This chapter discusses cost terms, concepts, and classifications. It defines costs and gives examples. It explains that a cost object is anything for which cost data is desired, like products or organizational subunits. It's important to know costs according to a cost object to determine selling prices. Costs are classified in different ways like variable/fixed, direct/indirect, and sunk/differential/opportunity costs for income statements, predicting behavior, assigning to cost objects, and making decisions. Manufacturing and merchandising activities are also compared.

1. Chapter 2
An introduction to Cost Terms,
Concepts, and Classifications

2. • What is costs? Give examples on costs.
• A cost object is anything for which cost data are
desired – including products, product lines,
customers, jobs and organizational subunits.
• Why is it very important to know the costs
according to a cost object?
Who determines the selling price?

3. • Cost classifications
Income statement (showing the profit)
Behaviour – variable or fixed
Assigning costs to cost object as departments or
products – direct or indirect
Making decisions

4. Comparing Merchandising and
Manufacturing Activities
Merchandisers . . . Manufacturers . . .
Buy finished goods. Buy raw materials.
Sell finished goods. Produce and sell
finished goods.
MegaLoMart

5. Costs classification: Income statements (absorption costing)

6. Manufacturing or product Costs
Direct
Direct Direct
Direct Manufacturing
Manufacturing
Materials
Materials Labour
Labour Overhead
Overhead
The Product (cost object)

7. Direct Materials
Those materials that become an integral part of the
product and that can be conveniently traced directly
to it.
Example: A radio installed in a car
Example: A radio installed in a car

8. Direct Labour
Those labour costs that can be easily traced to
individual units of product.
Example: Wages paid to car assembly workers
Example: Wages paid to car assembly workers

9. Manufacturing Overhead

10. Absorption Costing: Cost classification
in connection with income statement
• Manufacturing costs = Direct labour + direct
materials + manufacturing overhead
• Gross margin = sales – manufacturing costs
• More details about the method in chapter 6

11. Cost Classifications for
Predicting Cost Behaviour
Contribution margin = sales – variable
cost
How a cost will react to
How a cost will react to
changes in the level of
changes in the level of
business activity.
business activity.
A variable cost is constant
A variable cost is constant
per unit of activity but
per unit of activity but
change when activity
change when activity
changes.
changes.
A fixed cost is constant in
A fixed cost is constant in
total for changes in activity
total for changes in activity
within the relevant range.
within the relevant range.

13. Cost Classifications for
Predicting Cost Behaviour
Behaviour of Cost (within the relevant range)
Cost In Total Per Unit
Total variable cost changes Variable cost per unit remains
Variable as activity level changes. the same over wide ranges
of activity.
Total fixed cost remains Fixed cost per unit goes
Fixed the same even when the down as activity level goes up.
activity level changes.

14. Cost Behaviour
Fixed costs are usually characterised by:
a. Unit costs that remain constant.
b. Total costs that increase as activity
decreases.
c. Total costs that increase as activity
increases.
d. Total costs that remain constant.

15. Cost Behaviour
Variable costs are usually characterised by:
a. Unit costs that decrease as activity
increases.
b. Total costs that increase as activity
decreases.
c. Total costs that increase as activity
increases.
d. Total costs that remain constant.

16. Categories the following costs
Variable costs Fixed costs
Materials
Depreciation Yes
Leasing cost Yes
Salary Yes
Wages labour Yes
Insurances Yes
Semi-manufactured Yes
Maintenance Yes
Marketing Yes
Rent Yes
Administration Yes
Heat Yes

17. Categories the following costs
E2-4 p. 46 Cost Behavior
Cost item Variable Fixed
1 X-ray film used in the radiology lab Yes
2 The costs of advertising a rock concert Yes
3 Depreciation on the a restaurant building Yes
4 The electrical costs of running a roller coaster Yes
5 Property taxes on your local cinema Yes
6 Commission paid to salespersons at McGraw-Hill Yes
7 Property insurance on a Coca-Cola bottling plant Yes
The costs of synthetic materials used to make Nike
8 running shoes Yes
The costs of shipping Panasonic televisions to retail
9 stores Yes
The cost of leasing an ultra-scan diagnostic
10 machine at a hospital Yes

