ADVANCED MANAGEMENT ACCOUNTING

“An Introduction to Cost Terms and Concepts”

Dosen Pengampu: Ni Putu Sri Harta Mimba, SE.,M.Si.,Ph.D.,Ak,CA,CMA

KELOMPOK 2 :

1. Ayu Intan Sari (05)

2. Anak Agung Made Oka Wilantara (07)
3. Ni Putu Ayu Sintya Artha Dewi (24)

PROGRAM STUDI MAGISTER AKUNTANSI

FAKULTAS PASCASARJANA
UNIVERSITAS UDAYANA
2023
Cost Terms and Concepts

The Concepts of Cost

Cost reflects a monetary measure of the resources given up to attain some objectives such as
acquiring a good or service. Cost is a monetary measure of the amount of resources used for a
cost object. So, a cost object or objectives is an objective where cost is measured i.e., it is an
activity or item for which a separate measurement of cost is desired. Broadly speaking cost is
the amount measured by the current monetary value of economic resources given up or to be
given up in obtaining goods and services. Economic resources may be given up by
transferring cash or other property, issuing capital stock, performing services, or increasing
liabilities. From the above definition, it will be clear that three ideas are included in the
concept of cost.

First, the most basic nation is that cost measures the use of resources. The resources used in
producing tangible goods or intangible services are physical quantities of material, hours of
labour services and quantities of other services.

Second, cost measurement is expressed in monetary terms. Money provides a common

denominator that permits the number of resources, each measured according to its own scale
(kilograms of materials, hours of labour) to be aggregated so that the total amount of
resources used can be determined.

Third, cost measurement is always related to a purpose, that is, to a cost object. A cost object
is an activity or resource for which a separate measurement of costs is desired. A cost object
can be a thing, such as a product or asset, it can be the provision of a service, it can be
segment, such as parquet centre, a department, or other organizational unit, it can be the
conduct of a programme or it can be the operation of an entity.

Costs, Expenses and Losses: It is important to distinguish costs, expenses, and losses. But
before that it is necessary to understand what and asset is Normally a cost is viewed as an
asset if it can be shown that it has future service potential that can be identified. For example,
prepayment of insurance premium. Now as we have already understood a cost is the value of
assets given up, or to be given up, to acquire other assets, i.e. cost is a sacrifice of resources.
Expenses are costs that are applicable to the current accounting period. Expenses in its
broadest sense includes all expired costs, i.e. costs which do not have any potential future
economic benefit. The term expense is the cost of services or benefits received, or resources
consumed during an accounting period.

The term "cost is not synonymous with expense". Expense means a decrease in owners’
equity that arises from the operation of a business during a specified accounting period,
whereas cost means any monetary sacrifice whether or not the sacrifice affects the owners
equity during a given accounting period. Example, cost of goods sold and selling and
distribution expenses. A loss is an unplanned cost expiration and for these reasons is often
included in the broad definition of expense. When assets are given up for nothing in return,
the value of the assets given up becomes a loss. A more precise definition restricts the use of
the term loss, stating that the cost expiration which does not benefit the revenue producing
activities of a firm. Examples, unrecovered book value on the sale of fixed assets, the write-
off goodwill, carelessly destroyed supplies etc.

General Cost Classification

Classification of costs is the process by which costs are grouped according to some common
characteristics. Classification is the arrangement of cost items in logical groups having regard
to their nature (subjective classification) or purpose (objective classification) to be achieved
and requirement of an organizations. Subjective classification is used to indicate the nature of
the expenditure, for example, material, labour; whereas objective classification indicates the
cost centre or cost unit where the costs are to be charged. Cost classifications are needed for
the development of cost data and each classification throws light on the different aspects of
the decision-making process. In this lesson, cost classifications are used to define costs in
terms of their relationships to the following items:

 natural characteristics.

 changes in the volume/levels of activity.

 tractability of the product.

 association with product or period.

 the nature of functions.

 relation with accounting period.

 the time of cost determination.

 the nature of data.

 the nature of prediction.

 the management policies.

 Managers' relevancy of decision making and analysis.

