Classification and Behavior of Costs

Classification and Behavior of Costs
Cost is the economic value, measured in currency, of resources given in exchange for services or other items
representing potential economic benefits. Examples of these services include those of employees,
contractors, and utilities. Examples of items representing potential economic benefits include raw materials
and machinery used in making products, warehouses used to store materials and finished products, and trucks
used to deliver finished products to customers. Managers commonly refer to the cost of products or services
sold to customers. This reference to the cost of products or services is actually shorthand for the costs of
those activities performed in making and delivering products and services to customers, as examined further,
below.
As examined further below, accountants classify costs in several ways. In a manufacturing business, one cost
classification scheme is manufacturing costs and nonmanufacturing costs.
 Manufacturing costs include the costs of materials and labor and other activities used in making products.
 Nonmanufacturing costs include all other such costs, such as the costs of administrative, selling and
distribution, and research-and-development (R&D) activities.
Components of Product Costs
In order to determine the cost of products they manufacture, businesses must track and assign to those
products the costs of direct materials and direct labor used in producing them.
 Direct materials are materials used directly in producing goods. Examples of direct materials are metals,
plastics and resins, chemicals, coatings, colorants, electronic subassemblies, and computer
semiconductors.
 Direct labor refers to the services of production employees directly involved in producing goods.
Examples of direct labor activities are cutting, machining, assembly, and finishing.5
Costs not comprising direct materials or direct labor are indirect costs. Accountants classify indirect costs as
non-manufacturing overhead costs and manufacturing overhead (MOH) costs. In addition to direct
materials and direct labor, the cost of a business’ products includes allocations of MOH costs.
6 MOH costs
include the costs of a manufacturing plant and a variety of supporting services, examined below.

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