Cost Terms,

Concepts and
Behavior
 3-2

Cost
∙ It is the amount sacrificed for the purpose
achieving its objective.
∙ A value foregone or value of resources
sacrificed to achieve a specific objective
∙ The amount given-up in producing a
product or providing a service in order to
obtain a profit or future benefit.
 3-3
Cost Terms in Managerial Accounting
Cost Object. It is an object or service where cost is computed
Example: Service fee of professionals, cost of manufacturing
the product

Cost Driver. These are variables that affect the costs of a product or
service over a period of time.
Example: production volume, number of hours in producing a
product or service, number of laborers in producing a product

Cost Pool. It is a grouping of individual cost items.

Example: Work in process, factory overhead control

Activity. It refers to task, event, action, transaction, or unit of work with

a specified purpose. It may be value-adding activities or
non-value-adding activities.
 Classification of Cost
1. Based on function or group of activities involved (or
natural classification):

❖ Manufacturing or production costs. These are costs of

direct materials, direct labor and manufacturing overhead
incurred in production.

❖ Commercial (or operating) expenses. These are the

following:
• Selling (or distribution) expenses. These are incurred in
selling the products.
• General and administrative expenses. These are incurred
in the general direction, control and administration of an
enterprise.
 3-5

Classification of Cost
2. Based on their traceability to products.
a) Direct product costs. This refers to cost items directly charged to the
cost of a product in the costing process, namely:
• Direct materials cost. These the cost of materials that form an integral
part of the finished product. Example: Lumber in making furniture.
• Direct labor cost. These are cost of labor expended directly on goods
being processed and can easily be included in calculating the cost of
the finished product. Example: Wages of sewers in garments
manufacturing.

b) Indirect product costs. These are manufacturing costs incurred in

production and not classifiable as direct materials nor as direct labor and
are called manufacturing overhead. Examples: Fuel and oil, repairs and
maintenance.

Direct materials plus direct labor = Prime costs

Direct labor plus manufacturing overhead = Conversion costs
 Classification of Cost
3. Based on their behavior:
a) Variable costs. These are the costs that vary in direct proportion to
the changes in volume of production within a relevant range.
Examples: Direct materials, direct labor and sales commissions.

b) Fixed costs. This refers to costs not affected by changes in volume

within a relevant range.
Example: Depreciation expense using the straight-line method)

Cost Total Cost

Variable Cost

Fixed Cost

Unit of Production
 Classification of Cost
c. Mixed (or semi-variable or semi-fixed) costs.
They are characterized as partly fixed and
partly variable. Example: Light and power
expense.
1. Semi-variable costs change in total but not
in direct proportion to changes in the level
of production and sales.
2. Semi-fixed costs are constant in a given
level of activity but changes when a new
level of activity is reached.
 3-8

Classification of Cost
4. Based on the accounting period
benefited:
a. Capital expenditures. This refers to outlays
that benefit future periods and are classified as
asset.
b. Revenue expenditures. These benefit the
current period only and are classified as
expense.
 3-9

Classification of Cost
5. Cost for planning and control:
a. Budgeted costs. This refers to costs estimated
to be incurred in undertaking activity or in the
completion of a project.

b. Standard cost. It refers to cost per unit of

finished product for materials, labor and
factory overhead which are predetermined
based on an intensive research on the product.
 Classification of Cost
6. Based on generally accepted accounting treatment:
a. Product costs. These are inventoriable costs and
allocated between the sold and the unsold units.
Examples: direct materials, direct labor and factory
overhead.

b. Period costs. These are items charged as expense or

loss in the period during which they are incurred.
Examples: rent expense, salaries and wages, utilities
and supplies expense.
 Classification of Cost
7. Based on the economics involved in making managerial
decisions:
a. Opportunity costs. These are the benefits or advantages
foregone in rejecting an alternative.

b. Imputed cost. This term refers to the peso amount

assigned to an item but which has not been the subject of a
transaction so that no liability is incurred nor is there a
need for cash outlay.

c. Controllable costs. These are the cost items which can be

regulated depending on the level of management.

d. Marginal cost. This refers to the increase in total cost

brought about by the production/sale of an additional unit.
 Classification of Cost
e. Sunk cost. This term refers to historical cost and is
therefore irrelevant in the decision making process.