1. Classification of Cost According to Natural Characteristics: According to this

classification, costs are divided into three categories; i.e. Material, labour and other
costs.

 Material: Material is rated as the first element of cost because without material to
work upon nothing can be manufactured. Conversion of material in the production
process increases the utility of the finished product. Material can be divided as (a)
direct material and (b) indirect material.

Industry/Product Direct material Indirect material

Garments industry - Shirt Cloths Thread, Button

Cloth Industry - Cloth Yarn, Cotton Colour, Starch

Jute industry - Sack Cloth Jute Baching oil.

 Labour: Labor is considered as the second element of cost because without labour the
form, shape or nature of material cannot be changed to increase its usefulness. This
cost can also be of two types, direct labour and indirect labour.

Wage which can be economically traced to the output is known as direct labour and
on the other hand, salaries paid to supervisor, cleaner, guard and production manager
are treated as indirect labour/wages.

 Other Costs: All other manufacturing costs are classified as the third elements i.e.
other costs, because, unless certain other costs are incurred, material cannot be
worked upon by labour. Examples of this types of costs include tools must be
supplied, supervision must be exercised, machinery must be maintained, a place of
work must be furnished to make possible labours work upon the raw material
furnished.
Classification of costs according to natural characteristics is important because it is
necessary to know the cost of each element that enters into a product to answer to the
questions relating to stock valuation, decision making, and controlling the
organisation’s activities.

2. Classification according to changes in the volume/levels of activity:

Within a period, a particular cost may be observed changing with corresponding
changes in some measures of activity. Hence, costs are classified according to their
behaviour in relation to changes in the volume of output (production), which others, as
they are incurred in relation to time, remain more less fixed in amount.

On this basis, costs are classified into the four categories, viz., fixed, variable, semi-
fixed and semi-variable:

 Fixed Costs: A cost that is not immediately affected by changes in the cost driver.
Activities that affect costs are often called cost driver. A fixed cost is that which tends
to remain unchanged despite often wide changes in output or activity. On a per unit
basis, a fixed cost varies inversely with changes in the level of activity. This means
that the per unit fixed cost decreases with increase in the activity level, and increases
with decrease in the activity level. The rent of buildings of an organization,
supervisor’s salaries, taxes on real estate, maintenance and repairs of buildings and
grounds, depreciation (other than that computed under the units of production
method), insurance are good examples of fixed costs. Fixed costs are sometimes
termed as "capacity cost" because fixed costs are generally incurred to create
facilities.

Illustrates the behaviour of fixed cost found in the following tabulation of

fixed cost Table # 2.1

Activity (or Cost driver) Fixed Cost per unit Total Fixed Cost
(Tk.) (Tk.)
10 2,500 25,000
20 1,250 25,000
100 250 25,000
110 227.27 25,000
200 125 25,000
210 119.05 25,000
300 83.33* 25,000
*Rounded

Total Fixed Cost

Tk.25000

Activity
50 100 150 200 250 300 (or cost driver)
Exhibit 2.1 (A): Graph of total fixed cost

Unit fixed cost

2,500

2,000

1,500

1,000

500

Activity
50 100 150 200 250 300 (or cost driver)
Exhibit 2.1 (b) : Graph of unit fixed cost.

The graph illustrates that total fixed cost remains unchanged irrespective of whether
activity changes. When activity doubles or triples, from 100 to 200 to 300, total fixed
cost remains constant at Tk.25,000. However, the fixed cost per unit does change
level as activity changes. If activity level is 20 units, then the fixed cost per unit
declines to Tk.1,250 and Tk.250 respectively.
Algebraically, a fixed cost graphs is represented by : y = a, where; 'y' is the total cost
and 'a' is the fixed cost.

 Variable Costs: A cost that changes in direct proportion to changes in the cost driver.
A cost that varies in total in direct proportion to changes in activity levels, a variable
cost must be a constant amount per unit. The cost of raw materials, wages, sales
commission, use of machine on rental basis are the good examples of variable costs.
Thus, as activity changes, total variable cost increases or decreases proportionately
with the activity changes, but unit variable cost remains the same.

