Chapter One

Cost Concepts, Cost behaviour and Cost

Estimation

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Outline:

• cost concepts

• Behavior patterns of costs

• Estimating cost behaviors

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 Introduction

Cost Accounting measures, analyzes, and

reports financial and non-financial information
relating to the costs of acquiring or using
resources in an organization. Provides
information for management accounting and
financial accounting.

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 …cont

For example, calculating the cost of a product

is a cost accounting function that answers
financial accounting’s inventory-valuation
needs and management accounting’s decision-
making needs (such as deciding how to price
products and choosing which products to
promote).

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 … Cont
Issue Management A. Financial A.

Users Internal External

Information Financial and Non-Financial Financial

Information purpose Planning, directing, controlling, Investing and lending

etc. decision

Primary accounting Any internal accounting report Financial statement

product deemed by management

Format As the manger needs IFRS or GAAP format

Information basis Past and future Past (historical)

Information Relevant Reliable and objective

characteristics
Unit report Segments Whole organization

Report period As management needs Annually or quarterly

Anyone who verify the May be by internal audits or no By independent audits

information
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 1.1 Costs and Cost Terminology

 Accountants usually define cost as a resource

sacrifice or foregone to achieve specific objective.

 A cost object is anything for which a measurement

of costs is desired. Examples: a product, a service, a
project, a customer, a brand category, an activity, a
department, and a program, etc.

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 …Cont
Costs are measured and used in many
different ways by managers to fit the
requirements of various situations.

Important of cost data:

Planning
Control
Income Statement
Statement of Financial position

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 1.2 Cost Accumulation & Cost Assignment
How does a cost system determine the costs of
various cost objects?

 The two costing system stages:

1. Accumulation, followed by
2. Assignment.

 Based on the method assigns costs to a cost object,

costs are classified into two:

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 …Cont

a. Tracing accumulated costs to cost objectives-Direct

costs ; and
b. Allocating accumulated costs to a cost objective-
Indirect costs.

 Direct costs of a cost object are related to the

particular cost object and can be traced to it in an
economically feasible (cost-effective) way.
Example: Cost of steel and tires for the particular car
model.

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 …Cont

Indirect Costs of a cost object are related to the

particular cost object but cannot be traced to it in an
economically feasible (cost-effective) way. Example: the
salaries of plant administrators.
(based on the number of workers working on each product
type or the number of products produced of each product
type),

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 Factors Affecting Direct/Indirect Cost
Classifications

1. The materiality of the cost in question.

2. Available information-gathering technology.
Example: Bar code
3. Design of operations

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 Summary of Cost Assignment

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 1.3 Manufacturing Company

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 1.4 Manufacturing Inventories

A Manufacturing firm has three major levels of

inventory:

1. Raw Materials Inventory = Materials

2. Work-In-Process Inventory= Partially complete and
3. Finished Goods Inventory = Completed but have
not yet been sold

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 … Cont

Analyzing Activity in Inventory Accounts

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1.5 Cost Flows and Classifications in a Manufacturing
Company

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1.6 Cost Classifications on the Financial Statements

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1.7 Schedule of Cost of Goods Manufactures

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 …Cont
 Illustration: On June 30, 2019, the Beginning
Inventory accounts Balances of Amazon
Manufacturing Company were:
Raw Materials Inventory --------------------- $5,000
Work-In-Process Inventory ----------------- $8,000
Finished Goods Inventory ------------------ $11,000

 During the month of June, Raw Materials costing

$12,000 were purchased. Direct Labor and Factory
Overhead costs were $20,000 and $15,000 respectively.
The June 30, Ending Inventory Accounts Balances
were as follows:
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 …Cont
Raw Materials Inventory --------------------$7,000
Work-In-Process Inventory --------------- $14,000
Finished Goods Inventory ------------------$6,000

Moreover, Amazon June 30, 2019, for this illustration,

assume that the month’s Sales of $90,000 and Selling
& Administrative Expenses of $30,000.

