COST CONCEPTS

& BEHAVIOR
STRATEGIC COST MANAGEMENT
Cost Concepts and Behavior

OUTLINE

Cost
Categories of Costs
Presentation of Costs in FS
Product Costs vs. Period Costs
Categories of Manufacturing
Costs Cost Allocation
Direct vs. Indirect Costs
Manufacturing Cost Flows
Cost Behavior

COST
Cost Concepts and Behavior

Definition
A cost is a sacrifice of resources.

Cost vs. Expenses

An expense is a cost charged
against revenue in an accounting
 period; hence, expenses are
deducted from revenue in that
accounting period.

Cost Concepts and Behavior

 COST EXPENSE
⮚ A cost is a sacrifice of against revenue in an
resources. accounting period

⮚ Incurred only if it is accounted

⮚ Incurred regardless of as an expense. If accounted
whether it is accounted as an as asset, it is capitalized.
asset or an expense.
⮚An expense is a cost charged
Cost Concepts and Behavior
 The focus of cost
accounting is on costs, not expenses.
MAJOR
CATEGORIES OF
COSTS
 Outlay Costs
r
An outlay cost isa past, present,
i
o
or future cash outflow.
v

B
Opportunity Costs
d

t
Opportunity cost is the forgone
p

n
benefit that could have been
o

s
realized from the best forgone
o

alternative use ofa resource.

 Cost Concepts and Behavior

Accounting systems
typically record outlay
costs but not
opportunity costs.

A well-designed cost
accounting system
presents all relevant
information to managers,
including opportunity costs that
they may otherwise ignore in
decision making.
 PRESENTATION OF
COSTS IN FINANCIAL
STATEMENTS

We are not seeking the “most accurate” information;

we are looking for the best information,

understanding how the information is used in

 decision making, and recognizing the cost of

preparing and using the information.

Cost Concepts and Behavior

Generally, the basic form of

the income statement is the
same regardless of the product
or service an organization sells.
However, the details, especially with respect to costs,
vary depending on how the organization acquires the
resources used to produce the product or service.
Cost Concepts and Behavior
Presentation of
Costs
⮚Service

⮚Merchandising
⮚Manufacturing Presentation of costs basically
depends on the types of
businesses/organizations.
Cost Concepts and Behavior

⮚Service
⮚Merchandising ⮚Manufacturing

Presentation of
Costs

Cost Concepts and Behavior

⮚Service

⮚Merchandising ⮚Manufacturing

Presentation of Costs
Cost Concepts and Behavior
Presentation of Costs
⮚Service

⮚Merchandising

⮚Manufacturing
Cost Concepts and Behavior

Financial reporting
distinguishes costs in a
manufacturing firm based on
when the costs are
recognized as expenses on
the financial statements.

⮚ Product Costs
⮚ Period Costs
Cost Concepts and Behavior product is sold.

Product (manufacturing)
costs follow the product
PRODUCT COSTS
through inventory.
Product costs are those
costs assigned to units of
production and recognized PERIOD COSTS
(expensed) when the
 include all other costs
and are expensed as they
are incurred.
Period costs
(nonmanufacturing costs)
Cost Concepts and behavior

Types of Product Costs

Direct Manufacturing Costs
Direct manufacturing costs are those product costs
that can be identified with units (or batches of
units) at relatively low cost.
 Indirect Manufacturing Costs
Indirect manufacturing costs are all other product
costs, often referred to as manufacturing overhead.
Cost Concepts and Behavior Direct Materials Direct Manufacturing
Costs
Direct materials that can be feasibly identified directly,
at relatively low cost, with the product. Direct materials
are often called raw materials.

Direct Labor
Direct labor can be identified directly, at reasonable
cost, with the product. These workers transform the
materials into a finished product.
Cost Concepts and Behavior

Manufacturing Overhead
Indirect Materials
 Indirect materials are materials not a part of the
finished product but are necessary to manufacture
it.

Indirect Labor
Indirect labor are costs of workers who do not work
directly on the product yet are required so that the
factory can operate.
Other Manufacturing Costs
Other similar expenses incurred to keep the factory
operating
Cost Concepts and Behavior

Categories of
Manufacturing
 Costs

⮚ Prime Costs
⮚ Conversion Costs
Cost Concepts and Behavior

Prime Costs
Prime costs are the direct costs,
namely, direct materials and
direct labor.
 Conversion Costs
Conversion costs are the. costs
to convert direct materials into
the final product

These are the costs for direct

labor and manufacturing
overhead.
Cost Concepts and Behavior
Cost Concepts and Behavior
Types of Period Costs
 Marketing Costs
Administrative Costs
Marketing costs are the costs Administrative costs are the
required to obtain customer costs required to manage
orders and provide customers the organization and
with finished products. provide staff support.
Nonmanufacturing costs are
expensed periodically (often in
 the period they are incurred) for
financial accounting purposes.

n
For managerial purposes, however,
a

p
managers often want to see
e

o
nonmanufacturing costs assigned
C

o
to products.
C

Cost Concepts and Behavior

COST

ALLOCATION
Cost allocation is the
process of assigning
indirect costs to products,
services, people, business
units, etc.
Cost Concepts and Behavior ⮚Cost Allocation Rule
A cost object is any end to
which a cost is assigned,
for example, a unit of
product or service, a
⮚Cost Object ⮚Cost Pool
department, or a customer.
 Cost Concepts and Behavior

⮚Cost Object ⮚Cost Pool

⮚Cost Object ⮚Cost Pool
⮚Cost Allocation Rule
⮚Cost Allocation Rule The cost allocation rule is
A cost pool is a collection of the method or process
costs to be assigned to the used to assign the costs in
cost objects. the cost pool to the cost
Cost Concepts and Behavior object.
Cost Concepts and Behavior
 DIRECT COST
VS.
INDIRECT COST

DIRECT COSTS

Any cost that can be unambiguously related to

a cost object is a direct cost of that cost object.
Cost Concepts and Behavior
 DIRECT COST
VS.
INDIRECT COST

INDIRECT COSTS

Those that cannot be unambiguously related

to a cost object are indirect costs.
Cost Concepts and Behavior
 another.
Whether a cost is
considered direct or
One difficulty is that a cost indirect also depends on
may be direct to one cost
the costs of linking it to
object and
indirect to
the cost object.