Exhibit 2.2: Illustrates the behaviour of variable cost found in the following
Tabulation of variable cost Table # 2.2.

Activity (or Cost driver) Variable Cost per unit Total Variable Cost
(Tk.) (Tk.)
100 10 1,000
200 10 2,000
300 10 3,000
400 10 4,000
500 10 5,000
600 10 6,000
700 10 7,000
Total variable Cost
8000

7000

6000

5000

4000

3000

2000

1000

0 100 200 300 400 500 600 700 800 Activity

(or Cost driver)

Exhibit 2.2: Graph of total variable cost

The graph illustrates that total variable cost increases proportionately with activity.
When activity doubles from 100 to 200 units, total variable cost doubles, from
Tk.1,000 to Tk.2,000 and so on. However, the variable cost per unit remains the same
as activity changes. The variable cost associated with each unit of activity is Tk.10
whether the activity level is 100 units, 400 units or 700 units.

Algebraically, a variable cost line in the graph is represented by : y = bx where; 'y' is

the total cost

'b' is variable cost per unit; and

'x' is the number of units of output.

 Mixed Cost: A mixed cost is a semi-variable cost (sometimes known as a semi-fixed

cost) that has both a fixed and variable element to it. So a mixed cost has both a
variable and a fixed component. On a per unit basis, a mixed cost does not fluctuate in
direct proportion with changes in activity nor remains constant with changes in
activity. Telephone cost is an example of a mixed or semi-variable cost. This is so
because it has a fixed rental charge and a varaiable cost per unit of telephone time
used per call. This means that the total telephone cost is a mixture of fixed and
variable costs. Another good example of a mixed cost is electricity that is computed
as a flat charge (the fixed component) for basic service plus a stated rate for each
kilowatt-hour of electricity used (the variable component).
The graph illustrates the electricity charge of a company, which consists of a flat rate
of Tk.500 per month plus Tk.0.010 per Kwh. If the company uses 80,000 Kwhs of
electricity per month, its total electricity bill is Tk.1,300 [Tk.500 + (Tk.0.010 x
80,000]. If 90,000 Kwhs are used, the electricity bill is Tk.1,400. The distance
between the fixed cost line and the total cost line in Exhibit is the amount of variable
cost. The slope of the total cost line is the variable cost per unit of activity.
Algebraically, a mixed cost (semi-variable) graph is represented by; y = a
+ bx
where; 'y' is the total cost
'a' is the fixed cost value
'b' is the variable cost per unit, and 'x' is the number of units of output

 Step Cost: A step cost is so called because the cost increases in steps (or jumps) such
that over one range of output the cost remains fixed. A step can be variable or fixed.
Step variable costs have small steps and step fixed costs have large steps. For
example; canteen staff wages. The costs are fixed upto a certain level of output but
beyond that level as the number of workers increases to meet the increased production
an additional member of canteen staff is required to cater the needs of additional
workers resulting in a change in canteen staff wages. If steps are narrow and small the
behaviour pattern approximate pure variable cost pattern [Exhibit 2.4 (A)] is termed
as step-variable costs. One the otherhand, if the steps are wider, the step cost is termed
as 'step fixed cost'. [Exhibit 2.4 (B)]

