Chapter 2

Cost - Concepts and

Classifications
A Closer Look on Cost Accounting, De Jesus, 2019
Cost Accounting, De Leon, et al, 2020
Learning Objectives
At the end of the slides, the student should be able to:
1. Distinguish between cost, expenses, losses
2. Distinguish between direct and indirect costs
3. Know the different elements of costs
4. Distinguish the direct materials, direct labor and factory overhead costs.
5. Explained the difference between Product Cost and Period Cost
6. Know the different cost behavior
7. Define the different costs for planning, control and analytical processes.
8. Compute using the different cost estimation analysis
9. Know the advantages and disadvantages of different cost estimation analysis.
Distinguish between cost, expenses, losses
Cost is the cash or cash equivalent value sacrificed for goods and services that are expected to
bring a current or future benefit to the organization. Costs are incurred to produce future
benefits in a profit-making firm, future benefits usually mean revenue. (De Leon)

“Cost may be defined as the sacrifice or resources given up for a particular purpose. Cost is
frequently measured by mandatory units that must be paid for good or service.” - Horngren

As costs are used up in the production of revenues, they are said to expire. Expired costs are
called expenses.

A loss is a cost that expires without producing any revenue benefit.

Classification of Costs (De Leon)
I. As to relation to a product:

A. Manufacturing cost / product costs

1. Direct materials

2. Direct labor

3. Factory overhead

B. Non-manufacturing cost / period costs

1. Marketing or selling expenses

2. General or administrative expenses

Classification of Costs (De Leon)
II. As to variability

A. Variable costs

B. Fixed costs

C. Mixed costs

III. As to relation to manufacturing departments

A. Direct departmental expenses

B. Indirect departmental expenses

Classification of Costs (De Leon)
IV. As to their nature

A. Common costs

B. Joint costs

V. As to relation to accounting period

A. Capital expenditures

B. Revenue expenditures
Classification of Costs (De Leon)
VI. Cost used for planning, control and analytical processes

A. Standard costs

B. Opportunity costs

C. Differential costs

D. Relevant costs

E. Out-of-pocket costs

F. Sunk costs

G. Controllable costs
Classification of Costs (De Jesus)
I. As to element or Nature
A. Material
B. Labor
C. Expenses
1. Direct Expenses
2. Indirect Expenses
3. Overheads
3.1 Factory overheads
3.2 Administrative overheads
3.3 Selling and Distribution overheads
Classification of Costs (De Jesus)
II. As to Product
A. Product costs
1. Direct costs
a. Direct materials
b. Direct labor
2. Indirect costs
c. Factory overhead (indirect materials, indirect labor, other factory overhead costs)
B. Period costs
1. Selling or marketing costs
2. General or administrative costs
Classification of Costs (De Jesus)
Prime costs (Direct materials and direct labor)
Conversion costs (Direct labor and factory overhead)
C. As to Behavior
1. Variable costs
2. Fixed costs - a. Committed fixed costs b. Discretionary fixed costs
3. Mixed costs (semi-variable costs)
Classification of Costs (De Jesus)
D. as relation to manufacturing departments

1. Direct departmental charge

2. Indirect departmental charge

E. as to common or joint cost

1. Common costs

2. Joint costs
Classification of Costs (De Jesus)
F. as to accounting period

1. Capital expenditure

2. Revenue expenditure

G. by normality

1. Normal costs

2. Abnormal costs
Classification of Costs (De Jesus)
H. For planning, control and analytical processes

1. Standard costs 7. Sunk costs

2. Opportunity costs 8. Controllable costs

3. Differential costs 9. Uncontrollable costs

4. Relevant costs 10. Avoidable costs

5. Out-of-pocket cost 11. Shutdown costs

6. Imputed costs 12. Marginal costs

Cost behavior assumptions and limitations (De Jesus)
1. Relevant range assumption - Relevant range refers to the range of activity within
which the cost behavior pattern is valid. Any level of activity outside this range may
show a different cost behavior pattern.
2. Time assumption - The cost behavior patterns identified are true and only over a
specified period of time. Beyond this time, the cost may show a different cost
behavior pattern.
3. Linearity assumption - The cost is assumed to manifest a linear relationship over a
relevant range despite its tendency to show otherwise over the long run.
 Segregation of Fixed and Variable elements of Mixed Costs (De Jesus)

