Chapter 02

CHAPTER 02 Md.
Jamil Sharif, PhD

AN INTRODUCTION TO COST TERMS AND Associate Professor,
PURPOSES University of Dhaka.
LEARNING OBJECTIVES
• 2.1 Define and illustrate cost, expense and a cost object

• 2.2 Distinguish between direct costs and indirect costs
• 2.3 Explain variable costs and fixed costs
• 2.4 Interpret unit costs cautiously
• 2.5 Distinguish inventoriable costs from period costs
• 2.6 Illustrate the flow of inventoriable and period costs
DEFINITION OF COST, EXPENSE AND COST OBJECT
Cost is a element from which future economic benefits will flow to the entity.
Accountants define cost as a resource sacrificed or forgone to achieve a
specific objective. A cost (such as direct materials or advertising) is usually
measured as the monetary amount that must be paid to acquire goods or
services.
An actual cost is the cost incurred (a historical or past cost), as distinguished
from a budgeted cost, which is a predicted or forecasted cost (a future cost).
Expense is an element from which an organization has already got benefit.

DEFINITION OF COST, EXPENSE AND COST OBJECT
A cost object is anything for which a measurement of costs is desired.
Example of Cost Objects at BMW
DISTINGUISH BETWEEN DIRECT COSTS AND
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.
For example, the cost of steel or tires is a direct cost of BMW X5s. The cost of the
steel or tires can be easily traced to or identified with the BMW X5. The cost of labor
can easily be traced to the X5 and is another example of a direct cost.
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. For example, the salaries
of plant administrators (including the plant manager) who oversee production of the
many different types of cars produced at the Spartanburg plant are an indirect cost of
the X5s.
Indirect Costs are Electricity, Rent, Property taxes and Plant administration
expenses
WHY SEGREGATION IS NECESSARY
VARIABLE VS FIXED COSTS
Variable costs change, in total, in proportion to changes in the related level
of activity or volume of output produced.
Variable costs are constant on a per-unit basis. If a product takes 5 pounds
of material each, it stays the same per unit regardless if one, ten or a
thousand units are produced.
Fixed costs remain unchanged, in total, for a given time period, despite
changes in the related level of activity or volume of output produced.
Fixed costs per unit change inversely with the level of production. As more
units are produced, the same fixed cost is spread over more and more
units, reducing the cost per unit.
Fixed Cost is fixed up to a relevant range.

Costs are fixed or variable for a specific activity and/or for a given time period.
What is Mixed costs?
Example???
COST DRIVER
The level of activity or volume is a cost driver if there is a cause-and-
effect relationship between a change in the level of activity or volume
and a change in the level of total costs.
For example, if product-design costs change with the number of parts
in a product, the number of parts is a cost driver of product-design
costs. Similarly, miles driven is often a cost driver of distribution costs.
A cost driver is a variable, such as the level of activity or volume that
causally affects costs over a given time span. An activity is an event,
task, or unit of work with a specified purpose—for example, designing
products, setting up machines, or testing products are examples f cost
drivers.
MULTIPLE CLASSIFICATIONS OF COSTS
PRACTICE
Units VC per unit FC Total VC Total Costs Unit Cost