When step variable or step fixed costs exist, the accountants must choose a specific
relevant range of activity that will allow step variable cost to be treated as variable
and step fixed costs to be treated as fixed.
3. Classification according to traceability to the product
Cost control is facilitated by tracing costs to the department or work center in which the
cost was incurred. It is usually possible to determine the cost of raw materials, labour
inputs with production of each unit. Other items cannot be easily and accurately
separated and attributed to individual units of output. For the purpose of traceability of
costs to product, costs are classified as either direct or indirect.
 Direct Cost: Direct costs are those which are incurred for a particular cost unit, and
can be conveniently linked with that particular cost unit. Direct costs are those
incurred primarily for, and which can be identified as part of the cost of a given
product. So once the cost object is specified, any costs that are distinctly traceable to
it are called direct costs. Examples of direct costs include cost of direct material,
direct labour, direct charges (special tool used for product) etc.
 Indirect Cost: Indirect costs are those of a more general nature which cannot be
identified primarily as part of the cost of a given product but without which the
product could not be manufactured. So these costs that can not be traced are called
indirect or common costs and are allocated or assigned to the cost object using one on
more appropriate predictions or arbitrarily chosen bases. Examples of indirect costs
include supervisors' salary, rent, rates and taxes, lighting etc.
The build-up of total cost showing how direct and indirect costs are related is shown
in the following figure:
Note: the term Factory or works cost is the same as the 'production cost' or 'cost of
goods manufactured and the term production overhead/indirect cost is the same as
'Factory Overhead'.
The distinction between direct costs and indirect costs depends upon the unit under
consideration. This is important because it provides the medium for charging costs to
different classes of production. It should be mentioned that direct costs are
controllable costs for various responsibility centers and indirect costs are not
controllable.
4. Classification according to association with product of period: An important issue in
both managerial and financial accounting is the timing with which the costs and services
are recognized as expenses. Costs are also classified by time period to provide some
bases of comparison of the firm's financial position from period to period. Costs related
to time periods are either period costs or product costs.
 Period Costs: Period costs refer to those items of cost which are recognized as
expenses for the period in which they are incurred and are charged against the revenue
for the period. So period costs are charged in the profit and loss account in the period
in which they are incurred because they relate to the passage of time, rather then being
associated closely with the manufacturing process. It should be remembered that
period costs are not assets, because they are not expected to provide any future
economic benefits to the organization. Examples of period costs are salaries of sales
personnel, sales representatives’ commission, administrative expenses, selling
expenses, distribution expenses, depreciation of the office equipment, and finance
expenses etc.
 Product Costs: Product costs refer to those items of cost that are included in the costs
of inventory and become expenses when the product is sold subsequently. So product
costs are those costs that are assigned to inventory because they are closely associated
with production activities rather than with the passage of time. It should be
remembered that product costs are considered assets when incurred, because they are
resources that are expected to provide future economic benefits to the organization.
Product costs associated with making or acquiring inventory are also called
“inventoriable costs”, which means the amount of inventory remains unsold that is the
portion of product cost stored. During the time period of sale the product costs are
recognized as an expense called “cost of goods sold”. For examples, the cost of direct
materials, direct labour, and manufacturing overhead consist product costs for
manufactured goods.

It is important to classify period costs and product costs with due care. As shown in the
above flow diagram, marketing and administrative costs are not product costs either in
merchandising or manufacturing companies. Merchandise company inventory
represents merchandise purchase for sale while manufacturing company inventory
consists of cost of material, labour and manufacturing overhead that are used to
manufacture product. So if the period costs and product costs are classified incorrectly,
the financial statement for the period will be inexact.

