What is a COST?

Cost Concepts and

• A cost reflects the amount of resources sacrificed in order for the company
Classifications to achieve a certain objective such as creation of goods or rendering of
services in order to earn revenues.
• Costs are incurred to produce FUTURE BENEFITS (REVENUE) in a
profit making firm.

Product Costs/Manufacturing Product Costs /Manufacturing

Costs/Inventoriable Costs Costs/Inventoriable Costs
MATERIALS LABOR OVERHEAD
• These are costs identified and incurred by an entity to manufacture a
product. It includes all raw materials used, labor costs incurred, and all other All raw materials and other Salaries and other benefits All indirect costs necessary for
supplies used in the provided to all workers product conversion that are not
indirect costs. manufacturing process. direct materials and direct labor.
• MATERIALS Direct Materials: cost of glass Direct Labor: Cost of salaries E.g: Indirect Materials, Indirect
in lightbulb manufacturing, cost paid to laborers of furniture Labor, Depreciation of
• LABOR of wood in chair and table associated directly in the process. equipment in the factory,
manufacturing. insurance of factory plant
• OVERHEAD Indirect Materials: Cost of Indirect Labor: Salaries paid to E.g: maintenance and repairs of
glue, nails, screws, and the like. all factory personnel necessary in equipment, factory utilities
mfg process but is not directly
related in the conversion process.

3 components of Product Costs 3 components of Product Costs

• Direct Materials PRIME COSTS

• Direct Materials + Direct Labor = Prime Costs
• Direct Labor • Direct Labor + Factory Overhead = Conversion Costs
CONVERSION
• Factory Overhead COSTS • Prime Costs + Factory Overhead = Total Mfg. Cost
• Conversion Costs + Direct Material = Total Mfg. Cost
 Components of Product Costs Period Costs
• The entity’s operating expenses. They are called as such since they are much more
• Direct Materials x associated with time periods rather than manufacturing process. They are all
• Direct Labor x other expenses not related to manufacturing.

• Manufacturing Overhead x • Examples:

• Marketing and Advertising – expenses incurred in promoting the entity’s
• Total Manufacturing Costs x products and services.
• Selling and Distribution – include salaries of sales personnel and delivery
expenses
• Administrative Expenses – include office utilities, depreciation of office PPE,
repairs and maintenance of office PPE, and all other expenses in the office.

Mixed Costs (items of cost with fixed and

Cost Behaviors
variable components)
Variable Costs Fixed Costs Semi-Variable Cost Step Costs
• They are costs that change as the • At whatever level of production • Fixed portion of semi-variable • The fixed part of step costs
quantity of the goods produced within the relevant range, this cost costs usually represents minimum changes abruptly at various activity
changes. Total amount of variable does not change. It is independent fee while variable portion is the levels.
costs is dependent to the level of of the level of the production. cost charged for actually using the
production. • Costs that are constant on a certain
• Examples: Rent of Facilities, service.
• Examples: cost of materials, cost Depreciation of equipment level of activity but increases on
of direct labor computed per piece • Exs: Electricity, Cellphone plan another certain level of activity.

Step Costs (Supervisor’s Salary) Cost Behaviors

• Cost behavior patterns indicate how costs change in response to

changes in production or sales.
TOTAL COSTS PER UNIT costs
Fixed CONSTANT Decreases as production
increases(INVERSE)
Variable Increases as production as CONSTANT
production increases(DIRECT)
Mixed(Semi-Variable) Increase less proportionately (vs. Decrease less proportionately (vs.
TOTAL variable cost) as unit fixed costs) as production
production increases increases
 Example: Assume an entity’s normal manufacturing process
Cost Behaviors with a range of 5000 to 7000 units of goods with variable cost
per unit of P20 and P15,000 Fixed Costs.
VC/unit Total Fixed FC/unit
Variable Costs Fixed Costs Variable Costs
• Constant on a per-unit basis • Constant when presented as Costs @ 5,000 units P15,000 P3.00
• Varies when presented as TOTAL TOTAL
@ 5,000 units P20 P100,000
• Varies on a per unit basis @ 6000 units P15,000 P2.50
@ 6000 units P20 P120,000