Required: Schedule of cost of Goods Manufactured,

Financial Statements

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 1.8 Cost-Behavior Patterns
 Cost behavior refers to the classification of costs
according to their behavioral pattern, that is, the way
costs change as volume of production output (activity)
changes.
a. A variable cost
Changes in total in direct proportion to changes in the
related level of total activity or volume. But a per
unit basis is constant. Examples include the costs
of direct materials, direct labor, supplies and direct
expenses like sales commissions.

Total Variable costs (TVC) = Unit variable costs x units

(volume)
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 …Cont

For example: Assume Fountain Hotel, cost of the

meals on a per person basis in the Hotel remains
constant at $30. How much will be the total cost of
meals, while 250, 500, 750 and 1,000 number of
guests are served in the Hotel.

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 …Cont

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b. A fixed cost

Remains unchanged in total for a given time period,

despite wide changes in the related level of total activity
or volume. There is an inverse relationship between
volumes of output and fixed costs per unit.

Examples: Rent & Taxes of buildings, insurance charges

& depreciation of plant, machinery and buildings,
salaries of foremen, workers, managers, permanent
staff and executives.

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 …Cont
For example: To continue the Fountain Hotel
expeditions example, assume the Hotel decides to rent
a building for $500 per month to store its equipment.
How much will be the total fixed cost and unit fixed
cost, while 250, 500, 750 and 1,000 number of guests
are served in the Hotel.

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 …Cont

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 c. Semi-Variable costs
Costs that are neither perfectly variable nor
absolutely fixed in relation to changes in the
volume of output.
Partly fixed and partly variable
 Called semi-variable or semi-fixed or mixed costs.

Examples: utility bills, such as power costs,

telephone charges, water, repairs and
maintenance costs, etc. because minimum
charge is must even if you don’t consume.

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 … cont
Total Mixed cost (TMC) = Fixed Costs + UVC x units
(volume)

Y = a + bx
Example:
To continue the Fountain Hotel example, the company
must pay a license fees of $25,000 per year plus $3 per
party to the state’s Department of Natural Resources
(state fees). If the company runs 500 parties this year,
how much will be the total state fees paid to the
state?

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 …Cont

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 …Cont
How do we segregate mixed costs into fixed and
variable costs?

Methods:
1. The Comparison Method
2. High-Low Point or Range Method
3. The Equation Method
4. The Average method
5. The Method of Least Squares
6. The Analytical Approach

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…Cont

Example: Based on the following data segregate mixed

costs into fixed cost and variable cost.

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 1. The Comparison Method

 The quantum of output at two different levels of

activity is compared with corresponding amount of
semi-variable costs.

Variable cost per unit = Change in the Amount of Semi-variable Costs

Change in Activity or Volume of Output

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 2. High-Low Method

 You begin by identifying the period with the lowest

level of activity and the period with the highest
level of activity, i.e.

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 3. The Equation Method

Under this method, variable and fixed element of

semi-variable cost is determined by means of
Straight line Equation, which is as follows:

Y = a + bx
Where, Y = Total semi-variable cost
x = Output (in units)
b = Variable cost per unit
a = Fixed cost element

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 4. The Average method

 Average of the data relating two levels of activity is

calculated and then the equation method or range
method is applied.

5. The Method of Least Squares

 Most accurate method because uses all of the data to
separate a mixed cost into its fixed and variable
components.

 A regression line of the form:

Y = a + bX

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6. The Analytical Approach

 The analyst determines from the past experience as to

what portion of semi-variable cost comprises of
variable and fixed cost element.

 Each account under consideration is classified as

either variable or fixed based on the analyst’s prior
knowledge of how the cost in the account behaves.

 This method is simple but suffers from the

subjectivity of the accountant or the analyst.

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 Assignments

1. Articles review related to cost, 5/10 articles

2. Visit any institution and report the costing
system (Chapter 6). More preferable, if the
institution is manufacturing.

Next to chapter two deal about Multi-product

CVP Analysis

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 THANK YOU FOR
YOU
ATTENTION!!!

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