MANAGEMEN ADVISORY SERVICES

KARLO D. RECLA

02: COST CONCEPTS & CLASSIFICATIONS

DIFFERENT COSTS FOR DIFFERENT PURPOSES (Classification of Costs)

A. ACCORIDNG TO GENERALLY ACCEPTED ACCOUNTING TREATMENT

1. PRODUCT COSTS – costs incurred to manufacture the product
 Product costs of the units sold during the period are recognized as expense
(cost of goods sold) in the income statement
 Product costs of the unsold units become the costs of inventory and treated
as asset in the balance sheet
2. PERIOD COSTS – the non-manufacturing costs that include selling, administrative,
and research and development costs. These costs are expensed in the period of
incurrence and do not become part of the cost of inventory.

B. ACCORDING TO FUNCTION
1. MANUFACTURING COSTS – all the costs incurred in the factory to convert raw
materials into finished goods
a. Direct Manufacturing Costs – materials and labor
b. Indirect Manufacturing Costs – the manufacturing overhead or factory
overhead costs
2. NON – MANUFACTURING COSTS – all costs which are not incurred in transforming
materials to finished goods
a. Research and Development – incurred in designing and bringing new products
to the market
b. Marketing Costs – advertising and promotion expenses
c. Distribution Costs - costs incurred in delivering the products to the
customers
d. Selling Costs – salaries and commission of sales staff and other selling
expenses
e. After-sales Costs – costs incurred in dealing with customers after sales.
Examples are warranty, repairs costs and costs incurred in
receiving/entertaining/acting on customers’ complaints
f. General and Administrative Costs – all the non-manufacturing costs that
do not fall under categories (a) to (e).

C. AS TO TRACEABILITY / ASSIGNMENT TO COST OBJECT

1. DIRECT COSTS – costs that are related to a particular cost object and can
economically and effectively be traced to that cost object.
2. INDIRECT COSTS - costs that are related to a cost object, but cannot
practically, economically, and effectively be traced to such cost object.
Cost assignment is done by allocating the indirect cost to the related cost
objects.

D. ACCORDING TO MANAGERIAL INFLUINCE

1. CONTROLLABLE COST- cost which are likely to respond with the attention
devoted to them by specified manager.
2. NON-CONTROLLABLE COST- cost which are likely not to respond with the
attention devoted to them by a specified manager

E. ACCORDING TO COMMITEMENT TO COST EXPENDITURE

1. DISCRETIONARY COST- cost which management decides to incur in the current
period to enable the company to achieve objectives other than filling of
orders placed by customer
2. COMMITED COST- cost which are governed mainly by past decisions that
establish the present levels of operating and organizational capacity and
which only change slowly in response to small changes in capacity

F. FOR DECISION – MAKING

1. RELEVANT COSTS - future costs that will differ under alternative courses of
action.
2. DIFFERENTIAL COSTS – difference in costs between any two alternative courses of
action
 a. Incremental Costs – increase in cost from one alternative to another
b. Decremental Costs – decrease in cost from one alternative to another
3. OPPORTUNITY COSTS – income or benefit given up when one alternative is selected
over another
4. SUNK / PAST, OR HISTORICAL COSTS - already incurred and cannot be changed by any
decision made now or to be made in the future.

G. AS TO BEHAVIOR (REACTION TO CHANGES IN COST DRIVER)

1. VARIABLE COST – within the relevant range and time period under consideration,
the total amount varies directly to the change in activity level or cost driver,
and the per unit amount is constant.
2. FIXED COST – within the relevant range and time period under consideration, the
total amount remains unchanged, and the per unit amount varies inversely or
indirectly with the change in the cost driver.
a. Committed Fixed Costs – long term in nature and cannot be eliminated even
for short period of time without affecting the profitability or long -term
goals of the firm.
Example: depreciation of buildings and equipment
b. Discretionary or Managed Fixed Costs – usually arise from periodic (may
be annual, etc.) by management to spend in certain fixed costs area such
as research, advertising, maintenance contracts. Discretionary fixed
costs may be changed by management from period to period or even during
(within) the period, if circumstances demand such change.
Examples: research and development costs, advertising expense,
maintenance costs provided by service contractors

