11/19/2009

Cost Classifications Costs Classification by Relevance

• If costs influence a decision

• Costs that are applicable to a particular decision.
• Relevance Relevant • Costs that should have a bearing on which
alternative a manager selects.
Costs • Behavior • Costs that are avoidable.
• Future costs that differ between alternatives.
• Controllability
can be • Traceability
classified • Function
by: • Time
Irrelevant • If costs do not influence a decision

Costs Classification by Relevance Costs Classification by Relevance

Sunk Costs (Historical Cost) Out-of-pocket costs

• All costs incurred in the past that cannot be
changed by any decision made now or in the
future.
• should not be considered in decisions.
• Irrelevant
• Example: You bought an automobile that cost
Rs.30,000 two years ago. The Rs.30,000 cost is
sunk because whether you drive it, park it, trade it,
or sell it, you cannot change the Rs.30,000 cost.
• require future outlays of cash
• associated with a particular decision
• relevant for future decisions
• Example: Considering the decision to take
a vacation or stay at home, if you choose a
vacation, you will only have travel costs
(out-of-pocket costs), labour cost, material
cost etc..

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Costs Classification by Relevance
Opportunity Costs
• The potential benefit that is given up
when one alternative is selected over
another.
• Example: If you were not attending
college or university, you could be
earning Rs.25,000 per year. Your
opportunity cost of attending college or
university for one year is Rs.25,000.
Costs Classification by Controllability
Controllable vs. not controllable
• depends upon the employee’s
responsibilities.
• Example: A lower level manager may
have control over overtime costs but
not over the purchase of high-cost
machinery.
11/19/2009
Costs Classification by Behavior or by
Variability
Cost behavior refers to
• how a cost will react to changes in the level of
business activity.
Fixed costs
• do not change when activity changes e.g.
factory rent.
Variable costs
• change in proportion to changes in the
volume of activity e.g. material costs
Semi Variable costs – Partly Fixed
and partly Variable e.g. telephone
charges
Example of controllable and non
controllable cost
For example, certain advertising spent
specifically for a given department
would be an expense controllable by
the manager of that department.
Advertising expenses that benefit
many departments or products are,
however, non controllable cost .
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Costs Classification by traceability Costs Classification by Function

• Direct Cost • Manufacturing Costs

- that can be traceable directly e.g. – are necessary and integral to the production
of finished goods.
direct wages – Examples: direct labour, direct materials, and
• Indirect Cost manufacturing overhead.
- that cannot be directly traceable e.g. • Non
Non--Manufacturing Costs
– are not integral to the manufacture of finished
Factory rent goods.
– Examples: selling and administrative
expenses.

Costs Classification by Function Cost classification by time

• Non-Manufacturing costs (period costs) • Historical Cost
are expenses not charged to the product. - ascertained after being occurred
– Selling Costs - has already been done
• Costs incurred to obtain customer orders and to
deliver finished goods to customers —advertising • Predetermined Cost
and shipping. - Estimated cost
– Administrative Costs
- Helps to control the cost
• Non-manufacturing costs of staff support and
administrative functions —accounting, data
processing, personnel, research and development.