CHAPTER 2

COST CLASSIFICATIONS

Dr. Le Hoang Oanh

LOGO
LEARNING OBJECTIVES

Understanding the cost classification in different ways

for different purposes
Identify the types of costs in each classification
Understand the analysis of mixed cost
Prepare income statement in two ways: absorption
income statement and variable income statement
CONTENTS

Cost concepts
Cost classifications
Income statement
COST CONCEPTS

LOGO
COST

is defined as
a resource sacrificed or forgone to
Cost
achieve a specific objective in
production and business activities
of enterprises.

Cost is classified differently according to the immediate

needs of management
COST UNITS

a unit of product or service which

Cost unit
has costs attached to it

the basic control unit for costing purposes

A Single item
Room (in a hotel)
A composite item
Patient night, a passenger mile
A batch of 1,000
Batch of 1,000 shoes
COST CLASSIFICATIONS

LOGO
 COST CLASSIFICATIONS
Element Nature Function Relationship with Behaviour
acc period
Material Direct Production cost Product cost Fixed cost
cost
Labour Indirect Selling & Period cost Variable
cost Distribution cost
cost
Expenses R & D cost Step-cost
Financing cost Semi-
variable
cost
Administration
cost
8
CLASSIFICATION BY ELEMENT

Types of costs

Materials Labour Expenses

labour cost (salaries)

9
COST CLASSIFICATION BY NATURE (FOR
ASSIGNING COSTS TO A COST UNIT)

Types of costs

Direct costs Indirect costs

 COST CLASSIFICATION BY NATURE

- Directly involve to a cost unit

(product or service)
à Easily and conveniently traced
to the particular cost unit

Prime
cost
Direct costs

Direct materials Direct labour Direct expenses

All materials which All wages paid for labour Any exp incurred on
form part of the product (either as basic hour or as a specific product
(unless used in negligible overtime ) which involved other than direct
amounts &/or having directly in making the material cost & direct
negligible cost àindirect product wages
materials) small cost/ amount
 COST CLASSIFICATION BY NATURE

Direct costs

Direct materials Direct labour Direct expenses

- Raw materials - Workers altering condition - Cost of Special
- Component parts & composition of product designs , drawing &
- Part-finished work - Inspectors, analysts & layouts
- Primary packing testers: specifically required - Hire of tools or
materials bán thành phẩm - Foremen & shop clerks: equipment for a
fiber cost --> cloth --> T-shirt wages are specifically particular job
part - finished work: Cloth identified
Finished product: T-sh
Normally: indirect
the salary you pay for direct workers Direct: 1 job
 COST CLASSIFICATION BY NATURE

-Not included in Non-mfg overhead incurred in the

production Cost course of making a
of goods or for product or providing
Inventory a service, but which
Indirect costs cannot be traced
valuation purpose
directly and in full to
- A, S & D the product or
overhead service.
Administration, Selling, Distribution
Manufacturing overhead

Indirect materials Indirect labour Indirect expenses

are used for the benefit wages of all employees all manufacturing costs
of all products rather who do not work on the other than direct &
product itself but who indirect labour, direct &
than for any one specific
assist in the indirect materials and
product.
manufacturing operation direct expense.
 COST CLASSIFICATION BY NATURE

Manufacturing overhead

Indirect materials Indirect labour Indirect expenses

as lubricants for as supervisors and as heating and

machinery, maintenance workers lighting for the
grease, nuts, factory
screws
COST CLASSIFICATION BY NATURE

Materials = Direct Materials + Indirect Materials

+ + +

Labour = Direct Labour + Indirect Labour

+ + +

Expenses = Direct Expenses + Indirect Expenses

Total cost = Direct Cost + Indirect Cost

COST CLASSIFICATION BY FUNCTION

Production costs

Costs incurred to make things & get them ready to sale

Direct (Production) cost

Indirect production cost

Direct
Direct
Materials Direct Production
Labor
expense Overhead
COST CLASSIFICATION BY FUNCTION
Non-production costs Indirect non-production cost
= non-production head
= selling, administration and distribution
cost