produced
100,000 60 10,000,000
200,000 60 10,000,000
500,000 60 10,000,000
800,000 60 10,000,000
1,000,000 60 10,000,000
SOLUTION
DISTINGUISH INVENTORIABLE COSTS
FROM PERIOD COSTS
Types of Inventory
Manufacturing-sector companies purchase materials and components and convert
them into various finished goods. These companies typically have one or more of the
following three types of inventory:
1. Direct materials inventory. Direct materials in stock and awaiting use in the
manufacturing process (for example, computer chips and components needed to
manufacture cellular phones).
2. Work-in-process inventory. Goods partially worked on but not yet completed (for
example, cellular phones at various stages of completion in the manufacturing
process). This is also called work in progress.
3. Finished goods inventory. Goods (for example, cellular phones) completed but
not yet sold.
INVENTORY MANUFACTURING COSTS
1. Direct material costs are the acquisition costs of all materials that eventually become
part of the cost object (work in process and then finished goods) and can be traced to
the cost object in an economically feasible way. Acquisition costs of direct materials
include freight-in (inward delivery) charges, sales taxes, and custom duties. Examples
of direct material costs are the steel and tires used to make the BMW X5, and the
computer chips used to make cellular phones.
2. Direct manufacturing labor costs include the compensation of all manufacturing
labor that can be traced to the cost object (work in process and then finished goods)
in an economically feasible way. Examples include wages and fringe benefits paid to
machine operators and assembly-line workers who convert direct materials purchased
to finished goods.
INVENTORY MANUFACTURING COSTS
3. Indirect manufacturing costs are all manufacturing costs that are related
to the cost object (work in process and then finished goods) but cannot be
traced to that cost object in an economically feasible way. Examples include
supplies, indirect materials such as lubricants, indirect manufacturing labor
such as plant maintenance and cleaning labor, plant rent, plant insurance,
property taxes on the plant, plant depreciation, and the compensation of plant
managers. This cost category is also referred to as manufacturing overhead
costs or factory overhead costs. We use indirect manufacturing costs and
manufacturing overhead costs interchangeably in this book.
INVENTORIABLE COSTS/PRODUCT COST
Inventoriable costs are all costs of a product that are considered as assets in the
balance sheet when they are incurred and that become cost of goods sold only
when the product is sold.
For manufacturing-sector companies, all manufacturing costs are inventoriable
costs. Consider Cellular Products, a manufacturer of cellular phones. Costs of
direct materials, such as computer chips, issued to production (from direct
material inventory), direct manufacturing labor costs, and manufacturing
overhead costs create new assets, starting as work in process and becoming
finished goods (the cellular phones).
Hence, manufacturing costs are included in work-in-process inventory and in
finished goods inventory (they are “inventoried”) to accumulate the costs of
creating these assets.
PERIOD COSTS/NON-MANUFACTURING COSTS
Period costs are all costs in the income statement other than cost of goods
sold.
Period costs, such as marketing, distribution and customer service costs, are
treated as expenses of the accounting period in which they are incurred
because they are expected to benefit revenues in that period and are not
expected to benefit revenues in future periods.
Some costs such as R&D costs are treated as period costs because, although
these costs may benefit revenues in a future period if the R&D efforts are
successful, it is highly uncertain if and when these benefits will occur.
Expensing period costs as they are incurred best matches expenses to
revenues.
PRODUCT AND PERIOD COST
PRIME COST AND CONVERSION COST
AN ILLUSTRATION OF COSTS
Determine product cost, period cost, prime cost, conversion cost,

variable manufacturing costs and Total fixed costs.
OTHER COSTS-OPPORTUNITY COSTS
SUNK COST
SEGREGATING MIXED COSTS
1. Scatter plot Method
2. High-Low Method
3. Regression Method
SCATTER PLOT METHOD
SCATTER PLOT METHOD
HIGH-LOW METHOD
REGRESSION METHOD
PROBLEM
COST TERM-PRACTICE
D
O
IT
DETERMINATION OF COST OF GOODS MANUFACTURED
DETERMINATION OF COGM
DETERMINATION OF COGS
INCOME STATEMENT
Particulars TK
Beginning Raw Materials (1/1/19) 11000
Ending Raw Materials (31/12/19) 8000
Beginning WIP (1/1/19) 6000
Ending WIP (31/12/19) 7000
Beginning Finished Goods (1/1/19) 10000
Ending Finished Goods (31/12/19) 12000
Purchase of Direct Materials 75000
Transport cost of raw materials 1000
Purchase return and allowances 3000
Direct Labor 9000
Indirect manufacturing labor 7000
Supplies 2000
Utility expenses 5000
Depreciation of Factory machinery 2000
Depreciation of Factory furniture 3000
Supervisor's salary 1000
ALTERNATIVE CLASSIFICATIONS OF COSTS
Thank You

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CHAPTER 02 Md.

Jamil Sharif, PhD

• 2.1 Define and illustrate cost, expense and a cost object

Expense is an element from which an organization has already got benefit.

Fixed Cost is fixed up to a relevant range.

Units VC per unit FC Total VC Total Costs Unit Cost

Determine product cost, period cost, prime cost, conversion cost,

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