1. High-Low method
2. Scattergraph method
3. Least square regression method
4. Account analysis
5. Engineering method
6. Conference method
Illustration - Segregation of Fixed and Variable Costs in Mixed Costs

Month Units Total Costs Month Units Total Costs

Jan 1,750 P115,000 July 1,450 P100,000

Feb 1,875 125,000 Aug 1,650 105,000

Mar 1,900 130,000 Sep 1,800 120,000

Apr 1,700 110,000 Oct 2,950 190,000

May 2,900 170,000 Nov 2,800 175,000

June 2,750 165,000 Dec 2,500 145,000

High-Low Method
(1) Variable cost per unit = (P190,000 - P100,000) / (2,950 - 1,450)
= P90,000 / 1,500 = P60
(2) Fixed cost (High) = P190,000 - (P60 x 2,950) (Low) = P100,000 -(60*1,450)
= P190,000 - P177,000 = P100,000 - P87,000
= P13,000 = P13,000
(3) Equation = Fixed cost + Variable rate x units
y = P13,000 + P60x
Scattergraph method
Scattergraph Method
Step 1 - Plot the data points for each period on a graph.
Step 2 - Visually fit a line to the data points
The straight line is drawn through the point representing 1,750 units and a total
production cost of P115,000.
Step 3 - Estimate the total fixed costs
The total fixed cost is simply the point in which the line drawn meets the y-axis
(vertical axis). The graph indicates that fixed costs is approximately P24,000.
Scattergraph Method
Step 4 - Calculate the variable cost per unit
Using January data, (P115,000 - P24,000) / 1,750 = P52

Step 5 - State the equation

y = P24,000 + P52x
Least Square Regression Method
Step 1 - Compute the mean of the x-values, the mean of the y-values; the mean of xy
values, and the mean of X2 values.
Step 2 - Supply the values in the formula and compute of variable cost per unit.
(1) ∑y = na + b∑x

(2) ∑xy = a∑x + b∑X2

Step 3 - Compute the value of y-intercept (total fixed cost).
Step 4 - State the result in equation form. y = a + bx
Least Square Regression Method
Month X Y XY X2
Jan 1,750 115,000 201,250,000 3,062,500
Feb 1,875 125,000 234,375,000 3,515,625
Mar 1,900 130,000 247,000,000 3,610,000
Apr 1,700 110,000 187,000,000 2,890,000
May 2,900 170,000 493,000,000 8,410,000
June 2,750 165,000 453,750,000 7,562,500
July 1,450 100,000 145,000,000 2,102,500
Aug 1,650 105,000 173,250,000 2,722,500
Sep 1,800 120,000 216,000,000 3,240,000
Oct 2,950 190,000 560,500,000 8,702,500
Nov 2,800 175,000 490,000,000 7,840,000
Dec 2,500 145,000 362,500,000 6,250,000

Total 26,025 1,650,000 3,763,625,000 59,908,125

Least Square Regression Method
Step 2 - Supply the values in the formula and compute of variable cost per unit.
(1) ∑y = na + b∑x 1,650,000 = (12)a + b(26,025)

(2) ∑xy = a∑x + b∑X2 3,763,625,000 = a(26,025) + b(59,908,125)

(2,168.75)[1,650,000 = (12)a + b(26,025)]
3,578,437,500 = 26025a + 56,441,718.75b
3,763,625,000 =26,025a +59,908,125b
185,187,500 = 3,466,406.25b

b = 185,187,500 / 3,466,406.25 = 53.423484 or 53.42

Least Square Regression Method
Step 3 - Compute the value of y-intercept (total fixed cost).
∑y = na + b∑x
1,650,000 = (12)a + (53.42)(26,025)
1,650,000 = (12)a + 1,390,255.5
a = (1,650,000 - 1,390,255.5) / 12
a = 21,645
Step 4 - State the result in equation form. y = a + bx
y = P 21,645 + 53.42x
Account Analysis Method
Illustration: ABC Corporation production department provided the following
information for the month of January:
Produced: 100,000 units
Materials used in production P1,000,000
Labor used in the production (Assembly - ⅔; Supervisor - ⅓) 600,000
Production facility costs (75% variable, 25% fixed) 200,000
Total Production Cost P1,800,000
Account Analysis Method
Variable Fixed Total

