XCOSTMAN: PRELIMS

MODULE 1: BASIC COST MANAGEMENT CONCEPTS are all costs associated with production of goods.

COST MANUFACTURING COST:

• the value forgone or sacrifice of resources for
✓ Direct Materials
the purpose of achieving some economic
benefit which will promote the profit-making are all raw materials that become an integral part of the
ability of the firm. finished product and that can be conveniently and
• A cost is used when a resource is used for some economically assigned to specific units manufactured.
purpose. It is also an outlay or expenditure of
✓ Direct Labor
money to acquire goods and services that assist
in performing operations. are all labor costs related to time spent on products that
can be conveniently and economically assigned to
specific units manufactured.
COST POOLS
✓ Manufacturing Overhead
costs collected into meaningful groups. Cost pools may
be classified: is the third element of manufacturing cost, includes all
costs of manufacturing except direct materials and
1. by type of cost
direct labor.
2. by source
3. by responsibility ✓ Indirect Materials
COST OBJECT include materials and supplies used in the
manufacturing operation that do not become part of
any product, service or organizational unit to which cost
the product.
are assigned for some management purpose. Products
and services are generally cost objectives. Any item to ✓ Indirect Labor
which cost can be traced and that has a key role in
management strategy can be considered as cost object. also cannot be identified or traced to specific units
manufactured.
COST DRIVER
✓ Non-Manufacturing Costs
any factor that has the effect of changing the level of
total cost. The management of key cost drivers is include costs related to selling and other activities not
essential for a firm that competes on the basis of cost related to the production of goods.
leadership. NON-MANUFACTURING COSTS:
COST ASSIGNMENT ✓ Marketing Costs
• Cost assignment are all costs associated with the marketing or selling of a
is the process of assigning cost to cost pools or from product or all costs incurred by the marketing division
cost pools to cost objectives from the time the manufacturing process is completed
until the product is delivered to the customer or all
• Cost allocation costs necessary to secure customer orders and get the
finished product or service into the hands of the
is the assignment of indirect cost to cost pools.
customer.
• Allocation bases
✓ General and Administrative Costs
are cost drivers used to allocate cost.
include all executive, organizational and clerical costs
COST CLASSIFICATION: associated with the general management of the
organization rather than with the manufacturing,
• NATURE OR MANAGEMENT FUNCTIONS marketing or selling.
✓ Manufacturing Costs
XCOSTMAN: PRELIMS
• TIMING OF RECOGNITION AS EXPENSE the cost of completed goods that have not been sold at
✓ Product Costs the end of the period.

include all costs that are involved in acquiring or making • TRACEABILITY TO COST OBJECTIVE
a product. ✓ Direct Costs (traceable; separable)

✓ Period Costs are costs that can be economically traced to a single

cost object.
are costs that are identified with accounting periods and
not included in product costs. ✓ Indirect Costs

• FINANCIAL STATEMENTS are costs that are not directly traceable to the cost
✓ Statement of Financial Position object.

Presented as part of Inventories (further divided • MANAGERIAL INFLUENCE

depending on whether a manufacturing or ✓ Controllable Costs
merchandising business)
costs that are subject to significant influence by a
✓ Statement of Income particular manager within the time period under
consideration.
Presented as part of the Cost of Goods Sold or
Operating Expenses ✓ Non-controllable Costs

• PREDICTING COST BEHAVIOR costs over which a given manager does not have a
✓ Cost Behavior significant influence.

refers to how a cost will react or respond to changes in • USED FOR PLANNING AND CONTROL
the business activity ✓ Standard Cost

✓ Variable Costs is a predetermined cost estimate that should be

attained; usually expressed in terms of cost per unit.
costs that change directly in proportion to changes in
activity (volume). ✓ Budgeted Cost

✓ Fixed Costs is used to represent the expected/planned cost for a

given period.
costs that remain unchanged for a given time period
regardless of change in activity (volume). ✓ Absorption Costing

✓ Semi-variable Costs is a method that includes all manufacturing costs in the

cost of a unit of product.
costs that contain both fixed and variable elements.
✓ Direct Costing
• TYPES OF INVENTORY
✓ Raw Materials Inventory is a type of product costing where fixed costs are
charged against revenue as incurred and are not
the cost of all raw material and production supplies that
assigned to specific units of a product manufactured.
have been purchased but not used at the end of the
period. ✓ Information Costs

✓ Work-in-process Inventory are costs of obtaining information.

the cost associated with goods partially completed at ✓ Ordering Costs

the end of the period.
are costs that increase with the number of orders
✓ Finished Goods Inventory placed for inventory.

