Cost Accounting and

Control

Session 2

Instructor: Airen L. Bequiso, CPA, CTT, MBA

Week 1
COST TERMS, CONCEPTS AND
CLASSIFICATION
 What is a COST?
may be defined as the value foregone or sacrifice of
resources for the purpose of achieving some economic
benefit which will promote the profit making ability of
the firm.
Cost Pools
- are costs collected into meaningful groups.

Cost pools may be classified 

1. by type of cost (labor cost in one pool, materials costs
in another) 
2. by source (department 1, department 2 and so on) 
3. by responsibility (manager 1, manager 2 and so on)
and many more
Cost Object
- is any product, service or organizational unit to
which costs are assigned for some management
purpose. Products and services are generally cost
objects, while manufacturing departments are
considered either cost pools or cost objects, depending
on whether management's main focus is on the costs of
the products or for the production department. Any
item to where costs can be traced and that has a key
role in management strategy can be considered a cost
object.
 Example of Cost Objects
Cost Object  Illustration

Program  An athletic program of a university

Department  A department within a DENR that studies air emissions standards

Activity  A test to determine the quality level of television set

Brand Category  All soft drinks sold by a Pepsi-Cola bottling company with “Pepsi” in
their name

Customer  All products purchased by Landmark (the customer) from Purefoods

Inc.

Project  A special sports car assembled by Toyota Motors

Service  An airline flight from NAIA to Hongkong

Product  A motorcycle
Cost Drivers 
A critical first step for achieving a competitive
advantage is to identify the key cost drivers in a firm or
organization.

- is any factor that has the effect of changing the level of

total cost. The management of the key cost drivers is
essential for a firm that competes on the basis of cost
leadership.
 Example of Cost Drivers
Business Function Cost Driver
Research and development  ∙ Number of research projects 
∙ Manpower hours on a project 
∙ Technical difficulties of projects
Design of products, services and ∙ Number of products in design 
processes  ∙ Number of parts per product 
∙ Number of engineering hours
Production  ∙ Number of units produced 
∙ Direct manufacturing labor costs 
∙ Number of setups 
∙ Number of engineering change orders
Marketing  ∙ Number of advertisements run 
∙ Number of sales personnel 
∙ Peso sales
Distribution  ∙ Number of items distributed 
∙ Number of customers 
∙ Weight of items distributed
Customer service  ∙ Number of service calls 
∙ Number of products serviced 
∙ Hours spent servicing products
Cost assignment is the process of assigning costs to
cost pools or from cost pools to cost objects. 

Cost allocation is the assignment of indirect costs to

cost pools. Allocation bases are cost drivers used to
allocate costs. 
 CLASSIFICATIONS OF COSTS 
A. Costs classified by Nature or Management Function 

1. Manufacturing Costs 

Manufacturing costs are all the costs associated with

production of goods. They are frequently classified as
direct materials, direct labor, and factory overhead. Since
costs attach to the product or groups of products as they
are manufactured, expenditures, regardless of their
Nature, usually are capitalized as inventory assets and do
not become “expired costs” or “expenses” until the goods
are sold. 
Direct Materials 

All raw material costs that become an integral part of

the finished product and that can be conveniently and
economically assigned to specific units manufactured.
Materials cost includes the invoice price plus other
costs paid to vendor, shipping costs, sales taxes, duty,
cost of delivery containers and pallets (less net of
return refunds), and royalty payment based on direct
materials quantities. Trade discounts and cash
discounts (if they exceed reasonable interest rates)
should reduce materials costs. 
Direct labor 

All labor costs related to time spent on products that

can be conveniently and economically assigned to
specific units manufactured. Estimates of direct labor
quantities and unit prices may be sufficiently accurate
to be considered “specifically identified" with a cost
object. 
Manufacturing Overhead 

Manufacturing overhead, the third element of

manufacturing cost, includes all costs of manufacturing
except direct materials and direct labor. Indirect
materials, indirect labor, property taxes, insurance,
supervisor's salaries, depreciation of factory building
and factory equipment, and power are examples of
factory overhead.
Indirect materials

Indirect materials include materials and supplies used

in the manufacturing operation that do not become part
of the product, such as oil for the machinery and
cleaning fluids for the custodian. 
Indirect labor

Labor costs that cannot be identified or traced to

specific units manufactured. Examples include
supervision, inspection, maintenance, personnel and
material handling. 
Other Manufacturing Overhead

