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Cost term, Concept &

Fakultas Program Studi Tatap Muka Kode MK Disusun Oleh

Economic & Business Accountancy 84033 Alfiandri, MAcc

Abstract Kompetensi
The term of cost used in some After completing this module, the
different ways. One of the reason is student should be able to
there are some type of cost and the 1. Understand cost concept and
cost classify differently rely on the classification
manager’s needs. Cost can be
mainly classified into three 2. Understand between product
categories direct material, direct cost and period cost
labor and manufacturing overhead. 3. Understand cost behavior i.e.,
Furthermore, the cost also reacts or variable cost, fixed costs and
responds to change in the level of mixed cost
business activity.
1. Introduction

The term of "cost" is used in different context (and by different individuals) with
different meanings. It is therefore useful to distinguish term of cost based on the
accountant's used with the economist's used. Accountants are concerned primarily with
the proper recording and measuring of historical costs based upon a uniform set of rules.
They have developed a comprehensive system of recording and reporting data about the
costs, which is used by managers, investors, regulators, and economists in carrying out
their respective jobs. The data, recorded in the books and records of a firm, are referred
to as "accounting". Accountants have developed various "cost accounting" rules
concerning how costs should be allocated to various categories. There are some types
of costs that occur in the firm business activities and the costs are classified differently
according to the manager’s needs. Module two is briefly explain about the cost concept,
cost classification and costs recognition.

Module two begins with cost concept which focuses on the manufacturing
companies. The reason select manufacture company that because they are involved in
the most of activities compare to other types of industry (Garrison & Noreen 2006).
Manufacture companies have more complex business activities than others industry.
Such acquires raw materials, producing finished goods, marketing, distributing are name
of few complexity of business activities in the manufacture companies. In addition,
understanding costs in the manufacture industry thus will help understand costs in others
sector industries i.e., service and trading industry

2. Cost Concept and Cost Classification

Cost defines broadly as the value of money that has been used up to produce
something and hence is not available for use anymore (
In the specific definition costs are monetary value of expenditures for supplies, services,
labor, products, equipment and other items purchased for used by business or other
accounting entity ( It is value which state in the invoices
as the prices and recorded in bookkeeping records as expenses or assets.

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Business activity in the manufacture industry is commonly related to make the products
that sell to the customers therefore the managers have to manage the cost used

The majority of manufacture companies divided cost into three categories direct
materials, direct labor and manufacturing overhead. Let’s define one by one.

2.1. Direct Material

The materials that go into the final product are called “raw materials”. Raw
materials refer to any materials that are used in the final product; and the finished
product of one company can become the raw materials of another company
(Garrison & Noreen 2006). For example, Ink which produced by a firm is used for
the company which produce the ballpoints or pen.
Raw material actually consists on direct material and indirect material. Direct
materials are those materials that become an integral part of the finished product
and that costs can be conveniently traced to the finished product (Garrison &
Noreen 2006). In simple understand direct materials are the materials or goods to
make the products. Indirect materials on the other hand are the materials involve
and as support tools to make the products, solder and glue for example. Indirect
materials are included as a part in the manufacturing overhead (Garrison & Noreen

2.2. Direct Labor

Direct labor consists of labor costs that can be easily (i.e., physically and
conveniently) traced to individual units of product (Garrison & Noreen 2006). Direct
labor can also call as “touch labor” which means the labor whose touch the product
is being made.
Indirect labor other hand is “untouched labor” and recognize in the manufacturing
overhead. Indirect labor is labor costs that cannot be physically traced to particular
products or that can be traced only at great cost and inconvenience (Garrison &
Noreen 2006). Indirect labor includes the labor costs of janitors, supervisors,
materials handlers, and night security guards. Although the efforts of these workers
are essential, it would be either impractical or impossible to accurately trace their
costs to specific units of product. Hence, such labor costs are treated as indirect
labor (Garrison & Noreen 2006).