✓ Out-of-pocket Costs
XCOSTMAN: PRELIMS
are costs that must be met with a current expenditure Cost Behavior
or cash outlay.
Cost behavior means how a cost will react as changes
• TIME-FRAME PERSPECTIVE takes place in the level of business activity. Managers
✓ Committed Costs who understand how costs behave are better able to
predict what costs will be under various operating
are costs that are inevitable consequence of incurrence
circumstances. An understanding of cost behavior
of a previous commitment.
under varying conditions is essential to adequate
✓ Discretionary Costs (Programmed; decision making in the planning and control of firm
Managed Costs) activity.

are costs for which the size or the time of incurrence is a Importance of Understanding Cost Behavior
matter of choice.
Planning requires that management make decisions
• TIME PERIOD based in part on expectations as to the future.
✓ Historical Costs (Past Costs) Control is the process of using feedback information for
are costs that were incurred in a past period. comparison with expectation and the implementation of
actions on the basis of that comparison.
✓ Future Costs
Cost analysis is an integral part of the planning and
are budgeted costs that are expected to be incurred in a control function. The key to effective cost production
future period. lies in an understanding of cost behavior patterns.
• ANALYTICAL PURPOSES Types of Cost Behavior Patterns
✓ Relevant Costs
• Variable Costs
are future costs that are different under one decision • Fixed Costs
alternative than under another decision alternative. ✓ Committed fixed costs
✓ Incremental Cost ✓ Discretionary fixed costs
• Mixed Costs
is the difference between two or more alternatives.
Variable Cost -Change in total as the level of activity
✓ Sunk Costs changes in the short run and within the RELEVANT
are past costs that have been incurred and are irrelevant RANGE
to a future decision. Relevant Range -Range activity within which
✓ Opportunity Cost assumptions relative to variable and fixed cost
behaviour are valid.
is the value of the best alternative forgone as the result
of selecting a different use of resource or by choosing a • *Variable cost PER UNIT is constant in the
particular strategy. relevant range

✓ Marginal Cost • *TOTAL Variable cost changes with respect to

the ACTIVITIY BASE
is the costs associated with the next unit or the next
project or incremental cost associated with an Activity base- Measure of whatever causes the
additional project as opposed to the discrete unit. incurrence of variable cost

