BASIC COST MANAGEMENT CONCEPTS COST DRIVERS

COST  Any factor that has effect of changing the level of total
cost
 The value foregone or sacrifice of resources for the
purpose of achieving some economic benefit that will  The management of the key cost drivers is essential for a
promote the profit-making ability of the firm. firm that competes on the basis of cost leadership.
Example to achieve its low-cost leadership in
 Incurred when a resource is used for some purpose
manufacturing electronic products, Sony Manufacturing
 Outlay or expenditure of money to acquire goods and watches carefully the design and manufacturing factor
services that assist in performing operations that drive the costs in its products.

 Accounting costs – classified in numerous ways.  Firm that are not cost leaders – the management of
Classified differently depending on the type of cost drivers may not be as critical but focusing attention
organization involved, that is merchandising, service or to the key cost drivers contributes directly to the
manufacture. success of the firm,

COST POOLS  COST ASSIGNMENT – process of assigning costs to cost

pools or from cost pools to cost objects
 Costs collected into meaningful groups.
 COST ALLOCATION – the assignment of indirect costs
 Classified as to cost pools
1. By type of cost (labor cost in one pool, materials in  ALLOCATION BASES – cost drivers used to allocate
another) costs
2. By source (department 1, department 2 and so on) CLASSIFICATION OF COSTS
3. By responsibility (Manager 1, Manager 2 and so on)  Necessary for the development of cost information to
COST OBJECT serve the needs of management.

 Any product, service or organizational unit as to which  Understanding these concepts and classification enables
costs are assigned for some management purpose. the managerial accountant to provide appropriate cost
data to the managers who need it.
 Any item to where costs can be traced and that has a
key role in management strategy. A.COSTS CLASSIFIED BY NATURE OR MANAGEMENT
FUNCTIONS
 Ex. Products and services – cost object
 MANUFACTURING COSTS – costs associated with
 Manufacturing departments – considered either cost production of goods.
pools or cost objects, depending on whether
management’s main focus is on the costs of the  Frequently classified as direct materials, direct labor
products or for production department and factory overhead
 Since costs attach to the product or groups of products  MANUFACTURING OVERHEAD –all cost of
as they are manufactured, expenditures regardless of manufacturing except direct materials and direct labor
their nature, usually are capitalized as inventory assets
 Ex. Indirect materials, indirect labor , property taxes,
and do not become “expired costs” or “expenditures”
insurance, supervisors salaries, depreciation of factory
until the goods are sold.
building and equipment
 DIRECT MATERIALS – costs that become an integral
 Cost of operating service departments (those that do not
part of the finished product and that can be
work directly on manufacturing products but are
conveniently and economically assigned to specific units
necessary for the manufacturing process to occur. EX.
manufactured.
Equipment-maintenance department.
 Includes the invoice price plus other costs paid to the
 Indirect Materials – include materials and supplies
vendor, shipping costs, sales taxes, duty, cost of delivery
used in the manufacturing operations that do not
containers and pallets ( less net of return refunds) and
become part of the product such as oil for the
royalty payment based on direct materials quantities.
machinery and cleaning fluid for the custodian.
 Trade discounts and cash discounts ( if they exceed
 Indirect Labor – labor costs that cannot be identified
reasonable interest rates) should reduce material costs.
or traced to specific units manufactured. Ex.
 also includes scrap, waste and normally anticipated Supervision, inspection, maintenance, personnel and
defective units that occur in the ordinary course of the material handling.
production process.
 OTHER MANUFACTURING OVERHEAD
 Unanticipated quantities of scrap, shrinkage, waste or
 Include overtime premiums and the costs of idle time
defective units should be included in manufacturing
overhead or expensed in the period incurred.  Manufacturing Costs – include direct materials,
direct labor and manufacturing overhead.
 Routine quality assurance samples that are destroyed as
part of testing should be classified as materials.  Conversion Costs- direct labor and overhead . Cost
of “converting or transforming raw materials into
 Non routine quality assurance samples are taken due to
finished products.
manufacturing problems and cost of marketing samples
should not be added to material costs  Prime Costs – Direct Labor and Direct Materials
 DIRECT LABOR - Labor Cost related to time spent on  NON MANUFACTURING COSTS
products that can be conveniently and economically
assigned to specific units manufactured.  Generally include costs related to selling and other
activities not related to the production of goods.
 Estimates of direct labor quantities and unit prices
maybe sufficiently accurate to be considered :specifically  Marketing/Selling Costs - include all costs associated
identified” with a cost object 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  A product cost such as direct materials or direct labor
secure customer orders and get the finished product or might be incurred during one period but not treated as
service into to hands of the customer. Order an expense until a following period when the completed
getting/order filling costs product is sold.
 NON MANUFACTURING COSTS  PERIOD COSTS – Include all the costs that are
identified with accounting periods and not included in
 General & Administrative Costs - include executive,
product costs
organizational and clerical costs associated with the
general management of the organization rather than  Expensed on the income statements in the period in
with manufacturing, marketing or selling. which they are incurred. Not included as part of the
cost of either purchased or manufactured goods.
 PRODUCTION COSTS IN SERVICE INDUSTRY FIRMS
AND NON-PROFIT ORGANIZATIONS  Ex. Selling and administrative expenses such as sales
commissions, office rents and transportation expenses
 Service industry- schools, hotels, banks, airlines,
accounting firms, and automotive repair shops, also  Financial Statements prepared by a manufacturing
engaged in production. company are more complex than the statements
prepared by a merchandising company because
 - service is consumed as it is produced
manufacturing companies must produce its goods as
 Manufacturing – can be stored in inventory while less well as market them.
commonly applied in service firms
 The manufacturing company’s product cost includes
 Recording and classifying costs is important not only for not only the cost of purchasing but also the cost of
manufacturing firms but for service industry firms and converting materials into saleable products.
nonprofit organizations as well .
 STATEMENT OF FINANCIAL POSITION
 Cost Analysis is necessary in pricing, banking and
MERCHANDISING COMPANY - has only one class of
insurance services, hotel and travel rental agencies,
inventory called merchandise inventory - goods
setting tuition fees in school
purchased from suppliers that are awaiting resale to
B. COSTS CLASSIFIED ACCORDING TO THE TIMING OF customers
RECOGNITION AS EXPENSE
MANUFACTURING COMPANY
 PRODUCT COSTS – Include all the costs that are
 RAW MATERIAL - ,materials that are used to make a
involved in acquiring or making a product
product
 Also called inventoriable costs, costs that attach” or
 WORK IN PROGRESS – consists of units of product
cling to the units that are produced and are reported as
that are only partially complete and will require further
assets until the goods are sold.
work before they are ready for sale to a customer.
 Initially assigned to an inventory account on financial
position/ balance sheet.
  FINISHED GOODS – consist of units of product that
have been completed but have not yet been sold to
STU COMPANY
customers
INCOME STATEMENT
C. COSTS CLASSIFICATION ON FINANCIAL FOR THE YEAR ENDED DECEMBER 31, 2023

