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Classification of Manufacturing Costs and Expenses-list of expense types

Management Accounting | 51
Classification of Manufacturing Costs and Expenses
Management accounting, as previously explained, consists primarily of planning,
performance evaluation, and decisionmaking models useful to management in
making better decisions. In every case, these tools require cost and revenue infor
mation. A basic assumption of management accounting is that it is the responsibility
of the management accountant to provide the needed cost and revenue information.
Consequently, the management accountant needs a complete understanding of the
different types of costs required by the various models. In Figure 4.1, the major costs
associated with each management accounting tool is listed.
In management accounting, as in financial accounting, it may be said that a major
building block in the conceptual foundation is cost. Both the financial and manage
ment accountant must have a sound understanding of the varied and complex rami
fications of cost. From a financial accounting viewpoint, a faulty understanding of
cost may cause financial statements to be incorrectly prepared. From a management
accounting viewpoint, an inadequate understanding or use of costs will result in poor
There are two broad aspect of the term cost that needs to be understood: cost
classification and cost behavior. Cost classification refers to the separation of costs
into categories for proper preparation of financial statements or for use in deci
sionmaking models. Cost behavior refers to the effect that volume (production or
sales ) has on total expenses or costs. In this chapter, both aspects will be discussed
in some depth.
52 | CHAPTER FOUR ? Classification of Manufacturing Costs and Expenses
Cost Classification
In accounting, the term cost refers to the expenditure or sacrifice made to acquire
something of value. In financial accounting, all transactions are recorded in terms
of historical cost; that is, the money expended or to be expended at the date of the
transaction. The monetary value associated with an asset acquired is said to be its
cost. Cost is the sacrifice made in resources to acquire another resource. Cost is
measured in monetary units which in the United States is the dollar. For example, a
machine is purchased by paying $4,000 in cash and trading in an old machine having
a sales value of $1,000. The cost of the new machine is $5,000 because resources
worth a total of $5,000 were given in the exchange. Stated differently, resources
worth $5,000 were sacrificed.
Figure 4.1
Tools Cost Information Required
Flexible Budget Fixed and variable costs
Costvolumeprofit analysis Fixed and variable costs
Direct costing Fixed and variable costs
Budgeting Planned data, fixed and variable costs
Variance analysis Fixed and variable costs
Incremental analysis Escapable , opportunity, relevant
Segmental reporting Indirect costs, direct costs
Inventory models Purchasing cost, carrying cost
Present value models Cash inflows, cash outflows
Depending on the type of activity and the passage of time, the cost of an asset in
accounting can be classified in several ways. Proper financial reporting and correct
decisionmaking require an understanding of the different ways in which costs can
be classified. In Figure 4.2 is a list of costs that pertain to both financial statement
preparation and decisionmaking analysis.
For purposes of management accounting, there are three important dual classifica
tions of cost that require some understanding: Expired and unexpired, manufacturing
and non manufacturing, and fixed and variable. These three classifications are
somewhat interrelated, particularly concerning financial statements.
Expired and Unexpired Costs
Expired costs or expenses are the used up value of assets. Expired costs are
always shown on the income statement as deductions from revenue. Expired costs
may be thought of as that portion of the asset value benefitting current operations.
It is helpful to think of expired costs as former assets values. To illustrate, supplies
expense is an expired cost. The cost allocated to supplies expense, of course, is
the used portion of supplies, an asset. The relationship between asset values and
expired costs is further illustrated in Figure 4.3.
Management Accounting | 53
Figure 4.2
Financial Statements Cost Concepts Management Accounting Cost Concepts
(Decisionmaking Cost Concepts)
Direct and indirect Relevant and irrelevant
Prime Escapable and inescapable
Joint Sunk
Fixed and variable Fixed and variable
Manufacturing and non manufacturing Opportunity and sunk
Expired and unexpired Incremental
Expenses Direct and indirect
Fixed and variable expenses Mixed, semi-variable
Carrying cost, purchasing cost
Manufacturing Costs/Expenses
The difference between a cost and an expense is frequently misunderstood.
Because the terms variable costs and variable expenses will be used later in this
chapter, and also throughout this book, the difference in meaning between a cost and
a expense will now be clarified.
Technically, there is a difference between a manufacturing cost and a manufac
turing expense. The term manufacturing costs usually refers to material used, direct
labor incurred, and overhead incurred in a manufacturing business. Material used,
direct labor, and manufacturing overhead at the time incurred are not expenses; rather
they incurred costs. In the manufacturing process, material, labor, and overhead do
not expire; rather through manufacturing activity they become transformed from one
type of utility to another.
In a manufacturing business, the accountant will debit work in process for mate
rials used, direct labor incurred, and manufacturing overhead. Since work in process
is an asset account, it would not be logical to regard material used, direct labor, and
manufacturing overhead as expenses. Expenses cannot be transformed back into
asset values.
Figure 4.3
Asset Values and Related Expenses
Asset Expired
Accounts receivable Bad debts expense
Finished goods Cost of goods sold
Prepaid insurance Insurance expense
Supplies Supplies expense
Building Depreciation
Manufacturing costs, however, do eventually become manufacturing expenses
Material used, direct labor incurred, and manufacturing overhead are first recorded

What are expense categories? What are three major types of expenses? Fixed expenses are those that don’t change for the foreseeable future. These can include auto lease payments or rent. Variable expenses are expenses such as utilities, which can change from month to month. Periodic expenses are ones that happen occasionally, like business travel or emergency car repairs.