✓ Value Added Costs FIXED COSTS - Costs that remain constant in total
regardless of the changes in the level of activity within
are costs that add value to the product. the relevant range
MODULE 7: COST ESTIMATION
XCOSTMAN: PRELIMS
*Fixed cost PER UNIT decreases as the level of activity Steps:
increases.
Review each cost account and identify as either variable
Committed fixed costs - Long-term in nature and cannot or fixed in relationship to some activity.
be significantly reduced even for short periods of time
Each major class is itemized and each cost is divided into
without impairing the profitability or long- run goals of
variable and fixed component.
the organization.
*Advantage: involves detailed examination
Discretionary fixed costs- Usually arise from annual
decisions by management. Management is not locked *Disadvantage: uses subjective, judgmental approach.
into a decision regarding such costs.
Industrial Engineering Method
MIXED COSTS/SEMIVARIABLE COSTS -Contains both
variable and fixed cost elements. The industrial engineering method estimates cost
functions by analyzing the relationship between inputs
Relationship between mixed cost and level of activity: and outputs in physical forms.
Y = a + bX STEPS:
FIXED PORTION -Basic, minimum cost of just having a Study of physical relation between the quantities of
service ready and available for use. inputs and each unit of
VARIABLE PORTION- Cost incurred for the actual output
consumption of the service.
Costs are assigned to each of the physical inputs to
The Analysis of Mixed Costs estimate the cost of the outputs.
The fixed portion of mixed cost represents the basic, *Advantage: it can detail each step required to perform
minimum cost of just having a service ready and an operation.
available for use while the variable portion represents
the cost incurred for the actual consumption of the *Disadvantage: quite expensive to use.
service. The variable element varies in proportion to Conference Method
the amount of service that is consumed.
Cost functions are estimated based on the analysis and
METHODS FOR COST ESTIMATION opinions about costs and drivers obtained from various
1. Account analysis method departments of an organization such as purchasing,
2. Industrial Engineering method or Work process engineering, manufacturing, employee relation
measurement method and so on. This information is used to determine the
3. Conference method selling price of the product, optimum product mix, and
4. Quantitative analysis of current and past costs evaluate cost improvements overtime.
relationships The High-Low Method
– High-low method
– Regression analysis method It is based on costs observed at both the high and low
5. Scattergraph or Visual fit method levels of activity within the relevant range.
6. The least-squares regression method Steps in Applying the High-Low Cost Estimation
Account Analysis Method 1. Obtain relevant data on past costs and related
Account analysis is considered a very useful and easier actual activity levels.
way to estimate costs. It makes use of the experience 2. Estimate the variable cost per unit or rate using
and judgment of managers and accounts who are the following equation:
familiar with company operations and the way costs
react to changes in activity level.
XCOSTMAN: PRELIMS
Variable cost rate or per unit = Cost at highest activity – o = residual term that includes the net effect of other
Cost at lowest activity /Highest activity – Lowest factors not in the model and measurement errors in the
activity dependent and independent variables.
Least-squares Regression Method
3. Compute the fixed cost as follows:
A statistical technique which is often used in separating
Fixed Cost = Total Cost at highest activity – [Variable
mixed costs into their fixed and variable components is
cost per unit x Highest activity stated in units]
least-square regression. Basically, a line of regression is
Or determined by solving two simultaneous linear
equations which are based on the condition that the
Fixed Cost = Total Cost at lowest activity – [Variable sum of deviations above the line equals the sum of
cost per unit x Lowest activity stated in units] deviation below the line.
Regression Analysis Method The equation for the determination of straight line is:
It uses all available data to estimate the cost function. It Y = a + bX
is a statistical method that measures the average
amount of change in the dependent variable (costs) that The two linear equations that are used to solve for a
is associated with a unit change of one or more and b are:
independent variables. Sample regression analysis
Equation (1) EY = Na + bEx2
estimates the relationship between the dependent
variable and multiple independent variables. Multiple Equation (2) EXY = EXa + bEX2
regressions are used when the dependent variable is
Where:
caused by more than one factor. Although adding more
factors or variables make the computation more Y = Total cost
complex, the principles involved are the same as in the a = Fixed cost
simple regression analysis. b = Variable cost rate X = measure of activity
N = number of observations
Simple regression analysis- Estimates the relationship
E = Greek letter signifying summation
between the dependent and one independent variable.
Scatter graph or Visual Fit
Multiple regression analysis – Estimates the
This is a rough guide for cost estimation which plot the
relationship between the dependent variable and
cost against past activity levels. These activities are
multiple independent variables.
referred to as predictors or independent variables (X),
Simple Regression analysis uses the following or the right-hand-side of a regression equation. The cost
estimated cost function or equation: to be estimated may be called the dependent variables
(Y), or the left-hand-side of the regression equation.
Y=a+bX
The line is drawn, insofar as it is possible by visual
While multiple regression analysis uses the following judgment, so that the distances of the observation
equations: above the line are equal to the distances of the
observations below the line. This line called the line of
Y = a + b1 X 1 + b2 X 2……… + o regression represents the data as a line of conditional
Where: expected values.