Materials used in 1,000,000 1,000,000

production

Labor used in the 400,000 200,000 600,000

production

Production 150,000 50,000 200,000

facility costs
Total Production 1,550,000 250,000 1,800,000
costs
Account Analysis Method
The estimated fixed cost is P250,000.
The variable cost per unit = P1,550,000 / 100,000 units = P15.50
The total production costs are y = P250,000 + P15.50x
 Advantages versus Disadvantages
Method Advantages Disadvantages
High - Low Method Simple, inexpensive and easy to Use only 2 data points which may not
apply. produce accurate results.

Scattergraph (1) Uses all observations of cost (1) The fitting of the line to the
Method data. graph is subjective.
(2) Relatively easy to understand (2) Difficult to do if there are several
and apply. independent variables (cost
(3) It provides more accurate driver) to be used.
results than high-low method. (3) Unable to give the exact extent
(4) Outliers or values of extreme of correlation.
items are easily seen and do
not affect this method.
 Advantages versus Disadvantages
Method Advantages Disadvantages
Least Square (1) Uses all observation of cost (1) It requires relatively strict
Regression Method data. assumptions for the result to be
(2) Relatively easy to use with valid.
computer and calculators. (2) If an outlier is present, this can
adversely affect the result.

Account Analysis It provides detailed expert analysis (1) Subjective, judgmental

Method of the cost behavior in each approach. The different analyst
account. may derive different estimates
of cost behavior.
(2) It is more labor intensive and
time consuming than regression
analysis.
(3) The cost of data collection may
surpass benefit.
 Advantages versus Disadvantages
Method Advantages Disadvantages
Engineering (1) It can be used to estimate cost of (1) It is quite expensive to use because
method totally new activities because it each activity is using expert
does not require data from prior engineers that are costly.
activities in the organization. (2) Are often based on optimal condition
(2) It can detail each step required to (No error, machine breakdown). It is
perform an operation. not useful when the physical
(3) It permits a comparison of other relationship between inputs and
centers in which similar operations outputs is indirect.
are performed and enables the
company to review its productivity
and identify strengths and
weaknesses. It helps managers to
identify non-value added activities.

Conference Its credibility is gained through the pooling Its accuracy (cost estimate) is dependent on
method of expert knowledge. objectivity, care of the people providing the
information.
Activity 1 - Blue Corner Company (De Jesus, Prob 5, Chap 2

Blue Corner Company manufactures a variety of clothing types for distribution to several
department stores. The following costs are incurred in the production and sale of ready to
wear clothes:

1. Buttons P20,000.
2. Consulting fee of P500,000 paid to industry specialist for marketing advice.
3. Depreciation of office equipment P10,000.
4. Dye P200,000.
5. Electricity costs of P0.50 per kwh of factory building.
6. Fabric P1,500,000.
Activity 1 - Blue Corner Company (De Jesus, Prob 5, Chap 2

7. Insurance premiums on office property, plant and equipment, P30,000/year.

8. Office janitor salary P4,000 per month.

9. Leather for patches identifying the brand on individual pieces of apparel P40,000.

10. Infringement suit, P10,000 per month plus P200 per hour.

11. Office building property tax P15,000 per year.

12. Office supplies P5,000.

13. Property taxes on factory building P25,000.

Activity 1 - Blue Corner Company (De Jesus, Prob 5, Chap 2

14. Rent on factory plant equipment P20,000 per month.

15. Rental costs of showroom P80,000 per month.

16. Salary of designers P300,000 per month.

17. Salary of human resource manager P20,000.

18. Salary of production supervisor P18,000.

19. Salesperson’s salary P50,000 plus 5% commission on the total sales.

20. Straight-line depreciation of sewing machines P100,000.

21. Thread used P150,000.

Activity 1 - Blue Corner Company (De Jesus, Prob 5, Chap 2)

22. Wage of sewing machine operators P150,000.

Required: Classify the costs according to behavior as either fixed, variable or mixed; and classify
the costs according as to relation to the product: period costs or product costs; if product cost,
either prime cost or conversion cost. Use the format below. Answer to no. 1 is shown where (x) is
placed below each column to show your answer. Buttons are variable, product cost, prime cost..

