Cost Classification in Management Accounting

Cost Classification

• Cost is always modified by context (fixed, variable, sunk, etc.).
• Classification of costs depends on the purpose of the analysis.
• Costs can be classified based on management function, traceability, timing of charge against revenue, accounting period, and relevance to decision-making.

Management Function

• Manufacturing costs are incurred in the factory to convert raw materials into finished goods.
  • They include direct materials, direct labor, and factory overhead.
• Non-manufacturing costs are incurred outside the factory.
  • They include selling expenses (advertising, delivery, salaries, commissions) and administrative expenses (salaries of executives, legal expenses).

Traceability

• Direct costs can be traced directly to a specific product, department, or branch (e.g., materials, direct labor).
• Indirect costs cannot be traced directly to a specific cost object (e.g., factory overhead, operating costs).

Timing of Charge Against Revenue

• Product costs are part of inventory and charged against revenue when the product is sold (e.g., direct materials, direct labor, factory overhead).
• Period costs are not inventoriable and are expensed in the period they are incurred (e.g., selling expenses, administrative expenses).

Accounting Period-Wise Classification

• Capital expenditure results in the acquisition, extension, or enhancement of an asset (e.g., acquiring land, building, machinery).
• Revenue expenditure maintains assets in working condition and is not intended to increase revenue-earning capacity (e.g., repairs, maintenance).

Relevance to Decision-Making

• Overhead cost represents ongoing business expenses not related to direct labor or materials (e.g., rent, utilities, insurance).
• Standard cost is a predetermined cost based on past experience, budgeted amounts, or industry standards.
• Opportunity cost is the benefit forgone when choosing one alternative over another (e.g., choosing to use a building for production instead of renting it out).
• Sunk costs are historical costs that are irrelevant to decision-making (e.g., acquisition cost of equipment, manufacturing costs of finished goods).
• Committed costs arise from an organization's structure or facility use (e.g., property taxes, management salaries, rent).
• Discretionary costs arise from management decisions on spending for specific purposes (e.g., research and development, charitable contributions, advertising).
• Controllable costs can be influenced or controlled by a supervisor or manager within a given period.

Variable Costs

• Variable costs change proportionally with activity levels.
• Formula for Total Variable Cost: TVC = Production in units x Variable cost per unit.
• In the given example, the variable cost per unit remains consistent at P14.00, but the total variable cost increases as production of each perfume line increases.

Mixed Costs

• Mixed costs contain both fixed and variable components.
• Formula for Variable cost per unit: Change in cost / Change in activity.
• Formula for Variable Cost: Highest or lowest level of activity x Variable cost per unit
• Formula for Fixed Cost: Highest or lowest costs - Variable cost at each level of activity.

Inventory Accounts

• Raw Materials Inventory represents available raw materials for manufacturing processes.
• Work-in-Process Inventory reflects costs of partially completed goods.
• Finished Goods Inventory summarizes costs of completed goods stored for sale.

Raw Materials Inventory System

• Perpetual Inventory System maintains stock cards or records for each raw material, tracking inflow, outflow, and balance in both quantity and peso amount.

Normal Costing System

• Normal costing charges direct materials and direct labor to the job.
• Predetermined overhead rate is used to apply overhead to production.
• Formula for Normal Cost: Predetermined overhead rate x Actual direct labor hours utilized.
• The predetermined overhead rate is calculated by dividing estimated total overhead by estimated total cost driver.
• Formula for Predetermined Overhead Rate: Budgeted manufacturing overhead / Budgeted production activity.