Y = costs to be predicted Correlation Analysis

X1 X 2 X3….. = independent variable on which the In the process of estimating and controlling costs,
prediction is to be based management must evaluate whether o not the factor
a = fixed cost selected for estimating cost behavior in suitable for that
b1b2b3…. = estimated coefficient of the regression purpose. Costs may or not react with changes in the
model factor selected for cost analysis.
XCOSTMAN: PRELIMS
r2 = 1 – (Estimated conditional standard deviation Direct materials
measured from line of regression)2 / (Standard Direct labor
deviation measured from the average of all data)2 Variable manufacturing overhead
• Period Costs
The Learning Curve Theory
Fixed manufacturing overhead
One assumption in estimating cost behavior is that the
Variable selling and administrative expenses
cost of each input is a linear function of the quantity
Fixed selling and administrative expenses
assigned. However, the relationship between costs and
independent variables is not always linear. As to treatment of the various operating costs
Some of the Uses of Curves are as follows: ABSORPTION COSTING
1. Preparing cost estimates for bidding purposes • Product Costs
2. Setting standards and budget allowances
3. Scheduling labor requirements Direct materials
4. Evaluating performance by comparing progress Direct labor
reports with the a accomplishments anticipated Variable manufacturing overhead
under the learning curve Fixed manufacturing overhead
5. Setting incentive wage rates with due • Period Costs
consideration for the fact that labor times will Variable selling and administrative expenses
normally be reduced as the workman becomes Fixed selling and administrative expenses
more experienced As to net operating income
Learning rate formula:
Net income is not affected by changes in production
Average input quantity (cost) for the first 2 x units under variable costing. Net income, however is affected
Average input quantity (cost) for the first x units by the changes in production when absorption costing
is in use. Net income goes up under the absorption
MODULE 2: VARIABLE COSTING
approach in response to the increase in production for
Variable costing (Direct Costing) a particular year and goes down when production goes
down. The reason for this effect can be traced to the
is a method of recording and reporting costs which
shifting of fixed manufacturing cost between periods
regards only the variable manufacturing costs as the
under the absorption costing method as explained
variable manufacturing costs as product costs. Fixed
below.
manufacturing costs are written off as period costs.
As to amount of inventory
Absorption Costing
Inventory value under absorption costing would be
Absorption costing (also known as full, traditional,
higher in amount than that under variable costing. The
conventional, and normal costing) is a method of
inventory amount would carry a portion of fixed
product costing in which all manufacturing costs, fixed
overhead incurred during the period under absorption
and variable, are treated as product or inventoriable
costing.
costs. This method is generally accepted for external
reporting purposes. Reconciliation of Net Income under Variable Costing
with Net Income under Absorption Costing
Comparison between Variable Costing and Absorption
Costing The reconciliation of the net income figures under the
two product costing methods may be done as follows:
As to treatment of the various operating costs
Net income, Absorption costing
VARIABLE COSTING
Add: Fixed overhead in ending inventory
• Product Costs Total
XCOSTMAN: PRELIMS
Less: Fixed overhead in ending inventory DIFFERENCE IN NET INCOME UNDER ABSORPTION
Net income, Variable costing
AND VARIABLE COSTING
PRODUCT COST COMPONENTS
Variable and absorption costing methods of
ABSORPTION COSTING VARIABLE COSTING accounting for fixed manufacturing overhead result
in different levels of net income in most cases. The
Direct Materials Direct Materials differences are timing difference, i.e., when to
recognize the fixed manufacturing overhead as an
+ Direct Labor + Direct Labor
expense. In variable costing, it is expensed during
+ Variable FOH + Variable FOH the period when the fixed overhead is incurred,
while in absorption costing, it is expensed in the
+ Fixed FOH Product Product Cost
period when the units to which such fixed overhead
Cost
has been related are sold.
DISTINCTIONS BETWEEN PERIOD COSTS AND PRODUCT PRODUCTION EQUALS SALES:
COSTS
When production is equal to sales, there is no
• PERIOD COSTS change in inventory. Fixed overhead expensed
1. Cost that is charged against current revenue under absorption costing equals fixed overhead
during a time period regardless of the expensed under variable costing. Therefore,
difference between production and sales absorption costing income equals variable costing
volume. income.
2. Does not form part of the cost of inventory.
3. Reduces income for the current period by its PRODUCTION IS GREATER THAN SALES:
full amount.
When production is greater than sales, there is an
• PRODUCT COSTS
increase in inventory. Fixed overhead expensed
1. Cost that is included in the computation of a
under absorption costing is less than fixed
product cost that is apportioned between the
overhead expensed under variable costing.
sold and unsold units.
Therefore, absorption income is less than variable
2. An inventoriable cost. The portion of the cost
costing income.
that has been allocated to the unsold unite
becomes part of the cost of inventory. ACCOUNTING FOR DIFFERENCE INCOME
3. Reduces current income by the portion allowed
Change in inventory (Production less Sales)
to the sold units.
x Fixed FOH cost per unit
PRINCIPAL DIFFERENCES BETWEEN ABSORPTION AND Difference in income
VARIABLE COSTING METHODS