The indirect costs of an organization that are not classified as

manufacturing overhead.
COST CLASSIFICATION BY FUNCTION
R: costs of searching for new
Costs incurred to get the
/improved products.
finished items to the point R&D D: are costs incurred between
where people can buy and the decision to produce a new or
improved product and the
persuade people to buy commencement of full
them. manufacture of the product
Non-production
Distribution cost
& Selling costs
Administration
costs
Financing
costs interest cost: chi phí lãi vay Costs incurred in co-
Costs incurred when a business ordinating activities of the
has to borrow to purchase non- production function and the
current assets or to operate on a distribution and selling
day to day basis function.
 COST CLASSIFICATION BY FUNCTION

PRODUCTION COST Income statement

Revenue
1000

(-)
DM DL POH
900 2000 COGS
sold
500

used (=)
100 Work in process inventory Gross
unused sản phẩm dở dang margin
End of period non-.
(-)
3000
Pr.cost
SA&D
400

Direct Work in process Finished goods cost

Assets
100 Material inventory inventory Balance (=)
inventory sheet Net income
Asset Asset

unfinished finished chưa bán: asset

bán: COGS
 COST CLASSIFICATION BY ASSOCIATION WITH
THE PRODUCT
Non-production cost
Production cost

Types of costs Income statement

Product costs Period costs chi phí thời kỳ

Costs of making or buying the No direct relations to the

stock item. production of goods or purchase
à Identified with the product & of goods
included in inventory values à Not identified with product or
à Prior sales: deferred as job
inventories; shown on the à charged in the profit and loss
balance sheet as assets account for the period in which
à At the time revenue is they are incurred
realized: become part of the à Not carried forward as a part of
period costs (inventory value of inventory to the next
account à COGS account) accounting period
COST CLASSIFICATION BY ASSOCIATION WITH
THE PRODUCT

PRODUCT COST Income statement

Revenue
(-)
DM DL POH
COGS
sold
used (=)
Work in process inventory Gross gross

unused
profit
margin
End of period Period
(-)
cost
SA&D
Direct Work in process Finished goods cost
Material inventory inventory Balance (=)
inventory sheet Net income net

unfinished finished
prof
it
COST CLASSIFICATION IN RELATIONSHIP WITH
ACCOUNTING PERIOD

Manufacturing costs = Product costs (Manufacturer company)

IS
COST CLASSIFICATION BY BEHAVIOR

- Volume of output number of units produced

- Value of items sold - Number of items sold
- Number of invoices issued
- Number of units of electricity consumed

Cost behavior is the way that costs are changed

by changes in the level of activity

Knowledge of cost behavior is essential for budgeting,

decision making and control accounting
COST CLASSIFICATION BY BEHAVIOR

Mixed costs
(semi-variable/semi-fixed costs

Types of costs

Variable costs Stepped – fixed costs Fixed costs

biến phí định phí cấp bậc

VARIABLE COSTS positive

- Cost of raw materials

Variable costs
- Direct labour costs
- Sales commission

A cost that changes in total in

a linear relationship
direct proportion to changes between cost &
in the volume of output. activity assumed

- Purchase price per unit of

The variable cost per Implied
materials purchased
constant
unit is the same for - Cost per labour hour worked
each unit produced - Rate of material usage
The more I produce, The more I spend - Labour productivity
VARIABLE COST

($’s)
Petrol costs
30

20

10

100 200 300 kms travelled

10/26
VARIABLE COST PER UNIT

($’s)
Petrol
VC/ unit = constant

costs/km

0.1

100 200 300

kms travelled

10/27
FIXED COSTS - Salary of managing director
(per month)
- Rent cost (per month)
- Straight line depreciation of
Fixed costs single machinery (per month)

A cost that remains constant in

Total FC = constant
total even when the volume of VC/ unit = constant

FC/ unit: decrease

output changes

Fixed cost per unit will decrease

as more units are produced.
FIXED COSTS

Fixed costs

Period charge

- Relate to span of time

- Time span
à Fixed cost
FIXED COSTS

($)
Vehicle
insurance
costs

Vehicle insurance costs

$1,200

20,000 30,000
10,000
kms travelled pa
FIXED COSTS

($)
Vehicle
insurance
costs/km

20,000 30,000
10,000
kms travelled pa
FIXED COSTS & VARIABLE COSTS

Costs are either variable or fixed, depending upon whether

they change when the volume of production changes

Costs are either direct or indirect, depending upon how

easily they can be traced to a specific unit of production

usually
Direct costs are variable

Variable costs is not just another name

for a direct cost
Quick Check ü

Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activity
decreases.
c. Total costs that increase as activity
increases.
d. Total costs that remain constant.
Quick Check ü