MANUFACTURING
COST FLOWS
⮚ If a company uses just-in-time (JIT) inventory methods, people
in direct materials receiving send the components to the
machining line immediately.
⮚ If a company does not use JIT, people in this department
send the components to a materials warehouse until it
is needed for production.
o Any product that has been purchased but not yet transferred to
manufacturing departments will be part of Direct Materials Inventory
on the balance sheet at the end of the accounting period.
Work-in-process Inventory
⮚ Product in the production process but not yet complete.

Finished Goods Inventory

 ⮚ Product fully completed but not yet sold.
Cost Concepts and Behavior
Statements
Manufacturing companies
typically prepare a cost of
COST OF GOODS goods manufactured and
MANUFACTURED AND SOLD sold statement to
How Costs Flow summarize and report
manufacturing costs.
through Such statements are for
the managerial use; you will
rarely see one published in statements.
external financial
Cost Concepts and Behavior
Cost Concepts and Behavior
Cost of Goods
Manufactured
and Sold Cost of Goods
Manufactured
Cost Concepts and Behavior

Total Manufacturing Total

Costs Manufacturing Costs

Cost of Goods Sold

 Materials

Direct
Manufacturing Labor
Overhead

Direct
Cost Concepts and Behavior

Cost
 Behavior
Cost behavior deals with
the way costs respond to
changes in activity levels.

A cost driver is a factor that

causes, or “drives,” costs.
Cost Concepts and Behavior
 Classification of
Costs by Behavior
⮚Fixed Costs
⮚Variable Costs
⮚Semi-variable Costs (Mixed Costs)
⮚Step Costs
Cost Concepts and Behavior

Relevant Range
Relevant range is the activity levels/range
within which the total fixed costs and unit
variable costs do not change.
Cost Concepts and Behavior activity.

FIXED COSTS VARIABLE COSTS

Costs that are unchanged

Costs that change in direct
as volume changes within
proportion with a change
the relevant range of
 in volume within the relevant range of activity.

NOTE: The identification of a cost as fixed or

variable is valid only within the relevant
range.
Cost Concepts and Behavior

Although labor has traditionally been considered

a variable cost, today the production process at
many firms is capital intensive and the amount of

labor required is not sensitive to the amount

produced.

In a setting in which a fixed amount of labor

is needed only to keep machines operating,

labor is probably best considered to be a

fixed cost.
Cost Concepts and Behavior

Complication in Classification of Costs

by Behavior
1. First, not all costs are strictly fixed or variable.
2. Second, some costs increase with volume in
“steps”.
3. Third, the cost relations are valid only within a
relevant range of activity.
4. Finally, the classification of costs as fixed or
variable depends on the measure of activity
used.
Cost Concepts and Behavior

SEMI-VARIABLE COSTS
A semi-variable cost has
both fixed and variable Step costs, also called semi-
components. Semi-variable fixed costs, increase in steps.
costs, also called mixed
costs.

STEP COSTS
Cost Concepts and Behavior
COMPONENTS
OF PRODUCT
COSTS
 Full Cost
Sum of all costs of manufacturing
r
and sellinga unit of product

i
o
(includes both fixed and variable
v

e
costs).
B

n
Full Absorption Cost
a

c
All variable and fixed
n

t
manufacturing costs; used to
s

computea product’s inventory value under GAAP.

Cost Concepts and Behavior
 Cost Concepts and Behavior

When analyzing costs

for decisions, you
should use unit fixed
costs very carefully.
Many managers fail to
realize that they are
valid at only one
volume.

When fixed costs are

allocated to each unit,
accounting records often make
the costs appear as though they
 are variable.
Gross Margin
It appears on external financial
statements as the difference
r

h
between revenue and cost of
e

d
goods sold.
n

o
Contribution Margin
C

C
It is the difference between the

sales and the variable cost.

 Cost Concepts and Behavior

Information More
Cost Concepts and Behavior

Useful for
⮚Full Absorption Costing Managers
⮚Variable Costing
Make Cost

CostingThe determination of product

⮚Managerial
costs varies, depending on
the approach used.
Cost Concepts and Behavior
Make Cost
Information More
⮚Full Absorption Costing
Useful for
⮚Variable Costing Managers
⮚Managerial
Costing
Under this approach, all
fixed and variable Make Cost
manufacturing costs are
product costs. All other Information More
costs are period costs. Useful for
Managers
Cost Concepts and Behavior

⮚Full Absorption Costing

Using this approach, only
⮚Variable Costing
variable manufacturing
⮚Managerial costs are product costs.
Costing All other costs are period
costs. Useful for
Managers
Cost Concepts and Behavior

⮚Full Absorption Costing This approach assumes

⮚Variable Costing that management
⮚Managerial
determines which costs
Costing are associated with the
product and should be
Make Cost considered product costs.
Information More
Cost Concepts and Behavior

THANK YOU
STRATEGIC COST MANAGEMENT