3. MIXED COST – this cost has both a variable and fixed component.

* RELEVANT RANGE – a range of activity that reflects the company’s normal

operating range. Within this relevant range, the cost behavior given above is
valid, i.e.: Commented [L1]: https://efinancemanagement.com/costin
g-terms/what-is-relevant-range
TOTAL AMOUNT PER COST DRIVER https://www.accountingtools.com/articles/what-is-the-
VARIABLE COST Varies directly with cost Constant relevant-range.html
driver
FIXED COST Constant Varies inversely with cost
driver

Splitting Mixed Costs

a. High–low method – based on costs observed at both the high and low levels of
activity within the relevant range.
b. Least square regression – a line of regression is determined by solving two
simultaneous equations which are based on the condition that the sum of deviations
above the line equals the sum of deviations below the line.
Simple regression – only two variables are involved; one dependent variable and
one independent variable.
Multiple regressions – only one dependent variable is involved but more than one
independent variables are considered.

The equations used to determine the equation for the least squares regression line
Ey = na + bEx
Exy = Exa + bEx2

Correlation Analysis – a technique used to measure the strength of the linear

relationship between two or more variables.
Coefficient of Correlation (r) – measures the relative strength of the linear
relationship
-1.0 <r < 1.0
= a value of -1.0 indicates a perfectly inverse linear relationship between x and y
= a value of 0 indicates no linear relationship between x and y
= a value of 1.0 indicates a direct relationship between x and y

Coefficient of Determination (r2) – amount of variation in the dependent variable

explained by the independent variable.
STRAIGHT PROBLEM 1 Commented [L2]: Direct
Direct Manufacturing Period
Yates Manufacturing Company incurs the following manufacturing costs and expenses during Cost Item Materials Labor Overhead Costs
the month of May. 1. X
1. Assembly line wages 2. X
2. Raw materials used directly in product 3. X
3. Depreciation on office equipment 4. X
4. Property taxes on factory building 5. X
6. X
5. Rent on factory building
7. X
6. Sales commissions 8. X
7. Depreciation on factory equipment 9. X
8. Factory utilities 10. X
9. Wages for factory maintenance workers 11. X
10. Advertising 12. X
11. Indirect materials used in production
12. Factory manager's salary

Instructions
Complete the following matrix by placing an X mark under the appropriate headings.
Direct Manufacturing
Cost Item Materials Direct Labor Overhead Period cost
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.

STRAIGHT PROBLEM 2

SMARTS Company wants to conduct an analysis of the behavior of the maintenance of its
factory equipment in relation to the to the number of units produced using such equipment.
Historical cost production data were gathered for the past seven (7) months.

Units Produced Maintenance Cost

April 200 2,250
May 700 5,000
June 600 4,000
July 400 3,250
August 800 4,500
September 25 125 Commented [L3]: OUTLIER
October 350 2,800

Required:
1. Assuming SMARTS uses High-Low method, determine
a. The variable cost rate Commented [L4]: 3.75
b. The fixed cost
Commented [L5]: 1,500
c. If the company is planning to produce 310 units in November, compute the
estimated maintenance cost Commented [L6]: 2,662
 2. Assuming the SMARTS uses the Least-Square method, determine
a. The variable cost rate
b. The fixed cost
c. If the company is planning to produce 310 units in November, compute the
estimated maintenance cost

SOLUTION GUIDE
X Y XY X2

STRAIGHT PROBLEM 3

ABC Company's total overhead costs at various levels of activity are presented below:
Commented [L7]: Answer:
Month Machine Hours Total Overhead Costs a.
March 60,000 P216,800 Total overhead cost at 80,000 machine hours .......
April 50,000 194,000 P262,400
May 70,000 239,600 Less:
June 80,000 262,400 Utilities (P54,000  50,000) x 80,000 ..........
86,400
Assume that the overhead costs above consist of utilities, supervisory salaries, and Supervisory salaries (fixed) ...................
maintenance. At the 50,000 machine-hour level of activity these costs are: 62,000
Utilities (V) P54,000 Portion of overhead for June that represents
maintenance ......................................
P114,000
Supervisory salaries (F) 62,000
Maintenance (M) 78,000
Total overhead costs P194,000 Commented [L8]: b. High-low analysis of maintenance
cost:
V = Variable; F = Fixed; M = Mixed.
Maintenance Cost Machine-Hours
High point ............... P114,000 80,000
The company wants to break down the maintenance cost into its basic variable and fixed Low point ................ 78,000 50,000
cost elements. Change observed......... .P 36,000 30,000