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2.3. Manufacturing Overhead

Manufacturing overhead consists of indirect material and indirect labor. This

element of cost is not associated directly in the products. According to Garrison &
Noreen (2006), Manufacturing overhead includes the items such as indirect
materials; indirect labor; maintenance and repairs on production equipment; and
heat and light, property taxes, depreciation, and insurance on manufacturing
However, sometimes few costs above cannot consider as manufacturing
overhead, instead treat as non-manufacturing overhead. Such cost as heat and
light, property taxes, depreciation and insurance which are not associated with
operating in the factory, those are recognized as non-manufacturing overhead.
Various names are used for manufacturing overhead, such as indirect
manufacturing cost, factory overhead, and factory burden. All of these terms are
synonyms for manufacturing overhead (Garrison & Noreen 2006).

2.4. Non-Manufacturing Cost

Non-Manufacturing cost divided into two categories, selling cost and administrative
cost. Selling costs are the cost that incurred to secure customer orders and get the
finished product to the customer (Garrison & Noreen 2006). For example, travel
and accommodation, freight shipping and sales commission.
Administrative costs are the cost associated with general management of
organization (Garrison & Noreen 2006). For example, accounting and audit, bank
administrative charge, legal and public relation. Furthermore, the costs are not
associated with operating activities in making the product its recognize as non-
manufacturing cost.

Another cost classification can also be identified by distinguish between product costs
and periodic costs

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2.5. Product Cost

Logically speaking product costs are the costs are involved in making the product.
Therefore, direct material, direct labor and manufacturing overhead are cost of the
product. According to Garrison & Noreen (2006) Product costs “attach” to units of
product as the goods are purchased or manufactured, and they remain attached as
the goods go into inventory awaiting sale. In addition, product cost will consider as
expenses while the goods are sold and that is called as cost of goods sold (COGS)
which is the COGS will match again the revenue in the income statement.

2.6. Periodic Cost

Periodic costs are the cost which not included in the product costs. Therefore,
selling and administrative cost are periodic cost. According to Garrison & Noreen
(2006) Period costs are not included as part of the cost of either purchased or
manufactured goods; instead, period costs are expensed on the income statement
in the period in which they are incurred using the usual rules of accrual accounting.
As conclusion, all the cost in making the products (COGS) is not included in the
periodic cost.

2.7. Prime Cost and Conversion Cost

Prime cost is the sum of direct materials cost and direct labor cost. Conversion cost
is the sum of indirect labor cost and manufacturing overhead cost.

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3. Cost Classification on Financial Statement

The financial statements prepared by manufacturing company are more complex

than financial statement for merchandise company, this is because Manufacture
company produce its goods and market them, while merchandise company like retail
company for instance, received goods for its purchase and sale to the customers.
Furthermore, such costs in the process of production in the manufacture company must
take into account while Merchandise Companies do not. In addition, the cost recognition
in the balance sheet and income statement between those companies are little different.

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 Balance Sheet

YKS Manufacture Company

Balance Sheet

Current Assets
Petty Cash xxx
Bank xxx
Account Receivable xxx
Inventories : 285,000
Raw Material 60,000 50,000
Work In Process 90,000 60,000
Finished Goods 125,000 175,000
275,000 285,000
Prepayment xxx

Total Current Assets xxx

Fixed Assets
Land xxx
Building xxx
Acc. Depre - Building xxx
Equipment xxx
Acc. Depre - Equipment xxx
Vehicles xxx
Acc. Depre - Vehicles xxx

Total Fixed Assets xxx

Figure 2 Manufacture company balance sheets

Such costs occur in the process of production in the YKS manufacture company should
be reported therefore, raw material, work in process and finished good should be stated
in the balance sheet. Figure 2 shows the inventory reports beginning balance and ending
balance of three classes of inventory.

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Balance Sheet

Current Assets
Petty Cash xxx
Bank xxx
Account Receivable xxx
Inventories 100,000 150,000
Prepayment xxx

Total Current Assets xxx

Fixed Assets
Land xxx
Building xxx
Acc. Depre - Building xxx
Equipment xxx
Acc. Depre - Equipment xxx
Vehicles xxx
Acc. Depre - Vehicles xxx

Total Fixed Assets xxx

Figure 3 – Merchandise company balance sheet

In contrast with inventory account in the Effendy book store which states of entirely the
costs of books that the company purchased from publishers for resale to the public or
customers as depict in Figure 3.