18. Cost classifications for assigning costs to
cost objects such as departments or
products
Direct costs Indirect costs
•Costs that can be •Costs cannot be easily
easily and conveniently and conveniently traced to
a unit of product or other
traced to a unit of product
cost object.
or other cost objective.
•Example: manufacturing
•Examples: direct material overhead.
and direct labour.

19. Cost classifications for making decisions –
Differential Costs and Revenues
Costs and revenues that differ among alternatives.
Example: You have a job paying £1,500 per
month in your hometown. You have a job
offer in a neighboring city that pays £2,000
per month. The commuting cost to the city is
£300 per month.
Differential revenue is:
£2,000 – £1,500 = £500
Differential cost is:
£300

20. Cost classifications for making
decisions –
opportunity costs
• Opportunity Costs.The
potential benefit that is given
up when one alternative is
selected over another.
•Example: If you were
not attending university,
you could be earning
£15,000 per year.
Your opportunity cost
of attending university for
one year is £15,000.

21. Cost classifications for decisions making –
Sunk Costs
• Sunk costs: Historical costs, cannot be
changed by any decision. They are not
differential costs and should be ignored when
making decisions.
Example: You bought a car that cost £10,000 two
years ago. The £10,000 cost is sunk because whether
you drive it, park it, trade it, or sell it, you cannot
change the £10,000 cost.

23. Period
Cost identifikation Product cost (Selling
Variable Fixed Direct Direct Mfg. and Admin. Opportu- Sunk
Name of the cost P2-8 Cost Cost Materials Labour Overhead Cost) nity cost cost
Rental revenue
foregone £30,000/year Yes
Direct material cost,
£80/unit Yes Yes
Rental cost warehouse
£500/month Yes Yes
Rental cost equipment,
£4,000/month Yes Yes
Direck labour cost
£60/unit Yes Yes
Deprecialtion annex
space, £8,000/year Yes Yes Yes
Advertising cost,
£50,000/year Yes Yes
Supervisor´s salary,
£1,500/month Yes Yes
Electricity machines,
£1.20/unit Yes Yes
Shipping cost,
£9/unit Yes Yes
Return earned on
investment, £3,000/year Yes

24. Problem 2-10 s. 49 – production 2 000 unit/year
Cost behaviour Product cost
Costs Variable Fixed S&A Direct Indirect
Direct labour production £118,000 £118,000
Advertising £50,000 £50,000
Factory supervision £40,000 £40,000
Property taxes, factory £3,500 £3,500
Sales commissions £80,000 £80,000
Insurance factory £2,500 £2,500
Depreciation office equipment £4,000 £4,000
Lease cost factory equipment £12,000 £12,000
Indirect materials factory £6,000 £6,000
Depreciation factory building £10,000 £10,000
General office supplies (billing) £3,000 £3,000
General office salaries £60,000 £60,000
Direct materials used £94,000 £94,000
Utility factory £20,000 £20,000
321,000 182,000 197,000 212,000 94,000

25. Problem 2-10(2)
Produktion unit/year 2.000
Product costs $/unit
Direct (212,000/2,000) $106
Indirect (94,000/2,000) $47
Total $153
Required 3.
Product costs per unit increase. Reason : fixed costs are allocated to fewer units.
Production= 1,000. Calculate the total production costs £/unit. :
Total production costs £/unit = 200 (106+(94,000/1,000))

26. Exercise Zenith
• Go to Blackboard and opload:
• Zenith Business Eco. autumn 2012
• Zenith Business Eco.templet students
autumn 2012
• Solve the following problems:
• 1: Job order costing alternativ I
• 2: Job order costing alternativ II

27. End of Chapter 2