STATEMENTS
Sales 1,500,000.00
Cost of Goods Sold:
MERCHANDISING COMPANY Beginning finished goods inventory 125,000.00
Add cost of goods manufactured 850,000.00
CDE TRADING COMPANY Goods available for sale 975,000.00
INCOME STATEMENT Ending finished goods inventory 175,000.00 800,000.00
FOR THE YEAR ENDED DECEMBER 21, 2022 Gross Margin 700,000.00
Less operating expenses
Sales 1,000,000.00 Selling expense 250,000.00
Cost of Goods Sold:
Beginning Invty 100,000.00 STU COMPANY
Add: Purchases 650,000.00 STATEMENT OF COST OF GOODS MANUFACTURED
Goods available for sale 750,000.00 FOR THE YEAR ENDED DECEMBER 31, 2023
Ending Inventory 150,000.00 600,000.00
Gross Margin 400,000.00 Direct Materials
Less operating expenses Direct Materials inventory, Jan 1, 2023 30,000.00
Selling expense 100,000.00 Purchases of Direct Materials 210,000.00
Administrative expense 200,000.00 300,000.00
Total Direct Materials Available 240,000.00
Net Income 100,000.00
Direct Materials inventory, Dec 31, 2023 15,000.00
Direct Materials Used 225,000.00
CDE TRADING COMPANY Direct Labor 250,000.00
CURRENT ASSETS SECTION OF THE STATEMENT OF Manufacturing Overhead
FINANCIAL POSITION Indirect Materials 35,000.00
December 31, 2022 Factory Utilities 70,000.00
Factory Supervision 70,000.00
Current Assets:
Property Taxes on Factory Equipment 20,000.00
Cash 10,000.00 Factory maintenance and repairs 20,000.00
Depreciation of plant and equipment 90,000.00
Accounts Receivable 60,000.00
Total Manufacturing overhead 305,000.00
Merchandise Inventory 150,000.00 Total Manufacturing costs 780,000.00
Prepaid Expenses 5,000.00 Work in process inventory, Jan 1, 2023 130,000.00
Total 910,000.00
Total Current Assets 225,000.00 Work in process inventory, Dec 31, 2023 60,000.00
Cost of Goods manufactures 850,000.00
 STU COMPANY F . COSTS CLASSIFICATION ACCORDING TO
CURRENT ASSETS SECTION OF THE STATEMENT OF FINANCIAL POSITION
TRACEABILITY TO COST OBJECT
FOR THE YEAR ENDED DECEMBER 31, 2023
 DIRECT COSTS – ( Traceable , Separable) Costs that
Current Assets:
Cash 15,000.00
can be economically traced to a single cost object ( ex
Accounts Receivable 100,000.00 product, department or unit)
Inventories
Raw Materials 15,000.00  INDIRECT COSTS – costs that are not directly traceable
Work in Process 60,000.00 to the cost object
Finished Goods 175,000.00 250,000.00
Prepaid Expenses 10,000.00 G . COSTS CLASSIFICATION ACCORDING TO MANAGERIAL
Total Current Assets 375,000.00 INFLUENCE
D . COSTS CLASSIFICATION FOR PREDICTING COST  CONTROLLABLE COSTS – ( Traceable , Separable)
BEHAVIOR Costs that is subject to significant influence by a
particular manager within the time period under
 COST BEHAVIOR – refers to how a cost will react or
consideration
respond to changes in the business activity.
 NONCONTROLLABLE COSTS – costs over which a
 Variable costs – change directly in proportion to
given manager does not have a significant influence
changes in activity ( Volume) ex. Direct Labor and
Direct material H . COSTS TERMINOLOGIES USED FOR PLANNING AND
CONTROL
 Fixed Costs - costs that remained unchanged for a
given time period regardless of change in activity  STANDARD COSTS - a predetermined cost estimates
( Volume) Ex, Rent , Insurance on property that should be attained, usually expressed in terms of
cost per unit.
 Semi Variable Costs – costs that contain both fixed and
variable elements. Ex. Materials handling, heat light  BUDGETED COSTS – used to represent the
and water expected/planned cost for a given period
E . COSTS CLASSIFIED BY TYPE OF INVENTORY  Absorption costing – Costing Method that includes all