Required:

a. Estimate the maintenance cost for June.

b. Use the high-low method (to estimate the cost formula for maintenance cost)
determine the variable and fixed component of the maintenance cost (mix cost). Variable rate:

Change in cost = P36,000 = P1.20 per machine hr

c. Estimate the total overhead cost at an activity level of 55,000 machine hours.
Change in activity 30,000 MH

Total fixed cost:

Total maintenance cost at the low point......... P78,000
Less variable cost element (50,000 x P1.20)..... 60,000
Fixed cost element ............................. P18,000

The cost formula is: Y = P18,000 + P1.20X

Commented [L9]: c. Total overhead at 55,000 machine

hours:
Utilities (P54,000  50,000) x 55,000 .. P 59,400
Supervisory salaries ................... 62,000
Maintenance cost:
Variable: (55,000 x P1.20) ........... P66,000
Fixed ................................ 18,000 84,000
Total overhead cost at 55,000 MH ....... P205,400
 TRUE-FALSE STATEMENTS
1. Direct materials costs and indirect materials costs are manufacturing overhead. Commented [L10]: FALSE
2. Manufacturing costs that cannot be classified as direct materials or direct labor
are classified as manufacturing overhead. Commented [L11]: TRUE
3. Raw materials are equal to direct materials minus indirect materials.
Commented [L12]: FALSE
4. Raw materials that can be conveniently and directly associated with a finished
product are called materials overhead. Commented [L13]: FALSE
5. The total cost of a finished product does not generally contain equal amounts of
materials, labor, and overhead costs. Commented [L14]: 5. TRUE
6. Both direct labor cost and indirect labor cost are product costs.
Commented [L15]: TRUE
7. Period costs include selling and administrative expenses.
8. Indirect materials and indirect labor are both inventoriable costs. Commented [L16]: TRUE
9. Direct materials and direct labor are the only product costs. Commented [L17]: TRUE
10. Total period costs are deducted from total cost of work in process to calculate cost
Commented [L18]: FALSE
of goods manufactured.
11. Period costs are not inventoriable costs. Commented [L19]: 10. FALSE
12. Ending finished goods inventory appears on both the balance sheet and the income Commented [L20]: TRUE
statement of a manufacturing company.
Commented [L21]: TRUE
13. In calculating gross profit for a manufacturing company, the cost of goods
manufactured is deducted from net sales. Commented [L22]: FALSE
14. Finished goods inventory does not appear on a cost of goods manufactured schedule.
Commented [L23]: TRUE
15. If the ending work in process inventory is greater than the beginning work in
process inventory, then the cost of goods manufactured will be less than total
manufacturing costs for the period. Commented [L24]: 15. TRUE
16. Finished goods inventory for a manufacturing company is equivalent to inventory for
a merchandising company. Commented [L25]: TRUE
17. Raw materials inventory shows the cost of completed goods available for sale to
customers. Commented [L26]: FALSE
18. Many companies have significantly lowered inventory levels and costs using just -in-
time inventory methods. Commented [L27]: TRUE
19. Managerial accounting is primarily concerned with managers and external users.
Commented [L28]: FALSE
20. When the physical association of raw materials with the finished product is too
small to trace in terms of cost, they are usually classified as indirect materials. Commented [L29]: 20. TRUE
21. Product costs are also called inventoriable costs.
Commented [L30]: TRUE
22. Direct materials become a cost of the finished goods manufactured when they are
acquired, not when they are used. Commented [L31]: FALSE
23. The sum of the direct materials costs, direct labor costs, and beginning work in
process is the total manufacturing costs for the year. Commented [L32]: FALSE

MULTIPLE CHOICE QUESTIONS

1. Both direct materials and indirect materials are

A. raw materials.
B. manufacturing overhead.
C. merchandise inventory.
D. sold directly to customers by a manufacturing company.

2. The work of factory employees that can be physically and directly associated with
converting raw materials into finished goods is
A. manufacturing overhead. C. indirect labor.
B. indirect materials D. direct labor.

