SU 1.5 Cost Classification

Manufacturing Capacity - Ideal Capacity

Also called theoretical capacity, is the maximum capacity assuming continuous operations with no holidays, downtime, etc.

By-products

Are products of relatively small total value that are produced simultaneously from a common manufacturing process with products of greater value and quantity (joint products). Initial refinement of crude oil to kerosene produced a residual that became gasoline.

Avoidable vs. Committed Costs

Avoidable costs are those that may be eliminated by not engaging in an activity or by performing it more efficiently. An example is direct materials cost, which can be saved by ceasing production. Committed costs are those that arise from holding property, plant and equipment. They are by nature, long-term and cannot be reduced by lowering the short-term level of production.

Rework

Consists of end products that do not meet standards of salability but can be brought to salable condition with addition effort. The decision to rework or discard is based on whether the marginal revenue to be gained from selling the reworked units exceeds the marginal cost of performing the rework.

Controllable Costs vs. Noncontrollable Costs

Controllable costs are those under the discretion of a particular manager. Noncontrollable costs are those to which another level of the organization has committed, removing the manager;s decision. In other words controllability is determined at different levels of the organization, i.e. is it not inherent in the nature of a given cost. A piece of equipment may be controllable at the division level but uncontrollable at the plant level.

Imputed Costs

Costs that should be involved in decision making even though no transaction has occurred that would be routinely recognized in the accounts. They are a type of opportunity cost - example is the profit lost as a result of not being able to fill orders because inventory is too low.

Split-Off Point

Often manufacturing processes involve processing a single input up to the point at which multiple end products become separately identifiable.

Outlay vs. Opportunity Costs

Outlay costs require cash disbursements (also called out-of-pocket or explicit costs). Example is tuition paid to attend college. Opportunity costs is the maximum benefit forgone by using scarce resource for a given purpose and not the for the next-best alternative (also called implicit cost). Example is wages forgone from attending college.

Relevant vs. Sunk Costs

Relevant costs are those future costs that will vary depending the action taken. All other costs are assumed to be constant and thus have no effect the decision. Sunk costs are those either already paid or irrevocably committed to incur. Because they are unavoidable and will therefore not vary with the option chosen, they are not relevant to future decisions.

Waste

consists of raw material left over from the production cycle for which there is no further use.

Scrap

consists of the raw material left over from the production cycle but still usable for purposes other than those for which it was originally intended.

Historical Cost

is the actual (explicit) price paid for an asset, heavily relied upon by financial accountants for balance sheet reporting; management accountants often find other (implicit) costs to be more useful in decision making because historical costs are essentially sunk costs.

Manufacturing Capacity - Normal Capacity

is the long term average level of activity that will approximate demand over a period that includes seasonal, cyclical, and trend variations. Deviations in a given year will be offset in subsequent years.

Manufacturing Capacity - Practical Capacity

is the maximum level at which output is produced efficiently. It allows for unavoidable delays in production for maintenance, holidays, etc. Use of practical capacity as a denominator value usually results in under-applied OH because it always exceeds the actual level of use.

Engineered vs. Discretionary Costs

Engineered costs are those having a direct, observable, quantifiable cause-and-effect relationship between the level of output and the quantity of resources consumed (i.e. direct materials and labor) Discretionary costs are those characterized by an uncertainty in the degree of causation between the level of output and the quantity of resources consumed. They tend to be the subject of a periodic (annual) outlay decision. (i.e. advertising or R&D expenses)

Incremental vs. Differential Costs

Incremental cost is the addition cost inherent in a given decision. Differential cost is the difference in total cost between two decisions. Example: a company must decide between two new product lines: The incremental choice of the first option in the initial investment of $1.5M the incremental choice of the second option in the initial investment of $1.8M. The differential cost of the two choices is $300K

Joint vs. Separable Costs

Joint costs are those costs incurred before the split-off point (since they are not traceable to the end products, they must be allocated). Separable costs are those incurred beyond the split-off point (at the point where separate products become identifiable).

Normal vs. Abnormal Spoilage

Normal spoilage is the spoilage that occurs under normal operating conditions. It is essentially uncontrollable in the short run. Since normal spoilage is expected under efficient operations, it is treated as a product cost and incorporated into COGS. Abnormal spoilage is spoilage that is not expected to occur under normal, efficient operating conditions. The cost of abnormal spoilage should be separately identified and reported to management. Typically treated as a period cost because of its unusual nature.

Economic Costs

The sum of implicit and explicit costs

Value-adding Costs

are the costs of activities that cannot be eliminated without reducing the quality, responsiveness, or quantity of the output required by a customer or the organization.

Carrying Costs

are the costs of storing or holding inventory. Examples include the cost of capital, insurance, warehousing, breakage and obsolescence.

Transferred-in Costs

are those incurred in a preceding department and received in a subsequent department in a multi-departmental production setting.