manufacturing costs- direct materials, direct labor, and
 RAW MATERIALS INVENTORY - The cost of all raw
both variable and fixed manufacturing overhead in the
materials and production supplies that have been
cost of unit of product. Also referred to as the full cost
purchased but not used at the end of the period
method
 WORK IN PROCESS INVENTORY - The cost associated
 DIRECT COSTING – a type of product costing where
with goods partially completed at the end of the period
fixed costs are charges against revenue as incurred and
 FINISHED GOOD INVENTORY - Cost of completed are not assigned to specific units of product
goods that have not been sold at the end of the period manufactured. Also referred to as variable costing.
 Information Cost - cost of obtaining information
  Ordering Costs – Cost that increase with the number of  Opportunity Costs – the value of the best alternative
orders placed for inventory foregone as the result of selecting a different use of a
resource or by choosing a particular strategy.
 Out of Pocket Costs – Cost that must be met wit a
current expenditure or cash outlay  Marginal Costs - the increase in production costs
generated by the production of additional product
I . COSTS CLASSIFICATION ACCORDING TO TIME FRAME
units
PERSPECTIVE
 Value Added Costs –  incurred when an asset is
 COMMITTED COST – Cost that is inevitable
consumed in order to increase the value of goods or
consequence of a previous commitment
services to the consumer. Results from activities that
 Discretionary Cost ( programmed, managed cost) - are necessary to satisfy the requirements of the
Cost for which the size or the time of incurrence is a consumer.
matter of choice.
ILLUSTRATIVE PROBLEM ON COST CLASSIFICATION
J . COSTS CLASSIFIED ACCORDING TO TIME PERIOD FOR
Christina Santos is the production manager of a ready
WHICH THE COST IS INCURRED
to wear manufacturing outfit. A decision needs to be
 Historical Costs ( past costs) – Costs that were made about the type of clothing or fabric to be used to
incurred in a past period make a shirt. The fabric that has been used in the
previous production cost P40 per yard but it is not
 Future Cost – Budgeted costs that are expected to be available currently. Similar material from another
incurred in a future period supplier will cost P50 per yard.
K . COSTS CLASSIFICATIONS FOR DECISION MAKING AND The cost of the fabric can be classified as follows:
OTHER ANALYTICAL
1. Time period
 Relevant Costs – Future Costs that are different under
P40 – historical cost
one decision alternative than under another decision
P50 future cost
alternative
2. Management Function:
 Incremental Costs - difference in cost between two or The cost of the fabric is a manufacturing Cost
more alternative : additional revenue to determine the
3. Accounting Treatment
feasibility of this particular alternative - It must be a
future cost and be different under various Whatever is paid for the fabric will be capitalized as a
alternatives product cost and carried in inventory until it is sold.
 Sunk Cost – Past Costs that have been incurred and 4. Traceability to Product:
are irrelevant to a future decision, retrospective cost
that cannot be recovered. Ex Research ◦ 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
5. Cost Behavior
Both the P40,00 and P50.00 cost per yard are variable cost,
As the number of yards purchases 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. Santos has the authority to make production
decision
8. Others
The fabric is an out of pocket cost associated until producing
additional skirts which will involve cash outlay in its
acquisition.