Other manufacturing overhead costs include

overtime premiums and the cost of idle time. An
overtime premium is the extra compensation paid to an
employee who works beyond the time normally
scheduled. 
2. Nonmanufacturing Costs 

Nonmanufacturing costs generally include costs related

to selling and other activities not related to
the production of goods. 
Marketing costs 

Marketing or selling costs include all costs associated

with marketing or selling a product or all costs incurred
by the marketing division from the time the
manufacturing process is completed until the product is
delivered to the customer or all costs necessary to
secure customer orders and get the finished product or
service into the hands of the customer. These costs also
called order-getting and order-filing costs. Examples of
marketing costs are advertising shipping, sales
commissions and storage costs. 
General and administrative costs 

General administrative costs include all executive,

organizational and clerical costs associated with the
general management of the organization rather than
with manufacturing, marketing or selling. 
Production Costs in Service Industry Firms and
Nonprofit Organizations
B. Costs classified according to the Timing of
Recognition as Expense 

An expense is defined as the cost incurred when an

asset is used up or sold for the purpose of generating
revenue. The terms product cost and period cost are
used to describe the timing with which various
expenses are recognized. 
1. Product Costs 

Product costs include all the costs that are involved in

acquiring or making a product. Also called inventoriable
costs, they are costs that "attach” or cling to the units
that are produced and are reported as assets until the
goods are sold. In the case of manufactured goods, these
costs consist of direct materials, direct labor, and
manufacturing overhead.
2. Period Costs 

Period costs are all the costs that are identified with
accounting periods and not included in product costs.
These costs are expensed on the income statement in
the period in which they are incurred. Period costs are
not included as part of the cost of either purchased or
manufactured goods. Examples of period costs include
selling and administrative expenses such as sales
commissions, office rent, and transportation expenses. 
C. Costs classification on Financial Statements 

The financial statements prepared by a manufacturing

company are more complex than the
statements prepared by a merchandising company.
Manufacturing companies are more complex business
firms than merchandising companies because the
manufacturing company must produce its goods as well
as market them.
1. The Statement of Financial Position 
The statement of financial position of a manufacturing
company is similar to that of a merchandising company.
However, the inventory accounts differ between the two
types of companies. A merchandising company has only
one class of inventory called merchandise inventory.
These are goods purchased from suppliers that are
awaiting resale to customers. In contrast,
manufacturing companies have three classes of
inventories, namely, raw materials, work in process and
finished goods. The overall inventory figure is usually
broken down into these three classes of inventory in
footnote to the financial statements. 
• Raw materials are materials that are used to make a
product. 
• Work in process consists of units of product that are
only partially complete and will require further work
before they are ready for sale to a customer 
• Finished goods consist of units of product that have
been completed but have not yet been sold
to customers. 
2. The Income Statement 
D. Cost classification for Predicting Cost Behavior 

Cost behavior refers to how a cost will react or respond

to changes in the business activity. As the activity level
rises and falls, a particular cost rises and falls as well-or
it may remain constant. For planning purposes, a
manager must be able to anticipate which of these will
happen; and if a cost is expected to change, the
manager must know by how much it will change. To
help make such distinction, costs are often categorized
as variable, fixed or semi-variable. 
1. Variable Costs - Costs that change directly in proportion
to changes in activity (volume). Direct labor and direct
materials are examples of variable costs. 

2. Fixed Costs - Costs that remain unchanged for a given time

period regardless of change in activity (volume). Rent,
insurance on property, maintenance, and repairs of buildings,
and depreciation of factory equipment are examples of fixed
costs. 

3. Semivariable Costs or Mixed Costs - Costs that contain

both fixed and variable elements. Examples of social security
taxes, materials handling, personnel services, heat, light, and
power. These cost elements must be divided into their proper
elements. 
E. Costs classified by Types of Inventory 

1. Raw Materials Inventory - The cost of all raw material

and production supplies that have been purchased but not
used at the end of the accounting period. 
2. Work-in-process inventory - The cost associated with
goods partially completed at the end of the accounting
period. 
3. Finished Goods Inventory - Cost of completed goods
that have not been sold at the end of the
accounting period. 
4. Merchandise Inventory - Cost of purchased
merchandise by retailers/ wholesales that have not
been sold at the end of the accounting period. 
F. Costs classification according to Traceability to
Cost Objective 

1. Direct costs (traceable; separable) - Costs that can

be economically traced to a single cost object (i.e.
product, department or unit). 