5. Classification according to the nature of functions: According to this classification

costs are classified relating to the number of functions performed by a business
enterprise. It leads to grouping of costs according to the broad division of activity i.e.
functional costs may be classified into the following types.
 Manufacturing Costs: These refer to the costs of operating the manufacturing
division of an undertaking i.e. this costs include the transformation of material into
finished products through the use of labour and factory facilities. This cost is also
termed as “production cost” or “factory cost”, which is the sum of direct material,
direct labour, and factory overhead. The portion of manufacturing costs which
represent work completed is transferred to finished goods to offer for sale while
incomplete works remain in work-in-process.
 Administrative Costs: Administrative costs refer to all costs of running the
organization as a whole. So it includes all expenditure incurred in formulating the
policy, directing the organization and controlling its operations, which is not directly
related to production, selling, distribution, research and development costs. Examples
of such costs include salaries of top management personnel, general accounting,
secretarial, cost of legal and public relation activities, general administration etc.
 Marketing Costs: Marketing costs also known as selling costs incurred at the point
where manufacturing costs end that is, when manufacturing process is completed and
the finished product is ready for sale. So the marketing costs include the cost of
selling goods or services and also the cost of distribution. This cost is often termed as
“order-getting” and “order-filling” cost. Order-getting costs also known as selling
costs include salaries, commissions, travel costs of sales representatives, and cost of
advertising and promotion. On the other hand, order filling costs also known as
distribution costs include costs of storing, handling and shipping finished products.
Taking together, marketing cost is well known as “selling and distribution cost.”
 Research and Development Costs: Research cost is the cost of researching for new
or improved products, new application of materials or new or improved methods,
processes, systems or services. Development cost is the cost of the process which
begins with the implementation of the decision to use scientific or technical
knowledge to produce a new or improved product or to employ a new or improved
method, process, system, etc., and ends with the commencement of commercial
production of that product or by that method.
6. Classification according to relation with accounting period: The concepts of capital
and revenue are of fundamental importance to the connect determination of accounting
profit for a period. In addition to the costs discussed earlier other costs relate to its
efficiency or capacity are incurred from time to time during its service life. For the
purpose of costs related to accounting period, costs are classified as either capital cost or
revenue cost.
 Capital Expenditure: Capital expenditure is the outflow of funds to acquire an asset
that will benefit the enterprise more than one accounting period. A capital expenditure
takes place when an asset or service is acquired or improvement of a fixed asset is
affected. These assets are expected to provide benefits to the business in more than
one accounting period and are not intended for resale in the ordinary course of
business. For example, the cost of Plant and Machinery in case of a manufacturing
company, Buildings, Vehicles, Patents etc.
 Revenue Expenditure: Revenue expenditure is the outflow of funds to meet the
running expenses of an enterprise and that will be of benefit for the current period
only. A revenue expenditure is incurred to carry on the normal course of business or
maintain the capital asset in good condition. Examples include raw materials used,
labour changes, electricity, stationery, rent, insurance etc
7. Classification according to the time of cost determination: Costs classified in relation
to the time of incidence include historical costs, replacement costs and budgeted costs.
 Historical Costs: Historical costs or actual costs refer to the costs actually incurred
and ascertained after they have been incurred. Historical costs were incurred in the
past and are normally used in financial accounting. These costs are objective and
verifiable in quantities for income statement and balance sheet valuations. It is a
postmortem of the costs. However, historical costs are frequently not so useful for
decision making because conditions may have changed since the costs were incurred.
 Replacement Costs: A replacement cost is an amount that a firm would currently
have to pay to replace an asset or to buy one that performs functions similar to an
asset currently held. It is the cost of replacement at current market price. So
replacement cost valuation states the costs at prices that would have to be paid
currently.
 Budgeted Costs: A budgeted cost is a planned future expenditure. A budgeted cost
could be, but is not necessarily, the same amount as the replacement cost.
8. Classification according to the nature of data: Costs classified according to the nature
of data include explicit costs and implicit costs.
 Explicit Costs: In general, costs refer only to explicit costs. In fact, historical costs
are explicit costs of the firm for which explicit payment had been made sometime in
the past or for which the firm is committed to make future payments. Examples of
such costs are wages and salaries, rent, cost of materials, depreciation, the amount
paid for a machine, and interest payments.
 Implicit Costs: Implicit costs are those which do not involve actual payment by a
firm to factors of production, but nevertheless represent costs to the firm in the sense
that in order to use certain inputs in the production process, opportunities for the firm
to use them else where have been foregone. Example, the value of the firm owners’
time is used to manage the business also component of total implicit costs.
9. Classification according to the nature of production: Fundamentally depending on the
nature of production, there are two major groups of costing methods; process costing,
and job costing. There is also a flux method combining features of both into one usually
called a batch costing method. Costs classified according to the nature of production
include separable cost, joint cost, and common cost.
 Separable Cost: A separable cost refers to any cost that can be attributed to
exclusively and wholly to a particular product, process, division or department.
 Joint Cost: In costing of joint products, difficulty arises in apportioning joint costs,
that is the cost incurred up to the spilt-off point between individual joint products. So
a joint cost is the cost of a process which results in more than one main product. So,
the costs which are a sort of common costs exist when units of different goods are
produced out of one and the same material or process.
 Common Cost: Common cost refers to those costs which are incurred collectively for
a number of cost centres and are required to be suitable apportioned for determining
the cost of individual cost centres. Common costs are costs of maintaining common