@ 7000 units P15,000 P2.14

@ 7000 units P20 P140,000

Cost Behavior Assumptions and Limitations Cost Behavior

• Relevant Range Assumption
• -refers to the range of activity within which the cost behavior patterns are
VALID.
• - the usual capacity of the company’s production

How much is the total cost to manufacture products with a variable manufacturing costs per
unit of P25 and total manufacturing fixed costs of P40,000 at the ff. production levels: Cost Estimation: Segregating Variable and
A. 2000 units B. 4500 units C. 7250 units
Fixed Costs
Y= a + bx • Cost Function(Cost Equation): Y= a + bX
Y= 40,000 + 25(2000)
Y=40,000 + 50,000
• Y = total costs (dependent variable)
Y= 90,000 • a = total fixed costs (y-axis intercept)
• bX = total Variable Costs
Y= a + bx
Y= 40,000 + 25(4500) • X = volume of activity or cost driver (independent variable) –
Y=40,000 + 112,500 • b = variable costs per unit
Y= 152,500
 Separating Mixed Costs High-Low Points Method
• 2 methods: • The Fixed and Variable components of the mixed costs are computed from
• High-low method the highest and lowest points based on the activity or cost driver(X).

• Least Squares Regression Method • Variable Cost Per Unit(b) = Change in Costs (YH- YL)
Change in Activity (XH-XL)

• PURPOSE: In order for company to properly classify and analyze their

COSTS, they need to separate or segregate the variable cost component and
fixed cost component.

Step 1: Determine the highest and lowest

HIGH-LOW METHOD
activity and costs associated thereto:

200

Step 2: Obtain the variable cost per unit by dividing the

change in cost over the change in activity.
OUTLIER
• A data point that falls far away from other data points
Step 3: Obtain the total fixed costs by removing
Or solve using the equation: (a=?)
the variable cost component in the total costs.
• Y= a + bx • Y= a + bx
• 24,800 = a + 2.50(9000) • 9,800 = a + 2.50(3000)
• a = 24,800 – 22,500 • a =9,800 – 7,500
• a = 2,300 • a = 2,300

High-low method Least-Squares Regression Method

• A statistical technique that determines the LINE OF BEST FIT for all data
points by minimizing the sum of squared deviations between line and the
data points.
• ONE INDEPENDENT VARIABLE = SIMPLE REGRESSION
• MULTIPLE INDEPENDENT VARIABLE = MULTIPLE REGRESSION

Step 1: Prepare a table calculating x(activity),

Least-Squares Regression Method
y(total cost), xy and x2
Step 2: Substitute the computed amounts in the Step 2: Substitute the computed amounts in the
following equation to get VC/unit. following equation to get VC/unit.

Equation 1: 118,500 = 8a + 46,500b

Equation 2: 756,350,000= 46,500a +301,750,000b

Step 2: Substitute the computed amounts in the Step 3: Substitute b to any equation to get a
following equation to get VC/unit. (Fixed Cost)
• Equation 1: 118,500 = 8a + 46,500b • Equation 1: 118,500 = 8a + 46,500b
• Equation 2: 756,350,000= 46,500a +301,750,000b
118,500 = 8a +46,500 (2.15)
GOAL: Cancel a to get b
118,500 = 8a + 99,975
46,500/8 = 5812.5
756,350,000= 46,500a +301,750,000b 8a= -118,500 + 99,975
-5812.5 (118,500 = 8a +46,500b) -688,781,250=-46,500a – 270,281,250b 8a= 18,525
67,568,750 31,468,750b
8 8
b= 67,568,750/31,468,750
b= 2.15
a = 2315.63

High-low method vs. Least squares regression Other Cost Terminologies

HLM LSRM • Opportunity Cost – Benefits foregone in choosing one action over another
Variable Cost Per Unit P2.50 P2.15 • Sunk Cost – Cost incurred that will not affect a future decision
Total Fixed Cost P2,300 P2315.63 • Committed Cost – Costs resulting from organizational structure or use of facilities
• Discretionary Cost – Costs arising from managerial decisions
• Controllable Cost – Costs that are able to be influenced on how much shall be spent.
• Noncontrollable Cost –Costs that cannot be controlled or influenced.