e. Out-of-pocket costs. This refers to costs requiring

disbursements. It is relevant when it comes to differential
cost analysis.

f. Discretionary costs. These are the costs incurred

depending on the discretion of a manager.
 Classification of Cost
h. Relevant costs (or differential costs). They are costs that
differ in two or more alternatives or are to be affected by
decisions to be made.

i. Committed costs. The are costs that must be incurred

because of past decisions, contractual agreement, and
government regulations.

j. Avoidable costs. This refers to items of cost that are not

expected to be incurred if a particular activity were
discontinued.
 Classification of Cost
9. Based on managerial influence.
a. Controllable cost. These are costs wherein
the incurrence or non-incurrence, can be
influenced or decided upon by the manager.
b. Non-controllable costs. Costs beyond the
control of the manager.

10. Based on significance in decision making.

c. Relevant
d. Irrelevant costs.
 Classification of Cost
11. Based on time period for which cost is
incurred.
a. Historical (past or post-mortem)
b. Future costs.
 3-16

Separation of Mixed Costs

Mixed costs (Total costs). It has the component of
the variable and fixed costs. The total cost is
expressed as:
TC = FC + VCU(x)

Where: TC = Total cost

FC = Total fixed cost
VC = Variable cost per unit
x = number of units
 3-17
Separation of Mixed Costs
High-Low Method

The high-low (two-point) method is a

relatively unsophisticated, yet widely used,
method of estimating the components of a
mixed cost.
 3-18
Separation of Mixed Costs
High-Low Method

An Example

Month Utility Costs Units Produced

March P4,000 400
April 5,000 800
May 9,000 1,200
June 10,000 1,600
July 15,000 2,000
 3-19
Separation of Mixed Costs
High-Low Method
Variable Cost per unit = (P15,000 – P4,000)
(2,000 – 400)
= P11,000 /1,600
= P6.875 per unit

Fixed Costs = P15,000 – P6.875(2,000)

= P1,250

The cost formula using the high-low method is:

Y = P1,250 + P6.875 (X)

 3-20
Separation of Mixed Costs
Scatter-Diagram Method
The scatter-diagram (or graphical) method
requires cost and volume data from prior
periods, and drives an equation (cost
prediction formula) based on those data.

The placement and slope of the line are

matters of judgment; the manager “eyeballs”
the data and fits the line visually.
 3-21
Separation of Mixed Costs
Scatter-Diagram Method
Utility Cost (y) y = a + bx = 1,500 + 6.25(x)
P16,000
x
Analyst can fit line
based on his or her b = Y 2 – Y1
12,000
experience X2 – X1
x
x
= 9,000 – 4,000
8,000 Y2 1,200 – 400

= 6.25
4,000 x
x a = y – bx
X1 X2 Y1 = 9,000 –1,200(6.25)
= 1,500
0
400 800 1,200 1,600 2,000
Units Produced (x)
 3-22
Separation of Mixed Costs
Regression Method
Regression analysis is a more sophisticated
method for estimating the fixed and variable
components of a mixed cost.

Regression uses cost and volume data from

prior periods to yield an equation of the form
y = a + bx.
 3-23

n=5
 3-24

Let x = 1,000

Y = P500 + 6.75(1,000)
= 7,250
3-25
 3-26

Exercise
3-27
 3-28

Exercise
3-29
 3-30

Exercise
 References:
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Accounting. McGraw-Hill Irwin.: USA

• Garrison, Ray H., Noreen, Eric W. and Brewer, Peter C. (2012). Managerial Accounting.
McGraw-Hill Irwin.: USA

• Hilton, Ronald W. and Platt, David E. (2016). Managerial Accounting: Creating Value in a
Global Business Environment. McGraw Hill.

• Louderback, Joseph, G. , and Holmen, Jay S. (2013). Managerial Accounting.

South-Western, a division of Thomson Learning.

• Mejorada, Nenita D. (2000). Management Advisory Services Part I 3rd edition. Goodwill
Trading Co., Inc.: Manila, Philippines.

• Roque, Rodelio S. (2018). Reviewer in Management Advisory Services. Roque Press, Inc.:
Manila, Philippines.

• Weygandt, Jerry J., Kieso, Donald E., and Kimmel, Paul D. (2017). Managerial Accounting
– Tools for Business Decision Making. John Wiley & Sons, Inc.: USA.