 Income Statement
EFFENDY BOOK STORE YKS Manufacture Company
Income Statement Income Statement

Sales 1,000 Sales 1,500

Cost of Good Sold Cost of Good Sold
Beginning Balance (Inventory) 100 Beginning finished good (Inventory) 125
Purchase of Good 650 Cost of Good Manufactured 850
Goods available for sale 750 Goods available for sale 975
Ending Balance (Inventory) 150 Ending finished good (Inventory) 175
Total COGS 600 Total COGS 800
Total Revenue 400 Total Revenue 700
Less Operating Expenses Less Operating Expenses
Seeling Exp 100 Seeling Exp 250
Administrative Exp 200 300 Administrative Exp 300 550
Net Income 100 Net Income 150

Figure – 4 comparability income statement

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The basic formula to calculate the inventory is beginning balance adds purchase
(addition inventory), deducts withdrawals from inventory then finally ending balance is
earned. However, that formula can apply for merchandise company only, while
manufacture company must calculate “cost of good manufactured” firstly before state in
the balance sheet. That is to identify the cost in making the products. Figure 5 show the
calculation of cost of good manufacture

Cost of good manufacture

Direct Materials:
Beginning raw material 60
Purchase raw materials 400
Ending raw material 50
Raw material used in production 410

Direct labour 60

Manufature overhead:
Insurance, factory 6
Indirect labor 100
Machine rental 50
Utilities, factory 75
Supplies 21
Depreciation, factory 90
Property taxes 8
Total Overhead 350

Total manufacture cost 820

Beginning work in process 90
Ending work in process 60
Cost of good manufactured 850

Figure 5 – Cost of good manufacture

During business operational, it is commonly find how the cost will respond to change in the
activities. Responding costs is affected by rise and fall of level activities in operational and
that is named as “cost behavior”. Cost behavior refers to how a cost reacts to changes in the
level of activity. As the activity level rises and falls, a particular cost may rise and fall as
well—or it may remain constant (Garrison & Noreen 2006). It is commonly find at planning
stage, the managers should be able to estimates the costs in making the products. In order
to estimates the costs, therefore, cost can be categorized by variable cost, fixed cost and
mixed cost.

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 Variable Cost

A cost to be variable, it must be variable with respect to something. That is “something

its activity based. An activity base is a measure of whatever causes the incurrence of a
variable cost (Garrison & Noreen 2006). Frankly speaking, variable cost is the cost
affected by others. For examples, cost of goods sold for a merchandising company,
direct materials, direct labor, selling expenses and administrative expenses

 Fixed Cost

A fixed cost is a cost that remains constant even though raise and fall of level of activity.
For example, rent, insurance, salaries, straight-line depreciation and advertising. Unlike
variable cost, fixed costs are not affected by change in activity unless its affected by
extraordinary circumstances from outside such as rent building increase due to increase
living cost cause economic problem of the country.

Figure 6 – Variable cost and Fixed cost

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 Mixed Cost
Mixed cost in the combination both variable cost and fixed cost. Mixed cost is well known
as semi variable cost. Mixed cost can be expressed in the equation form as,

Y = a + bX

Y = The total mixed cost

a = The total fixed cost (the vertical intercept of the line)
b = The variable cost per unit of activity (the slope of the line)
X = The level of activity

For example, Nooksack Expeditions, a small company that provides daylong whitewater
rafting excursions on rivers in the North Cascade Mountains. The company provides all
of the necessary equipment and experienced guides. According to rules and regulation
in the US, each expedition companies include Nooksack Expedition should pay license
fee of $25.000 per year plus $3 per rafting party to the State’s Department of Natural
Resources. Assuming the company runs 800 rafting parties this year therefore, the total
feed should pay about $ 27.400 which consist $ 25.000 is fixed cost and $ 3.00 is
variable cost, the calculation can see below:

Y = a + bX

Y = 25.000 + (3.00 rafting party x 800 rafting parties)

= $ 27.400

In case that the company fails to attract customer, the company have to still pay $
25.000 as fixed cost but do not have to pay variable cost.

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Daftar Pustaka
Garrison, R.H. 2006. Managerial Accounting. Edisi 11. Penerbit Salemba Empat. Jakarta.

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