facilities.
10. Classification according to the management policies: Another dimension to the
classification of costs debate is that of management policy. Management policy on cost
behaviour is important, otherwise attempting to analyze cost behaviour could prove to
be a problem. According to the management policy, fixed costs and variable costs can
be further classified as follows:
 Committed Fixed Costs: Committed costs are the result of commitment in fixed
costs and other long-term activities. Consequently, these are mostly fixed costs.
Committed fixed costs are those which arise from creation of capacity and the size
of such costs depends upon the technology. Committed costs are sometimes known
as non-controllable costs. They become non-controllable once the commitment is
made. Examples of committed fixed costs are, depreciation and insurance, property
taxes, rent, rates, and supervisory salaries. Such costs are committed because short-
term management decisions cannot change these costs and they are incurred even
when output is zero; that is, they do not change as activity changes.
 Discretionary Variable Costs: Discretionary variable costs are those costs that
are incurred or reduced or eliminated as needs arise and they are dependent upon
management policy. Labour overtime cost is a good example. for further example;
if the management policy is to spend a specified percentage of sales revenue
achieved on research, and on advertisement, these two items of variable costs
would fit in the discretionary classification.
 Discretionary Fixed Costs: They are costs which are not the result of output but
which are at the discretion of management. The good examples of discretionary
fixed costs include advertising costs, training expenses, management consultancy
services, sales promotion costs, research expenses, charitable and political
donations. These costs are also known as programmed costs or managed costs
because these costs are caused by management policy decisions. The most
important characteristics of these costs is that it is very difficult, if not impossible,
to determine whether the services or resources acquired through these costs have
been used effectively and as a result the need and amount of such expenses are
decided afresh everytime.
 Engineered Variable Costs: As the term indicates, are the costs which have a
scientific relationship with the output level. An engineered cost is any cost that has
an explicit, specified, physical relationship with a selected measure of activity.
Such relationship is known with experience and could be established scientifically
to set the standards. The best-known examples of engineered variable costs include
direct material, direct labour, sales commissions, distribution expenses etc.
Variable costs are normally engineered.
11. Classification according to manager’s relevancy of decision making and analysis:
Although costs are accumulated for cost as curtailment and cost control, one of the
main purposes of cost accounting is to provide detailed information for managerial
decision making. In fact, the fixed-varible classification cannot deal with all cost
relationships involved in managerial decisions. So it is necessary at this stage to
discuss a wider range of cost concepts. Each classification throws light on manager’s
relevancy of decision making and analysis.
 Opportunity Cost and Outlay Cost: The term opportunity cost, used by accountants
is borrowed from economists. We know that, in managerial decision making, a cost
is not really a cost unless it requires a sacrifice of alternatives, i.e., unless it is an
opportunity cost. Opportunity cost is the cost of selecting one course of action in
terms of the opportunities which are given up to carry out that course of action; that
is, an opportunity cost is the cost of an opportunity foregone. The concept
recognizes that resources are scare and have alternative uses. For example, assume
that a manufacturer can sell his work-in-process to outside market for Tk.1,00,00.
They decide, however, to keep it and finish it. The opportunity cost of the work- in-
process is Tk.10,000 because this is the amount of economic resources foregone by
the manufacturer to complete the product. Further, if fixed deposits in the banks are
proposed to be withdrawn for financing a project, the opportunity cost would be the
loss of interest on the deposits. Since the opportunity cost represents only sacrificed
alternatives, they are never recorded as such in the financial accounts.
On the contrary, the concept of cost which normally enters into the accounts of a
business is known as outlay cost. Outlay costs refer to the actual expenditures
incurred on raw materials and other productive facilities.
 Relevant Costs and Irrelevant Costs: Any cost which is relevant in making a
decision is relevant cost. Costs or revenues are relevant when they are logically
related to a decision and vary from one decision alternative to another. Any cost
which is relevant in making a decision is relevant cost. Costs that will be incurred
as a result of a decision and thus appropriate to a specific managerial decision are
known as relevant costs. These costs are relevant for future decision making. On
the contrary, costs which are not affected by a decision are irrelevant costs, that is
costs that have already been incurred irrespective of what is being done by the
enterprise at present are irrelevant costs
 Incremental Cost and Differential Cost: For most practical decision problems,
the two terms incremental cost and differential cost are used synonymously. When
the cost of an option is shown as additional to that under another option it is called
an incremental cost. On the otherhand, differential cost is the difference in the total
cost of two options compared. The option may involve change in production,
introduction of new machinery on new product, marketing on any other business
activity. It is noteworthy here that, although technically an incremental cost should
refer only to an increase in cost from one alternative to another; decrease in cost
should be refereed to as decrement cost. Differential cost is a broader term,
encompassing both cost increases (incremental costs) and cost decreases
(decremental costs) between alternatives
 Sunk Cost: A sunk cost is a cost that has already been incurred at the time that a
decision is being considered and is therefore not of importance for the new decision
under consideration. So sunk costs are costs that have been incurred in the past and
consequently they do not affect future costs and cannot be changed by any current
or future action. Such costs are irrelevant in a decision-making situation because
there is nothing that can be done to undo the decision to invest in them.
 Out of Pocket Costs and Book Costs: Out-of-pocket costs refer to costs that
involve current payments to outsiders as opposed to book cost, such as
depreciation, that do not require current cost expenditures. The payments for
management in deciding whether or not a particular project will at least return the
expenditures associated with the project reelected by management. Out of pocket
costs could also be like sunk cost and irrelevant if the firm is not in a position to
save them, otherwise these costs are relevant costs.