Variable costs are usually characterized by:

a. Unit costs that decrease as activity
increases. FC/ U

b. Total costs that increase as activity

decreases.
c. Total costs that increase as activity
increases.
d. Total costs that remain constant.
Quick Check ü

Which of the following costs would be variable with

respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one
correct answer.)
A. The cost of lighting the store. FC

B. The wages of the store manager. FC

C. The cost of ice cream. VC

D. The cost of napkins for customers. VC

STEPPED-FIXED COSTS

Stepped-Fixed costs

Costs that are fixed in nature within

certain level of activity

Basic wages of employees is usually fixed, but as

output rises more employees are required.
Accommodation requirements increase when output
rise, therefore rent costs increase.
STEP COST

FIX: relevant range

MIXED COSTS

Electricity bills =
Mixed costs Standing basic charge
+ A variable charge per
unit of consumption

Part fixed and part variable

Partly affected by changes in the

level of activity.
Mixed Costs
§ y: the total mixed cost
§ bx: total variable cost
§ b: the variable cost per unit of activity biến phí đơn vị

constant § x: the level of activity

§ a: the total fixed cost tổng định phí
Y
bX
a+
Total Utility Cost

Y=
t
MC = FC + VC

o s
d c
i x e Variable
m bX
t al Utility
T o
Charge
Fixed Monthly
a
X
Utility Charge
Activity (Kilowatt Hours)
MIXED COST

FC = 1500
VC/u = 0.2

FC = road tax, insurance, VC = petrol, oil, repairs

(vary with miles travelled)
MIXED COST
§ y: the total mixed cost
§ bx: total variable cost
§ b: the variable cost per unit of activity
§ x: the level of activity
§ a: the total fixed cost

Total
cost y = a + bX

Variable costs

yF = a
Fixed costs
Lowest Highest level of activity
MIXED COSTS

($)
Cost per
unit

Level of activity
 MIXED COST

To better control mixed costs à analyze mixed cost into

fixed component and variable component

The high-low method

first lesson
THE HIGH-LOW METHOD

Estimate b: E: Lighting the factory (Fixed)

Running the machines (Variable)
y increase or decrease depend on x

Determining data points: A1 (x1, y1), … , An (xn, yn)

– y1 = a + bx1 hidden numbers: a & b

– …………………………………… y1: total electricity bill in generating (known)

a: (unknown) how many kw running machinery (E)
x1: number of machine hours (known)
– yn= a + bxn. b: variable cost/ 1 machine hours (unknown)

Identifying 2 periods with 2 levels of activity within the

relevant range
• Lowest level of activity Ai (xi, yi)
yi = a + bxi.
• Highest level of activity Aj (xj, yj)
yj = a + bxj.
Solving equations à b = yj – yi / xj – xi
Estimate a: a = y – bx. total FC = MC - VC
THE HIGH-LOW METHOD

Plot the data points on a graph, connecting the lowest and

highest data point to have the straight lineof mixed cost

Simple to apply
x
xx

x xx incorrect
 THE HIGH-LOW METHOD
different number of x, different number of y

Month Direct Labor Total maintenance

Hours x cost ($) y
Example: mixed cost

1 1,100 2,650
Determine variable
2 1,000 2,500
cost per labor
3 1,300 3,150
hour, total 4 1,150 2,700
fixed cost of 5 1,400 3,350
maintenance, 6 1,250 2,900

Cost equation for 7 1,100 2,650

maintenance at 8 1,200 2,900

Company M 9 1,350 3,250

in 20x8 10 1,450 3,400

11 1,150 2,700
12 1,500 3,500
VC/ LH (b) = 2 (constant) Total FC (a) = Total MC (highest) - toal VC (highest)
= $ 3500 - 1500 x $2 = 500
THE HIGH-LOW METHOD

variable
cost per =
hour
Total
=
fixed cost
or =

Cost equation for maintenance

y = $500 + $2x planning

THE HIGH-LOW METHOD

Total
cost ($)
y = $500 + $2x
Relevant range
relevant range:
phạm vi phù hợp

3,500
High activity level

2,500
Low
activity level

500

Total FC

1,000 1,500
Direct
labour
hours
 COST ASCERTAINMENT

Direct Direct Direct Prime

Materials + Labor + Expenses = Costs

Direct costs

2 - 49
 COST ASCERTAINMENT

Cost components need to change raw

materials to finished goods

Direct Manufacturing Conversion

Labor + DE + Overhead = Costs

Indirect Indirect
Materials Other
Labor 2 - 50
INCOME STATEMENT

LOGO
 ABSORPTION AND VARIABLE COSTING
Product costs (in inventory)
POH:
production include variable & fixed
overhead
production costs
Absorption Variable
Costing Costing
= Marginal
costing

