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Classifying Costs
 By Behavior
 Fixed
 Variable
 By Traceability
 Direct
 Indirect
 By Function
Product
Period
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Cost Classifications Click

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by Behavior

Cost Behavior
How a cost will react to
changes in the level of business activity.

 Total variable costs change

when the level of activity changes.
 Total fixed costs remain unchanged
when the level of activity changes.
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Total Variable Cost

A variable cost is one that changes in total
in proportion to changes in the volume of activity.

Your total long distance telephone bill

is based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
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Variable Cost Per Unit

On a per unit basis, a variable cost
remains constant over a wide range of activity.

The cost per long distance minute talked is constant.

For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
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Total Fixed Cost

A fixed cost is one that remains constant in total
even when the volume of activity changes.

Your monthly basic telephone bill probably does not

change when you make more local calls.
Telephone Bill
Monthly Basic

Number of Local Calls

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Fixed Cost Per Unit

On a per unit basis, a fixed cost changes
as the volume of activity changes.
The average cost per local call decreases
as more local calls are made.

Telephone Bill per

Monthly Basic

Local Call
Number of Local
Calls
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Cost Classifications for Click

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Predicting Cost Behavior

Behavior of Cost (within the relevant range)
Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
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Classification of Costs Click

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by Traceability
Direct Costs Indirect Costs
 Costs that can  Costs cannot
be easily and be easily and
conveniently traced conveniently traced
to a unit of product or to a unit of product or
other cost objective. other cost objective.
 Examples:  Example:
 Direct material  Manufacturing
 Direct labor
overhead
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Classification of Costs by Function

Product Costs Period Costs

 Direct materials  Selling
 Direct labor  General and
 Overhead
administrative
expenses
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Comparing Merchandising Click

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and Manufacturing Activities

Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

MegaLoMart
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Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product
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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 an automobile

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Direct Labor
Those labor costs that can be easily traced
to individual units of product.

Example: Wages paid to automobile assembly workers

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Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect labor and indirect materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production.
Examples:
Examples: lubricants and cleaning
maintenance workers, supplies used in the
janitors and security guards. automobile assembly plant.
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Balance Sheet

Merchandiser Manufacturer
Current Assets: Current Assets:
 Cash  Cash
 Receivables  Receivables
 Prepaid expenses  Prepaid Expenses
 Merchandise  Inventories
inventory Raw Materials
Work in Process
Finished Goods
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The Income Statement

Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.
Merchandising Company Manufacturing Company
Cost of goods sold: Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Cost of merch. + Cost of goods
purchased 234,150 manufactured 234,150
Goods available Goods available
for sale $ 248,350 for sale $ 248,350
- Ending
- Ending
merchandise
finished goods
inventory (12,100)
inventory (12,100)
= Cost of goods
sold $ 236,250
= Cost of goods
sold $ 236,250
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Manufacturing Cost Flows

Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Selling and

Period
Administrative Administrative
Costs Expenses
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Product Costs – Raw Materials

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Manufacturing Work
Raw Materials Costs In Process

Beginning raw
materials inventory

Beginning inventory
is the inventory
carried over from
the prior period.
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Product Costs – Direct Materials

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Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
– Ending raw materials
inventory As items are removed from
= Direct materials used
raw materials inventory
and placed into the
production process,
they are called direct materials.
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Product Costs –
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Total Manufacturing Costs

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Conversion

materials inventory + Direct labor costs are costs
+ Raw materials + Mfg. overhead
purchased = Total manufacturing
incurred to
= Raw materials costs convert the
available for use direct material
– Ending raw materials
inventory
into a finished
= Direct materials used product.
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Product Costs – Goods in Process

Here

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Total manufacturing

materials inventory + Direct labor costs
+ Raw materials + Mfg. overhead + Beginning work in
purchased = Total manufacturing process inventory
= Raw materials costs = Total work in
available for use process
– Ending raw materials
inventory
= Direct materials used All manufacturing costs incurred
during the period are added to
the beginning balance of
work in process.
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Product Costs –
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Cost of Goods Manufactured

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Total manufacturing

materials inventory + Direct labor costs
+ Raw materials + Mfg. overhead + Beginning work in
purchased = Total manufacturing process inventory
= Raw materials costs = Total work in
available for use process
– Ending raw materials – Ending work in
inventory process inventory
= Direct materials
Costs associatedused
with the goods that = Cost of goods
manufactured
are completed during the period are
transferred to finished goods
inventory.
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Product Costs – Cost of Goods Sold

Work
In Process Finished Goods

Total manufacturing Beginning finished

costs goods inventory
+ Beginning work in + Cost of goods
process inventory manufactured
= Total work in = Cost of goods
process available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of
manufactured goods sold