2. Indirect costs - Costs that are not directly or easily

traceable to the cost object (i.e. product,
department, etc.) 
G. Costs classification according to Managerial
Influence 

1. Controllable cost - Cost that is subject to significant

influence by a particular manager within the
time period under consideration. 

2. Noncontrollable cost - Cost over which a given

manager does not have a significant influence. 
H. Cost Terminologies Used for Planning and Control 
1. Standard Costs - A predetermined cost estimate that
should be attained; usually expressed in terms of costs
per unit. 
2. Budgeted Cost - Used to represent the
expected/planned cost for a given period. For example,
a company plans to manufacture 1,000 units of product
X, which has a standard cost per unit of P4, would have
budgeted cost for the period of P4, 000 for product X. 
3. Absorption Costing - A costing method that includes
all manufacturing costs direct materials, direct labor, and
both variable and fixed manufacturing overhead in the
cost of a unit of product. It is also referred to as the full
cost method. 
4. Direct Costing - A type of product costing where
fixed costs are charged against revenue as incurred
and are not assigned to specific units of product
manutactured. Also referred to as variable costing.

5. Information Costs - Costs of obtaining information. 

6. Ordering Costs - Costs that increase with the

number of orders placed for inventory.

7. Out-of-pocket Costs - Costs that must be met with a

current expenditure or cash outlay.
I. Cost classification according to a Time-frame
Perspective 

1. Committed Cost - Cost that is the inevitable

consequence of a previous commitment.

2. Discretionary Cost (programmed; managed cost)

- Cost for which the size or the time of incurrence is
a matter of choice. 
J. Costs classified according to Time Period for
Which the Cost is Incurred 

1. Historical costs (past costs) - Costs that were

incurred in a past period. 

2. Future costs - Budgeted costs that are expected to be

incurred in a future period. 
K. Costs classifications for Decision-making and
other Analytical Purposes 

1. Relevant Costs - Future costs that are different under

one decision alternative than under another decision
alternative. 

2. Incremental Costs - The difference in cost between

two or more alternatives. In evaluating a
given alternative, incremental cost is the additional cost
to determine the feasibility of this particular
alternative. To be an incremental cost, the cost must be a
future cost and be different under vari0us alternatives. 
3. Sunk Costs - Past costs that have been incurred and
are irrelevant to a future decision.
4. Opportunity Costs - The value of the best alternative
foregone as the result of selecting a different use of
resource or by choosing a particular strategy 
5. Marginal Costs - Costs associated with the next unit or
the next project or incremental cost associated with an
additional project as opposed to the next discrete unit. 
6. Value-Added Costs - Costs that add value to the
product. These costs result from activities that
are necessary to satisfy the requirements of the
consumer. Effort should be made to eliminate those
costs that do not add value to the product, such as storage
and materials handling.
Dree Cadua is the production manager of a ready-to-
wear manufacturing outfit. A decision needs to be made
about the type of clothing material or fabric to be used
to make a shirt. The fabric that has been used in the
previous production cost P40 per yard but it is not
available currently. Similar material from another
supplier will cost P50 per yard.
The cost of the fabric can be classified as follows: 

1. Time period 
P40.00 -- historical cost 
P50.00 - future cost

2. Management function 
The cost of the fabric is a manufacturing cost.
3. Accounting treatment 
Whatever is paid for the fabric will be capitalized as a
product cost and carried in inventory until it is sold.

4. Traceability to product 
The fabric is a direct cost because it represents a
significant portion of the cost of the product and can be
traced to a specific unit of finished product.
5. Cost behavior 
Both the P40.00 and P50.00 cost per yard are variable
costs. As the number of yards purchased increases, the
total fabric cost increases proportionately. 

6. Decision significance 
The P50.00 cost is relevant because it can be compared
with the price of other fabrics of similar quality to
select the best alternative. The P40.00 cost is irrelevant.
7. Managerial influence 
The cost of the fabric to be acquired is a controllable
cost since Ms. Cadua has the authority to make
production decisions.

8. Others 
The fabric is an out-of-pocket cost associated until
producing additional skirts which will involve cash
outlay in its acquisition.
FUNCTIONS
OF FINANCE
MANAGER