Direct Materials Variable cost

Product
Product Direct Labor Variable cost Variable Variable

Costs
All production cost production cost production

Costs
cost

Variable POH

Fixed POH Fixed production cost

FOH
Period Non-

Period Variable Selling and Administrative Expenses production

Costs
Non-production cost cost

Costs Fixed Selling and Administrative Expenses

Assume Direct Labor: Variable cost (exam, if no mention anything

Product costs (in inventory) only
include variable
manufacturing costs
ABSORPTION AND VARIABLE (MARGINAL) COSTING

ABSORBTION I.S VARIABLE

VARIABLEI.S
I.S

- Cost data is organized in - Cost data is organized in

a functional format in cost behavior format
VARIABLE VERSUS ABSORPTION COSTING

Fixed manufacturing
costs must be assigned
to products to properly Fixed manufacturing
match revenues and costs are capacity costs
costs. and will be incurred
even if nothing is
produced.

Absorption Variable
Costing Costing
 § VARIABLE VERSUS ABSORPTION COSTING

Treament on fixed production costs FPOH incurred in Jan: $10000

Unit produced: 1000 units FPOH/ U = 10
Unit sold: 800 units VARIABLE I.S correctly,
fairly

ABSORBTION COSTING MARGINAL COSTING

All fixed production costs = period cost

production cost Fixed production costs
absorbed to products: P&L $10 000 (Income statement)
not share for inventory

Sold: P&L 8000

Unsold: BS 2000 lower profit

Unit produced = Unit sold --> AC = MC

Outside: Absorbtion costing

IS (COGS): Expenses Assess managers: Marginal costing
800 x 10 = 8000
$10000
FPOH
200 x 20 = 2000 Balance sheet: Finished goods inventory (Assets)
INCOME STATEMENT

INCOME STATEMENT IN ABSORBTION COSTING

Total
Under absorption
Sales costing, SA&D costs
Less Cost of goods sold are always treated as
Gross margin period expenses and
Less operating expenses deducted from
Variable SA&D cost revenue as incurred.
Fixed SA&D cost
Net operating income

Fixed Production Total fixed production costs

=
costs per unit Number of units produced

Fixed production = Fixed production x Number of

costs in COGS costs per unit units sold
INCOME STATEMENT

INCOME STATEMENT IN VARIABLE COSTING

Total
Sales
Less variable costs
Contribution margin
Less fixed costs
Fixed production = all are incurred in the current period
costs
Fixed SA&D costs
Net operating income
 INCOME STATEMENT
Example 2
Company K has started the business since 20x6, unit selling
price of product X over 3 years of 20x6, 20x7 and 20x8 is
$80. Income statement over 3 years and each of these years?

Costs $
Direct material costs $30/unit 20x6 20x7 20x8
Direct labor costs $10/unit Beg.Inv 0 0 2,000
Variable POH $5/unit Number
of goods 6,000 8,000 4,000
produced
Variable selling costs $4/unit
Number
Fixed POH $90,000/yr of goods 6,000 6,000 6,000
Fixed administration $36,000/yr sold
costs
INCOME STATEMENT
 INCOME STATEMENT
20x6 20x7 20x8 3 years
Absorption costing
Sales 6000 X 80 1,440,000
Cost of goods sold 1,080,000
Gross profit 360,000
SA&D 180,000
Net operating income 60000 82500 37500 180,000
Variable costing
Sales 1,440,000
Variable costs 882,000
Contribution margin 558,000
Fixed costs 378,000
Net operating income 60000 60000 60000 180,000
 INCOME STATEMENT

RELATION BETWEEN ABSORBTION AND VARIABLE INCOME

Production …... Sales Effects on inventory Absorbtion inc …. Variable inc

> Inventory >

< Inventory <

= No change =
 End of Chapter 2

5.4,5.5,5.10,5.13,Problem 5.17 E2.13 (Q1,2),

Absorption costing profit - Marginal costing profit = A. Inventory x FPOH/ U

A. Inventory = Ending Inv - Beginning Inv = Units produced - Units sold.

contribution = marginal = variable