Book costs can be converted into out-of-pocket costs by selling assets and leasing
them back from the buyer. For example, A firm can sell own factory building but
can continue to use it by paying rent to the new owner. The rental payment then
replaces the depreciation charge and interest cost of owned capital.

 Past Costs and Future Costs: Most of the important managerial decisions using
cost information requires forecast of future costs, rather than actual costs, i.e.,
unadjusted records of past costs. Actual costs incurred in the past and recorded in
the books of account are known as past costs. On the contrary future costs are those
that are likely to be incurred in a future period. They are not recorded in the books
of account, and hence, have to be estimated. Since managerial decisions are
forward looking, it centres round future costs and not past costs for expenditure
control, projection of future income statements, capital investment decisions,
pricing etc.
 Controllable Costs and Uncontrollable Costs: The controllability of a particular
cost depends upon the level of management, that is, it is related to a special centre
of managerial responsibility. Controllable costs are those which can be influenced
by the decisions and actions of a specified member of an undertaking and
uncontrollable costs are those which cannot be influenced by a specified member of
an undertaking. The distinction is not absolute because many costs are not
completely under the control of one individual. In classifying costs as controllable
or uncontrollable, managerial accountants generally focus on a manager’s ability to
influence costs. Examples of controllable costs are indirect labour, lubricants,
power costs while depreciation, rent, and property tax are uncontrollable costs.
The time period factor and the decision making authority can make a cost
centrollable or uncontrollable. If the time period is long enough, all costs can be
controllable. Similarly, whether a cost is controllable or not should be decided by
the decision-making authority.
 Escapable Costs and Inescapable Costs: Whether certain costs are escapable or
inescapable varies according to the decision. Escapable costs refer to these costs
that may not only be postponed but may also be avoided entirely as a result of
contraction of business activity. For example; A portion of depreciation which
varies with the use of a machine can be avoided by reducing output. Therefore, the
part that continues regardless of output is escapable only if the machine or building
is sold and if, of course, there is a ready market for the asset.
 Shut-down Costs and Abandonment Costs: Shutdown costs are those costs
which have to be incurred under all situations in the case of stopping manufacture
of a product or closing down a department or a division. Shut down costs are
always fixed costs. For example, in case of a manufacturing company, if a product
manufacturing is stopped, then a part of fixed costs associated with the product like
rent, watchman’s salary, property taxes will be incurred. Such fixed costs are
unavoidable.
On the otherhand, abandonment costs are those that result from a permanent
cessation of business activities. In other words, when a fixed asset is retired from
service and is to be disposed of, the costs connected with disposal an known as
abandonment costs.