3. Which one of the following would not be classified as manufacturing overhead?

A. Indirect labor C. Insurance on factory building
B. Direct materials D. Indirect materials

4. Manufacturing costs include

A. direct materials and direct labor only
B. direct materials and manufacturing overhead only.
C. direct labor and manufacturing overhead only.
 D. direct materials, direct labor, and manufacturing overhead.

5. Which one of the following is not a direct material?

A. A tire used for a lawn mower
B. Plastic used in the covered case for a home PC
C. Steel used in the manufacturing of steel-radial tires
D. Lubricant for a ball-bearing joint for a large crane

6. Which one of the following is not a cost element in manufacturing a product?

A. Manufacturing overhead C. Office salaries
B. Direct materials D. Direct labor

7. A manufacturing process requires small amounts of glue. The glue used in the
production process is classified as a(n)
A. period cost. C. direct material.
B. indirect material. D. miscellaneous expense.

8. The wages of a timekeeper in the factory would be classified as

A. a period cost. C. indirect labor.
B. direct labor. D. compliance costs.

9. Which one of the following is not considered as material costs?

A. Partially completed motor engines for a motorcycle plant
B. Bolts used in manufacturing the compressor of an engine
C. Rivets for the wings of a new commercial jet aircraft
D. Lumber used to build tables

10. Which of the following is not a manufacturing cost category?

A. Cost of goods sold C. Direct labor
B. Direct materials D. Manufacturing overhead

11. As current technology changes manufacturing processes, it is likely that direct

A. labor will increase. C. materials will increase.
B. labor will decrease. D. materials will decrease.

12. For the work of factory employees to be considered as direct labor, the work must be
conveniently and
A. materially associated with raw materials conversion
B. periodically associated with raw materials conversion.
C. physically associated with raw materials conversion.
D. promptly associated with raw materials conversion.

13. Which of the following is not classified as direct labor?

A. Bottlers of beer in a brewery C. Wages of supervisors
B. Copy machine operators at a copy D. Bakers in a bakery
shop

14. Cotter pins and lubricants used irregularly in a production process are classified
as
A. miscellaneous expense. C. indirect materials.
B. direct materials. D. nonmaterial materials.

15. Which of the following is not another name for the term manufacturing overhead?
A. Factory overhead C. Burden
B. Pervasive costs D. Indirect manufacturing costs

16. Because of automation, which component of product cost is declining?

A. Direct labor C. Manufacturing overhead
B. Direct materials D. Advertising

17. The product cost that is most difficult to associate with a product is
A. direct materials. C. manufacturing overhead.
B. direct labor. D. advertising.

18. Manufacturing costs that cannot be classified as either direct materials or direct
labor are known as
A. period costs. C. selling and administrative expenses.
 B. nonmanufacturing costs. D. manufacturing overhead.

19. Which one of the following is an example of a period cost?

A. A change in benefits for the union workers who work in the New York plant of a
Fortune 1000 manufacturer
B. Workers' compensation insurance on factory workers' wages allocated to the
factory
C. A box cost associated with computers
D. A manager's salary for work that is done in the corporate head office

20. Which one of the following costs would not be inventoriable?

A. Period costs C. Indirect materials
B. Factory insurance costs D. Indirect labor costs

21. It is a part of the accounting system that measures costs for decision -making and
financial reporting purposes.

A. Financial Accounting C. Responsibility Accounting

B. Cost Accounting D. Segment Accounting

22. At 40% capacity, overhead cost is P 1,450; at 75% capacity, overhead cost is P
2,150. Determine the variable overhead cost at 80% capacity.

A. P 20 C. P 1,600
B. P 650 D. P 2,250

23. Why is equity capital generally more expensive than debt financing?

A. Interest on bonds is a legal obligation

B. Dividends fluctuate more than interest rates
C. Investors expect to be paid more for exposure to higher risk
D. Investors have a greater demand for equity investments than for debt
investments

24. In standard regression equation Y=a + bx. The letter b is best described as a(n):

A. Independent variable C. Constant coefficient

B. Dependent variable D. Variable coefficient

25. The letter X in the standard regression equation is best described as a (an):

A. Independent variable C. Constant coefficient

B. Dependent variable D. Constant coefficient of determination

Items 26 to 28 are based on the following information:

Meng Company is preparing a flexible budget for next year and requires a breakdown of
the factory maintenance cost into the fixed and variable elements.

