Cost Terms, Concepts, and Classifications

Chapter

2

Prepared By:Subika Kaleem (BB-25063)Arsalan Javed (BB-25079)Anora Zfar (BB-25801)

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General Cost Classification

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Product Cost Versus Period Cost

Product cost It includes all the

costs that are involved in acquiring or making a product i.e direct materials,

direct labor, and manufacturing

overhead costs.

Period cost

It includes all the costs that are not

involved in the product cost. They

are expenses recorded in the

income statement period in which

they are incurred.

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Cost Classifications for Predicting Cost Behavior

how a cost will react to changes in the level of

business activity.Total variable costs

change when activity changes.

Total fixed costs remain unchanged when activity changes.

how a cost will react to changes in the level of

business activity.Total variable costs

change when activity changes.

Total fixed costs remain unchanged when activity changes.

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Total Variable CostA cost that varies in total in direct proportion to changes

in the level of activity.

example: Your total long distance telephone bill is based on how many minutes you talk.

Minutes Talked

Tot

al L

ong

Dis

tanc

eT

elep

hone

Bill

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Total Fixed Cost

Minutes Talked

Per

Min

ute

Tel

epho

ne C

harg

e

A cost that remains constant in total regardless of changes in the level of activity.

example: The cost per long distance minute talked is constant, i.e 10 cents per minute.

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Direct Costs and Indirect Costs

Direct costsCosts that can be

easily and conveniently traced to a unit of product or other cost objective.

Examples: direct material and direct labor

Indirect costsCosts cannot be easily

and conveniently traced to a unit of product or other cost object.

Example: manufacturing overhead

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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.

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

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Differential Costs and Revenues

Costs and revenues that differ among alternatives.

Differential revenue is: $2,000 – $1,500 = $500

Differential cost is:$300

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.

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.

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Opportunity Costs

The potential benefit that is given up when one alternative is selected over another.Example: If you werenot attending college,you could be earning$15,000 per year. Your opportunity costof attending college for one year is $15,000.

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Sunk Costs

Sunk costs cannot be changed by any decision. They are not differential costs and should be

ignored when making decisions.

Example: You bought an automobile 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.

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Thank You !!!