costs and also known as
period costs.
MANUFACTURING COSTS

Example 1:

Costs And Expenses RM

Factory Equipment Rent 1,500

Factory Building Insurance 500

Direct Materials 200,000

Factory Utilities 800

Office Supplies 400

Assembly Line Wages 70,000

Depreciation on Office Equipment 400

Indirect Materials 10,000

Factory Property Taxes 125

Factory Supervisory Salaries 1,700

Advertising 1,250

Sales Commission 80,000

Depreciation on Factory Building 900

Calculate:

a.Prime costs
b.Manufacturing overhead
c.Conversion costs
d.Manufacturing costs
Solution:
a.Prime costs

Prime costs RM

Direct Materials:

Raw Materials 200,000

Direct Labour:

Assembly Line Wages 70,000

Total 270,000

b.Manufacturing overhead

Manufacturing overhead RM

Factory Equipment Rent 1,500

Factory Building Insurance 500

Factory Utilities 800

Indirect Materials 10,000

Factory Property Taxes 125

Factory Supervisory Salaries 1,700

Depreciation On Factory Building 900

Total 15,525
c.Conversion costs

Conversion costs RM

Direct Labour:

Assembly Line Wages 70,000

Manufacturing Overhead 15,525

Total 85,525

d.Manufacturing costs

Manufacturing costs RM

Direct Materials 200,000

Assembly Line Wages 70,000

Manufacturing Overhead 15,525

Total 285,525
NON-MANUFACTURING COSTS

Example 2:
Refer to cost information in Example 1
Required:
Calculate non-manufacturing costs:
Solution:

Non-manufacturing costs RM

Office Supplies 400

Depreciation on Office Equipment 400

Advertising 1,250

Sales Commission 80,000

Total 82,050
DIRECT COSTS

Example 3
Refer to cost information in Example 1
Required:
Calculate direct cost:

Solution:

Direct costs RM

Direct Materials:

Raw Materials 200,000

Direct Labour:

Assembly Line Wages 70,000

Total 270,000
Example 4
Refer to cost information in Example 1
Required:
Calculate indirect manufacturing costs and indirect
non-manufacturing costs:
Solution:

Indirect manufacturing costs RM

Manufacturing Overhead:

Factory Equipment Rent 1,500

Factory Building Insurance 500

Factory Utilities 800

Indirect Materials 10,000

Factory Property Taxes 125

Factory Supervisory Salaries 1,700

Depreciation On Factory Building 900

Total 15,525

Indirect non-manufacturing costs RM

Office Supplies 400

Depreciation On Office Equipment 400

Advertising 1,250

Sales Commission 80,000

Total 82,050
 PRODUCT
Product COSTS AND PERIOD
Costs COSTS
Period Costs

Costs involved in the Costs involved in the

process of making process of selling

products. products and

administrating the whole

company.

Also known as Also known as non-

manufacturing costs. manufacturing cost.

Reported in the Statement Presented in the Statement

of Cost of Goods of Profit or Loss or

Manufactured. Statement of Comprehensive

Income as operational

expenses.

Example: Example:

Direct materials Cost, Advertising Expense, Sales

Direct Labour Cost and Commission Expense,

Manufacturing Overhead Freight Out and Director’s

Cost. Salaries Expense.

Example 5
Refer to cost information in Example 1
Required:
Calculate product costs and period costs:

Solution:

Product costs RM RM

Direct Materials:

Raw Materials 200,000

Direct Labour:

Assembly Line Wages 70,000

Manufacturing Overhead:

Factory Equipment Rent 1,500

Factory Building Insurance 500

Factory Utilities 800

Indirect Materials 10,000

Factory Property Taxes 125

Factory Supervisory Salaries 1,700

Depreciation on Factory 900

Building

Total Manufacturing Overhead 15,525

Total Product Costs 285,525

Period costs RM

Office Supplies 400

Depreciation on Office Equipment 400

Advertising 1,250

Sales Commission 80,000

Total Period Costs 82,050