N Costs Fixed Variable Mixed Period Product Prime Conversion

o. Cost Cost Cost Cost

1 Buttons X X X
Activity 2 - Milktopia Inc. (De Leon, MC 26, Chap 2)
Milktopia Inc. produces and sells milk flavored bubble gum. Over the last five months, Milktopia had the following
production costs and production volume.
Month Costs Volume (in cases) March P6,000 12
April 6,659 14
May 8,370 18
June 8,800 19
July 8,050 17

Required: (1) Determine the variable cost per unit and fixed cost using (a) high-low method, and (b) least squares method.
Express your answer in this format Y = a + bx where a is the fixed cost and b is the variable cost per unit. (2) Use your
answers in (1) to determine the estimated costs when producing 22 cases using (a) high-low method and (b) least square
method.
Activity 3 - Naruto Corp. (De Jesus, Prob 28, Chap 2)
Naruto Corporation has observed the following processing costs at various levels of
activity over the last 15 periods:
Period Units Produced Total Costs Period Units Produced Total Costs

1 2,250 19,000 9 5,750 26,000

2 5,500 26,000 10 3,000 21,500

3 6,000 28,000 11 4,250 24,000

4 2,750 20,000 12 5,000 25,000

5 4,500 23,500 13 3,250 22,000

6 5,250 26,000 14 4,750 24,000

7 3,750 22,000 15 4,000 23,000

8 2,500 20,500
Activity 3 - Naruto Corp. (De Jesus, Prob 28, Chap 2)
Required: (1) Compute the total fixed cost and variable cost per unit using (a) high-low
method, and (b) least square method. Express your answers as Y = a + bx where a is total
fixed cost and b is the variable cost per unit. (2) Compute the total cost @ 3,500 units
using your answers in (1).
Activity 4 - Promise Corp. (De Jesus, Prob 29, Chap 2)
Promise Corporation manufactures single product. The company keeps careful records of
manufacturing activities from which the following information has been extracted:
April-Low June-High
Number of units produced 12,000 18,000
Cost of goods manufactured 336,000 514,000
Work in process inventory - beginning 18,000 64,000
Work in process inventory - ending 30,000 42,000
Direct materials cost per unit 6 6
Direct labor cost per unit 10 10
Manufacturing overhead cost, total ? ?
Activity 4 - Promise Corp. (De Jesus, Prob 29, Chap 2)
The company’s manufacturing overhead consists of both variable and fixed cost elements.
To have data available for planning, management wants to determine how much of the
overhead cost is available with units produced and how much of it is fixed per month.
Required: (1) For both April an`d June, estimate the amount of manufacturing overhead
cost added to production. The company had no under- or over-applied overhead in either
month. (2) Using the high-low method, estimate a cost formula for manufacturing
overhead. Express the variable portion of the formula in terms of variable rate per unit of
product. (3) If 14,000 units are produced during the month, what would be the cost of
goods manufactured? (Assume that the work in process inventories do not change and
there is no under- or over-applied overhead cost for the month.
What to do on the activities?
● Create a shared drive “Cost Accounting BSA 2__ 2021-2022” and subdrive “Chapter 2”
● Make every member of the class able to access, write/edit on the shared drive.
● The class mayor will assign five persons to answer the activities and another five persons
to edit/review the answers. By the end of the semester, everyone must contribute to at least
an activity. Class mayor to do the monitoring.
● Copy the activities on subdrive. One filename (use company name as filename) for every
activity. For every activity, the answer(s) follow.
● Inform your instructor your answers are ready for checking and putting grade. Per
activity: 5 points with correct answer; three points with almost correct answer; 1 point for
mostly incorrect answer. No point for no answer.
● The grade earned in the activities will be grade in the project.
● Everyone can view/use the answers on the shared drive for studying.