The maintenance costs and machine hours (the selected cost driver) for the past six
months are as follows:

Maintenance costs Machine hours

January P15,500 1,800
February 10,720 1,230
March 15,100 1,740
April 15,840 2,190
May 14,800 1,602
June 10,600 1,590

26. If Meng Company uses the high-low method of analysis, the estimated variable rate of
maintenance cost per machine hour is
A. P7.23 B. P8.73 C. P5.46 D. P5.33

27. The average annual fixed maintenance cost amounts to

A. P4,160 B. P8,320 C. P49,920 D. P5,120

28. What is the average rate per hour at a level of P1,500 machine hours?
 A. P5.33 B. P8.11 C. P7.23 D. P5.46

Items 29 to 33 are based on the following information:

As part of a cost study, the cost accountant of Shinly Corporation has recorded the cost
of operations at seven different levels of materials usage. The records show the
following:

Kilos of Materials Costs of Operation

80 P 800
60 480
20 320
120 1,200
140 1,280
40 480
100 1,040

Sum of the kilos (∑x) 560

Sum of the costs (∑y) P5,600
Sum of the kilos multiplied by the costs (∑xy) P545,600
Sum of the kilos squared (∑x 2) 56,000

29. Using the high-low points method, the variable cost of operations per kilo of
materials used is

A. P8.00 B. P9.14 C. P16 D. P10

30. Using the same high-low points method, the fixed cost of operations is

A. P320 B. P103 C. P160 D. P206

31. Using the least squares method, the average rate of variability per kilos of
materials used is

A. P8.00 B. P0.11 C. P10.00 D. P8.71

32. Using the least squares method, the fixed portion of the cost is

A. P320 B. P103 C. P160 D. P206

33. The projected cost of operations for 90 kilos of materials is

A. P886.90 if the high-low points method is used

B. P880.00 if the method of least squares is used
C. P886.90 if the method of least squares is used
D. P880.00 regardless of the method used

34. Which of the correlation coefficients represents the weakest relationship between
two variables?

A. + 0.50 C. -0.05
B. -0.80 D. +1.05

35. The coefficient of correlation that indicates the strongest linear association
between the dependent and independent variables is

A. -0.08 C. -0.80
B. 0.40 D. 0.04

Items 25 to 26 are based on the following information:

For budgeting and control purposes, the controller of Mabun Manufacturing Co. is in the
process of estimating the variable cost per hour and the fixed cost per month of operating
automated equipment. Data for the past 12 months of operations have been gathered as
follows:
 Number of observations 12
Sum of the hours (x) 840
Sum of the costs (y) P9,000
Sum of the hours multiplied by the 655,000
costs (xy)
Sum of the hours squared (x 2) 63,800

Using the least-squares method in cost segregation:

36. What was the variable cost per hour to operate the machine?

A. P5.25 C. P5.00
B. P10.25 D. None of these

37. What was the fixed cost per month?

A. P360 C. P90
B. P400 D. None of these

38. An income or benefit that is given up when one alternative is selected over another
is called

A. Loss C. Relevant cost

B. Opportunity loss D. Differential costs

39. For decision-making purposes, relevant costs are

A. Variable past costs

B. All fixed and variable costs.
C. Anticipated future costs that will differ among various alternatives.
D. Costs incurred within the relevant range of production.

40. Differential costs

A. Are variable costs

B. Are anticipated future costs that will differ among various alternatives
C. Are the differences in costs between any two alternative courses of action
D. Are costs that differ under alternatives

41. Which of the following costs would be considered relevant in short -term decision-
making?

A. Production costs of goods available for sale

B. Incremental fixed costs
C. Acquisition cost of idle asset to be used in a proposed project
D. Variable costs

42. In cost accounting, the term relevant range refers to the range over which

A. Relevant costs are incurred

B. Production should be confined
C. Total fixed cost fluctuate
D. Cost relationships are valid

43. Depreciation computed using the straight-line method is classified as

A. Variable cost C. Relevant cost

B. Fixed cost D. Opportunity cost

44. Within the relevant range, unit variable costs

A. Are constant per unit, regardless of units produced or sold.

B. Vary directly with the activity level.
C. Vary inversely with the activity level.
D. Vary inversely with the activity level.